How to Break the “From Shirtsleeves Back to Shirtsleeves in Three Generations” Cycle

Family involvement in management adds a level of challenge and complexity to family business governance. The practice of placing family relationships ahead of corporate rules often results in severe internal conflicts within a family firm and can even sow hatred amongst family members. It’s really a pity to see so many family businesses suffer the same fate - loss of family wealth, disrupted operations, and damaged reputation are among the frequent consequences. What Chinese family businesses today need most is a step-by-step governance plan that aligns the development goals of their firms with the interests of their families. This is the only way they will be able to preserve their family wealth, demonstrate their morality, fulfil their social responsibilities, and safeguard the interests of family members.

Family Wealth and Family Businesses: From the SEW and Governance Perspectives

How the Cycle Began

The maxim that “wealth does not last for more than three generations”, is not specific to Asia. In the West, in fact, a well-known proverb, “from shirtsleeves to shirtsleeves in three generations”, reflects the tendency of family fortunes to be quickly eroded. Why have many Chinese companies not been built to last? First, most Chinese companies relied on the cheap domestic labour force, a model that has proven unsustainable as overseas competitors can now provide the same low-cost merchandise. For example, Sri Lanka and Vietnam are now in a low-cost competition with China. Therefore, despite their enhanced operations efficiencies, Chinese companies are not well-positioned to follow a sustainable development pathway, as rising domestic labour costs put pressure on their margins and reduce profits. Family wealth is generated by the family business. A family that runs an enterprise in an unsustainable manner is not likely to be prosperous over the long-term.

Second, for historic reasons, Chinese people are less inclined towards long-term investment, and this carries over to those running family businesses as well. Over the past century and a half, most people in China and Southeast Asia have suffered the effects of political instability. In some cases, they don’t need to be citizens of a country for their business to suffer there. For example, a regime change in another country may result in a Chinese business losing the assets they have invested there. In such an unstable environment it is difficult to create a sustainable business model or brand. It is also rather difficult to create a world-renowned brand. Even today, few Chinese brands have established a global presence. Most Chinese businesses have failed to invest substantially in R&D and have developed a reputation for stealing the ideas of others. This kind of entrepreneurship or entrepreneurial spirit is, in a sense, another cup of tea altogether.

Third, Chinese family businesses do not trust non-family members. With no brand capital, family business owners often worry that family outsiders will eventually copy their ideas and become competitors. As a matter of fact, many Chinese entrepreneurs had previously worked for other companies, and then borrowed from that company’s ideas to strike out on their own as a business rival. Therefore, when at the helm of their own business, these entrepreneurs distrust outsiders. This attitude makes it impossible to expand the talent pool within a company. In addition, most Chinese family business owners select their son to succeed them. Their prejudice against women further restricts the talent pool. In China, it’s expected that the daughter of an entrepreneur will marry a man with wealth and/or influence that can benefit the family business.

Chinese family businesses are run in a traditional way, known as the word-of-mouth style, where there are no clearly defined duties or decision-making procedures. In other words, within a family business, everyone seems to do everything, and there is no clear division of departmental functions. In addition, many of the titles Chinese entrepreneurs display on their business cards carry little significance. Even when a second-generation family member has assumed the lowest position in the firm, it does not diminish his status as a family business successor. Before China implemented its family planning policy, family members used to pin their hopes on their eldest son, who, unlike younger brothers, seemed naturally destined to be a business leader. Though they may be self-disciplined and meticulous, eldest sons are not always prepared to take risks. In today’s world, following the well-trod path will likely mean failure for a new start-up business. In China, second-generation family members will easily follow in their fathers’ footsteps.

Family businesses often give little thought to succession planning. How will the business succession process be carried out in event of the death of the founder’s only son or daughter or in the event of the founder’s sudden death? In China, for cultural reasons, second-generation family members will not bring up the topic with their fathers. Presently, the majority of companies remain in the charge of their founders, most of whom are unwilling to pass on the mantle as they cannot bring themselves to retire, so they see no point in developing a succession plan for their business.

Most Chinese family businesses have never considered diversifying their assets. Many are accustomed to putting all their eggs in one basket even though asset diversification protects a firm against the various risk factors in a business cycle. Chinese companies usually only begin to diversify when they see their competitors move into other businesses. In addition, successfully managing a family business does not mean a founder can manage his own personal assets well. Chinese family businesses also do not trust outsiders to manage their assets, which further complicates the diversification issue.

New Challenges Facing Chinese Family Businesses

Education is of paramount importance to Chinese people. Most parents are willing to provide their children with a first-rate education no matter the cost. We place a premium on education because it can elevate our social status. We are convinced that a western education is much better than what is available in China. When asked which university they expect their children to enrol in, most Chinese parents give a similar reply - the prestigious universities in the West, such as Harvard and Cambridge. Most Chinese students study well abroad and will return to China after they graduate. However unlike their parents, they have been inculcated with western ideas. In a family, often the older generation works hard and lives a frugal life while the younger generation thinks differently, and intergenerational conflicts are common. Persuading the second generation to join the family business poses a considerable challenge. Many refuse to take up leadership of the family business because more favourable opportunities are available elsewhere.

Family businesses are often dismissed as being small firms, and some may wonder why a well-educated man decides to work for his family business. However, parents must also consider whether their children are up to the task of running the business. Not everyone is equipped for the job.

The Importance of CCKP

CCKP refers to the qualities needed to successfully run a family business. The first letter “C” refers to self-confidence. How can the second-generation gain confidence if the founder of the family business doesn’t groom them properly to assume a leadership position? The second letter “C” means commitment to the family business. The letter “K” stands for knowledge. When running their firm, family members must have a clear picture of the business. The letter “P” represents passion. The family business will go nowhere if family members don’t have passion and enthusiasm for their work. Even though the founder of a business seems passionate and enthusiastic about their duties, their children may not have the same drive and motivation. This is one of the biggest challenges facing family businesses.

Chinese family businesses face other unique challenges. For example, most that are focussed on manufacturing products for other companies need to find a way to move up the value chain. How to attract external managers to expand the talent pool? What factors do experienced outside managers consider when deciding whether to join a Chinese family business? When family members lack trust in outsiders, a manager from outside the family often faces an unbreakable glass ceiling.

Secrets of Li & Fung’s Success

Li & Fung was founded in 1906 by Fung Pak-liu and Li To-ming. William and Victor Fung are its third-generation business leaders. Li & Fung began as a small company that specialized in exporting goods from China to other countries, particularly the US. More recently, Li & Fung has ventured into the logistics sector by integrating producers and purchasers like Wal-Mart. These clients entrust Li & Fung with the task of finding them suitable suppliers. Though the sustainability of such a business model is open to debate at the moment, Li & Fung has a market capitalization of more than US$ 14 billion. It is a listed company and the family members hold more than 50% of the shares. Without owning a single factory or producing anything itself, Li & Fung instead zeroes in on the best factory, no matter its location. One family member is in charge of organizing the cargo shipments for the manufactured goods.

What is the secret of Li & Fung’s success? Firstly, the family has properly tackled the family ownership issue. They privatized Li & Fung by purchasing all of its shares before relisting the company on the Hong Kong stock exchange. The third generation has simplified the shareholding structure. Good at grasping business opportunities, they have begun to focus on supply chain management. The firm is also open to recruiting external managers, such as the current CEO of Li & Fung Group. It has also expanded its businesses into the international market through mergers and acquisitions.

Family members have a clear retirement plan. After retiring, William Fung set up the Fung Global Institute for studies on social issues. His younger brother Victor Fung took over his post in Li & Fung, becoming the firm’s ambassador. Today Li & Feng’s sales network covers more than 40 countries and regions and in 2011 it had sales revenue of US$ 18 billion.

The Secrets to LEE KUM KEE’s Success

Founded in 1888, LEE KUM KEE has developed into a world-renowned Chinese company. Today it has more than 8,000 employees and manufactures products in China, Malaysia and the US. The company’s success comes from its global brand value and diversification. In 1990, LEE KUM KEE developed Chinese medicinal herb products, which now contribute to more than half of the company’s total revenues. Family members gather annually for at least 30 days of networking and training. Family members have clearly defined duties and have implemented a job rotation system among the brothers so that each can play a different role. The daughter originally had no stake in the company; later on, her father decided to grant her some shares. But in a fit of anger, she rejected his proposal. It was not until many years later that she changed her mind. However, she has not yet been put in charge of any of the company’s operations. For her, family is more important than business. The third generation of the LEE KUM KEE family has bought out all their cousins’ shares. This means the family business is now controlled by only one branch of the family. The more cousins who retained equity, the more complicated the family’s business operations would have become.

In addition, LEE KUM KEE has attracted and retained external talent. Long-term investments, commitment to education, and product and brand development have made LEE KUM KEE a sustainable company. For every company, regardless of whether or not it is a family business, the most critical factors for sustainability are “preservation of wealth”, “preservation of spirit” and “preservation of harmony”. I am convinced the wealth of LEE KUM KEE will last for three generations and in future the shares of all the cousins will be again bought out.

Source: Prof. Roger King’s Speech at the 2nd China Family Heritage Forum 2013: Breaking the Chinese Curse: “Wealth does not pass beyond three generations”, June 1, 2013.