‘Organizational health’: A key metric PE firms often overlook

How to know whether a company is poised for growth, or trouble

Private equity firms are expert at assessing the financial health of a potential acquisition. Sometimes, however, they do not recognize weaknesses in the organizational health of companies they acquire, which too often leads to operational and, ultimately, financial problems down the road.

Let me offer some of the warning signs of an unhealthy organization based on the work of my firm, Hammer Results. First, a definition of “organizational health.”

A healthy organization is one that outperforms over time because of clear management direction, engagement of employees and open communication among all involved. We look at communication as the circulatory system of the business, permitting small problems to be addressed early and information from the marketplace to be shared, which enhances product/service quality and builds customer loyalty.

By definition, therefore, companies with apparent or latent organizational health issues are those that are having difficulties in creating or communicating direction, engaging employees and communicating in general.

To assess organizational health, my firm uses a 38-question diagnostic measuring how employees’ view the company in those three areas, as well as their views on important factors including trust. We ask employees to respond with answers ranging from “totally agree” to “totally disagree.” Once we know what employees are thinking and feeling, we create a program to address behaviors and practices that will raise levels of engagement and, ultimately, improve the organization’s health.

An example of what this means in the real world is our work with a company I’ll call Cebot, a midsize manufacturer of precision measuring instruments whose products are used in quality control departments at large technology companies. The 250-employee company was family-owned until its recent sale to a private equity firm, which brought in an experienced senior manager at a competitor as CEO.

Once he saw Cebot from the inside, CEO Sven sensed that he would have a hard time effecting the changes he believed were necessary to improve the business. Before the acquisition, Cebot was run by its founder/owner who led the company in an autocratic, paternalistic way. Employees were rewarded for taking orders, doing their jobs as told and keeping quiet.

The diagnostic assessment Sven asked us to undertake found that employees were reluctant to offer suggestions or question directions for fear of rocking the boat. They also expressed confusion about the company’s direction and objectives, especially under the new ownership, since these were never articulated or communicated.

Once the results were in and communicated to the company’s managers, we began a program that included training the firm’s top and middle managers in key elements of participative leadership, new ways of setting objectives and more effective performance-review techniques.

We also encouraged the firm to complete its strategy planning and communicate its objectives and goals openly and more frequently with employees.

Cebot implemented our suggestions and the bottom line was a healthier organization — not just in terms of more engaged and more satisfied employees, but in financial terms as well. After three money-losing or near break-even years, the company is on track to 10%+ net profitability. The company’s top management and its PE owner believe that a substantial increase in value already has been achieved, and that more is on the way. What’s more, a repeat assessment after one year showed a 13% improvement in overall organizational health, with no single area of the firm performing in the lowest benchmark quartile, which was the case after the first assessment.

Clearly, organization health pays healthy dividends.

Klaus Hammer is the founder of HammerResults, an international organizational consulting firm. Formerly McKinsey’s organization solution general manager for the EMEA region, he has worked with Bain Capital, Terra Firma and Argos-Soditic, as well as with scores of operating companies.