Well, when foreigners come to Japan they very often do not understand the historical connections behind Japanese companies. They might think, I want to do business with Sanyo Foods – What do I need to know about Mitsubishi!? Nothing! That’s a huge mistake. Why should I know that Nikon belongs to such and such a corporate group, it makes no difference – I am only doing business with Nikon. Well, that’s again a big mistake.
Let’s check out few things about the structure of Japanese market and see how it basically works.
What is Keiretsu?
A keiretsu "系列" is a set of companies with interlocking business relationships and shareholdings. It is a type of informal business group. The keiretsu maintained dominance over the Japanese economy for the second half of the 20th century.
The member's companies own small portions of the shares in each other's companies, centered on a core bank; this system helps insulate each company from stock market fluctuations and takeover attempts, thus enabling long-term planning in projects. It is a key element of the manufacturing industry in Japan.
The keiretsu system’s primary criticism is that the affiliation essentially results in a mega-company that excludes outside interference and restricts free market competition.
The keiretsu of Japan arose out of the prewar Zaibatsu but differed from the zaibatsu in essential ways. The zaibatsu were family-owned conglomerate businesses that were promoted by the Meiji Government of Japan. When the government ran out of funds to carry out major projects for the development of the country, the government commissioned private businesses, often one which had business dealings with the court, to carry out those projects. The businesses received in return monopolies and special privileges from the government.
The zaibatsu were strong supporters of the militaristic government that gained control of Japan. The Allied Occupation broke up the zaibatsu to punish their leadership but also the Occupation wanted to promote democracy and saw the zaibatsu as anti-democratic concentrations of power. However the Cold War dictated the necessity of Japan having a strong, vigorish economy. The zaibatsu companies were allowed to re-form and utilize their old names. For middle management in those companies the process was beneficial; they moved up in the management hierarchy.
Types of Keiretsu
Cartels and groupings of various kinds are common in Japan. There are two types of keiretsu; horizontal and vertical, that can be further categorized as:
The primary aspect of a horizontal keiretsu (also known as financial keiretsu) is that it is set up around a major Japanese bank through cross-shareholding relationships with other companies. The bank assists these companies with a range of financial services. The leading horizontal Japanese keiretsu, also referred to as the “Big Six”, include: Fuyo, Sanwa, Sumitomo, Mitsubishi, Mitsui, and Mizuho Financial Group. Horizontal keiretsu may also have vertical relationships, called branches.
Horizontal keiretsu peaked around 1988, when over half of the value in the Japanese Stock Market consisted of cross-shareholdings. Since then, banks have gradually reduced their cross-shareholdings. The Japanese corporate governance code, effective from June 2015, requires listed companies to disclose a rationale for their cross-shareholdings. Partly as a result of this requirement, the three Japanese "megabanks" descended from the six major keiretsu banks (namely Mitsubishi UFJ Financial Group, Sumitomo Mitsui Financial Group and Mizuho Financial Group) have indicated plans to further reduce their balance of cross-shareholding investments.
Vertical keiretsu (also known as industrial keiretsu) are used to link suppliers, manufacturers, and distributors of one industry. One or more sub-companies are created to benefit the parent company (for example, Toyota or Honda). Banks have less influence on distribution keiretsu. This vertical model is further divided into levels called tiers. The second tier constitutes major suppliers, followed by smaller manufacturers, who make up the third and fourth tiers. The lower the tier, the greater the risk of economic disruption; moreover, due to low position in the keiretsu hierarchy, profit margins are low.
Nature of the Keiretsu
At the center of the "big six" keiretsu are a bank and a trading company (Sogo Shosha). Japanese banks are allowed to have equity in other firms with a quota of less than 5% of the total number of shares issued by the company. Banks play a crucial role in the smooth functioning of this organization. They assess the investment projects and provide loans when required. The trading companies deal in imports and exports of an assorted range of commodities throughout the world. Unlike trading companies in other countries, which are generally specialized in certain types of products, Sogo Shosha have extremely diversified business lines, in which respect the business model is unique to Japan.
The structure of Sogo Shosha can give them advantages in international trade. First, they have extensive risk management capabilities in that they trade in many markets, keep balances in many foreign currencies and can generate captive supply and demand for their own operations. They also have large-scale in-house market information systems which give them economies of scale in pursuing new business opportunities. Their vast scale also allows them to provide capital in the form of credit, financing and export services at low cost.
Each major company has its own "President's Club", enabling interaction of core members to better help decide their strategies.
The Japanese keiretsu took various preventive measures to avoid takeovers from foreign companies. One of them was "interlocking" or "cross-holding" of shares. By doing so, each company held a stake in the other's company. This helped reduce the pressure on management to achieve short-term goals at the expense of long-term growth. Besides that, interlocking of shares serves as a tool for monitoring and disciplining the group's firms. The level of group orientation or strength between the member companies is determined by the "interlocking shares ratio" (the ratio of shares owned by other group firms to total shares issued) and the "intragroup loans ratio" (the ratio of loans received from financial institutions in the group to total loans received).
Industries such as banking, insurance, steel, trading, manufacturing, electric, gas and chemicals are all part of the horizontal keiretsu web. The member companies follow the "One-Set Policy" whereby the groups avoid direct competition between member firms.
Note that these Japanese companies generally do not have the kind of problems that foreign companies have. They don’t have to worry about their sales figures. For example, if Mitsubishi motors see their sales is low they go to the bank and tell them we are little short this year, and the bank tells everyone in the group buy some car from the car company and that’s it.
In the 1920s, government officials maintained close relations with the zaibatsu, and the roots of their influence still hold strong. The keiretsu have great influence on Japanese industrial and economic policy. The preferential buying habits of the keiretsu kept foreign investors and foreign goods out of their markets, which America criticized as "barriers to free trade". This enabled the keiretsu to enjoy monopoly privileges over the Japanese market, thus maintaining high prices for their goods, as they had full dominance over the price and distribution of products and services throughout the supply side.
And of course, in such a work environment, the probability of an employee to remain working in the same company for his entire working life was very high. Moreover, this framework allowed rapid co-operative development (sharing vital information, reduction in cost of R&D and higher quality products) of the keiretsu.
Another difficulty which makes working in Japanese market more complicated is the distribution system. The main distribution channels for imported brands in Japan are department stores, select stores chain-stores, specialty chain-stores, E-commerce, shopping centers and fashion buildings, outlets malls and local independent retailers.
Each distribution channel has its own structure to import brands. Japan distribution system still relies a lot on middlemen: agent, trading company, importer, global wholesaler and local wholesaler.
Agents are less and less present in the market as the wholesalers now act as the importer, distributor and sometimes retailers, are becoming the agent. Take a look at Suzuken Group Website as an example. This is called Oroshi Business “卸売業”, in Japan.
Shortening of Distribution Channels
Foreigners are trying to be comfortable and acculturate themselves to Japanese society and market. It is like going through an onion – you keep going through the layers and there are some layers that are just kind of impenetrable. But, they can still live and have a business. There are many small businesses in Japan that they do the export/import and also sell the imported products all by themselves.
Example: For a long time, the typical distribution channel for shoes was: Manufacturer ⇒ Wholesalers ⇒ Retailers. Since 1990, brands and/or makers started selling directly to retailers. This shortening has reduced costs and prices of merchandised products. Internet retailing has also been increasing, making it easier for manufactures/brands to sell products directly to consumers.
However, the retail prices are fixed in Japan for one item. So even though you are selling your brand directly to retailers, you must take into account the wholesale margin if you are also selling through wholesalers.
Since 2000, more retailers, including small independent stores, select stores and department stores started to import directly in order to increase their margin. But the exchange rate fluctuation between the Yen and the USD has impacted their cash flow and margin control; therefore, the middlemen are still predominant for imported brands.
Brands have 3 main options to sell in Japan: through Trading Companies, through Global Wholesalers or Direct to Chain-stores. The most common distribution channel for imported brands is to go through global wholesaler that will import and distribute the products through the retail network.
Consider P&G Japan, the branch of American multi-national consumer goods corporation - the execution of their Japanese market entry strategy was a rocky road. At one point, they seriously had to consider writing off their investment and retiring from the Japanese market. They chose to stay and compete with local competitors, even though it meant having to develop a precise understanding of Japanese consumer needs, their way of doing business, and especially their distribution infrastructure. Today, P&G continues to enhance this understanding, and constantly adapt strategy and execution, in a blend of world brands and centralized functions with local adaptation.
An example for local adaptation is P&G’s distribution strategy which has evolved over the years, to address changing consumer demands. P&G observed that the largest U.S. distributor, Walmart, moved over 30% of its business, while their largest Japanese wholesaler accounted for no more than 2.5%. Consequently, from initially over 2,500 wholesalers, each of which serving only a small number of retailers, P&G moved to a 100, and eventually to 5 “key partner” wholesalers. At times, this was a painful process that countered the Japanese philosophy of building lifetime relationships.
Modern Japanese Keiretsu
The basic structures of Keiretsu remain in place but there have been many changes in Japanese business. In the last 20 years business has changed, the landscape has changed and also some part of the original big 6 Keiretsu has changed; mostly the banks have merged. But now, if these big Keiretsus are centered on the bank and the banks now merge with a rival bank, what do you do!?
Today's keiretsu horizontal model still sees banks and trading companies at the top of the chart with significant control over each company's part of the keiretsu. Shareholders replaced the families controlling the cartel as Japanese law allowed for holding companies to become stockholding companies. Yet vertical integration is still a part of the larger horizontal structure of today's keiretsu. For example, each of Japan's six car companies belongs to one of the big six keiretsu, as do each one of Japan's major electronics companies.
It seems for the first time in recent Japanese history, Japanese keiretsus found their first crack, resulting in a forced loosening of traditional standards. Globalization and technology are other aspects that would force Japanese companies to open to competition by identifying new customers, increasing the efficiency of orders and researching new markets.
The major question that remains: Is this a permanent solution, or will the keiretsu evolve into another new entity – much as the Zaibatsu morphed into keiretsu a half-century ago.
If you succeed in Japan, you will succeed anywhere else in the world.