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The resilience of family businesses is under threat

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Family businesses are facing organisational challenges, as never before. If anything, the pressures are set to intensify, making many of them less resilient, and less relevant, in the 21st century. 

Technology, demographics, and economics are all moving in directions which are not advantageous to the family business model, as we know it today. 

Of course, many family enterprises will continue to thrive and prosper for years ahead, not least because they are robust businesses and possess great brands. 

Walmart, for example, has employed technology to revolutionise the way it buys and sells goods. LVMH is very innovative in the luxury brand world. UK-based Dyson has emulated Apple by mass-producing fashionable, reliable, products on 20% operating margins. 

All too often, however, family businesses have failed the tech test, making themselves vulnerable to takeover, or disappearing altogether. 

Many comprise multi-generational businesses in unfashionable or overbroked sectors like automotive, retail and consumer markets, and hospitality and leisure. Pricing pressure, intensified by the coronavirus crisis, has never been so challenging but capital investment is badly needed.

Market performance and technology

Family Capital has looked at the performance of US-listed family businesses on the S&P 500 and compared it to equivalent non-family companies. The chart below shows US large-cap listed family businesses have been underperforming their peers since 2017. Instead, money has poured into large-cap growth stocks which have boosted their attraction to investors with share buybacks. 

What this chart shows is investors are marking family businesses down. And this trend appears to be gathering pace – at least in the US, the world’s biggest economy. US big tech stocks are now within a whisker of regaining the ground they lost during the March stock market panic. 

By comparison, value stocks are flat on their back, as investors wonder whether old economy businesses and property will retain any resilience at all. Small-cap value stocks, vulnerable to stagnation or collapse, have suffered their worst decade since the Great Depression of the 1930s.

Exuberance for tech-driven companies may lead to a sharp correction for their shares at some point. But a new generation of passive, and active, investors want exposure to the new world.

What is most concerning for the big listed family businesses is that they operate in old economy sectors vulnerable to digital disruption. The cost of entry for new competitors is low as is their cost of capital, courtesy of their stratospheric market rating.

Big tech has proved to be adept at spotting competitors before they gain market share, and snapping them up. Antitrust provisions within the US are low, making intervention from state agencies unlikely.

Even where family businesses are using the latest tech to keep up with the disruptive forces they face, their core businesses are buried in the old economy. In theory, cash flow from their legacy businesses will fund new businesses. In practice, this rarely happens, as managements hang onto their fiefdoms.

Take for example the top ten biggest family businesses in terms of revenue in the world, as compiled by Family Capital in its annual 750 ranking. All of them are operating in old economy sectors and all ten are vulnerable – with the four automakers – VW, Fiat Chrysler (Exor), Ford and BMW – the most vulnerable. 

Disruption in the automobile sector is huge. Tesla is arguably the world’s most valuable automaker. In terms of market capitalisation (around $150 billion in mid-May 2020), it is at least $20 billion more than the combined market cap of the four family-owned automakers listed above. Tesla didn’t exist 20 years ago. VW, the world’s second-biggest family business in terms of revenue, has been a promising electric car but its cash flow still relies on traditional models.

The remaining six biggest family businesses are vulnerable to tech disruption. The huge commodities conglomerates Cargill and Koch Industries are going to feel pressure from advances in plant and clean meat production, the accelerating move away from fossil fuels, and other commodities like fertilizers and animal feed. 

Low-price supermarket chains like Walmart and Lidl, owned by Schwarz-Group, will continue to fare better than many of their rivals but they are operating in an intensely competitive sector. Amazon is encroaching and Facebook has revealed an online shopping approach. 

Berkshire Hathaway is also vulnerable as Warren Buffett looks to be losing his Midas touch: over the years, he has avoiding investing in tech, putting aside Apple, saying he doesn’t understand it. His stock has been badly lagging the S&P 500 index and Buffett reaches 90 in a few months time. Right-hand-man, Charlie Munger, is 96. 

It is worth adding that Buffett has been a serial investor in old economy family businesses such as newspapers and retail.  Now, they need to be updated. 

Tata and Sons (Tata Group) is possibly the least vulnerable out of the top 10, given its presence in so many sectors in the fast-growing Indian economy, including technology. But it is also committed to traditional businesses, such as heavy industry and chemicals.

Resilence

Digital distribution is most obvious in the US – and this is having its effect on the resilience of family businesses there. Where big tech is less dominant the resilience of family businesses still shines through. But for how long?

German family businesses are an excellent example of resilience. The country has one of the most highly developed family business cultures in the world, largely centred on its privately controlled Mittelstand companies. The chart below, which shows the DAX 30 listed family businesses compared with the listed non-family businesses, reflects their strength.

 

Yet, the German stock market isn’t a very good representative of the digital disruption going on in the US. It has no big tech stocks on its board.

Its ethos is an old economy model which suits family businesses and their long-standing ability to outperform. Local investors tend to be value driven and allocations to Europe by global investors reflects their interest in geographical spread rather than tech-driven growth.

Is this outperformance by listed family businesses in Germany and other economies where domestic big tech companies are likely to continue? Probably not. 

Demographics

Another factor undermining the resilience of family businesses is demographics, always important due to succession issues.

But the trend is not their friend. The ageing populations of Western countries means business owners are enjoying longer and healthier lives. Bringing in the next-gen is becoming an increasingly long term prospect.

But the next-gen isn’t waiting around. Many are starting their own businesses and most of them have a tech and digital flavour to them. Family Capital wrote about next-gen and their venture efforts last week. 

Sometimes, the next generation may need to wait forever to inherit a business. The Bill Gates model of business ownership is gaining ground. There has never been so much capital available for private equity and corporate purchases as a result of central bank stimulus. 

Successful entrepreneurs, particularly in the technology sector, are more likely to sell the companies they founded and move onto a second career involving investment and good causes. 

All this adds up to an environment less advantageous to the longevity of family businesses. 

Of course, family businesses have been written off in the past, most recently when their investments fell victim to the financial crisis of 2008. Their political capital rose rapidly after the crisis, as the long-term approach to business and investing became the zeitgeist.

But can they bounce back this time?

2 Comments

  1. This is an incredibly well researched and thoughtful account of challenges, and in this time of turmoil, every family business has to do a new assessment of its prospects and challenges, and consider paths that may have been unheard of. The benefits of family business need to be emphasized–low debt, clear control and ability to act, and a social commitment that is being tested. This is so helpful as background for every family’s reflections.

  2. I do have one question that is also a comment. In the FB vs. NFB indexes, how was survivor bias handled? If we start with companies that are only here today and go back and see what an index of them would look like if we followed them from a start time to today, you don’t have effects of companies that were closed or sold. If the way you did it was to start with a matched group of companies at a fixed point in time and when a company was sold or closed, proceeds were reinvested in the index (remaining companies) on that date (less applicable taxes of course), then it would be a better comparison. The same treatment would also have to apply to dividends. As to the S&P, that is super tricky to have an accurate comparison. Companies are added and removed all the time so I guess you’d have to run the numbers making an assumption like: as a company is removed, the shares are sold and reinvested in the rest of the index or in the companies that were added. It is very messy since the S&P rebalances quarterly. All I can say is that my belief, without testing it, is that if things were rebalanced or adjusted for survivor bias, the FB’s would outperform even more!

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