What You Can Learn from Family Business

Many think the term “family business” connotes a small or mid-sized enterprise with a regional focus and familiar problems, including succession disputes. Although several mom-and-pop businesses fit the description, they still need to fully reflect the significant role family-owned companies play in the global economy. They contain sprawling companies like Walmart, Samsung, Tata Group, Porsche, and Tata Group. However, they also represent more than 30 percent of businesses with more than 1 billion USD in sales, as per The Boston Consulting Group’s research.

The conventional wisdom is that the unique family-owned structure can provide them with the long-term focus that public companies typically need. Beyond that, little is known about the factors that make family-owned businesses unique. Certain studies suggest that, in general, they are more successful than other companies in the long run, but other studies show the opposite.

To answer this query, we, together with Sophie Mignon, an associate researcher at the Center for Management and Economic Research at Ecole Polytechnique, compiled a list of the 149 family-owned and publicly traded businesses with revenues exceeding $1 billion. They were in the United States, Canada, France, Spain, Portugal, Italy, and Mexico. In every business, a family held a substantial share, although not always a majority of the shares, and family members were on the board of directors and in management. We then created a comparability group of similar companies from the same regions and sectors that were similar in size but not owned by families. (We did not look at Asian companies since there are so many family-owned ones that it is hard to develop a good comparison group.) Then, we conducted a detailed study of how these two kinds of firms were governed differently and how they affected their performance.

Our research shows that family-owned businesses earn a different amount of money in good times in the economy than those with distributed ownership. However, when the economy is down, family-owned businesses outperform their competition. When we examined the business cycles between 1997 and 2009, we discovered that the average long-term financial performance was more significant for family-owned businesses than non-family businesses in all the countries we studied.

The most obvious conclusion is that family-owned businesses focus on resilience rather than just performance. They do not take advantage of the high profits they can earn during good times to improve their chances of survival in difficult times. A CEO of a family-owned company may enjoy the same financial incentives as the chief executives of companies that are not family-owned. However, the familial obligation feels it can lead to distinct strategic decisions. The CEOs of family-owned companies typically invest within a ten or 20-year timeframe and focus on what they can do today for the benefit of the future generation. Additionally, unlike most CEOs, they take care of their risks more than they manage their upsides and seek to make their mark by outperforming.

In a world where the top managers of every business are urged to think about the long run, family-owned businesses run by well-trained people could serve as role models. In our studies, we found numerous companies with dispersed ownership that had similar strategies to those of family-owned businesses. These companies also showed the same performance pattern, which was lower than their competitors during periods of growth but leading during times of crisis. (See the section “It Operates Like a Family Business– but It is Not.”)

1: They are shrewd both in good and bad times.

After years of analyzing the family business of our grandparents, we have concluded that it is possible to recognize one from the lobby of the company’s headquarters. Contrary to the vast majority of multinationals, many of these companies do not have luxury office spaces. The CEO of one global family-owned commodity firm stated to the media, “The easiest money to earn is the money we haven’t spent.” Although numerous corporations utilize options and stock grants to transform managers into shareholders and reduce principal-agent conflicts and conflict, family-owned companies are infected by the notion that the company’s cash is the family’s, and consequently, they have tremendous success in managing their expenses. When you look at a company’s financials in the past economic era, you will find that family-owned businesses could survive the recession with lower costs, which means the likelihood was lower to make significant cuts.

They keep the goal of capital expenditures at a high level.

Family-owned firms are cautious regarding capex. “We have a simple rule,” the owner-CEO of an established family business told us. “We do not spend more than we earn.” This may sound like common logic. However, the fact is that you rarely hear these words spoken by corporate executives that are not owners. The CEO, who is the owner, added: “We make roughly EUR450 million of free cash flow every year, so we try to spend no more than EUR400 million per year, and we keep the balance for rainy days.”

In most family-owned businesses that invest in capex, there is an additional hurdle to get over. The first is that a project must yield a decent return on its own merits, which is then compared with other possible projects to stay within the limits set by the company. Because they are more rigorous, families tend to invest only in solid projects. This means they need to be able to take advantage of opportunities (hence their poor performance) during times of expansion. However, their exposure is limited in crises as they have stayed clear of projects with borderlines that could turn into black pockets of cash.

3: They can carry very relatively little credit.

In contemporary corporate finance, judicious amounts of debt are viewed as an asset since leverage increases value creation. However, companies that families own are acquainted with debt with risk and fragility. The debt means that they have less room to move if the unexpected happens, as well as being dependent on an investor outside the family. The companies we examined were less leveraged than the other group. Between 2001 and 2009, the debt of these firms accounted for 37 percent of their capital on average. However, it accounted for 47% of nonfamily-owned firms with capital. Family-owned firms could make small sacrifices to finance their needs during the downturn. “People think we are rich and courageous,” one executive of a family-owned firm said to the media, “but we are cowardly–we leave most of the cash in the company to avoid giving away too much power to our banks.”

4: They purchase smaller (and smaller) firms.

Of all the moves managers can play, one of the most exciting is a transformational acquisition. It might be the one that is most difficult to resist. It is a risky investment but also has enormous benefits. Most family businesses we researched did not favor these types of deals. They preferred smaller acquisitions close to the heart of their current business or deals involving a simple geographical expansion. There were some instances where the family believed that its industry was undergoing changes or disruptions in its structure or when the management believed that not taking part in industry consolidation could jeopardize the long-term viability of the business. However, generally speaking, family-owned businesses need more energy to make deals. On average, we observed that they made acquisitions for less than 2% of their revenues annually, while non-family companies have made acquisitions worth 3.7%–nearly twice the amount. Family-owned businesses are more inclined to organic growth and often consider joint ventures or partnerships rather than acquisitions. The HR director of a significant family-owned luxury goods firm put the situation: “We don’t like big acquisitions–they represent too much integration risk, you may get the timing wrong and invest just before a downturn, and more importantly, you may alter the culture and fabric of the corporation.”

5: A lot of them exhibit a remarkable degree of diversification.

Many family-owned companies like Michelin and Walmart remain focused on their core business. However, despite generations of wisdom from the financial world that diversification is best accomplished by investors on their own as opposed to corporate investors and we discovered a considerable number of family-owned businesses, such as Cargill, Koch Industries, Tata, and LG, that had a greater degree of diversification than a typical corporation. Our study found that 46% of family enterprises were highly diverse. However, just 20% in the group were. Certain family businesses had expanded into new business lines organically. Others had bought small businesses in new fields and subsequently built upon their existing businesses. Executives we talked to claim that as recessions become more frequent and profound, diversification has become an important strategy to secure the family’s wealth. When a recession hits one industry, companies in different sectors could generate funds enabling a business to invest in the future while rivals retreat.

6. They are more global.

Family-owned businesses have been ambitious in their international expansion. They have more sales overseas than most businesses; approximately 40% of their profits are generated outside their home area, compared to 45% of revenue at non-family-owned enterprises. However, family businesses usually achieve foreign growth organically or through small local acquisitions–without big cash outlays. They are also highly conscient when they enter the market of a new. “We accepted that we’d lose money in the U.S. for 20 years, but without this persistence we would not be the global leader today,” states an executive of a family-owned global company that sells consumer goods.

They retain talent more effectively than their counterparts do.

The retention rate at family-owned businesses the study examined was better, on average than the other companies. Only 9% of employees (versus 11% of non-family businesses) were replaced yearly.

Family-owned companies praise the advantages of longer employee tenures, which include greater trust, a greater understanding of coworkers and their decisions, and better company culture. They share a lot with what researchers Karlene Roberson and Karl Weick describe as “high-reliability organizations,” in which teams of experts who have been in the business for a long time create effective team dynamics and a common mindset that allows them to achieve their objectives. According to the CEO of a multi-million dollar diversified company: “We don’t have the smartest guys out there, but they know their job like nobody else, and when a problem hits they can act immediately as a team–one that has been there before.”

In contrast, family-owned businesses typically do not rely upon financial rewards to boost retention. Instead, they create a culture based on determination and goal, avoid layoffs in recessions, encourage from within, and invest in their employees. Our study revealed that they splurged more on education: EUR885 a year per employee, on average, compared to at least EUR336 for non-family firms. Examine these seven principles, and you will see how synergistic and coherent they are. Following one of them makes it simpler to follow the next. A low-cost approach and a lower level of debt can reduce the need to lay off employees, which improves retention. International expansion is an opportunity to diversify risks. Fewer acquisitions mean less debt. The money saved by frugality can be spent wisely if the company maintains a high standard for capital expenditures. Instead of focusing on one area of each principle, they complement each other well.

When we meet with the top managers of family-owned businesses, They smirk at rivals with a reputation for “bet the farm” or “swinging for the fences.” They discuss the things that keep them awake late at night. Although they recognize they are losing opportunities because they are too prudent, they want to reap higher profits in the future as business cycles shift from bad to good.

The cycles are increasing in speed. If the pattern continues to be the case, then the resilient strategy of family-owned businesses may be attractive to any company. In a world economy shifting between crisis and crisis with increasing frequency, settling for the possibility of a lower return during good times to guarantee survival during times of crisis could be a choice that executives are delighted to accept.