The central role that family plays in the lives of Indians cannot be overemphasized. This is just as true in business. In India, family-owned businesses (FOBs) contribute more than 75 percent of national GDP, one of the highest percentages in the world, and this is likely to rise to 80 to 85 percent by 2047. McKinsey research reveals that, from 2017 to 2022, FOBs reported around 2.3 percent higher revenue growth than businesses that are not family-owned. Additionally, over the period from 2012 to 2022, FOBs’ returns to shareholders were twice as high as those of non-FOBs.
Since the liberalization of the Indian economy in 1991, the business landscape has been changing rapidly, and today, India is increasingly being seen as a global economic powerhouse. Traditional industries are evolving, while new industries are emerging as global economic interdependence rises. Today’s accelerating technology trends, such as AI, mean that businesses are shorter-lived and more dynamic, and they face greater competition than ever before.
In this landscape, FOBs in India face the twin challenges of maintaining their higher growth rates and remaining relevant in the face of increasing disruptions. If FOBs are to continue to power growth—both their own and that of the wider economy—it is imperative for them now to be bold. It is vital that their owners understand what drives distinctive performance among FOBs in India. Our research offers some definitive insights as they chart their way forward.
Outperforming FOBs
Although FOBs are the lifeline of India’s economy, not all achieve the level of performance and scale they desire. To understand how the best-performing family businesses create value, we analyzed about 300 publicly listed Indian FOBs and interviewed the leaders of a significant number of them (see sidebar, “Exploring FOB performance”).
Notable gaps emerged as we placed all the FOBs on an economic profit power curve and then compared those in the top quintile for performance (the “top performers” or top 20 percent of the FOBs in our research base) with the rest—indicating significant variation in performance. Top-performing FOBs enjoy 2.9 percentage points higher revenue growth, have an economic spread of 11.0 percentage points, and have operating margins 6.3 percentage points higher than other family businesses (Exhibit 1).
This highlights the substantial value-creation opportunity that exists for FOBs in India. Our estimates indicate that a performance jump equivalent to just one quintile could translate to additional annual economic profit of about 100 crore to 300 crore Indian rupees (approximately $12 million to $36 million) for an average family business over a five-year period.
Top-performing FOBs: Five differentiators
Our research uncovered five points that differentiate a top-performing FOB from others: their core operational distinctiveness; effectiveness of the transition to the next generations; the level of diversification of the portfolio; talent, capabilities, and culture; and robustness of the governance arrangements (Exhibit 2). Over the long term, all top performers excel across these themes relative to other FOBs.
1. Core operational excellence
Top-performing FOBs distinguish themselves by maintaining high profitability while sustaining high revenue growth; in other words, they deliver value-accretive growth. We explored what drives this high profitability for FOBs with different governance structures and found that, although operational excellence is at the core of business performance for all FOBs, value-creation levers for top-performing FOBs vary according to their governance archetypes.
Top-performing family-run archetype FOBs outperform primarily by pursuing operational excellence compared to other FOBs of the same archetype (Exhibit 3). Notably, they deliver operating margins approximately 7.8 percentage points higher than those of other FOBs within the same archetype.
However, when professional executives get involved, differentiators increase. Top-performing FOBs in the family-governed and family-ownership archetypes outperform by being both better operators and better asset utilizers compared to other FOBs within the same archetypes. Top-performing family-governed FOBs differentiate themselves in terms of capital turnover in addition to operating margins. They deliver approximately 7 percent higher capital efficiency compared to that of other FOBs within the same archetype. This difference jumps substantially, to about 14 percent, for top-performing family-ownership FOBs.
As families assume strategic roles and move away from management roles, these capital and strategic decisions come to further differentiate top performers from others.
2. Effective transition from one generation to the next
Beyond the founding generation, the generation leading the business has a profound effect on sustaining performance. As generations pass and business complexity grows, it is vital to ensure effective transitions. Having an external viewpoint also helps to separate the owner’s perspective from the business perspective.
Leadership styles vary from the founder’s generation to the next. We see that, although the proportion of top-performing FOBs across generations remains almost the same (20 to 25 percent), more FOBs tend to accumulate in the bottom performers (last two quintiles of the power curve) as they progress from the founding generation to subsequent generations (Exhibit 4). Our research suggests that the proportion of bottom-performing FOBs increases with the passage of generations: from about 33 percent of first-generation-run FOBs to about 43 percent of the second generation and 46 percent of the third generation or beyond. Most likely, this can be attributed to mindsets and priorities shifting after the founding generation, which prompts a look at the effectiveness of transitions from one generation to the next. With time, the tendency to create value and focus on high growth even at the expense of liquidity gives way to an emphasis on preserving wealth. An additional cause could be that when an FOB loses the benefit of its founder’s entrepreneurial edge, growth slows and performance drops. To sustain performance over generations, FOBs need to groom the next generation to lead effectively, shaping and nurturing the right culture, building the right talent, and establishing the necessary support systems.
In addition, bringing in professional executives who complement the capabilities and skills of the leader from the owning family can help to sustain high performance. This can ensure that the entire range of attributes required to run a successful business remain at the helm despite the passage of generations. Business owners typically have a “growth mindset” and look for similar-minded executives to run their businesses. The owners believe in continuously improving performance, and not merely sustaining it, and so are very careful to choose external executives who mirror their mindset and passion.
3. A diversified portfolio to scale the business
Our research also explored organization size in relation to FOBs. We found that diversification across nonadjacent sectors is a key enabler for FOBs to achieve substantial scale (Exhibit 5). For FOBs to scale in size, they need to have a highly diversified portfolio and dynamically allocate their capital to the most promising new businesses, regions, or channels. Many successful FOBs tap discontinuities in the industry or economy to bet on new emerging segments with strong tailwinds for the foreseeable future. This also helps to significantly de-risk the diversification. Through risk mitigation in the portfolio and improved access to market expansion opportunities, diversification also ensures long-term sustainability for FOBs.
Our analysis found that most “at-scale” FOBs (those with annual revenues of more than 6,500 crore Indian rupees) achieve this status through a highly diversified portfolio across different sectors. Our research indicates a significant increase in the proportion of diversified companies as the size of FOBs transitions from “emerging” (annual revenues of less than 2,500 crore Indian rupees) to “scaling” (annual revenues between 2,500 crore and 6,500 crore Indian rupees) to “at scale.” Here, too, introducing external executives plays a pivotal role as FOBs plan to diversify their portfolio. We noticed that archetypes with external executives (family-governed or family ownership) are significantly more diversified than family-run FOBs across all sizes. This is to provide the bandwidth at scale to diversify.
4. Talent, capabilities, and culture
In more than two decades of serving FOBs in India, we see that one of the main factors in companies’ sustained success is organizational health—or how they “run the business.” Talent, capabilities, and culture are the most important factors in driving business health. According to a recent McKinsey survey of about 600 FOBs, 86 percent of respondents at top-performing FOBs agree or strongly agree that their company attracts the best talent. More than 90 percent either agree or strongly agree that their company successfully identifies, trains, and develops their best talent., McKinsey, November 28, 2023.
