In an era of corporations with global reach, multinational workforces and board-dominated corporate structures, it is easy to overlook the fact that some of the most successful companies are still family businesses — the oldest type in the world. Wal-Mart, the world’s largest corporation based on sales, Ford, Cargill and Bombardier in the Americas all began as family businesses. Peugeot, LVMH, IKEA and Bosch in Europe also fall into the category, as do Tata, LG and Samsung in Asia. These businesses have survived economic downturns, wars, family feuds and other challenges. They not only have survived — they have out-performed their respective index: a Credit Suisse index shows that family firms have outperformed non- family firms in shareholder value creation by 15 percent from January 2005 to October 2008.
Our analysis of international and regional family businesses indicates that the most critical factor to success is families’ coordinated and sustained long-term strategy for growing and controlling their businesses. This involves exercising patience in managing capital, holding onto companies through bull and bear markets, focusing on core businesses and emphasizing long-term performance ahead of quarterly gains. In the GCC, family firms are an up-and-coming force. They tend to be relatively young — most are less than 40 years old — and are typically managed by first or second generation family members, with few seeing significant involvement from third generation members. Despite their short tenure, some family businesses have gained international stature in the past few years. Their success, however, has been based on factors specific to emerging markets and the region’s cultural heritage. First, successful GCC family-owned businesses have enjoyed distinct advantages, including limited external competition and special access to capital, business networks and information. This allowed family businesses to build large conglomerates spanning a variety of sectors. In many GCC countries, activities were implicitly divided among the privileged family businesses. Second, the cultural heritage of the region has so far protected family businesses from many major and destructive family feuds. As an example, the passing of control has been less contentious an issue in GCC family businesses, where leadership traditionally is passed to the eldest brother, a practice typically accepted by other family members. Even in instances of conflict between family members, the dispute tends to, with few exceptions, be kept private and managed within the family, limiting the impact on the business. This advantage, however, is fragile as families expand and as the gap in experience and knowledge increases among various family members.
These advantages, though, will not insulate family-run businesses in the region forever. Leaders of many GCC family businesses have acted as “restless entrepreneurs,” more focused on developing new businesses and entering into new investments than on scaling and institutionalizing businesses once they are created or acquired. This is typical not only of family-run firms, but of any company that operates in an environment of strong economic growth, limited competition and abundant capital. Today, family businesses are going to be put to the test as they face an economic slowdown and an upcoming generational change. On one hand, the current worldwide economic slump, coupled with increased competition from both regional and global firms across industry sectors and the democratization of business development in the GCC, will likely put additional strain on family businesses’ cash positions and will force them to improve performance and better manage their capital and liquidity. On the other hand, ownership of the business, and consequently control of the business, will likely become more fragmented with the inclusion of the third generation and the lack of appropriate legal frameworks like preferred shares.
Continuing a tradition of success
Given these challenges, we have identified six key actions to drive the successful evolution of a family-run conglomerate.
• Re-evaluate the existing business portfolio, creating sharper focus. This can be difficult as many GCC families tend to hold on to their traditional businesses for emotional rather than rational reasons. However, family- run conglomerates must have the discipline to optimize the use of their capital and to target fewer businesses to drive superior performance. Our analysis of family businesses shows that focused family conglomerates (i.e. firms with focus on related businesses within an industry group) generate higher shareholder value than those conglomerates with a wider variety of unrelated businesses.
• Apply rigorous discipline when evaluating new investments. As the portfolio of existing businesses is rationalized, family conglomerates must create clear guidelines for new investments, focusing on scalability, relative return on capital and management time. For businesses or ventures that do not fit the criteria but are important for the family, they can be financed by funds — individual or collective — that are independent of the business.
• Build management capabilities and relinquish control when necessary. An essential element for an “immortal” family business is a management team that is able to grow the business independently of the shareholding. A silver lining in the current economic downturn is the sudden availability of management talent. To attract that top talent, family businesses must be open to ceding some level of decision-making, eliminating the glass ceiling, and creating the right incentive structures.
• Separate family and business activities. In the GCC, the line between family activities and investments is often blurred, reducing transparency and making it difficult to assess a businesses’ real profitability. One option is to create a ‘family office’ to handle activities ranging from basic services such as travel arrangements to managing individual family members’ wealth. Philanthropic activities should also be separated from the business by creating a foundation or leaving the activities to individual family members.
• Create a formal governance structure to govern family and business activities. This will ensure effective delegation and separation of activities and will help families prepare for succession. A governance structure can also be used to include and involve family members who might not otherwise be actively engaged with the company. However, while designing a governance structure is relatively straightforward, implementation can prove to be more difficult. It is best to introduce the structure gradually, over a long period of time.
• Appoint a change agent. Some families split necessary actions among themselves, with no clear accountability. This often fails to implement change because no single person has taken ownership of the evolution. In our experience, successful change in GCC family businesses should be championed by one individual, a change agent. The latter could be a family or non-family member, but must be close to and respected by the family, have a thorough knowledge of the business and be viewed as unbiased towards a branch of the family. Most importantly, the change agent’s interest has to be aligned with the family’s success.
When it comes to family businesses, there’s an old saying that contains a grain of truth, “The first generation makes the money, the second generation tries to keep it, and the third generation loses it.” Some studies show that up to 80 percent of family businesses fail to survive through the third generation. Today, many GCC family businesses will be put to the test. The large family size will require them to seek around 20 percent a year in growth to maintain the same level of wealth across generations. This has to be managed through economic downturns and across generational changes. These businesses can risk decline or possible extinction, or they can create an enduring corporation and lasting legacy for their families by managing the ‘restless entrepreneur’ syndrome and institutionalizing their business.
Ahmed Youssef, principal and Marc-Albert
Hamalian, associate with Booz & Company.