Japanese Keiretsu System

And  

Its Impact On The US

Date          05/  02/ 1995
To             J. Henley
From         C. Tolunay
Subject       Research Paper

 "Keiretsu" is a Japanese term and translated as "Group". It also interpreted as "partnership" or "alliance".

    After World War 2, Japanese had no choice but to borrow money, because they had no significant capital to invest. Other financial markets were immature and the government encouraged the banks to set interest rates a very low level so that business could borrow money relatively easily. This method made all the banks very important and companies became depended on the banks.

     In this system, the huge multi-company groups in Japan are anchored by cross-shareholding. In contrast to their US. counterparts, Japanese companies are more inclined to choose to subcontract with other companies than merge with them. This arrangement works certainly for  long-term management, and it has enjoyed outstanding success for the last two decades.

    Cross-shareholding developed widely in Japan as a method of absorbing the stock that had been liquidated from the resolution of the prewar Zaibatsu groups just after World War 2 and otherwise could not have been digested in the market. At the center of each keiretsu there is a bank or cash-rich company that provides low-cost capital. Cross-shareholding by the keiretsu groups developed under the strong leadership of the main bank for each keiretsu group. As a result, more than 40 percent of the stocks in the Japanese market are shared by banks, nearly 30 percent by other companies and only a little more than 20 percent by individuals.

    This system helped protect Japanese companies from takeovers by foreign investors or companies. It can still serve that purpose and did in 1984, when members of the Mitsubishi Group protected the Mitsubishi-Oil Company from being acquired by Texaco. Together the Sumitomo, Sanwa, Mitsui, Mitsubishi, Fuyo and Dai Ichi Kangyo groups account for roughly one-fourth of Japan's total business assets and revenues.

    This is a pyramid of companies that serve a single master. Every large manufacturer, whether it belongs to a horizontal group or not, dictates virtually everything including prices it will pay to hundreds of suppliers that are often prohibited from doing business outside the keiretsu.

    The heart of the keiretsu relationship has been the affinity of Japan's business culture, both corporate managers and employees, for long-term cooperative relationships. Traditionally Japanese managers have opted long-term contracts with a limited number of  partners. Employees have favored a system of life time employment.   

    Throughout the post-World War 2, the managers of Japan's largest companies have kept their companies slim, preferring to contract large amounts of labor-intensive work out to smaller firms rather than to absorb new contracts through mergers. One reason large Japanese companies began contracting work out was the substantial wage difference between large and small companies. In 1960 salaries in small firms were only about 60 percent of these in large firms.

    In this situation, it is a  better competitive strategy for a large company to contract large portions of its products to a smaller company. This way it can reduce production costs more effectively if the quality of goods or services are the same.

    Under the strict lifetime employment and seniority systems, labor mobility in Japan is very low, estimated to be one-fourth of that in the US. Therefore, it is quite natural for Japanese company managers to be cautious about how many employees they hire every year, because they need to look after their employees until they become nearly 55 years old.

    Large companies tend to establish business networks to send of their employees to smaller companies. This practice not only strengthens their influence, but also absorbs any large employment surplus during economic recessions.

    Other characters of the keiretsu relationship are cross-shareholding among partner companies and their banks to the Kanban system of just-in-time delivery, with the manufacturer depending on its supplier to furnish inventory as needed. It also knits keiretsu member companies together in long-term cooperative relationships.

    The main bank influence over keiretsu members result in higher output and lower prices. The bank does to encourage relevant companies to produce more, in order to stimulate these companies' borrowing demands. This means that industries where keiretsu shares are high are likely to be industries that seek to expand their market shares rather than to maximize their profits. However the influence of main banks differs among industries, and main banks do not always participate in the initial process of the investment-expanding decision made by large corporations.

    This system seems to be very efficient when the industry expects expansion. However if the industry is at a saturated stage and the amounts of each supplied part for a particular good are estimated to decrease, it is very difficult for subcontractor companies to stick to a single long-term transaction.

    Lately the rational of the keiretsu system has begun to weaken. During 1987-1990, the period of Japan's "bubble economy", most of the Japanese companies engaged in aggressive equity financing and built strong cross-shareholding relationships with banks.

    The situation for both Japanese banks and corporations in the early 1990's were severe. Large banks and insurance companies suffered as the hidden asset value on which they had relied heavily for expanding their business fell sharply. Most major companies' operational profits fell dramatically during the severe economic recession that began in 1991.

    Because of the recession, in Japan for many of the small companies, business is down 40 percent from prerecession peaks. Small companies bear the burden of the recession as big companies press suppliers for bone-crunching price cuts and those suppliers in turn press subsuppliers. It is also pressuring the economy as a whole, forcing up unemployment, slicing into consumer demand and increasing bankruptcies.

    In addition, with the Japanese economy in recession and industry no longer expanding, subcontracting companies have been unable to depend on the traditional single long-term relationship. In 1986, when a sudden appreciation of yen slowed the Japanese economy, even Toyota advised its subcontractors to build up business with other contractors.

     According to the common belief in Japan, this recession is different than others. The oil and yen shocks of the 1970's and 1980's had effected and hurt Japan but this time the danger is more severe. Japanese big companies believe that they can compete with Southeast Asian companies in any area of  quality and service. However in some areas, Japanese subcontractors can no longer compete on cost.

    The recession is revolutionizing the way Japanese companies operate. It even effects the auto industry in Japan. While many Japanese companies rarely use foreign suppliers in Japan, auto makers are redrawing traditional supply patterns to slash costs. When Nissan sought a supplier of automatic transmission , it went outside its keiretsu and hired Toyota affiliate Tokai Rita. Nissan posted a loss of $260 million in 1993's first half, compared with a $128 million loss in the first half of the previous year, and there is no sign of demand picking up. " This is the time to reconsider the way we purchase parts" says Masoru Ohta, a Nissan purchasing manager.

    Suppliers, meanwhile, no longer wait for the orders to come in. They are trying to seek out orders from companies besides their long-term buyer big companies. They believe, it will be very difficult if they stick to one main company.

    There has been current criticism of just-in-time delivery system between firms, which was developed during the 1960's in the automobile industry. The media commented that, although the system was very convenient for receivers of goods,  the frequent transportation needed for quick delivery produced heavy traffic congestion and created tremendously hard work for the deliverers.

    The perspective of employees is also changing, well-educated workers, especially women are beginning to have second thoughts about the life time employment system. They view it less as a source of social status and more as an impediment to their self-development as professionals who might want a variety of business experience.

    The main reason for changes in the employment system is that the "baby boom generation",  because of the miraculous growth of the economy during the bubble economy time. Now this generation has begun to delay the promotion of younger generations.

    Another change is the wage differences between large and small companies. Salaries in small firms are now nearly 80 recent of those in large firms and have erased much of the cost advantages of keiretsu relationships for managers of larger firms.

    Beginning in the early 1970's Japanese managers began to derive more of their funds directly from the bond and equity market. Yamaha, a large musical instrument, motor-cycle, and sports equipment company issued new stock at the  market price for the first time in Japan in 1969. Over time the debt-equity ratio of domestic companies gradually fell, from an average of more than 70 percent in the 1950's to under 50 percent in the 1980's. Their dependency on the banks has declined even further.

    There have been some changes in the nature of cross-shareholding recently;

  1  The amount of keiretsu groups' cross-shareholding has been decreasing gradually. Research of Japanese Fair Trade Committee concerning the six motor keiretsu groups observed that the relationship of mutual shareholding and of direct-exchanges among each group has decreased recently.

  2  Each member company of these keiretsu groups has begun to transact with some companies other than group members.

  3  Cross-shareholding for the purpose of financing has increased since the 1980's. Cross-shareholding partners did not necessarily belong to the some keiretsu group. These companies used this method only for the purpose of  mutually increasing their potential stock assets. In 1992, Nikke newspaper reported that five Japanese companies, all of which were totally unknown each other, made cross-shareholding arrangements.

    Although hard times threatened the keiretsu to break up, it is not the end of the keiretsu. Because of these crisises many of them are drawing together. It is like how they pulled out of the oil and dollar crises. For them mutual dependence is the key to survive.

    Itoman is a food and textile trader with annual sales of $4.8 billion. The company is a member of the Sumitomo keiretsu. Because of some operational mistakes and risky loans company was in debt by 1990. Sumitomo Bank Ltd. sent in a dozen of managers to get a grip on things, but the problem kept compounding. Bank's president Sotoo Tatsumi arranged a merger of Itoman with one of Sumitomo Metal's trading subsidiaries into a new company. The new establishment saved all 1,342 Itoman jobs and became Japan's 12th largest trader.

    The rescue method is not always financial. When Fuji Heavy Industries faced a big loss, its main bank, Industrial Bank of Sapan Ltd. asked fellow keiretsu member and 4.2 % Fuji Heavy shareholder Nissan to step in. Nissan assigned the president of Nissan Diesel Motor Co., Isamu Kwai to Fuji. Kawai, a manufacturing company who had quickly turned Nissan Diesel around, soon was applying the same prescription at Fuji Heavy by streamlining operations and improving 60,000 Nissan Pulsar model a year to sop up excess capacity. Nissan also started buying sophisticated electronic transmission from Fuji Heavy. Nissan made its US car financing system available to Fuji for a modest fee and started carrying all Subaru cars to Europe on its own fleet for a nifty savings. As a result analysts expects Fuji Heavy to return  back on consolidated basis.

    The problem with this safety net is that it only works for Japan's largest corporations. The small and mid-size companies, which almost entirely account for the rise in bankruptcies have no such resource. However members of the keiretsu can take big risks, knowing that they will be saved if they get  in trouble.

    Today the erupting cost and soaring complexity of new technology are haunting America's future. Even giants such as IBM worry about surviving. Small innovative companies are being forced to retreat into niches. Many investors believe that US industry has forgotten how to compete. It is time for US industry to try cooperation and risk-sharing.

    Many researches indicate that profit margins do not differ significantly between the US and Japan. The average profit margin for keiretsu member firms is significantly lower than for nonkeiretsu firms.

    The higher cost of goods sold percentage for Japanese companies appears consistent with a low pricing strategy to achieve high market share. The lower selling and  administrative expense percentage for Japan offsets its higher cost of goods sold percentage and, in effect equalizes its profit margin with US companies.

    Within Japan, keiretsu member firms achieve an average, the same cost of goods sold percentage as affiliated firms. The mean selling and administrative expense percentage for the keiretsu firms is higher than for nonkeiretsu firms, a result which is consistent with an earlier finding that average compensation of employees if keiretsu firms exceeds that of nonkeiretsu firms. Other possible explanation include higher coordination costs with other firms in the keiretsu and less concern with cost control because of the protection from bankruptcy afforded by keiretsu membership. The average profit margin of all US firms fall between those of keiretsu and nonkeiretsu firms and is not significantly different from either.

 

Profit margins            1986          1987               1988

US                             2.8%           3.6                   3.5

Japan                          2.8              3.2                   3.6

J: keiretsu                    2.7              3.0                   3.4

J: nonkeiretsu              2.9               3.3                   3.8

 

    Within the Japanese sample, it is obvious that membership in a keiretsu does not give member firms a measurable advantage in profitability. In fact, profit margins are significantly lower for keiretsu members.

    Now there is a new concept in the US called "American keiretsu-type"(AKT). This is used to describe a special type of relationship or alliance that emphasizes the critical nature of some upstream relationships. The expression describes an open relationship that meets the needs of both the buyer and seller.

    There are some examples in the market place about this new kind relationship between buyer and supplier. A few years ago, a car window maker Excel Industry Inc. gained Ford Motor Co.'s attention by its innovations. Ford proposed a deal to Excel. For $18 million Excel would buy Ford's window factory in Futon, Ky. Then, to keep some control, Ford would acquire 40% of Excel for $25 million. Ford also agree to buy 70% of its windows from Excel. As a result the smaller company's sales had hit $350 million and Ford had saved millions. Excel has invested $4 million in to better manufacturing systems. Today, it can equip new Ford models a year faster than before. This help has shortened Ford's new product cycle.

    For decades, American companies have been altering their game to play Japanese-style, streamlining their lumbering corporate hierarchies to focus on teamwork, quality and speed. The power of AKT techniques can reduce costs dramatically by assuring supply quality at better prices and reduced risk.

    However the horizontal relationships would create trust and are banned in the US; the vertical chains can be adopted by American entrepreneurship. On the other hand encouraged by the Bush Administration's leniency toward antitrust, even direct competitors are working together. The most astonishing deal may be the one between IBM and archrival Apple Computer Inc. to jointly develop personal computer and software.

    Although the pure keiretsu are against the American system the US can still learn from them. The horizontal groups provide security and stability to promote the risk-taking and long-term investment often shunned by US companies. By collaborating on research and production, keiretsu members regularly deliver new products ahead of their rivals. Toyota Motor Corp. one of 24 companies in the Mitsui Group, drives its new-car designs into showrooms in four years, vs. five to eight for Detroit and Europe.

    Tomorrow's technologies will be more expensive. Many experts believe that US companies can not commercialize them without banding together and sharing the risk. In short there is a pressing need for US manufacturers to develop something similar to keiretsu.

References

.   Mari, Kiyoshi (1994). Industrial sea change: How changes in keiretsu are opening the Japanese market. Brookings Review, Fall, 20-23.

.   Marcum, James W (1994). The American keiretsu: A strategic Weapon For Global Competitiveness. National Productivity Review. Spring, 310.

.   Holyoke, Larry; Spindle, William; Gross, Neil (1994). Doing the unthinkable. Business Week ,January 10, 52-53.

.   Anonymous (1994). Ah, so.... Management Today, January, 86.

.   Parker, Peter (1994). East or West. Management Today, October, 35.

. Kevin Kelly (1992). Learning From Japan. Business Week, January 27, 52-59.

.   Brown, Paul R; Soybel, Virginia E; Stickney, Clyde P (1994). Comparing US and Japanese corporate level operating performance using financial statement date. Strategic Management, January, 75-83.

.   Ross, Douglas N (1992). Keiretsu, American-style. Business Week, January, 110-112.

.   Yang, James (1992). For bankrupt companies happiness is a warm keiretsu. Business Week, October 26, 48-50.

.   Mari, Kiyoshi (1994). An appropriate corporate and financial strategy for successfully investing in the Japanese market. Business Economics,  July, 50-55.  

 

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