Entrepreneurship & Innovation

New ventures creation and diversification strategies of family business groups in india

Kavil Ramachandran (Indian School of Business, Hyderabad, India), Prof. Ajay Bhalla (Cass Business School)

Does ownership structure affect the decision to establish new ventures to diversify? Scholars examining this question have documented strong evidence to demonstrate the linkages (Denis et al., 1999) and found using data from Fortune 500 firms, that firms with greater ownership concentration are not only less diversified, but because they suffer from agency problems they also fail to create value. Though the research to examine this question has progressed recently with contributions from Goranova et al. (2007), who made a novel attempt to study if managerial ownership in one time period is associated with subsequent changes in diversification, there has been no specific attempt to examine the linkage between family firms and their decision to establish new ventures to implement diversification strategies.

Family firms are of interest because there is little or no separation between the family members making decisions and consequences of those decisions. Hence, family firms are likely to make diversification choices, which maximize family's wealth. However, they are also likely to confront the challenge to maintain cohesion and familiness of the business, when they are presented with opportunities where expected profitability is higher than their own (Merino and Rodriguez, 1997). This is because senior family members who are also decision makers are considered to be stewards of family wealth, and called upon to take long-term view in the interest of family and the business (Zellweger, Meister and Fueglistaller, 2007; Ward, 1997). Furthermore, much of the research on family controlled businesses are based on data from the Western countries (Sharma, 2004) leaving a gap to study such businesses in emerging market economies such as India where most businesses are family controlled.

This study aims to fill this gap by exploring the strategies adopted by Indian family business groups while creating new ventures in their process of evolving as large conglomerates. Indian stock market is dominated by family business groups that constitute more than 60 percent of the total market capitalization. We also believe that understanding their evolution process and their success/failure strategies can throw light on the future direction of family entrepreneurship.

Method

We use data sourced from Prowess, Center for Monitoring Indian Economy for the period 1992- 2008 of all family business groups in India that have more than two new ventures created during the sample period (109 family business groups, with 1345 affiliated firms), for more than 20 years with at least two new ventures created during the sample period. During this period, India as an economy also evolved from being closed and non-competitive economy into more open and highly competitive economy. Using this sample we analyse time series diversification strategies (through new venture creation) adopted by the 109 family business groups over 16 years. On average, there are 22 ventures created by each family business group across 10 industries during our sample period. As of 2008, our sample represents 46% market capitalization of the Indian stock market.
We compute measures of diversification using Herfindhal index, entropy, and related and unrelated diversification and related these measures to the wealth creation (groups market capitalization over time) of each group over time. We use several measures for robustness purposes. Herfindhal index measures the degree of industry concentration of group's activities. On the other hand, entropy focuses on the degree of diversification of business group activities in industries. The entropy measure can be decomposed into related and unrelated diversification measures. It is relevant to note that earlier studies in the literature mainly focussed on the cross section analysis of diversification strategies. In other words, existing studies did not explore the long-term effects of new venture creation, especially in a conglomerate setting.

Results and Implications

In our regression model, after controlling for various group characteristics such as group size, industries and age, our preliminary results show that there is cross sectional variation among family groups in their new venture creation strategy. Family groups that create new ventures in the unrelated areas compared to the exiting venture/s generally succeed when economy is relatively underdeveloped (first phase of liberalization in India). However, those family groups that change their strategy by starting ventures in the related businesses compared to the existing venture/s succeed. In the long run those family groups, which maintain dynamic, venture creation strategies with the changing economic conditions succeed. In summary, our initial findings supports the hypothesis that new ventures have to be dynamic and they have to change with the changing economic conditions. We believe that India acts as a natural experiment to further investigate the strategies adopted by entrepreneurs with the changing economic conditions.

Resource allocation and new venture creation in family firms

Prof. Joseph Lampel (Cass Business School) and Prof. Ajay Bhalla (Cass Business School), Kavil Ramachandran (Indian School of Business, Hyderabad, India)

The process of resource allocation (RAP), i.e. how sequential resource commitments are made is central to developing our understanding of how strategy is actually made in firms (Sull, 2007; Noda & Bower, 1996). In case of multibusiness firms, investment programs of several business units, each trying to build competitive advantage, requires the board to make difficult strategic choices to allocate resources often in the form of scarce funds (Bower & Gilbert, 2007; O'Donnell, 2000; Hill, 1988). Scholars, such as Burgelman (1983) and Eisenmann & Bower (2007) have noted that in case of new venture (NV) formation within multibusiness firms, RAP can be top-down in the form of a plan being initiated at corporate level or it could also be bottom-up, initiated by operating manager who may have spotted new growth opportunities. This involves soliciting sponsorship, and entering into a negotiation process with the top management, to acquire resources (Greene et al., 1999) essential to set-up a new venture. The top management resolves the agency problem by looking towards structural design to act as a conduit in aligning the managerial interest with the top management interest (Burgelman, 1983; Gupta & Govindrajan, 1986; Bower & Gilbert, 2007).

Despite the importance of corporate entrepreneurship (Ireland et al., 2009) and the NVs to the success of family firms (Kellersmanns & Eddleston, 2006), few studies have investigated how the RAP for NVs differs in case of family firms, where the conflict between owners and managers is minimized as a result of family involvement in both ownership and management (Jensen & Mecklin, 1976; Chua et al., 2009). Top management team constituting of close family members promotes greater familiness (Habbershon et al., 2003), and as a result, the risk of opportunistic behavior in managers that are related to the family is reduced, and the firm may opt for a family member to head the NV. In such instances, family members may be able to lobby for more resources upfront and secure favorable performance measurement terms than non-family managers. Furthermore, once the NV is formed, a family member heading the NV may be able to obtain preferential access to resources by bypassing the structure set-up to manage the venture. In contrast, even though non-family managers may have better track record in leading NVs into sustainable growth phase, they may be constrained by lack of access to resources controlled by the family, and bound by structural norms.

This research attempts to fill this gap by using the agency theory framework and looking at how the RAP and NV creation differs when the NV is headed by family member as compared to non-family member? It examines the following three research questions:

1. How are NVs initiatives processed and championed in family firms?
2. To what extent does the RAP differs during the NV formation phase when a family member vs. non-family manager leads the venture?
3. As the NV enters the growth phase, to what extent does the RAP differ when led by family member vs. non-family manager?

Method:

Our research was based in India. Using a database (CapEx), we identified 124 NVs, which were launched or announced over the past 18 months by the 56 Indian family firms listed on the BSE 200 index. We then selected 86 NVs, which were (a) not merely an expansion of existing business unit (b) or in the form of pure equity investment where it was clear that the family was not to be involved in any management of the NV. We then used the alumni network of a leading business school to make contacts by telephone with the corporate level. When contacting, we asked these family firms (a) if the NV announced was going ahead. So far we have been able to secure access into 10 family firms and are in the process of conducting interviews with both family and non-family executives.

Results and Implications

To the best of our knowledge, this is the first study to bring together the literature on RAP and NVs to explain how the NV creation process differs if the NV is headed by a family member or a non-family member. We point out that in case the family member initiates the NV he/she is likely to have preferential access to resources and carry more autonomy in the initial venture stages. However, the degree of preferential access and autonomy during idea generation and NV creation stage is likely to be lower for family members where the family firm is professionalized to the extent that it has laid strong governance structure that provides clarity on family wealth management, and eligibility criteria for resource allocation for NVs. In such instances, the advantages family member may posses due to his family identity no longer exist, and he may be treated as an agent (Chrisman et al., 2007; Chua et al., 2009). We point out that in case the non-family member heads the NV, continued access to the NV champion from the family is central to secure access to resources. We further point out that family firms resolve the agency problem by offering them the opportunity to build relationship with the controlling family and giving them visibility (Wasserman, 2002; Miller et al., 2008).

Model growth - do employee-owned businesses deliver sustainable performance?

Prof. Joseph Lampel (Cass Business School) and Prof. Ajay Bhalla (Cass Business School), Dr Pushkar Jha (Newcastle University Business School)

The employee-owned sector - comprising companies that are wholly or substantially owned by their staff - is worth around £25 billion annually, accounting for 2 per cent of UK GDP. Employee-owned companies operate in a wide range of sectors in the UK - from retail, manufacturing and engineering to financial services.

The financial crisis and the subsequent global recession have stimulated a far-reaching debate about the future of capitalism and the way that companies are owned and run. This has led to renewed interest in employee ownership - and in the role that employee-owned companies could play in future economic growth.

The study assesses the financial performance of employee-owned businesses compared with conventionally structured companies where employees do not have a significant stake in ownership or the right to participate in decision-making. It also examines how employee-owned companies maintain the advantages of their ownership structure as they grow in size and complexity. The research by Cass Business School is based on an in-depth survey of senior executives and analysis of the financial data of over 250 companies.

It finds that employee-owned firms create new jobs more quickly than conventionally structured businesses and demonstrate the same levels of profitability. Employee-owned businesses are more resilient: their performance is more stable over business cycles, and they have outperformed the market during the downturn. They are also more robust: employee-owned businesses have a lower risk of business failure. The employee ownership model offers particular advantages to small and medium-sized businesses and in knowledge and skill-intensive sectors, where employee-owned companies significantly outperform competitors. Employee-owned businesses also add more value to output and human capital. They recruit more employees at a faster rate and reward employees with higher wages.

To download the full copy of the report here

The UK as an innovation powerhouse: the hidden innovators

Microsoft, £50,000 (Sept 07-Jan 08). Researchers: Prof Julie Logan, Prof Chris Hendry, Jim Brown, Nigel Courtney

The study set out to investigate trigger points for innovation, how these could become more effective, and how entrepreneurial success in the UK's minority cultures and groups could be transferred more widely within these groups and to UK society as a whole.

The UK is recognised as having a history in creativity and innovation and is seen as a nation of inventors. The country has systems and structures in place to support innovation and encourage enterprise, including the provision of finance, availability of business support, and access to knowledge networks. However, rates of innovation and entrepreneurship are still perceived as being low, particularly in such groups as ethnic minorities, people with disabilities, older workers and women, suggesting more is at play than rational actions alone can address.

It may be that there is insufficient attention given to many innovations that are already taking place and that there is a thriving, though 'hidden', innovation-based economy. One of the consequences of this is that there is a lack of awareness of the opportunities that exist and the pathways by which potential entrepreneurs can realise their ambitions. In order to derive a better understanding of these 'hidden innovators', the research team developed ten case studies of successful innovators and their innovations from social groups that have been neglected in the innovation literature. The case cover three groups: (1) Indian innovators and entrepreneurs; (2) dyslexic and partially sighted innovators; and (3) older workers.

The report, 'Unlocking the potential of the UK's Hidden Innovators' finds that entrepreneurial self-confidence is a critical issue for all the hidden innovator groups and a major barrier in pursuing an entrepreneurial path. It makes several recommendations for ways to build a profile, for example by encouraging self- confidence through the creation of an entrepreneurial culture and tailored encouragement and support. The authors urge policy makers to make financial support and investment more equitable across all groups, and for business support services to take diversity seriously. They urge the UK Government to change the 'macho' image of entrepreneurship, and to send a clear message that entrepreneurship is not only about innovation but also improvement.

Read the final report 'Unlocking the potential of the UK's hidden innovators'

The effects of market and technological uncertainty on academic spinout formation

Economic and Social Research Council, £95,523 (2007-08). Researchers: Vangelis Souitaris and Djordje Djokovic

Commercialisation of academic inventions is currently central to the innovation policy agenda of most developed nations as it contributes to their global competitiveness. In the UK, this commercialisation activity accelerated in the late 1990s, with the establishment of Technology Transfer Offices in universities and the creation of spinout firms. Spinout creation in UK universities is quite impressive; 338 spinout firms were generated between 1996-2000, while 175 spinouts were incorporated in 2001 alone (Wright et al., 2002). However, the Lambert review of business-university collaboration (Lambert 2003) suggested that spinning out is overemphasised in the UK while licensing might be a better way forward for UK universities.

An ESRC-funded research project led by Professor Vangelis Souitaris at Cass Business School explored the reasons universities opt for spinouts instead of licensing. According to real options theory, technological and market uncertainty may affect the way academic inventions will be commercialised. Using this theory, the proposed set out to explain the conditions of technological and market uncertainty that render new firm formation the dominant mechanism for commercialising academic invention.

The study used a dataset of the total population of patented inventions (1313) from the German Max Planck Institute (the largest research institute in Europe) between 1979 and 2004. It found that both market and technological uncertainty have a positive effect on firm formation whereas threat of preemption is negatively influencing it. It additionally found that the probability of spinning out is increased by the previous failure experience of TTO managers to commercialize inventions and by their spinout experience. Also, the inventors' previous spinout experience and the experience of their network of co-inventors are positively related to the probability of spinning out.

The results are generalisable to other developed countries such as the UK, as the effect of technology and market uncertainty are generic forces applying universally to all market economies. The final report suggests that the study has important implications for the following practitioner audiences:
a) Technology transfer managers. The results point out that commercialisation decisions should consciously consider technology and market uncertainty and internal experience of TTO managers and inventors and not be made only on the basis of university policy preferences.
b) Aspiring academic entrepreneurs. The results show that they should target inventions with high uncertainty and low threat of pre-emption (having more chances of creating a spinout), learn from other inventors with prior experience in spinning out and partner with TTO managers experienced in facilitating spinouts.
c) Venture capitalists investing in spinouts. They should also spot inventions with high uncertainty and low threat of preemption and collaborate with teams of inventors and TTO managers experienced in spinout creation.