The culture of an organization is the sum of its values, aspirations and expectations. These include what the organization’s members perceive they are trying to achieve collectively and the accepted means by which this will be done. All these clearly affect the bottom line. But how does this occur?
This has been a difficult question to answer. Explanations of culture normally center on psychological and sociological rather than financial or strictly business factors. As such, they stress the importance of social and communal agreement and harmony. As business value has started to influence HR thinking and approaches, so have explanations based on human capital management (HCM) factors. These center on the importance of talent and creativity and their eventual — presumed positive — impacts on the bottom line.
In the HCM approach, people are assets, just as they might be on a balance sheet. But how is the value of this asset actually measured? What is the linkage between the value of these assets and the eventual impact on the financial value of the organization?
These questions remain largely unanswered. Current approaches, including HCM, lack a precise explanation of the mechanisms that lead from attracting and leveraging human talent to overall profitability metrics.
The issue of culture’s impact on the bottom line is not an academic one. Depending on what the impact really is, different approaches to organizational development and HR programs will be indicated. These can direct this area into new trajectories, some of which might be very different from those in use now.
Enter the Idea of Financial Culture
The culture of an organization also is driven by the financial values and approaches of its leaders and managers. These are not just an issue of product and market but also of the financial styles of these participants.
All individuals have a set of innate financial behaviors that drive their financial decisions. Particular organizations and their cultures are distinguished by the types of financial styles they prefer. Organizations tend to hire and promote individuals who have a financial style and mission that reflects that of the organization and to favor them over those who do not possess this financial style. These decisions are institutionalized in hiring and development systems, so they tend to perpetuate themselves. This, in turn, leads to a distinct financial culture.
Financial styles can be identified and categorized. Each type has a characteristic impact on the organization’s financial performance, distinctly and predictably influencing the profitability and financial value of the organization.
A financial style is, in large part, innate. People might pursue a financial mission in practice that differs from their innate financial style, but their behavioral tendency constantly will be to revert.
For many people, the financial style and financial mission will be the same. For some, there will be a difference, either because they have become aware of it, or because they have absorbed the financial mission of the organization.
By identifying and understanding the linkage between financial style and financial outcome, you can predict the likely growth and profitability of an organization. By focusing on developing the right kind of financial missions in an organization’s members and leaders, it is possible to improve its financial performance and steer its financial culture in a direction that is consistent with its financial value objectives.
Collective Propensity to Create Capital
A financial style reflects the conjunction of two behavioral traits. The first is the propensity to add value, in a commercial sense, to a product or service. The second is the propensity to use resources more or less intensively.
If the value-adding behavior is stronger than the intensity of resource utilization (i.e. the value-adding more than compensates for the resources consumed in achieving that level of value), an individual will tend to create more capital. If the reverse is the case, the individual will tend to create less.
If all individuals in an organization have a strong tendency to create capital, the financial culture of the organization will reflect itself in high growth and profitability, all other things being equal. If the reverse holds, then the financial culture will tend to lead to lower growth and profitability.
Thus, dominant financial styles can lead to more or less growth and profitability, depending on what they are. This is reflected in and perpetuated by the organization in its HR management systems, whether they are formal or otherwise. The combined impact of these styles is reflected in a dominant financial culture, which will directly drive the financial results of the organization.
Financial Culture and Income
The behavioral propensity to add commercial value is reflected in the gross margin for products and services. The precise metric is the gross margin expressed as a percentage of revenues relative to competitors. If the dominant value-added propensity of an organization is high relative to competitors (say, a gross margin of 90 percent for a software company), the dominant financial styles will comprise mainly leaders and managers who have a breakthrough value-added propensity relative to the leaders and managers at competing organizations.
Similarly, with the resource-utilization propensity, you can use the organization’s metric of level of expenses expressed as a percentage of revenues relative to competitors. If the general resource-utilization style of the leaders and managers of this company is to use minimal resources relative to its competitors, then the dominant financial style will be one of frugality.
In this particular case, the financial style would comprise breakthrough value and frugal resource utilization relative to competitors, and the organization would have rapid growth and high profitability relative to its competitors. Over the longer term (i.e. enough time for the impact of these leaders and managers to have an effect), the income statement of this organization would show high gross margins and low expenses relative to its competitors, thus high profitability for its industry and market.
Now, the interesting part. The income statement is, in effect, reflecting the financial styles of the leaders and managers. It is reflecting the financial culture in a measurable way. It is showing us, at least in part, how the organization’s financial culture has affected the bottom line in measurable, financial terms. You just have to know what to look for and how to interpret it.
Implication of Financial Style
What happens if an individual manager has a financial style that significantly differs from the organization’s? The manager is not in financial alignment, and his or her financial decisions will not be consistent with those of the financial culture.
If the financial culture reflects a realistic and achievable valuation goal (which is sometimes far from being the case), this individual’s financial decisions will be at least somewhat in variance with those of the culture and its valuation objectives. In such a case, there will be a significant development requirement for this person.
Bringing about alignment between the financial missions of the organization’s employees and its valuation objectives should be a primary objective. The better the alignment between individual financial missions and financial culture, the better the financial performance of the organization, and the more this will be reflected in its competitive financial performance as outlined in the income statement.
Organizational development programs can affect this in many ways, including executive development and succession planning, individual development and team collaboration, by moving from a psychosocial basis toward a financial focus. Their aim also must be to align the financial missions of individuals with the financial culture of the organization.
By doing so, the organization can improve its financial performance and its competitive positioning. It can measure the impact of these programs by comparing income statement metrics over time with those of its competitors.
Business Strategy and Financial Culture
Financial culture affects all areas of an organization. One of the key areas is strategy. Many corporate strategies are unsuccessful because they do not take into account the financial culture of the organization.
Nowhere is this clearer than in failed mergers and acquisitions (M&A) initiatives. Although the failure often is attributed to incompatible cultures, it might be more accurate to say it is due to incompatible financial cultures.
For example, take a company that has a focus on preserving current value and an intensive resource-use style. If it acquires a company with a breakthrough style and moderate to minimal resource use, it will be difficult for executives of the two organizations to ever agree on development and investment initiatives.
This often happens when a larger company in a mature industry acquires a smaller company with innovative products and a more frugal style. In such cases, the senior executives of the acquired company who made it all happen drift away from the smaller entity, and it loses its value over time. As a result, the acquisition might fail or never achieve its true potential.
Financial culture has a major impact on financial outcome, not just in M&A but also in other strategic areas, including market repositioning initiatives, new products and services, joint ventures, etc.
If the execution imperatives of the financial culture are not recognized and acted on, strategic initiatives likely will have a negative impact on the bottom line — no strategy can be effective unless human assets are aligned financially and in sufficient numbers to be able to execute it.
The Way Forward
Moving forward, HR needs to recognize the issue of culture is broader than that which is conventionally accepted. Leaders of organizational and workforce development programs need to formally integrate financial factors and the issues of financial style into the design and structure of their offerings. In addition, the business side needs to be introduced to this linkage and shown its implications if it hopes to improve its long-term financial performance and achieve a financial culture that is more aligned with financial value goals.
The concepts of financial culture and financial style introduce a common language that facilitates dialogue among all the stakeholders and contributes to improving the return on human capital for the entire organization.
E. Ted Prince, Ph.D., is the author of “The Three Financial Styles of Very Successful Leaders.” He is founder and CEO of the Perth Leadership Institute and a visiting lecturer in the Warrington College of Business Administration at the University of Florida. He can be reached at firstname.lastname@example.org.