Insiders or Outsiders? Choosing your company’s next leader

Japan’s oldest companies offer some clues for the rest of us.

The Chrysanthemum Throne – Japan’s existing monarchy – is said to go as far back as the 6th century and the imperial succession has continued uninterrupted right up to the present emperor. This record of continuity is unsurpassed by any other existing monarchy, not only in neighboring Asian countries, but in the world.

The political authority of the emperor may only be symbolic but its continued existence is a lesson on effective succession planning which is, without a doubt, as relevant to running a business as it has been to running the affairs of a nation.

Succession Planning and its Benefits

Succession planning refers to a process of determining critical roles within the company, identifying and assessing possible successors for people currently in those roles, and providing those possible successors with the appropriate skills and experience for future opportunities. Experts generally agree that succession planning is a combination of the following key elements:

− Recruiting the right people.
− Providing them with proper training so as to develop their knowledge, skills and abilities.
− Preparing them for advancement or promotion into more challenging roles.
− Dealing with the fact that eventually there may be a need to replace talented employees.

Succession planning is important not just in terms of organizational development and providing a means of identifying and preparing suitable employees to replace key management roles. It is also a means of averting risk, particularly the risk the company faces due to the loss or demise of any of its key personnel.

As such, it is not unusual for succession planning programs to require the most senior-level executives to review those at the next levels to maintain a steady pool from which replacements may be chosen to fill each senior position.

Planning is vital because leadership does not mature overnight. Moreover, sometimes talents are not innate and need years of grooming. Organizations will need to prepare candidates with high leadership potential not only to ensure minimal disruption to management responsibilities but to minimize the impact on organizational effectiveness.

Not too long ago, most of this planning was focused on key management and leadership roles, much like grooming the successors of empires and kingdoms. Recently, however, succession planning has been steadily evolving to include not just an organization’s most senior positions, but managers and team leaders at all levels. This new view of succession planning, according to experts, reflects the transition of leadership development from being a specialized activity to a company-wide culture that is relevant throughout the organization.

The Inside-Outsider Approach to Succession Planning

Unfortunately, according to Harvard Business School Professor Joseph Bower, most companies pay little attention to the issue of succession so they end up hiring either an outsider who quickly gets mired in corporate politics, or an insider who knows the business but does not have the ability to lead.

In his book, “The CEO Within: Why Inside Outsiders are the Key to Succession Planning,” Bower insists that the best candidates for the top posts are not just insiders per se, but insiders who have somehow maintained as much detachment from the local traditions, ideologies and shibboleths as any outsider. This “inside-outsider” knows the company intimately but is outside the mainstream and hence still capable of providing a dispassionate perspective.

There is no debate that insiders outperform outsiders. Bower’s own study of the top 500 companies in the U.S. led him to conclude that insiders performed better than outsiders regardless of the overall climate of the company at the time of their appointment. Being insiders may have given them an acute understanding of the organization and its culture, as well as the skills and knowledge that outsiders would only be able to accumulate over time, albeit with some difficulty.

Succession Planning in Japan

Interestingly, in Japan, some of the most successful companies are also among the oldest. These are typically family businesses whose control and management have been handed down in succession for centuries.

Shrine builder Kongo Gumi used to be the oldest company in the world until its unexpected demise in 2006. The business is said to have started when Prince Shotoku invited a carpenter from Chosun (present-day Korea) to construct the country’s first Buddhist temple. Soon, business became brisk – brisk enough to last for 40 generations. What made the company last for more than 1,400 years? In an April 16, 2007 Business Week article, Kongo Masakazu , the company’s last patriarch, cited flexibility as a key factor.

For instance, rather than always handing the reins to the oldest son, Kongo Gumi chose the one who best exhibited good health, a sense of responsibility, and talent for the job. Moreover, it did not always have to be a son. The 38th Kongo was Masakazu's grandmother. Another factor that contributed to Kongo Gumi's extended existence was the practice of allowing sons-in-law to assume the family name when they joined the firm. This common Japanese practice allowed the company to continue under the same name, even when there were no male heirs in a given generation. What pulled the company down was not bad management but bad debts that went as far back as Japan’s post-war reconstruction in the 1950s.

Another good example is Kikkoman, the world’s largest producer of soy sauce and soya products, which was founded in 1630 by Shige Maki of the Mogi family who ventured into business after she lost her husband in the battle of Osaka Castle. Her small business officially became a global brand in 1917 when eight branches of the family merged their companies together.

Sumitomo Corporation, a worldwide conglomerate based in Tokyo, was established in 1630 when its first patriarch, Masatomo Sumitomo, opened a pharmacy and bookstore in the old capital, Kyoto. Succeeding generations eventually expanded the business. Currently, the company has about 20 companies engaged in diverse areas such as banking, shipbuilding, mining, glassmaking, electronics, cement, lumber and chemicals.

According to a study by Yupana Wiwattanakantang, conducted in 2008 when she was at the Institute of Economic Research of Hitotsubashi University, in Japan heir-managed family firms have been outperforming non-family firms. This is in sharp contrast to the general tendency of family firms in other developed countries.

A comparison within Japan’s heir-managed family firms also shows that non-blood, heir-managed family firms have been outperforming descendant-managed family firms. As mentioned earlier, Japanese family firms are unique in that they customarily bring in male heirs from outside the founding family (non-blood heirs) either by adoption or marriage.

Non-family firms belonging to a keiretsu (set of companies with interlocking business relationships and shareholdings) corporate group are ranked lowest, both in terms of performance and firm value, among various other types of firms that include founder managed family firms; descendant-managed family firms; non-blood, heir-managed family firms; professionally-managed family firms; and non-keiretsu-affiliated, non-family firms.

If anything, this goes to show that Japanese companies, even those that are traditionally called family businesses, generally pass the torch to insiders even in the absence of competent heirs from within the family. Adoptions and marriages not only overcome the problem of intergenerational transmission of managerial skills but also mitigate the problems of alignment of incentives between managers and shareholders.

It may be worthwhile to mention that with regard to family firms, it appears that non-blood heirs are more competent than descendant heirs. Using educational background as indicator of competence, Wiwattanakantang found that non-blood CEOs had higher educational backgrounds relative to descendant CEOs, although in many cases descendant CEOs had higher educational backgrounds than founder CEOs. In terms of the length of tenure, non-blood heirs stayed as CEO for roughly 20 years on average, almost the same as the tenure of descendant heirs and substantially longer than the sixyear average of professional managers. Of course, we know that things do not always work as they should, as the unfortunate fate of Kongo Gumi demonstrates. Even Japan’s imperial throne has been recently put to a test. The possibility of the imperial tradition vanishing with the last male heir remained a real possibility, a serious problem that was just narrowly averted with the birth of Prince Hisahito in 2006.

The Succession Planning Imperative

It is clear that succession planning is no longer an option but an imperative for companies (and even empires) to perpetuate themselves and be rightfully called “built to last.” As the saying goes: Failure to plan for succession is planning to fail.

The real challenge then, becomes one of execution. If you are really determined to do this, start by letting go of some of the traditional beliefs regarding the type of people you consider potential leaders. As HR professionals, maybe it is time for us to rethink, review, challenge and update our own concepts of leadership and move toward succession and workforce plans that attract, recruit, select, train and advance those individuals with the skills most aligned with current values.

It may also be time for us to provide better career tracks for younger employees to get early exposure, for women to occupy key leadership positions, for foreigners to be designated to positions of responsibility. It may even be time to sometimes challenge the commonly-held view that outsiders cannot perform as well as insiders.

Abridged with permission. Original article can be read here.

[Editor's note: Jun is teaching Human Resource Management at GLOBIS in the 2016 October term.]

Jun Kabigting, MBA/MS/SPHRi is representative director and president of HR Central K.K., a lecturer at GLOBIS University, and an adjunct professor with Temple University Japan Campus. He is the Founding Chief Community Officer of The Japan HR Society (JHRS) and also serves as the Managing Editor of The HR Agenda -- Japan's first & only bilingual HR magazine.
Jun has more than 25 years of experience across the entire HR value chain, most of them Japan-focused. He has a solid experience as a trainer, HR consultant, and talent acquisition professional. He likewise serves as nominal representative and/or external director for other organizations.
Jun holds an MBA from the University of Hawaii, an M.S. in Industrial Engineering from the University of the Philippines, a Certificate in HR Studies from Cornell University’s School of Industrial Labor and Relations and credentialed as a Senior HR Professional - International (SPHRi) by the HR Certification Institute (HRCI) and an accredited Harrison Assessments (HA) consultant and solutions provider in Japan.
He has been a frequent speaker/resource person in various domestic and international HR conferences in Japan, Singapore, Malaysia, and USA. He passionately believes in advancing the HR agenda in Japan through continuing HR education, knowledge sharing and use of HR best practices.