John L Ward is the Co-Director of the Center for Family Enterprises at Kellogg Graduate School of Management (USA) and the Wild Group Professor of Family Business at IMD (Switzerland). He serves on the boards of four family companies in Europe and the USA.
There are fundamental differences in the assumptions and practices of family and non-family firms. While non-family firms can learn much from the 'family business paradigm', family firms need to be careful not to ignore the perspectives of efficient markets, asset leverage, strategic revolution, and economically driven personal leadership
Family firms are profoundly different. In fact, they challenge and violate the conventional wisdom of business text best practices and business school education. Getting to the roots of these differences creates the opportunity to lead the family business to more financial success and longer continuity.
The differences start with, and are explained by, the economic assumptions of the nature of the firm. Non-family businesses are shaped by the powerful theory of shareholder capitalism. The firm is an economic asset; the capital markets are efficient.
In shareholder capitalism ownership is widely dispersed and virtually impotent. If owners are unhappy with the firm's performance, they simply sell their shares. It's impractical for them to complain to the board or management. Selling is easier and more efficient than trying to reform the business.
To protect these weak, poorly informed owners, a strong board of directors is prescribed. That board focuses on maximising the share value by meeting, predictably, the near term expectations of financial analysts and investment firms. The board also promotes transparency.
Family firms are not only an economic asset, but also an emotional asset. The focus is at least as much on continuity of the firm as it is near term profitability. Owners are few and find exiting their ownership position difficult – legally, financially and, most of all, emotionally. When things are wrong, family owners speak out, not quickly flee.
With the owners' intense and personal interest, they seek a board to add value to their business. They are concerned with their personal and family reputation. They are more concerned with doing the right thing, even when times are tough, than they are in doing what financial analysts want done. Over the business cycle, family firms aren't compelled to cut and cut. Meanwhile non-family firms feel forced to make the profits at the expense of corporate culture and future strategic commitments. Without accountability to the stock markets, family firms can also retain privacy, with the benefit of pursuing strategy more quietly and subtly.
Non-family firms operate with the assumption of efficient markets. Family firms know markets are quite inefficient.
The differences in basic economical assumptions are magnified in the financial philosophies of family and non-family firms. Non-family firms, in their drive to maximise shareholder value, follow the axiom of more risk leads to more returns. Taken to the natural conclusion, non-family firms feel compelled to optimise the use of all their assets, leading to a focus on economies of scale. Eventually, when profits slide, speculation tempts management to eventually make such risky decisions that they may 'bet' the very survival and continuity of the firm itself.
Business owning families, with a concern for their reputations and the drive to avoid catastrophe, are far more conservative risk takers. They worry first about the threat to continuity, second about shareholder returns. To protect that motivation for continuity, family firms work to hedge business risks; they keep some surplus balance sheet resources to insulate themselves from the unexpected; they look for opportunities to diversify their business portfolio in order to weather cycles and to secure more stable cash flows.
Family firms protect their assets. Non-family firms leverage their assets.
The basic difference between the goals of securing continuity versus meeting market expectations for consistent, maximum returns also shapes the strategic thinking of the firm. Non-family firms must seek constant growth. As all strategies eventually mature, they must find growth through innovation and transformation. To sell the prospects for growth they need to pursue bold strategies that are comfortable to the financial markets and to the outside directors on their board. Therefore, they promote strategies with clear competitive advantages and measure success in strategic position. The outside pressures and executive incentives to outperform the markets are so strong, that eventually the business itself may be sold at auction to the highest bidder – or broken up into pieces placing focus on specific core competencies.
Differently, family controlled firms, with long-term continuity in mind, can be like the tortoise in the race with the hare. They can steadily, incrementally improve in basic, less glamorous business practices. Those practices and the organisational discipline behind them reinforce an effective business culture. The culture is subtle and not easily understood by financial investors, but cherished and nurtured by family owners. The culture becomes the advantage; adaptation becomes the skill.
Breaking up or auctioning off the business is the last thing in the minds of family owners who see the business as their legacy, as an heirloom. The business is more than a business; it's a social institution with its own integrity – often making an important contribution to society, in the minds of its owners.
Rather than following the prescription of 'creative destruction', family led firms follow the prescription of 'the living company'.
Not only are the approaches to strategy and risk different, but so, too, are the assumptions about leadership. Non-family firms typically attribute their successes to great personal leadership, and they drive and reward that leadership through a rich system of individual economic incentives. Recognising that managers are inherently interested in their own status, power and wealth, efforts are made to tie their rewards to the shareholder value of the firm. To assure clarity of responsibility, rarely do you see team leadership at the top.
Family firms usually don't have stock to give, or don't want to. Besides, they are most often led by family members who are substantial owners, or at least leadership is closely supervised by family owners. Management's interests are not necessarily adversarial to owners' interests. Owners seek more than economic returns.
Consequently, family firms find a different kind of leader, one motivated more by a sense of pride in the institution and belonging to the culture of the company. Incentives can be more widely shared. Teamwork, even team leadership, is more likely.
While the non-family firm sees man as an 'economic' being, family firms hire, promote and reward with a belief that man is more a 'social' being.
Certainly to contrast the fundamental differences between family firms and non-family, widely held firms, each point was presented in contradiction. But in our surveys of family firms, we learn that they do see themselves operating under a very different paradigm of assumptions and practices. While non-family firms can learn much from the family business paradigm, family firms need to be careful not to ignore the perspectives of efficient markets, asset leverage, strategic revolution, and economically driven personal leadership. It's in knowing your competitor's paradigm that you can sharpen the appreciation of your own distinctiveness. Society is fortunate to have both types of institutions to challenge each other.