Fine-tuning family businesses for a new era
Family
businesses were the particular beneficiaries of three decades of favorable
global economics. Now operating a la familia should prompt
soul-searching about how they manage their unique strengths.
It was, in many ways, the best of times. For the
past 30 years, the rise of new consumers around the world, declining input
costs, and the expansion of global supply chains have lifted multinational
corporations to their longest and most powerful run of profit growth in the
postwar period. From 1980 to 2013, global post-tax corporate earnings rose from
7.6 percent of world GDP to nearly 10 percent, outpacing GDP growth by 30
percent. Corporate net income rose even faster, surpassing GDP growth by 70
percent.
Family businesses did
especially well riding this rising tide. Propelled by fast growth in the
emerging world, their share of the companies in the global Fortune 500grew from
15 percent in 2005 to 19 percent in 2013. Five years ago, founders or their
families owned some 60 percent of emerging-market companies with sales of $1
billion or more. By 2025, an additional 4,000 companies may join the list, so
that family-owned businesses would then represent 40 percent of the world’s
large enterprises, up from roughly 15 percent in 2010, according to McKinsey
research and expert projections.
For companies of all
types of ownership, this remarkable era may be drawing to a close. There are
now twice as many multinationals as in 1990. Many are from emerging markets and
compete in the tech sector. These companies are expanding aggressively,
focusing more on revenue growth and scale than on profit margins. Meanwhile,
the prospects for global growth and opportunities to exploit supply chains are
dwindling, and falling costs may have bottomed out. Many of these trends were
already visible in the past decade; as they gather pace over the next one, they
could dramatically slow down the growth of profits. Real growth in net income
could fall from 5 percent during the past 30 years to 1 percent in the next
decade. As a share of world GDP, profits could decline to 7.9 percent—undoing,
in a single decade, most of the gains of the past 30 years.
For family businesses,
the changing environment poses distinct opportunities and challenges to a
business model that has delivered outsize gains during a protracted period of
economic expansion. These companies have long been active in Europe, but today
they have an even larger presence in some emerging economies, such as those of
China, India, Latin America, and Southeast Asia, where they account for roughly
40 percent of total revenues. They tend to predominate in consumer-facing
sectors (such as retail, consumer goods, and automobiles) and are less
prominent in infrastructure-intensive ones (such as transport and utilities).
Family businesses are also less common in innovation-intensive, asset-light
sectors (like pharmaceuticals, IT, and finance), whose share of Western
corporate profits has nearly doubled since the turn of the century.
Overall, family
businesses deliver returns on assets that are comparable to or even higher than
those of state-owned or widely held companies. But what’s noteworthy about
their performance is asset productivity and brand value: their asset turnover,
or ratio of revenues to invested capital, is roughly twice that of other
companies, and they account for 80 percent of the brand value of the world’s
most valuable labels. These attributes are especially strong in family
businesses from developed economies, possibly because many of those in emerging
ones focus on rapid growth and expansion.
Despite the growing
power and influence of family businesses, executives and investors typically
have a poor understanding of the unique attributes providing that edge. Indeed,
it is difficult to parse the DNA of family businesses—a complex mix of family,
management, and wealth creation, all overlaid with a rolling ownership dynamic
that claims all but 30 percent of them by the third generation. 7
To better understand
the complex dynamics now at the heart of the most successful family businesses,
we combined a series of interrelated research efforts to distill the unique
elements that sustain their performance, as well as the factors that promote dysfunction
and decline (see sidebar, “About the research”). We used surveys, more than 200
hours of interviews with family members and executives of such businesses, and
a proprietary in-depth study of their health factors. These helped us to
explore how the elements that influence their fortunes differed from those of
other businesses and how they manage their unique challenges. We also
investigated the options they can use to stay in the competitive sweet spot as
the economic landscape shifts and as the complex tensions between personal and
professional life—tensions that lie at the heart of the family
business—continue to intensify.
Four dimensions emerged
as sources of differentiation and tension among these businesses. Entrepreneurial
vision—in particular, a long-term orientation and a diversified
portfolio—is a hallmark of successful family businesses. But this advantage is
often jeopardized by emotional attachments and risk aversion, which stifle
innovation just as it is becoming even more critical to corporate success. The
top-performing family-owned businesses use a governance approach that
regulates company, ownership, and family topics, thereby avoiding too much or
too little formality. Family capital builds remarkable
organizational cultures that speak to both the hearts and heads of
employees—unless its elements are overdone and promote a dangerous
introversion.
Perhaps the number-one
worry we encountered in conversations with family owners was the challenge
of developing the next generation as motivated and responsible
shareholders. Addressing this topic, which is critical to the long-term
sustainability of family businesses, calls for both a technical and an
interpersonal focus.
Maintaining entrepreneurial vision
The classic family
enterprise starts with an innovative founder who leads it through some of its
most dramatic growth years. It’s increasingly evident that maintaining this
entrepreneurial edge is critical for long-term survival. Creative destruction
constantly churns the rankings of companies in the S&P 500 index of the
largest US corporations. Renewal is a strategic imperative.
One advantage that
these businesses start with is their strategic long-term thinking. Nine out of
ten family-business leaders and top nonfamily professionals who participated in
our research underlined the importance of long-term thinking in decision
making. That’s quite a sharp contrast with the short-termism evident at many
publicly owned companies. Sixty-three percent of more than 1,000 board members
and C-suite executives from family and nonfamily businesses reported increasing
pressure to perform in the short term. Armed with a long-term vision and less
subject to market pressure, family businesses can make investments and
undertake portfolio strategies that publicly owned companies resist.
But as family
businesses grow through the generations, barriers to entrepreneurship and
innovation creep in. These businesses are famously careful with their capital
for two reasons: they are often not willing to dilute the family’s equity
stake, and they are risk averse about leverage. That attitude may not be as
well suited to an era of profit constraints, when advantage is shifting to
nimble, idea-intensive sectors revolving around R&D, brands, software, and
algorithms. In our survey of board members, top managers, and family owners, 60
percent disagreed or strongly disagreed when we asked them if their companies
took risks when situations couldn’t be controlled.
The result is often a
failure of renewal and resolve. A McKinsey study of 200 large companies over a
ten-year period showed that those with passive portfolios—they didn’t sell
businesses or sold only underperforming ones under pressure—did less well than
companies with active portfolios. The best performers systematically divested
and acquired companies. Close-knit family leaders add to the problem of renewal
by acting slowly—particularly when shedding underperforming assets. “The hard
part is letting go,” says one family owner. “We tend to decide by consensus,
but that often means the lowest common denominator, not the best decision for
the business.” A similar perception exists for innovation: overall, respondents
to our survey described their companies’ approach to it as neutral rather than
weak or strong.
The good news is that
many close-knit family businesses have the ingredients needed to retain an
entrepreneurial edge. Maintaining a long-term view is one critical factor.
Tapping the inherent strengths of family capital (as we discuss below) can
harness the trust and commitment of both owners and top management. That kind
of trust is often absent in more broadly held organizations. A third element is
the highly educated and able cohort of next-generation leaders that almost all
family businesses have. The ability to put family members into leadership roles
early can provide a competitive advantage, particularly at a time when
technological disruption rapidly reorders industries and consumer behavior
changes dramatically with each new generation.
Sometimes the challenge
of renewal calls for breaking with long-held interests. At one large European
family-owned industrial conglomerate, the question was how to restructure its
portfolio downstream into consumer-facing areas. While its traditional
businesses were highly successful and profitable, the controlling family
realized that, over time, it would not be able to expand both parts of the
business, so it divested the one with the higher capital intensity. Another
conglomerate systematically divested all businesses in which the family would
not be globally relevant unless it diluted its ownership share.
Our research points to
three mutually reinforcing approaches that successful family businesses use to
maintain and, in some cases, restore their entrepreneurial energy and innovation.
First, they align on an ownership strategy. Over time, different members of a
family that owns a business will inevitably embrace objectives that require
different levels of risk, and some will want mostly to preserve the family’s
wealth, while others want to enlarge it. Such differences can bog down strategy
and decision making.
Aligning owners on one
set of objectives and guidelines can reduce the tensions that plague all
multigenerational family businesses. In one large third-generation conglomerate,
the owners of four branches with very different growth ambitions and risk
appetites had long found it hard to make decisions on possible M&A targets.
Through negotiations and the extensive modeling of assumptions about growth,
risk, and liquidity, the owners of the individual branches better aligned their
objectives for the future. This, in turn, opened up a path to speedier decision
making about M&A opportunities.
Second, we find that
many family businesses sustain an entrepreneurial spirit by internalizing the
market’s creative destruction, which forces them to build, operate, and
terminate businesses constantly. One approach is to divide the portfolio into
three parts: a creation part, often represented by venture-capital activities;
a core part, often run through a classic corporate center; and a trading part
(with defined exit rules), often represented through private-equity funds. Some
long-standing European family businesses clearly separate the components of
their portfolios in this way to encourage a diversity of managers, performance
metrics, and business cultures. The inherent long-term perspective of family
businesses enables such a strategy in ways that companies driven by quarterly
results have difficulty matching.
Finally, family
businesses can boost their entrepreneurism by fostering the talent of the
next-generation owners. Research shows that their “emotional ownership” is
generally high, even when they are not directly involved. Almost two-thirds of
the next-generation family members we questioned said that they felt themselves
to be part of the family business whether or not they worked for it.
If a company seeks to
involve the next generation in the business more closely, one way is to segment
its members by talent and to match them with components of a dynamic portfolio.
In practice, this could mean that those who show an aptitude for
entrepreneurship might run the family venture fund or build new businesses
supported by the company. In a number of family-owned retailers, for example,
next-generation leaders have separated the e-commerce arm from the core
business. Another segment might demonstrate a penchant for corporate life,
which could be pursued within the core business. Still another segment, with a
talent for trading, might work in the private-equity arm.
Above all, the key to
the ability of family businesses to thrive in an era of new constraints could
be injecting the markets’ dynamism into their ongoing business operations and
mastering the expertise to operate and trade companies at the ownership level.
The inherent aspiration to create something permanent gives these businesses an
advantage as long-term thinkers. But in an ever-faster-paced world, many of
them fall behind because they are excessively risk averse and too emotionally
attached to legacy assets. Next-generation leaders can often play a critical
role in making this strategic pivot when they get the responsibility for
bringing expertise in new technologies to bear on the existing businesses. In
other cases, we have seen new-generation leaders focus on venture capital to
foster new opportunities that carry old-line businesses into the future.
Finding the right governance balance
The entrepreneurial
drive and personal commitment at the heart of family businesses gives them an
advantage over companies with a more fragmented shareholder structure. However,
examples of family-owned companies with concentrated ownership, weak transparency,
and a record of treating some investors unfairly are common. As a result, they
face many unique challenges to arrive at a durable governance structure that
can handle the needs not only of the company but also of the family and the
ownership group. The task of finding a balance between the family’s informality
and a more rigid governance bureaucracy grows as businesses expand.
When we gauged a broad
range of organizational-health measures, we saw that family businesses have
particular governance strengths—for example, more delegation and empowerment
than would be characteristic of companies that have a broader shareholder base.8They are also better at
producing inspirational leaders, offering career opportunities to employees,
and rewarding and recognizing them for good work. In addition, we identified
superior practices for coordinating and controlling performance reviews and
managing operations and finances.
The healthiest family
businesses, we found, emphasize building commitment and inspiring employees by
giving them a sense of involvement, providing career opportunities, and
encouraging personal responsibility. The least healthy9ones overemphasize an
authoritarian leadership style, formal policies, and rules. Such traits
encourage bureaucracies that often slow down decision making—traditionally, a
problem for consensus-driven family businesses. When we asked 161 of their
executives if they found it easy to make investment decisions, just 24 percent
said that they did. Only 12 percent said it was easy to make capital-allocation
decisions. Only 6 percent think that their companies make both types of
decisions quickly.
In an era when agility
is at a premium, the key challenge for many family businesses is finding the
right path from an informal, centralized decision-making process to a more
empowered top team. One way to speed up decision making is to concentrate
shares in the hands of fewer stakeholders. In a fourth-generation European company,
more than 15 cousins held similar numbers of shares but had different levels of
interest in the business. Decision making therefore became increasingly
complex. After five brothers bought shares from their cousins, the company
could define new roles and responsibilities that speeded up decision making.
In our experience, the
hallmark of long-lived family businesses is strong governance revolving around
an active board of directors that steers the business, accompanied by a
separate council to manage family matters. The trick is to avoid an excessively
formal governance process and slow, difficult decision making. In our survey,
nine out of ten family-business directors said they had a clear understanding
of the roles and responsibilities of the board, were motivated to serve on it,
and trusted one another. About eight in ten said that board members were
aligned around the future direction of their companies.
However, other
executives, especially nonfamily ones, see opportunities to improve these
boards. “We need younger, new blood,” one executive said. “We need to have
international experts to develop expertise in some key strategic areas.”
Diversity is another issue: eight out of ten board members (all current family
owners and top executives) said that the personalities of board members and
executives were similar. Only 10 percent of the companies we surveyed have a
woman on their boards.
One of the most
striking insights from our research into the elements that distinguish
better-performing family businesses from the rest is the importance of
informal, inspiring leadership that provides generous career opportunities for
nonfamily professionals. The worst performers often have a rule-based,
authoritarian governing style. The involvement of owners in top management
holds the promise of dramatically boosting a company’s strategic agility,
particularly compared with CEOs of publicly held corporations. The fact that a
majority of large family businesses remain privately held underlines this
point. When the need for a more formal governance structure arises, such
businesses shouldn’t lose sight of the role leadership plays in maintaining the
entrepreneurial spirit of the company founder.
The family-capital conundrum
Family capital, a
bundle of unique resources, represents a true differentiator between
family-owned businesses and companies with a fragmented shareholder base. In
short, family capital expresses itself as the organization’s culture, ethos,
and network. While hard measures linking it to performance are elusive, it
clearly conveys powerful advantages. For example, our Organizational Health
Index database indicates that family-owned businesses enjoy a significant
advantage in providing career opportunities to employees—a gap that grows even
wider among family businesses in the top quartile of healthy companies. Family
capital also conveys intangible organizational advantages, including a sense of
belonging, loyalty, and commitment to the development of employees. In
addition, it fuels a social conscience that extends to philanthropic engagement
and fuels a virtuous cycle of family capital.
Our research unpacked
the four distinct components of family capital: tribe, family identity, trust,
and stewardship.
Tribe
Tribe is the sense of
connectedness, shared culture, and support in the social fabric of a family
business—beyond the immediate “clan,” or owning family. It is expressed through
a sense of closeness that nonfamily employees feel toward the owners. Around
two-thirds of respondents in our survey said that they felt or strongly felt a
degree of togetherness in their organizations and believed that the owning
family would help employees in a personal crisis.
Vitabiotics, the UK
producer of neutraceuticals, provides an example of this sense of connection in
a first- and second-generation family business. Treating staff as extended
family is a core company and family value. When a longtime member of founder
Kartar Lalvani’s administrative staff became ill, he provided her with
treatment for several months until she recovered. Although the employee could
not work full time upon returning to the job, Lalvani paid her a full salary
for five years.
In another large
family-owned business, family owners and the nonfamily CEO take to the road
throughout the year to demonstrate a commitment to the wider workforce. In what
an executive calls “management by walking,” company leaders meet 7,000
employees each year, interpreting and espousing the family’s values through
engagement with the workforce.
Family identity
The degree to which
members of families that own businesses identify with them can vary widely.
Family identity also extends to how consciously families decide to express
their image through the company’s brand and how much a sense of family promotes
the family’s legacy and visibility in the market. In our survey, 72 percent of
respondents said that family values are incorporated into the business brands
of their companies. Fifty-nine percent said that a sense of family atmosphere
upheld the owners’ visibility and legacy. Yet there is room for improvement.
Overall, only 46 percent of respondents said that they agreed or strongly
agreed that family identity was felt at all levels of the organization.
British footwear-maker
C&J Clark is an example of a company conscious of preserving a family
identity in its business. Its leadership style, which relies on consensus to
make decisions in board meetings, expresses the owning family’s Quaker roots.
Company leaders also made a conscious decision to keep the headquarters in the
rural English village of Street, despite its remote location, to honor the
family’s origins. The physical attributes of the headquarters building manifest
the family’s culture and history, which includes an artistic vein. Paintings,
sculptures, and idiosyncratic architecture selected by family members fill the
building, and the original longhouse factory for making shoes by hand is
maintained as a mini-museum in the otherwise modern and sleek headquarters.
Trust
In essence, family
capital’s trust element refers to the owners’ reliability: the degree of trust
the organization’s members have in the ability of family leaders to improve the
company’s performance, to keep their promises to stakeholders, and to do what they
say they will do generally. Our research finds that respondents have a high
level of trust in family leaders.
Trust also extends to
the broader communities where family businesses operate. At one Indian business
in our sample’s infrastructure-and-construction sector, the chairman uses the
family foundation to build trust in places where the business operates, since
its large construction projects can disrupt them, and to instill his values of
teamwork and respect for individuals into his employees. The foundation’s
efforts include operating mobile hospitals that treat thousands of residents,
building free vocational-skill centers, and establishing village-level
empowerment groups that help women build marketable skills. Employees are
motivated to participate in this kind of community work by receiving three paid
days off each year to devote to the foundation’s projects.
Stewardship
In the chemistry of
family capital, stewardship denotes the strength of family values, the idea
that family leaders put the organization’s interests above their own, and the
degree to which they take a long-term perspective. Overall, our research found
that large majorities of respondents, from board members to middle managers,
believe that family leaders serve as good stewards. In our
organizational-health research, family-owned businesses scored significantly
better than other companies for shared vision and meaningful values. When we
asked family and nonfamily members of these businesses to state their most
important values, five led the list: a long-term perspective, honor, doing the
right thing, fairness, and authenticity. In our experience, the vision of the
founder is the unique source of values for family businesses.
Of course, the benefits
of even a positive family-oriented network can go awry in the mix of personal
and professional tensions that may characterize such a business. If applied in
excess, the qualities that make up family capital can encourage overly
authoritarian leadership and introversion, discourage diversity, and build a
“fit in or fly off” culture. These weaknesses can make managing performance all
the more difficult.
Awareness of family
capital’s dark side is the first step in controlling it. The second is a
concerted effort to counter these negative effects by systematically sharing
knowledge, encouraging innovation, and implementing solid talent- and
performance-management systems. Family businesses are also extremely well
positioned to counter a lack of diversity: half or more of their shareholder base
is typically female. Yet only a tiny portion of our participating businesses
have even one woman on their executive committees. McKinsey research finds that
companies in the top quartile for gender diversity have returns on equity that
are 47 percent higher than the returns of those with no women at the top.
Including outside nonexecutive directors to challenge company leaders is
another way to battle blind trust and complacency.
Family capital is the
strongest intangible asset of family businesses. In the most successful ones,
owners can always be seen to hold strong values, adhere to them, and pass them
along to the new generation. In some companies, the processes to encourage this
outlook are quite elaborate. Attracting, aligning, and motivating employees are
necessary steps in building a strong culture—the inimitable, competitive
advantage of any organization.
The next-generation imperative
Since so few family
businesses survive to their third generation, it is perhaps not surprising that
respondents to our survey strongly indicated that developing, engaging, and
motivating the next generation of family leaders is their biggest challenge.
The logic behind these sentiments is clear. Family owners want to keep the next
generation involved to maintain the business as a source of family pride, to
preserve the founders’ legacy by keeping it within the family, and to better
maintain the family’s values and image in society. Accomplishing all this
during a period of swarming new competitors and tighter profit growth is a
challenging task.
Our respondents say
that conducting generational transitions isn’t easy, either for newer
businesses or for those that have survived as long as seven generations. Survey
participants cite the challenges of ensuring that values remain constant across
generations whose lives can vary widely—compare the international MBAs of
younger generations with the more home-grown experience of older ones.
Attracting younger family members to a business is also difficult if they have
competing job opportunities or their interests differ. When to begin a
generational transfer is challenging, too, since it has no clear starting
point. Finally, the transition is something that most families prefer to avoid
because the change and loss it involves are difficult.
Successfully managing
the development of the next generation as motivated and responsible
shareholders requires both a technical and an interpersonal focus. A critical
element is providing new family executives with support to manage their careers.
Our research points to three important guidelines for family businesses
engaging the next generation and preparing it for succession.
1. Build emotional
connections. The survey
revealed high levels of emotional ownership in the presiding family group and
the next generation. Seventy-seven percent of these respondents rated their
emotional ownership as high or very high. But when asked if the older
generation was very responsive to the needs of younger ones and took a close
interest in their activities, 36 and 30 percent of next-generation respondents,
respectively, disagree or are neutral. “Communication is difficult, especially
across generations and borders,” says one younger family executive. “We live in
quite different worlds.”
The gap highlights the
need for more active, clearer communication by older leaders, as well as
support to promote active and emotional ownership among younger family members.
By keeping them informed about what’s happening in the business—for example,
arranging regular meetings and promoting family rituals—the current leadership
can stimulate communication to engage them and transmit family values.
2. Develop responsible
shareholders. Our survey
revealed that next-generation family members are willing to take on more
responsibility in running the family business but lack the confidence to do so.
Two-thirds of them would like to have more responsible ownership roles, yet
only 30 percent feel confident about making decisions involving the family
business. Just 30 percent feel that they manifest active ownership in it,10compared with 94
percent of family members who work there.
Developing responsible
shareholders is thus a top priority for family leaders to uphold tradition and
increase the company’s value for the future. “It is essential that the next
generation understand the importance of our legacy,” says the chairman of one
family conglomerate.
Preparing the next
generation to engage more deeply in the affairs of a family business begins
with a concerted communications strategy to engage younger members. Engagement
has to go beyond family newsletters and assemblies. The best advances come when
the next generation takes charge of its own personal development. In one such
business, younger family members shaped their own shareholder-education program
and hired professionals to help them run it—with the seniors’ blessing, of
course. Another family focuses on creating mechanisms to help it make the best
decisions for the broad family group, whose leaders have set up a venture fund
that teaches the next generation to make business decisions collaboratively.
Families achieve the highest level of engagement when their members work
together in the informal and relaxed way that younger people value.
3. Establish clear
rules and career paths. A
leadership position is not the only role for members of the next generation.
There are several important roles to be played above and beyond full-time
employment, including work as advisers, board members, family-foundation
leaders, and responsible and active shareholders. It’s critical to develop the
paths available and to explain how family members can embark on each of them.
An open-door policy for
family members is common in the first generation, to reflect the wide variety
of career paths in the working world. We have found that clear guidelines and
guidance are necessary for those who want to join the business. These include
clear rules about meritocracy, explicit entry and exit requirements, and
conditions (such as feedback from managers and coaching) for development.
This is a long game to
play, but family businesses are uniquely positioned to succeed at it. Many
owners have grown up with a stewardship model that calls on them to give the
next generation something better than what they received. By focusing on family
capital and making additional investments to support it, attentive owners can
weather—and thrive in—an era of heightened constraints.
Family businesses outperformed more
widely held competitors in many ways during an era of expanding profitability.
But a new era of profit constraints will test the strengths and weaknesses of a
business model that uniquely mixes the personal and the professional. Family
businesses that can pivot to greater innovation and savvy risk taking will
continue to benefit from their unique strategic makeup.
By Åsa Björnberg, Ana Karina Dias, and
Heinz-Peter Elstrodt
http://www.mckinsey.com/business-functions/organization/our-insights/fine-tuning-family-businesses-for-a-new-era?cid=other-eml-alt-mip-mck-oth-1610
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