Old corporate champions can’t save Japan

Author: Richard Katz, Carnegie Council for Ethics in International Affairs

Different technological regimes give rise to and require different business institutions. When circumstances change, so must the institutions. Otherwise yesterday’s strengths become today’s weaknesses, and economic growth slows. This is unfortunately Japan’s plight, with its analogue era champions failing to adapt to today’s digital world. No longer does Sony churn out one must-have product after another.

Japan ranked a dismal 25th in overall digital competitiveness in 2020 according to the IMD World Competitiveness Center. Companies in Japan spend plenty on information and communications technology (ICT), but get less bang for the yen. Japan ranks 56th in ‘business agility’, which measures how well a country uses ICT.

Most Japanese companies use ICT primarily to cut costs by automating tasks they are already doing, like inventory control. But what makes ICT revolutionary is that companies can do things that were previously impossible. They can not only reach more customers and suppliers via e-commerce, but also use big data and the internet to develop new products and improve old ones. UPS parcel delivery trucks have internal sensors to monitor conditions that typically precede a part breaking down, avoiding expensive failures of trucks filled with parcels.

Using ICT should enable the rest of the economy — distribution, services and non-ICT manufacturing — to increase productivity and get, for instance, a 2 per cent increase in output from a 1 per cent hike in inputs. Unfortunately, Japan’s non-ICT sectors have not enjoyed this productivity boost. During Japan’s ‘economic miracle’ following the Second World War, in the analogue era, technological innovation was led by giant, capital-intensive and vertically integrated companies. They relied solely upon themselves and long-time allies in corporate conglomerates — known as keiretsu — to create distinct products. Companies moulded themselves to conform to this technological regime.

But we now live in a digital world, where the vanguards of innovation are often newer, entrepreneurial and knowledge-intensive companies. It is a world where giants regularly partner with others, including newcomers, in a process called ‘open innovation’. Pfizer’s COVID-19 vaccine was developed by a small German biotechnology firm founded in 2008 called BioNTech. Amazon’s Alexa and Google’s Android and Chrome are all products developed through open innovation.

In Japan, 70 per cent of corporate giants still believe that they must do everything in-house. However, with 10 per cent of a car’s manufacturing cost involving software — and with that amount steadily increasing with time — automakers can no longer go it alone. Having repeatedly failed to develop a collision-avoidance system on its own, Honda finally bought technology from Bosch, only to face outrage from the company’s research and development veterans who insist that using homegrown parts was central to ‘Honda’s soul’.

Analogue era champions were so successful that they have an ingrained a mindset which companies find hard to change — even when they try hard. These firms do not hire or promote recruits who are eager to revamp business models. Around 82 per cent of senior managers in Japan’s leading corporations have never worked in another firm. In Germany, that share is 28 per cent and in the United States, just 19 per cent.

The difficulty of teaching an old dog new tricks is hardly unique to Japan, but what differentiates it is the difficulty new firms face in supplanting past corporate leaders. Not a single new manufacturer has entered the top ranks of electronics since 1946, when Sony and Casio were born. By contrast, 8 of the top 21 electronics hardware manufacturers in the United States did not exist in 1970. Among rich countries, Japan has the second-lowest rate of new firms entering and old firms exiting.

In the digital era, bigger is not necessarily better. Back in 1981, 71 per cent of all business research and development in the United States was carried out by firms with at least 25,000 employees and just 4 per cent by those with fewer than 1000. By 2014, the share of giant firms halved to just 36 per cent, while the share of those with less than 1000 increased to 20 per cent.

Japan resists this trend. In 2015, only 7 per cent of its research and development was conducted by firms with fewer than 500 employees, compared to 17 per cent in the United States and 33 per cent in France and the United Kingdom. One reason is that Tokyo directs almost 90 per cent of the government’s financial aid for research and development to large incumbents — the highest ratio in the OECD.

Prime Minister Yoshihide Suga has announced a program to increase digitisation, including the creation of a new digitisation agency. It is a good first step, but one unfortunately limited to intra-governmental functions and citizens’ dealings with the government. If it is to be helpful to Japan’s economy, it needs to be extended to business.

If Japan wants to revive, it has to recognise that, to paraphrase the famous American car commercial, ‘This is not your father’s economy’. Its analogue era champions are holding Japan’s economy back.

Richard Katz is a Senior Fellow at the Carnegie Council for Ethics in International Affairs.

This article is drawn from his forthcoming book on reviving entrepreneurship in Japan, Gazelles or Elephants: The Contest for Japan’s Economic Future.

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