Are Indian family businesses well run?

Financial Express, 20 January 2010

How well-run is the typical family-run business in India? While divergences from scientific management methods are obviously present, do these reflect the native genius of the entrepreneur responding in iconoclastic ways to a unique set of problems? Or would the typical family-run business in India benefit greatly by bringing in scientific management methods? A recent experimental study, which examined Indian textile companies, finds big gains by bringing in top-end consulting inputs.

There is a certain unmistakable native genius in Indian entrepreneurs. The traditional CEO operates in a very difficult environment: with limited financing, a hostile government, difficulties in labour law, etc. For a firm to survive and flourish in this environment requires remarkable capabilities. This leads most of us to think that the decisions of the traditional CEO are on the right track.

Some think otherwise. It is argued that the traditional family run Indian business is often incompetent. Excessive centralisation goes with a weak HR process comprising hiring, training, evaluating and firing. Second rate people recruit third-rate people, so gaps in staff quality become endemic. Technological capabilities lag the frontier by a decade or more. There is insularity bordering on arrogance, where there should instead be an attitude of constant learning, self-criticism and self-improvement. Such firms survive in competition against imports, or in the export market, owing to the labour cost advantage which outweighs mismanagement.

This quarrel between the present and the past perennially rages in India. Some argue that the traditional family business knows what it is doing, and denigrate the fancy-pants MBAs and consultants. Others argue that the state of the art in scientific management has a lot to offer. In a remarkable recent paper titled Management matters: Evidence from India, a team of five economists (Bloom, Eifert, Mahajan, McKenzie, Roberts) has brought new evidence on the table.

The authors setup a free consulting program for 17 randomly chosen textile weaving firms in Tarapur and Umbergaon. These were large firms, with an average of 270 employees, 1.6 plants and sales of Rs.34 crore. Each of these firms was given consulting inputs from Accenture, a top-end global consulting firm. One month of diagnostic work was followed by four months of intensive implementation support for recommendations. The market price of these consulting services was Rs.2 crore per target firm.

The consulting inputs were `the treatment' that was applied to 17 companies. In parallel, a set of six firms were `the control sample': their outcomes were measured in the absence of consulting inputs.

The results were impressive. There was a rise in profit of the treated companies by Rs.1 crore a year. Even if the market price - of Rs.2 crore - was paid for the consulting, it pays for itself within two years.

There is selection bias at the outset. Of 66 firms who were offered this free consulting, only 17 firms signed up for it. It is likely that these 17 firms were more open-minded about change. The remaining 49 firms - who turned down free consulting inputs worth Rs.2 crore - are probably in even more dire need of a management transformation.

How much can these results be generalised? We can now say with good confidence that consulting inputs worth Rs.2 crore from a global consulting firm are well justified for a 270-man family-run textile company. But we do not have a comparable ability to make statements about 135-man or 540-man firms, about other industries, and about other kinds of consulting inputs.

We can, however, venture into some interesting speculation. These results support the idea that there are serious deficiencies in management by traditional family-run companies in India. The wily old-school CEO is not actually doing such a great job. More openness to modern management ideas would help.

Translating this into action is, of course, not easy. New ideas can be put into business in a few different ways. It can be done by recruiting better people - but it is not easy for family run companies to identify the right people and to empower them. It can be done by bringing in consultants - but it is not easy to choose the right consultant with the right mandate. There is huge heterogeneity in quality and price amongst MBAs and amongst consultants: choosing the right inputs is not easy.

This evidence encourages a style of private equity investing: where the investor takes a controlling stake in the firm and brings in the necessary knowledge and human resources to achieve business transformation. This is a lot of work when compared with an investor who only puts in capital. But if the core impediment to progress is the stasis of a family-run company, then this could be of essence.

Back up to Ajay Shah's 2010 media page
Back up to Ajay Shah's home page