Chapter 1

Family BusinessWhat Makes It Unique?

Family Business, First Edition, by Ernesto J. PozaCopyright © 2004 South-Western/Thomson Learning

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Course Goals

Gain an understanding and respect for family business continuity

Understand better the challenges and advantages faced by your own family business

Learn managerial, governance, and family practices that increase odds of family business success

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Family Business: Working Definition A family business is a synthesis of:

Ownership control by members of a family or consortium of families

Strategic influence of a family in the management of the firm

Concern for family relationships The dream (possibility) of continuity across

generations

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Family Businesses . . .

Constitute 80–98% of businesses in U.S. and other free economies

Generate 49% of GDP in U.S. and more than 75% in most other countries

Employ 59% of private sector U.S. workforce and more than 85% of working population overseas

Created about 80% of all new jobs in the 1980s and 1990s

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Other Statistics

Between 17 and 22 million family-owned businesses in U.S.

Annual revenues exceed $25 million for 35,000 family businesses

Family-controlled companies comprise 37% of all Fortune 500 companies 60% of all publicly held companies

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The Bad News

In their first 5 years of operation, 90% of family-owned companies disappear

Of remaining 10%, 67% die or change ownership after first generation

Only 12% survive under current ownership past the third generation

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What Makes the Difference Presence of the family Owner’s dream to keep the business in the

family Overlap of family, ownership, and

management Competitive advantage derived from

interaction of family, management, and ownership

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Family Business Theories

Systems theory Agency cost theory Resource-based theory

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Systems Theory

Model shows overlapping subsystems of family, management, and ownership

Firm is dynamic system in which integration achieved by adjustments to subsystems

Individual perspectives of family and firm may differ, leading to overemphasis on one sub-system at expense of others

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Systems Theory Model

Family Management

Ownership

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Blurred Boundaries

Boundaries among family, ownership, management systems may become blurred Problems determining if decisions relate to family,

ownership, or management issues Family rules used in the business Problem-solving ability diminished by blurred

boundaries Businesses may become family-first,

ownership-first, or management-first

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Family-First Businesses

Employment in business is membership right Members of same generation paid equally Extensive family perks from business Secrecy often paramount and family

members protect each other Business becomes part of lifestyle Commitment to continuity depends on

agendas of individual family members

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Business-First Firms

Employment on the basis of qualifications—family discouraged from working in business

Performance of employed family members reviewed as for nonfamily

Compensation based on responsibility and performance

Conversation between family members is all business

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Business-First Firms, continued Business growth, market share, profitability,

return on assets, return on equity constitute the scorecard

Next generation viewed in terms of how they can manage and grow business

Family events often cancelled/delayed for business reasons

No automatic commitment to family business continuity

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Joint Optimization Alternative Family employment policy guides employ-

ment of family Some family members are employees; others

responsible shareholders Performance of employed family members

reviewed as nonfamily

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Joint Optimization, continued Family members encouraged to work outside

business to get experience When family members meet, conversation is

both family and business oriented Commitment to family business continuity

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Agency Cost Theory

Traditional theory: Alignment of owners and managers decreases need for agency costs

Recent research: altruism of owner-managers leads to increased agency costs

Agency costs can be controlled by managerial and governance practices

Board of directors important in monitoring managerial behavior and controlling costs

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Challenges to Continuity

Shortening product life cycles High transfer tax penalties High market valuations of ongoing businesses

by historical standards Family businesses considered outdated Family structure far from stable Next generation family business leaders

unable/unwilling to accommodate CEOs living longer—obstacles to succession

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Resource-Based Theory

Resource-based theory highlights unique capabilities or resources that family firms convert into competitive advantage

These resources referred to as organizational competencies

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Competitive Advantages of Family Business Speed to market Strategic focus on market niches Concentrated ownership structure Lower overall costs Quality of product/service Agility and flexibility Owner-manager and long-term view

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Speed to Market

0

5

10

15

20

25M

onth

s

>$100 <$100

Sales in millions

U.S. Japan Europe

Source: Boston Consulting Group.

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Strategic Focus: Niches

Size of Market and Business Performance

Under $50 million 28.1% ROI*

$50 to $100 million 26.8% ROI

$100 to $250 million 24.2% ROI

Over $1 billion 10.9% ROI

*4 year average ROI.Source: PIMS Program

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Concentrated Ownership

Ownership structure impacts corporate productivity

Stock concentration positively correlated to Related diversification R & D expenses per employee Training per employee Overall corporate productivity

Source: Hill and Snell, Academy of Management Journal, 32#1.

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Lower Overall Costs

Cost of capital is nearly 0% when owner controls stock

Financing for other businesses: 25–30% for venture capital 17–20% for mezzanine financing Prime rate for bank financing

Administrative and control costs also reduced absent need for principal supervision

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Quality

Relative Product Qualityand Business Performance

High relative quality 27.1% ROI*

Medium relative quality 19.8% ROI

Low relative quality 16.8% ROI

*4 year average ROI.

Source: PIMS Program

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Agility and Flexibility

Flexibility of new manufacturing and distribution technology makes smaller runs economically attractive

Customization, changing consumer preferences, shorter product life cycles reward agility

EDI/Internet-based partnerships make agility possible across value chain

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Owner-Manager

Focused on customers, family, employees, profitability, lifestyle

Experiences conflicts between family, management, and ownership and optimizes links

Average tenure of 18 years vs. 3 years for public company CEOs