Why a great culture or business model alone isn’t enough

There are two things I look for in any company before I invest – a strong business model and a strong culture. Both boxes need to be ticked. 

If I have serious doubts about a company’s culture, I won’t invest – no matter how good the business model. Equally, a great culture isn’t enough if I have concerns about the business itself.

A poor culture or sub-par business model can make a company vulnerable. Conversely, a great business model combined with a strong culture can be enormously powerful – I’ve seen it time and again.

Netflix – a great culture

You know a company takes culture seriously when it produces a 128-page culture deck, like Netflix. Without its unique culture the entertainment giant could have easily gone the same way as video-rental company, Blockbuster.

Unlike Blockbuster, Netflix remained agile. It navigated the transition from DVD rentals to online streaming and emerged stronger. It expanded into producing its own content, winning a raft of awards. And it has successfully crossed international borders, now operating from 190 countries. 

This success has been driven by an innovative, entrepreneurial culture where employees are empowered to make decisions and take sensible risks.

Many large companies stifle employees with rules and policies; Netflix seeks to employ the brightest and the best, then trusts their judgement. Their vacation policy is: “Take vacation.” Their travel and expenses policy is five words long: “Act in Netflix’s best interest.”

This culture might not work in all industries. But in creative entertainment, speed and agility are key – and both have been critical to Netflix’s success. 

…but streaming is an extremely difficult industry

Unfortunately, the streaming industry is about as challenging as they come.

Netflix must constantly refresh its content to keep customers happy – spending around $17 billion last year. 

It also has to contend with intense competition. Consumers have never had so much choice, and rivals like Amazon, Apple and Disney have deep pockets. Netflix will probably have to keep the spending taps open to retain customers.

Those customers can quickly and easily cancel their subscriptions too. And many did just that once global economies emerged from lockdowns.

All of which means Netflix needs to stay on top of its game to remain successful. The minute it stops creating hit shows, it will likely struggle. In a fast-changing industry Netflix must constantly adapt to stay relevant. As the 800-pound gorilla of the streaming world, it now has a lot more to lose from industry shakeups than it has to gain. 

So, much as I admire Netflix’s culture, I’m very unlikely to own it in my Quality Shares Portfolio. 

Unilever – a solid business model

Unilever’s business is almost the opposite to that of Netflix. 

Its industry doesn’t change quickly. Marmite (a Unilever brand) was first introduced to the UK in 1902. Over a century later, it’s still loved (or hated!) by millions of Brits.

Unlike Netflix, Unilever doesn’t rely on ground-breaking innovations. Product improvements tend to be incremental, like tweaking formulas or packaging.

And the capital demands of the business are much more modest – last year its capital expenditure was €1.6 billion, about a tenth of Netflix’s content spending.

In theory there’s little to stop consumers switching away from Unilever’s brands, in practice they are reluctant to do so. Even in bad times, most people stick with their favourite shampoo or deodorant. This contributes to Unilever’s resilience in austere times. 

Unilever also has tremendous positions in emerging markets where over half its sales are generated. With incomes and populations growing in these regions, that isn’t a bad place to be.

… but let down by its culture

With all these advantages, Unilever should have performed better, in my opinion. The share price has made little progress over the last five years to July 2023:

Unilever has not been as agile or innovative as it could have been. Despite repeated attempts to speed up decision making and improve accountability, I believe it has been weighed down by the shackles of bureaucracy.

I also think Unilever’s track record of mergers and acquisitions leaves a lot to be desired in recent years. It paid rich prices for several small businesses (including $1 billion for Dollar Shave Club), when it might have been better focusing on its core business. It also unsuccessfully tried to buy GlaxoSmithKline’s Consumer division for £50 billion. This business (spun off as Haleon and listed on the London Stock Exchange) is still valued well below Unilever’s offer.

Culture can change and Unilever now has a new CEO, Hein Schumacher. So unlike Netflix, I don’t rule out owning Unilever in the Quality Shares Portfolio. But Schumacher has his work cut out in transforming the corporate culture equivalent of a Reliant Robin into the kind of nimble sports car Unilever needs.

Roper Technologies – the best of both worlds?

I own Roper Technologies in the Quality Shares Portfolio because I believe it combines the best of both – a superb business model and excellent culture.

Roper has built a diverse collection of software and technology businesses through acquisition. These businesses are all rather different – one provides software for legal firms, another sells single-use bronchoscopes into hospitals. But they all share similar characteristics that should make them resilient.

Many of Roper’s businesses occupy market-leading positions in a niche. The relatively small size of these markets means there is limited incentive for new entrants, helping keep a lid on competition.

The software and technology Roper sells is critical to its customers. Without it, lawyers can’t do their jobs and surgeons can’t perform procedures. The technology is also deeply embedded in customers’ operations, with relationships spanning decades. Switching is difficult and expensive. 

In addition, a large portion of Roper’s sales are repeat or recurring. Combine this with defensive end-markets and it means Roper should be well insulated from the economic cycle.

This business model is reinforced by a culture with parallels to Netflix, even though the business model couldn’t be more different. 

Roper’s companies are kept independent and given lots of autonomy. The leaders of these businesses are provided context to make decisions, rather than rules – then trusted to make good judgements. This leads to an entrepreneurial culture with high levels of accountability.

Like Netflix, Roper’s culture eschews politics and embraces candour. Bad news travels quickly. Mistakes and failed projects are discussed openly so everyone can learn from them. And the determination to continually improve permeates all aspects of the business.

The proof is in the pudding

The power of Roper’s business model and culture is demonstrated by its performance over the last three decades to July 2023.

Roper Technologies vs US Stock Market (%)

Roper hasn’t stood still. Industrial businesses, which are more economically sensitive, have been sold, and proceeds redeployed into software and technology companies. This evolution has made Roper an even higher-quality and more resilient business, in my opinion.

I believe the acquired businesses have got better under Roper’s ownership too. Roper is enjoying higher margins and stronger growth than at any time in its history (see chart below). To me this shows acquired companies don’t just go to die or stagnate at Roper, they flourish.

Roper: Organic revenue growth and margins (%)

Why sometimes 1 + 1 = 3

Companies with a fine culture, but difficult business model must run hard to stand still. Sometimes they succeed, and in Netflix’s case flourish. But it only takes a small slip up or rapid industry change to undo years of great work. That creates too much vulnerability and risk for me. 

Companies with a great business model but uninspiring culture will often tread water. Usually this is because they stifle employees with processes and policies. The result is a bloated bureaucracy bereft of innovation, making it difficult for the business to fulfil its potential. 

But, combine an outstanding business model with an entrepreneurial culture, and amazing things can happen. A culture working in harmony with the business model accentuates the strengths of both (1+1 = 3). It’s why the best businesses don’t just retain relevance, but usually get stronger over time.