Growing beyond smallness: How do small, closely ... - SAGE Journals

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Research Note

Growing beyond smallness: How do small, closely controlled firms survive?

International Small Business Journal 28(6) 620–630 © The Author(s) 2010 Reprints and permission: sagepub. co.uk/journalsPermissions.nav DOI: 10.1177/0266242610369879 isb.sagepub.com

Wilson Ng

University of Westminister, UK

Kevin Keasey

University of Leeds, UK

Abstract This research note on a family-controlled firm in Singapore suggests how such businesses, in competitive industries, may grow and survive. Located in the literature on small firm growth, we explore a corporate incident that threatened the survival of the firm under study. An analysis of the manner in which the firm’s managers responded to this threat by developing and launching a new core business, without external intervention, forms the basis of the scholarly contribution of the case. It illustrates how a corporate incident can draw the attention of core shareholders to their need to address specific business and management issues and make subtle organizational changes that ensure the firm’s survival under close control. Keywords absorptive capacity, closely controlled firms, critical incident, family firms, tipping points

Introduction This research note contributes to scholarly understanding of how small firms may achieve longterm survival1 through timely strategic and management changes. We ask: how may such firms, typically family controlled,2 survive in a competitive market? The note is based on an analysis of a critical incident3 in a Singaporean family firm that presaged a ‘tipping point’, which is defined as a critical point in a firm’s evolution, before which relative stability is the norm, but after which organizational changes occur that significantly alter its future (Phelps et al., 2007: 8). In our case firm, ‘Sinocare’4, the tipping point exposed problems which, if not addressed, threatened the firm’s survival as a closely held entity. Those problems were, firstly, the need to develop a new, high-potential business to supplement the firm’s low-potential core activity, and secondly, to institute a management system capable of developing the new core business.

Corresponding author: Wilson Ng, Westminster Business School, 35 Marylebone Road, London NW1 5LS, UK E-mail: [email protected]

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Our perspective of tipping points suggests that while they may arise in one of the key areas of a firm as described by Phelps et al. (2007), their importance for closely held firms seems to lie in the way that they draw the attention of key shareholders and managers to specific problems in the closely held firm. Such problems must be solved in order to stave off possible terminal decline. Based on evidence from the case study, we suggest that closely held firms may be able to survive by making subtle organizational changes that improve their competitiveness while retaining close control. One means of achieving this occurs when controlling shareholders draw upon prior knowledge of a specific area within the family firm’s expertise. In Sinocare, one such important area of expertise was its long-standing relationships between controlling shareholders and the firm’s core managers and customers. We explore how that expertise became central to the development of an internal system for funding and managing the firm, which then generated growth without external intervention.5 This observation forms the basis of our argument, namely, the manner in which tipping points in closely held firms may be negotiated by key stakeholders for the principal purpose of retaining the firm’s closely controlled form of organization. Our work is located in a body of literature on the growth of small, closely held businesses that explores how such firms in competitive industries may have to alter their family-centred management style, in order for the business to be able to grow and survive (Carney and Gedajlovic, 2003; Chrisman et al., 2004; Cressy, 2006; Handler, 1994; Morck, 2005). We also draw on the literature exploring firm growth, principally that of Phelps et al. (2007), in analysing a critical incident and its effect on a closely held firm. This literature suggests that tipping points typically arise from a sequence of unremarkable events (Gladwell, 2000), and that they are encountered either during a firm’s growth or following changes in its operating environment (Phelps et al., 2007: 8). Our study presents a further consideration of tipping points that prompt a number of important organizational changes in the context of closely held firms. Based on our analysis of Sinocare’s response to the critical incident, we advance several propositions on how small firms may grow and survive under close control.

Literature Success and failure of small, closely held firms The central issue in our case is how a small, family-controlled firm was able to respond to a critical threat to its survival by drawing on long-standing relationships with core stakeholder groups, namely, family shareholders, non-family managers and core, ‘VIP’ customers. The fact that family firms are capable of responding to external threats may seem unsurprising based on the large volume of literature on this popular form of organization. Indeed, small family firms are well known for their opportunism and parsimony, which are said to underpin their initial success (Carney, 2005, 2008; Gersick et al., 1987). Small, family firms may remain profitable for long periods6 in environments with weak regulations (Claessens et al., 2000) and an undeveloped financing infrastructure (Carney and Gedajlovic, 2003) where the controlling family’s business approach can prove very effective. It is, therefore, possible that the family-controlled firm may remain a highly efficient form of organization where family owners continue to manage the firm (Fama and Jensen, 1983). Where family firms have sought to expand, for example, in Germany (Linnemann, 2007) and East Asia (Carney, 2008), then they have tended to cede control to non-family shareholders who contribute resources and expertise to support growth. However, what we do not really understand is why some family firms, in well-regulated and well-developed environments, have grown substantially while remaining under family control

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(Carney, 2008; Ng and Roberts, 2007; Sharma, 2004). From our research, few scholars seem to have questioned how far it is necessary for closely controlled firms, traditionally acknowledged to be efficient, to have to access outside market resources in order to grow and survive. To re-express our research question: how far may closely held firms grow based mainly on the support of their core shareholders and customers? One recent strand of literature that focuses on the success factors behind organizational growth considers how expanding firms face a number of key issues. These key issues, or tipping points, emanate either from growth or from environmental changes, and will have to be negotiated for firms to grow and remain competitive (Gladwell, 2000; Phelps et al., 2007). It is suggested that a firm’s ability to negotiate tipping points depends on the ‘absorptive capacity’ (Cohen and Levinthal, 1990) of its key actors, their ability, developed through prior knowledge, to recognize the value of new information, to assimilate it and then exploit it commercially (Phelps et al., 2007: 11). Absorptive capacity, therefore, refers to a firm’s process of knowledge management and has implications for growing firms, based on their awareness of what specific tipping points they have to address and their commitment to finding and using new knowledge to negotiate them (Phelps et al., 2007: 12). Scholars have indicated a number of potential hazards in applying absorptive capacity to SMEs, in particular their typically ‘mechanistic’ approach to, and lack of investment in, knowledge management (McAdam and Reid, 2001). The application of absorptive capacity to small, closely held firms may be similarly constrained. However, we have drawn on a core feature of this theory in terms of the family firm’s prior knowledge of a specific area of expertise to illustrate how our case firm grew largely without external intervention. Although more research is required, we believe that our perspective potentially extends the work of both Phelps et al. (2007) and Cohen and Levinthal (1990) in suggesting how a small family firm was able to negotiate a specific tipping point in order to grow and survive under family control. In this research note, the tipping point we discuss revolves around human resource issues. As Phelps et al. (2007: 8) suggest, human resources are a neglected area of study in terms of their influence on firm growth. It is suggested that much of the work in this area has explored the importance of developing communication and teamwork in order to make a successful transition from owner-management to larger-scale professional structures (Hornsby and Kuratko, 1990). By contrast, in closely held firms, relationships among key family and non-family stakeholders are often critical to the family firm’s survival (Gomez-Mejia et al., 2003; Morck, 2005; Ng and Roberts, 2007). Similarly, we know that teamwork among ‘inside’ stakeholders in closely held firms has helped them to grow and develop under close control (Redding, 1990; Schein, 1997). However, little is known about how relationships may in fact help the closely held firm. Here, our work contributes to understanding how strong teamwork among a core group of stakeholders can help the survival of the closely held firm. We have, therefore, focused on analysing how internal stakeholder relationships were developed and drawn upon in order to resolve a key tipping point in the management of the closely held firm. This view, that firms may survive by applying existing know-how when making important organizational changes, is supported in a number of studies. For example, Cooper (1994) and Knoke (1998) suggest that simply structured ‘amoeba organizations’ may survive in competitive industries if they can react to competitive threats by feeding off stakeholders who provide longterm capital and revenue. Viewing Sinocare as a firm that has survived by drawing upon its business knowledge as a closely controlled organization opens up several channels for further research, as we suggest in the final section.

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Methodology Sinocare’s business context The setting for our case study is Singapore, a highly successful economy founded upon its open business approach backed by a well-regulated corporate regime (Vogel, 1991). This business approach has attracted a large number of international investors and financiers who have supported both local and foreign firms (Loh et al., 2000). At first glance, Singapore’s open economy, with its easy access to external financing, would seem to challenge the persistent survival of small, internally funded firms. Yet, for many years now, business in Singapore has involved family- and state-controlled firms, both of which continue to represent the principal form of organization in local business and commerce (Carney, 2008; Vogel, 1991). Families control between 55 per cent and 75 per cent of the aggregate market value of locally quoted firms (Claessens et al., 2000), with several ethnic Chinese families controlling key industries, such as banking and property (Loh et al., 2000). Within these industries, a few old family firms continue to dominate: two out of only three local banks remain family-controlled, as are two of the largest property groups. Historically, many of these family firms remained as small- and medium-sized enterprises (SMEs) for long periods, until they made appropriate business and management changes in order to grow while remaining family controlled (Loh et al., 2000).

Sinocare’s history In this environment, Sinocare has operated for over four generations of the same founding family. From its foundation in 1879 until the 1990s, its sole activity was the production and sale of Chinese medicinal products, mainly to ethnic Chinese customers in Southeast Asia. This niche business suited Sinocare as a small-sized, owner-managed firm. However, after more than a century of owner-management, the firm faced an unexpected critical incident in the form of a hostile takeover that destabilized its business and threatened its survival as a family-controlled business. This constituted an ‘extreme situation’ (Pettigrew, 1990: 275) for Sinocare, which prompted core family shareholders to develop a management system capable of strengthening and protecting the family’s close control of the firm. The outcome of Sinocare’s reaction seems clear. Since the critical incident, professional managers have launched a new core activity of ‘integrated healthcare’,7 supplementing the old Chinese medicine business. Substantial financial growth has been reported. Sinocare’s survival as a closely held firm following the end of a hostile takeover suggests the importance of the case study on how far close control may help or hinder the survival of small, closely held firms.

Researching Sinocare We employed an empirical, case study method of research tailored to our interest in Sinocare’s process of survival under close, family control. We approached data analysis as social constructionists: we related research data to the relevant literature on small firms and our research question by moving back and forth from the data to the literature, to develop propositions on small firm survival and growth (Pratt and Rafaeli, 1997).

Data collection and analysis There were two main steps in data collection. We constructed a chronology of Sinocare’s growth and development from the perspective of key family actors (Pettigrew, 1990). Public data were obtained from two sources: first, corporate data from filed annual reports since Sinocare’s original

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public listing in 1973. The trail of published data formed the primary source for building a chronology of corporate events over the firm’s 130-year history. To supplement these data, we collated media news items from Sinocare’s in-house archive of corporate events. Archival data were further supplemented by interviews, conducted by two co-researchers, with former Sinocare directors. These multiple sources enabled the researchers to complete and cross-check details of important corporate events. With a chronology of key events to hand, the second stage of data collection was to develop the chronology with a detailed, event-based narrative (Maguire and Phillips, 2008). Our focus turned to a critical incident and a number of significant events that seemed to follow (Chell, 1998), most notably board and management changes and then, in 2001, an announcement by Sinocare of an imminent change in its core business. As key actors were family directors and the firm’s four most senior non-family managers,8 we developed a detailed narrative of the critical incident and its aftermath from interview-based conversations with family directors and three of the four senior managers (Maguire and Phillips, 2008). In sum, 45 interviews lasting between one and three hours each were conducted with 24 board directors, senior and middle managers. Interviews were initially conducted between 2000 and 2003, and most of the original interviewees were re-interviewed in 2006 and 2007, with multiple interviews for family directors and top managers. Interviews took the form of interactive conversations during which we aimed to understand (1) how Sinocare developed a new management system and (2) how far key actors then used this system to develop and implement a new core business for the firm. The format of interviews followed a discussion protocol. The protocol was framed by the critical incident (Chell, 1998) and comprised three parts. Part 1 explored Sinocare’s historical skills and competencies up to the takeover. Part 2 comprised a questionnaire with 38 questions on a Likert scale that sought respondents’ perceptions of the involvement and influence of key family and non-family actors in strategic and operational areas of the family firm following the takeover. The questionnaire was e-mailed before each interview and interviewees were invited to complete it in advance. Based on answers, the ensuing discussion (part 3) sought to relate actors’ perceptions of their roles with their actual contributions in Sinocare’s corporate developments, first, in the rebuilding phase following the takeover, and thereafter, when the firm sought to establish a new core business.

Contrasting outcomes of corporate control Our job as [family] shareholders is to support our managers. Our customers expect [the family] to see that managers deliver the service we promise as the founders [of the business]. But we’re investors not administrators. So [named manager] runs our show in Singapore. We set him up so he can do his job. (Family chair)

The critical incident in question was a hostile takeover. Drawing upon the perspective of family shareholders and senior, non-family managers, we suggest how the takeover precipitated a tipping point in the development of managerial strategies aimed at protecting the family’s corporate control.

Critical incident: Takeover and collapse At the time of the critical incident in 1991, Sinocare’s performance was weak and stagnant. The firm was managed by a fourth-generation family CEO, who realized that Sinocare’s financial weakness made it vulnerable to a takeover. Corporate predators, primarily interested in its property portfolio, took control of the firm after buying out a group of family shareholders. The core medicine business was then left to run down such that just 12 months after the takeover, sales had

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declined by over 60 per cent: ‘[The takeover] made me realize that if we were to survive we had to be become a right old profit churning thing ... We had to come up with something pretty drastic’ (family CEO).

A tipping point in business and management Two years after the takeover, the family CEO took what he described as ‘drastic’ action by retaking control of Sinocare. This was achieved by persuading both family shareholders and core customers to support a bid to buy back Sinocare shares in the market. The strategy succeeded when the predatory purchasers became locked in by minority shareholders, who refused to allow any alterations to the firm’s business or any asset liquidation. The family CEO then made an offer for the predators’ shareholding in Sinocare, which was accepted. The return of family control was followed by further, urgent discussions to secure the firm’s future. There seemed to be two significant outcomes from those discussions. First, family shareholders agreed that Sinocare had to grow rapidly and develop a business model that would forestall future takeovers. This was to be achieved by supplementing Sinocare’s Chinese medicine business with an untried, but high-potential business, of integrated healthcare: We had to make up for lost time. The most obvious course of action was to pump up the new business because we already had the expertise. The idea was to use our VIPs to underwrite the new business and get our [non-family] managers to take charge of the business because they had the experience and credibility to pull it off. (Finance director)

Second, family shareholders established a professional tier of senior managers under the control of Sinocare’s four executive non-family managers in order to launch and grow the proposed new business. From their experience of the takeover, family shareholders realized that the exisiting family managers were unable to ensure the firm’s survival. Instead, as suggested in the opening quote of this section, it was recognized that the primary skills of family shareholders lay in their role as long-term investors. However, given that family shareholders had always managed Sinocare, the decision to establish a professional management team with no family connections warrants further analysis.

Strategic re-direction At the turn of the millennium, family shareholders faced a managerial challenge. The management team had to have the skills capable of launching and managing the new core business. The family CEO and other family managers responded by resigning from their management roles while supporting the appointment of professional managers in their place. This paved the way for the establishment of a distinct non-executive investment role for family shareholders while managerial control of Sinocare was ceded to a team of executive professional managers. Essentially, the family CEO now focused on organizing family capital to fund Sinocare’s expansion into integrated healthcare. We suggest that what turned the two distinct managerial roles into a cogent, effective system was that the enactment of these respective roles depended on the prior, historical development of a strong, mutually dependent partnership between professional managers and family shareholders. Specifically, the professional management team relied on the investment and clientele which family shareholders supplied; in turn, the latter depended upon the ‘experience and credibility’ of their loyal, long-serving managers. Over time, both parties had become closely identified with the family firm and both had a deep interest in its survival under family control. In terms of this objective,

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based on the urgent need to achieve corporate growth, it suited the interests of both parties to draw from the complementary ‘fit’ between their respective roles and contributions when launching the new business. An important third element of Sinocare’s development was the firm’s ongoing support from its most loyal, core customers, who continued to bolster the demand side of the business, contributing the bulk of sales. The support of ‘VIP customers’ had long enabled family shareholders to fund the business. As those customers expected to see the continuing involvement of family shareholders in the business, professional managers developed a marketing strategy whereby family shareholders communicated directly with VIP customers. From the perspective of Sinocare’s development, this strategy drew on a well-established system that had now been subtly altered to prioritize the role of professional managers. This approach reinforced an internal belief that Sinocare could survive by adjusting, rather than by discarding, its closed, self-sustaining system of private capital and customers (Figure 1).

Discussion Scholarly implications The nature of Sinocare’s closed, self-sustaining business system lies at the heart of what may be learnt about how small, closely held firms in competitive businesses may thrive and survive under close control. We suggest that Sinocare survived a takeover because its core shareholders were able to prioritize the survival of the closely held firm, by pursuing an unfamiliar growth strategy requiring the careers of family managers to be sacrificed. They were able to do so because of their

Core shareholders (Capital supply)

Inputs:

Core customers (Product/service demand)

Core managers (Product/service delivery)

Outputs: Business & marketing Strategies Relationship-protected boundary of the closely controlled firm

Figure 1. Sinocare’s Closed Capital Management System

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collective, robust response to important business and management issues – the tipping point – that arose from the takeover. Here lies our main contribution in this research note as we suggest how the takeover exposed specific issues for our closely held firm to negotiate. In contrast to Phelps et al. (2007), the tipping point here was not located in a growing firm. Until the takeover, Sinocare’s shareholders were not pressed to make any changes. The takeover and subsequent collapse in business brought about change as Sinocare’s core shareholders negotiated the issues to ensure the firm’s survival while protecting its closely controlled form of organization. We suggest that Sinocare’s core shareholders responded to the critical incident by creating a central, coordinating role for a professional management team within a closed, capital management system. Our analysis in this article also contributes to the literature on the growth and decline of small, closely held firms. In contrast to the view that small firms may need to surrender close control in order to grow and survive, Sinocare survived when its core shareholders bolstered their continuing control of the firm by drawing on the firm’s prior knowledge in the form of long-lasting relationships with other core stakeholder groups. We suggest that under certain specific conditions, such firms may in fact become less mechanistic and more flexible in their willingness to manage their own knowledge despite their poor record of knowledge management (McAdam and Reid, 2001). A key condition may arise when the survival of the closely controlled firm is threatened by an external event, and in responding to that event, the prior intention of core shareholders to ensure the firm’s survival under close control may then motivate shareholders to act. In Sinocare’s case, the knowledge that was drawn upon in response to the deficiencies exposed by its takeover involved activating and reinforcing stakeholder relationships that were already in place. In turn, the subsequent success of the relationship system in growing and protecting the closely controlled firm focused attention on the ongoing management of core relationships within the system. Close control of such firms and their ongoing survival were thus entwined. These arguments may be captured in the following propositions: Proposition 1a: Tipping points in small, closely held firms comprise the response of core shareholders to key issues that have to be resolved for the firm’s ongoing survival under close control. Proposition 1b: Tipping points are preceded by one or more critical incidents, which have a principal effect of exposing corporate problems that may become fatal to the closely held firm. Proposition 1c: The survival of the closely held firm is influenced by, inter alia: (1) the resolve of core stakeholders to address Proposition 1a and (2) how the firm engages its prior knowledge in the form of long-lasting relationships among core shareholders, managers and customers to sustain the firm’s business without substantial outside intervention.

Managerial implications Firstly, managers may have to develop and coordinate the support of the firm’s core shareholders and customers as an integral part of managing the closely controlled firm. They may achieve this by drawing on their own strengths in management to develop an attractive business strategy for stakeholders to focus on, as Sinocare’s managers did. A second lesson is that small, closely held firms may grow substantively when core shareholders and managers collaborate and play meaningful, mutually supportive roles in regulating capital supply and customer demand for the

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firm’s business. Sinocare’s capital management system is noteworthy because it was able to alter the firm’s business without discarding the established system supporting the business. Here we suggest that the effectiveness of this management system may be related to its continuing cell-like, ‘amoebic’ profile with a compact, optimally manageable size of operations run by a group of non-family managers, each with distinct expertise and supported by family directors. The compact nature of this collaborative group may facilitate decision-making by managers in close consultation with core shareholders, while the co-ordinated expertise of the group’s professional managers obviates any need for shareholders to manage the business. These lessons may be encapsulated in the following managerial propositions for the growth of small, closely controlled firms: Proposition 2a: Senior managers should encourage close relationships among core shareholders and core customers by pursuing a strategy of corporate growth which aims to protect the firm’s close control. Proposition 2b: In developing a successful strategy for growth, core shareholders and customers must underwrite a restructuring of the firm’s business or the establishment of a new core business. Proposition 3: The main role of senior management is to maintain the effectiveness of the firm’s capital management system by monitoring and managing the size and balance of its stakeholder relationships. This may be achieved by developing an attractive business strategy that draws stakeholders to understand what is required in order to survive under close control.

Limitations and further research A principal limitation of this case study is its applicability to other closely held firms. Consistent with Gladwell’s (2000) suggestion of the importance of environmental changes in the development of tipping points, the Singapore environment may have provided unique opportunities for small firms such as Sinocare to continue as closely held firms by leveraging their internal capital and customers to compete in new businesses. However, our findings in Singapore might be balanced against research of closely held firms elsewhere, such as in the UK, where more dispersed forms of organization are the norm and where many industries have had a longer, more openly competitive history. To what extent, therefore, might small, ‘amoebic’ firms similar to Sinocare survive in other competitive markets? How far will the compact, cell-like operating structure of such firms help their ongoing survival? We have begun answering these questions by proposing an approach in which scholars and managers might de-couple the ability of closely held firms to survive from any need to go to the market in order to survive under close control. We believe that this approach advances understanding of how such firms may survive without substantial external intervention. The ambitious manner of Sinocare’s survival in a competitive market suggests how closely held firms may prove more resourceful and less inflexible in persisting under close control than much of the small firm literature has suggested. Acknowledgements We gratefully acknowledge comments from reviewers of this journal, which have significantly improved the manuscript. We thank the British Academy for funding the research.

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Notes 1.

2.

3. 4. 5. 6. 7. 8.

We adopt the American Small Businesses Association’s definition of small family firms as having 50– 500 employees and an annual turnover of up to US$20 million, depending on the industry: http://www. sba.gov/services/contractingopportunities/sizestandardstopics/summarywhatis/index.html Family control requires board and management decision-making rights to be held by shareholders related by blood or marriage, who act in concert with one another (Chua et al., 1999). Family control does not always mean family ownership: typically in family-controlled firms, substantial residual interests are held by unrelated parties (Claessens et al., 2000). By contrast, market control refers to publicly controlled firms where no single party has such decision-making rights. Critical incidents are instances of ‘extreme situations and social dramas’ that make the phenomenon of study ‘transparently observable’ (Pettigrew, 1990: 275). Sinocare is a pseudonym. Pseudonyms have also been used for all interviewees in this research note. Sinocare continues to be funded by its founding family shareholders, who still hold over 70 per cent of its common stock, and the free float in the stock market remains at less than 20 per cent. See, for example, La Porta et al. (1999) who compare the typically well-established business systems of family firms around the world. Integrated medicine is Sinocare’s term for medical services and products in which knowledge of Chinese medicine and best practices of western medicine have been combined. At the time of our research Sinocare now has six top managers, each handling different core areas of the firm.

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