The charm of family businesses in India

Credit Suisse, did an extremely interesting research, dated in 2017 where they analysed family businesses globally. Two interesting trends emerged from the study – across geographies, family businesses outperformed non-family businesses in shareholder returns, and the margin was in excess of 5%. Secondly, family businesses tended to spend a higher %age of their revenues on technology and R&D in investing for the future. This outperformance and the drive to invest for the future stemmed from four broad trends that were noticed in global family businesses:

1. They tended to have a much stronger balance sheet, as the focus on expansion was tied to internal accruals
2. Their focus was more towards longer term-growth as against short term profits
3. The businesses had strong cash flows which continue to grow and the businesses exhibited prudence around expansions
4. They were able to bring in a professional management with the founder working closely at the board

Closer to home, this has a significant implication for India, where family businesses contribute to 30% of the total sales of the listed companies in India, and close to 74% of the total GDP of the country. The analyst team at Itus put together the returns of the family businesses in India and their shareholder returns to compare them with non-family businesses and the broader market. Interestingly, there was underperformance in a family business in India as against a non-family business (contrary to global experience). A deeper understanding of where the underperformance came from, saw two core aspects that stood out:

1. People and Transition

Family businesses, over time, tend to have multiple stakeholders in the family with different visions which tend to put pressure on the company’s growth. The best run family-businesses have managed this transition extremely well where they bring in a professional management to oversee operations, with at least 2 members of the family overseeing the business and strategic decisions at the board.

Fig 1: Lifecycle of family businesses

For an Indian family business, this transition is never easy, because this has a precedent of giving up control. As a society, this is not something we are used to and have been guilty of implementing this poorly. Doing this in a half-hearted way makes it much harder for the incoming professionals to translate the vision into future growth too.

In the Indian context, a few families have managed this transition well – the standing example, while it continues to be the Murugappa family, more recently, the Apollo Hospitals group have managed this transition through creating a formal constitution and governance mechanisms which every member in the family needs to go through. There have been multiple instances in the country that did not achieve the required results by separating ownership from management and were forced to return to the older order as the separation led to a decline in family fortunes. Such things make other business families also apprehensive of such changes.

2. Transfer of Values:

One of the most significant reasons for shareholder creation has been in family businesses that have managed to transfer the values and culture of the business down generations. Family businesses (listed in particular) have a tendency globally to not take decisions with a 90-day window (for quarterly profits). This helps them to take a long-standing view around decisions and capital allocation. This has an impact on the vision of the firm, and this stems from the value system and culture built in the firm. In a US Based family business, we studied the sequence of events that led to independent directors behind hired was as below:

The directors of the company, both family representatives and independents, agreed that an outsider should succeed the CEO. But they had to manage the expectations of multiple stakeholders, including family owners, a young and capable next-generation family member in management, and more-seasoned non-family executives. An outside CEO would be a first for the company, and the owners needed to feel confident it was the right choice. To ensure their comfort, some directors suggested a completely external and unbiased evaluation of potential candidates, including the young family member; others suggested that the family member be given special consideration; others simply wanted the individual to feel included and valued; and still others just wanted the best decision for the company. The board nodded to all these viewpoints in designing a succession process, which ended up being lengthier and less efficient, but helped deepen trust. Directors at another company came up with a unique but effective trust-building tactic: They organized a retreat at a vacation spot where most of the family-owned homes – which allowed them to get to know other directors better and to develop ties with family members beyond the boardroom. When trouble later emerged in the company, the directors already were at ease with one another and were able to communicate clearly with the family. This effectively created a close system of trust and gave comfort to the stakeholders outside the family that communication and transparency was an important value of the family.

Family businesses globally will continue to be the backbone of every economy’s GDP and it’s important that we adopt the best practices of value creation to ensure some of the best businesses in India, continue to generate growth across generations as the eco-system they have created has been extremely valuable for the country’s growth engine.

Source: The Irresistible Charm of the “Family Factor”

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