A family affair

As competition for business hots up in the GCC, family run firms can no longer afford to take their futures for granted, according to a new study by Booz & Company. BM investigates.

Family-run businesses are still going strong in the GCC – dominating most market segments. But as international players encroach on domestic markets and economic conditions worsen, these companies must modernise if they are to survive long enough for the fourth generation to take over. This is the verdict of a new study by Booz & Company, which identifies the challenges facing the family run firms in the GCC, including the “restless entrepreneur syndrome” and the need to develop longer-term business strategies. The first step for any family firms undergoing this process, he says, is to reevaluate their existing business portfolio and to, if necessary, shed parts of the business that no longer fit into the company’s long-term strategy. “The same discipline is required for the evaluation of new investments and may call for individual family member investments to be separated from the family firm’s activities,” says Joe Saadi, Chairman of Booz & Company. One of the most important steps these companies must take, he says, is to recruit outside management to oversee this process of change as well as “change agents” whose interests are closely aligned with those of the business.

Managing change
Some of the world’s most successful companies are family-run with governance structures under the control of the original founding family. So far this strategy has proven effective, allowing companies to survive economic downturn, war and family feuds. Indeed an index compiled by Credit Suisse found that between January 2005 and January 2008 family firms outperformed non-family firms in shareholder creation by 15 percent. “Our analysis of more than 100 family businesses reveals the most critical factor to their success ‎is the families’ coordinated and sustained long-term strategy for growing and controlling their ‎businesses,” explains Ahmed Youssef, a principal at Booz & Company. He goes on to say that the corporate governance strategies of family run firms usually involve the ‎exercise of patience in investing capital, the retention of companies through bull and bear ‎markets, a focus on core businesses, and an emphasis on long-term performance over quarterly ‎gains. However, Booz & Company’s study points out that this method of operating will not necessarily continue to sustain family run firms in the long term or overcome some of the challenges they face. Among these are the firms’ attachments to the long term businesses that define the legacy of the family but that may not necessarily still be generating profit. In this situation, the study claims, many families will retain the business just for the sake of preserving tradition. They also risk losing objectivity and failing to distinguish between family and business issues resulting in conflict and badly judged commercial decisions: “The line between family and business activities is often blurred, thus making it difficult to calculate the real profitability of the business and increasing the potential for areas of conflict among family members,” says Youssef.

The restless entrepreneur
Another problem is the “restless entrepreneur syndrome” that can afflict members of family run firms – the main symptom of which is a constant focus on new business opportunities rather than the insitutionalisation of the businesses once they have been created or hired. A survey by Booz  & Company of 25 family owned firms found that 48 percent of respondents were involved in five or more sectors. Another 40 percent were involved in three or four sectors and 12 percent in two sectors or fewer.  According to Booz & Company the restless entrepreneur syndrome was particularly applicable to companies that operate in strong economic conditions with limited competition and abundant capital to spend on new ventures.  Economic conditions in the region have destabilised however and family firms also face additional challenges from the democratisation of the Middle East business world which has seen international players enter the market bringing increased competition. This means that the time has come for them to address the profitability of existing businesses, stop investing in new opportunities and take an overview of their existing operations and what their long-term strategy should be. Booz & Company has identified four steps should family owned firms should take in this regard:

Revaluate existing portfolio of businesses to create sharper focus: When capital costs increase and management time is stretched thin, family businesses must focus on the best use of both by divesting or lowering the priority of some traditional businesses.

Let go of emotional attachments to traditional businesses: Family businesses must have the discipline to focus on the most advantageous use of capital and target fewer businesses to drive superior performance. Between 2003 and 2007, family firms that focused on one coherent sector outperformed those that didn’t by 5.5 percent per year.

Apply rigorous discipline to evaluation of new investments: Family conglomerates must create clear guidelines for new investments, focusing on scalability and relative return on capital and management time. Other businesses important to the family can be financed by funds that are independent of the business.

Build management capabilities and relinquish control when necessary: An essential element for an “immortal” family business is a talented management team that is able to grow the business independently of the shareholding. Family businesses must delegate control to the management team when required, eliminate the glass ceiling and create the right incentive structures.

In terms of family issues – and preventing these from affecting business decisions – Booz & Company advises firms to ensure there is separation between family and business activities, by creating a ‘”family office” to handle such issues. It also urges these companies to separate the philanthropic activities of individual members from the business itself and to create a separate financial arm to specifically support the family members’ own business ventures.   One the biggest “family issues” facing family firms is the fact that many are going through a transition period of passing on the business to the third generation. This, warns Booz & Company, creates greater difficulty in maintaining control over the business as a company formerly controlled by siblings is now controlled by cousins, leading to weaker family ties and obligations. It also creates pressure to increase the size of the business to support more family members. According to Booz & Company’s research team, family firms need to grow by on average 18 percent each year, just to maintain the same level of wealth across generation. Creating a formal governance structure for the company, will help to ensure effective delegation and separation of activities but will also prepare the firm for successful. A change agent may also be appointed who can oversee this transition period.

This is a critical time for family firms, with studies showing that 80 percent on average fail to make it through the third generation. Given the vital role that family firms play in the GCC economy it is crucial that they survive this transition and the challenges that the economic situation throws at them. Family ties have enabled these firms to become the highly successful businesses today. But unless companies adapt to the changing conditions around them, these ties could ultimately strangle any potential they have left.