MScBA Master’s Thesis
Innovation within the Family Business Environment
By
A.M. Quintana Moorman
Supervisor: Dr. Hendrik Snijders Co-Assessor: Thijs Broekhuizen
University of Groningen
Specialization Strategy and Innovation, Faculty of Management and Organization
2006
Innovation within the Family Business Environment
KEY TERMS Family Business Innovation Agency theory Ownership
Three circle model Cultural traits
ABSTRACT: This paper discusses the relation between innovation and family business. It
utilizes mainly the Three Circle model, innovation and agency theories in relation to case
studies in order to asses if the family business is a propitious environment for innovation and
what factors affect the firm’s innovativeness. Propositions deal with the relation of cultural
traits, family firm characteristics and innovation, and how each family firm has a different way
of leveraging cultural and family business traits.
INDEX
1. INTRODUCTION ...Error! Bookmark not defined.
2. STRUCTURE...Error! Bookmark not defined.
3. THEORETICAL FRAMEWORK ...Error! Bookmark not defined.
3.1. INNOVATION...Error! Bookmark not defined.
3.1.1. Innovation and the firm ...Error! Bookmark not defined.
3.1.2. Environment for innovation...Error! Bookmark not defined.
3.1.3. Culture and innovation ...Error! Bookmark not defined.
3.2. THE FAMILY FIRM ...Error! Bookmark not defined.
3.3. THE THREE CIRCLE MODEL AND INNOVATIVENESS OF FIRMS Error! Bookmark not defined.
3.3.1. An Overview of Agency Theory to Study the Ownership Dimension Error! Bookmark not defined.
3.3.2. Innovative Character to Study the Family Dimension... Error!
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3.3.3. Management Practices to Study the Business Dimension ... Error!
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4. EMPIRICAL RESEARCH...Error! Bookmark not defined.
4.1. CASES...Error! Bookmark not defined.
4.1.1. Case Study “Holding A”...Error! Bookmark not defined.
4.1.2. Other cases ...Error! Bookmark not defined.
4.2. FINDINGS AND PROPOSITIONS ...Error! Bookmark not defined.
5. DISCUSSION ...Error! Bookmark not defined.
6. CONCLUSIONS ...Error! Bookmark not defined.
REFERENCES...Error! Bookmark not defined.
APPENDIX A. INTERVIEW GUIDE...Error! Bookmark not defined.
APPENDIX B. PEOPLE INTERVIEWED HOLDING A ... Error! Bookmark not
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1. INTRODUCTION
Family business and the innovation phenomena nowadays are two relevant factors in the world’s economy; and the intension of this thesis is to analyze the relation that exists among the two of them.
According to diverse sources, family firms represent around ¾ of the firms in most countries.
The exact percentage may vary according to the definition of family business, but they it is for sure that they are relevant in the world’s economy. Diverse authors have shown interest on developing a family firm theory (e.g. Hoy and Verser, 1994; Gersik et al., 1999; Chua et al., 2003; Chrisman et al. 2004; Chrisman et al., 2005). It has been focused on issues like succession, family altruism, on establishing a relationship to entrepreneurship literature and on analysing whether family firms differ from privately owned firms or not, and how.
On the other hand innovation has proved to be essential for the firm’s performance and competition (Rigny, 1976/77; Holmstrom, 1989; McAdam, 2000; Nohria, 2003; Aghion et al., 2005; Tang, 2006). And the innovation theory has been focused on its definition and classification (e.g. Wijnberg, 2004; Jacobs, 2005; Tidd, 2001) as well as its relation to firm performance and competition.
Due to the remarkable importance of both, family business and innovation, it was expected that the literature showed interest in both. However it can be quite surprising that noticing such great importance worldwide, researchers have not paid much attention to the relation between family firms and innovation (Litz and Kleysen, 2001; Craig and Moores, 2006). Family business literature has focused on attempts to identify innovation driving or decreasing factors in small and medium sized enterprises have been made (Schmidt, 1990), although not precisely within family firms. Diverse authors have also suggested that family firms could be very innovative and aggressive in their markets (Aronoff, 1998, in Craig and Moores, 2006). But there is still a long way to go in order to build a grounded theory on the subject matter.
It is very interesting and useful to address this research gap. Hence by writing this thesis I intend to contribute to the commencement of the construction of an innovation & family firm theory;
with the goal of analyzing if the environment presented within family firms is actually
propitious or not for innovation. Unfortunately, since this subject still shows lack of exploration,
the nature of my study is explorative rather than confirmative.
The presented thesis is developed within the search to answer the following research question:
Is the family business a propitious environment for innovation, and what factors affect the family firm’s innovativeness?; aided by the following sub-questions: What is the relationship between ownership and innovation?, What family characteristics have an effect on innovation?, How do family firm management characteristics affect innovativeness?.
Looking for the answers for these questions, I resort to a combination of information analysis;
based on both, theory and empirical evidence. According to Yin (1981) and Eisenhardt (1989b) the case study approach is quite useful in the process of building theory; hence after combining observations from previous literature, an empirical study based case studies is provided.
The combination of theory and case studies brings us to the end of this work in which some propositions on the matter are presented; which in a way intend to provide a possible explanation to the innovation activities within family firms.
The relevance of the current work does not only rely on trying to make a connection among innovation and family firm theory; it also addresses two of the issues mentioned by Zahra et al.
(1999) as needing more attention in studies. They mention how most of the studies on innovation at the firm level have been performed in the U.S.; whereas this work looks for an application in Mexico through the use of a Mexican family firm as case study and also the comparison to other cases and empirical research of all around the world. Moreover, Zahra et al.
also note that the interaction of national and organizational culture should be included in such studies. This thesis studies cultural traits and their effects on innovation, plus the family business environment that may as well be considered a culture.
Overall this study intends to be of assistance to the understanding of strategic management of innovation. It will contribute to the assortment of research studies of the library of the University of Groningen and may serve to study the named topics by other students in the future.
In general, chapter three consists of relevant theoretical subjects. The chapter gives an overview
of innovation theory, explaining especially what innovation is and what factors affect the firm’s
innovativeness. Then a general idea of the family firm theory is given, aided by the introduction
of the Three Circle model that is used later on as well. Finally a link of both theories is built by
using a family business model that relates the family business dimensions with the
innovativeness of the firm. The following chapter provides the empirical research, providing an
in depth case study and some other empirical studies previously performed. The chapter ends with the findings and propositions obtained from the theory and empirical research. Finally chapters five and six discuss the findings and provide the conclusions respectively. Due to the nature of the study propositions are given in order to build a base for future research on the subject matter. Emphasis is given to the fact that each family firm represents a different environment and it has its own way of leveraging family and cultural traits to influence the firm’s innovativeness.
2. STRUCTURE
This study follows the hourglass model, which consists of a general base, narrowing down to a specific subject and generalizing again at the end.
Eisenhardt (1989b) mentions how case studies can be indeed used for theory building purposes;
even with no hypothesis to test; the use of case studies establishes a “connection with empirical reality which then permits the development of a testable, relevant and valid theory” (Eisenhardt, 1989b, p.532). She explains that especially when working with unexplored topics, it is advisable to work with not so much theory but that it can be related to the subject, then analyze within- case data; and look for support in relevant previous cases. Since she mentions how there are probably as many approaches to use case studies as there are researchers; the current work offers an overview of pertinent theory as the base of the hourglass, and then situated at the waist of the hourglass, one in depth case study followed by supporting extra case studies performed by other authors. Therefore the use of multiple data collection methods provides a stronger authentication of the obtained results.
The theoretical part of this work is formed by a section about innovation itself, and an overview of what are those characteristics that make an environment propitious for innovation, or what is more that affect the firm’s innovativeness. Next, an introduction to the family business which is followed by a linkage between the two subjects by analyzing the family business based on the Three Circle model often used by researchers in the field (e.g. Gersik et al. 2001; Hoy and Verser, 1994). The model explains how strategic management in family businesses occurs at the intertwining of three dimensions: ownership, family and business or management. Through this thesis, these three dimensions will be studied in terms of their relation to innovation.
The first dimension, ownership, is studied based on agency theory and the relation between
ownership and innovation. The family circle is analyzed in terms of how innovative are the
family members. Finally the business dimension is examined through certain management practices inherent to family firms.
As for the empirical part, it is formed by the analysis of one Mexican firm (case study), and then by the presentation of results obtained in diverse case studies previously done.
Due to the nature of this study it is not really possible to offer generalizations that would
represent the whole universe of the family business and their relation to innovation. Hence,
propositions based on the theory and the empirical analysis are provided in the last part of the
hourglass together with the conclusions and the concerning discussion. This study and the
propositions provided in it intend to be the beginning of a large journey of studying innovation
within one of the most important forms of business not only of the present but from the past and
most probably of the future, the family business.
3. THEORETICAL FRAMEWORK
3.1. INNOVATION
“For an increasing number of firms, innovation has become an urgent concern” (Holmstrom, 1989, p. 305). This might be an important reason why the scientific literature has paid so much attention to such issue. Before actually analyzing innovation in the family business according to the goal of this thesis, it is important to clarify what is actually considered an innovation.
Innovation as a term has been tried to be defined by several authors. Ki (2001) refers to innovation involving the development and application of a new product, service or process.
Gartner (1990) refers to something new, whether it is an idea, product, service, market or technology in either a new or an established organization. Based on important factors of these definitions the author will use the definition provided by Tushman and Nadler (1986) who define it as “the creation of any product, service or process which is new to a business unit”.
Based on this definition the creation or redefinition of something (product, service, process) even if it already exists in the industry, within a company where it did not exist is still an innovation as it is new, different and creates value for the firm itself. The possible benefits for the firm can be administrative efficiency, staff well-being, personal growth, increased satisfaction, improved group cohesiveness, better interpersonal communication, and also productivity and economic measures usually utilized to measure effectiveness of innovation (West and Anderson, 1996). Therefore, new processes, managing forms and products within a firm will be considered to be innovations at least for the relevant unit of adoption. Such definition might be considered broad but it encloses the different types of innovation of which we will talk subsequently.
The literature has classified innovation according to different characteristics; technical or non technical, radical or incremental. On the other hand, it is also possible to classify innovation not based on its characteristics but on what is being created: product, service, process innovation or transaction innovation (Jacobs, 2005). In the end certain innovations may not belong only to one classification but be the result of the combination of more than one. For example, a new software that changes the procedures and the way things are done within a company is a technical innovation but at the same time a process innovation.
According to Jacobs (2005) technical innovations add practicality or efficiency whilst non
technical innovations rely on design, image or concept creation which are not so methodological
or technical, but aesthetical. Technical innovations can also be referred to as “the process by which industry generates new and improved products and production processes” (Mogee and Schacht, 1980, in McAdam, 2000). For example a new packaging machine is a technical innovation (in the most strict sense) while a new product image is a non technical innovation.
Conversely, radical innovations are such that change the way people see or use things; whereas, incremental innovations are changes that make the product, service or process different in a way that not necessarily changes its usage by the consumer (Jacobs, 2005). For example, the change from analogue to digital cameras is a complete and radical innovation; whilst a new digital camera with better image resolution than the previous one (4.1 pixels to 5.1 pixels), is just an improvement of what already existed (nowadays) and does not change the “essence” of the use (the camera is still used to take photos, better ones but still photos).
Finally it is also important to note that innovations can take the form of a product, service, process or transaction (Jacobs, 2005). It will be considered a product innovation when changes are made to a certain product, whether in style and design, a new concept, or a completely new product. Service innovation occurs when the product being changed is actually a service such as insurance; hence it is possible to enclose service innovation within product innovation. Process innovations refer to the way of doing certain activities. At last, transaction innovations as the name implies are new forms of performing economic transactions (e.g. paying through internet).
Such innovations might be technical when related to technological developments, organizational when related to design or structure like new organizational forms, or a combination of both.
It is important to mention that there are many different classifications of innovation provided in the literature; as there is great diversity of research studies on the subject. The one utilized on this thesis intends to help the reader understand the concept of innovation and how it can be presented in different ways.
A topic tightly linked to innovation is that of innovativeness; usually referred to as a measure of
the innovation’s newness (Garcia and Calantone, 2002) so, high degree of newness is related to
highly innovative and vice versa. But this can lead into confusion when the definition of
newness and innovativeness are not exactly the same for diverse authors. This can also be
related to the fact that there are different ways of measuring innovativeness. On the one hand as
it has been mentioned, is related to the innovation itself, but on the other hand innovativeness
can be related to the firm. On the first view of innovativeness, it deals with newness: new to the
world, new to the adopting unit, new to the industry, new to the market and new to the
consumer. Therefore within innovation “innovativeness” there are several ways of classifying it.
As for firm’s innovativeness, it has been defined as the propensity for a firm to innovate or develop new products or also as the propensity for a firm to adopt innovations (Garcia and Calantone, 2002). This thesis gives emphasis to how does the family business environment affect the innovativeness of the firm.
3.1.1. Innovation and the firm
Innovation has proven to be a positive element for the performance of firms. In the work of Nohria et al. (2003) innovation is identified as a management practice that if embraced adequately is able to produce better results. Innovation has been studied by different authors in terms of competition and competitive advantage (e.g. Wijnberg, 2004; Tang, 2006; Aghion et al., 2005) emphasising the relation between such elements. McAdam (2000) also makes reference to how innovation can help companies to maintain or even increase their competitive advantage.
It is also important to mention another reason that supports the benefits of an innovative culture in a firm. Rigny (1976/77) emphasises the existence of institutional and psychological reasons for a firm to innovate. On the one hand, the firm belongs to a certain society in a certain period of time; and it needs to be accepted and recognized within the society. Thus, it has an influence and a role within the social structure in which is located. In other words, the firm has a responsibility to continuously search for solutions to new problems therefore, innovate.
Overall, all the different types of innovation may represent benefits for firms. The goal of this thesis is not to determine the precise result of innovations made within family businesses innovativeness of these but; analyzing if family businesses are, or not, a propitious environment for any of this types of innovations that can bring great results for them. Moreover, it tries to analyze if the family business is a propitious environment for the firm’s innovativeness.
Consequently, it is necessary to know which factors drive innovation within firms, before one can understand in what way the family business environment is propitious for the innovativeness of the firm.
3.1.2. Environment for innovation
Innovations within organizations are influenced by diverse forces including the individual,
organizational and environmental (Damanpour, 1991); in this section such factors will be
discussed in order to give an overview of the characteristics that enhance the development and
implementation of innovation.
Beginning at the broadest level of forces, the environmental forces present a large influence on innovation, on the one side market conditions, but also cultural traits, which have a strong relation with how propitious for innovation the environment is. Every organization is affected by the society in which it operates, and reflects its values (Shane, 1993). This issue has raised a common concern in international business literature on the influence played by culture on the behaviour of individuals at work (Adler, 1983; in Kelley et al., 1987), and diverse studies on how it affects a society’s innovative and inventive character (Shane, 1993; Kedia et al. 1992:
Shane, 1992; in Shane, 1994). Therefore, after analyzing narrower levels, there is an entire section based mainly on Hofstede’s work (1980) dedicated to explain further the four main cultural traits and their influence on innovation.
Passing on to the organizational level of analysis, Damanpour (1991) mentions that innovative activities are affected by the type of organization where they take place, even the industry or sector in which the firm is situated. For example, he mentions that the actual implementation of innovation is favoured by managerial control as it helps to get things done. This type of control is usually present in manufacturing organizations. On the other hand such control and standardization would have an opposite effect in service providers. Other variable he mentions is bureaucracy, frequently related to public organizations but not exclusive to them, and how it inhibits innovation.
Although not mentioned by Damanpour, the relation between size of the firm and innovation has also been analyzed, generally showing that there is no real innovatory advantage on neither small nor large firms (Rothwell, 1989, Evangelista and Mastrostefano, 2006, Soete, 1979).
Rothwell explains how larger firms present an advantage in terms of financial and technological resources; allowing them to invest greater quantities of capital in the development of innovations, better access to: experts, patents and legal service, even gaining scale economies.
On the other side, smaller firms present the advantages of entrepreneurial dynamism, internal flexibility and responsiveness to changing circumstances; the lack of bureaucracy, efficient and informal communication networks also allow managers to react quickly to changes in the market.
Diverse studies have found smaller firms to be the engines of innovative activity (Audretsch and
Vivarelli, 1994; Pavitt et al., 1987; Rothwell, 1989; in Camagni and Capello, 1997). On the
other hand Viotti and Baessa (2005) based on various national innovation surveys found that
larger companies have larger innovation rates in several European and Latin American countries
contradicting what was previously mentioned. Overall, there is no final conclusion on the issue.
Alternatively, in addition to the type of organization, firms need an entrepreneurial orientation (EO) to foster innovation; Alolulou and Fayolle (2005) mention that although small firms do not have the capabilities, market power and other resources that larger firms do, EO is a valid strategic pathway that enables the promotion and sustainability of competitiveness and the transformation of corporations and industries into opportunities for value-creating innovation (Aloulou and Fayolle, 2005). EO is an important issue for small business as innovation is entrepreneurially driven as opposed to the management drive that larger firms present. A firm with an entrepreneurial orientation should have a strategic orientation; that means that EO is a part of the strategy of the firm; an entrepreneurial strategy makes emphasis on innovation, risk taking and proactiveness. Secondly, there should be a willingness to engage in entrepreneurial behaviour, such as entering new markets and manufacturing new products. Consequently, EO definitely makes the environment more propitious for innovation.
Organizations (small and large) frequently resist change and innovative activities due to different reasons; they prefer to abide by old routines that have worked in the past, they do not trust different ideas, or they are doubtful of the real value of innovations (Shane, 1995). A concerning issue in this matter is that of risk acceptance; as it can be considered to be related to innovation. According to Nooteboom (1994), it is possible to think that there can be both, less and more acceptance of risk in small firms. On the one hand, it can be expected that owner entrepreneurs will prefer less risk, than those firms that are able to spread the risk among shareholders’ portfolios. On the other hand, as small firms often obtain their capital through family and friends, these capital providers may be prepared to incur higher risks for emotional reasons (love, friendship, and loyalty). A higher risk acceptance could mean higher innovation rates.
In addition to all the characteristics of a propitious environment, whether or not innovations are developed and implemented depends on a very important factor: the top management team. It has been argued that the most influential group within an organization in employing or not innovation is this team; their values and attitude toward innovation play a crucial role in the firm’s innovativeness (West and Anderson, 1996). West and Anderson’s results show that size of the group does not affect the overall level of innovation but it does affect radicalness of innovations developed, the larger the group, the more radical they are. Longevity on the team is another factor that does not really affect innovation, just as organizational resources and size.
On the other hand, participation in the decision process, task orientation and support for
innovation within the team and the proportion of innovators in the team are positively related to
innovation. Therefore a team that emphasizes innovation, formed by innovative task oriented members that have an important role in the decisions made, will enhance innovativeness.
Passing from the organization and management team forces to a more individual perspective;
Shane (1995) mentions the need for certain characteristics or attitudes in people within the company in order to foster innovative activities. An example of such recommended characteristics is the need for autonomy from the rules, procedures and systems for the innovators, so that they can solve existing problems with creative solutions. Moreover, innovators need support from other members as well as, loose monitoring systems that allow the innovator to act creatively. Finally, Shane refers to the necessity of people who would stand out for the innovator, by developing coalitions with managers in different areas to support the innovation. The presence of people enacting these types of roles will enhance the development of innovation.
Besides analyzing the environmental, organizational, management team and individual levels, the innovation level itself is also important. First, the type of innovation proposed (Damanpour, 1991) is an influential factor on the firm’s innovativeness; whether it is technical or non- technical, radical or incremental, product or process innovation. On one side, low professionalism, high formalization and high centralization favour administrative process innovations, while the opposite characteristics favour technical ones. Firms also differ in the emphasis they give to product or process innovations (Ettlie. 1983; Hull, Hage, & Azumi, 1985 in Damanpour, 1991), although the differential impact has not yet been specified. Finally, managerial attitude toward change and technical knowledge resources in an organization will support radical innovations, but structural complexity and decentralization favour incremental innovation.
Finally, the stage of the innovation is also an important factor identified by Damanpour (1991);
different characteristics support different stages of the innovation process. High structural complexity, low formalization, and low centralization facilitate the initiation of innovation, whereas the opposite characteristics make the implementation easier.
3.1.3. Culture and innovation
In this section the broader environmental force is explained, culture. Hofstede (1980, p.43)
defines culture as “the collective mental programming of the people in an environment. Culture
is not a characteristic of individuals; it encompasses a number of people who were conditioned
by the same education and life experience”. The influence of such cultural framework has
brought diverse authors to analyze the subject. It has been said that convergence between individuals, irrespective of culture, and the industry exists (Kelley et al., 1987). Otherwise, certain studies (Kelley et al., 1987; Hofstede, 1980) imply that although convergence with the industry may exist in some part, divergence is present in other, such as personal attitudes and work behaviour which may actually differ completely for different cultures. Traits like time definition and value, power distance, uncertainty avoidance, individualism and masculinity vary across cultures and influence attitudes and work behaviour, hence innovation performance.
In terms of this thesis it is pertinent to understand the cultural framework in which the revised case study takes place, in other words describing the cultural traits inherent to the Mexican culture thus, the Mexican way of doing business.
The work of Hofstede (1980) describes the main four traits of different cultures around the world. According to his study, Mexico classifies as having large power distance, being collectivist and masculine and having strong uncertainty avoidance. A further description to explain the meanings of each characteristic is given next.
Power distance refers to the extent to which a society accepts the unequal distribution of power. In large power distance countries like Mexico there should be an inequality among people. Subordinates are dependant on their superiors who are dependant on their superiors themselves. Power is very important, power holders are therefore entitled to privileges.
Cooperation among the powerless is difficult to attain because of their low-faith-in-people norm.
Collectivism / Individualism. Individualism implies a loosely interlaced social framework in which people are supposed to take care of themselves and immediate family only. Whereas collectivism refers to a tight social framework in which people expect to be taken care by the group (relatives, clan, organization), and in exchange they are loyal to it. In collectivist countries like Mexico, people are born into extended families who protect them, there is a “we”
consciousness. Identity is based on the social system; there is an emotional dependence of individuals in organizations. Private life is invaded by organizations to which one belongs.
Belief is placed in group decisions and friendships are predetermined by stable social relationships.
Uncertainty avoidance refers to the extent to which a society feels threatened by uncertain and
ambiguous situations, by risk; and avoids such situations. Mexico has strong uncertainty
avoidance hence, there is higher anxiety and stress, time is money, there is an inner urge to work hard. There is a strong need for consensus, deviant persons and ideas are dangerous. There is great concern with security in life. People search for ultimate, absolute truths and values; and a need for written rules. Belief is placed on experts and their knowledge.
Masculinity / Femininity. Masculine values are assertiveness, acquisition of money and things opposite to caring for others, the quality of life, or people which are feminine values. In a more masculine country such as Mexico, men should be assertive, while women should be nurturing.
Sex roles are clearly differentiated, men should dominate society. They focus on performance, one lives in order to work, “machismo” is appreciated.
Mexican people are also characterized by setting family as a very high priority (Morris and Pavett, 1992); following a patriarchal model (Martinez and Dorfman, 1998). In addition to the previously mentioned traits the father and/or head of the family has “power” over his subordinates / family members; and represents an important figure of authority on whom everyone else (of the group) depends.
The results of Shane (1993) show that for innovation to be possible, it is necessary to accept uncertainty, most likely because of the strong relation between innovation and tolerating risk and change. Shane’s (1995) results show that societies that avoid uncertainty are less likely to prefer innovation-enhancing attitudes at work like those discussed previously in section 3.1.2.
Furthermore individualism turns out to influence rates of innovation as well, possibly due to its association with autonomy, independence and freedom; that would enhance innovation development. Societies with lower power distance prove also to be better for innovation rates, attributable to the distribution of power play in the innovation process. On the other hand, the study also shows that the relation with innovation of both, individualism and power distance, has decreased overtime, hence less important in determining a society’s innovative and inventive activities. This result is also related to how collective and hierarchical societies like the Asian and Latin American have become more innovative through time, with new ways of doing business, introducing new products into the markets, and so on. Therefore Mexico stands in a difficult place in terms of innovation-enhancing cultural traits.
In conclusion, although size and economic capabilities are not so important in determining how
propitious for innovation the environment is, organizational and personal characteristics as well
as environmental forces like cultural traits of societies are in fact significant factors in such
Ownership
Business Family
Fig. 1.1 The Three- Circle Model
evaluation. The next section builds upon the family firm Three-Circle model and innovation, with the purpose of unifying in a certain way both theories.
3.2. THE FAMILY FIRM
“The dominant form of business around the world is the family business” (Mallin, 2004, p.53);
such firms are often significant contributors to gross domestic product and employment in many different countries (Athanassiou et al., 2002). According to The Family Firm Institute in Boston, family firms represent 80 to 90 per cent of all business in North America, contributing 64 per cent of the GDP and employing 62 per cent of the U.S. workforce (The Family Firm Institute).
This type of business represents 70 per cent of the largest Brazilian business groups, 75 to 90 per cent of the firm in Chile, among other Latin American countries; at the end of 1999, 80 per cent of all Finish companies were family owned, over 90 per cent in Italy is estimated and 75 per cent of the British businesses. So, overall family firms (depending on the definition) represent around ¾ of the firms of diverse countries. Thus, the importance of such firms around the world has brought many academics to study the phenomenon.
Variance in the family business conception has brought scholars to define it based on diverse elements such as ownership management, family involvement, generational transfer or combining multiple elements (Brockhaus, 1994). Therefore numbers and conclusions about family firms may vary among results of diverse researchers.
In the last fifteen years, the three circle model has been the principal conceptual model of family
firms (Gersik et al., 1999) in which the family business is analyzed as a whole system
comprising three overlapping subsystems: Ownership, business/management and family (Hoy
and Verser, 1994, Tagiuri and Davis, 1996; Gersick et al., 1999) as seen in Fig. 3.1. Every
dimension is correlated to the others and works simultaneously.
Strategic management of the firm is situated in the entwined area; thus balance of the three elements is necessary to enable transitions to fortify the enterprise; and issues that belong to one dimension are related to issues that belong to other. The names of each circle clearly define what they make reference to. The ownership circle entails matters related to investors, whether family or non-family members. The family dimension comprises themes related to the members themselves, attitudes, behaviours and characteristics. Finally, the business circle involves management issues, the way they actually work and administrate the firm.
This model can be used to analyse issues that involve the different circles. Factors involved in the interaction of the three circles are leadership, culture, board of directors, life cycles, strategic management processes and ethics and values (Hoy and Verser, 1994); but another factor that seems to have been left out of the literature is that of innovation and it may well be associated to the relation between the circles or dimensions. In the next paragraphs I intend to analyze the relation among the family firm dimensions and innovation; and thus assessing the factors that determine how hospitable is the family business environment for innovation.
Differentiation of the Family Business
Whether family firms are different to non-family firms is decisive for making an analysis like this one worth doing; if they were completely the same, there would be no significance in trying to build family firm theory. Scholars have studied the two types of organizations finding some main differences. Lee and Rogoff (1996) found differences in terms of goals; as in family firms the well being of their own family is one of the main goals. McConaughy and Philips (1999) found differences in size and financial structure; family firms are usually more financially efficient than non family firms of the same size and industry. According to their results it seems that family ties help to align management and firm interests better than managerial ownership with no family ties does, resulting in more efficient operations and superior results. Finally, Lyman’s (1991) work discusses the difference in management approaches; and Harris, Martínez and Ward’s work shows the presence of a longer term commitment in family businesses.
Therefore family firms can actually be considered to be different to non family firms validating
the reason to actually perform this study. The characteristics inherent to family firms are further
discussed in convenient sections, in terms of ownership and agency costs and management
approaches or strategies in the organization.
Ownership
Business Family
Fig. 1.2 The Three- Circle Model - Ownership
3.3. THE THREE CIRCLE MODEL AND INNOVATIVENESS OF FIRMS
3.3.1. An Overview of Agency Theory to Study the Ownership Dimension
As Eisenhardt (1989a) states in her work, origins of agency theories lie as back as the 1960s and 70s when economists analyzed risk sharing among individuals or groups; describing such problem as arising from the different attitudes toward risk of the cooperating parties. The theory broadened to the agency relationship that exists between “the principal” and the “agent”, in which the first delegates work to the latter. In theory the conflict in such relationship arises from the difference in interests and information; regularly parties will have different interests and the agent will usually have more information than the principal (Chrisman et al., 2004, p.
336).
According to Eisenhardt (1989a, p.58) the two main problems studied by agency theory are:
agency problem and risk sharing problem. The first one arises from a) difference in goals between principal and agent, and b) it is very hard or expensive to monitor the agent’s work.
The second problem arises from the different attitudes toward risk of both parties. To avoid such conflicts the parties may opt for designing a thorough contract preventing every possible solution; but the capacity to do this is limited (Simon, 1957 in Chrisman et al., 2004, p.337).
Agency costs are those incurred by the firm to monitor and ensure that agents act according to the principal’s interests (Chrisman et al., p. 340). Hence, based strictly on Agency theory principles, the less the difference of interests and information between principal and manager the less agency cost there will be.
Agency theory can be related to other organization theories: Cooperative behaviour, political
models of organizations, contingency theory, efficiency theories, organizational control and
transaction costs (Eisenhardt, 1989a, p. 63-4). However, this thesis analyses agency costs in relation to family firm theory and innovation theory.
Ownership and Innovation
Agency cost issues are related to the ownership and control of management (Balakrishnan and Fox, 1993); which are related to innovation within a company (Hoskisson et al., 2002; Francis
& Smith, 1995). According to Hokisson’s et al. (2002) research, different types of owners show different interests especially in terms of innovation. The main differences rely on time horizons and incentives. Basically their results indicate that those managers under long term incentives (e.g. pension fund) support internal innovation, whereas those under short term incentives (e.g.
professional investment fund) prefer external innovation. Similarly inside directors (current or former employees of the firm in question, or holding a dependant relationship) support internal innovation while external directors (those who are not current or former employees of the firm in question, nor holding a dependant relationship) prefer external innovation.
In the same way, firms in which the CEO, management as a group, or a non management investor owns a large quantity of the stock, encourage internal innovation. While diffusely held firms focus more on growth by acquisition or external innovation (Francis and Smith, 1995).
In other words firms which are owned in their majority or in large part by one party probably have less conflict of interests as there are fewer parties to state different opinions. Fewer parties in the ownership thus a lesser amount of interests at play mean less agency costs. Therefore, the lesser the agency costs the more a firm can focus on innovation. Then again a company owned and managed mostly by one party, with complete coherence of interests and opinions could possibly result in less innovation; due to the fact that diversity in the top management is positively related to innovativeness (Auh and Menguc, 2005); different interests and opinions result in different ideas thus higher probability of innovation so, probably higher firm’s innovativeness.
Toward the Application of Agency Theory in Family Firms
Agency theory has been previously used to study family firms (e.g. Chrisman, et al., 2004;
Corbetta and Salvato, 2004). It could be said that family businesses are exempt of agency costs (Eisenhardt, 1989, Chrisman et al., 2004). Supposing that family businesses are firms largely held by a certain party (the family) with the same interests, therefore avoid agency costs.
If agency costs were note present at all, probably they would be more profitable; but agency
costs in family firms are different to those of non family firms (Corbetta and Salvato, 2004;
Family
Fig. 1.3 The Three- Circle Model - Family
Ownership
Business
Chrisman et al. 2005), mainly they have been related to family altruism (Gómez-Mejía et al., 2002; Shultze et al., 2001 in Sharma, 2004, p.16). Such term relates to situations in which family members include other members in the business regardless of their managerial aptitudes, just based on the fact that they belong to the family. This is considered an agency cost assuming that family firms only pursue economic performance; family firms’ goals might be economic and non-economic (Chrisman et al. 2004, p348), for example looking for the family wellbeing (Lee and Rogoff, 1996). Therefore measuring agency costs in such firms might be difficult. But when comparing agency costs in family and non-family businesses Chrisman et al. (2004) found that their economic performance was similar but the latter gained more from strategic planning than the first one. Overall according to their results family involvement can indeed reduce agency costs in general.
As mentioned previously, the family members involved in the business do not only care about the firm but about the family’s well being. From a certain point of view, this could be taken as having a long term commitment; no matter if there are new members of the family in charge they will still be concerned with a long term well being of the family.
3.3.2. Innovative Character to Study the Family Dimension
Innovation can be related to the family dimension, by analysing the innovative characteristics of the family members who will then enhance or not innovation within the firm. The creative interaction of both, founding and inheriting generations, will bring as a result intergenerational creativity (Litz and Kleysen, 2001) thus, innovation; although opinion, interest and values similarities among family members could then inhibit innovation.
Litz and Kleysen (2001) provide a classification, providing examples, based on two variables:
generation – older or younger (under the assumption that only two generations are involved);
and innovation – innovative or non innovative. Therefore the four possibilities are: Non innovative older and younger generations, Innovative younger generation, Innovative older generation, and Innovative older and younger generations.
The most treacherous scenario is that of non innovative older and younger generations, as innovation is not present in either generation. It is problematic to find but may happen for example in inherited firms like Canadian retailer Eaton’s which went bankrupt.
The next dimension, innovative younger generation, implies that the older generation is not innovative. This is also hard to find as it is usual to find entrepreneur founders of family firms, but an example is that of Turner Broadcasting Systems, in which the innovative approach of a member of the younger generation saved the company.
Alternatively, it is possible that the innovative approach of the older generation overcomes that of the younger one. An example is Radio Corporation of America (RCA) (Today part of Sony BMG) in which the innovative activities of the father completely outperformed those of the son.
Finally, the case in which both generations are innovative, supporting each other’s creative efforts. A great example for this is IBM in which both generations provide complementary contributions.
The innovative characteristic of the generations is not enough to explain the innovation in the
company. Other variable is the interaction / autonomy of the actions taken by different
generation members. For example, a member of the younger generation can act autonomously
without the older generation knowing; or both generations can act together in their creative
activities. This is important because family firm innovation is not only the addition of individual
effort but the synergies formed from the interaction of several members (Litz and Kleysen,
2001).
Business Family
Fig. 1.4 The Three- Circle Model - Business
Ownership
3.3.3. Management Practices to Study the Business Dimension
In this section, management characteristics of family firms and their relation to innovativeness of the firm will be analyzed. Although certain studies claim that there are no significant differences between family and non family business (Daily & Thompson, 1994); other studies find differences between both types of firms. Family businesses tend to perform based on a more personal business approach rather than based on formal policies and procedures (Lyman, 1991). Family firms also hold a long term commitment horizon (Harris, Martinez and Ward, 1994) making them a hospitable environment for entrepreneurial activities (Aldrich and Cliff, 2003; Rogoff and Heck, 2003; in Zahra, 2005).
Other relevant difference is that family management groups and the firms remain faithful to values, visions and missions of the founders (Athanassiou et al., 2002). While privately owned firms’ goals are mainly based on financial performance, family firms tend to have broader goals than wealth creation such as the family well being (Sharma, Chrisman and Chua, 1997). Family firms tend to be more conservative in terms of accepting change; they tend to resist it as long as possible protecting their habits and routines (Gersik et al., 1999). Such close cooperation and cohesiveness of family firms can be related to innovation, especially in the implementation stage as discussed earlier in the environment for innovation, but the change resistance may inhibit innovation development. A less financial approach can then leave room for a more strategic vision and acceptance of investments that would be in the future interest of the family well being. On the other hand, the similarities among members and the traditionally conservative attitude of family businesses may act as inhibitors of innovation.
The cultural context also affects the business and its management style. The case study for this
thesis is based on a Mexican firm thus; Mexican cultural factors may also be variables to take
into account for environment hospitality for innovation. The work of Athanassiou et al. (2002),
based on Mexican culture, reveals the importance of founder centrality and the effects of other cultural characteristics in the management of family firms. Founder centrality refers to the role that the founder plays in shaping culture, strategic vision and goals. Their results demonstrate that due to the fact that founder centrality in Mexico is very high the top management group demonstrates great cohesiveness in terms of perception of the firm’s culture, perception of and commitment to strategic vision and understanding of strategic goals. Moreover, it is also mentioned that the founder’s influence tends to be quite high in Mexican firms due to their high power distance culture. A more influential and powerful founder will have a higher power distance in the top management group thus; other members of the group will be less likely to impose differing visions on the firm’s external goals or policies.
Other relevant issue of the Mexican culture in terms of management mentioned by Athanassiou et al. (2002), is collectivism; in which people value social networks and relationships and expect group members to support and sustain one another. Then a collectivist culture like the Mexican may support everyone’s vision in setting family oriented objectives; and will include the interests of all family members.
4. EMPIRICAL RESEARCH
The empirical part of this thesis is conformed by the in depth analysis of one Mexican family
“holding”
1and also by diverse empirical studies previously performed by other authors in different countries.
The data on the company was obtained through semi-formal and informal interviews basically held by phone, video conference, personally when possible or by e-mail when needed. The interviewees are family and non family members that are or have been involved with the company either by working directly within the firm, for the firms or are related to the firms by close family ties. Several studies that have tried to analyze entrepreneurship and innovation at the firm level, have relied on the answer of only one respondent; but obtaining more responses increases reliability (Zahra et al., 1999); therefore interviews with 9 people have been held for the analyzed firm. The interviews were conducted in Spanish, as it is the first tongue of both, the author and all interviewees.
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