Business in Japan: Not Invented Here

Not invented here

Nov 29th 2007
From The Economist print edition

Entrepreneurs have had a hard time, but things are slowly improving

TAKASHI MASUDA wiggles his finger next to an apparently random collage of tinsel, cuddly toys and cutlery, illuminated by a spotlight. A small black chip, glued to a plastic ruler, is propped up nearby, with wires running to a circuit board festooned with blinking red lights. From this another cable runs to a large high-definition TV where every ridge of the skin on Mr Masuda's finger, every twinkly highlight on the tinsel and every hair on the cuddly toys can be clearly seen.

Mr Masuda's company, Acutelogic, makes specialist image-processing chips and software for digital cameras. Its newest product, which picked up every nuance of Mr Masuda's wiggling finger, is a tiny high-definition video sensor that can fit into a mobile phone. The idea is to make camcorders obsolete, says Mr Masuda.

He founded Acutelogic after leaving Sony, where he worked on the team that created the Cyber-shot digital camera. He felt that the electronics giant's management had lost its way and wanted to start his own company. So he set up Acutelogic, with venture-capital funding, some investment from Fujitsu, a computer giant, and money raised from friends and family.

All this sounds very similar to the way things are done in America's Silicon Valley, where large firms such as IBM, Oracle, Sun and Hewlett-Packard often act as unofficial “incubators” for engineers who spend a few years learning the ropes and then leave to set up on their own. But Mr Masuda's story differs in one crucial respect: he was 50 when he left Sony, and was able to make the leap because he was offered an early-retirement package. “It would have been better to do it at 40,” he says. But had he done so, he would have lost his company pension. His story illustrates not how easy it is to start a company in Japan, but how difficult.

Japan scores poorly on almost every measure of entrepreneurship. It has the second-lowest level in the OECD of venture-capital investment as a share of GDP, and what little venture capital is available goes disproportionately into existing firms rather than start-ups. Venture-capital investment in Japan amounts to some $2 billion a year, around a tenth of the figure in America. Start-ups account for 4% of all firms, compared with 10% in Europe and 14% in America. Japan also came last in the International Institute for Management Development's rankings on entrepreneurship and second-last in the Global Entrepreneurship Monitor's ranking of early-stage entrepreneurial activity (defined as the proportion of people of working age who are involved in such activity). Why?

Cultural factors are a big part of the explanation. As a hoary old Japanese saying has it, “the nail that sticks out is hammered down.” Conformity is valued over individualism. “Students work hard at school, but they learn how to take tests, not how to think,” laments Sakie Fukushima of Korn/Ferry. And unlike American culture, which venerates the maverick self-made millionaire and is tolerant of failure, Japan frowns upon public displays of wealth and stigmatises business failure.

On the outer edge
Take Takafumi Horie, an example of the sort of entrepreneur who remains extremely rare in Japan. With his characteristic jeans, sneakers and spiky hair, this self-styled rebel against Japan's corporate establishment transformed his internet start-up, aptly named Livin' On The Edge, into a vast conglomerate, which he renamed livedoor in 2004. At its peak, livedoor was worth some ¥930 billion ($8 billion) and owned an accounting-software firm, an internet travel agency, a securities house and a second-hand car business.

In 2005 Mr Horie mounted a takeover bid for Nippon Broadcasting System, a radio station, which would have given him control of Fuji Television, Japan's biggest commercial television station. The battle ended in a truce between Fuji and livedoor, but Mr Horie had infuriated the business establishment. In January 2006 raids on his home and office were broadcast live on television, and in March this year he was convicted of fraud and sentenced to two-and-a-half years in jail.

Mr Horie's critics regarded his use of elaborate financial engineering as evidence that pro-market reforms had gone too far; his supporters claimed that the attack on his empire had been orchestrated by Japan's corporate old guard. But his fate sent a clear signal to anyone who regarded Mr Horie as a new role model for Japanese entrepreneurs, says Hirotaka Takeuchi, dean of the school of corporate strategy at Hitotsubashi University. “He showed you can be an entrepreneur and be successful, but you shouldn't take it to excess. You've got to abide by the rules.”

In truth, Mr Horie was not the American-style capitalist people imagined him to be; indeed, the way he concealed the precarious financial state of his sprawling empire reeked of old-style Japanese book-cooking. But his behaviour served to reinforce the traditional Japanese scepticism towards showy entrepreneurs.

“If you stand out too much you become a target,” says Yoshito Hori, a venture capitalist and the founder of Globis Management School, a business school. That alone persuades many entrepreneurs to keep a low profile. But they face more than just cultural obstacles: the rigidity of the Japanese labour market makes life that much harder for them. Anyone who leaves a regular job for a start-up will find it difficult to get another job if the venture fails. And pensions are a particular problem: as Mr Masuda's example shows, people working for large companies are reluctant to leave their jobs in their 30s and 40s because they will lose their retirement benefits.

Other difficulties facing entrepreneurs include the lack of venture-capital funding, a dearth of knowledgeable angel investors, difficulty in hiring experienced managers and a lack of support networks, says Joichi Ito, an internet investor with experience both in Japan and in Silicon Valley. This forces some entrepreneurs to rely on foreign funding. “VCs and entrepreneurs are not as professional as they are in Silicon Valley,” says Sachio Semmoto, the entrepreneur behind a series of successful Japanese telecoms firms. Goldman Sachs, an American investment bank, put $25m into his most recent venture, whereas local Japanese venture funds contributed just a few hundred thousand dollars.

Given the innovative prowess of Japan's industrial giants, does it matter if start-ups have a hard time? The Economist Intelligence Unit, a sister company of this newspaper, ranked Japan first in a recent study of innovation, based on the number of patents awarded per million people. Japan generates 51% more patents than America in absolute terms, which works out at around 3.5 times as many patents per person. It also has more scientific researchers per million people (5,900 compared with 4,200 for America) and a higher research-and-development (R&D) intensity, at 3.4% of GDP compared with 2.8% for America.

But things may not be as rosy as these numbers suggest. Patents are an imperfect proxy for innovation; Japan's armies of researchers spend more time than their foreign counterparts on non-research activities such as administration, which reduces their effectiveness; and a report by the Cabinet Office found that the effectiveness of Japan's private-sector R&D—the ratio of operating profits to R&D expenditure—declined throughout the 1990s (see chart 7).

All this has fuelled concerns that Japan might now be on the wrong side of several trends. Japan's most famous innovations, such as the Sony Walkman and the Toyota Prius, originated in big companies. But the internet boom highlighted the vibrancy of the American way of innovating, in which a host of entrepreneurial start-ups try out risky new ideas and the most successful of them either become, or are acquired by, larger firms. The American approach supports radical technological breakthroughs but depends on plenty of risk capital.

Akira Takeishi of the Institute of Innovation Research at Hitotsubashi University has investigated why Japanese firms are highly competitive in some industries (carmaking, electronics, imaging products, video games) and less so in others (personal computers, software). He concluded that Japanese firms did best in manufacturing industries with closed product designs that do not require collaboration with the rest of the industry, and worst in fields based on open standards and modular architectures. So if the nature of innovation has changed, and it now depends on collaboration with other firms around the world, Japan could be in trouble. Japanese patents with foreign co-inventors accounted for less than 3% of the total, compared with 12% in America.

Another worry is that Japanese companies concentrate too much on incremental innovations rather than radical breakthroughs. This served them well in the second half of the 20th century. But given the disruptive impact of the internet and the need for entirely new energy technologies to mitigate climate change, it may no longer be the right thing to do.

The government has formulated a series of plans and targets, including measures to boost international co-operation and increased funding for researchers in fields such as nanotechnology and clean energy, where breakthroughs could open up big new markets. It has also set about improving the climate for entrepreneurs and start-ups, for example by offering more favourable tax treatment for venture-capital investments, reducing the minimum capital requirement for new businesses to ¥1 and making it easier for start-ups to issue share options to staff.

Land of opportunity?
One sign of progress is the higher turnover of new firms. Between 1997 and 2004 an average of 99 new companies a year were listed in Japan, up from 26 a year in 1981-89 and 36 a year in 1990-96. The number of delistings also rose, from four or five a year in the 1980s and early 1990s to an average of 41 a year in 1997-2004. This is due in part to the rise of second-tier stockmarkets such as Mothers in Tokyo and Hercules in Osaka, and the loosening of listing requirements on JASDAQ, which has made it easier for start-ups to go public. Mr Hori notes that there were 747 IPOs in Japan between 2001 and 2005, compared with 617 in America.

The slightly more flexible labour market has made it easier for start-ups to attract skilled workers. “Things are changing—people are coming out of big firms to join us,” says Mr Masuda, whose firm has hired engineers from JVC, Canon and other electronics giants. He says start-ups also offer more opportunities and better prospects to Chinese and South Korean engineering students in Japan: “We evaluate people for their skills, not their skins and eyes.”

Mr Hori goes so far as to suggest that start-ups have played an unacknowledged role in helping to turn around Japan's economy in recent years. He says the rebound was partly driven by the emergence of new companies in knowledge-based industries, led by entrepreneurs in their 20s and 30s. He points to Rakuten, an internet-shopping firm that now has a market capitalisation of nearly $6 billion, making it one of the largest internet-commerce firms in the world. Other Japanese success stories include DeNA, an internet-auction and shopping site, and Mixi, a social-networking site. Mr Ito is heartened by Japan's latest crop of internet entrepreneurs, such as Mixi's Kenji Kasahara. “The new generation of internet CEOs are very humble. They don't spend all their money in Ginza buying cars,” he says.

It seems that entrepreneurs can do well in Japan as long as they do not draw too much attention to themselves. Mr Hori thinks they have excellent prospects. There are still relatively few of them, and productivity in Japan's service sector is notoriously low, offering plenty of opportunities for start-ups. He says 70% of his venture-capital investments are in services companies, from nursing homes to wedding planning. Apart from services, says Mr Hori, “we are betting in areas where Japan has an edge,” such as mobile technology, optics, robotics, digital animation and video games.

Despite these hopeful signs, however, some worries remain. One concern is that if economic growth strengthens and more full-time jobs are created, would-be entrepreneurs may be tempted to take the safer option of a job instead. Japan's recent wave of entrepreneurship, suggests Randall Jones at the OECD, was caused in part by the lack of job opportunities for talented graduates during the hiring freeze of the 1990s. But Mr Hori insists that times have changed, and “the best and brightest are now going into the entrepreneurial field, which has never happened before.”

Another concern is that too much government effort to encourage start-ups and promote innovation is concentrated on manufacturing and technology rather than services, which is arguably where change is most needed. To keep the momentum going, the OECD recommends reductions in capital-gains tax to encourage venture capital; more portable pensions and performance-based pay for researchers to encourage mobility between academia and industry; a broader educational curriculum; and the promotion of cross-border trade and investment, since good ideas often come from abroad. Changing Japanese attitudes to entrepreneurship will take time and further reforms, but at least the wheels have started turning.