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The family business advantage: unconventional strategy

Family businesses have special traits that allow them to follow different, unconventional business strategies to those pursued by non-family firms – the advantages of trust within the business, ownership commitment and a longer term view all contribute to their strategic success

A fundamental tenet of strategy is to do things differently in order to achieve competitive advantage. Businesses often create opportunities for competitive advantage and superior performance by pursuing unconventional strategies. Family-controlled companies have special traits that allow them to more readily break with conventional strategic wisdom. They can do the right thing rather than the expected thing.

Conventional theory
For centuries. family businesses have had obvious advantages in economies with an inefficient market system. If the supply and mobility of professional managers were limited. families successfully attracted talent through loyalty and paternalistic generosity. If regulations or licenses were doled out by government discretion. well-established families could trade on their professional relationships. community political support and favours. If consumer markets were unstable. owner-controlled firms could rapidly adjust and seize opportunity through facile decision-making.

But do family-controlled firms have competitive advantages in free. open and efficient markets? Can they successfully compete where globalisation demands huge scale and massive resource investments? The evidence is clearly 'yes'.

Research provides many examples of family firms that create superior financial performance in global markets by systematically following strategies different from those pursued by nonfamily firms. Three strategies follow.

Strategic consistency
Early research shows that familycontrolled companies maintain more stability in their strategic investments during a recession than publicly traded companies. Firms subject to stock market expectations tend to cut back on important strategic investments that are beneficial in the long-term. in order to preserve current operating profits. Other research has shown that family firms make decisions that better maximise cash flow while their publicly controlled peers are willing to sacrifice cash for accountingdriven operating profit.

Diversification
Conventional wisdom holds that diversification is often driven by selfaggrandising managers. Managers seek diversification in order to create greater job security or to garner the increased compensation and status that come with greater firm size. Further. conventional wisdom holds that diversification is more effectively achieved by individual investors who can acquire a portfolio of securities according to their own interests and profile. While this is true for publicly traded companies and their owners. it is not true for investors in family-controlled firms. Family firms that pursue diversification strategies outperform the overall market.

There are several reasons for this. First. when owners are managers (or closely tied to them). management is not likely to pursue its own interests if they are contrary to ownership's interests. In other words. when diversification takes place. it does so for the right reasons and not the wrong ones.

Furthermore. the owners of a family business can often only achieve diversification through their firm or when they find it is economically advantageous to do so. Family business owners often hold most of their assets in one investment that is relatively illiquid. In addition. liquidating business assets and distributing them for individual investment is not efficient because of the punishing taxation of distributions imposed by most countries.

Finally. a diversified family business portfolio can facilitate the sale of an asset. when necessary. to satisfy shareholder liquidity needs. This allows liquidity needs to be satisfied without testing the family ownership's commitment to the overall business in an all-or-nothing decision.

In sum. sounder investment motives drive diversification in a family-controlled firm. where the ability of ownership to control these decisions is stronger. Also. the benefits of diversification are likely to be appreciated by family business owners and can help earn their loyalty. For these reasons. family business owners benefit from firm diversification. The better it is done. the more owners are able to remain committed and supportive of the firm as a long-term investment.

Vertical integration
Vertical integration is often discouraged by economic theory. yet proves promising for family-controlled firms. Academics argue that firms should outsource all but scarce or precious functions. Then the firm can pit external bidders against each other for services and get the best price and best competencies. The competitive market assures the best value.

Moreover. doing non-essential activities in-house creates a lot of internal bureaucracy and inefficiency. Units of the same business argue over transfer prices and preferences. and an expensive infrastructure has to be set up to negotiate. mediate and control these debates. If only a firm could reap the benefits of vertical integration – more coordination. control and profits – without all the expensive disadvantages.

Family-controlled firms have that opportunity. Family businesses have shown a distinct competence for doing vertical integration effectively. They accomplish this by promoting a company culture that focuses on the common good rather than on creating incentives for rival internal units to benefit themselves at the cost of other internal units. Recent research has shown that vertical integration works for family firms. As with diversification and strategic consistency. the family firm can successfully run counter to conventional wisdom and practices in vertical integration.

Meeting expectations
Publicly traded companies in wellestablished capital markets must manage themselves to match the expectations of security analysts and institutional investors. Because management and directors are particularly sensitive to the requirements of analysts and funds. they are careful not to violate their norms.

Stories of how companies compromise almost everything. including their ethics. to meet 'street' earnings expectations are legend. While the motivation to perform is compelling. so are the costs of such a single. golden master. For example. in some industries firms load up extra sales promotions at the end of most every quarter to book needed revenues. In other industries. customers demand margin-cutting deals as the quarter or year-end approaches – fully knowing that they have the seller over a barrel.

Family-controlled firms can avoid many of these pressures and expectations. They can do the 'right things' rather than the expected things. By not following conventional strategic practices. family businesses can pursue many of the potential benefits of being different. In other words. family firms don't have to 'follow the herd of conventional wisdom'. They can dare to be different. Research shows that. on average. those differences are translated into better financial performance over the long-term.

Common foundations
In addition to being unconventional. the ten types of unconventional strategies share three other common foundations: a long-term view that allows firms to break the paradigms of conventional wisdom and 'follow the crowd' thinking; trust that emboldens courage to think long-term; and an excellent governance structure that creates trust regarding management's intentions.

The most commonly asserted disadvantage of family firms is their relatively limited access and openness to outside capital. While a lack of capital can certainly be devastating under some circumstances (ie bidding against competitors to acquire the only producer of an invaluable. indispensable raw material). perhaps this disadvantage is often exaggerated in its relevance. Entrepreneurial literature and family firm histories demonstrate that scarcity of resources often stretches businesses to be more creative and efficient. Ample resources can often generate careless risks.

Moreover. family firms are frequently perceived as undisciplined and unprofessional. Often. the family's culture of loyalty. paternalism and nepotism is perceived as leading to 'less than the best' managerial competence. That is certainly possible. however. demands for professional discipline and results at any cost can also compromise many of the advantages of family firms. 'Doing the right thing' can fall prey to doing what is expected. Short-term decisions can outweigh long-term patience. One important challenge for the governors of a family business is to understand and balance the benefits of discipline with the advantages of patience.

Long-term view
A long-term view makes the benefits of unconventional strategy possible. If owners are committed to long-term ownership. then the benefits of patience are meaningful. Committed ownership also liberates the opportunity for longterm thinking. If continuity is a more important goal than current return. the long-term view is more natural.

Robert Mondavi. a California vintner. illustrated this point as follows: "My family and I had worked for 30 years to learn wine making from the roots up. to develop our sales and distribution network. establish our name and credibility in the marketplace. and earn our stripes by delivering a top-quality product. year in. year out. Show me a conglomerate with that kind of patience and dedication! You have to think in blocks of five years minimum and to be really successful you have to think in blocks to 10 years. 20 even – long enough to embrace the next generation. "

These sentiments were echoed by the Durst real estate development family. "Because this is a family business. we're not thinking about tomorrow or next week. We're thinking about our children and grandchildren. and so we do develop buildings and begin planning for them 20 or 30 years before they are actually built. "

Trust
Trust makes the long-term view possible. Without trust. owners will not chance the long-term gain against the more predictable short-term benefit. The future is less predictable; doing the right thing instead of managing to expected results introduces further unpredictability. To overcome the discomfort of this unpredictability. interpersonal trust among the governors must be strong.

As trust justifies the long-term view. it also lubricates the advantages of unconventional strategies. The advantages of vertical integration. for example. are built on a culture of trust. Managing a successful. diversified company requires trust between operating units and the parent company. In other words. trust is both a means and an end to capturing the competitive advantages of unconventional strategies. Trust encourages deference to different. and better. thinking.

Governance
Just as trust enables the long-term view. and long-term thinking. in turn. makes unconventional strategy possible. excellent governance creates trust. Governance includes the roles. responsibilities and relationships found among the owners. members of the board of directors and senior managers. If owners trust the managers. the managers can take the chance of proposing unconventional strategies. If the owners. directors and managers trust one another. the board can approve unconventional strategies.

When there is trust. owners and directors can be more patient about letting unconventional strategies develop and they will tend to support managers in 'doing the right thing' more than 'doing whatever it takes to get the expected results'. If owners. directors and managers trust each other. then they can hold honest. open discussions on the trade-offs between 'doing the right thing' and insisting on the discipline of meeting expectations.

Thus. trust in the governance system. is the most valuable competitive advantage of family firms. Without trust in the governance system. unconventional strategies fall victim to the suspicions of sceptical self-interest that lead to conventional thinking and the status quo. 

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