Last Updated 06 Jul 2020

Critical Success Factors in Managing Family Owned Business

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In the Family Owned Business (FOB), the family and the business are two distinct institutions that will form to become two subsystems that will interact to become a family business system. While the importance of the family cannot be denied, the business is no less important. It depends on the perspective of whether the business is the means to an end or the end in itself. Basically the FOC is a family with business. How the family effects the operation and management of the business and how the influence can be directed towards more productive business performance and profitable outcomes are the goals of my research.

CHAPTER 1. THE PROBLEM AND ITS BACKGROUND Landes (2006) has underlined the value of FOBs and their importance to developing and emerging economies as they play a vital role in the spectacular booms of India and China, as well as their dynamism. The has emphasized the importance of family capitalism and says "Clearly, the family firm is not about to disappear. The vast majority of new businesses throughout the world remain family enterprises, and I believe this will remain the case for the foreseeable future".

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Gersick (et all, 1999) has explored some success and failure of well known FOBs and the authors speak of the Barings of France, whose unbearable snobbery and anti-Semitism played a striking part in their business decline. The author also speak of the French company of the de Wendels, from the beginning an aristocratic family with a strong political engagement, always for very conservative causes and he also speaks of the manner in which Ford demoralized and destroyed his son Edsel.

The authors also speak of the demoralized children, characterized the Agnellis, whose line of succession went from the founder Giovanni who set up Fiat in Italy, to his grandson, another Giovanni ("Gianni"), and most recently, after the death of Gianni, skipped a generation to pass to his grandson John Elkann. The Guggenheims, Rockefellers, and Schlumbergers moved from politics to collecting, foundations, patronage, and politics. In the case of the Schlumbergers the politics was very cranky.

While the Rothschilds did much better than the Barings, there is no doubt about the decline of their family firms' significance since the nineteenth century. Speaking of positive notes, the author speaks of the Toyodas of Toyota who have risen to greater heights of success and he accounts the achievement mainly for the fact that the Japanese marries into powerful relations. The main point that arises is why some families do better than others? why generational transitions are easier and quarrels less destructive in some FOBs?

1. 1. Statement of the Problems The general problem that would be explored in this thesis are as to what are the critical success factors in successfully managing family owned business and how do these factors effect the business performance. The following specific problems would be addressed in the thesis: 1. What are the strengths and weaknesses of FOB as well as opportunities and threats that they face? 2. What are the critical success factors that affect the performance of FOB and how may these factors be described? 3.

How is business performance of FOBs determined? 4. Do the critical success factors stated above significantly affect the business performance of FOBs 5. How may the organizational culture be described in terms of the following organizational culture characteristics? 6. Do the organizational culture characteristics have a significant influence on the effects of the critical success factors on the business performance of the FOBs? 1. 2. Significance of the Study The study would attempt to highlight factors that contribute to the success or failure of FOBs.

The study would serve as the starting point for further research of FOBs and help entrepreneurs in adopting the right strategy for growth and success. 1. 3. Scope and Delimitation The study would conduct an extensive literature review of FOBs and develop an understanding of certain key drivers that are common to FOBs. The study would also attempt to research the practices adopted by pre-determined sample FOBs. There are certain limitations in the study since it should be realized that FOBs do not readily share confidential information and business records and financial reports are not readily accessible.

Moreover, the student of this thesis admits that achieving success in the market space also involves adopting the correct product mix, tackling competition, branding and marketing, pricing, advertisement, financial reserves and many more and these are different domains of business practices and hence they are not approached in the thesis. 1. 4. Notes on Chapter 1 The chapter has discussed examples of FOBs that have seen success and failure and has pointed out instances such as Agnelli of Fiat that was a failure and also Toyodo family of Toyota that has been a success.

The chapter has also made a statement of the problem that relate to finding critical success factors in FOBs. The paper has also mentioned the scope of the study and specified the limitations of the research. CHAPTER 2. THEORETICAL FRAMEWORK The chapter will attempt to lay a framework for the research and will form a hypothesis for the research that would be researched in the next chapters. A SWOT analysis of FOBs is provided along with relevant literature review that forms the basis for the research.

2. 1 SWOT Analysis of FOBs An analysis of the strengths, weakness, opportunities and threats has been performed in this section. The issues pointed out have been supported with published literature. 2. 1. 1. Strengths Welter (2006) has spoken about the inherent strength of FOBs. They include factors such as direct involvement of stakeholders and the owners and such an involvement means that such companies see higher awareness and quick collective response to business exigencies and opportunities.

The reaction time is also very quick in FOBs and they are able to react quickly to market forces, deploy resources, take a personal interest in the company affairs and generally promote efficiencies. The author also suggests that such companies are able to take quick decisions and ensure that the opportunities are addressed effectively. 2. 1. 2. Weakness Cadieux (June 2007) ho has performed extensive research on the subject has pointed out that FOBs have certain weaknesses that make them vulnerable to failure.

The author argues that succession factor is a major issue in FOBs. According to the author, the second and successive generations tend to fragment the business and members attempt to gain control over the business and this creates power struggle with employees taking sides with one factions and in many cases this leads to an escalation in the company that can lead to open boardroom clash. Such fights prove very harmful to the motivation of the employees and the success of the company.

Fiegener (1996) has pointed out that small FOBs are prone to stagnation and are not able to expand and integrate vertically with the supply chain. Many of them are vendors to large enterprises and when a product line is discontinued, the FOB is not able to quickly make investments to develop the new product. The author also suggests that FOBs are not able to harness new technology and replace machines since the financial outlay needed would be beyond their immediate means. Lansberg (1999) has argues that FOBs, especially the SME has problems of talent stagnation and high employee turnover.

The author argues that small FOBs are not able to attract new talent since there are restrictions on the salary that can be paid and consequently, the companies do not change their business methods unless change is forced on them. The author also contends that FOBs fall prey to changing market conditions or change in customer base and product preferences. 2. 1. 3. Opportunities Colli (2003) has provided an analysis of how FOBs function and has commented that such companies are able to quickly change their direction and strategy in exploiting different market opportunities.

The FOB is able to quickly change factors such as pricing, appoint new dealers and distributors, change commission rules, set up new branches and enter new markets. The author contends that while financial support is needed for any investments, the decisions can be much more quickly formed, than compared to corporate which need to pass resolutions through board of Directors, give sufficient notice of any events and meetings, etc. 2. 1. 4. Threats

Rothausen (1999) has pointed out that FOBs face threats in the form of not being able to adapt to market changes since they may not have the means to support financial incentives that come through. The author also reports that internecine struggle for power, poor preparation of a successor, lack of coordination among future generations, distrust and feelings of being sidelined, etc. are some of the threats that FOBs face. The author also reports that the heads of some FOBs are reluctant to hire competent staff in the fear that their authority and power may be challenged and this culture is transmitted down the hierarchy.

2. 2. Relevant Theories Pieper (December 2007) has commented that the FOB field is growing at an increased pace and is gaining relevance in the business research field. The author has commented that a few models have been developed that explains the structure and complex intersection of the family and the business. The models that have been framed to explain family businesses include family business dimensions and attempt to create important relationships among subsystems that may influence family business behavior.

The author comments that some of these models are framed at basic levels of abstraction, which do not allow for feedback loops and reciprocal influence. FOBs grow through a life cycle just like any other type of business but this time with the added dynamic of a family. Family businesses move through the following five stages (Sirmon, 2003): • Family Employment Firm (FEF) - as many family members as can be accommodated are employed in the new endeavor. • Family Management Firm (FMF) - family members with formal education move into management roles.

• Family Governance Firm (FGF) - family members move out of direct daily management and into roles as officers and board members. • Family Governance and Investment Firm (FGIF) - the family firm is now moving into community involvement and creating/funding new family ventures. • Family Firm Turning Point - time at which the family decides to cease being a strictly family owned firm. Sirmon (2003) has proposed a resource-based view of entrepreneurship theory and the exclusive characteristics of FOBs and these are:

• Human capital - can be both a negative and a positive encompassing the knowledge and skills of each family member in regards to the business. The negative is when family membership eclipses knowledge and skill that can be brought to the business. The positive is exemplified by via the stronger dedication and servitude a family member brings to a family legacy business that an outsider would rarely feel. • Social capital - human capital is focused on the individual, social capital is focused on the relationships between individuals.

Supplier, resource and finance ties to outside stakeholders are a few examples. Strong social capitalties have been shown to be invaluable in training subsequent generations in operating the family firm. • Survivability capital - resources the extended family is willing to expend in support of the business; for example, loans, gifts, and labor. In other words, a family safety net. • Patient capital - family firms are not interested in quarterly reporting nearly as much as they are interested in generational advancement.

While family-owned firms may be limited in the capital they can raise, they are usually not limited to short term financial thinking. • Governance structure -cost of monitoring, controlling and punishing those who manage the firm. Family responsibility, and let's be honest, family guilt, keep these costs relatively low compared to non-family owned firms. Mazagatos (2007) speaks of FOB as a nexus of contracts between co-specialized resource owners who are linked through a special contractual structure that combines economic relations and family ones.

The family manages the firm and thus can control the firm to guide decision making toward its main concern: to maintain control of the firm over the course of generations, for the sake of the non-pecuniary benefits that the family obtains from this control such as lifestyle within the community, job creation for family members and so on. From the family business view, the firm's capacity to create value depends not only on the quantity and quality of its resources, but also on the quality of the ties that link the resources within the firm.

This fact creates a trade-off. The aim of guaranteeing family control of the firm reduces its array of potential financial resources and thus limits its entire resource structure. Lack of financial resources is one of the chief causes affecting the development, growth opportunities, and long-term survival of private family businesses. Anderson (2003) argues that value creation depends not only on the resources held but also on the way resources are managed by the firm.

The particular ties that link family resources are characterized by altruism. The nature of this altruism and the types of agency problems engendered by it are contingent on the ownership stage of the family business. In the first generation, the duality of economic and family ties acts as a regulator and incentive for a cooperative attitude on the part of resource holders that reduces agency costs in their relationships. With succession, however, family businesses suffer from adverse selection costs, since managers are selected altruistically.

Even more, ownership dispersion and the lessened intensity of family ties will engender agency costs, so the family business will need to increase its financial resources to maintain the firm's value. Addressing the issues of succession, McConaughy (2001) argues that once successors join the firm, the agency costs derived from the relations among different resource owners will increase. Altruism exposes family businesses to agency problems associated with lack of ability because family successors are more likely to occupy senior management positions irrespective of merit.

Because hiring and promotion are not subject to either external market mechanisms or internal evaluation processes, family businesses are deprived of the best managerial talent possible. Thus, family interests in management appointments may harm corporate objectives, such as maximizing value creation. Additionally, the dispersion of ownership and the diversity of roles that family members may perform in the firm over the course of generations will increase conflicts of interest and information asymmetries between owners and managers.

Schulze (2003) argues that fractional ownership reduces the managers' motivation to exert effort in promoting cooperation, while it increases their incentive to act opportunistically because they bear only a part of the cost of such action but enjoy all the benefits. In addition, as the branches of the family continue to fan out, the affective bonds with the original family will be less intense, and family interests will be centered on the new family unit that each member is forming.

In this context, altruism will have less power to drive cooperative attitudes. Members will give priority to current rents, which may be enjoyed by their new nuclear family, to the detriment of long-term rents that will go to the extended family. The family members' objectives will disperse, and the information asymmetries will increase. Therefore, agency conflicts among the different resource holders will rise and there will be greater possibilities for managerial opportunism. 2. 3. Review of Related Literature

Zahra (et all, 2006)has commented that at the environmental level, the particular cultural and economic setting provides the context for the family business system and the individual. At the organizational level, the family business consists of four subsystems: family, business, ownership, and management. The four organizational subsystems consist of groups that, in turn, consist of individuals business system can be members of only one or of several subsystems and their membership can differ over time.

Hernandez (2007) has attempted to characterize salary and compensation of employees in FOB when compared to ones in non-family firms and professionally managed family firms. The authors suggest that employee compensation differs between firms and argues that the role of ownership concentration and management composition in the firm plays a decisive role. The authors contend that since salary and wages are explicitly defined according to risk sharing and to the interest of the owners, CEO, and employees, the pay mix would be more oriented to variable pay in family owned and managed firms than in non-family firms.

Jensen (et all, 1990) have pointed out that the pay is lesser in FOB owned and managed business than in non-family and professionally managed family business. The author reports that are no differences in employee pay levels between professionally managed family firms and non-family firms. Employees in professionally managed family firms obtain an increased proportion of variable pay when compared to family owned and managed firms and non-family firms, where the fixed pay has more weight in the pay mix.

The authors also speak of the temporal orientation of incentives, those mainly oriented toward the short term are more common in family owned and managed firms compared to professionally managed family firms and non-family firms, where incentives are designed over a longer term and that temporal orientation of incentives is established in a similar way in family owned and managed firms and in non-family firms. Small firms often suffer the problems associated with asymmetric information and information costs when they seek new financing (Ang, 1992; Ennew, 1994).

In this sense, small family businesses could be affected by the typical problems studied in the theory of pecking order (Poutziouris, 2001). FOBs tend to set their financial policy by a trade-off between tax savings and the likelihood of financial distress derived from debt, as in the trade-off theory (Romano, 2000). Donckels (1999) argues that directors of small and medium-sized family businesses are more involved in corporate finances than their nonfamily business counterparts and that interaction occurs the very moment the business is established through seed capital.

Haynes (1999) reach the conclusion that family businesses use available resources efficiently by developing strategies that link family and business capital, particularly when they are aimed at reducing the tax burden. However, some authors believe overlapping business and family finances can create inefficiency. Such examples include paying out dividends or salaries that are not in line with profits or using personal assets to guarantee corporate loans.

Recently, Poza, (2004), pursuing univariate analysis, highlighted the fact that a positive relationship between firm and family influences managerial and governance practices, suggesting that it could represent a resource for competitive advantage and sustained business performance. Moreover, they noted that the nature of the interaction between family and business significantly contributes to the reduction of potential agency costs. Additionally, Jaskiewicz, (2005) finds that family-owned businesses under perform compared to non-family businesses when they go public via initial public offerings (IPOs), although not significantly.

They obtained evidence on the positive influence that strong family presence in listed companies exerts on their performance. As regards capital structure, numerous studies indicate that family businesses adopt highly conservative strategies, characterized by a stronger preference for using internal resources for financing, less investment in intangible assets, a lower level of debt, a high concentration of capital in the hands of one sole family, and a static ownership structure that leads them to reject the possibility of sharing control of the business with external partners (Gallo, 1996).

Moreover, Gallo, states that a "peculiar financial logic" in family businesses is driven by owner managers' personal preferences concerning growth, risk, and ownership control that put the company in a difficult situation for competing in the future. The reasons why most family businesses do not survive the second generation can be grouped into five factors (Green, 2002): • Ending of the product life cycle. • The business did not reinvent itself. • The business could not finance itself. • No estate planning. • Estate taxes forced the business to sell. 2. 4. Review of Related Study

Reviews in the previous sections suggest a few critical factors for success in FOB and they are: • Succession issues of future generations should be smooth and beneficial to all stakeholders. • The FOB should have a proper financial structure. • The FOB should have professional non-family managers who are vested with sufficient decision-making powers. • The FOB should be able to attract new people who would bring in new ideas and generate new strategies. • Control of the FOB should be given to qualified personnel who are employed and not be default to the business owner.

2. 5. Conceptual Framework Todd (2007) has proposed a framework that was proposed after extensive literature review and case studies of successful and failed FOBs. The conceptual framework would attempt to cover the following aspects. The framework is a co relation between the present incumbent of a FOB and the Successor: • Quality relationship - the more positive this relationship from any angle, the better the transition; mutual respect leading to trust leading to feedback which cycles back into the relationship.

• Motivation - how does the incumbent view leaving the firm; as losing control and a death sentence and psychologically difficult or is the motivation one of the natural process, a positive letting go for the family legacy. • Personality - delegating vital for the successor to make own mistakes and successes while still being guided; the opposite is a micro manager hanging on too long causing resentment • Abilities - proven management skills backed up by experience; legitimacy; interpersonal skills.

• Ground rules - weakest area in the literature having to do with succession guidelines. • Succession plan - known throughout the family for long time. • Shared vision - overall family business goals firm, supported by all and known by all. • Nurturing/development of successor - training of the successor • Formal education - college degreed successors have smoother transitions than high school degreed successors. • Training program - the more formalized the better; demonstrates focus and increased successor profile, grows involvement in the firm.

• Transfer of knowledge - begins at home but increased to the firm as a growing involvement; relationship with incumbent pivotal. • Career development - exposure to the business so the earlier the better for credibility, experience and interpersonal contacts. • Outside work experience - working outside the firm to establish an independent reputation; often one of the strongest criteria for success. • Incumbent phase out/transition and new role - mentoring relationship to ease the transition can be positive if handled well by both sides.

Having a new "job" or plan ready in the outside world can satisfy incumbents need for purpose. • Successor phase in - clear responsibilities and time frame for each to occur very helpful is smoothing the transition. Well-defined boundaries for incumbent creating successor independence. 2. 6. Hypothesis of the Study The hypothesis of the study has been framed after a through literature review. The following hypothesis have been put in place.

For a second and third generation FOB to succeed, there should be a satisfactory succession plan, the organization should have a professional management team with adequate decision making power and the financial structure must be equitable and well balanced meaning that even if the owner wishes to withdraw some money, it has to be entered into the proper in the appropriate voucher or expense statement. The hypothesis would further cover areas such as expansion into related and non-related markets and further introduction of new products or expanding the current business line.

2. 7. Definition of Terms The following terms stand defined as per various literature reviews done in the previous sections: Incumbent: The present head of the FOB who is managing the business. Successor: The person next in line who would be expected to take over the business once the incumbent relinquishes the business. FOB: A family owned business that is managed by a family or a single individual who manages the business. 2. 8. Notes in Chapter II Chapter II has provided a rigorous literature of different theories that relate to FOB.

The section has examined certain common critical success factors in FOBs and suggest that: planning a successor, having clear financial and capital structures, providing a vision, placing an emphasis on quality personnel and employees and vesting them with sufficient decision making powers, are crucial. CHAPTER 3. METHODS OF RESEARCH The section provides information on the methods and techniques of research that would be used to test the hypothesis that has been framed in the previous section. 3. 1. Methods and Techniques of the Study To conduct the study, a combination of qualitative and quantitative measures and methods would be used.

Qualitative methods would involve face to face interviews with heads of FOBs and quantitative methods would involve mailing a questionnaire to selected heads of FOBs. The following figure illustrates the methods that would be used. Figure 1. Methods used for the research ( According to Miles (1994), qualitative research focuses on “qualitative data” or “descriptive data” that describe the social phenomenon under investigation with respect to the nature of people, objects, and events. They further highlighted that the emphasis is on discovering emergent findings not on a measurement of predetermined variables.

Interestingly, Denzin (1994) define qualitative research as multi-method in its focus, involving an interpretative, naturalistic approach to its subject matter. This means that qualitative researchers study things in a natural setting, attempting to make sense or interpret with minimum intervention. Miles and Huberman (1994) agree that due to the desire to discover the emergent findings rather than measurement of variables, qualitative research requires a minimum intervention of the study setting in order to allow the qualitative data to reveal themselves in a natural setting.

Diefenbach (2007) has argued that quantitative analysis is more likely to be secondary and exploratory (or descriptive) in nature, summarizing data in the form of charts, tables, percentages and averages. In the event that a survey is carried out, the data obtained would mostly be categorical, hence is likely to be ranked across a scale. This data might be represented in terms of frequency, central tendency or dispersion. It is highly unlikely the research might require the necessity of inferential data analysis.

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