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Research Shows: Family Firms Have Special Strategic Advantages

The latest research says:

  • Family Controlled Firms have superior financial performance.
  • Family Controlled Firms are more successful with vertical integration strategies.
  • Family Controlled Firms are more successful with diversification strategies.

In powerful, sophisticated new research by Harvard business professor David Kang, the strategic advantages of family ownership have been again well supported. Kang’s conclusions directly contradict conventional for non family businesses “wisdom.”

The conventional wisdom of strategy suggests:

  • Family firms are burdened with unresponsive, myopic thinking and, therefore, don’t perform as well.
  • Rarely is it wise to vertically integrate except to control a scarce or precious capability. (Otherwise vertical integration brings added bureaucratic costs and conflicts of intra-firm negotiations such as transfer prices. It is better, per most strategy research, to force focused suppliers to compete with each other for your business.)
  • For twenty years, most academics, financial analysts and management consultants have argued against a firm diversifying. Doing so dilutes forces, doesn’t exploit special core competencies, and deprives stock market investors of the opportunity to diversify as they wish.

Well, it appears those concepts do not apply to family firms. Not only do family firms outperform the market, but according to Professor Kang, they are successful with both vertical integration and with diversification, particularly in the case of businesses in mature industries going through turbulent times.

With his analysis of 81 family-controlled, publicly-traded firms in the U.S. textile industry over 10 years, Kang provides the best research to date on how ownership structure affects corporate governance, affects strategic choice, and affects company performance.

Why does the strategic experience of family firms differ from that of other firms? What makes family firms distinct? Why should those distinctions lead to superior performance?

Ownership Influence

Non family firms typically have dispersed ownership, with no real influence or expertise in the business. Even if some of the non family owners are powerful and attempt to exert influence, it’s not the same as the more collaborative, trusting and long standing personal relationships the founding family has with management. In other words, family owners and their managers are more like partners, not adversaries, and family owners have a special feel and knowledge for the business that brings mutual confidence with management in strategies that are unusual, risky or against the conventional wisdom.

Vertical Integration

When certain industries mature, vertical integration becomes an important way to extend growth, profits and competitive power. But successful vertical integration can be attributed to special characteristics of family firms. Typically, vertical integration brings internal conflict between the buying and selling units within the business. The climate of family control does a better job of uniting the organization in a positive, constructive culture that relieves many of the internal business conflicts and allows the business to take advantage of the benefits of vertical integration.

Diversification

Most research suggests diversification is more motivated by management “empire building” than sound judgement. Instead, in family firms, diversification is more motivated by balancing cyclical cash flows. In addition, the acquisition decision is made in concert by owners and managers, thereby assuring the soundness of the decision.

Conclusion

According to Kang’s research, family controlled firms have several important advantages because of the strengths that ownership can bring to the strategic decisions of the firm:

  • Owners have social relations with management and, therefore, more comfortable, trusting relationships seeking mutual benefit.
  • Family owners have expertise from historic experience that can add perspective to strategic decisions.
  • Family companies more likely have a culture of cooperation.
  • Family businesses have vigilant owners that serve as a check and balance on possible management egos.

Of course, owners’ expertise can become outdated and then their influence can, potentially, be harmful to the business’ strategic decision making and performance. That’s why we believe that owners must remain active, informed and educated about the business and its strategic environment.

Research from “Ownership Sttucture and the Boundaries of the Firm: How Large-Block Family Owners Lead to Vertical Integration, Diversification, and Superior Firm Performance,” working paper by Professor David L. Kang, Harvard Business School, 1998.

 

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