The Diversity Dividend[1]: A Corporate Strategy to Build Brand Equity/Loyalty Across Communities
Is there a causal relationship between increasing diversity within organizations and the bottom line? This has traditionally been a difficult question to answer, but, over the last ten years more and more data appears to be answering the question in the affirmative.
Workplace diversity is gaining momentum. LinkedIn’s 2018 Global Recruiting Trends report found 78 percent of the US companies surveyed are focusing on diversity.
A report by global management consulting firm McKinsey & Company, observing more than 300 companies in the US, Canada, the United Kingdom and Latin America, found that companies ranking in the top 25th percentile for gender diversity on their executive teams were 21 percent more likely to turn a profit above the national average.[2]
What does all that mean for performance? How do the financial outcomes of homogeneous partnerships compare with those of diverse collaborations? The difference is dramatic. Along all dimensions measured, the more similar the investment partners, the lower their investments’ performance. For example, the success rate of acquisitions and IPOs was 11.5% lower, on average, for investments by partners with shared school backgrounds than for those by partners from different schools. The effect of shared ethnicity was even stronger, reducing an investment’s comparative success rate by 26.4% to 32.2%.
To understand why homogeneous teams have worse investment outcomes, it’s critical to determine exactly when decision making suffers. Interestingly, projects selected by both homogeneous and diverse sets of investment partners were equally promising at the time the decision to invest was made. Differences in decision quality and performance came later, when the investors helped shape strategy, recruitment, and other efforts critical to a young company’s survival and growth. Thriving in a highly uncertain competitive environment requires creative thinking in those areas, and the diverse collaborators were better equipped to deliver it.
Diversity attracts more talent
Companies that display ethnic, gender and age diversity appeal to a broader spectrum of job seekers, giving those companies a better chance at attracting top talent. Today’s companies are in a fierce competition for the best employees and are always looking for ways to draw them in. Simply put, diverse companies appeal to a diverse workforce and have a distinct advantage over companies that do not have a healthy percentage of women and people of color and varying ages on staff. When recruiting, businesses that source candidates from a diverse base are more likely to hire people with diverse characteristics.
McKinsey and Company also reported that when ethnic and cultural diversity were taken into account for executive teams, companies were 33 percent more likely to see better-than-average profits.
Promotes innovative solutions and products: “Diverse perspectives are more likely to generate new and different ideas,” Ng says. “An organization that truly promotes, encourages, and values diverse perspectives is better positioned to innovate to become and remain a market leader.”
Widens the talent pool. The McKinsey & Company report concluded that diverse companies were more likely to win over top talent, and thus improve performance, employee satisfaction and retention. “An organization known for its fair employment practices and appreciation for diverse talent is better able to attract a wider pool of qualified applicants,” Ng says.
Broadens marketing and customers. Companies employing workers who identify with a small portion of the market don’t have access to the experiences and insights of the entire marketplace. “A workplace with a diverse group of individuals from different backgrounds enables a company to more effectively market to a broader groups of consumers and tap into related business opportunities,” Ng says.
Strengthens collaborative culture. “Organizations which successfully implement diversity foster increased employee inclusion, engagement, success and retention,” Ng says. “They create and instill a collaborative culture of employees helping each other to achieve goals, which ultimately helps to enhance organizational success.”
Enhances company reputation. “Business reputation flourishes when a company shows its commitment to diversity and inclusion,” Ng says. “It leads to more customers, increased profitability and opportunities for workers.”[3]
Diverse thought leads to increased customer satisfaction
Serving the end user is difficult if a company’s decision-making team doesn’t include people who can relate to that customer. A diverse team is more likely to relate to a particular audience’s wants, needs and pain points, creating greater opportunities to resonate with customers. Also, a diverse staff introduces the potential to reach new demographics in ways that might not have come to light with a homogenous group at the helm. Ultimately, customer volume and satisfaction can be improved through higher levels of diversity, which raises profitability.[4]
The VC Case Study
In the venture capital industry, firms are fairly flat in structure, composed primarily of investment partners and relatively few junior professionals. Every investor is a decision maker, and choices have clear business consequences. We know which firms make what investments, and for the most part we can identify the individuals leading those investments, because they usually take seats on the boards of portfolio companies. Using publicly available information, we can analyze VC professionals’ “endowed traits,” such as gender and ethnicity, and “acquired traits,” such as schooling and work history. In other words, we can see how similar or different these decision makers are and compare the quality of their decisions on the basis of their investments’ performance. Because their incentives are aligned and readily discernible—compensation for VCs is largely determined by profit sharing, ensuring that they and their investment partners have the same goals—the analysis is not clouded by inscrutable interests. The goal of every venture capital investor and firm is to choose and groom the companies that will yield the best possible outcomes.[5]
All in all, we couldn’t have asked for a better “lab rat” than the VC world. Over the past several years one of us (Paul Gompers) has examined the decisions of thousands of venture capitalists and tens of thousands of investments, and the evidence is clear: Diversity significantly improves financial performance on measures such as profitable investments at the individual portfolio-company level and overall fund returns. And even though the desire to associate with similar people—a tendency academics call homophily—can bring social benefits to those who exhibit it, including a sense of shared culture and belonging, it can also lead investors and firms to leave a lot of money on the table.
The Impact on Business Results
The gender and racial makeup of the venture capital industry is staggeringly homogeneous. A comprehensive data set of every VC organization and investor in the United States since 1990 shows that the industry has remained relatively uniform for the past 28 years. Only 8% of the investors are women. Racial minorities are also underrepresented—about 2% of VC investors are Hispanic, and fewer than 1% are black. Those groups have seen significantly increased representation in other fields and in advanced professional and scientific degree programs, but not in the VC industry. It’s against that backdrop that venture capitalists choose their collaborators at other firms, investing their money side by side and joining the boards that guide the start-ups. Most investors specialize in a particular industry or sector, so potential partners are easy for researchers like us to identify: They are investing in the same types of deals at around the same time. And venture capitalists are far more likely to partner with people if they share their gender or race. They’re also significantly more likely to collaborate with people if they share their educational background or a previous employer. Belonging to the same racial group increases the propensity to work together by 39.2%, and having a degree from the same school increases it by 34.4%. Not only is the likelihood of collaborating on any one deal greater, but VCs tend to keep teaming up with those who share their traits.
Of course, the industry’s homogeneity is continually reinforced by individual firms’ hiring decisions. Because these organizations are small (they usually have three to five investment professionals), and spots open up infrequently (every two to four years), even a slight preference for candidates who are similar to existing partners has a lasting effect. Here’s just one example: Many prominent venture capital firms were founded by Harvard Business School alumni, and now nearly a quarter of all VCs with MBAs come from Harvard. To put that into perspective, only 9% of VCs with MBAs are from Wharton, and just 11% are from Stanford—both top-tier schools.
Prospects are even worse for female candidates. Remember that only 8% of venture capital investors are women. It’s no wonder, since nearly three-quarters of VC firms have never hired a woman in that role. What separates that overwhelming majority from the firms that have hired women? One powerful factor is the gender of the partners’ children. When a firm’s partners have a higher proportion of daughters, the likelihood that a female investor will be hired goes up significantly. Simply replacing one son with a daughter would increase the probability of hiring a woman by 25%.
Only 8% of VC investors are women. Fewer than 1% are black.
Of course, we aren’t suggesting that male VCs should have daughters to reduce gender bias and increase diversity in their firms. But because the gender of one’s child isn’t a choice, the finding offers a tighter lens on diversity’s effects. When the “daughter effect” does bring more women into the fold, it has a strong impact on performance. Venture capital firms that increased their proportion of female partner hires by 10% saw, on average, a 1.5% spike in overall fund returns each year and had 9.7% more profitable exits (an impressive figure given that only 28.8% of all VC investments have a profitable exit).
The economic impact of diversity isn’t limited to the VC world. A recent NBER analysis of highly skilled occupations (in fields such as law, medicine, science, academia, and management) shows a positive relationship between diversity and the value of goods and services produced in the United States. The study looks at GDP trends beginning in 1960, when significant barriers prevented white women, black women, and black men from entering those professions. Though we’re still nowhere near parity, gender and racial diversity have increased markedly in such fields over the past 50 years—and the U.S. economy has grown in that same period. Using a model that assumes innate skills are evenly distributed across gender and racial groups, the NBER analysis attributes about 25% of the GDP growth per capita to the uptick in white women and black Americans of both genders. In short, the authors argue, the United States began making better use of the talent at its disposal.
[1] HBR Article
[2] https://www.weforum.org/agenda/2019/04/business-case-for-diversity-in-the-workplace/
[3] https://www.cpapracticeadvisor.com/payroll/news/12416935/5-ways-diversity-can-help-boost-profits