03 January 2016
Toyota Manufacturing UK - Assembly

Japan's business world

Japan’s business world has undergone profound transformations over the past few decades, writes John West.

Japan's business world has played a big role in the development of not only Japan, but also of Asia and the global economy.

What are the main characteristics of Japan's business world? How has it changed, and how well has it adapted to the global economy of the 21st century?

1. Large companies and SMEs

We have all heard of leading Japanese companies like Toyota, Sony, and Softbank. But small and medium enterprises (SMEs) are still the backbone of the Japanese economy. They account for 99.7% of all Japanese companies. They employ 70% of all Japanese private sector employees, and account for 50% of value-added. All big companies like Toyota, Sony and Softbank started out as SMEs. But too few Japanese SMEs are able to follow in their footsteps due to Japan’s weak entrepreneurship.

You find SMEs everywhere like family stores, and small restaurants. Many SMEs also play an important role in global value chains (GVCs), as they supply parts, components and services to large companies.

2. From manufacturing to services

Following World War 2, the Japanese economy began a spectacular renaissance. In these early days, Japanese companies specialised in manufacturing activities like steel, chemicals, shipbuilding, motor vehicles, electronics, and toys and gadgets. It was mainly a producer of low-tech, low-quality, labour-intensive manufacturing products, much like China today.

Over the decades, Japanese business has undergone many great changes, and become a world leader in high-tech, high-quality, capital-intensive manufacturing. For many years now, Toyota has been the world's leading motor vehicle producer. And most other Japanese motor vehicle producers like Nissan and Honda are still very successful. In the electronics industry, Sony, Panasonic, Sharp and others soared to great heights in global markets. But they have since lost their edge. Companies like Korea's Samsung, Taiwan's Foxconn, and America's Apple have overtaken them. Nintendo is still however the world's largest video game company.

In more recent times, Japanese companies have emerged as key suppliers of high-tech components for GVCs. For example, it has been estimated that more than half of the parts and components, like capacitors, transistors and the liquid crystal screen, used in the iPhone 5 are made by Japanese manufacturers. And more than 65 Japanese companies supply the aircraft manufacturer Boeing with parts and components across its commercial and defence product lines.

These hidden champions may be “invisible”, but they are “indispensable” linchpins not only to Japan’s economy, but to GVCs. They are a sharp reminder of just how critical manufacturing is to our modern economies, and help explain why Japan remains a world leader in manufacturing.

There has also been a new wave of Japanese companies, especially in the services sector. Softbank is a leading telecommunications and Internet company, which is also the biggest shareholder in China's Alibaba. UNIQLO has a growing global presence in the clothing industry, with its "lifestyle" garments. Muji is an increasingly popular retailer of household products. Rakuten is an ecommerce giant. Family Mart, Lawson, and 7-Eleven are Japanese convenience stores with large footprints in Asia and elsewhere.

Kinokuniya is a Japanese book company with 27 stores, in the US, Asia, the Middle East and even Sydney, Australia. SANAA is an award-winning architectural firm whose lead architects, Sejima and Nishizawa, were awarded the Pritzker Prize. Their design has been chosen for the extension of the Art Gallery of New South Wales, the “Sydney Modern Project”. Nobu is a Japanese restaurant with locations in the US, Asia, Middle East, and Australia.

3. Japanese companies become multinationals, but not global enterprises

Japanese large companies strut the global stage. They have always been export-oriented, and have conquered markets the world over. They have also invested massively in the US, Europe and Asia. Factors driving this outward investment have been: protectionism in the US and Europe, especially in the 1980s; rising costs at home, especially in the 1980s; a sluggish domestic market following the 1990s financial crisis; and rising market opportunities, notably in fast-growing Asia.

Despite their success on global markets, Japanese companies remain very Japanese. In particular, very few Japanese companies have a non-Japanese CEO. Carlos Ghosn of Nissan is perhaps the only rare case of a foreigner working as CEO in a major Japanese company. And his is a very particular case, where Renault bought the failing Nissan, which was revived under Ghosn’s leadership.

Michael Woodford is an unhappier case. Of British nationality, Woodford was appointed CEO of Olympus Corporation, a manufacturer of optics and reprography products. He discovered and exposed a big financial scandal at Olympus, but was fired for doing so. In Japan, it is important to never rock the boat. In contrast to Japan, you will find many foreign-born individuals heading up American companies, such as Microsoft, Google and Pepsi.

Only 7.4% of Japanese companies have a woman leader. And it is very rare to find young people like Mark Zuckerberg as business leaders in Japan. The Japanese business world is very much one of old men in grey suits.

4. From copycat to innovator?

Like China and most emerging economies today, Japan was a copycat nation for much of the 1950s and 1960s. This is typical as emerging economies usually try to copy products of advanced economies, and compete with them on the basis of lower costs and prices. But gradually Japan mastered existing technologies, especially in the motor vehicles and electronics industries. And with strong investments in education and R&D, Japan became more innovative.

Japan does have some of the world's most innovative companies according to the Boston Consulting Group's listing of the world's top 50, namely, Toyota (6th), Softbank (14th), Fast Retailing (which owns Uniqlo) (15th), Hitachi (38th), NEC (41st). However, the world's most innovative companies are America's Apple, Google, Tesla Motors, and Microsoft, while Korea's Samsung ranks 5th. China also ranks well with Tencent at 12th, Huawei at 45th and Lenovo at 50th.

But Japan is only ranked 19th out of 141 countries in the Global Innovation Index. Japan is thus ranked behind countries like Switzerland (1st), US (5th), Singapore (7th), Hong Kong (11th), Korea (14th), and Australia (17th). China is ranked 29th.

Japan has always been much stronger at incremental innovation, small gradual improvements, rather than disruptive innovation. Kaizen, a Japanese word meaning “continuous improvement”, has been at the heart of Japanese management, especially at Toyota.

Japan's relatively weak innovation performance has been criticised by organisations like the OECD in several ways. There are very many things that Japan needs to do to improve its innovation performance -- like opening up to more domestic and international competition, and strengthening links between business and universities, and becoming more integrated into global innovation networks.

5. Japan's weak entrepreneurship

It is quite astonishing that today the Japanese economy is suffering from weak entrepreneurship. After all, Japan's resurgence following World War 2 was led by entrepreneurs like Panasonic's Konosuke Matsushita, Sony's Akio Morita and Toyota's Kiichiro Toyoda. And in recent years, entrepreneurs like Softbank's Masayoshi Son, Uniqlo's Tadashi Yanai, and Rakuten's Hiroshi Mikitani have been a driving force in the 21st century Japan's economy.

But all studies point to a problem of weak entrepreneurship in Japan which is another factor hindering innovation. "Low rates of firm creation and exit reflect a lack of economic dynamism in the business sector", laments the OECD. One consequence is that Japan's SMEs are on average relatively old. This is disappointing because, for the advanced OECD countries as a whole, firms less than 5 years old created half of all new jobs during the 2001-2011 period, even though their share of the economy was very much less.

According to the Global Entrepreurship Monitor (GEM), Japan's entrepreneurial activity has been very low since GEM started collecting data in 1999, and in 2014 was the second lowest of the more than 100 countries surveyed (coming just before Surinam)! Its entrepreneurial activity is much less than neighboring countries like China and Taiwan. Japan’s entrepreneurial attitude rates are also very low.

The average Japanese entrepreneur is not a young dynamic graduate from a business school. On the other hand, it is a male, over 45 years of age, with a bachelor degree. And he typically starts up his business in the industry where he worked.

What is the problem? How did Japan lose its entrepreneurial zest?

It seems clear that once Japan had reestablished itself, around the 1970s and 1980s, life became comfortable. The typical aspiration for Japanese youth became a position in a large Japanese enterprise or government ministry, rather than the excitement of launching a startup.

Such jobs provide both prestige and job security. In deeply conservative Japan, there is a great stigma attached to the risk of failure which is often associated with entrepreneurship. And the quest for security was probably enhanced by the pessimism emanating from the stagnating economy since the 1990s. Families and schools are reportedly a big part of the problem, as they inculcate attitudes of conformity and risk aversion.

Another factor is the close partnership between government and business dating from Japan's high growth period, which means that that both government policy and banks' lending tend to favour existing firms to the detriment of startups. The Japanese government and banks still prop up ailing companies, with Sharp being a notable case at the present moment. In this context, it is very difficult for startups to obtain finance, especially since the venture capital market is not very well developed.

Further, in the cosy "old boys’ context" of Japanese business and government, startups like Softbank and Rakuten are often perceived to be outsiders. And in Japan's male-dominated business world, women entrepreneurs are a rarity. Gender equality in Japan is as bad, and sometimes worse, than many Islamic countries.

The OECD has made a number of useful recommendations to foster entrepreneurship like improving entrepreneurship education, reducing the stigma attached to failure to promote second chances, enhancing the role of venture capitalists, and promoting a more active M&A market to allow investors to realise their gains.

But there is much more that could be done. Japan’s appalling bureaucracy is in desperate need of reform. For example, according to the World Bank, Japan ranks a shameful 81st in the world for ease of starting a business, and 68th for dealing with construction permits.

Japan's very closed migration policies could also be opened up for migrant entrepreneurs, especially women entrepreneurs from countries like the Philippines. More serious efforts could be made to open Japan to foreign investment. And Japan's higher education sector would benefit from inviting foreign business schools to establish operations.

Despite this rather gloomy analysis, there are positive stories in Japan's entrepreneurship scene. Entrepreneurs like Masayoshi Son of Softbank, Tadashi Yanai of Uniqlo and Hiroshi Mikitani of Rakuten show that success is possible. Incubators and accelerators such as Samurai Startup Island, and Open Network Lab are also providing ecosystems for budding entrepreneurs. There are success stories like Yoshikazu Tanaka, founder and CEO of Gree, a mobile social gaming business, who is a self-made billionaire and has been called “Japan’s Zuckerberg”, after the founder of Facebook.

There are also reports of foreign investors financing Japanese start-ups. And under the Abenomics program, the government has announced the medium-term target of doubling entrepreneurial activity.

6. Japan’s weak corporate governance

Good corporate governance is essential for promoting efficiency, productivity, and innovation. Corporate boards should, on behalf of shareholders, hold management’s feet to the fire, as should banks that provide corporate finance. But Japan’s corporate governance lags behind global standards.

in Japan’s case, close relationships between the main banks and large corporations have provided long-term stability, rather than efficiency, as have cross shareholdings within corporate groups. Company board members have been typically insiders, coming from a main bank, the corporate group and the corporation itself. This means that management have been weakly supervised, and companies have been substantially protected from mergers and acquisitions, especially from overseas.

In the words of Hugh Patrick, director of the Centre on Japanese Economy and Business at Columbia University, it "was a system of cosy backscratching, some might say collusion, among the management of Japan's large industrial companies, financial institutions and the government bureaucracies".

This system seemed to serve Japan well during its high-growth period leading up to the financial crisis that hit the country in the early 1990s. In reality, however, poor corporate governance probably contributed to some of the bad lending that led to the crisis, and to the sluggish response that followed – as well as to the chronically weak profitability of the country's corporates over the past two decades.

Reform of Japan’s corporate governance – particularly in disclosure, transparency and accountability – has been on the agenda for more than two decades. And the need for reform has only been highlighted by incidents such as the 2011 accounting scandal at Olympus, when it emerged that the company had concealed considerable investment losses. But, as Mr Patrick points out, reform has been mainly “legal and institutional reform, rather than a fundamental change in the management mindset”.

To the surprise of many observers, Japan's prime minister Shinzo Abe has now placed reform of the country’s corporate governance (along with 'womenomics') at the centre of the government’s revised growth strategy (known as 'Abenomics') with the objective, Mr Abe says, of “restoring Japan’s earning power”.

The government has expressed concern that Japanese companies have lower productivity than their Western counterparts (about 30% lower, on average, than those in the US), and that they are struggling to quickly respond to market environment changes, which, in turn, is having an adverse effect on the Japanese economy. Better corporate governance would push the management at these companies to pay more attention to shareholders’ interests, and to withdraw from unprofitable activities and invest excess cash in new areas.

Under its Abenomics program, the government has been pushing for deep reforms to Japan’s system of corporate governance, including bringing in outside directors, a virtual war cry to the cosy boardrooms of corporate Japan.

Many experts are sceptical of the proposed corporate governance reforms. This is not surprising since, in the past, Japan has promised reform without delivering. Moreover, Japan’s peak industry lobby organisation, Keidanren, is resisting the reform agenda.

Japan’s efforts at reforming corporate governance are symbolic of its reform agenda more generally. Too little, too late, as the country slowly slips down the global economic pecking order.

7. From lifetime to precarious employment

During Japan’s high-growth period, from the 1940s until 1990, most employees enjoyed a high-level of job security, with lifetime employment being very common. At the same time, companies offered their employees very substantial in-house training. This was a very rational policy at the time. Firms used the lifetime employment system to hold onto their valuable well-trained workers.

For their part, workers enjoyed job security. The secure work environment was enhanced by a seniority-based pay system. Japanese companies were characterised by loyalty and devotion by workers, a strong spirit of cooperation, and a family-like atmosphere.

The work context was characterised by regular rotation among various branches of the company every few years. This meant that Japanese company workers (“salarymen”) tended to be “company men”, rather than specialist technicians.

Every year, big Japanese companies still hire new graduates to follow a professional career track of this nature. But the number of such recruits has declined substantially. Increasing numbers of workers are now hired on “irregular contracts”, meaning short-term contracts, part-time work, or agency work.

In 2014, some 37% of Japanese workers were on irregular contracts, up from 16% in 1985. This offers greater flexibility to companies, as irregular workers can be hired and fired with great ease. Such flexibility is argued to be necessary in the context of globalisation and fierce international competition.

But increasing irregular work also has many downsides. First, it is contributing to the growing gap between rich and poor, and rising poverty, as irregular workers earn low wages. It may also be a factor contributing to Japan’s low rates of marriage and childbirth. Irregular workers have less access to social welfare benefits.

Further, irregular workers have much less access to inhouse training. And once you are on the irregular employment track, it is very difficult to obtain a secure job. Many women when they return to the workforce after raising a family find themselves in irregular work.

Some argue that the proliferation of irregular work is a short-sighted policy. Irregular workers have become part of Japan's productivity and innovation problem, as they are less well-trained, less inclined to take initiatives and risks, and generally fearful of being fired.

8. Inside the Japanese corporate family

Some of the main actors in the Japanese corporate family are:

(i) the “salaryman”, which is "Jap-lish" for white-collar worker.

(ii) the “office lady” or “OL”, a female office worker who performs pink collar tasks such as serving tea and secretarial or clerical work.

(iii) the “senpai” is a senior who will train or mentor the “kōhai”.

(iv) the “shachou” is the president.

Some of the main customs are:

(i) drinking after work with colleagues. This is considered critical for team-building. Since Japanese can be very indirect in their communication, “nomunication” (a combination of “nomu” to drink and “communication”) after work is very important. A kohai must always ensure that his senpai’s glass is full.

(ii) very long working hours. Japanese workers spend very long hours at work, but all too often this is an act of devotion and loyalty, rather than working hard. Japanese productivity is still very much lower than in advanced Western countries.

(iii) arranging marriages. If you are having trouble finding a marriage partner, then your senpai or other senior colleague will always help you find someone, such as an OL.

(iv) retirement. When the Japanese salaryman retires after devoting his whole life to work, he finds his family which has not seen very often for the past 30-40 years. Unfortunately, his wife who has been living comfortably, going out with her girlfriends, might then refer to him as "industrial waste".

These customs are however gradually fading as irregular employment becomes more prevalent, and Japanese society westernises.

9. Some concluding comments

Japan’s business world has been a key driver of the country’s exceptional postwar economic renaissance. But Japan is no longer a catchup economy. It needs to be driven by more innovation and entrepreneurship, as well as competing with a broad array of players. In this context, Japan has much work to do to lift its business practices and performance to global standards, in order for Japan to remain a very prosperous country.
Tags: japan, business, smes, toyota, entrepreneurship, innovation, corporate governance

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