From Succession's Roy clan in Midtown Manhattan high-rises to Yellowstone's Dutton family in the prairies of Montana, the trials and tribulations of family businesses have had a popular culture resurgence. The dysfunction and intrigue may not be typical of real-world family-owned businesses (FOBs). But the pressure to succeed and anxiety about the future might strike a chord.
And the fate of FOBs matters, not only to individual families, but also to society. Globally, FOBs — defined as those whose founders or their descendants hold significant share capital or voting rights — account for more than 50% of GDP. Family businesses account for nearly 60% of private employment in the United States.
FOBs outperform non-FOBs in important ways. But the reasons are not well understood. To explore why, McKinsey analyzed 600 publicly listed FOBs from 75 countries and 10 sectors — some brand new, others centuries old. We then compared these with 600 non-family-controlled public companies. We also surveyed 600 primarily private FOBs and interviewed dozens of leaders.
On total shareholder return (TSR), for example, FOBs analyzed in the survey recorded an average return of 2.6%, compared with 2.3% for non-FOBs. And when we assessed “economic spread,” meaning the difference between a company's return on invested capital and its weighted average cost of capital, the spread was 33% higher for FOBs.
Our research suggests that one important reason for FOBs' higher TSR is superior underlying operational performance. Moreover, we found that the sources of outperformance change as companies grow larger and older. Midsized FOBs, for example, tend to be more efficient investors, while larger family firms outperform because they are superior operators.
These are tendencies, however, not rules: There are significant variations within and among FOBs. Wal-Mart, the largest FOB, has different attributes and challenges than Tyson Foods or a 200-person factory in the Midwest. So, the more interesting question is this: What sets the best FOBs apart?
To answer that, we examined the 120 companies in the top quintile of performance. On that basis, we identified a “4+5 value creation formula,” consisting of four distinctive mindsets and five strategic actions. The four mindsets are: a focus on purpose beyond the bottom line (although, of course, the bottom line is critical), greater reinvesting of capital (a sign of longer-term orientation), a conservative financial record (with lower average debt ratios), and centralized, efficient decision-making. Crucially, outperformers complement these mindsets with five strategic actions.
They diversify their portfolios. The numbers tell the story: 40% of top FOBs got at least half their revenues from outside the core business, while the rest drew just 7% of revenues from outside their core operation. And the outperformers are not stopping: 70% of them say they plan to continue expanding, for example by moving into new industries or geographies. To do so, they actively seek opportunities: Previous McKinsey research found that FOBs make smaller but more value-creating deals than non-FOBs. But outperformers don't shy away from bigger bets — 58% have done a large M&A deal in the last decade, compared with 36% of their peers. As one executive of a family-controlled industrial company told us, it's important to avoid “core myopia.”
They actively allocate resources. As with M&A and diversification, outperformers are also nimbler when it comes to the use of capital. In fact, they were three times as likely to have shifted 30% or more or their capital to new businesses or regions over the previous five years. This is important because McKinsey research has found a correlation between companies with higher levels of capital reallocation and average shareholder returns. These FOBs are also more likely to avoid bankruptcy or acquisition.
They excel in operations and investing. In general, successful young FOBs do well because of efficient capital deployment. As they age and grow, operational efficiency becomes more important. The best are good at both. Their capital turnover is slightly higher than that of other FOBs (and the same as the best non-family businesses), and their operating margins are much better (17.7% vs. 9.4%). There are three major reasons for this record: a hands-on management approach, stronger performance management and greater investment.
They obsess over talent. And they believe they manage it well: 86% of outperformers said their company attracts the best talent, and more than 90% said they are good at developing it. This doesn't just happen. Leaders take clear action, such as benchmarking compensation against the competition and offering effective training programs to prepare the next generation.
They ensure strong governance. Among privately owned FOBs, looking at the outperformers specifically, 80% had written guidelines on the roles and responsibilities of family members; 90% had an independent board of directors (compared with 72% for the rest), and 95% involved non-family executives in strategy decisions. Multigenerational FOBs tend to have a meritocratic approach to management. They know that long-term success requires focusing on the survival of the business, and if that means loosening the reins of family stewardship, so be it.
These four mindsets and five actions are not a fail-safe formula. Judgment and adaptability to circumstances are essential. For example, FOBs facing a leadership transition may want to focus on governance. Those in stagnant or vulnerable industries may choose to prioritize new business building.
Whatever the sequencing, the conclusion of our research is clear: Companies that implemented the 4+5 formula did much better, and they realized a four-fold increase in valuation creation. And others can do the same.