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Why family business succession is China's biggest threat

China is facing a new economic crisis, and it is not about mounting local debt or even a rapidly slowing property market. The crisis in the making is about family business succession in the world’s second-largest economy.

China is facing a new economic crisis, and it is not about mounting local debt or even a rapidly slowing property market.  The crisis in the making is about family business succession in the world’s second-largest economy.

This issue may seem innocuous for many observers, but it is in fact one of the many pressing issues for the country’s economy, which is undergoing a painful process of rebalancing.  Why is the family succession issue so important?

We have to start by debunking one of the most enduring misunderstandings about the Chinese economy.  Many people think the Chinese economy is dominated by state-owned enterprises, but this could not be further from truth.

Nicholas Lardy, a leading China economist and senior fellow at the Washington think tank, the Peterson Institute for International Economics, estimates private enterprises in China account for two-thirds of total output in China, up from zero decades ago when private business was outlawed in the country.

Chinese official statistics tell a similar story. The country has close to 40 million private businesses and they produce 60 per cent of China’s GDP.

The state sector only accounts for between one third and one quarter of GDP. In manufacturing, which represents about 41 per cent of GDP, state-owned enterprises only account for 20 per cent of output. The overwhelming majority of China’s private enterprises are family owned.

These privately-owned family businesses are facing succession issues roughly at the same time -- an unprecedented phenomenon in the world of family business. All private businesses started more than three decades ago, when China abandoned the Maoist ideological craze in favour of market reform. Those brave entrepreneurs who embraced the market are fast approaching retirement age.

According to a white paper released by Fortune Generation, a magazine affiliated with China Relay, an exclusive club made up of children from the country’s most powerful and richest private sector tycoons, Chinese family business faces a looming succession crisis in five to 10 years’ time.

The succession crisis is happening at a time when China’s privately controlled manufacturing sector is under unprecedented pressure to move away from its labour intensive production model, which is unsustainable in light of soaring wage increases.

Mao Li Xiang, the chairman of Fotile Group, the country’s leading producer of kitchen appliances, warns that the succession crisis has the potential to be more destructive than the global financial crisis. Fortune Generation’s white paper estimates that only 8 per cent of family companies have successfully managed to pass on the baton to the next generation.

Family succession is not an easy issue to deal with anywhere in the world, and the problem is particularly acute in China.  Cultural differences between first generation entrepreneurs and their children could not be greater.

Nearly all of China’s elder business people grew up during the depravity of Maoist China, when there was a shortage of everything. Many endured starvation and years of languishing in the countryside for so-called “re-education”. Many of these early entrepreneurs don’t have much formal education. Their successes have relied on their drive, instincts and entrepreneurship.

But, in sharp contrast, 88 per cent of their children have university degrees and 52 per cent of them have studied overseas, including at many leading institutions such as Harvard, Wharton and the London School of Economics.

Anecdotally, members of the overseas-educated second generation often clash with their parents over the management of their companies. The children are keen to introduce advanced Western management systems to their family businesses, against the wishes of their parents. The children’s push to modernise these businesses is often viewed with suspicion, as the parents believe many Western practices are incompatible with the reality of doing business in China.

The first generation entrepreneurs also operate under a very different value system from their children, who have grown up only knowing affluence.  Many Western educated second generation children also don’t like dealing with government officials, which is a necessary evil in the Chinese business world. 

Kelly Zong, the only child and heiress to the multi-billion-dollar Wahaha fortune recently publicly criticised China’s social ills. “I think we lost our soul. In the US, they have beliefs: Christianity and Catholicism. China has Buddhism, but I don’t think people really believe it in their heart,” she told The Guardian.

Two days after the interview, her father Zong Qinghou, one of China’s most powerful tycoons, rebuked his daughter in the Chinese media saying she was influenced by foreign culture when young, and was not clear about the present situation in China.

The transition is particularly evident in the manufacturing industry; many children who are educated abroad shun the manufacturing sector and prefer to seek opportunities in finance and other “cool” areas.  Fortune Generation estimates more than 65 per cent of children whose parents own manufacturing businesses don’t want to be involved in the industry.

This could potentially evolve into a large problem, with economy-wide significance, if China’s family dominated manufacturing sector fails to find enough successors to carry on the businesses. However, it is not all doom and gloom, and there are examples where second generation business people have risen to the occasion, taking on the challenge of running a family business.

One such person is Australian-educated Chen Danxia, who is expected to lead the Guangzhou-based Liby Group, the market leader in selling consumer goods such as cleaning agents and personal care products.

She has successfully managed to acquire and rejuvenate an ailing cosmetic brand in Shanghai, adding it to the family fortune. The heiress also took advantage of the global financial crisis to acquire Western brands, including those from Australia.

Nevertheless, the family succession issue is shaping up to be a major economic challenge for China as the country seeks to transform its manufacturing-based industry and redefine the relationship between the state and the private sector.

This article was originally published in Business Spectator, and is reproduced with permission.

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