Business Runs in the Family in Indonesia
Family-owned businesses (FOBs), are considered a safe haven in tumultuous times. They appear closely managed, and in Asia, well diversified to outlast a recession. But is this the case in Indonesia?
According to the Family Business Review, the main costs of family ownership are the potential to expropriate resources from other stakeholders in the firm and to appoint incompetent family members to positions in the company. On the other hand, the benefits are long-term commitment, stewardship of the firm and the ability to monitor managers. According to recent academic research, in Southeast Asia, the costs are higher than the benefits.
Indonesia presents an interesting conundrum. FOBs in this country gained strength in the Suharto era and the major players survived the crisis of the late 1990s. If history was the yardstick, investors would be running for cover and putting their money in these institutions. However, according to our research, results are mixed.
If we were to only look at the biggest FOBs and their share performance compared to the rest of the market, findings seem to support the hypothesis that diversified FOBs are a favorite destination for investors in tough times. However, it is important to go beyond that. We should also compare these family companies against their regional and international peers, both before a crisis and during one. When that is done, results change considerably.
There are several explanations for this; the main one is, ironically, that what helped them survive the last crisis may be hurting them in the current one: diversification.
What helped FOBs survive the last crisis may be hurting them in the current one: diversification
Indonesian FOBs seem to be to be too diversified. As their Japanese peers are witnessing, over-diversification can be especially harmful in a recession. Since businesses in Indonesia, whether family, state or publicly owned tend to be widely spread, looking at the Indonesian market by itself may be misleading. That is why looking at an international set of peers is of greater significance.
Several problems arise from over-diversification. One is capital allocation. This symptom is not limited to conglomerates, but the headache worsens with the degree of diversification.
In times of crisis, a little capital needs to go a long way. A company that has three or four business units has less of a problem in allocating limited funds than a holding firm with four or five smaller companies and dozens of business units. In growth periods, each of these smaller companies can probably secure funds on their own, but not during slumps.
Nevertheless, diversification is tempting. Historically, a “supermarket” strategy can allow a company to ride the business cycle better than its less diversified peers and made it seem an attractive target for investors.
However, in most countries, diversifying by investing in a conglomerate has a cost. Investors believe that senior management at the holding company is unlikely to have expertise in several business areas. Therefore, they assign less value to the overall company - sometimes significantly so - than to the sum of its parts. This phenomenon is known as a conglomerate discount.
Investors used to not mind this discount, but times have changed. Today, mutual funds and exchange-traded funds (ETFs) make it easier and cheaper for investors to diversify.
The other problem is that conglomerates, as in Japan, began focusing on size instead of profits. Banks open restaurants and telcos sell rice cookers. Indonesia has not seen this level of diversification yet, but it can’t be ruled out.
So how do we identify which companies are “dogs” and which are “stars”? The problem lies in the way that companies measure performance. Most do not even have a performance measurement system in place, and cash from a well-performing company may end up in the chief executive’s pet company which can then be wasted.
Family businesses in Indonesia have the opportunity to thrive not only in this recession, but also thereafter. It is only a matter of measuring performance correctly and allocating capital in an objective way.
Martin Schwarz is vice president of Stern Stewart & Co. Research in this article was contributed by Josephine Nicole.
According to the Family Business Review, the main costs of family ownership are the potential to expropriate resources from other stakeholders in the firm and to appoint incompetent family members to positions in the company. On the other hand, the benefits are long-term commitment, stewardship of the firm and the ability to monitor managers. According to recent academic research, in Southeast Asia, the costs are higher than the benefits.
Indonesia presents an interesting conundrum. FOBs in this country gained strength in the Suharto era and the major players survived the crisis of the late 1990s. If history was the yardstick, investors would be running for cover and putting their money in these institutions. However, according to our research, results are mixed.
If we were to only look at the biggest FOBs and their share performance compared to the rest of the market, findings seem to support the hypothesis that diversified FOBs are a favorite destination for investors in tough times. However, it is important to go beyond that. We should also compare these family companies against their regional and international peers, both before a crisis and during one. When that is done, results change considerably.
There are several explanations for this; the main one is, ironically, that what helped them survive the last crisis may be hurting them in the current one: diversification.
What helped FOBs survive the last crisis may be hurting them in the current one: diversification
Indonesian FOBs seem to be to be too diversified. As their Japanese peers are witnessing, over-diversification can be especially harmful in a recession. Since businesses in Indonesia, whether family, state or publicly owned tend to be widely spread, looking at the Indonesian market by itself may be misleading. That is why looking at an international set of peers is of greater significance.
Several problems arise from over-diversification. One is capital allocation. This symptom is not limited to conglomerates, but the headache worsens with the degree of diversification.
In times of crisis, a little capital needs to go a long way. A company that has three or four business units has less of a problem in allocating limited funds than a holding firm with four or five smaller companies and dozens of business units. In growth periods, each of these smaller companies can probably secure funds on their own, but not during slumps.
Nevertheless, diversification is tempting. Historically, a “supermarket” strategy can allow a company to ride the business cycle better than its less diversified peers and made it seem an attractive target for investors.
However, in most countries, diversifying by investing in a conglomerate has a cost. Investors believe that senior management at the holding company is unlikely to have expertise in several business areas. Therefore, they assign less value to the overall company - sometimes significantly so - than to the sum of its parts. This phenomenon is known as a conglomerate discount.
Investors used to not mind this discount, but times have changed. Today, mutual funds and exchange-traded funds (ETFs) make it easier and cheaper for investors to diversify.
The other problem is that conglomerates, as in Japan, began focusing on size instead of profits. Banks open restaurants and telcos sell rice cookers. Indonesia has not seen this level of diversification yet, but it can’t be ruled out.
So how do we identify which companies are “dogs” and which are “stars”? The problem lies in the way that companies measure performance. Most do not even have a performance measurement system in place, and cash from a well-performing company may end up in the chief executive’s pet company which can then be wasted.
Family businesses in Indonesia have the opportunity to thrive not only in this recession, but also thereafter. It is only a matter of measuring performance correctly and allocating capital in an objective way.
Martin Schwarz is vice president of Stern Stewart & Co. Research in this article was contributed by Josephine Nicole.