Family Biz Go Into Decline After Three Generations: HBS Professor

By Dibyendu Ganguly

Originally published in The Economic Times (July 2014)

In 1983, Rajesh Kohli dies intestate, without a will, at the age of 57. Rajesh and his wife, Shobita, created a strong middle class family and invested most of their assets in educating their three sons, Ravi, Nitin and Arvind. It was to Nitin, the son with a head for business, that the father bestowed $50,000 shortly before his death, asking him to invest it on behalf of the family. This vague commandment works for nearly 25 years.

Nitin grows his original business to assets of over $30 million, all of which are in his name, as is the custom in Hindu Undivided Families. He thinks he has been loyal, dependable, trustworthy, supporting his brothers and their children financially through good times and bad. But now his brothers want a clear separation of the business and his former feelings of generosity are replaced by a desire to be free of them and their lack of appreciation.

Nitin Kohli is one of the several case studies that John Davis of Harvard Business School (HBS) has written on Indian business families. The names are disguised, as is usual with HBS case studies, but the students attending the HBS programme he teaches in India wouldn’t have any problem identifying with the Kohli family. Nor would the students from other parts of South Asia and the Middle East who fly down to Mumbai for the programme.

Davis, who teaches an elective course on Managing the Family Business at HBS and has been researching the subject the for 30 years, including in 60 countries outside of the US, and he feels that family businesses are remarkably similar the world over: “Different cultures do more or less of certain things, but the similarities are more than the differences. For example, the patriarch exists everywhere, though he may have more power in certain cultures than others.

“India has seen the decline of the joint family in business houses, which has been replaced by a loose system of living independently in proximity. This is similar to the way things are done in South America. “Activities are arranged to ensure that families come together regularly. It helps perpetuate the family business, uniting everyone around a sense of mission. Of course, there will always be some who find even this to be stifling and they will move away and establish a wholly independent life,” says Davis.

The focus of Davis’ current research is on how families identify and develop wealth creaters in every generation. In the Nitin Kohli case, the father identified the middle sibling as the wealth creator. How do other business families do it? “The wealth creators are usually identified when they between 8 and 14 years of age,” says Davis. “I’ve asked heirs when they knew they were going to follow their dads into the family business and some said they has a strong sense of their destiny at the age of six. It may not be planned, but a certain amount of implicit searching goes on in every business family.”

Traditional business families go to great lengths to develop the next generation and instill in them a sense of dynasty. Earlier, the eldest son might have been the first choice, but that has changed and younger siblings — including daughters — with a genuine talent for business are being given their due. “Being a successor is a tough road,” says Davis, “You’re constantly compared to your father and you have to prove yourself worthy. People doubt you capabilities, which means you need a thick skin. You are dealing with a consortium of relatives and need political skills. You may have to fire a non-performing nephew, while dealing with your sister, who may have a substantial stake in the company. For most heads of family-run companies, family issues take up half the time.”

Once the family has found its wealth creator, other siblings are usually left free to make their own choices, including the option of moving out of business altogether and making a career in the arts. Davis himself comes from a entrepreneurial lineage — both his grandfathers were businessmen — but he has chosen to teach rather than practice. The importance of family businesses has declined in the US, though even now, more than half the publically traded corporations there are family run. In India, Davis estimates it to be two-thirds, which is close to the world average. However, many of these are now run by professionals, though the chairman may be from the family. “Once the company grows beyond a certain point, it’s hard for the family to keep up. That’s when they transition to a bringing in a professional CEO,” says Davis.

Family-run companies have never been the top choice for graduates of top b-schools like HBS, but Davis feels the option shouldn’t be scoffed at. “Family companies focus on the long term and thereby provide a sense of stability. They did better than other companies during the recent downturn. Banks are now paying more attention to them because family run companies have more money than anyone else,” says Davis.

Do family business houses inevitably go into decline after three generations? Davis doesn’t have scientific proof — three generations last over 100 years and nobody seems to have collated the data — but he’s inclined to agree with this perception. The reasons are many. Wealth is best generated through operations and not stock investments, but over time assets mature and the industry that the family is in often goes into decline, which means a fall in returns. And of course, there’s the indolence that sets in among family members of the third generation. “By the third generation, family members are consuming too much, more than they can afford. That’s when the decline becomes visible,” says Davis.

5 Points to ponder points:

  1. Family businesses do go into decline after three generations
  2. For heads of family-run companies, family issues take up half the time
  3. A successor needs political skills to deal with a consortium of relatives
  4. The family needs to identify future business leaders when they are still children
  5. Patriarch’s power may vary depending on the cultural context