August 11, 2009

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. ‎