Why women make businesses more profitable
- While the workplace is slowly diversifying, some industries have been slow to change.
- A growing body of research is uncovering that workplaces with greater diversity actual perform better. One of the clearest examples of this effect is in venture capitalism, where nearly all venture capitalists are white, male, Harvard graduates.
- When VC firms hire more women, their effectiveness and profitability explodes.
One of the big questions that any society needs to answer is how open and diverse they wish to be. Whether you’re talking about immigration, college admissions, or workplace diversity, our culture helps inform how many “others” we’re willing to let in.
There’s a variety of perspectives on this issue, but the data is clear in at least one aspect: When it comes to business, more diversity is objectively better. Research has shown that companies with greater gender, racial, and ethnic diversity earn more.
One recent study, publishing during the summer, demonstrates this effect particularly well. Economist Paul Gompers and research associate Silpa Kovvali examined the success of venture capital (VC) firms and the proportion of women those firms employed, adding to the growing consensus among experts that having different faces in the workplace is good for business.
Why venture capital?
VC firms aren’t going to be winning any awards for diversity any time soon. For the most part, VC firms have stayed fairly homogenous since the 1990s — the earliest point where we started collecting reliable data. About 2 percent of VC investors are Hispanic, 1 percent are black, and 8 percent are women. Not only that, but about a quarter of all venture capitalists graduate from Harvard, dwarfing other, equally prestigious schools. It’s an industry for white dudes who graduated from Harvard Business School, which makes it the perfect place to study what happens when you let an outsider into the club.
Human beings have a tendency towards homophilia; we like people who are similar to us. In some ways, having a highly homophilic group can be a good thing. Groups with similar members have a sense of shared purpose, and group members coordinate exceptionally well on tasks. In their sample of 42,000 VC firms, Gompers found that VC firms were highly homophilic. “We really saw how powerful the force of ‘birds of a feather flocking together’ was,” he told Forbes. “The more similar you are to someone, the more likely you are to work with them.”
However, the problem with highly homophilic organizations and industries is that they are prone to groupthink. After all, part of how you think about the world depends on where you came from. Without different perspectives to counter your own, you can easily find yourself overlooking opportunities, ignoring threats, and just generally misconstruing how the world truly is. Gompers summed it up thusly:
“There is a lot of psychological research showing that your background influences the way you frame problems. […] If I am in a firm with five white guys who all went to Harvard, it’s likely we are going to see the world in the same way and make more mistakes. [Diversity] can help you avoid blind spots.”
A change of perspective
In VC firms, the impact of extra diversity was incredibly strong. More diverse firms made successful investments 32.2 percent of the time compared with homogenous VC firms’ 26.4 percent. What’s more, when VC firms increased the number of female partners, Gompers and Kovvali’s research showed a 1.5 percent increase in overall fund returns each year and 9.7 percent more profitable exits. That last number is particularly impressive considering that only 28.8 percent of VC firms make profitable exits. Keep in mind, too, that most VC firms don’t have any female partners at all. So, for some firms in the sample, hiring just one woman as a firm partner dramatically boosted their performance.
The boost in performance, however, didn’t arise because diverse VC firms were picking better investment opportunities than homogenous firms. In fact, the quality of their investments were just about equally attractive at the time. The difference came about because of what happened after identifying an investment opportunity. After investing in a start-up company, VC firms shape the young company’s strategy and tactics to maximize the likelihood that their investment pays off; more diverse VC firms tended to be more creative and effective in this regard.
Precisely because VC firms tend to be homogenous, they made the perfect lab rat to look at what diversity can do for a company. Because different perspectives can be incorporated into strategy, a diverse business can be more agile, better prepared for otherwise unexpected outcomes, and more creative in how it operates.