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What Makes The Current Times So Great For Family Businesses ?


wealthymattersA commonly cited statistic is that only 30% of family businesses make it through the second generation, 10-15% through the third, and 3-5% through the fourth.

Now for some perspective : How many businesses of any kind are still around after the equivalent of three or four generations? A study of 25,000 publicly traded companies from 1950 to 2009 found that, on average, they lasted around 15 years, or not even through one generation!  In this context, family businesses look pretty enduring,don’t they?

In the hyper competition of the Fourth Industrial Age, family businesses have innate strengths over others forms of ownership, especially public companies. In the Second and Third Industrial Age, businesses had access to vast opportunities, which meant that winning strategies revolved primarily around size. Public companies had a clear advantage while raising massive capital. But firms today are no longer looking at endless opportunities. Instead, they have to struggle for their very survival in an intensely competitive world of slower growth and more frequent economic crises.

In these circumstances, the qualities often associated with family businesses that were a handicap before, are turning out to be powerful sources of advantage, giving them the potential to be more adaptive to the increasingly intense competition that all businesses are facing.

Specifically, family businesses have the opportunity to achieve sustainable advantages in five key areas:-

1.) Talent: From Mass Employment to a Higher Calling :

For much of the 20th century, success depended on a company’s ability to hire, train, and retain ever-larger numbers of employees. This was the era of the company man, where employees exchanged long-term loyalty for a livable wage and a pension plan. In today’s knowledge economy, success depends instead on finding, empowering, and retaining the most talented people. Businesses need to do more than offer competitive wages and benefits; they have to provide a “higher calling” that makes clear the intrinsic value of working for their companies. Employees want to work hard because they believe in their company’s mission and values, not just because they hope for a large salary or a fast promotion.Families are the primary carrier of values, and business families can weave their values into the very fiber of the organizational culture. Because employees work directly with the owners in family businesses, there is often a pronounced loyalty effect, which augments the important sense of mission.

2.)Investment: From Other People’s Money to Captive Capital:

In the scale economy, capital was the lifeblood of success. And given the pace of growth, capital was always in demand.In today’s economy, however, the priority has shifted from the quantity to the quality of investment. Outside funds bring with them a pressure to achieve short-term results that trade-off with value creation.Family businesses don’t have these problems because they can obtain “captive capital” that will not easily migrate to other firms. Their owners often think in generational terms – in decades rather than quarters or years. Without external markets to please, they can take a long-term perspective and make decisions on the basis of sustainable economic value. As a result, family equity can come at a very low cost of capital, where businesses can meet the annual needs of their shareholders without having to worry about paying back the principal. What’s more, since the money at stake is their own, family businesses tend to be cautious in their spending, and the discipline that comes from frugality is a tremendous advantage when top line growth is harder to achieve.

3.)Reputation: From Profit Motive to Sustainable Footprint:

In the past there were relatively few media outlets by which companies could build their reputations and the largest companies soon found a way to control them.At best unhappy customers could write a letter to the editor. Now, they can click a picture of a defective product, upload it to social media, and all of a sudden it’s gone viral!

Family businesses have a big head start in building a sustainable footprint.There is often a personal connection between the family and the communities in which it operates; reputations matter to families. Investments in the community are likely to have social rationale in addition to an economic one. With a longer time horizon, trade offs between strengthening the community and making profits can simply disappear.

4.)Organization: From Managing Complexity to Rapid Response:

The leading companies of the 20th century were behemoths. Henry Ford’s company covered the entire value chain from end-to-end, including owning the grazing land for the sheep whose wool was used in seat covers. But instead of managing highly complex structures, the greatest organizational challenge of the 21st century is dealing with change. Businesses need to be flexible, adaptable and able to take quick,decisive action in response to shifting market conditions. Family businesses are well-suited to dealing with this imperative of rapid response.They tend to have nimbler and flatter structures, where information flows quickly and easily in to the leaders and decisions come out. There is also often more of a direct connection from the ultimate decision-makers to their employees. While less adept at delegating, they can more quickly and decisively commit the organization to action. The privacy that family ownership allows also helps executives stay focused on strategy rather than meeting market expectations.

5.)Governance: From Separation of Powers to Engaged Owners:

Decision-making in large public companies is primarily vested in management, which generally is not composed of majority owners. As a result, ownership of the business is split from day-to-day control,creating a “principal-agent” problem. The traditional priority for good corporate governance has been to align management incentives with the interests of shareholders, often through equity-linked compensation plans. But by the end of the 20 century it had became clear that this endeavor has failed. Efforts to make managers act like owners through stock options have backfired, leading to skyrocketing pay, and opening the door to numbers-rigging scandals such as Enron.

The principal agent problem is far less severe in family businesses because they foster engaged ownership.The simple fact that there are fewer owners makes the oversight of decisions far easier; even family businesses with hundreds of owners are better positioned to provide effective oversight than public companies, whose owners can number in the hundreds of thousands. And when family members with large ownership stakes are also involved in managing the business, incentives are easily aligned.

The public corporation has been the dominant model for business enterprise for most of the last century, and this was the best solution to a particular set of economic circumstances. But those circumstances have changed and family businesses have the advantage now.

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About Keerthika Singaravel
Engineer,Investor,Businessperson

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