New Challenges for GCC Family Businesses
With most GCC family firms under 60 years old: sustained long-term strategy for growth and formal governance structure will lead them through challenging economic environment and third generation transition.
The family-run business is a viable model for competing effectively in the global economy, achieving impressive long-term growth, and increasing family wealth; but family businesses in the GCC face today the dual challenge of operating in a difficult global economic environment and managing the transition of the business to a third generation of family control, finds a new study by Booz & Company.
To survive, grow, and ensure enduring success, firms must tame the “restless entrepreneur” syndrome, and develop a long-term strategy to manage the family and the business. Steps for lasting success begin with a reevaluation of the existing business portfolio, which may involve the divestment of original businesses that no longer fit the long-term growth 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,” commented Joe Saddi, chairman of the Board of Booz & Company.
Creating a formal governance structure and recruiting and developing outside management talent are other crucial steps. The appointment of a change agent, whose interests are closely aligned with that of the family and the business, ensures such changes are achieved.
Family Business, Managing Change, Achieving Lasting Success
Some of the world’s most successful companies are family businesses, with governance structures either controlled by, or with the strong involvement of, members of the original founding family. They have thrived; surviving economic downturns, wars, family feuds, and other challenges. An index compiled by Credit Suisse found family firms have outperformed non-family firms in shareholder creation by 15 percent between January 2005 and October 2008.
“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,” explained Ahmed Youssef, a principal at Booz & Company. It usually involves 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, and most importantly the development and retention of management talent.
The GCC: Unique Environment, Unique Drivers for Family Firm Success
GCC family firms tend to be young, with most under six decades old. Many are managed by members of the first or second generation, with a few seeing involvement from third generation members. Some GCC family businesses have historically benefited from privileged advantages specific to the market and the region’s cultural heritage. These advantages include:
Limited external competition, abundant opportunities, and special access to capital, business networks, and information: These have allowed families to build large conglomerates spanning a variety of sectors.
More concentrated control within families: Most family-controlled GCC businesses are still driven by one or two members of the family with many driven by the original owners, some of whom are highly visionary and entrepreneurial.
Respect for traditional rules of succession: The cultural heritage of the region has protected family businesses from destructive family feuds. In instances of conflict, disputes tend to be kept private and managed within the family, limiting negative impacts on business. This advantage is dissolving as families have expanded and the gap in experience and knowledge has increased.
“These factors have helped families create successful, diversified conglomerates, but these will not forever insulate them from other growth-oriented challenges,” commented Saddi.
Many who run family conglomerates are “restless entrepreneurs”—focused on new business/ investment development, rather than on the institutionalization of the businesses once created or acquired, leading to a lack of focus: A survey of 25 family-owned firms in the GCC showed that nearly half (48 percent) were involved in five or more sectors; (40 percent) engaged in activity in three or four sectors; and 12 percent active in two sectors or fewer. The “restless entrepreneur“ syndrome is typical of any company that operates within a context of strong economic growth, limited competition, and abundant capital.
Another characteristic of family firms in the GCC is the emotional attachment to the original or earliest businesses, which define the legacy of the family. Even if these businesses generate returns below the cost of capital, the family often keeps the business to preserve the identity and brand of the group.
Upcoming Challenges for Family Firms
The current global economic slowdown, increased competition, and the democratization of business development in the Middle East will force family businesses to focus on scaling businesses and improving performance. “Many GCC family businesses over the next decade will also have to contend with the hurdles posed by the transfer of company control to a third generation,” commented Youssef. This creates two challenges in particular:
Greater difficulty in maintaining control over the business: As shareholders become more numerous, centralized control becomes more difficult. Transferring control to a third generation means a company formerly controlled by siblings is now controlled by cousins; leading to weaker family ties and obligations. The absence of the “preferred shareholder” concept in some countries may exacerbate this.
An increase in pressure to grow the business: Large family size (an average family in the GCC has five children) puts pressure on family businesses to grow as quickly as possible to maintain wealth. Based on the current average size, the typical family business needs to grow 18 percent each year just to maintain the same level of wealth across generations.
Continuing a Tradition of Success
The evolution of family businesses is expected, but many do not survive in the face of so many challenges. These seven key actions will drive the successful evolution of a family-owned firm.
In terms of business management and development, family-owned firms must take four steps:
Reevaluate 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 independent 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, there are three separate steps for firms and families:
Separate family and business activities: “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,” commented Youssef. Families need to focus on drawing clear lines between family and company activities. This can be accomplished by:
Creating a “family office” to handle family-related activities.
Separating philanthropic activities of individual family members from the business.
Exploring the creation of a separate financing arm that could specifically support family members’ own business ventures.
Create a formal governance structure for family and business activities: Formalizing the governance will ensure effective delegation and separation of activities and will prepare for succession. The structure should be managed carefully and introduced gradually, involving various family members.
Appoint a change agent: Successful change can be championed and implemented by one family-appointed change agent. Many families split actions among family members with no clear accountability, which leads to failure.
Some studies show that up to 80 percent of family businesses fail to make it through the third generation. Today, many GCC family businesses will be put to the test, requiring around 20 percent a year in growth to maintain the same level of wealth. They will survive economic downturns and generational changes by institutionalizing their businesses and managing the restless entrepreneur syndrome—or face extinction. Many of the world’s greatest corporations are family dynasties, which have successfully evolved and adapted to changing business conditions and family needs and abilities.