The Culture Effect

When America Online, an upstart Internet company, merged with Time Warner, a traditional media company, to form AOL Time Warner earlier this year, shareholders and employees at both companies wondered how the two cultures would blend. After all, many of Netscape Communication's star performers had left the company since its acquisition by AOL in 1998. And Time Inc.'s merger with Warner Communications in 1989 had more than a few bumps in the road.

Indeed, there is good reason for concern. During periods of rampant mergers and acquisitions, a critical eye is given to a company's corporate culture. According to recent research by Ronald S. Burt, a professor of sociology and strategy at the University of Chicago Graduate School of Business, a strong corporate culture can positively affect a firm's economic performance. But there is no guarantee that a strong culture assures high performance.

Corporate culture is defined by a shared set of beliefs, myths and practices. As in any other social system, this shared culture binds people together. Burt's research begins with corporate culture, but specific beliefs and how they are formed do not concern him. Instead, it is the strength of a firm's corporate culture within a particular industry that is the focus of his study, "Competition, Contingency and the External Structure of Markets," co-authored by Miguel Guilarte of the Fielding Institute, Santa Barbara, Calif., Holly Raider of the European Institute of Business Administration (INSEAD), Fontainbleau, France, and Yuki Yasuda of Rikkyo University, Tokyo, Japan.

Examining Culture

Consider a hypothetical case of two consultants designing research on the performance effects of a strong corporate culture. One selects 10 beverage firms for in-depth case analysis because the consultant worked in the industry and has good personal contacts there. The other consultant selects 10 apparel firms. According to Burt, there is no need to do the research. The first consultant has selected a market where competition is low. A strong corporate culture offers no competitive advantage. The consultant will find no evidence of higher performance in strong-culture firms and thus conclude that there is no culture effect. His advice to client firms will be to avoid wasting resources on institutionalizing a strong corporate culture.

The second consultant has selected markets at the other end of the competition spectrum. Competition is high for apparel firms and a strong corporate culture is a competitive advantage. The consultant will find proof of higher performance in strong-culture apparel firms and conclude that performance is dependent on a strong corporate culture. Later, this consultant will advise client firms to concentrate on institutionalizing a strong corporate culture.

So when considering a merger with another firm, Burt recommends that as a first step, investigate the firm's corporate culture. Ask the following questions:

• To what extent have managers in competing companies commonly spoken of the firm's style or way of doing things?
• To what extent has the firm made its values known through a mission statement and made a serious attempt to encourage managers to follow them?
• To what extent has the firm been managed according to longstanding policies and practices other than those of the incumbent CEO?

Next, examine the industry's market structure. A strong corporate culture can be a powerful competitive asset in a market that resembles a commodity. The raw products of mining or agriculture, such as coal and corn, are commonly referred to as commodity goods. On the one hand, if the industry's market is like a commodity and the company already has a strong corporate culture, take care because the company's performance is in some part due to its culture. On the other hand, if the company operates in a complex, dynamic market, it can be freely integrated because culture is irrelevant to performance in such markets.

The Value of Culture

Effective competition is in some part due to explicit factors, observable from market concentration, and in some part implicit, seen only in the ability of producers to obtain higher-than-expected profit margins based on the observed market structure. To the extent that producers show lower-than-expected margins from the network of their transactions with suppliers and customers, effective competition is low. Only when there is effective market competition does the impact of a strong corporate culture on a company's performance increase.

"The value of culture is contingent on the market," says Burt. "Market competition is derived from the network effect on profit margins of buying and selling between suppliers and customers-the effective level of competition in an industry."

For example, the largest real estate firms account for only a small proportion of all U.S. real estate transactions. Market concentration is close to zero. To obtain high profits observed in real estate, producers must be coordinated in ways not apparent from concentration. In fact, real estate markets are locally organized by interpersonal referrals and dominant local brokerages, with city and state regulations playing an important role in who gets to sell what.

Business services are another example. This market is a hodge-podge of services, 21 percent advertising, 13 percent architects and engineers, 12 percent lawyers and 9 percent management consulting. Local and internal suppliers (staff lawyers, engineers, managers) provide the majority of these services to firms. Personal ties with clients are critical to success, and such ties are invisible.

A Matter of Costs

The strength of an organization's culture can and does affect a company's bottom line. A strong corporate culture stabilizes performance. When a company's stock varies with the market on a daily basis, increasing as the market increases and decreasing as the market decreases, then performance is stable. Setting aside textiles and the communications industry, Burt's research shows that performance is more erratic for strong-culture firms in industries like pharmaceuticals, retail and personal care, where market competition is less intense. Accordingly, performance is more stable for strong-culture firms in highly competitive markets like motor vehicles, airlines, textiles and apparel.

A strong corporate culture also reduces costs, says Burt. The firm's goals and practices are clearer, which lessens the chances of an employee taking inappropriate action due to conflicting accounts of the firm's objectives. As a result, costs of monitoring employees are reduced. The shared beliefs that define a corporate culture function as an informal control mechanism that coordinates employee effort.Employees who deviate from accepted practice can be easily detected and admonished faster and less visibly by friends than by the boss.

Employees also work harder and for longer hours in an organization with a strong corporate culture. Contributing factors include social pressure from peers and the attraction of pursuing a transcendental goal that exists beyond the day-to-day demands of a job. Furthermore, a strong corporate culture tends to drive out those who do not feel comfortable with the corporate culture, leaving a stronger and more unified group.

In addition, when corporate culture is socially constructed by employees rather than imposed through formal lines of authority, employee motivation and morale increase. Employees develop a sense of ownership and establish a stake in the firm's health and performance. Whatever the magnitude of economic enhancement, Burt calls it the "culture effect."

The value of a strong culture varies inversely with the level of competition in the external environment. A strong culture is most valuable in intensely competitive environments. The contingent value of culture can be a guide to thinking strategically.