Surviving Creative Destruction

By James E. Barrett

Long-range shifts in the marketplace threaten your firm’s survival but also offer opportunities. Do you have the will to manage them?

Sixty years ago the Harvard economist Joseph A. Schumpeter wrote about long–running forces that gradually but inexorably shake up markets and cause upheavals in the economy. Schumpeter saw what he called “creative destruction” as an engine of progress, causing new businesses to form, existing businesses to adapt, and non–adapting businesses to disappear.

These long-running forces may include dramatic demographic shifts, such as the migration of customers from rural areas to cities, or the influx of greater numbers of women into the workplace. Or they may result from changes in transportation, such as the growth in global air travel, which has made it cheaper and quicker for new competitors to reach markets where they had never been able to do business before. Or they may be due to new infusions of capital from Wall Street that have enabled companies in some industries to grow to a size where they can invade niches and take over smaller firms.

All businesses are subject to these forces, but family businesses, I believe, have special areas of vulnerability. Faced with long-range strategic challenges that call for major changes in the way they do business, too many family businesses fail to respond creatively. Their owners lack the resilience and commitment to make the wholesale changes that are needed for survival. Others get caught napping —they don't do a good job of tracking these trends or simply ignore the challenges until it is too late. The first reflex of too many family companies, when the creative destruction wave begins to wash over them, is to head for the lifeboats and sell the company.

If many family firms are particularly vulnerable to these forces, some have demonstrated exceptional strengths in coping with them. The four essential requirements for controlling creative destruction may be summed up in four C's: Capital, Commitment, Control, and Culture. Perhaps the most vital ingredient of all is a strong company culture in which everyone from employees and nonfamily managers to shareholders and family members are committed to making the changes that the situation often demands. For the CEO, another intangible is required: the will to manage. Many leaders of family businesses, especially founders, have the will to succeed. Far fewer have the will to manage.

I will examine in this article a few notable examples of family companies, past and present, that have either succeeded or failed at mastering the long-range forces that have overtaken them and threatened to overwhelm them. That should give us clues to how family companies can better track and counteract these forces—and demonstrate the importance of the “four C’s” to a successful survival strategy.

 

Why Studebaker disappeared

 

Older readers will remember the Studebaker Company, an Indiana based family firm that was well known as a manufacturer of farm wagons in the 19th century and became a manufacturer of automobiles and trucks in the 20th. John Studebaker, one of five brothers in a German family, had gone to California in the 1849 Gold Rush. While others panned for gold, he made wheelbarrows and tools for sale to the miners. When the boom faded, he returned with his capital to Indiana, where he and his brothers began producing implements and wagons needed by farmers.

Building on its brand acceptance by the nation's farmers, the Studebaker Co. began to build motorized work vehicles for farms. Pre–World War I photos show the strong resemblance between their early wagons and motorized trucks. The Studebaker brothers began producing good cars as well as trucks, but remained a rural marketing force.

Eventually, the business foundered and the family lost control of it because of the forces of creative destruction. With the decline of small farms, more and more of their customers moved to the cities. Studebaker was not able to follow them to these new markets to continue selling them their cars and trucks. Finally, Ford, General Motors, and Chrysler used their access to public markets to raise the capital needed to expand and innovate in the industry, and Studebaker was not able to match the Big Three’s capital. Studebaker vehicles remained clunky-looking, while its competitors' designs were more stylish and innovative.

The family hired professional managers, who corrected the investment and design problems. Car aficionados will remember the stunning designs by Raymond Loewy of the 1949 series Studebaker cars—especially the eye-catching model that looked like Siamese twins in the front and rear. The continued dominance of the Big Three, however, led many in the automobile industry to advocate a consolidation of the “Little Six”—Kaiser, Willys, Studebaker, Hudson, Nash, and Packard—into a fourth strong player. First proposed in 1954, the proposal even included a positioning plan for the products and models of the planned new company. The fierce independence of Studebaker’s founding owners, family shareholders, and others who would not cooperate (including the Dutch royal family, which had taken a sizable position in the company) caused the plan to fail.

New migrations to the suburbs and competition from the Big Three forced Studebaker into the merger with Packard. The rurally oriented Studebaker products combined with Packard's luxury car line produced vehicles which can only be described as strange-looking. When it stopped making cars in 1966, Studebaker was the oldest car manufacturing firm in the United States.

 

Rocco Co.: A success story

 

An example of a family business that has dealt successfully with the forces of creative destruction is Rocco Enterprises Inc. of Harrisonburg, Virginia. Founded in the 1930s as a feed mill by the Strickler family, the company has been led for many years by two second-generation brothers, Charles (Chip) and Robert (Twig) Strickler. It remains family owned, producing poultry products for numerous domestic and international customers.

Like many family owned firms, Rocco has been battling the forces of creative destruction for decades. Back in the 1930s, the Stricklers' mill bought grain from farmers and then sold the processed grain back to them as feed for their animals. Even in those days, farmers were grappling with serious threats to their way of life. While the economy grew steadily more sophisticated, most farmers did not. Coping with crops, weather, marketing, tending animals, supply-demand, and financing was too much for most farmers. Thousands decided to leave farming or were forced out by their own management errors and competition from large-scale, highly mechanized agribusiness farms. Slowly and steadily, the Stricklers were losing customers—one of the clearest warning signals of creative destruction.

The Stricklers realized that a different view of their customers and market was needed. Instead of simply being traders and processors, they began to create new products and markets for their customers and to assist them with planning and financing. Gradually, the grain and feed business found itself supplying eggs and chicks to farmers who raised them for a profit. The Stricklers then bought the mature turkeys and chickens from their customers, processed the animals in their new plants, and took them to market under the Shady Brook Farms, Marval, and Valley Chef brands.

The business schools describe this as vertical integration. In the 1950s, the Stricklers also integrated horizontally, acquiring like companies in other areas of the South and becoming a supplier of building products to their customers. Careful capital planning left the firm free of undue pressure from outside sources. The business developed a scale and sophistication which has taken care of its capital needs while keeping it fully family owned. Rocco Enterprises, now international, posts annual sales of $550 million.

Enter Barrett's Law: “You can build a business a lot larger and a lot faster than you can grow a family to manage it.” Like many firms which have grown quickly, the company had outgrown the family. Rocco Inc. currently employs 300 managers and supervisors. But after three decades, the family had grown only eight third-generation members, not all of whom had an interest in working for the business or in being a manager. If a business is to continue to prosper, only the best, competent, committed people can run it. And, if there is to be a large management group, in which the family has few, if any, representatives, the culture must be developed as one of ownership and direction rather than active management.

So Chip and Twig did the right thing. The Stricklers decided to modify the culture and professionalize management. They recruited a nonfamily manager, Jim Darazsdi, as CEO. Members of the next generation would be trained to be competent shareholders and encouraged to remain committed. The door would be open to employment if they were qualified and interested.

Twig and Chip are now in their 60s. Chip is president but not CEO. Twig, officially retired, maintains the busy pace of many “retired” entrepreneurs as he explores other ventures and continues to monitor relationships with their 500 contract farmer producers of turkeys and chickens. Although Jim Darazsdi recently left to take a college position, another nonfamily manager, George Pace, has taken his place as CEO with the family's full support. Pace had been head of marketing for Rocco.

Five of their eight offspring are active in the company and two more might also develop roles. Although Chip and Twig originally thought all of the eight would be on the board, they decided instead to have only two serve as directors and to fill the other seats with outsiders who could bring different expertise and points of view to the board.

Families develop a culture of values which can support or destroy a family business. If the business is simply a vehicle for making a living, or a fortune, it can be disposed of in the same way most of us sell a house. Rocco employs 3,700 people in the Shenandoah Valley and 400 people in North Carolina. Throughout its history, the family has demonstrated a commitment to their hundreds of customers and suppliers as well as to the community, where they are a principal supporter of many cultural and philanthrophic activities.

Rocco is a fine example of the effects of a family commitment to continue the ownership and a culture which would work to insure high management standards. Having dodged bullets for nearly 60 years is the company free of hazards? Not at all. Global competition remains intense. Capital requirements continue to increase. Many, many, talented professional executives today still find the culture of family ownership unappealing and will not join such a firm.

For the present, Rocco's culture will support this ownership-management arrangement. But that's an issue which has to be settled again in every generation. In many family owned firms, the culture doesn't evolve to fit the situation. Thousands of companies doubtless would have refused to do what the Stricklers did. It took commitment to the business to elect a nonfamily CEO. Many others at that point decide to cash out rather than going through all the work necessary to develop and maintain the firm.

 

Seizing an opportunity

 

For all the publicity that has surrounded the growth of Stew Leonard's Dairy in Connecticut few people remember that Stew's enormous success grew out of a threat to his business that he saw as a marvelous opportunity.

It happened during the late 1950s and ’60s, when the milk business was in transition. At the time, new technologies were changing everything from processing and packaging to storage and marketing. Ten-gallon jugs were replac ed by tanker trucks, round quart bottles were replaced by square half-gallon and gallon carboard containers. The last ice-based storage went to modern refrigeration. Most terrifying of all, customers were turning away from home delivery and saving money by buying at supermarkets and “jug stores.”

This was a highly competitive, price-regulated business with marginal profits to begin with. As delivery routes shrank, milk producers had to invest more and more to survive. As if these long-range forces weren't trouble enough, Stew Leonard, then a 38-year-old dairyman, was faced with a more immediate threat: When the Interstate highway system was laid out, he discovered that the state's plans called for a road that would slice right through his dairy farm.

His competitors wished that the state would condemn their land and pay them for their losses so they could get out of the business—they ran for the exits. But Stew saw a great future in retail milk. He wanted to be part of the new, revolutionized milk business but didn't know what form of business would be best and where he would get the capital for it. He saw the forthcoming condemnation as an opportunity to turn illiquid land and aging plant into cash.

He spent months visiting 47 milk producers and retailers in a 10-state area, finally fashioning his dream of a farm store with a dairy plant inside, situated on the busy U.S. Route 1. Stew's Dairy would specialize in fresh-from-the-farm products in a fun, exciting retail environment. With the plan complete and state action imminent, he reviewed it with his friends and advisers. They all told him not to do it. Only his wife, Marianne, told him to go ahead and pursue his dream, even though it meant he would have to take on lots of debt, plow any profits in the first few years back into the store, and work long hours while she took care of four children.

Stew's success has been well chronicled. The family's two stores in Connecticut are now a $200 million business being managed by his children. He had risked his capital at a time of peril and turned the forces of creative destruction into an opportunity. His unswerving commitment to continuing family control has ensured the perpetuation of the business.

 

Invisible enemies

 

The forces of creative destruction can be controlled. The probabilities of revolutionary changes in the economy can usually be glimpsed early by those business owners who take the trouble to look. Most, however, are attuned to forces affecting their own industry. They don't look beyond it for other less familiar and unpredictable threats.

When tracking rivals in their industry, they tend to track only known competitors. For example, take the hundreds of thousands of family firms that represent brand name manufacturers or service providers. They get help from the larger firm, which provides data on share of market held by its (the larger firm's) competitors. This leads distributors and merchants to think the same way.

Those players are their like competition—competitors that are like them, generally. The invisible enemy is the in-kind competitor. This is the company that performs the same function in a very different way, but close enough to serve the need. For example, the in-kind competitors of the airlines are telephones and video conferences. The airline executive may deny that these communications companies are a threat, argung that “They can't match the benefits we provide...” Of course they can't, not exactly. But if many people prefer to do business face to face, some will use the phone or video instead of every second or third trip. How much of your volume does a company have to lose to in-kind competitors before overhead is no longer covered and profits begin to plummet?

When television spread quickly to most homes, many experts predicted a dim future for movie theaters, book stores, and neighborhood bars. They underestimated people's need to get out of the house and socialize. They also missed completely the huge developing market for book stores, which is a byproduct of the 500 percent increase in college graduates and a 1,000 percent increase in college students between 1955 and 1975. Anyone visiting one of the country's mega book stores in the late evening, when it's still very busy, can testify to that trend. And, by the way, those busy readers also watch a fair amount of television. As for the neighborhood bars, those that became family restaurants escaped creative destruction and did well.

Sometimes multiple forces converge to transform a market. Retail florists, for example, have a product that is seasonal and perishable. At the high end, customers can be maddeningly fussy. At the low end, the lack of value-added leaves small florists vulnerable to supermarkets, which sell the same product at the same price but are open over 100 hours a week. Florists are also wrestling with new overseas competitors. They have suffered declines in business for funerals and Easter, but they see opportunities for growth in other areas.

These multiple emerging forces have enticed outsiders in transportation and communications services to enter this business. The new floral competitors could avoid the inventory of perishable products by arranging to fill orders for cut flowers just–in–time every day at the wholesaler's. Orders came in from a much broader area due to wide area marketing. Deliveries required no fleet. UPS or FedEx took whatever was ready. Local florists, whose competitor intelligence was limited to keeping a watchful eye on vehicles with other florists' names, did not notice where the new competition was coming from. Likewise, telemarketers 1,000 miles away were soliciting their juiciest accounts. No highly visible ads or billboards warned them of this threat.

 

Think laterally

 

How can you prevent the forces of creative destruction from sneaking up on you while your attention is focused on tactical, day-to-day decisions? Talk with your customers and suppliers. They also do business with your competitors. As responsible players, they may not disclose very much about what they do with your competition. But they may provide you with information on what's going on in other industries or channels in which they're active. The information will help you look across industry lines or to see multiple forces at work that may one day rock your business.

In your strategic planning, think laterally. As defined years ago by Edward deBono, lateral thinking is in the current jargon described “thinking outside the box.” It attempts to look beyond the conventional solutions in your own industry and come at the problem from a different direction. There are many historic examples of this approach.

Back in the 1920s, for example, when the Coca-Cola Company was still a large network of family owned firms, the company learned that theirs was an impulse-buy product. Most people in those days drank a lot of water because it was free and easily accessible. To get them to purchase Coca-Cola on impulse, the product had to be cold and convenient to buy.

Lateral thinking resulted in the push by Coca-Cola to get other companies to develop and manufacture vending machines for their drink. Coca-Cola's route drivers would sell and service the machines. Or the bottlers would buy the machines, rent space for them in stores, service stations, and restaurants, and make sure they were stocked. To keep them in service, Coca-Cola added its own mechanics. This inventiveness by Coca-Cola resulted in the creative destruction of thousands of local bottlers who delivered warm product and hoped it would sell.

Shifts in customer habits and requirements may be subtle but revolutionary, opening up possibilities for adding value and gaining a competitive edge. Clemens Markets, a Pennsylvania chain of going-on 18 stores, learned in its market research that suburban customers would pay to have their shopping done for them. The stores’ Shop–For–You Program uses technology for shopping convenience: Order by modem, by fax, or talk with phone specialists. Pick up your order at an agreed time, or have it delivered home. Several hundred customers gladly pay an extra 10 bucks per order to shop with this innovative family owned firm. As one career woman in a Clemens focus group said, “Now if I can just get them to put the stuff in the cabinets for me!”

Businesses provide value-added to their products when they take over things that customers would prefer not to do themselves. Some customers don't want such a service, or won't pay for it. But for those who do, Clemens will help, and be rewarded for it.

Well, some will argue, this is just good customer service. Sure it is. But markets like Clemens have been dealing with the forces of creative destruction for years. In 1994, the food store share of our food dollar, which had been as high as 75 cents, dropped to 49 cents. The other 51 cents goes to fast food outlets, cafeterias, vending machines, restaurants, coffee shops, book stores, delicatessens, or street vendors.

 

Capitalization: The Achilles heel

 

To manage creative destruction, a family business must have enough capital and a formal plan for developing capital. Its leaders must have continuing forecasts of the firm's capital needs, and they should become knowledgeable about the multiple sources of outside capital that might be available to them. Lastly, they have to plug leakages of capital from, for example, “keep-the-peace” dividends to unhappy relatives or family “toys and hobbies.”

Most family members don't think about the firm's capitalization, and, when forced to, many don't understand it. It is the CEO's job to see that they are educated in these matters. This is where the will to manage comes in. Family members should understand the concept of capital accounts: owned capital (equity), rented capital (debt), and acceptable ranges between them (established, say, by industry groups or bank guidelines).

Every business can calculate how much working capital is necessary to support an additional $1,000 in sales revenue. If it is 20 percent, for example, they have to add $200,000 in capital to support another $1 million in sales.The question becomes: Where will that capital come from?

The cheapest source is family members—and that is the Achilles Heel. How many family members would like to buy more stock this year or sign up for a significant three-year planned purchase? And do those who invest understand that they may have to wait patiently for the payoff? Likewise, a huge amount of stock in family firms is transferred through gifts. For the recipients, it's like winning the lottery, except that there's no cash immediately. This gift is invested capital, which was retained and reinvested in order to increase its value. But someone else, usually the parent, did that. The beneficiaries never had to write a check to pay for any of it. In street parlance, “they have no skin in the game.”

Some members of the shareholder group—whether family or not, voting or not, recipients of dividends or not—may simply refuse to consider their shareholdings as long-term investments. They may be risk-averse, perhaps because they don't want to lose any money. They may be cash-hungry for one reason or another. They may be restless at being locked into a closely held company with no way to sell their shares at a decent price. Or they may believe that all the goodies they have received come from the tooth fairy.

All these folks are candidates for outplacement as shareholders. If the firm is to deal with the forces of creative destruction, it needs to have a unified group of shareholders who support management's efforts to innovate and are willing to wait for the payoff that comes not at the end of the rainbow but after long, hard efforts to strengthen the firm's competitive position.

When long-term forces threaten the future of your business, the will to manage is needed to bring all of the resources of your organization to bear on making the necessary changes. “How will I find time to do it?” you may ask. My standard reply would be: “I didn't say that you have to do it by yourself. You do, however, have to see that it is done—through delegation, not abdication.”

If it doesn't get done, you are betting the company. And as the CEO, you'll have to explain one day how somebody as smart as you blew it so badly.

 

James E. Barrett is managing director of Cresheim Management Consultants in Philadelphia and head of the firm's family business management practice.

 

Maintain family leadership

Objective: To develop leadership to keep the company family controlled.

Strategy: Practice constructive nepotism.

Tactics:

1. Make sure you have the best key executives for this company, for this time and place.

2. Give preference to family executives over nonfamily, assuming equal competence and commitment.

3. Reward performance and help all to remain qualified.

4. Remove nonperformers and help them to relocate with dignity to other jobs inside or outside.

5. Insist that family members follow the same rules as other employees.

6. Use strong outside directors and advisers, avoiding the counsel of incompetent hangers-on and sycophants.

Develop a competitive culture

Objective: Remain well ahead of the creative destruction wave.

Strategy: Teach all key owners and managers to think strategically.

Tactics:

1. Avoid blind spots. Check both in-kind and like competition.

2. Watch for multiple forces such as converging technologies.

3. Check the supply chain. Adding value helps halt erosion early.

4. Supplement systematic analysis with lateral thinking.

Ensure adequate capital

Objective: Make sure you have enough capital to manage creative destruction.

Strategy: Develop a formal plan for capital needs.

Tactics:

1. Build earnings, retain them, invest them wisely.

2. Become more informed about the various sources of capital and the terms on which it is offered.

3. Be prepared to bring in capital when it is needed and can be effectively employed.

4. Close up leakages from “keep-the-peace dividends” and from family “toys or hobbies.”

5. Avoid large expenditures to redeem stock when the firm has higher-priority cash needs.

6. Make continuing forecasts of the company's capital.

-- J.B.

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Winter 1997

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