How employee incentives drive innovation in family firms

Innovation is the name of the game in today’s hypercompetitive markets: in order to survive, companies need to continuously innovate their products, processes and operations.

Based on conventional wisdom, family-owned firms are at a disadvantage in this regard, with risk aversion, conservative attitudes, organizational rigidity and limited capital commonly cited as obstacles to innovation.

At the same time, their anchorage to the past is also seen as a roadblock, undermining their openness to experimentation, adoption of new strategies and overall innovation potential.

But are these widely held beliefs actually true? Empirical evidence suggests otherwise.

New insights on family firms and innovation

Family business theory and practice posits that family firms deeply rooted in tradition hold on to their history and past, while those less attached are more forward-looking and willing to evolve and explore new terrain.

Yet academic studies challenge this view, finding little correlation between family firms’ attachment to tradition and innovation outcomes. In fact, half of Europe’s most innovative firms are family-controlled, and in emerging economies, examples abound of path-breaking innovations led by family firms.

Based on recent research, employee incentives might play a role in a family firm’s ability to drive innovation.

Employee incentives and innovation

By sharing knowledge and promoting change, employees are vital to spurring organizational innovation, yet the best incentives to motivate them are the subject of debate.

Some scholars say economic, calculative-based incentives based on tangible rewards are more effective, while others suggest point to a collaborative and relationship-based incentive system, grounded on teamwork and collaboration.

This debate extends to the realm of family business, where academics are divided on which model best inspires employee-led innovation: controlling and contractual human resource management (HRM) systems or a more supportive, flexible approach.

Striking the right balance

Inspiring innovation in family firms requires a nuanced approach by acknowledging the diversity among them. Their degree of attachment to tradition has a significant effect, as found in the aforementioned study:

(1) In family firms with a high attachment to tradition, a supportive and flexible approach leads to higher levels of innovation.

This approach eschews economic HRM constructs like salary incentives or pay-for-performance models and focuses instead on non-economic aspects such as:

    • Employee participation: non-family managers are involved in key strategic decision-making roles or leading teams from different functional areas, which fosters a sense of ownership and contribution to the firm’s heritage.
    • Work-life balance: providing employees with the flexibility to attend to unexpected personal circumstances. By trusting their employees and showing concern for their well-being, these firms inspire reciprocity in the form of commitment and behaviors conducive to innovation.

(2) In family firms with a low attachment to tradition, salary incentives combined with employee participation in decision-making lead to higher levels of innovation.

Both the business-owning family and employees adopt a transactional and economic approach, in which successful innovation is recognized and rewarded in monetary terms.

Employee participation in decision-making is still important to ensure alignment, yet serves primarily as a means to hold them accountable for their decisions and outcomes.

By incentivizing employees with financial rewards and decision-making opportunities, these firms foster innovation by charging employees with innovation-related responsibilities and adequately compensating them for their success.

So are family firms truly less equipped to drive innovation? The findings of this study clearly show otherwise, while shedding new light on the specific role of tradition in organizational dynamics.

By implementing the most appropriate employee incentives, family-owned firms can inspire their employees to think more creatively, embrace new strategies and contribute to the firm’s long-term success in an ever-changing business landscape.

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