Innovation Drivers in Family Firms

Why are some family firms more innovative than others? Cristina Cruz explains how factors such as economic goals, family cohesion, and focusing on a ‘legacy’ affect how family businesses innovate.

Family firms are often assumed to be conservative in their innovation strategy. However, the truth is that many family-owned businesses are actually amongst the most innovative in their industries. Moreover, many of them are able to thrive across generations, which indicates that the spirit of innovation is at the very heart of their company culture.

The impact of family ownership on a firm’s innovation has thus proved controversial and suggests that there is an “innovation paradox” when it comes to family-run businesses. Most research that attempts to explain this inconsistency tends to compare the innovation of family vs non-family firms. However, not all family firms are alike. So, it is important to forgo making across-the-board comparisons and consider what it is that sparks innovation in family firms.

In a recent study that investigates the underlying drivers of risk-taking for family firms, my colleagues Manuel Becerra of the University of Queensland Business School and Chris Graves of the University of Adelaide and I identify two particular idiosyncrasies of family firms that produce innovative tendencies.

The first is the proportion of the family’s personal wealth that is locked up in the business, which we call the wealth concentration (WC) effect. The second is what we call family-centered goals (FCG), which is the importance that family owners attach to the pursuit of business goals that are oriented to specifically benefitting the family.

The risk of all eggs in one basket

Family firms are unique to the extent that they have stockholders that are less diversified on account of the fact that they are members of the same family, and on top of that have a greater percentage of their personal wealth tied to the business. In any respect, low wealth diversification is risky from an investor’s point of view and in the case of family firms it implies that the family’s welfare as a whole is mainly dependent on the health of one business.

Our study shows that low-risk diversification is also a detriment to the very health of the firm to which the family has tied its prosperity. We demonstrate that as the percentage of family wealth invested in the firm increases, family firm innovation is reduced. This is because when their wealth is highly concentrated in the firm, family owners are relatively more sensitive to financial losses when making strategic decisions than other, more diversified shareholders. Since returns from innovation are uncertain, as the percentage of family wealth locked in one firm increases, family owners become more cautious regarding innovation.

Thus, it is ultimately the amount of the family’s personal wealth concentrated in the family firm that drives risk aversion in family firms.

Beyond making money: The importance of purpose

Of course, the “essence” of family firms is not defined solely by their concentrated ownership. What makes a family business unique is the presence of owners that have the power and authority to pursue goals that are aimed at benefiting the family – in addition to what would traditionally be considered the firm’s economic goals.

What really distinguishes the great family business innovators is having family owners with a true sense of purpose.

Family owners pursue two different types of family-centered goals: a) family-centered economic goals (FCG-E), primarily directed to ensure the financial well-being of the family and its control over the strategic direction of the firm, and b) FCGs that are non-economic in nature (FCG-NE), such as the creation of a unifying vision that ensures family cohesion, the promotion of family social status and reputation and the perpetuation of the family legacy.

While both types of goals are directed to benefit the family, they have different influences on innovation in family firms. What my colleagues and I expected to find through our research was a negative relationship between FCG-E and innovation reasoning, that as families put more emphasis on ensuring a regular income to the family, there would be fewer resources to explore new opportunities. We also anticipated that family owners, being focused on maintaining family control, would be reluctant to invest in innovation strategies that require specialized human capital or equity investments from outside the family pool.

Surprisingly, though, we did not find that family-centered economic goals dampened innovation. To the contrary, we discovered that innovation is positively impacted by the existence of family-centered non-economic goals.

Indeed, further analysis shows that family-centered non-economic goals have roughly twice the effect, compared to the size of wealth concentration, on whether a family firm embraces innovation activities. So, what really distinguishes the great family business innovators is having family owners with a true sense of purpose.

Families that prioritize family-centered non-economic goals, such as the continuation of family legacy, do not consider it a threat to family wealth to commit their resources to innovation. Rather, the investment is seen as a necessary condition to ensure the family’s well-being and the firm’s continuity. Moreover, family owners with strong family-centric non-economic priorities, for example family cohesion, tend to emphasize responsible ownership and commitment to the long-term success of the firm, which can outweigh any potential risks from innovation.

Addressing the innovation paradox in family firms  

Our results suggest that in order to unlock their innovation potential, family owners must pay attention to the “business of the family,” in addition to the family business.

First, they need to develop a strategy for diversifying the family wealth. Not surprisingly, many successful business-owning families have created a family office. By building a diversified portfolio and ensuring it is properly managed, a family office ensures that family owners can pursue their current lifestyles while optimizing the wealth transfer to future generations. Having their wealth well diversified, family owners are better able to transform their entrepreneurial mindset into innovation strategies.

Moreover, family owners need to make family cohesion and family legacy a key priority among family members. To do so, successful families work hard to develop responsible owners across generations. Through strong family and business governance mechanisms, these families ensure that each member understands the responsibilities that come with family ownership. Next generations are raised knowing that they are not just shareholders but guardians of the family legacy. This “stewardship” mentality implies that ideas would not be evaluated purely on an economic basis but on fostering continuity, which in turn allows innovation to flourish.

Multigenerational families, such as Hermes, testify to the importance of upholding family values to foster innovation. Now in its sixth generation, the Hermes family has adapted to maintain its competitive edge in the ultra-luxury segment. What remains unchanged is the family’s aim to preserve the family legacy. When Axel Dumas took the helm of the company in 2013, he remembered the last words he got from his grandmother on her deathbed to protect the family business as a farmer would protect his land. The combination of tradition and innovation is what unlocks Hermes’ innovation potential, levering the power of the brand as an icon of legacy.

 

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