Four Lessons Firms Can Learn From Family Businesses
At its height in the 1980s, more than 27 million Americans tuned in to watch the trials and travails of a fictional Texas oil family called the Ewings in the hit TV show Dallas.
Clearly, family-run businesses can be rich with drama, but they can also provide lessons for other companies.
Despite the inherent risks associated with succession and non-business issues disrupting operations, family businesses remain a force to be reckoned with. In fact, 90% of the world’s companies are family firms.
Many of them are mom-and-pop shops, but according to the Boston Consulting Group, 30% of all companies with revenues above $1 billion are family businesses.
This does not necessarily mean that they own the company outright, but they at least hold a stake, which allows them to influence important decisions, such as the appointment of the CEO and chairman.
In the U.S., household names such as Wal-Mart, Ford and Sears are among them. Internationally, car giant Volkswagen in Germany, French luxury goods conglomerate LVMH, and India's Tata also come to mind.
Besides the really big players, there are also hidden champions, who dominate niche markets. In Germany, they are seen as the main engine of growth.
The debate on how well family businesses perform is still ongoing. In a 2012 Harvard Business Review article, Nicolas Kachaner, George Stalk, and Alain Bloch argued that they outperform the peers in tough times, but under-perform when the economy is booming.
This suggests that family firms are more resilient, an attractive feature as we currently face so much uncertainty in many economies.
To identify some useful lessons for non-family firms, I looked at the world’s 100 largest family businesses, and relied on a database of 450 German companies that I built together with Kurt Matzler, Julia Hautz, and Viktoria Veider, all from the University of Innsbruck.
How do you align the interest of shareholders and managers? In the 1990s, stock options became popular. The idea was that CEOs would benefit from the option when the stock price stayed above its strike price.
In theory, that sounds great, but in practice, it led to a series of malpractices, such as options backdating and the manipulation of accounts, not to mention short-termism.
Family firms often avoid conflicts between managers and owners altogether by choosing a CEO who is a member of the family. But what happens if they have select an outsider as chief executive? They tend to stick to the one they appoint.
While the average tenure of CEOs in large US companies is 4.6 years, those currently in charge of one of the 100 largest family businesses have already served 13 years on average.
Their median tenure – perhaps a better indicator considering that in some exceptional cases family CEOs stay for several decades – is still 7 years. The commitment to give a CEO sufficient time to implement his ideas creates a sort of loyalty that financial incentives cannot achieve.
In a study of companies which outperform the stock market for more than 50 years, I found that CEO tenure at successful companies was two years longer than at comparable companies.
Historically, the tenure at top companies was 11 years, while more recently it has fallen to just under seven years. This matches the median tenure of CEOs in family firms.
No-one is born a CEO. Despite having similar jobs beforehand, nothing can fully prepare a person for the demands of the role. Judging a CEO after a short adjustment period is neither fair nor sensible. Only with the benefit of time are they able to truly develop their own agenda. Family firms get this right. Loyalty beats short-term performance.
Shoppers line up to enter an Hermes International SCA store on Canton Road in Hong Kong on April 18.... [+]
One of the most interesting features of family businesses is their strategic patience. Even when the chosen strategy does not deliver in the short-run, they tend to stick to it.
This avoids confusion among staff and customers. Take Hermès, a French luxury goods producer. In the 1970s, their focus on craftsmanship, top quality finishing, and exquisite materials seemed outdated.
Still, Hermès resisted the temptation to change direction and start mass manufacturing products. It was prepared to fight fiercely for its way.
In 2010, for example, Hermes fended off a hostile takeover bid from LVMH as its leadership felt that this would force them to make compromises. In the long-run, this patience (you might also call it stubbornness) paid off.
Customers are prepared to wait up to 10 years for some leather bags. Both revenues and operating incomes have grown steadily over the last decade – even during the financial crisis - while return on capital employed was 41% in 2013.
While the Hermès story highlights the benefits of patience when an existing business model fails to deliver the desired results, the same approach is useful when a company tries to introduce a new business model. Decaux, an outdoor advertiser, took a while to introduce the freemium model.
The plan involved supplying cities with free street furniture, such as bus stops, in exchange for the rights to place ads on them. Although it was not an immediate winner, it eventually turned Decaux into the biggest player in its industry.
CEOs of non-family businesses are under a lot of pressure to hit the numbers every quarter. Unfortunately, this also increases the pressure to discard strategies that don’t work immediately, but a glance at some of the most successful family businesses helps to illustrate why they should resist. Patience is a virtue when it comes to strategy.
Mega-mergers are back in fashion. But will family businesses participate? Probably not. Nicolas Kachaner, George Stalk, and Alain Bloch found that family businesses are substantially more conservative in regards to their finances than other companies.
Mergers are headline grabbing and exciting, but they also represent a substantial financial risk. On average, family firms only spend 2% of their annual revenues on acquisitions, while others spend almost double, 3.7%.
Similarly, family firms carry less debt. Between 2001 and 2009, it accounted for 37% of their capital, compared to 47% for non-family firms.
It is pretty much the same when it comes to capital expenditure. Family firms are reluctant to spend more than they earn. Having longer institutional memories, they're more aware that downturns are unavoidable. And the best way to go through these periods is by building reserves in the good times.
For non-family firms, it is particularly challenging to remain conservative. They are under constant pressure to grow, but the best companies do not grow at the expense of their financial health. The top companies in my study on long-term success were substantially less leveraged than their comparison companies.
In the 1920s, Siemens , for example, valued its assets in a much more conservative manner than AEG, allowing it to handle the Great Depression better.
The reluctance of family businesses to engage in risky undertakings is also reflected in their innovation activities. In a study of German companies between 2000 and 2009, Kurt Matzler, Vicki Veider, Julia Hautz and I found that family firms invest less in R&D than non-family firms.
At the same time, they were better at exploiting their findings. In short, they are more efficient innovators.
Three factors are at play here. First, family firms tend to stick to more narrowly defined niches. This is particularly true for Germany’s mid-sized companies, such as Kärcher, a producer of high-pressure cleaners and window vacuum cleaners, or Ekato, who manufactures industrial mixers.
In these niche markets, they combine technical expertise with customer knowledge. Secondly, the frugality of family firms filters down into R&D.
Researchers know they should concentrate only on ideas that can be implemented. Thirdly, most managers spend the best part of their career with the company. This gives them a better understanding of the business and hence an edge when they need to decide which ideas they want to invest.
The family approach towards innovation has its benefits, but also comes with a downside: it is less likely to produce breakthrough innovations. Considering how high the failure rate is in implementing them, this seems a price worth paying.
So what can we learn from family businesses?
The overall lesson is quite simple: be more conservative and stick with the people you chose. It is a business approach that ensures stability.
You might miss some of the upsides of more risk-embracing strategies, but if you want to still be in business a decade from now, family businesses show that playing safe is the way to go.