This article originally featured in Baillie Gifford’s Autumn 2018 issue of Trust magazine.
What quality allows a company not just to survive the destruction of its bread and butter business model but to disrupt itself to become the market leader? According to Gary Robinson the answer is to be found in a company’s culture. This separates exceptional growth companies from average ones.
For Robinson, cultural strength explains why Netflix, which started out as a DVD mail subscription service, is now the world’s largest content streaming provider. Conversely, cultural weakness explains why Kodak filed for bankruptcy in 2012 having fumbled for a decade to deal with the rise of digital photography.
“The critical cultural determinant in Netflix’s case was the founder, Reed Hastings,” explains Robinson. “He had the moral authority necessary to allocate capital away from the larger, cash-generative DVD hire business, and towards what at the time was a much smaller business, online streaming.
“In order to do that you have to battle a lot of vested interests internally, because the weight of the organisation is still in the old business, along with the human and physical capital. It is vanishingly rare for chief executives to pull off something like that, and it’s entirely due to a founder-created culture.”
Netflix is currently a top five holding in the Baillie Gifford US Growth Trust. Robinson regards spotting such rarities and backing them over five-to-ten years as one of the core strengths of Baillie Gifford’s low turnover style.
As Robinson describes it, the quest for “true outliers” is largely down to understanding an “intangible” cultural quality in companies. Components include readiness to innovate and to engage employees at all levels of the company with a shared mission.
“At the risk of oversimplifying, companies with distinctive cultures are generally those that are in it for the long term,” says Robinson. “Most companies in America aren’t run that way. They are run by corporate management teams incentivised for the short and medium term. They would rather buy back stock, boost their earnings-per-share, beat their bonus targets and collect their pay cheques than invest in projects with long-term timeframes and uncertain outcomes.
“We are looking for companies that behave in a different way, companies that think long term, that are willing to embrace risk, and willing to invest for the future. We then hold on to them for long periods of time to capture the potential upside inherent in their business models.”
Reed Hastings, CEO of Netflix.
© DPA/PA Images.
Candidate companies for inclusion in his portfolios are, he says, screened for the distinctiveness of their cultural attributes. The checklist of questions starts with: “What is the point of this company and what are its long-term ambitions? And secondly, does the company possess a significant culture and is this a source of competitive advantage?”
Robinson expresses surprise that so few investors seem to care about culture, a reflection, he suggests, of the market’s bias to shorter timeframes. He recalls one chief executive, Katrina Lake of Stitch Fix (see next page), telling him that he was the only person who raised the issue when she met investors before the company’s Nasdaq listing.
It is no coincidence that founder-led businesses such as Netflix, Amazon, Stitch Fix and Grubhub typically comprise around 70 per cent of the Baillie Gifford US Growth Trust’s holdings, while our research suggests they only account for around 25 per cent of the total US stock market.
“Founders embrace risk, and as with Reed Hastings at Netflix, Katrina Lake at Stitch Fix or Jeff Bezos at Amazon, are willing to invest in the future at the expense of short-term profits,” Robinson adds. “They are able to navigate changing circumstances and unlock new growth opportunities that aren’t always apparent at the time of our initial investment.”
Robinson notes that many managers seem ignorant of what corporate culture even means, confusing it with gimmicks or PR spin. “It’s not perks or crazy offices with slides from one floor to the next,” he says. “It’s about the shared values of the company and how it behaves. It’s about what the founders and the management teams say they want to do and how that relates to what they actually do over time.
“Ambition, vision, determination, risk-seeking… the outputs of a strong culture are difficult to measure precisely. But just because something is hard to measure doesn’t mean that you shouldn’t try. In fact we would argue the opposite. When something is hard it presents an opportunity for us to add significant value by analysing it and spending time on it.”
Robinson emphasises that a firm’s culture cannot be determined from presentations at broker-sponsored conferences, any more than it can from a balance sheet or a set of results.
It takes shoe leather and air miles to distinguish good cultures from good spin. In the past Robinson has spent months in the US, burrowing into culturally compelling company stories in hot spots such as the Boston or San Francisco healthcare clusters.
In addition, Baillie Gifford’s retained network of US researchers are well briefed on what cultural attributes to look for in up-and-coming unlisted companies.
“The easier information is to find, the less valuable that information is,” Robinson says.
Over the decades, Baillie Gifford’s quest for outperformance has sharpened its antennae for growth-oriented corporate cultures capable of defying Wall Street noise for long-term reward. The characteristics that the Baillie Gifford US Growth Trust shares with culturally compatible companies is a willingness to look very different from its peers, to challenge itself, to embrace uncertainty and to ride out cyclical volatility.
It is, as Robinson phrases it, “really simple, but difficult to do”. This explains why companies with the right culture – and the investors who understand them best – tend to stand out from the crowd.
Stand-out cultures tend to think differently on company structure and the role of technology. For Nasdaq-listed online personal styling company Stitch Fix, the attraction for Gary Robinson and colleagues is its rare integration of human and artificial intelligence (AI), in this case deployed to help those without the time or inclination to shop for clothes that suit their personal style and taste.
Stitch Fix selects clothes for customers by using a combination of experienced stylists and machine learning that mines customers’ data to track their preferences and buying behaviour.
The San Francisco-based company’s culture, according to Robinson, stems from its ability to incorporate and integrate new AI technologies into its platform. Its data scientists and fashion experts are given equal status at the company, based on common goals. And what’s more it has a chief algorithm officer – not many companies can lay claim to this.
Katrina Lake, chief executive of Stitch Fix, during the 2018 Makers Conference.
© Bloomberg /Getty Images.
Portfolio data in this article to 30 June 2018. Please remember that the value of a stock market investment and any income from it can fall as well as rise and investors may not get back the amount invested. Investments with exposure to overseas securities can be affected by changing stock market conditions and currency exchange rates. Investment trusts can borrow money to make further investments and there is a risk that when this money is repaid by the trust, the value of the investments may not be enough to cover the borrowing and the interest costs, and the trust will make a loss. The trustís risk is increased as it holds fewer investments than a typical investment trust and the effect of this, together with its long term approach to investment, could result in large movements in the share price. Investment in smaller companies is generally considered higher risk as changes in their share prices may be greater and the shares may be harder to sell. Smaller companies may do less well in periods of unfavourable economic conditions. The trustís exposure to a single market and currency may increase risk. The trust will have a significant exposure to unlisted investments and its risk could be increased as these assets may be more difficult to buy or sell, so changes in their prices may be greater.
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Colin Donald is a former business editor of the Sunday Herald and used to write for the Scotsman. Colin’s eclectic career has included working in Japan as a lecturer and business correspondent.