The Five Crises Facing GCC Family Businesses
A perfect storm of economic and demographic conditions could swamp family businesses if leaders don’t respond quickly.
Family businesses have unique management challenges in a normal business environment, but the current global recession is adding a layer of complexity to those issues, particularly in the GCC. No fewer than five crises are now hitting these companies at once, creating a perfect storm that is likely to radically alter the operating environment for family-owned businesses in the region.
Succession issues are looming, as the next generation prepares to step up and management must make hard choices between those who would traditionally be tapped for leadership positions and those who may be more capable of running the business. An ever-increasing number of family members is putting pressure on firms to grow quickly enough to support everyone who expects to work for the firm or draw an income from it. Many firms have diversified beyond their original business into an unwieldy portfolio of sometimes unrelated companies that must be trimmed back to focus on the group’s core capabilities. At the same time, the GCC market, long closed to outside companies, is now open to competition from specialized regional players and international firms looking for high-growth markets. Credit is becoming an issue as well—large merchant families used to have the unquestioned trust of suppliers and banks, but the disruption in credit markets has affected those relationships.
“Each of the five crises poses a very real risk on its own, but in combination, they are even trickier to deal with,” stated Ahmed Youssef, a principal at Booz & Company. At a minimum, family businesses that don’t adapt quickly could lose market positions to more focused and established competitors. “They could be broken up to address succession issues or resolve family feuds. And they could be forced to sell portfolio companies or other assets, in order to raise cash to continue supporting other businesses and a growing number of heirs,” he added.
Yet while these challenges are significant, isolating them and addressing each with specific solutions will help ensure that these businesses not only survive the current recession but come through with a more focused management, a more coherent set of portfolio companies, and a smooth transition of power.
Addressing the Five Crises
Three of the looming issues are unique to family businesses; two are universal but have significant implications for family businesses in particular. All must be addressed rapidly and effectively if GCC family businesses are to continue on their strong growth trajectories.
1. The succession crisis: Many family-owned GCC companies were founded in the mid-20th century, so they are now somewhere between their second and third generation of family control. That is a difficult time to transfer management control for businesses around the world, even when the global economy is healthy. But the current economic uncertainty and other factors discussed below make this a particularly acute issue for family businesses in the region.
Decision-making at these firms is typically controlled by a patriarch, who is not likely to surrender operational control of the company he founded and built. “Also, regional traditions may prescribe transfers of responsibility according to preordained patterns—for example, to the oldest son—regardless of the strengths and affinities of other siblings,” explained Youssef.
In some cases, acute succession problems will result in businesses being split among siblings, merely to ensure that everyone gets something to oversee. In others, irreconcilable conflicts may require that family members get “bought out,” which exhausts the capital of the business. In the messiest situations, people who feel the process of apportioning authority was handled unfairly may launch competing businesses, which distracts management and undermines the stability of both the company and the family.
“The solution is to establish clear lines between governance of the family and management of the business,” commented Youssef. “It’s crucial that the company recruits managers from outside the family, ensuring that responsibility for its future goes to those most qualified, not merely those best positioned because of their family ties.” Another necessary step is for family members to unify their voices through a structure similar to a shareholder council, which can resolve arguments inside the family before they’re presented to the company as competing mandates. Finally, family-owned businesses should appoint a change agent; someone whose interests are aligned with those of the family’s, but who has enough emotional distance and perspective to make impartial hiring decisions in accordance with the best long-term interests of the business.
2. The dilution crisis: The number of family members involved in family businesses in the GCC is constantly on the rise, due especially to large family sizes in the region. The number of family members working in the family business or deriving their main income from it, or both, will likely grow exponentially. It’s akin to a growing number of people drinking from the same well.
A recent analysis by Booz & Company found that family businesses in the GCC must grow at an average annual rate of 18 percent to maintain a family’s level of wealth across multiple generations. Until recently, such growth was relatively easy to sustain—but it will likely not be maintained over the long term, regardless of the competitiveness of the business. In addition, the growing number of family members prevents family businesses from continuing to employ all family members who want jobs. “The business cannot be the sole source of income for everyone in the family. In short, the family must encourage some of its members to find other ways of generating their own wealth,” stated Youssef.
These companies should consider establishing a venture fund that can back family members’ individual business initiatives outside the family’s core business, to ensure that such projects get sufficient financing in their critical early stages. In addition, these families should consider drawing a separation between wealth preservation (i.e., capital managed to preserve value at predefined risk levels) and wealth creation (i.e., capital invested in their businesses).
3. The control crisis: The increasingly diversified nature of GCC family businesses is making it ever more difficult to ensure that they will remain competitive. A Booz & Company survey recently found that nearly 90 percent of the family businesses surveyed were active in three or more business segments. That diversification is understandable given the prevailing conditions in the region throughout most of the 20th century—strong economic growth, limited competition, and easy access to capital.
Those conditions are slowly disappearing. Management at these companies now finds itself spreading critical time, attention, and capital across various companies that might be only tangentially related (or completely unrelated). “Principals are unable to effectively monitor performance and financials; stronger companies, for example, can mask the true underperformance of laggards, and outside stakeholders have a hard time understanding how the businesses fit together,” Youssef explained.
These managers will have to consider reshaping their holdings by divesting some businesses and growing others. A clear-eyed analysis of the relative growth potential and market position of each portfolio company will help managers devote more attention only to those that offer the highest return on capital and those in which the family is the “natural owner”—i.e., the business is more likely to thrive under the ownership of the family than under the ownership of any other shareholder. Such analyses can be difficult if they reveal significant weaknesses in a family’s original line of business, given that many families feel an understandable emotional tie to these companies. Moreover, divesting them may shift the brand of the overall company.
But the effort is worthwhile: A tighter focus on a smaller number of portfolio companies can result in better financial performance. Our analysis shows that between 2003 and 2007, those family firms that focused on coherent sectors outperformed more broadly diversified competitors by 5.5 percent per year.
4. The competition crisis: The three issues—dilution, succession, and control—affect all family businesses, but they have been compounded in the past five years by a regional crisis in competition. Until about five years ago, the GCC was a partially protected market. But the confluence of liberalizing markets, World Trade Organization agreements, and the global downturn has increased competition on an unprecedented number of fronts. “There are more and more local companies launching in a market that is no longer big enough for everyone. Regional companies, as their own markets become increasingly saturated, have begun pursuing opportunities in neighboring countries,” said Youssef. And international companies, which have seen their existing markets hammered by the downturn, are making aggressive moves in the MENA region, which they see as a growth market.
Furthermore, unlike many family businesses that have spread themselves thin across a number of industries, these new competitors specialize in their industries, giving them an advantage, as a single industry has leadership’s full attention. Finally, regional and international companies that are accustomed to playing in extremely competitive markets have already done the work of trimming their cost structures and making their operations as lean as possible—work that still lies ahead for many family businesses.
To keep up with these new competitors, family businesses will need to focus on the sectors where they have the potential to be industry leaders and rationalize the rest of their portfolios. In the businesses where they focus their attention, they will need to make their companies as productive as possible—whether by increasing scale, improving cost competitiveness, or upgrading customer service, for example.
“Family businesses do have some advantage over new regional and international competitors in that they have a deep understanding of their local markets,” stated Youssef. However, this advantage will be fleeting: Competitors will quickly develop the same understanding, whether through their own analytics or the acquisition of a local company. Therefore, family businesses must build on their knowledge and make market insight a true capability.
5. The economic crisis: Finally, and most significantly, the economic crisis is catalyzing the most profound changes in their operations. The GCC has been spared the worst of the global recession, but it has still been affected—primarily through constrained credit, slower growth, and a lingering sense of uncertainty about the future. When family businesses were smaller and less connected to foreign economies, they were less affected by global economic dips. But they’re now larger and more entwined in worldwide markets, and the recession is hitting them more emphatically.
Historically, these companies managed top-line growth well but didn’t worry much about inefficiencies in their balance sheets or cash flow statements. “The highest priority was to grow their revenues and profits fast enough to keep up with surges in demand. They financed their growth with short-term debt and managed cash loosely,” explained Youssef. Due to the downturn, many companies, despite the long-term health of their business, are finding themselves in a short-term cash trap. The recent public turmoil involving some of the region’s prominent family businesses could further exacerbate the problem. Financial institutions might put those businesses under pressure to pay their short-term loans, forcing them to make drastic moves to secure cash immediately—a phenomenon that could have a ripple effect on the credit market.
To survive the economic crisis and ensure a stronger position when it is over, many family businesses need to improve their working capital, improve their capital structure, and focus management incentives on cash flow indicators. At the same time, they should consider deferring investments, selling non-core assets, and suspending or reducing dividends. In short, they need to ensure that the CFO and the finance function use their expertise to play a key role in shaping strategy and generating value for the business, rather than just counting the money.
Staying Solvent in a Tough Environment
“The global business community as a whole is facing unprecedented challenges, and it is an especially precarious time for GCC family-owned businesses,” Youssef said. During previous decades, these problems were mitigated by the region’s strong, steady growth. Now however, problems that bubbled under the surface when times were good can no longer be ignored. Only by dealing with these five crises, both separately and together, will managers be able to navigate the storm and create a more competitive business when times are better.