CULTURAL DUE DILIGENCE
By
J. Robert Carleton
Senior Partner
Cultural Due Diligence
Mergers, acquisitions and alliances are once again booming. As always, these activities require considerable thought, planning and careful due diligence. There are, however, some changes coming in the definition of “thorough” due diligence. This change in definition is necessitated by new knowledge about organizational effectiveness combined with the poor success record of mergers and alliances. Additionally, the need for this change will probably be underscored by stockholder lawsuits waiting to happen.
Two things drive this change: the impact of corporate culture on organizational performance and the growing recognition that “culture clash” is a real and present danger in corporate America. In their 1992 book, Corporate Culture and Performance, John Kotter and James Heskett report phenomenal differences in long term results of companies that appropriately managed their cultures. By phenomenal, I mean revenue increases of 682% vs. 166%, stock price increases of 901% vs. 74%, and net income increases of 756% vs. 1%. These figures clearly indicate that corporate culture is about profit and business success.
However, when corporate cultures are not compatible, organizations typically confront “culture clash” – a term that has begun appearing regularly in the business press and professional journals. Culture clash is what happens when two groups have different beliefs about how best to make decisions, how to manage/supervise, organize, pass on information, decide what to measure, what is really important, and so on. Culture clash can lead to debates, arguments and differing assumptions regarding the internal process of pursuing a business plan.
In mergers, acquisitions and alliances great amounts of effort, time and money are spent analyzing physical resources, markets and the logic of potential mergers. Unfortunately, little to no time is generally spent analyzing the nature, demeanor and beliefs of the people who will be involved in carrying out the business plan.
Mergers, acquisitions and alliances have been—and will continue to be—major avenues to organizational growth and increased competitive advantage. Yet, in spite of the great initial promise of many of these business mergers and alliances, very few seem to actually yield the anticipated results. Numerous studies indicate that between 55% and 77% fail in their intended purpose.
In a 1995 Business Week article referencing a number of these studies, the editors questioned the viability of the entire merger and acquisition process. That’s because none of these studies gave a ringing endorsement to the actual results overall. In fact, Business Week’s own analysis revealed that stock prices of acquiring companies fell an average of 4%. In their article reviewing 30 years of merger acquisition activity, they concluded that a negative correlation exists between merger activity and increased profitability. Research on this high failure rate seems to indicate that more than half of the problem is due to culture clash.
The British Institute of Management, in 1996, conducted a management survey of executives involved in a number of acquisitions and came to the conclusion that “the major factor in failure was the underestimation of difficulties of merging two cultures.”
In another study of 100 companies with failed or troubled mergers done by Coopers & Lybrand in 1992, 85% of the executives said that differences in management style and practices are the major problem.
So, just what is corporate culture? The most thorough definition I know was written by Edgar Schein in his 1985 book on the subject;
“A pattern of basic assumptions — invented, discovered or developed by a given group as it learns to cope with its problems of external adaption and internal integration — that has worked well enough to be considered valid, and therefore to be taught to new members as the correct way to perceive, think and feel in relation to those problems.”
Unfortunately, many executives seem to misunderstand the creation and management of corporate cultures. The best example being the CEO who had read Kotter’s book and told me he wanted to improve corporate performance by putting in a good culture. He went on to say his company “did not yet have a culture” as he and his managers had not developed one. A classic misunderstanding of corporate culture and how it is formed.
Organizational culture exists, whether planned or unplanned. In the case of the unplanned, many cultures often are at play. This is particularly true of companies with multiple geographical locations.
Regardless of how the corporate culture was developed, it will have an impact on how people treat and react to each other, the business and the organizational environment. It affects the way people feel about the company and the work they do. It relates to how they will interpret and perceive the actions taken by others. It influences the expectations of people around changes and how they will view those changes. In short, it affects the overall operation of the human side of the business.
Or, as Warner Burke and George Litwin said in a 1989 article, “Organizational culture is the way we do things around here.”
Understanding corporate culture is critical to the ability of any organization to apply and make its business strategy come alive. Yet, this critical business component clearly is getting a short shrift in the acquisition and alliance process. And that can be dangerous. The fiduciary responsibility of officers and directors of publicly traded companies requires that they perform appropriate “due diligence” when making major decisions that can have an impact on the overall value or worth of the company. To fail to engage in due diligence is committing negligence.
Obviously, due diligence is a very important concept in corporate law, and one that is not casually overlooked. Yet, that is exactly what is occurring in the critical area of corporate cultures.
The Ernst & Young Management Guide to Mergers and Acquisitions provides the following guidelines as to the function of due diligence. “The due diligence period is a time of intensive searching for facts, thorough analysis, and constant reevaluation. A number of questions need to be asked and answered. Does the company really fit? Is it really as attractive as it appeared to be? Can we manage the company successfully and achieve the benefits we identified? Will the company’s managers support our objectives?”
The last two questions are particularly relevant. How can one answer these questions without considerable knowledge of the manner and nature of the management group, and not just the views or impressions of the senior team or teams? If the business plan is to be truly implemented, it will be the middle management group and front line supervision where the real task of “working together” occurs.
In larger organizations, a rather large gap often exists between the views, opinions and operating styles of the senior team and the rest of the organizations management and supervisory personnel.
Unfortunately, all too often the answer to the support question is limited to input from the companies’ executive groups. It is interesting to note that in financial and legal due diligence no such “act of faith” is acceptable. In other areas of due diligence, to avoid being negligent you have to investigate the issues directly, not just assume that what you were told is correct.
Unless culture clash is avoided entirely, or dealt with effectively, more time, energy, and resources will often be spent on internal issues than on achieving the company’s business plan and responding to competitive threats and customer needs. And this can result in substantial financial losses.
One of the most notable culture clash related failures was the ill-fated acquisition of Word Perfect Corporation by Novell. Novell was well established in software products and in heavy competition with Microsoft, but had no viable word processing software. Word Perfect at that time had a little over half of the market for word processing software. If Novell wanted to give Microsoft a run for its money in software dominance, this seemed like a match made in heaven. However, it didn’t turn out that way. When Novell eventually sold WordPerfect, it was for approximately $1 billion less than what they had originally paid. Additionally, WordPerfect had lost its number one position as provider of word processing software to Microsoft Word.
The business press was very clear in characterizing this catastrophe as a case of culture clash—everything else about the deal made eminent sense, yet it failed to work. The managers of the two corporations could not get along. As a result, the potential synergies were never realized. The focus became internal at a time when all parties needed to be very focused on the market and the moves of Microsoft. While sidetracked with internal arguments and discord, WordPerfect lost its number one position and Novel slipped in other areas as well.
The fact that WordPerfect, a year after being acquired from Novell by Corel, is again the number one seller for word processing software underscores the “culture clash” reason for the failure.
Organizational culture is critical to organizational effectiveness. Managing the culture is vital to successful business implementation. This is particularly important in times of large-scale change, such as an acquisition or alliance. Fiduciary responsibility and due diligence require careful examination of the cultural aspects of any acquisition as a major component of the ability to actually run the operation and achieve the potential synergies. What is needed is a rigorous Cultural Due Diligence audit.
So, what is involved in performing a Cultural Due Diligence audit?
To answer this question, we examined our own substantial experience in the field with both domestic and international clients. Over the last 15 years we have had projects to align, modify and/or create entirely new corporate cultures. We also have been asked to fix culture clashes when things were falling apart after an acquisition.
In answering this question, we also reviewed more than 300 books and articles — including masters and doctoral thesis through 1995 — on the subject. We paid particular attention to some 22 models of corporate culture where the authors had made attempts to measure or quantify the culture. Our next step was to condense our experience and that of others into a set of organizational culture domains (we ended up with 12). Finally, we had to modify our Organizational System Scan model to assure that it contained appropriate questions, tools and methods to gather data on all of the viable/relevant aspects of corporate culture as we had now identified them.
When performing Cultural Due Diligence it is necessary to gather operational and behavioral data on these 12 domains in both organizations — the one acquiring and the one acquired. Once data is collected from both organizations, you can contrast and compare, looking for potential areas of conflict and/or misunderstanding.
Following is a brief description of each of the 12 domains. These descriptions provide a general sense of each area and are not meant to be definitive.
1. Intended Direction/Results – Ascertain, from the top of the organization on down what the company intends to accomplish. What is the business plan about, what is the intent and purpose of the organization, what results are expected from the business activity of the organization, and, most importantly, how are these things talked about, described and communicated?
This one area alone can yield very telling data about the “way things are done.” For example, most of the airline industry is very overt about the importance of customer service and satisfying customer needs. At the boardroom level, and generally at the senior executive level, this is clearly understood as an issue of competitive position and repeat business. Yet, when you talk to the people on the plane, at check-in, in the airline club, the definition of customer service and customer satisfaction can take on some interesting nuances. For example, on one major carrier the cabin crew will first note that their “real job” is safety with the “service” aspects a clear second, in fact when the “service” part of the flight commences passengers are usually asked to stay in their seats and not get in the way. On the other carrier passengers are immediately encouraged to make their wishes known as “the crew is here to make your flight as pleasant and comfortable as possible.” When asked about airline efforts to improve customer satisfaction the former carrier’s staff talk about the money being spent on upgrading meals, decor of the aircraft, enlarged lounges and other physical aspects the airline is providing, the latter carrier’s staff talk about the passenger “experience” and their part in assuring the customer is “satisfied enough to choose us again next time,” with a clear emphasis on the interpersonal service provided. One set of staff focuses on equipment and the other on attitude as the key components in customer satisfaction. Both valid, both very different.
Two quotes from airline club staff neatly sum up yet another difference in approach. Club number one — “customer service and satisfaction are really important, customers can easily go to someone else for their next flight, but we have to control their demands or we could never get our jobs done.” Club number 2 — “customers pay our salaries, our job is to make sure you choose us again next time rather than trying someone else, our other duties come second.” For one company service and satisfaction was something you tried to achieve in addition to your job, and for the other it was the job, after which you had additional duties to perform.
You can make a great case for either approach. But just imagine the differing views and arguments which could ensue down through the ranks if these two carriers merged, even though both clearly value customer satisfaction and service as key elements of their business plan.
2. Key Measures – What the company measures, why, and what happens as a result. The key measures say a lot about the manner in which the company and its executives and staff are driven, particularly when you also consider the consequences for each measure.
When a retail client asked us to investigate why their initiative to enhance customer service and employee retention was not providing any results, a big part of the answer was in this domain. When the store managers’ supervisors reviewed results with the store managers, only inventory control, paperwork, and dollar volume received real focus. These areas were not only measured, but had consequences to both parties for success or failure. There was only a “nice job” comment for service and retention improvement. Since all parties had their hands very full, if not overloaded, with the “standard key measures,” there was no time for the “add-on” stuff. Especially in the current times of lean staff most people, particularly in management/supervisory positions, are extremely busy. The focus will always be on what they perceive as truly important. The measure of truly important will always be around the perceived consequences of failure, so don’t just look at what is measured; also look at the consequences for each measure.
3. Key Business Drivers—What are the primary issues driving the business strategy? Is the focus on competitive edge and, if so, how is that defined – price differentiation, quality, market share, service, reliability or what? This tells you how the company views its industry and its subsequent efforts within the industry. If one company defines success in terms of total market share while another defines it as net profit margin, there is considerable room for disagreement around things like what actions are appropriate to correct “unacceptable” results, or deciding on appropriate new product offerings.
4. Infrastructure – How is the company organized, what is the nature of the reporting relationships, how do the staff systems interface with the line systems? What is the nature of the relationship between groups and units in the organization?
For example, are people expected to “go directly to whomever you need to talk to” or must proprieties be observed between different levels or functions. Are business units supposed to drive their business priorities first and foremost and respond to corporate, staff, or other unit issues when appropriate or are they supposed to assure that they are responsive to corporate needs and check with other units to assure there are no conflicts or unexpected impacts?
5. Organizational Practices – What formal and informal systems are in place and what part do they play in the daily life of doing the work? How much flexibility is allowed at what levels in which systems? What is the relationship between political reality and business reality?
For example, how are budgets developed and managed? When Westinghouse bought CBS considerable disagreement occurred over what was and was not “reasonable” expenses, particularly when it came to entertainment budgets. These disagreements resulted in considerable upheaval.
Besides formal systems such as budgeting, this area includes how staff groups such as Legal, Human Resources, Public Relations, Purchasing, General Services and such are accessed/utilized by line units and each other. It is not unusual for us to find that some particular person or function is considered sacrosanct, regardless of the impact the person or function may be having on important business issues. “You don’t dare question the people in legal,” or finance or information management or some other (usually staff) function. These are people or functions that are considered above the routine issues of getting the business of the company accomplished. In common parlance these “unique” areas or people are generally referred to as “political” issues of power that are separate from, or above, the overall corporate purpose.
6. Leadership/Management Practices – What is the balance between Leadership and Management approaches with staff? What basic value systems about employees are in place? How are people treated and why? How does the business plan get implemented through the management system? How are decisions made? Who is involved in what, and when?
There are clear behavioral differences between management and leadership functions and both are clearly important in running a successful business. The issue is around which approach is predominant in each area/department of each company. This domain relates primarily to the middle management group but has obvious impact on the next area.
7. Supervisory Practices – What dynamics are at play in the immediate oversight of the performance of work? Supervisory practices have a major impact on employees’ feelings about the company and the work they do. The nature of the interaction between the employee and the immediate supervisor is one of the primary tone-setters for the culture of the company.
For example, at one company supervisors were expected to be gruff and aggressive with important issues, speaking softly meant the topic could safely be ignored when not convenient. The same behaviors in another company could properly be considered rude and abusive.
8. Work Practices – How is the actual work performed? Is the emphasis on individual responsibility or group responsibility? What degree of control, if any, does the individual worker have on the workflow, quality, rate, tools utilized and supplies needed?
A classic example here is in manufacturing, where two companies are making the same products but one allows any worker to “stop the line” at any time he or she deems it necessary. This company views the individual worker as in the best position to recognize a defective product. The other company does not allow unauthorized line stoppages. Instead, it decided that only the manager, who has the knowledge of overall production needs, can assess whether a stoppage is worth the lost production. These are obviously two very different, yet potentially appropriate, ways of viewing the same issue.
9. Technology Utilization – Both in relation to internal systems and equipment, as well as the services and products provided to customers. How current is the technology being utilized? What are people used to in relation to technological support/resources?
For example, conflicts and confusion may occur if a company that is firmly grounded in computer e-mail procedures merges with a company where individual computers are not generally available. Discussions of high-tech versus low-tech approaches to many aspects of running a business can quickly descend into accusations of “Luddites” opposing “techno-nerds” when the parties have differing experience and comfort with any given technology.
10. Physical Environment – How do the workplace settings differ? Open workspaces versus private offices, high security versus open access, buildings, furniture, grounds — all can have a bearing on how people feel about work and the company. Changes in these areas, particularly if it’s perceived as arbitrary, can result in bad feelings for years.
For example, we have two clients with contradictory approaches, both based on valuing people and increasing productivity. Company one says “we value people and know that an open office increases interactions and camaraderie making for happier and more productive workers.” Company two says “we value people and private work spaces aid in the thought processes, enabling greater focus and increased productivity.”
11. Perceptions/Expectations – How do people expect things to happen? What do they think is important? What do they think should be important, versus what they believe the company feels is important?
In resolving a union/management schism in a plant in jeopardy of being closed, we had to deal first with the conviction in union ranks that management was a revolving door occupied by short timers who didn’t care about the plant or the community. This was matched by management’s equally strong belief that the employees and unions didn’t care about the products, the competition or the plant’s profitability. Both statements were blatantly untrue, yet both parties were so sure of their perceptions that they never discussed them with the other party. Yet, these strongly held beliefs (perceptions) were at the core of their inability to work together.
12. Cultural Indicators/Artifacts – How do people dress and address each other? What is the match between formal work hours and actual hours spent working? What company-sponsored activities exist and what are they like?
“Company picnics and social clubs are a major tools in pulling people together and building a family atmosphere” versus “Company picnics and social clubs impose on employees personal and family time generating friction and resentment.” Once again, these are real statements from two different companies in the same business and similar social/geographical settings.
These 12 domains cover the relevant issues of corporate culture. However, at least two areas commonly mentioned in discussions of corporate culture may appear to be overlooked — values and beliefs, and myths, legends and heroes. In actuality, these issues are imbedded in the 12 domains. By digging into each domain, underlying values and beliefs are uncovered. This is far more effective than simply asking, “What are the values and beliefs around here?” That type inquiry generally results in puzzled looks.
The same is true of myths, legends and heroes. These are simply the “story” or anecdotal versions that give more direct and immediate meaning to the belief systems operating in the company. Myths, legends and heroes will present themselves as you delve into the twelve domains, but only if you use qualitative data gathering techniques.
In gathering corporate cultural data, our experience has been that the most useful information comes from qualitative processes – primarily interviews and focus groups. Data gathered in this manner is rich in anecdotes and examples of how the culture is acted out and talked about. These stories give personal meaning to the culture and provide examples and demonstrations that are easy for people in the target culture to relate with.
It is these anecdotes and stories that enable those doing culture modification to engage in dialogue about work issues in a direct manner. A rich trove of stories and examples, derived directly from the target culture(s), makes these discussions and their relevance to the business plan and individual behavior a relatively simple task.
Generic, off-the-shelf, culture instruments are certainly appealing given their relative ease of use and low cost. Yet they are inherently more difficult to apply when an organization is undergoing culture change. To use these instruments, the change agents have to interpret the data for the people and translate its relevance to the current activity. These instruments generate no ready anecdotes and examples from the “real world” situation to help in the understanding of what has to change and why. Without a rich trove of qualitative data, modifying corporate culture or cultures is far more problematic.
In my own experience designing and implementing culture change/modification projects I have always found the data from generic off-the-shelf instruments interesting and usually accurate. But, it has never been essential, or even really helpful, to the change process. On the other hand, without good and deep qualitative data the change process becomes much more troublesome, from design through implementation.
Once you have your data it’s time to do something with the information. Throughout the 12 domains, I have provided examples of very different approaches to each area. In all of the examples there was no “right” or “wrong” way, just different, and potentially equally valid ways of dealing with the same phenomena. This is the stuff from which “culture clash” can arise. However, it is also worth saying that in our experience the probability of having two cultures that cannot be effectively merged is highly unlikely. Most of these disagreements can be, and often have been, successfully handled. The issue in cultural due diligence is to have a plan and manage to that plan, just as companies do with divergent financial systems or information systems.
This leads us to the world of culture change and/or merging cultures, which are different topics altogether from this one, though obviously linked. For those of you interested in pursuing this subject, the simplest reference I can recommend is chapter 14, Culture Change, from the Handbook of Human Performance Technology (1992, Jossey-Bass) by Claude Lineberry and J. Robert Carleton. Additionally, Vector Group has a paper, “Merging Cultures” that gives a similar treatment to the unique aspects of merging two or more organizational cultures. Both the chapter and paper are available from Vector Group.
Regardless of what models you choose to use or the methodology employed, Cultural Due Diligence is coming, and soon. The impact on organizational effectiveness is very clear. The failure rates of mergers and alliances are too high. Stockholder suits for negligence in not dealing with this area are only a matter of time. Besides, given what we know now about the cause of merger and alliance failures, the effects of corporate culture, and the expense of culture clash, Cultural Due Diligence is simply a matter of good business management.
Selected Bibliography
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