Article: The Fortunes of Family Firms: What makes them flourish or flounder?

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The Fortunes of Family Firms: What makes them flourish or flounder?

If different promoter-family members steward traditionally conflicted functions or businesses competing for resources, their familial ties can reduce the bitterness of organizational battles. But being a sibling is not a permanent guarantee of kindred feeling. So when do blood ties become liabilities?
The Fortunes of Family Firms: What makes them flourish or flounder?
 

Since "founding families view their firms as an asset to pass on to their descendants rather than wealth to consume during their lifetimes", they have the invaluable advantage of 'patient capital'

 

Turns out, far too much has been written about great men and not nearly enough about morons. Doesn’t seem right." What Tyrion Lannister said about great men applies even more strikingly to great family firms. Admittedly, I have not examined each one of the approximately 5,64,00,00,000 results Google yielded to the search for family firms but the first five pages didn’t yield a single negative entry. Here is an attempt to restore the balance slightly. 

The intention is not simply to criticize family businesses. Having worked in both family-firm and non-family-firm environments, I have personally experienced the numerous advantages the family firm has in turbulent times and over the longer term. This column starts with listing these. I will then explore some of the fatal flaws that, in some cases, can destroy family firms. Finally, I shall turn to a few lesser-known remedies that can prevent the fires that burn in the bellies of family businesses from being extinguished.

The Nimblest Game in Town

When I moved from the European headquarters of an MNC to join a reputed family group in India, one of the first projects I undertook was a thorough revamp of the Performance Management System (PMS). It happened to have been a project I had struggled with for over six months in the MNC and even at the end of that time there remained business verticals that exercised their 'federal' right to stick to the earlier version. In the family group here, we designed and rolled out the new PMS in the two months that remained between my joining and the start of the new assessment year. That included bringing key stakeholders on board, training both assessors and assessees, and putting the requisite IT systems in place. Of course, only the full backing of the family patriarch made this possible. But that precisely is the point. When a family-led firm backs the professionals it hires, it can turn on a dime with an agility that remains the unrealizable dream of firms that do not have family quicksilver coursing through their veins.

Where the agility of the family firm truly comes into its own is in driving large-scale change. Such change, by definition, faces opposition from powerful players in any organization. Once again, the combination of a pioneering professional paired with a powerful champion from the promoter-family provides an irresistible force. Huge amounts of time, which a professional change-agent would have to spend to establish credibility before even being heard, are saved. Everyone is eager to give the new approach at least a fair trial other than the most vested interests and even they are circumspect in their criticism. Inevitably, a complex change effort faces ups and downs, especially when the pace is forced. During the downs, there is a distinct possibility of managers unhappy with the change forming a coalition to eject the change agent from the program or even from the organization as a whole. These setbacks are virtually impossible when the key backer is an important promoter-family member and, as a result, the change effort progresses at a much faster speed than it could have otherwise.

Another reason family firms can drive radical change is that they are relatively freer from the tyranny of having to justify quarterly results. This also permits them to avoid short-termism of other varieties. Since "founding families view their firms as an asset to pass on to their descendants rather than wealth to consume during their lifetimes",1 they have the invaluable advantage of 'patient capital' and a long-term perspective is virtually encoded in their DNA.

During the years I spent with a family group, we recruited scores of people from large MNCs – most of them headquartered overseas – without the lure of very high compensation packages. To do so, we developed an Employer Value Proposition that stressed the much higher empowerment a family firm like ours could provide to professionals. While this had always been a reality by and large, we institutionalized and routinized the decision-making authority people could wield and removed the minor but noticeable exceptions to the freedom of action enjoyed by managers. Of course, we got unexpected help from the MNCs themselves, many of which chose, at just that time, to reduce the traditional autonomy enjoyed by their India operations and devolve it to global business heads or to regional satraps. Most family businesses can exploit this advantage once they get over the 'control freakism' that a few founders exhibit.

The best-run family businesses also get the benefits of better team-work and lower organizational politics at senior levels than other enterprises. The prerequisites for this special dividend are: a single promoter-family member in charge with no succession battles on the horizon. In such situations, if different promoter-family members steward traditionally conflicted functions or businesses competing for resources, their familial ties can reduce the bitterness of organizational battles. Being a sibling is not a permanent guarantee of kindred feeling, however, as Abel, Remus, Dara Shikoh and many others found out to their cost. When do blood ties become liabilities?

Lears of Dysfunctionality

Sibling rivalry can lead to some of the most destructive outcomes for family firms. However, it is not the root source of dysfunctionality in most cases. The origins of the destructive canker are more complex.

To illustrate the origins and consequences of the problems that can bring family-run businesses low, I was sorely tempted to use examples from the family firms that I and people I know closely have worked in. Valor and discretion waged a long battle and valor was vanquished. I shall, therefore, rest my illustrative guns on the broad shoulders of Shakespeare and of his supreme tragedy, King Lear. In a recent interview (aired 27 July 2018) Ian McKellen told Christiane Amanpour that "Shakespeare is very, very interested in people who have power and he wants to tell you what they’re really like and what a dangerous thing it is to have too much power. And King Lear is such a man …" 

As McKellen hints, the tragedy of King Lear originated long before the action of the play in the many years of autocratic rule he enjoyed with advisors (presumably) telling him what he wanted to hear and not necessarily what was good for his realm. Lear’s great susceptibility to praise and the precipitate decisions he took even against his favorite child when she didn’t dish out enough of it was the culmination of "a long life of absolute power, in which he has been flattered to the top of his bent …"2. In an earlier column, we have seen how unrestrained power (and owner CEOs usually have much more of it than professional CEOs) leads them to take capricious decisions that erode organizational performance and summarily dismiss those who would speak truth to power. 3

The most deleterious consequence of arbitrary power exercised to the drumbeat of constant praise is what it does to the professional fabric of the organization. When the CEO’s ill-advised decision-making exacerbates a major crisis, whether brought on by external factors and competition or internal developments such as succession struggles, senior professionals reveal their true colors. The stronger and more independent characters either become Kent-types (if they remain true to the purpose of the organization even at cost to themselves) or the Edmund-types (who use the unsettled conditions to aggrandize themselves and willfully destroy whoever is in the path of their personal ambitions). Then there are the weaker, follower kinds of professionals, who simply adhere faithfully either to the old order (the Gloucester-types) or to the emerging lights (the Oswald-types) but these usually do not materially affect the unfolding narrative. 

As in Lear, the bloodiest family-business battles take place when succession is on the table. Unfortunately, also like in the play, it is normally not the nicest guys who win. We may not go to the extent of saying (as A C Bradley did about Goneril) that "She is the most hideous human being (if she is one) that Shakespeare ever drew" 2 but some winners incorporate family battles would certainly find it difficult to get rankings in the most-wonderful-person awards. When viciousness is victorious, it does something to the culture of the organization and lowers the standard of behavior that is considered to be acceptable for winning.

Almost fifteen years ago, Heinz-Peter Elstrodt wrote an article in the McKinsey Quarterly4 stating that only 5 percent of family businesses continue to create shareholder value beyond the third generation. This became known as the curse of the third generation. Our Shakespearean analysis takes us to a similar conclusion for dysfunctional family firms, where arbitrary decision-making and intolerance for honest feedback breeds a group of polarized and political professionals who are more attentive to their own gains than the good of the organization. As we have seen, these distractions and sub-optimal decisions reach a peak when there is a fought succession. Few organizations can survive three such debilitations.

Kinning Where it Counts

So much has been written about arresting the dysfunctionality and consequential decline of family businesses that I would like to deal only with a few aspects that have not received adequate attention. One of these is the freedom owners give to professional managers and the backbone and sensitivity with which these professionals exercise it. Obviously, this freedom comes at some cost to the absolute power of the owner-family. A lot, therefore, depends on how freely they permit this devolution of power.

Matters are a bit easier for first-generation entrepreneurs. The influence they wield is an amalgam of the creative fire, infective drive, and organizing prowess that earned them success, together of course with the unquestioned power they enjoy. Succeeding family generations, unless particularly gifted, may just have the power component to wield. When they use it to interfere with professionals excessively, they risk falling prey to its attendant temptations and consequences, especially if they have poor or self-seeking advisors. It is in the 'next-gen' successors’ hands to decide whether the fortunes of the firm are placed in the hands of the Kents (however cantankerous they may be) or the Edmunds of the corporate world. It is not enough, however, just to choose the right professionals. There has to be a structure which permits them to operate with freedom. 

I find it useful to think of the governance structure of family businesses in three layers: the professional management, the providers of active oversight and the (relatively passive) owners, with each of the upper layers having appointing and terminating authority over the one below. It might be reasonably pointed out that this is no different from a standard corporate structure with the Independent Directors of the Board providing the oversight layer. This would be true except that most independent directors have neither the time or the power, nor the skin-in-the-game to exercise genuine oversight. In fact, the impotence and ineffectiveness of Independent Directors is one of the great corporate governance challenges we face (and which will not go away even if we have more active owner-family oversight). Beyond a point, Independent Directors and actively involved promoter-family members have different interests to protect and are both needed for doing so. To come back to the point, family run businesses can steal a march over other firms when committed and keen family members become a 'superactive' board. While they collectively oversee and evaluate the top professionals of the firm, individual family members take on mentoring and championing roles for key business units and functions. Beyond active oversight, mentoring and championing, under this model, owner-family members should not play day-to-day executive roles themselves.

While the oversight layer is distinct from the management base, choosing the right individuals from the owner family, training them, and then allocating and inducting them into appropriate oversight roles requires no less attention than similar processes for the company’s regular management. There are a few vital differences between the two, however. Scions of the owners can never get a true feel of working in various functions and at different levels within their own family’s businesses.

They must spend their initial years taking jobs which they can acquire on their own merit and not because daddy’s friend gives them a position or a consultancy, eager for the family firm’s business, provides a berth of convenience. This experience should be sustained and rich enough for the person to be inducted directly into the oversight role with just a brief induction. It is futile to put these supposedly 'normal' owner-family members as trainees and later junior managers in the family firm and getting them evaluated like all the rest. The sands of the corporate world are filled with the whitening skeletons of managers who believed the parental claptrap and gave an honest rating of the 'royals', warts and all.

This doesn’t mean the princelings shouldn’t be evaluated. Just that the assessments should be carried out by senior family members or independent outsiders who have no other remunerated relationship with the firm or friendship with the promoter-family. Progressive family firms can reduce the potential for whimsicality in the treatment of senior professional managers by voluntarily adopting codes of conduct for owner-family members.

Such codes not only reduce the scope for misunderstandings and humiliations but also prevent misuse of the company’s processes and perquisites. 

The CHRO’s Role in Dysfunctional Family Firms

What should a professional CHRO do in an enterprise with dysfunctional family dynamics? If s/he has gained the trust of senior professionals, they too will turn to the CHRO for guidance or at least a patient hearing. This is the time to prove that the CHRO is the true guardian of the organization’s professed values and not simply a loudspeaker who finds the right jargon to support the actions the dominant family faction wishes to take. 

It is the rare family business in India that has separate and independent HR counsel for members of the family. Hence, the professional CHRO has to deal with sensitive and (sometimes) no-win issues such as those relating to the assignment, evaluation, and rewards of owner-family members as well as the frequently conflicting demands each of them makes. In this scenario, however politically savvy and competent the CHRO may be, it is inevitable that one day s/he will have to face a choice between kowtowing to an owner-family member’s whim on a matter that gravely compromises professional integrity or take the highway. When confronted with the demand to confirm or implement decisions owner-family members take to the detriment of the overall organization, I hope some of us have the courage to give up our continuation in that firm even if we don’t use Kent’s words while doing so:

What wilt thou do, old man?

Think'st thou that duty shall have dread to speak,

When power to flattery bows? To plainness honour's bound,

When majesty stoops to folly. 

… Nor are those empty-hearted whose low sound

Reverbs no hollowness.

 

Note:

  1. RC Anderson and DM Reeb, Founding family ownership and firm performance: Evidence from the S&P 500. Journal of Finance, 58, 1301–1326, 2003.
  2. AC Bradley, Shakespearean Tragedy: Lectures on Hamlet, Othello, King Lear, Macbeth, Macmillan and Company, 1919.
  3. Visty Banaji, Off With His Head - Is Due Process Past its Due Date?, People Matters. July 2018, 
  4. Heinz-Peter Elstrodt, Keeping the family in business, McKinsey Quarterly, 2003.
  5. William Shakespeare, King Lear, Act I Scene 1

Topics: Entrepreneurship

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