Chapter 1 Family Business What Makes It Unique? Family Business, First Edition, by Ernesto J. Poza Copyright © 2004 South-Western/Thomson Learning

1-2 Course Goals Gain an understanding and respect for family business continuity Understand better the challenges and advantages faced by your own family business Learn managerial, governance, and family practices that increase odds of family business success

1-3 Family Business: Working Definition A family business is a synthesis of:  Ownership control by members of a family or consortium of families  Strategic influence of a family in the management of the firm  Concern for family relationships  The dream (possibility) of continuity across generations

1-4 Family Businesses... Constitute 80–98% of businesses in U.S. and other free economies Generate 49% of GDP in U.S. and more than 75% in most other countries Employ 59% of private sector U.S. workforce and more than 85% of working population overseas Created about 80% of all new jobs in the 1980s and 1990s

1-5 Other Statistics Between 17 and 22 million family-owned businesses in U.S. Annual revenues exceed $25 million for 35,000 family businesses Family-controlled companies comprise  37% of all Fortune 500 companies  60% of all publicly held companies

1-6 The Bad News In their first 5 years of operation, 90% of family-owned companies disappear Of remaining 10%, 67% die or change ownership after first generation Only 12% survive under current ownership past the third generation

1-7 What Makes the Difference Presence of the family Owner’s dream to keep the business in the family Overlap of family, ownership, and management Competitive advantage derived from interaction of family, management, and ownership

1-8 Family Business Theories Systems theory Agency cost theory Resource-based theory

1-9 Systems Theory Model shows overlapping subsystems of family, management, and ownership Firm is dynamic system in which integration achieved by adjustments to subsystems Individual perspectives of family and firm may differ, leading to overemphasis on one sub- system at expense of others

1-10 Systems Theory Model Family Management Ownership

1-11 Blurred Boundaries Boundaries among family, ownership, management systems may become blurred  Problems determining if decisions relate to family, ownership, or management issues  Family rules used in the business  Problem-solving ability diminished by blurred boundaries Businesses may become family-first, ownership-first, or management-first

1-12 Family-First Businesses Employment in business is membership right Members of same generation paid equally Extensive family perks from business Secrecy often paramount and family members protect each other Business becomes part of lifestyle Commitment to continuity depends on agendas of individual family members

1-13 Business-First Firms Employment on the basis of qualifications— family discouraged from working in business Performance of employed family members reviewed as for nonfamily Compensation based on responsibility and performance Conversation between family members is all business

1-14 Business-First Firms, continued Business growth, market share, profitability, return on assets, return on equity constitute the scorecard Next generation viewed in terms of how they can manage and grow business Family events often cancelled/delayed for business reasons No automatic commitment to family business continuity

1-15 Joint Optimization Alternative Family employment policy guides employ- ment of family Some family members are employees; others responsible shareholders Performance of employed family members reviewed as nonfamily

1-16 Joint Optimization, continued Family members encouraged to work outside business to get experience When family members meet, conversation is both family and business oriented Commitment to family business continuity

1-17 Agency Cost Theory Traditional theory: Alignment of owners and managers decreases need for agency costs Recent research: altruism of owner- managers leads to increased agency costs Agency costs can be controlled by managerial and governance practices Board of directors important in monitoring managerial behavior and controlling costs

1-18 Challenges to Continuity Shortening product life cycles High transfer tax penalties High market valuations of ongoing businesses by historical standards Family businesses considered outdated Family structure far from stable Next generation family business leaders unable/unwilling to accommodate CEOs living longer—obstacles to succession

1-19 Resource-Based Theory Resource-based theory highlights unique capabilities or resources that family firms convert into competitive advantage These resources referred to as organizational competencies

1-20 Competitive Advantages of Family Business Speed to market Strategic focus on market niches Concentrated ownership structure Lower overall costs Quality of product/service Agility and flexibility Owner-manager and long-term view

1-21 Speed to Market Source: Boston Consulting Group.

1-22 Strategic Focus: Niches Size of Market and Business Performance Under $50 million28.1% ROI* $50 to $100 million26.8% ROI $100 to $250 million24.2% ROI Over $1 billion10.9% ROI *4 year average ROI. Source: PIMS Program

1-23 Concentrated Ownership Ownership structure impacts corporate productivity Stock concentration positively correlated to  Related diversification  R & D expenses per employee  Training per employee  Overall corporate productivity Source: Hill and Snell, Academy of Management Journal, 32#1.

1-24 Lower Overall Costs Cost of capital is nearly 0% when owner controls stock Financing for other businesses:  25–30% for venture capital  17–20% for mezzanine financing  Prime rate for bank financing Administrative and control costs also reduced absent need for principal supervision

1-25 Quality Relative Product Quality and Business Performance High relative quality27.1% ROI* Medium relative quality19.8% ROI Low relative quality16.8% ROI *4 year average ROI. Source: PIMS Program

1-26 Agility and Flexibility Flexibility of new manufacturing and distribution technology makes smaller runs economically attractive Customization, changing consumer preferences, shorter product life cycles reward agility EDI/Internet-based partnerships make agility possible across value chain

1-27 Owner-Manager Focused on customers, family, employees, profitability, lifestyle Experiences conflicts between family, management, and ownership and optimizes links Average tenure of 18 years vs. 3 years for public company CEOs