Excerpt from People First Leadership by Eduardo Braun.

One reason that culture has not been as studied and spoken about in analyses of management and leadership as strategy may be because the soft variables of people and culture are arguably harder to measure than so- called hard variables. But if they are, in fact, harder to measure, what should we do? Ignore them? It is fascinating to see that because these intangible variables are indeed harder to grasp and measure, people tend to neglect them as though they were not key to the organization’s performance.

The power of culture—the power of firing up people’s hearts and souls, giving them a purpose and a sense of belonging—does not appear on any ledger sheets. Nonetheless, culture is a major asset. Though culture is a primary creator of value in a company, it is not always recognized as such because of the biases we have in measuring value creation. Indeed, in order to understand where the biggest opportunities to create value lie, we must first tackle how we measure that value creation.

We usually measure value creation in two ways. One is through the method of discounting future free cash flows. Most businesspeople would be aware of the impact of changes in costs or revenues on future cash flows, and in fact they are always reflected in the accounting statements.

The second way we can measure value creation in a business is by the accumulation of value in its assets. The difficulty here is that accounting standards try to be as conservative as possible, and, therefore, true asset valuations are hardly ever reflected in balance sheets. In the case of tangible assets such as a buildings or real estate, one is more likely to be aware of the evolution of their real value because they have an easier- to- estimate market value. Intangible assets are registered in the accounting books only when you pay for them.

Therefore, there are intangible assets that are not declared in the accounting books and for which we do not have an easy way to estimate market value. Three great examples of this are creating a renowned brand, consolidating a portfolio of loyal customers, and building a committed, loyal, and effective team of employees. The first two are customer- related assets; the latter is an asset related to culture. Despite the substantial value that all three represent, they go unnoticed by the accounting department,3 which just looks at the balance sheet. This leads to a serious error in valuation. Moreover, it is also very likely that those assets will be undermanaged.

More, though, in some cases financial accounting may even lead us to the wrong conclusion or keep us from building value through culture. A real estate entrepreneur from Beverly Hills, Alan Long, founding partner of Dalton, Brown & Long Realtors—later DBL Realtors—shared a perfect example of this with me.

Originally from Chicago, Alan has degrees in chemistry and American literature from Loyola University. On vacations in Southern California, he met the owner of an established local real estate company who was so impressed by Alan’s attitude, charisma, and salesmanship that he offered him an opportunity to sell real estate on Los Angeles’s Westside. That caused a total career change. In 1987 Alan founded and built a successful real estate brokerage firm, achieving $3.3 billion in sales in 2003 with 600 brokers in nine offices around the Los Angeles area. In 2004, he received a purchase offer for his real estate agency, at which point he learned to value his company through the calculation of its Net Present Value. One day, he told me, “If I had done an MBA, I never would have been able to build and grow my company.”

“What? Why do you say that?” I replied, surprised.

“Because a key contributor to my growth was giving my salespeople higher bonuses than the ones my competitors were offering when they closed a deal. It was a small additional percentage, but it really motivated them and allowed me to attract and retain the best people. When I learned how to value future cash flows, I realized that giving them that extra bit had ‘cost’ me several million dollars. I never would have done it!” he concluded. However, given the evidence of his effective management method, it was perfectly clear that it would have been a big mistake to eliminate those bonuses. At the end of the day, thanks in good part to a policy at odds with traditional business thinking and prevailing strategic values, he was able to build a great empire!

An entrepreneur in the South American real estate sector told me a similar story about the power of culture. We were talking about the importance of people, and he said: “Last month, I realized that one of my star salespeople had a long face. I went and asked him what was going on, and he told me that his daughter was having problems at school, which had him worried. ‘Stay at

home for a couple of months until you get it all figured out,’ I said, and, of course, guaranteed him his salary.” In his mind, the strategic alliance and the value of his best talents went far beyond one or two months’ pay. This CEO was building and investing in the relationship between the company and its employees. But for most executives, everything in business is about transactions. It would be unthinkable to pay two months of salary without receiving anything in return!

Moral: The intangible assets that you create and develop— particularly a culture that values its people—do not appear in your accounting books. The accounting department is not effective at thoroughly measuring the creation of value and is therefore a very limited tool when planning how to create and manage a business. At the end of the day, it’s obvious that any asset— whether it appears in the accounting books or not—ends up creating cash flow, whether it be through the business itself or by selling that asset. But you should always identify which factors generate value, particularly around culture, because its impact is often harder to identify even though a properly managed culture multiplies results.

The paradox comes when culture is measured and shown to have a tremendous impact on results, and when it becomes both a key way of “how a business is competing” and the very foundation of “how a business is unique.” Yes, fostering a strong culture yields tangible economic results.