What’s the best course of action in growing the
Most of merchant wholesaling is entering the
third generation. This generation has a rather interesting history in American
Business and, if the history of family-owned, third generation businesses apply
to merchant wholesalers, the next decade will be interesting indeed. The third
generation of business is, generally, marked by the following traits:
Studies show only 3% to 5% of family businesses make it past the
third generation. Some businesses
dissolve, some sell out, and some few make it to the fourth generation.
Third generation family becomes extended with nieces, nephews, sons
and daughters holding stock of the original founders. A few family members may
work in the business but the disparate stock holders have a profound effect on
the firm. Decision-making becomes risk-averse as family members become
comfortable in using dividends and income distributions to fund a
Third generation management typically inherits a successful, going
and growing concern. However, third generation management typically does not
have the drive to grow the business of the prior two generations. They are
benefactors of the success of their forebears and the desire to drive the
business is typically not there. Ergo, third generation CEO’s have a propensity
to run the business as lifestyle and not for earnings and superior statistics
in growth and profit.
Successful generational businesses have a tendency to put family in
executive positions. The old saw, “family members are the most talented
business people as they all become V and C level employees,” applies. The
problem with the third generation family management is that many have not had
to develop the skills and education to drive the distribution company as it
grows. Guaranteed executive stardom in early career, many family execs of the
third generation simply find the business has outgrown their skill sets.
We find graduate business degrees in many sizable firms in the
manufacturing and service sector but seldom in the third generation managers of
family distribution companies. Those that do have graduate degrees typically
run much more profitable firms than those who don’t.
Because executive ranks are filled with family, the firm often
calcifies with family presence and relationships. New blood at the executive
level and from outside the family seldom works out. They are not given the room
to change family impediments to the performance of the firm.
All these challenges are not evident in all distribution
companies but you can usually find several of them at work. How does the third
generation guard against these issues? The bottom line is that family must
agree to run the business as a business, hire the best managers regardless of
whether they are family or not, and develop goals that are best in class for
growth and profitability.
In essence, family members of the third generation should
have to compete for the top spots in the firm and justify their position with
best in class performance. Of course, our experience is that many don’t do this
and this is why most third generation family businesses underperform or fail.
In a conversation with two, experienced, well-educated, and non-family
executives, I asked them how does one change the third generation family
business? The overall opinion is that it is almost impossible to do so unless
family cedes major decision making to outside elements and challenges the often
sedentary practices wrought by three generations of success.
In this environment, however, I believe it is an opportune time to succeed. Far
too many distributors I interact with are satisfied and rather sedentary
businesses. Many distribution executives think they are busy and don’t see how
they, or any one else, could do much more in their respective firms.
However, the financial performance of most durable goods
distributors, over time, is not good. Some two-thirds of family distribution
earn a satisfactory return on investment. Generally, the wholesale firm must
earn a consistent and minimum 2.5% to 3% of sales before taxes to get the same
returns, liquidity and diversification that they could in public markets.
Unfortunately, most distribution firms, over time don’t do
this and this is why they underperform and are vulnerable. Today, many
distribution firms are experiencing an earnings “pop” because of commodity
inflation. The prices of steel, copper, petroleum and other base metals have
skyrocketed 2.5x to 3.5x and this has lifted earnings of the average
wholesaler. We caution wholesalers that this effect is only temporary and the
commodity prices will come down and, over time, reflect marginal cost and
inflation led earnings will be a fond, and sometimes bitter, memory.
In this predominant third generation environment, the firm that does things
differently, smartly, and consistently can profit handsomely. This means
breaking up the family gene pool with the best management that can be found.
Whether or not the management is family is not as important as what they can
do. Secondly, the third generation firm that hires experienced, better
educated, and hard driving execs will have a better chance to
Extended family members who are clipping dividends and
distributions will have to sell out or come together and agree to let outsiders
drive the firm. They will have to give key outsiders stiff objectives when,
once reached, pay off handsomely. And, finally, our research leads us to
believe that the innovations and competitive advantage in distribution will
come from changes in the business model and less from typical sales, product,
branch, and acquisition growth.
The opportunity in distribution is as rich as it has ever been. The third
generation impediments are real and those governing families who acknowledge,
understand, and fight against them are going against the well established
history of observed decline in third generation family businesses. In essence,
they take the historical bull by the horns and, in the paraphrased words of
Winston Churchill, history will be kind to them for they intend to write it.