Growing pains for region's family businesses

While smaller companies in the region have successfully expanded their empires, all too often they do not address crucial issues.

Family businesses have good market knowledge and networks but often face other pressures.

Diversified family businesses are among the most common business models throughout the region. Founded as small businesses, these companies grew strongly by acquisition or organic growth and created diversified empires.

In the past, most of these companies had double-digit growth rates.

Many opportunities still exist for these businesses. They have good market knowledge, a very good network and the Middle East markets are catching up on growth rates.

But often they do not reach the level of profitability and efficiency compared with their competitors in the West or Far East. The root cause for this performance gap is often the same: the businesses are grown-ups by size, but their processes are often still in children's shoes. These problems can be drilled down to six major areas for improvement:

1. Processes and organisational structure not in line with strategy

Middle Eastern family businesses often used acquisitions to diversify and grow. This goal was in many cases achieved, but the target companies still kept their original structures and no standardisation in processes was realised.

This means that decisions on investments, best strategy and remuneration are not taken in the same way. Misalignments in the most fundamental decisions of a company are the results.

Streamlined and standardised processes need a greenfield approach. The best processes to support strategy, investments and remuneration have to be built up from scratch to deliver the highest business performance. Only a fresh start can overcome obstacles from the past.

2. Financial performance management not developed enough for decision-making

The owners of a diversified family conglomerate often face the challenge of knowing which parts of their empire create value and which parts destroy value.

Facing a portfolio with a variety of businesses, they also often do not know the key drivers and underlying business models for all their businesses. As a result, decisions are often driven by gut feelings rather than by facts and financial performance.

Transparency on financial performance needs standardised financial reporting driven by key performance indicators. This system has to be tailored to each reporting level.

3. More opportunistic than active portfolio management

The portfolio of a family business often develops over time. Opportunities were taken when they came up. Many businesses are now facing the issue that they do not know on what activities to concentrate.

Often no exit decisions are made. Every exit means a downsizing of the empire. The positive effect of concentrating on the most promising businesses is often not taken into consideration.

A solid examination of the entire portfolio is necessary to guide decisions. By assessing the market's attractiveness and the competitive strength of each unit, the best future strategy can be derived. This process offers an objective basis for discussion and helps to accelerate even not-so-popular decisions such as exiting from particular activities.

4. Governance structures

In family businesses in which decisions are made only by the owner, solid committee structures (executive committee, HR committee, investment committee) and responsibilities of committees are often not clearly defined.

As result, small subsidiaries often act independently and do not feel that they are bound to central decision processes. This phenomenon makes these companies impossible to steer from a holding level.

To solve this issue, a governance model based on western standards needs to be implemented. Committees with clearly defined tasks, decision power and agendas have to be defined and internal controls set up to guarantee compliance with the governance model.

This process needs time and the strong commitment of the owners to be successful but will definitely improve the overall decision process.

5. Mistrust in operational management

The owners of a family company often do not trust their operational management because they believe management has its own agenda for company development.

As result, the owners want to steer and control their business on their own. This means that owners often come up with unrealistic financial targets and keep on debating them with their management. Excessive budget rounds every year are the result.

The solution for this classic principal-agent problem is a target-setting process with objective benchmarks. Once a comparison to industry performance is on the table, the budget discussion can be more productive and realistic, but ambitious targets can be realised.

6. Management is not aware of risks

One of the biggest challenges of Middle Eastern family conglomerates is being aware of all major risks. Often many risks are not reported, because they are associated with weaknesses.

This means that even huge risks are not reported to the mother company. In addition, the coverage of systemic risks across all entities is nearly impossible.

The only solution for systemically cover risks is by an integrated management framework. Risk registers have be created to collect the major risks, as well as a system to quantify the impact of a risk. This procedure also realises a tracking of common risks across all entities.

Businesses have to address these issues to survive the current crisis and prepare for future growth. Without addressing these challenges, long-term future success is not achievable.

Konstantin Wrona is a partner and Philipp Krause a manager at SCCO International