In defence of business families

In Europe, the phrase is "from clogs to clogs". Harvard Business School prefers to label the phenomenon "the third generation syndrome". The Marwaris, a hardy Indian business community originally from Rajasthan, are more blunt: the first generation starts the business, the second generation grows the business, and the third generation destroys it.

There is data to prove this axiom, albeit data based on European firms. According to Switzerland-based business school IMD, 40 per cent of new family-run businesses die within the first five years, 66 per cent of the remainder die or leave the control of the founding family during the 1st generation, and only 17 per cent of the remainder make it into the 3rd generation of the founding family. If one does the math, these figures assert that 3.57 per cent firms make it to the 3rd generation.

There is no reason to believe that the data for India, or indeed any other country in the world, would be significantly different. However, I do believe that the same data can be turned around to assert a very different outcome. According to the IMD data, fully 60 out of 100 new businesses started by a business family member survive the critical first five years. Also, that of these 60 firms, only 21 make it to the 2nd generation.

At this point, it is worth mentioning the Pareto Principle (better known as the 80-20 rule) which argues that roughly 80 per cent of the effects come from 20 per cent of the causes. Angel investors (firms who provide the seed capital for startups) and private equity funds take this principle very seriously, and calibrate their investments and ROI projections accordingly.

Returning to the IMD data, we see that 21 companies are now being run by the 2nd generation. Under their management, roughly 17 firms fail or are sold, and three firms make it to the 3rd generation. The 80-20 rule has once again kicked in: data does not support the traditional notion that the "second generation grows the business". Once IMD completes its investigation, we will learn whether the 3rd generation does indeed destroy or grow the business, thereby challenging a view deeply embedded in corporate history.

At the same time, what cannot be denied is that each generation must play a different role within the firm if the latter is to survive and grow over decades, especially in the volatile 21st century. Also, India, like China, is in the process of developing new ways of managing, ways which do not have a Caucasian heritage nor do they resemble well-recognised, globallyadmired American practices. In time, as happened to Japan in the 1980s, these Indian and Chinese management methods will come to be articulated and documented.

Beyond the 80-20 rule and the roles of different generations in the history of the family firm, an interesting new dynamic is taking place. Legacy—the conviction that one is not just building a business, but providing a stable and successful future for the next generation—is one of the most important aspects of the Indian family business. In the West, ageing entrepreneurs either sell off the business or close it down if their children don't want to run it.

In India such an approach is largely unthinkable. It's assumed that children will continue the family venture, and that parents are building the business for that very purpose—not to sell it. Indian culture, like most of Asia, puts society at the centre of its foundation, unlike the West, and particularly the US, where the individual is the core pillar. Hence, Indian social mores are geared towards protecting the family business. These social mores translate into government regulations which make it very hard to close down a business. Further, if a firm downs its shutters or is sold, it is automatically assumed that there was a failure of some kind, rather than a rite of passage in an entrepreneur's long working career.

Very recently, we've seen some changes to this culture, from leaders like Hemendra Kothari (a merchant banker who sold his stake in DSP Merrill Lynch to Merrill Lynch) and Narotam Sekhsaria (founder of cement major Gujarat Ambuja), but these businessmen are still seen as outliers.

— Dr Gita Piramal is a business historian, author and chairman, ERGO