Business in Japan: No Country is an Island

No country is an island

Nov 29th 2007
From The Economist print edition

Japan is reluctantly embracing globalisation

THROUGHOUT its history Japan has oscillated between openness to foreign ideas and fierce isolationism. This ambivalence is still reflected in its attitude to globalisation. Despite the worldwide presence of companies such as Toyota, Honda, Canon and Sony, Japan's integration into the world economy is surprisingly weak.

Japan has the lowest levels of import penetration, inward foreign direct investment (FDI) and foreign workers in the OECD (see chart 8). Foreign affiliates' share of turnover in manufacturing and services, at 3% and 1% respectively, is the lowest in the OECD. Nor has Japan participated in the global wave of cross-border mergers and acquisitions (M&A). In 2004 the sale of companies in the European Union to foreign firms accounted for 47% of global M&A by value, and that of American firms for a further 22%. The Japanese share, by contrast, was just 2.3%. In an era of unprecedented mobility of people, as well as goods and services, Japan's net migration since the second world war has been approximately zero. And so on.

Why is Japan such an outlier? Part of the reason is regulatory hangover from the post-war period. Rules restricting inward flows of goods and investment, put in place to protect growing domestic industries after the second world war, have hindered economic integration. So too have complicated regulations governing particular markets, which deterred foreign firms from entering the Japanese market. (In one infamous example, Japan restricted imports of foreign skis, arguing that Japanese snow was different.) The use of cross-holdings made it very difficult for foreigners to take over Japanese firms.

For their part, many Japanese firms have been too preoccupied in the past 15 years to expand abroad, says Heang Chhor, the head of the Tokyo office of McKinsey, a consultancy: “They have been so busy with the domestic crisis that they have forgotten to remain connected with the rest of the world.” Having been enthusiastic about overseas expansion in the 1980s, many Japanese companies retrenched at home during the dark days of the 1990s. Now that the domestic market has matured and the population has started to shrink, Japanese firms must look abroad for growth opportunities.

That is the main reason for Japan to globalise more vigorously, but not the only one. As well as seeking new markets, Japanese firms will be able to benefit from foreign ideas, which could help to boost innovation. “There should have been a Japanese Silicon Valley,” says Mr Chhor. But during the 1990s, he explains, Japan's connection to the outside world actually weakened, “so the engine for innovation became much less powerful.”

Globalisation should also speed internal reform as more efficient foreign firms, particularly in services, shake up the domestic market. The government has duly set about dismantling regulations that hindered tighter integration with the rest of the world, and in 2006 the Council on Economic and Fiscal Policy even produced a “globalisation strategy” for Japan to enhance the country's international competitiveness by making better use of goods, services and expertise from abroad.

Better late than never—but it will not be easy. For while corporate Japan spent the past few years restructuring, a global M&A binge created multinational giants in many industries, often leaving Japanese firms looking puny by comparison. Japanese firms also face a shortage of managers with international experience and the mindset and skills needed to operate globally. In addition to competitors in America and Europe, they now also have to contend with new rivals from China, India and South Korea in many markets. But “Japan cannot continue to live as an isolated island,” says Keizai Doyukai's Mr Hasegawa. “Japan must strengthen its relationship with other countries.”

Some Japanese firms, of course, embraced globalisation years ago and have prospered as a result—notably Toyota, which is now nearly the world's biggest carmaker. For the past two decades, says Fujio Cho, the company's chairman, “we have been changing our business and management style to respond to the race of globalisation.” Today the company has factories in 27 countries around the world. Other Japanese multinationals include Sony, which makes 74% of its sales outside Japan, and Nintendo and Canon, Japan's second- and third-largest companies by market capitalisation after Toyota.

How to go global
But what of the Japanese companies that have come late to the globalisation party? They have several options, says Mr Marra of A.T. Kearney. The boldest is to try to achieve global scale through domestic and foreign acquisitions. This was the route taken by Nippon Sheet Glass, Toshiba and Japan Tobacco—as well as by Takeda, Japan's largest pharmaceuticals company, of which Mr Hasegawa is president. After spinning off non-core businesses in chemicals, agriculture and food, Takeda went on an acquisition spree, buying domestic and foreign pharmaceutical and biotech firms. A decade ago 50% of Takeda's revenue came from Japan; now the figure is below one-third, and falling.

Mr Hasegawa notes that Europe accounts for 30% of the world market for pharmaceuticals but only 14% of Takeda's sales, so future acquisitions in Europe are on the cards. And further consolidation is looming in Japan, he says, where there are still dozens of drugs companies that will be vulnerable once protectionist measures are unwound. Rather than grumble about this, says Mr Hasegawa, it is best to accept what is coming and plan accordingly.

Other options for Japanese firms, notes Mr Marra, are to move into high-value specialist products, as many Japanese steel and chemicals firms have done; adopt a regional strategy, focusing on Asian markets; or form a global alliance with a foreign firm, as Renault-Nissan has done in cars and Sony Ericsson in mobile phones. Alliances have the advantage of allowing Japanese firms to avoid the indignity (in their eyes) of a takeover. They also provide them with quick access to foreign markets and management expertise, says McKinsey's Mr Chhor: “Allying with international players will be the name of the game for the next five years.”

Even as they globalise, Japanese firms continue to do some things in distinctly Japanese ways, points out Steven Vogel of the University of California, Berkeley. Toyota, for example, has to some extent replicated its domestic supplier networks in other countries. “It doesn't act exactly like it does at home, but it doesn't act like an American company either,” he says. Japanese electronics firms have also taken a cautious approach to outsourcing. Sony, for example, outsources the manufacturing of standardised items such as mobile phones and PCs to India, China and Taiwan, but for digital cameras and video camcorders, where it has specialist manufacturing technology, it prefers to keep production in Japan, says Katsumi Ihara, head of the firm's electronics division.

Japan's relative lack of enthusiasm for outsourcing to China is due partly to the deep-rooted enmity between China and Japan, but also to Japanese firms' desire to protect their intellectual property and to a belief that manufacturing remains a core Japanese competency. The two countries have strikingly complementary economies and look like natural partners: Japan makes high-tech, high-margin goods whereas China tends to concentrate on high-volume, low-tech products. But China represents both an opportunity and a threat: it is a big market on Japan's doorstep, but it seems set in due course to displace Japan as Asia's biggest economic and political power.

China recently surpassed America as Japan's main trading partner, but new investment by Japanese firms in China actually fell by 30% in 2006, to $4.5 billion. In a survey asking Japanese firms to rate the best countries to invest in over the next three years, the proportion picking China fell from 91% in 2004 to 77% in 2006. That is still an impressive number, but the decline reflects both the expense of making things in China (compared with India and Vietnam) and growing concern over anti-Japanese sentiment.

Come in, gaijin
Globalisation is a two-way street, and Japan has as much to gain from letting in foreign firms as it does from sending its own firms out into the world. So in 2003 JETRO, a government agency that used to be in charge solely of promoting exports, was given a new mission: to encourage more FDI in Japan. This is not because Japan is short of capital; it has an excess of the stuff. It is because the government recognises that inviting in foreign firms is an indirect means of promoting reform, by exposing sleepy Japanese firms, particularly in the service sector, to a dose of competition.

“It is important to have new players in the Japanese economy with new ideas and new business models,” says JETRO's Nobuyuki Nagashima. In 2003 the then prime minister, Mr Koizumi, set a target of doubling FDI between 2001 and 2006, which was only just missed. Now JETRO has a new target: for FDI to reach 5% of GDP by 2010, more than twice the 2005 figure. But even if that target is reached, Japan's figure will still be far lower than other rich countries' (around 15% in America and 30-40% in Britain, France and Germany).

There is clear evidence that foreign investment has a galvanising effect. In 2002 labour productivity in foreign affiliates in Japan was 60% higher than the national average in manufacturing and 80% higher in services. Foreign companies operating in Japan also outperform domestic firms in profitability, capital investment and R&D spending. This is partly because they are not bound by existing business relationships, but also because only the most globally competitive and efficient firms enter the Japanese market. “We are benefiting a lot from the stimulus that foreign capital is bringing,” says Kuniko Inoguchi, a member of parliament and a former minister in the Koizumi government.

Deregulation has encouraged foreign firms to enter fields such as telecoms, retailing and financial services. The arrival of Starbucks forced outmoded and overpriced kissaten coffeeshops to do better. Foreign insurers offered new products that had previously been unavailable in Japan, prompting local rivals to follow suit. When an old rule banning roadside advertising hoardings was abolished, JCDecaux of France introduced bus-stop advertising. It now operates in 13 Japanese cities. And the simplification of complicated rules relating to large shops prompted IKEA, a Swedish furniture retailer, to open superstores in Japan, offering a wider range and lower prices than local firms, along with an unusual shopping experience. All this shows that Japan is not closed to foreigners, says Mr Nagashima, “but when things are very different, it just looks closed.”

Foreign firms going into Japan need to understand the local market but must also offer something distinctive, says Gerhard Fasol of Eurotechnology, a consultancy based in Tokyo that advises foreign companies about doing business in Japan. Starbucks, he notes, carefully crafted a strategy for the Japanese market; but Vodafone, a big European mobile operator, provides a cautionary tale. When it took control of Japan's third-largest mobile operator in 2001, it made the mistake of trying to introduce European-style handsets into Japan, causing customers to defect in droves. (Vodafone sold its Japanese arm to SoftBank in 2006.) “When you want to sell to Japanese consumers you have to give them what they want, not what you think they should buy,” says Mr Fasol. Another foreign giant that has failed to gain traction in Japan is Wal-Mart, which in 2002 bought a controlling stake in Seiyu, a Japanese retailer, and has yet to turn it around.

The introduction of the new triangular-merger law, which enables foreign firms to use their own shares to buy Japanese firms via local affiliates, should encourage more foreigners to enter the Japanese market. The first example—Citigroup's takeover of Nikko Cordial—will set a precedent for Citigroup's customers, says Mr Fasol. More deregulation is still needed, says Mr Nagashima, “but we are changing.”

Illustration by JacUnder new management
That foreigners might have useful expertise was strikingly demonstrated by Carlos Ghosn's turnaround at Nissan; another instructive case was the rescue by Ripplewood, a private-equity firm, of Long-Term Credit Bank of Japan in 2000. The bank was relaunched as Shinsei (which literally means “newborn”) with new management, including many foreigners who had previously worked for financial institutions in Japan. Shinsei went public in 2004, netting Ripplewood and its partners over ¥100 billion in profit. Goldman Sachs recently fixed and resold Universal Studios Japan, an ailing theme park, and is part of a consortium trying to sort out Sanyo, an electronics conglomerate.

In theory, Japan ought to offer rich pickings for foreign private-equity firms. There are lots of troubled companies that would benefit from an injection of management expertise, and Japan itself has few turnaround specialists. But suspicion of private-equity firms is even greater than elsewhere, so investors must tread carefully. “It's a market with a lot of potential, but requires an enormous amount of patience and determination,” says Thierry Porté, who became boss of Shinsei Bank in 2005. But, he points out, foreigners have often been catalysts of change in Japanese history: “They can be used in Japan to bring in new ideas, which are then adopted and get adapted to the Japanese system.”