Risk is No Longer a Four-Letter Word

By Peter Davis

Family businesses have to discuss it openly andmaintain a consensus on how large a dose they can take.

When Jan Carlzon was appointed CEO of ScandinavianAirlines System (S.A.S.) inthe early eighties, the company was a stagnant bureaucratic organization that wasbarely surviving on what remained of its monopoly powers. Carlzon'schallenge was to restore the airline to profitability, and he acted boldly. He decentralized company operations, giving localmanagers extraordinary discretion to allocate resources. He focused the companyon a single market-the business traveler. He replaced 13 of 14 top managerswith self-starters who could lead thecharge in transforming the corporate culture. He took enormous risks while flyingthrough the storm of deregulation, andhe emerged with significant rewards.

At meetings with leaders of familybusinesses around the world, I frequently ask: "Does Jan Carlzon provideus with a role model for leadership inyour business today? Don't you all haveto become more heroic, take on biggerrisks, transform your companies?"

The answer I usually get is interesting.''There is a big difference betweenJan Carlzon and us," my listeners say."Carlzon didn't own the company."

It is true that when you own a company that represents perhaps 90 percent of your family's net worth, and is your only real source of income, youare going to handle risk a little differently than did Jan Carlzon. Carlzon,after all, was a hired professional whocould walk away from the company.

Because the consequences of failureare more severe for family businessesthan for other firms, they tend to minimize risk. As the business matures, asthe owners grow older, they adopt a"steady-as-you-go" attitude and avoidbold steps.

During the merger-and-acquisitionfever of the eighties, thisconservative,steady-as-you-go approach paid off forfamily businesses. Many ofthem are in good shapein the nineties, while thefast-track companies areheavily in debt and theleveraged buyout deals arecoming apart.

The challenge of thenineties is not how to winby avoiding risk; it is how toprosper by better managingrisk. What families in someindustries don't fully appreciate is that not taking risksin today's business environment can bejust as harmful.

Changes in the business world areforcing bold moves. Consolidation insome industries will make it difficult forthe smaller firm with limited resourcesto survive in the middle. As the big players get even bigger, the smaller companies have to grow quickly to reach a critical mass, or shrink to a niche.

Many family businesses are beingforced to change by conditions in theirindustry and by their own customers.One of this year's winners of the Malcolm Baldrige quality award, for example, was a family-owned pipe and valvesupplier in Houston, the Wallace Co.,which in the eighties was suffering fromdoldrums in both the construction andoil businesses. In 1984, one ofits biggestcustomers, Celanese Chemical, cameto the Wallace Co. and announced thatit planned to cut back radically the number of suppliers of pipes and flttings forits plants. Only those companies thatcould assure the highest standards ofquality and speedy, reliable deliverywould get Celanese's business.

To meet those standards, the WallaceCo. had to transform their operationsand make huge investments of time andmoney. That they managed in a fewshort years to introduce rigorous quality controls and shift their business tosupplying large chemical plants is a tribute to a family company'scapacity to change. Sincethe quality program beganin 1985, Wallace's saleshave grown some 69 percent to $79 million in 1989.

Wallace was forced torisk big change. Management had to step into newterritory, take risks withpeople, and trust that awhole new way of operating would work. However,becoming too dependenton the business of one bigpartner (or, in Waliace'scase, a few) is like learningto dance with an 800-pound gorilla. Ifyour partner decides to walk right overyou, it won't do much good to complain.

Global expansion of markets alsocalls for bold moves. Europe will be onemarket by 1993, and families that wantto take advantage of opportunities theremust make their move soon. Likewise,the planned free-trade pact with Mexico will necessitate more venturing south of the border.

How can family businessesdeal with these challenges?Clearly, they must be morewilling to take risks. But theyalso have to think before theyleap, and develop better planning. They have to investwisely, and make certain thatevery dollar increases competitive advantage.

One family firm in thepaper products industry wasabout to invest $50 million ina new paper-making machine, in a last-ditch effort tokeep up with its Fortune 500competitors. Fortunately,the CEO of the family company decided to take a goodlook at the alternatives.What he discovered was thatthe capital investment in papermaking would bring thecompany to a "me-too" paritywith the big guys. He con-cluded that the money wouldbe better spent on anothersignificant part of the production process--equipment for binding, packaging,and shipping that was needed to guarantee rapid delivery.

Most discussions of risk-taking infamily companies turn on where themoney will come from. Because theydo not want to share ownership and control, most family businesses financesuch capital investments out of internally generated cash flow or throughdebt. For most family businesses, raising new equity is today unacceptable orimpractical. With the banks in trouble,borrowing is also difficult. And the problem with debt is that it adds anotherfixed charge to the company's operations, thereby increasing the risks in adownturn. In most cases, more efficientmanagement of cash flow is thus theonly way to generate the financial flexibility that family businesses need tomake the moves that are necessary.

But there's one other aspect of the financial picture that must be considered.As never before, families today mustprotect themselves financially. To have90 percent or more of their personal assets tied up in a single business nolonger makes sense. The risks are simply too great. Families need to look atthe portfolio of assets they control, ofwhich the family business is one bigpart. They have to make sure there isadequate diversity in these holdings.Only by building a secure core of financiai well-being will they be able totake the risks inherent in running abusinesstoday.

If business owners cannot meet thecapital needs of their company and diversify their own personal holdings,they must look toward partnerships. For most familybusinesses, this goes againstthe grain. But, of necessity,we are beginning to seetremendous growth in thenumber of equity partnerships between family businesses and individuals or institutions that handle privateplacements. These invest-ments provide capital forgrowth (frequently into foreign markets) and for thesharing of technology andknow-how.

More and more, familybusinesses that are expand-ing into Japan, or Mexico,orEurope want to do so bymeans of equity partnershipswith local companies thatprovide a regional presenceand expertise. These partnerships also reduce indebtedness and risk.

One family firm that hasemployed this strategy is Barney's, the New York clothingretailer. To finance an ambi-tious expansion ofits stores inthis country and Japan, Barney's joined with Isetan, a fourth-gener-ation family business in Japan. Isetan willsupply about half of the initial $250 mil-lion for the expansion, according to theNew York Times.

The motivation for the deal was simple. "In 1986 we hired Goldman Sachsas an advisor and sat down as a familyto try to figure out how to grow and stillsleep at night," said Robert Pressman,vice-president and grandson of Barney'sfounder.

Risk is a major concern for familybusinesses today. They need to aggressively manage risk, not avoid it orflirt with it. They have to discuss itopenly, assess it frequently, and maintain a consensus about how large a dosethey are willing to take. They'll sleepbetter at night if they do.

Peter Davis is chairman of Family Business's advisory board, and the director ofthe Division of Family Business Studiesat the Wharton School.

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January/February 1991

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