A trend towards family businesses breaking with nepotistic traditions may have repercussions through the entire business world. By Adele Ferguson
After years of sibling rivalry and family squabbles, one of Australia’s oldest and most private family businesses, G. H. Michell & Sons, has found peace by hiring an outsider to replace its managing director of 22 years, John Michell. It is the first non-family appointment to the top job in the company’s 130-year history.
This appointment marks a new era in family businesses: nepotism is out of fashion, and succession by genes is no longer a certainty. Instead, family businesses are starting to pick the best person for the job, regardless of their gene pool. Rupert Murdoch is the highest-profile example of this trend. Earlier this year he announced that his chief operating officer, Peter Chernin, would succeed him as chief executive rather than his elder son, Lachlan.
There are a number of reasons for the change, the most significant being the growth in pension funds and their increasing influence on succession planning and the strategic direction of the companies in which they invest. Savage competition in the funds management business and pressure to release quarterly performance figures are forcing institutions to pick the best businesses in which to invest their money. With the exponential growth in superannuation (caused mainly by the compulsory superannuation guarantee levy) institutions such as AMP, MLC, Mercantile Mutual and National Australia Asset Management are taking bigger and bigger stakes in listed and unlisted companies.
Money flows quicker than blood
As the power and influence of these funds grow, so does the intolerance for less-than-perfect chief executives. As a consequence, the Australian corporate landscape is littered with dumped chief executives and their senior managers. Jeff David, the son of John David, is just one example of a son who left the top job soon after his family’s listed business, David Holdings, was taken over by the South African wholesaler Metro Cash & Carry.
Michael Gilding, chairman of social and political studies at Swinburne University of Technology, surveyed a series of rich families about their views on succession. One family told him there was a strong contrast between nepotism and professionalism: “My strong feeling and [my partner’s] is that we wouldn’t have nepotism in the firm. Our genuine feeling is that the firm needs to be professional at the extreme level. Once you have introduced somebody without skills, simply because it’s your son or daughter, it creates a totally different environment. Now everybody here, on every level, knows that it’s their own skills that will get them their promotion and nothing else. The best thing you can do for your children is give them a good education and some help. If you look at the Gettys and various other families who went totally discombobulated, you know, it resulted in disasters for the individuals.”
Gilding reports an owner of a big family business as saying: “I think one of the biggest difficulties with generational successions is that, as the company gets larger, it makes it more and more difficult for the next generation to succeed their parents. We have a fairly large organisation here. I have an excellent management team, a managing director, marketing director, senior financial people; and so it is difficult to bring a son or daughter into a senior management position where they would soon become the heir apparent and be able to continue the dynasty. I worked closely with my father. The company, at the time I got involved, was fairly small. There was no management structure as such. He was the boss, everyone else the worker. You know, the opportunity to work at his right hand was there. Now it’s very difficult to bring that type of relationship into a larger company such as ours, with an established management structure. That, I think, is one of the reasons it is difficult for businesses to keep going to the third and fourth generations.”
This move away from nepotism towards picking the best person for the job reduces the gap in management style between a family business and a non-family business. Two things have usually distinguished a family business: “succession by genes” and the blurring of the lines between the collective called the family and the collective called the business. In a family business both collectives are mixed and can create confusing dynamics. There is the apocryphal story of the father who sacks his son, walks around his desk and puts his arm around him, saying: “You’ve been sacked? Is there anything I can do to help? And don’t tell your mother what happened.”
As globalisation gathers pace, the move is towards larger economic units, impersonally owned and professionally managed. In this context the family firm is becoming an anachronism, destined for extinction.
Yet there are great numbers of family businesses operating in Australia. Figures from Monash University reveal that between 80% and 90% of Australian businesses are family enterprises and that the overall wealth of Australian family businesses is about $1.2 trillion. The wealth estimate is $690 billion for first-generation business owners, $293 billion for second generation and $170 billion for third and fourth generations.
In the United States, more than 90% of all enterprises are family businesses, contributing more than 60% of the gross domestic product. In western Europe, family businesses represent 70 80% of all registered corporations, making significant contributions to their national economies.
The rise of big, impersonal economic units and increased percentage of family businesses in Australia seems to be a contradiction in terms. But a closer look at the family business reveals that many are metamorphosing into professionally run enterprises. For example, Rupert Murdoch runs News Corporation, and three of his children have strategic positions in the business. However, its vast global empire straddles many industries (newspapers, television, film, the Internet, satellites, books, sport, encryption and cable) and the main decisions are made by an inner circle of six people, including Rupert. This means the business does not “feel” like a family business in the sense that sibling rivalry has a limited effect on the running of the business. Instead, it has the appearance of being professionally run and has many management systems in place.
Family businesses are forming links with other businesses and adopting the structures of non-family businesses. They are also offering equity to non-family members to entice them to stay in the business. If the family business is listed, equity is part of the non-family manager’s remuneration package, as in the case of News Corporation, Frank Lowy’s Westfield Holdings, Kerry Packer’s Publishing & Broadcasting Limited and Len Ainsworth’s Aristocrat Leisure.
A glance at Australia’s biggest family businesses shows that the country’s wealth has been built on family dynasties. The earliest settlers built empires based on primary production, but many of these have been diminished by drought and a lingering rural depression. In their place have grown manufacturing, property and investment empires.
The common denominator for many of these new enterprises is that they were created from nothing. The Ingham family’s wealth was built from the inauspicious beginnings of a pushbike round, selling eggs. Ervin Graf, John Saunders, Frank Lowy, the late Sir Peter Abeles and the late Larry Adler arrived from a war-torn Europe with a few pounds in their pockets and the determination to succeed.
The latest growth stars and wealth generators are Internet and other technology businesses.
A new species evolves
A ground-breaking survey from Monash University reveals that more than half of Australia’s family businesses expect the current chief executive to be succeeded by a non-family manager. This is a critical finding, given that more than 60% of chief executives are planning to retire in the next decade.
It is this blend of professionalism and family business characteristics that is creating a powerful sharemarket beast. A study by Professor Claudio Romano and Dr Kosmas Smyrnios shows that listed family businesses outperform all stockmarket indexes. Using 200 listed Australian family businesses, Romano and Smyrnios have constructed a family business index. Preliminary results show that it outperforms the All Ordinaries index, the Standard & Poor’s 500 index and the Financial Times 100 index by more than 40% over one, three and five-year periods.
Observers of family companies believe that at the most basic level they outperform the market because family members have their wealth tied up in the business. Every time they make a decision, they risk their own wealth; if things go wrong, the family is the first to lose.
There are other reasons for listed family companies tending to outperform non-family listed companies: they make long-term decisions; they are not vulnerable to takeovers, allowing consistency in management planning; they have a special interest in the survival of the business, making them wary of high-risk strategies; they are steeped in the knowledge of their industry; and they have generally joined the stock exchange during a strong corporate growth phase.
Performance surveys in Britain and the US show that listed family companies generally outperform the broader market. In Britain, the Stoy Hayward/BBC Family Business index shows that, in a 21-year period, family companies outperformed the broad market index by 30%. In the US, listed family companies also outperform the market. A study by the Pitcairn Financial Management Group of Philadelphia reveals that the cumulative returns for family companies over a period of 20 years were more than double that of the Standard & Poor’s 500.
Control, flexibility and speed
The chief executive of Family Business Australia, Denis Tracey, says one of the reasons family companies do well is that they usually make decisions more rapidly. “They have that element of control that makes them more flexible in their decision making. The large conglomerates tend to canvass institutions. That takes time.”
Furthermore, family companies are not as preoccupied with dividend policy or how an investment will affect the profit and loss statement. They are more inclined to invest than a company concerned about the price/earnings multiple and dividend yield.
Family businesses tend to be less bureaucratic than large public companies, giving them dynamism often lacking in big businesses.
They are also less likely to make acquisitions. The Ernst & Young Mergers and Acquisitions index database (the top 300 industrial companies with a market capitalisation greater than $20 million) shows that small and mid-cap stocks, the category to which most family businesses belong, make fewer acquisitions. This can be a benefit given the high number of failed acquisitions.
Tracey says there is a sense of continuity in family businesses. “For example, Peter Fox is executive chairman of Linfox. He says his job is to preserve the company and hand it on in good shape. The children of his brothers and sisters are very young, so he is making plans for the next 30 years. Not many companies or governments make that sort of strategic plan.”
Mirror of society
Gilding of Swinburne says changes in family businesses over the past 20 years reflect changes in society. “Divorce is up 40%, and that means marriage does not rest on normative expectations of what men and women do. We know in traditional family businesses the men are the public face of the business and the women are crucial behind the scenes. When we are looking at a business where marriage is less normative, the emphasis is on negotiation. In an era when de facto relationships are commonplace, that also affects the workings of a family business.” Consequently, family businesses are placing more emphasis on choice, flexibility in gender roles, flexibility in the way the families operate, and allowing the children greater choice as to what they do.
Whatever change may be taking place in family businesses, they are still in a different category. Gilding says family businesses are far more complicated than non-family businesses because the owners, managers, board of directors and family all overlap. “Once you put the family in the equation there are 16 different roles and therefore many more dynamics.” For this reason, family businesses have to juggle three roles: family, ownership and management. When a member wears the family hat, the priority is being fair to other family members. Sometimes bad decisions affecting management and profit will be made when the family hat is being worn.
Passing the baton
With the passing of the pre-war generation, control of family businesses is being handed on to the baby-boomers at a rapid rate. And it is at times of generational change that businesses are at most risk. The high risk was most clearly demonstrated in the Fairfax ascendancy when “young” Warwick Fairfax took it upon himself to seize control of the media conglomerate. Fairfax was soon at the mercy of its bankers and, as a result, the family lost control to outsiders. In his autobiography, sportsman, wine maker, raconteur and businessman Sir James Hardy recalls his devastation at the family’s loss of control of Thomas Hardy & Sons through poor business decisions. “I was a shattered man inside,” he says. “In two years, 140 years of family tradition had been demolished.”
Conventional wisdom says it takes three generations to go from nothing to nothing; the first sets it up; the second builds it; and the third loses it. Many Australian family businesses are right now in the act of handing the baton to the next generation. The wealth of the entire nation would thus seem to be at stake.
However, researchers at the University of Connecticut disagree, saying that the longevity of a company is a good indication of its chances of survival, and that the more generations a family business passes through, the greater the likelihood that the grandchildren of the present generation will work in the business. According to their study, 25 35% of family businesses survive the first generation, 58% survive the second, and 70 88% the third.
The study suggests it is more than longevity that gives a family business strength. It also requires a foundation of professional management structures. The study says this is reflected in the high failure rate of first-generation businesses, which tend to be dominated by a patriarch or matriarch who is less likely to seek independent advice or appoint independent directors.
Why family businesses crash
American family-business consultant Marta Vago uses the adage “The fish stinks from the head” to describe an ailing family business. Vago, who has advised hundreds of family businesses in the past 20 years, believes founding patriarchs play significant roles in the demise of family companies. She says there are three key factors that affect the long-term viability and success of family businesses.
First, most lack accountability. There may be a board of directors but, at best, it is a rubber-stamp body composed of family members, a paid company advisor and a close friend or two. This lack of accountability at the top is mirrored throughout the organisation. The second most common characteristic of family businesses is tolerance of mediocrity. “In the absence of performance measures, competence becomes a matter of personal judgment filtered through a lens of family relationships and emotional ties,” Vago says. In most family businesses, there is an assumption that all family members must hold management positions regardless of whether they have the requisite technical and human skills, or even the desire to hold such a position.
The third defining element of most family businesses is the absence of effective governance. Boards in family businesses rarely consider the strategic effect of having a weak board. Additionally, the diverse, and often conflicting, needs of active and inactive shareholders on the board cripple many businesses.
Kosmas Smyrnios says many family businesses are unwilling to subject themselves to performance measures. This is where outside directors and advisers can contribute an element of objectivity, thereby removing some of the family emotion from business decisions, especially business decisions over who is to ascend the throne once the matriarch or patriarch abdicates.
Smyrnios refers to a Monash University survey of 5000 family businesses that indicates that management planning is a shortcoming in Australian family businesses. It reveals that, across generations, owners seem to be unprepared for the future. These findings are particularly the case for first and second-generation owners. For example, more than 38% of first-generation owners and 42% of second-generation owners report not having a business plan in writing. In contrast, third and fourth-generation owners show a greater propensity to plan (74%) and a greater propensity to have a management structure implemented (88%).
With succession planning high on the agenda for Australian families, the future economic health of the nation rests on their making the right decisions. Although the family business is the engine room of the economy, it is an area of study so far neglected by academe. Over the next few years, however, several universities hope to rectify this by training managers in how to deal with working in a family enterprise.