April 28, 2009

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.‎