Professionalism can entail risks in family firms

By Andreas Raharso

“The first generation builds the business, the second expands it and the third destroys it.” It is a universally acknowledged phenomenon that few family-owned businesses survive beyond the third generation. While most business owners are highly successful in building and managing their companies, they are often less successful when it comes to transitioning their enterprises from one generation to the next.

In the typical evolution of a family business, it moves from the controlling owner stage to the sibling partnership stage and then to the cousin consortium stage. Professionalizing the business is generally considered to be a necessary step in its evolution, as expansion and survival would naturally require companies to benchmark industry best practices and tap into the external labor market for access to a higher quantity and quality of human resources. The best practices and experts in the corresponding fields can contribute significantly to a family firm’s expansion and success potential. They also in turn inject more professionalism into the firm, enabling the family company to achieve rapid financial growth within a short time span.

While conventional wisdom dictates that higher levels of professionalism within family businesses will translate into better firm performance, there is, however, a limit to the amount of professionalism that a family firm should adopt.

Let us examine Yeo’s, a well-known food and beverage brand in Asia that was started as a family business in 1901. Today, none of the owners belong to the Yeo family that gives the brand its name. By the 1990s, squabbles over investment and business management decisions had caused tensions among the third generation of the Yeo family and led to an acrimonious dissolution of the business.

Yeo’s history illustrates that the initial success attained through professionalizing family businesses is often offset by problems, squabbles or even family feuds. The reason why many family companies fail to survive beyond the third generation actually lies in the process of professionalizing itself. How so?

a. Professionalism cannot sufficiently address the complexity associated with family ties. The involvement of the family in family businesses creates complexity and may undermine the business structure and theoretical methodologies commonly employed in non-family enterprises. For instance, professionalism requires all organizational processes to be intrinsically involved in delivering shareholder value. However, in the case of a family business, organizational processes must factor in not only the business, but also the family dimension, which encompasses both human and emotional aspects of the family. Enforcing professionalism could mean ignoring the family dimension, thus resulting in family conflicts that threaten survival of the business.

b. Professionalism causes family businesses to lose their inherent competitive edge over non-family businesses. It has been widely established that family businesses have a competitive advantage over non-family businesses. For instance, family firms have a unique working environment that fosters a family-oriented workplace and inspires greater employee care and loyalty. In fact, family businesses have reportedly seen better performance than non-family businesses, with an annual return on assets that is 6.65% higher than the return on assets of non-family firms (David Thayne Leibell, “Succession planning,” Trusts & Estates, March 2011).

However, as the level of professionalism rises, the traditional business structure and family relationships in the family business are gradually eroded. These consequences, coupled with the inherent complexity of the family business, may cause the organization to lose its competitive edge and eventually fail to survive.

Family capital as the cornerstone of success

Despite well-known headlines that captured the public’s attention, such as “Rum on the rocks: Bacardi’s family secrets are spilling into a court fight” and “Hot dog joint made famous on M*A*S*H [Tony Packo’s] threatened by family feud,” many family businesses have successfully bypassed the cold, harsh track to transcend beyond their third generation. In fact, the world’s oldest hotel, Hoshi Ryokan in Japan, is a family business that has successfully run for 1,300 years and transcended across 46 generations. In the West, we have Lyman Orchards in Conneticut (managed by its eighth generation), Heineken in the Netherlands (managed by its fourth generation), etc.

Indeed, successful family businesses today have engaged in some form of professionalization before they arrive at their current market standing and yet have managed to transcend beyond their third generation. Hence the question: Why them, and not the rest?

What most successful family companies have done to achieve their current performance goes beyond professionalizing their businesses. While it is important to professionalize to attain strong financial capital, it is even more crucial to secure a high level of family capital. This is achieved through building a strong, gratifying and supportive relationship among family members.

Family capital enables the firm to move forward as a unified body without strife and dissension, thereby ensuring its sustainability. Healthy relationships among family members aid in bonding the family together in tumultuous times and are a good form of defense in warding off hostile takeovers.

A strategy that overemphasizes professionalism and neglects the family will lead to a deteriorating family business. Even though the business might thrive initially, the family, which forms the basis of the enterprise, will start to fall apart, ultimately causing the business to fail. The study “Correlates of Success in Family Business Transitions,” by Michael H. Morris and associates (Journal of Business Venturing, September 1997) found that 60% of succession plans failed because of problems in the relationships among family members.

Kikkoman Corporation, a family company that was founded in 1630 and is still thriving today, demonstrates the importance of focusing on family as well as financials. A creed the company adopted in 1926 formalized numerous habits and traditions typically found in families, including “make strong morals your foundation, and focus on money last,” “strive for harmony in your family” and “have a family reunion twice a year. At these reunions, don’t judge your family members based on their income but rather on their character.” These core values were designed to support internal family harmony, and have worked well in sustaining the business.

What defines family capital?

Family capital is a unique form of social capital that is an asset to family enterprises. It comes in three critical forms.

1. The business connections and knowledge networks established by previous generations of family managers.

Implication: The next generation of family members can tap into these connections and networks, thereby fast-forwarding business success and ensuring business continuity. The new generations avoid making major mistakes by learning from their forefathers’ experiences.

2. Family rights and obligations. “Rights” refers to the power to make business decisions. “Obligations” refers to the responsibility of ensuring both the financial and the emotional well-being of other family members.

Implication: Meeting one’s family obligations maintains the fabric of familial relations and allows objective business decisions to be made with minimal opposition or ill feelings from family members that can threaten continuity of the business.

3. Family values and family governance (the set of processes and policies affecting how a family business is managed).

Implication: Teaching family values and professional ethics to the next generation equips future leaders with a sense of responsibility and the ability to differentiate right from wrong. The next generation of leaders will then act in a manner consistent with the preferred workplace behaviors and will integrate family values with other desired management practices.

Attaining deep pockets and warm hearts

It is important to maintain high levels of family capital to encourage further accumulation of financial capital. The current perception that professionalism is the key to long-term success in family businesses is misguided. Without accounting for family capital, professionalizing a family business will be equivalent to playing Russian roulette.

As the preceding case examples have demonstrated, family business success of depends on achieving balance between strong financials (deep pockets) and family capital (warm hearts). By monitoring the level of family capital on top of financial performance, family businesses can keep the hearts of their family members warm and the pockets deep, thereby ensuring long-term continuity.

Andreas Raharso (andreas.raharso@haygroup.com) is the director of Hay Group’s Global R&D Center for Strategy Execution, based in Singapore.

Copyright 2012 by Family Business Magazine. This article may not be posted online or reproduced in any form, including photocopy, without permssion from the publisher. For reprint information, contact bwenger@familybusinessmagazine.com.

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March/April 2012

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