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Research Note - Proving the Link


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The latest update to this Research Note continues to highlight the link between culture and financial performance. Including scores from as recent as 2010, this update sustains previous findings that stronger, more effective, cultures tend to do better than the comparison group on three financial measures: return on assets, sales growth, and market-to-book ratio. Tracking financial trends over time, the patterns between the higher and lower scoring organizations persist.

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Research Note - Proving the Link

  1. 1. Volume 7, Issue 2, 2012 Update* researchnotes Proving the Link: ROA, Sales Growth, Market to Book An organization’s culture is critical growth and market-to-book ratio (MtB), illustrating to its success or failure (Schein, 1992; 1999). that a strong and effective organizational culture can Many executives, managers, employees and provide a competitive advantage to an organization. experts intuitively recognize the importance of an organization’s culture for the health of the We used the data collected from 127 public organization. However, prior to 1984, there was no companies that completed the Denison hard evidence to prove the relationship between Organizational Culture Survey (DOCS). This research organizational culture and financial performance shows a significant relationship between culture and results. For over the last twenty-five years, Dr. financial performance. Figure 1 shows the DOCS Daniel Denison has conducted research to prove composite profiles in the top 25% versus those the link between organizational culture and financial in the bottom 25% on their overall organizational performance metrics (Denison 1984; Denison 1990). culture results. Table 1 translates these differences This Research Note highlights the latest compelling into financial results, indicating that companies with evidence linking organizational culture to financial higher positive culture scores also have the better metrics such as return-on-assets (ROA), sales financial results. Figure 1: Scores on Denison Organizational Culture Survey Bottom 25% Top 25% ROA = 1.2% ROA = 3.5% Sales Growth = 7.5% Sales Growth = 24.8% MtB = 2.5 MtB = 4.0 All content © copyright 2012 Denison Consulting, LLC All rights reserved. l l Page 1
  2. 2. Research MethodTo examine the relationship between culture balance sheet and $75 Million in liabilities. The bookand performance, we looked at a sample of value of that organization is $25 Million. (Assets –public companies surveyed using the Denison Liabilities = Book Value) If there are 10 million sharesOrganizational Culture Survey from 1995 to outstanding, each share would represent $2.502010. Organizations were removed if there were of book value. If each share sells on the marketfewer than 100 total respondents. Additionally, at $5 (market value), then the MtB would be 2organizations were removed if they were a (because 5/2.50 = 2). Essentially, market value is thesubdivision of a public company. The result was investment community’s expectations of the wortha sample of 127 companies in a wide variety of of the incorporated primarily in the US (86%).(Research indicates that the DOCS results are We predicted that the companies with the highercomparable across countries [Denison Consulting, scores in the DOCS culture traits of Mission,2012; Denison, Haaland, & Goelzer, 2003].) Consistency, Adaptability and Involvement would also have better ROA, sales growth, and MtB ratios than those with lower scores. To test ourMeasuring Performance hypothesis, we linked the organizations in ourOnce the sample was obtained, the next step was database to publicly-available financial performanceto measure performance over time. For this study, data from Standard & Poor’s COMPUSTATthree financial metrics were chosen to examine: database.return on assets, sales growth and market to bookratio.First we took a look at return-on-assets. ROA is Table 1: The Resultsthe percentage of profits derived from a company’s Performance Measure Bottom 25% Top 25%total assets, in other words, ROA tells you how Return-on-Assets 1.2% 3.5%much profit a company generated for each dollar Sales Growth 7.5% 24.8%in assets. The higher the percentage of ROA, thebetter the organization is at using their invested Market-to-Book Ratio 2.5 4.0capital, or assets, to turn a profit. For example, iftwo companies independently invest $100,000 inequipment for a project and one company produces$10,000 in profit and another produces $15,000,the second company has a greater ROA. “Culture matters…Second, we took a look at sales growth which If the organization begins to fail, thisis related to profitability. Sales growth is usually implies that elements of the cultureexpressed as the percentage of increased sales have become dysfunctional andfrom one year to the next. For example, if we must change. Failure to understandsurveyed an organization in 2000, year 1 wascalculated by subtracting the sales from 1999 from culture and take it seriously can havethe current sales year (2000). To get the percentage, disastrous consequences for anwe divided the difference by the 1999 sales. organization.”Finally we looked at market-to-book ratio as anothermeasure of an organization’s financial performance. Edgar H. Schein The Corporate Culture Survival Guide,1999,The MtB seeks to show the value of a company, p.3by comparing the book value of a share to themarket value of a share. For example, assume anorganization has $100 Million in assets on the All content © copyright 2012 Denison Consulting, LLC All rights reserved. l l Page 2
  3. 3. The Results Figure 2: Return-on-AssetsThe results of our analyses show someexciting findings. As you can see inTable 1, in the year of the survey, thoseorganizations with the lowest scoringpercentiles for Mission, Consistency,Involvement, and Adaptability earn$1200 for every $100,000 spent onassets, while those in the top 25%earned $3500. This profitability is alsorelated to how fast these companiesare growing. The sales growth of thetop 25% group was 24.8% versus thebottom scoring companies at 7.5%.Turning to the MtB ratio, the investment/market community is recognizing theorganizations with the higher culturescores at 400% of book value versus Figure 3: Sales Growth250% for organizations in the bottom25%.This evidence indicates that thecompanies with higher culture scoreshave better performance in the year ofthe survey. But this study also allowedus to take a look at the longitudinaldata and the results indicate that thosehigh scoring organizations also performbetter in the future. Figures 2, 3, and 4illustrate how the bottom and top 25% Figuresof organizations rank in their industry (byNAICS code) over a three year period foreach of the three performance measures.The graphs indicate that today’s culture Figure 4: Market-to-Book Ratioaffects tomorrow’s performance. Figure2 shows that companies in the top 25%exhibited a slight gain in industry ROAwithin a three year period, whereas thebottom 25% companies displayed anopposite trend. Figure 3 shows that, asmeasured by sales growth, both groupsdisplayed a negative trend but the bottom25% experienced a sharper decline thanthe top 25% in subsequent years. Figure4 shows the top 25% remained at aconsistent advantage over the bottom25% in market value. All content © copyright 2012 Denison Consulting, LLC All rights reserved. l l Page 3
  4. 4. ConclusionThese results indicate that culture has not only a short-term impact on performance but lasting effects asa competitive edge. Specifically, this research has shown an advantage in ROA, sales growth, and marketvalue for organizations scoring in the top (vs. bottom) 25% on the DOCS. Culture makes a difference infinancial performance. As a measurable and controllable aspect of your organization, it is a factor thatcan improve future business performance. Executives, managers, and employees can focus on theirorganization’s culture today to improve their financial performance tomorrow.The Denison ModelThis research uses a culture model developed by Daniel Denison built “This research showsto explain the cultural factors leading to financial performance and us how we canorganizational effectiveness (Denison 1990). The model assesses fourbehavioral traits: Involvement, Consistency, Mission, and Adaptability. measure culture in aThese traits are each broken down into three indexes. Ultimately, they way that is useful tocan be defined as “a code, a logic, and a system of structured behaviors managers because itand meaning that have stood the test of time and serve as a collective links culture withguide to future adaptation and survival” (Denison 1990, 175). The traits other bottom-lineand definition of culture match Schein’s notion of the “shared basicassumption that the group learned as it solved its problems of external performanceadaptation and internal integration” (1992, 12). The notion of survival in measures.”the external environment is manifested in the adaptability and missiontraits which describe how strategically-oriented and customer-focused Daniel Denison,an organization is. The learned responses to the “problems of internal Denison Consultingintegration” are manifested by the traits of involvement and consistency.Related Resources Denison, D. R. (1984). Bringing Corporate Culture to the Bottom Line. Organizational dynamics, 13(2)Denison Consulting. (2012, March). High-perfor- 5-22.mance Organizational Culture around the World.Denison Research Notes. Ann Arbor, MI. Denison, D. R. (1990). Corporate culture and organizational effectiveness. New York: John WileyDenison Consulting. (2005, April). Overview of the & Sons.Reliability and Validity of the Denison OrganizationalCulture Survey. White Paper. Ann Arbor, MI. Schein, E. H. (1992). Organizational culture and leadership (2nd ed.). San Francisco: Jossey-Bass.Denison, D. R., Haaland, S. & Goelzer, P. (2003).Is Asia different from the rest of the world?. Schein, E. H. (1999). The Corporate Culture SurvivalOrganizational Dynamics, 33 (1), 98-109. Guide. San Francisco: Jossey-Bass.Contact Information Copyright InformationDenison Consulting, LLC Copyright 2012 Denison Consulting, LLC121 West Washington, Suite 201 All Rights Reserved.Ann Arbor, Michigan 48104 Unauthorized reproduction, in any manner, is prohibited.Phone: (734) 302-4002 The Denison model, circumplex and survey are trade-Fax: (734) 302-4023 marks of Denison Consulting, LLC.Email: *This Research Note is an update of “Proving the Link”, originally released as Volume 1, Issue 2, 2006 All content © copyright 2012 Denison Consulting, LLC All rights reserved. l l Page 4