Why family businesses succeed

Relationships are the key to comparative advantage

Kongo Gumi Co., Ltd. is the world’s oldest continously-operating business

If you live in Japan and need to repair a temple, you can probably trust the services of Kongō Gumi Co., Ltd. It was founded nearly 1500 years ago, so if it’s still running today then it must be doing something right. Kongō Gumi is reckoned to be the oldest continuously-operating business in the world. And, like many venerable companies, it’s run by a family.

Established family businesses are respected worldwide to the point of reverence. The international association Les Hénokiens brings together nearly fifty European and Japanese family-run firms that have all operated for more than two centuries. Its exclusive membership covers sectors as diverse as artisanal producers, heavy industry and private banking.

But family firms aren’t just an ancient and ubiquitous phenomenon. They make up two thirds of the GDP of Western Europe and half of the US total. A study of S&P 500 companies by American academics Anderson and Reeb found that, on average, they outperformed their non-family rivals. Return on assets were statistically greater, and a measure of assets’ market value (Tobin’s q) was 10% higher in family firms. There is one obvious cause of this higher performance: people.

In family firms, business partners are also relatives. This means that the two main kinds of human relationships — exchange and communal — co-exist in family firms. In communal relationships choices aren’t about maximising profit. Psychologist Marylène Gagné describes how family business decisions may therefore prioritise welfare over money. This includes a value metric called socio-emotional wealth, or SEW: non-economic utilities such as family harmony, principles and reputation.

Prioritising SEW changes the way that businesses behave. For example, Prof. Luis Gómez-Mejia and colleagues looked back over fifty years of decision making by 1,200 Spanish olive oil producers. They found that, when given the option to join a cooperative, family-owned firms consistently chose sustained independence over greater income. According to the logic of profit, these communally-oriented strategies might appear sub-optimal.

However, such decision making does not automatically mean losses or failure. In fact, Nigel Nicholson of London Business School contends that the culture created by this family-oriented behaviour can be very good for business. Factors embedded in relationships — such as special knowledge, high social capital and brand identity — can give family firms competitive advantage.

The business becomes an expression of the family, its values and culture. For instance, as investment advisor Mark Daniell describes, family firms are perceived as more trustworthy by customers and clients. And, because the family is inseparable from the firm, members engage emotionally in the company and care about building and maintaining its reputation and legacy. None is more emotionally engaged than the founder.

Prof. Pramodita Sharma of the University of Vermont describes the pivotal role that founders play in family businesses. They are often spirited pioneers and innovators. Strong psychological ties mean that founders stay, on average, nearly three times longer than executives in non-family firms (17.6 years vs. 6.4, as Daniel McConaughy found in a study of American CEOs). And while in the hot seat they frequently go the extra mile, reporting sustained high levels of energy and commitment to the firm’s future.

Family businesses which are able to maintain their values, spirit and reputation while transitioning to scale can become successful at the global level. BMW, Samsung, H&M and LVMH have all been able to achieve this balancing act. These are the kind of family firms that appear on the list of highest performers across all major sectors of industry. But they are the success stories.

For every family business that uses its competitive advantages to thrive and scale up, there are two that fail. As family enterprise specialist Prof. John L. Ward notes, less than 30% of family businesses survive their second generation, while only 13% last three generations. And while family factors are responsible for the remarkable success of some businesses, those same relationships can be their undoing.

This is where psychology comes in.

Co-authored with Dr Chris Merritt

Digital Humanist and behavioural psychologist. Here to debate how we make sure humanity is the central consideration for any new technology