Deficiencies of Relationship-Based Management in Family Enterprises

In recent years, I have been based mainly in Hangzhou to conduct industrial research. A comparison with enterprise samples I served and studied in Beijing previously reveals distinct characteristics in the market entity structure of Zhejiang. The private economy holds a dominant position, and family enterprises account for the largest share among private businesses. A large number of local market entities in Zhejiang originated from home workshops, husband-and-wife stores, and partnership operations among relatives and friends. Relying on blood and geographical ties, these start-ups generated strong entrepreneurial momentum and risk resilience. In the seed stage, core members collaborated closely on the basis of high trust, with far stronger cost control and execution efficiency than ordinary start-up teams. Most of these entities were able to accumulate initial operating revenue within 3 to 5 years and establish a foothold in regional markets.

Nevertheless, extensive field research and case tracking show that once such enterprises scale up through recruitment expansion, production capacity build-up, and nationwide market penetration, they almost invariably hit growth ceilings. Concomitant issues include chaotic operation systems, rising internal friction, loss of core talent, and sustained stagnation in performance, leaving them struggling to break through the development threshold for micro, small and medium-sized enterprises.

This phenomenon has puzzled many private entrepreneurs in Zhejiang. Despite solid product competitiveness, mature and stable upstream and downstream supply chains, and continuous improvements in the regional business environment, their companies cannot easily expand in scale. Most operators initially attributed such bottlenecks to external constraints: insufficient working capital, limited sales channel coverage, and a shortage of large high-quality orders. However, in-depth empirical analysis of nearly one hundred local Zhejiang family enterprises leads to a clear conclusion: the core barrier to the scaled development of family enterprises has never been external market competition or industry cycles, but fundamental institutional flaws where relationship-based norms replace standardized governance systems within organizations.

From the perspective of organizational evolution logic: micro and small start-ups can substantially cut initial transaction costs through trust-based relationship mechanisms, which constitute a core competitive advantage in the early stage. Modern organizations pursuing scaled growth, by contrast, must rely on rigid standardized institutional frameworks to achieve efficient collaboration. Relationship ties, a core competitive strength for Zhejiang’s family enterprises at the founding stage, eventually become a path-dependence shackle preventing them from advancing through organizational life cycles and scaling up. Its negative impacts can be broken down into three structural dimensions:

1. Relationship-based management naturally fosters a patriarchal governance structure, confining the enterprise’s capability boundary within the personal cognitive limits of its owner. The de facto controllers of such enterprises often concurrently serve as heads of core sales, technology, and even human resources. When revenue stands at tens of millions of yuan, managers can directly oversee all frontline staff. Information flows through short channels, and decision-making outperforms hierarchical corporations. Yet once operation scale crosses the threshold, the de facto controller becomes the sole decision hub of the whole organization. All core procedures require their approval, and all internal and external interests demand their mediation. This results in an operational state where the organization halts without the lead decision-maker, lacking replicable expansion capacity for cross-regional and multi-business operations.
2. Staffing rules built on differential trust raise rigid compliance costs for corporate operations. A common setup appoints the controller’s spouse to lead finance and close relatives to fill key procurement roles. Such arrangements mitigate principal-agent risks in the start-up phase, yet long-term operation gradually normalizes informal practices such as mixed personal and corporate accounts and blurred boundaries for capital flows. Many operating funds are recorded as related-party loans between family members, creating insurmountable compliance obstacles for formal credit applications and listing preparations. Most financial institutions in Zhejiang have cut credit lines and imposed strict risk control thresholds for family enterprises with irregular governance. Informal relationship-driven procurement also creates grey areas marked by opaque pricing and related-party benefits that evade routine audits, directly eroding corporate profit margins.
3. Entrenched path dependence rooted in “favor debts” fundamentally hinders the development of professional talent pipelines. The prerequisite for family enterprises to achieve formal transformation is continuous recruitment of senior external professionals and the construction of teams aligned with modern corporate governance requirements. However, the underlying logic of relationship-based management inherently creates resistance to external professional talent. Zhejiang’s local family enterprises are now entering a concentrated window of second-generation succession. When many inheritors push forward reforms such as digital management systems (e.g. ERP) and KPI performance appraisal, they frequently encounter resistance from veteran founding staff who have worked alongside the original founders for over a decade. The core conflict lies not in the rationality of new systems themselves, but in organizational inertia where long-standing “relationship contracts” outweigh “rule-based contracts”. Out of gratitude for early contributors, original founders are reluctant to adjust vested interests through formal institutions, resulting in a deadlock where new governance frameworks cannot be implemented and legacy founding teams fail to meet the demands of new growth.

That said, a number of benchmark family enterprises in the region have successfully broken free from the shackles of relationship-based management. For instance, Mao Zhongqun of Fotile established a governance rule at the early entrepreneurial stage barring family relatives from core management, and built a standardized professional manager system incorporating modern Confucian ideas. Li Shufu of Geely launched recruitment and development mechanisms for high-end external talent in the early scaling phase, set up a formal board decision-making structure, and gradually reduced direct family intervention in business operations. More leading family enterprises in Zhejiang now comply with listing governance rules to raise the proportion of independent directors and implement full-scope standardized audits. Rigid institutional constraints from capital markets offset the flexibility of internal relationship norms and drive governance upgrades.

Finally, it is important to clarify that governance transformation for family enterprises does not simply mean removing all family members from management. Instead, it upgrades traditional kinship-based relationship maintenance into a modern organizational collaboration system founded on contractual spirit. Meanwhile, governance reforms and intergenerational handover cannot be delivered smoothly through radical, campaign-style changes. A phased iteration strategy is recommended: select low-resistance, easily implementable scenarios as pilots to let the whole organization witness efficiency gains brought by rule-based, systematic operations, then gradually expand reform coverage to achieve a smooth evolution from a relationship community to a modern commercial entity.