Goldman Sachs: breaking culture and making culture

Greg Smith, a senior manager at Goldman Sachs, has very publicly accused the company of abandoning its customer-focused ideals and merely following short-term profit. That should not be a surprise: this shift in values is occurring throughout the financial industry, and indeed throughout American society. In fact, it is deliberately driven by a pervasive mindset that emphasizes rational individualism, laissez-faire markets, and the use of incentives through “pay for performance.” But the answer as simple as Mr. Smith suggests: going back to the old culture is probably not an option that anyone would like, either.

Thirty years ago in large corporations pay was mainly determined by organizational level rather than by short-term performance. The real rewards lay in promotion, and promotion required building a network of supporters. Indeed, the higher you rose, the more important it was to be on good terms with a range of people and to show a wide scope of achievements. Your entire history followed you and shaped your career. Thus the kind of “short-termism” that Smith decries was considerably less common.

That kind of corporate culture lasted for over half a century, into the 1980s. Why has it declined? Initially it declined because there was a serious downside: it blocked major change at a time when change became essential. The consensual approach locked in place established players and ways of doing business. This became a problem in the late 70s and 80s as the landscape of business began to change fundamentally. First there was the expansion of markets, with a raft of new global players entering many industries and sharply increasing the level of competition. Corporate profits declined markedly. Then there was an acceleration of technological innovation, driven by computing capabilities. Finally, there was a growing awareness of a deep shift in the nature of value. Success in the twentieth century depended on the ability to produce and distribute reliably on a large scale; success since the turn of the twenty-first has been increasingly dependent on the ability to apply knowledge to emerging problems. The kinds of organization and culture needed for the first don’t work in the second. The best organizations of the past were stable bureaucracies that could maintain consistency and control across a large production process; the best ones now are are fluid, team-based systems that can rapidly bring together diverse specialists around new challenges. Increasingly companies are fleeing the first because the profit margins are shrinking, and seeking the second where profits are larger.

This transformation requires breaking crockery: closing unsuccessful businesses, reorganizing, changing strategies, encouraging different skills. Long-term performance no longer seems so relevant, because what brought success in the past might not do so in the future. Thus in that period companies began to seek leaders who were “not afraid to make the tough decisions.” You can’t get such leaders through internal growth and consensus, and you can’t motivate them through the promise of long-term promotion. Thence the rise of objective numerical targets: if you raise profitability x% you will get a big reward, even if people don’t like you.

In other words, there was a deliberate and sustained effort to break the old corporate culture because it was not suited to emerging the demands of business. Short-term rewards based on objective measures make complete sense for that purpose.

The pay-for-performance mantra is further reinforced because it fits with a comprehensive ideology or world-view: the classical economic claim that rational individuals, interacting in markets, will create the greatest good for all. This powerful idea, going back at least to Adam Smith, suggests that it is not necessary for people to think of the good of others, or of the system. Things work best, in this view, when people just focus on their own concerns and don’t try to meddle in or understand those of others.  If they do that consistently, the “invisible hand” of the market will balance supply and demand, ensure that the right products are made to meet all needs, and everyone will do well. From this perspective giving people money for achieving key goals is seen as just an extension of this broad appeal to rational individualism.

There is just one major problem with this: the theory of the invisible hand, especially when applied to organizations and societies, is deeply, profoundly wrong. If everyone merely pursues rational self-interest, the result will be cynical, manipulative behavior that leads to mutual undercutting and periodic crises. This is what’s known in game theory as the “prisoner’s dilemma”: when people can trust each other, they can often find ways to achieve mutual gains; but when they have no basis for trust, they will seek short-term personal gains – and in doing, undercut each other and make things worse for everyone.

Culture is important because it makes trust possible: it is a framework that gives us reason to believe that others will act constructively, not just in their own narrow self-interest. When you destroy the web of relations and shared values that is the basis of culture, you trigger self-reinforcing cycles of mistrust. And that is exactly what is happening at Goldman Sachs, at many companies, and to a considerable extent in our entire society.

Sometimes culture needs to be broken. Culture can sustain orders that are unjust and inefficient. But if it is broken, it needs to be rebuilt. The pay for performance fad, and the exaggerated emphasis on incentives and individualism in general, are effective at breaking culture, but they are not good at making it.

I don’t know about Goldman Sachs, whether the old culture would have worked in today’s environment. I do know that at many companies cultural destruction was absolutely necessary. IBM before 1991 had a culture that was customer-focused, supportive of employees, ethical – but also slow, bureaucratic, conflict-averse, tolerant of inefficiency. It almost died of it. But rather than falling back primarily on short-term incentives, it has rebuilt with a culture that tends much more towards flexibility and responsiveness. Culture building is slow and uncertain, and neither IBM nor anyone else has entirely filled in a set of relations and values that really meet the needs of a knowledge economy, that provide both efficiency and justice; but it and companies like it are doing better than the ones that have relied on individual stars and powerful monetary incentives.

Mr. Smith, in other words, has identified a serious problem at Goldman Sachs. But it’s a bigger one than he realizes – because the solution is almost certainly not to go back to the “old” culture which he so clearly admires. The task is to define and build a new one.