MIT

Massachusetts
Institute of Technology

Winter 1997

Volume 38
Number 2

Hiroyuki Tezuka
Success as the Source of Failure? Competition
and Cooperation in the Japanese Economy
Reprint 3826
 Success as the Source of Failure?
Competition and Cooperation in
the Japanese Economy
Hiroyuki Tezuka

Will the Japanese business system, based on favorable industrial policies, the
keiretsu, and lifetime employment, survive the current recession? While
simultaneous competition and cooperation among companies have fostered
growth and a system without “losers,” fundamental changes may require an
upsurge in risk-taking Japanese entrepreneurs.

T
he Clinton administration’s pressures on the
Japanese government in 1995 to increase U.S.
companies’ share in Japan’s automobile and
auto parts markets and Eastman Kodak’s accusation
that Fuji Film uses unfair competitive practices in the
Japanese market are the latest in a long series of asser-
tions that Japanese companies collude with each other
and with the government to suppress competition.
Those who make such assertions tend to focus on
three elements — industrial policy, the keiretsu (enter-
prise groups), and lifetime employment — that sup-
press competition in the Japanese business system.
U.S. negotiators’ view that Japan’s “closed” system fos-
ters collusion and restricts competition also leads them
to insist that their efforts to help U.S. firms in the
Japanese market are also in the interests of Japanese
consumers.
Given Americans’ insistence on the virtues of com-
petition, it is surprising that so many people see no
inconsistency in believing that Japan had nearly four
decades of economic growth with a fundamentally
collusive business system. A more compelling argu-
ment is that, in the 1970s and 1980s, Japan’s business
system was fueled by competition, not collusion, and
it was this competition that powered Japanese eco-
nomic growth.
Today, however, the sustainability of the key fea-
tures of Japan’s business system in the face of a five-
year recession and the strong yen is in doubt. The
prospects for change in the Japanese industrial system
as a consequence of these forces are much stronger
than any pressures that the U.S. government gener-
ates. In this article, I examine the nature of competi-
tion in Japan, the implications of its industrial policy,
the keiretsu, and the Japanese employment system and
assess the prospects for fundamental change in the
near future.
Competition and Industry Structure
Traditional economic theory espouses the view that
free competition is the source of sound economic de-
velopment. It maximizes total social welfare and
forces companies to be innovative and to price their
goods and services competitively. In this view, mo-
Hiroyuki Tezuka is a senior representative, NKK America Inc.,
Washington, D.C.

SLOAN MANAGEMENT REVIEW/WINTER 1997 TEZUKA 83

nopolies threaten the efficiency of markets, reduce in-
novation, and slow economic growth. On the other
hand, individual firms pursue strategies to reduce
competition — to find “niches” where they have a
monopoly or a commanding, dominant position and
to drive competitors to the wall. Weak firms either go
out of business (in the pure competition model) or
are acquired by strong firms trying to increase their
dominance. Therefore, most industrialized nations
are in the uneasy position of trying to balance free
competition and prevent monopolies.
Despite the pride many Americans exhibit in their
antitrust laws and a widespread belief that more coun-
tries should emulate these laws, many U.S. industries
are highly concentrated, and leading firms have long
been able to establish dominant or monopolistic posi-
tions. IBM, Xerox, Boeing, and Eastman Kodak histor-
T
his pattern of fierce competition
without losers has underpinned
Japan’s economic and
competitive success in the
postwar period.
ically have had quasi-monopolies in their core business-
es. When the airline industry was deregulated in the
early 1980s, an initial period of fragmentation as new
entrants joined the industry was followed by a wave of
mergers and bankruptcies. By the end of the decade,
the concentration ratio in the U.S. airline industry was
higher than it was before the deregulation initiatives
(eight airlines accounted for 91.7 percent of the market
in 1987, compared to 80.4 percent in 1978).1
In Japan, however, there are virtually no firms that
have been able to establish and keep monopoly posi-
tions. Whereas, in the United States, IBM maintained
long-standing domination in mainframe computers,
in Japan, Fujitsu, Hitachi, and NEC long battled for
market share with IBM Japan. Even the photographic
film industry, which has only one U.S. player —
Eastman Kodak — has two competitors in Japan,
which has a market half the size of that in the United
States. There are ten auto manufacturers in Japan, five
84 TEZUKA
integrated steel companies, five major manufacturers of
single-lens reflex cameras, and more than ten semicon-
ductor manufacturers.2 Even when a Japanese firm cre-
ates a new industry, as Nintendo did with video games,
it finds that other firms quickly challenge its position
(as Sega and Sony have challenged Nintendo). In vir-
tually every industry, approximately four to eight
firms compete fiercely for market position, even in
so-called mature industries like steel, aluminum, tele-
vision sets, and chemicals. And individual firms rarely
leave mature industries, through acquisition, bankrupt-
cy, or voluntary exit. Japanese economist Hiroyuki
Odagiri found that, between 1964 and 1982 (a highly
volatile period for the Japanese economy with two oil
crises and the end of the high-growth era), the survival
rate of manufacturing firms listed on the Tokyo Stock
Exchange was 87 percent, a much higher rate than in
Britain or the United States.3
Another feature related to this pattern of competi-
tion has been a consistently lower level of profitabili-
ty for leading firms in Japan, compared with those in
the United States and Britain. In the early 1980s,
Hiroyuki Itami analyzed the profitability of the top
U.S. firm and its Japanese counterpart in several
major industries and found that the Japanese firm
was significantly lower in profitability.4 Itami used
these data to question the quality of Japanese man-
agement at the same time U.S. managers were read-
ing the first wave of books and articles praising its
virtues. Later studies by Odagiri and by others5 have
confirmed that, despite the problems in comparabili-
ty caused by differences in accounting practices,
major Japanese firms consistently exhibit lower levels
of profitability, which Odagiri attributes in part to
more intense competition.6
Therefore, Japan’s most successful industries exhib-
it a pattern of competition that has, as economic the-
ory would predict, reduced profit levels, intensified
national competitiveness, and stimulated technologi-
cal innovation and improvements in productivity and
quality.7 However, it has not produced a falling out of
weaker firms by bankruptcy, acquisition, or voluntary
exit that one might expect as a consequence of com-
petition (and that has characterized industries in the
United States). This pattern of fierce competition
without losers has underpinned Japan’s economic and
competitive success in the postwar period. It involves
SLOAN MANAGEMENT REVIEW/WINTER 1997
three important elements: industrial policy, the keiret-
su system, and lifetime employment.
Japanese Industrial Policy
In 1982, Chalmers Johnson argued that the Japanese
government, symbolized by the Ministry of Interna-
tional Trade and Industry (MITI), had successfully
fostered a series of changes in Japan’s industrial struc-
ture through policies that guided firms into promising
new industries and gradually phased out old industries
in which Japan had lost competitive advantage.8 His
analysis triggered an extensive debate about the role
of industrial policy in Japan’s economic growth and
the implications of the Japanese experience for other
countries.
The MITI-sponsored project to develop VLSI
semiconductor technology (from 1976 to 1980) is per-
haps the most famous example of Japanese industrial
policy for new industries. The project, jointly funded
by government (¥30 billion) and industry (¥42 bil-
lion), was an important contribution to strengthening
the semiconductor industry in Japan. But what is often
overlooked in discussions of the cooperation involved
in the project is the intense domestic competition
that ensued. The project generated more than 1,000
patents on the VLSI process. These were held by the
Japanese government, which subsequently licensed
the technologies not only to the participating com-
panies (NEC, Toshiba, Hitachi, Mitsubishi Electric,
and Fujitsu) but also to the consumer electronics
firms excluded from the project, such as Oki, Sony,
and Sharp, “second tier” semiconductor manufactur-
ers without sufficient resources to invest in VLSI
technologies themselves. The project in effect equal-
ized the technology base among Japanese companies,
maintaining the competitive positions of smaller
players like Sony and Oki that might have dropped
out of the industry had they not been able to share
the results of the project. As a result of this redistri-
bution of technologies, Japan retained more than ten
major semiconductor manufacturers, which compet-
ed fiercely with each other, especially in capital in-
vestment. Japan’s semiconductor industry soon was
characterized by a number of world-leading semi-
conductor manufacturing facilities.
Another example is MITI’s role in administering
SLOAN MANAGEMENT REVIEW/WINTER 1997
the Voluntary Export Restraints (VERs) in autos.
Japan has been setting VERs in automobile export
since 1981. MITI and the U.S. government negoti-
ated the total number of Japanese exports, and then
MITI assigned export quotas to individual auto
manufacturers, based approximately on their current
export levels. In doing so, MITI intentionally gave
relatively favorable quotas to the weaker auto com-
panies. Mazda’s share in the Japanese domestic mar-
ket in the 1980s was 7.2 percent, while its share in
the total export quota was 9.4 percent. In Subaru’s
case, its domestic share was 1.5 percent, but its ex-
port share was 4 percent. The quotas supported
these relatively weaker players and prevented them
from dropping out of the export market. MITI’s
policy may well have been a factor in maintaining
Japan’s ten auto manufacturers, which competed
fiercely in the domestic market.
Both academic analysts and policy makers in
other countries too often overlook the role of Japan’s
industrial policy in sustaining strong domestic com-
petition. Japan has eschewed the path of creating and
supporting strong “national champions,” which has
often characterized European and Latin American in-
B
oth academic analysts and policy
makers in other countries too
often overlook the role of
Japan’s industrial policy in sustaining
strong domestic competition.
dustrial policy, choosing instead to maintain a num-
ber of players in each industry and to foster competi-
tion among them. Japan has also insisted, as the
VLSI project shows, that government subsidies for
R&D be matched by contributions from the compa-
nies involved and, until recently, has insisted on own-
ing the patents from such projects and making them
available for wider licensing (a practice to which for-
eign companies participating in Japanese govern-
ment-sponsored projects have vociferously objected).
Equally important have been MITI’s policies for
declining industries such as coal mining and ship-
building, which, in Japan as elsewhere, are heavily
TEZUKA 85
concentrated in certain regions of the country. By
subsidizing a gradual reduction of operations in these
industries and providing support for the companies
involved, industrial policies helped avoid social tur-
moil and rapid increases in unemployment. When
economists realized that MITI has given as much or
more support to declining industries — or “losers”
— as it has to emerging industries —“winners” —
some proclaimed MITI’s policies a failure. As an arti-
cle in The Economist put it, “Japan’s clever technocrats
picked and supported losers.”9 But these policies were
aimed not at “picking” industries targeted for future
growth but at cushioning the decline of industries in
trouble. Of course, they also helped weaker industries
to survive, increasing competition both domestically
and internationally, much to the irritation of some of
Japan’s competitors.
The Keiretsu
For many Western businesspeople and scholars, keir-
etsu symbolize Japan’s anticompetitive, collusive behav-
ior.10 However, closer examination reveals how keiret-
su work as a competitive mechanism. There are, in
fact, two different kinds of keiretsu: the horizontal
keiretsu (six large industrial groups that each cover a
wide range of industries) and the vertical keiretsu
(epitomized by the supplier assembler networks of the
major manufacturers).
Horizontal Keiretsu as a Mutual Insurance System
The six horizontal keiretsu are four groups that are
built on the companies of the four largest prewar in-
dustrial groups or zaibatsu (Mitsui, Mitsubishi, Sumi-
tomo, and Fuyo) and the two major bank-centered
groups, the Dai-Ichi Kangyo Bank Group and the
Sanwa Group. Each keiretsu has a member company
in each of Japan’s main industries, especially the growth-
era heavy industries (steel, shipbuilding, chemicals, con-
struction, trading companies, etc.). These groups are
not conglomerates: central holding companies are ille-
gal under Japan’s postwar commercial law. There is no
central strategy; the companies are independent and
publicly owned. Rather, these are loosely coordinated
groups characterized by minority cross-shareholding,
regular communication of top executives in the “Presi-
dents’ Club” of each group, and general cooperation
86 TEZUKA
for mutual benefit in unstated “gentlemen’s agree-
ments.”
A feature of these groups is cross-shareholding,
which, in 1987, averaged 23.4 percent (slightly higher
— about 30 percent — in the former zaibatsu).11 Ex-
pectations of dividends and returns on investment are
not the motivation for owning these shares; rather,
share ownership is a symbol of commitment and mu-
tual obligation. Group companies commit to being
stable owners, protecting member companies from
hostile takeover and external pressure, and allowing
company management a high level of autonomy.
Because the keiretsu bank is usually the lead bank
for group companies and because the trading compa-
ny usually assumes many of the trading transactions
for group companies, the horizontal keiretsu are per-
ceived as a symbol of Japan’s closed corporate society.
However, the groups are far from closed. One analysis
showed that fewer than 10 percent of the total con-
tracts of keiretsu companies were within their group
— except for the Mitsubishi group figure of 17 per-
cent. More than 70 percent of contracts were with
non-keiretsu independent companies, and the rest
were with companies in another keiretsu.12 The hori-
zontal keiretsu groups do not prevent the group’s
companies from having external relationships; instead,
as mutual shareholders and sources of financing and
information resources, keiretsu companies are com-
mitted to maintaining each other’s prosperity and
continued existence, thereby providing a mutual in-
surance system.
If a keiretsu company falls into financial trouble,
group companies provide help. In one famous case,
Mazda faced bankruptcy in the wake of the first oil
crisis, because of its highly energy-inefficient rotary
engine cars. The Sumitomo Bank, Mazda’s group
bank, put one of its executives in charge of Mazda,
provided generous financing, and encouraged group
companies to support Mazda in various ways (e.g.,
encouraging employees to buy Mazda cars). And
more recently, the Sumitomo Bank chairman was in-
strumental in getting Ford to raise its investment
stake in Mazda to provide the troubled auto firm
with much-needed capital for investment.13
The group aims to maintain a policy of having a
member company as a competitor in each major in-
dustry. It therefore functions as a mutual insurance
SLOAN MANAGEMENT REVIEW/WINTER 1997
system that ensures the existence of at least six com-
petitors in each industry sector (although the hori-
zontal keiretsu are not active in all sectors). In part
because of the continuing keiretsu support, a mem-
ber company could never drop out of competition or
be acquired by a company from another group.
Keiretsu group companies therefore have lower
risk than independent companies, because the whole
keiretsu group shares individual risks. Given this
lower risk, keiretsu companies obtain lower interest
rates from both keiretsu banks and other financial
institutions. Japanese companies in the horizontal
keiretsu therefore tend to have higher debt ratios
than either independent Japanese companies or their
U.S. counterparts.
The lead shareholders in keiretsu companies main-
tain their shares regardless of returns, enabling compa-
nies to provide lower returns on equity and lower
dividends. A study comparing horizontal group com-
panies with equivalent independent companies found
that returns to shareholders were lower for horizontal
group companies, although returns to employees were
greater.14 Group companies therefore reinvested earn-
ings into production and R&D and maintained their
presence in their core industry even if their profita-
bility and efficiency did not match the leading com-
petitors. Moreover, keiretsu companies built large cor-
porate assets in the form of land and the shares of
other keiretsu companies. In the growing economy
of the late 1970s and 1980s, the value of this asset base
soared and enabled keiretsu companies to borrow even
more extensively to finance capital investment, gener-
ating even tougher competition and enabling even
the weak players to sustain the investment levels nec-
essary to compete.
In summary, then, the horizontal keiretsu have been
an important factor in maintaining strong domestic
competition, keeping firms from dropping out of the
older line industries where they have been most strong-
ly represented, and making sure that member firms
moved into new, higher-growth industries, even when
such expansion intensified competition.
Vertical Keiretsu as a Way to Create Competitive
Teams
Virtually the only aspect that vertical keiretsu share
with horizontal keiretsu is the word keiretsu, which
SLOAN MANAGEMENT REVIEW/WINTER 1997
means “order” or “system.” Both are types of industri-
al groups held together primarily by complex relation-
ships, but the relationships are very different. In the
vertical keiretsu, as the name implies, a lead firm orga-
nizes the network, which is epitomized by the supplier
networks of the large auto and electronics firms. Every
large industrial firm, such as Toyota or Matsushita, is
the parent firm in a complex, layered group of firms;
some are suppliers and sub-suppliers, others are sales
and distribution companies, and still others are spin-
off firms engaged in related businesses.
Americans have focused attention on the supplier
networks and portrayed them as a key element of
Japanese competitive success.15 Americans see Toyota
outsourcing more than 60 percent of its parts and
subsystems or Canon outsourcing nearly 90 percent
of the value added in its copiers and think it gives
these firms flexibility, efficiency, and strategic focus.
The keiretsu is the primary mechanism for just-in-
time production and lean manufacturing: the lead
firm closely coordinates its activities in production
and engineering with its suppliers and itself concen-
trates on high value-added activities. The vertical
keiretsu is held together by a complex mix of people,
financial resources, information, parts and products,
and technology. Ownership is only a part of this link-
age: most lead firms have minority shares in their
suppliers, rather than what Americans would think of
as a “controlling interest” of more than 50 percent.
But while the business press has analyzed the close
cooperation that develops in the vertical keiretsu, it has
paid much less attention to its intensely competitive
nature. Most Japanese lead firms follow a multisupplier
policy, avoiding reliance on a single source, even a
member of the group: the ratio of single-sourced parts
in the auto industry in Japan is only 12.1 percent,
compared to as much as 69 percent in the U.S. in-
dustry.16 The lead firm buys, for example, 50 percent
of its parts from a main supplier, 30 percent from a
second supplier, and 20 percent from a third supplier.
The first and even second supplier may be a vertical
keiretsu member, but at least one supplier will be out-
side the group. The lead firm encourages the second
or third supplier to match the first supplier’s cost and
quality, often passing along important technical and
process information on the first supplier’s operations.
In doing this, the lead firm tries to encourage the
TEZUKA 87
weaker suppliers to improve and keeps competitive
pressure on its lead supplier. The lead firm tries to
avoid monopoly power in its network, thus stimulat-
ing all suppliers to be more efficient and price com-
petitive. If a keiretsu supplier falls behind outside
suppliers, the lead firm provides financial support
and even technology and often takes extraordinary
steps to revive its competitiveness. But if, over an ex-
tended period of time, the keiretsu supplier fails to
meet the competitive standards, it will find its share
of the lead firm’s business steadily declining and may
eventually be replaced by an outside supplier that has
become the preferred supplier. The lead firm’s pur-
chase of some of the outside firm’s shares symbolizes
the closer relationship.
Suppliers are encouraged to sell their products to
other assemblers to expose them to different ways of
doing business and to gain greater economies of scale.
But the lead firm remains their single largest customer,
and their destiny is dependent on it. One Japanese ex-
ecutive in a keiretsu supplier company described this
T
here is no fast track in the
Japanese company, but
there is a very long track.
dependency: “As soon as I succeeded in becoming
such a supplier, I was considered part of its ‘family.’ I
was expected to be loyal to that company no matter
what the sacrifice.”17
Suppliers in the same keiretsu group compete with
each other and with outside suppliers to excel in quali-
ty, delivery, reliability, and cost performance. But at the
same time, they cooperate with their lead firm and
even with competing suppliers in the same group to
compete against other keiretsu groups. Suppliers know
that their success is ultimately dependent on the com-
petitiveness of their lead firm in the final product mar-
ket. The lead firm carefully fosters this combination of
cooperation and competition among suppliers and
often establishes mechanisms for asserting the group
identity and providing a forum for cooperation by
having meetings of supplier executives, sharing group
trademarks, and setting up joint social activities such as
sports events. Toyota has established a first-tier suppli-
88 TEZUKA
ers’ group, the Kyoukoukai (176 companies); Nissan
has its Takarakai (104 companies). Members of the
vertical keiretsu have had little choice but to accept this
combination of cooperation and competition.
Lifetime Employment
Nearly three decades ago, James Abegglen identified
Japan’s human resource management system as a pri-
mary feature of its industrial companies.18 The other
features are: (1) lifetime, or more accurately, perma-
nent employment — a guarantee that the employer
will find a position for the employee until retirement,
usually at age sixty; (2) seniority-based promotion and
salaries; (3) group-based organization rather than indi-
vidual jobs; and (4) vaguely defined job descriptions.
Many Westerners have concluded that the Japanese
work environment is much more cooperative than in
the United States, and that Japanese employees enjoy
more comfortable, secure, and friendly workplaces.
But this is not true.
Lifetime employment means that employees have
few opportunities to change employers. The large
Japanese companies that are the country’s preferred
employers recruit new employees from the crop of
fresh graduates (blue-collar workers from high schools,
managerial recruits from bachelor’s programs, and
R&D personnel from the master’s programs). Mid-
career jobs are therefore rare; if an employee doesn’t
fit into the company, he or she has few attractive alter-
natives. Subsequent employment possibilities are like-
ly to bring lower wages, less security, and less status.
The seniority-based promotion system means that
people wait years for promotion, even if they are out-
standing performers. Vladimir Pucik’s twenty-five
year analysis of the promotions of employees hired in
1955 at a large trading company shows the patterns
found in virtually all Japan’s large firms.19 The trading
company has five managerial levels, with predeter-
mined minimum time periods for promotion to the
next level. The best people are promoted first, but
even they must wait many years before they reach
general manager positions. In Pucik’s study, less than
a quarter of the people hired in 1955 reached the
fifth level; only a small number (6.1 percent) reached
that level in less than twenty-five years. Gradually, the
less highly evaluated employees stopped rising.
SLOAN MANAGEMENT REVIEW/WINTER 1997
 There is no fast track in the Japanese company,
but there is a very long track. Because employees’ en- Figure 1 Harmony between Competition and
Cooperation in Japanese Business
tire lives are devoted to one company, the race cre-
ates fears of lagging behind and being outperformed.
Some people are left behind. They are not, however,
thrown out; the permanent employment guarantee Company B Company C
ensures that they are not “losers” in the sense of los-
Company A
ing their jobs. Competition
This fierce internal competition could have creat-
Cooperation
ed a hostile, individualistic work environment were
it not for the two other characteristics of Japanese Supplier B Supplier C
human resource management: group-based organi-
zations and vague job descriptions. Companies eval- Supplier A
Competition
uate employees’ performance not only on individual
performance but also on how well the person im- Cooperation
proved group performance. Usually that perfor-
mance is evaluated relative to similar groups in the Team B Team C

company, and, therefore, each worker must cooper-

ate with colleagues to achieve the best results. Even
the best individual performers will not succeed if
their group performs badly.
Vague or imprecise job descriptions give Japanese
workers much more scope in helping colleagues, mak-
ing suggestions, and implementing improvements.
Many studies of blue-collar workers in Japanese auto
plants and studies of managers have observed this.20
Companies expect managers to define their own roles
and find ways to contribute.21 A very important criteri-
on for becoming a manager is demonstrating whether
he or she can understand the general mission of the
position and discover ways to realize it, in both the
internal and the external environment. Lifetime em-
ployment and the seniority promotion system, which
are usually associated with periodic job rotations,
give managerial candidates the background and ex-
perience to develop capabilities to cope with open-
ended missions. Such “self-job definition” easily leads
people into intense work commitments, even over-
commitments. Because people have no preset goals
and because they are judged on the goals they set and
how they achieve them, people naturally compete by
setting higher and higher goals. The phenomenon of
karoushi — death by excess work — symbolizes the
stress this produces among managers. While the sys-
tem is stressful for people, Japanese companies have
benefited by getting the best performances from both
individuals and teams.
Team A
Competition
Cooperation
Person B Person C
Person A
Competition
The basic mechanisms of this system are very sim-
ilar to those we have observed in industrial policy
and in the keiretsu: getting full commitment from
the players, engaging them in unending competition
by providing few alternatives and by ensuring that
weaker contenders continue in the system, and en-
suring that cooperation is not overwhelmed by com-
petition.
There is coexistence and indeed essential harmony
between competition and cooperation in the Japanese
system. With few or no alternatives available, individ-
uals, groups, suppliers, and lead firms compete with
each other, but, at the same time, they cooperate as a
team to compete against outsiders. High-pressure
competition is generated in each layer, but successful
competition demands that the competitors also work
together. (see Figure 1).
Because the system creates no clear losers, Japanese
society avoids many social costs believed to be inher-
ent in a market economy. The market economy by

SLOAN MANAGEMENT REVIEW/WINTER 1997 TEZUKA 89

nature produces social losers as well as winners, and
the wealth generated by the winners offsets the pover-
ty of the losers because of social welfare programs for
the redistribution of wealth. But Japanese capitalism
embeds this redistribution process in the systems of
lifetime employment, the keiretsu, and industrial pol-
icy. As a result, Japanese society has incurred relatively
lower social costs and by far the lowest unemployment
level among the highly developed countries, even after
five years of continued recession. Japan’s unemploy-
ment rate remains approximately 3 percent. Econo-
mists argue that “hidden unemployment” raises the
figure to around 7 percent; i.e., there are some people
who continue to hold jobs at large corporations with-
out having significant work. But this figure shows that
the lifetime employment system functions as a substi-
tute for governmental welfare programs.
Trade-offs in the System
As a result of this competitive system, Japan has be-
come one of the world’s major economies in the five
decades since the end of World War II. But it has
not been without costs.
First, the severe competition among companies and
the refusal of weak players to drop out or be absorbed
by the strong has led to frequent overinvestment in
production capacity, and what MITI calls “excessive
competition.” The horizontal keiretsu system fostered
almost unlimited credit lines and made persistence
possible despite negligible returns, fueling the competi-
tion. Second, the competition has held down the oper-
ating profit levels of Japanese companies. Third, exces-
sive competition has accelerated the speed of product
development and shortened the life of many products.
Automakers change models every three or four years.
Consumer electronics firms introduce a stream of new
products, which lowers the value of the previous year’s
models substantially and encourages consumers to ex-
pect new models every year. The resource waste and
the disposal of unwanted but still serviceable products
is beginning to concern environmental groups in Japan
and elsewhere. Human resources are also consumed in
the process. One electronics company had ten equiva-
lent teams competing to develop a new stereo head-
phone. Should so many talented engineers be compet-
ing within one company just to make one new product?
90 TEZUKA
Finally, the system is intensely stressful for those work-
ing in it.
In addition, the Japanese system has an effect be-
yond Japan. Now that many Japanese companies have
globalized their competitive battleground, they have
set the base levels of profitability and competition for
non-Japanese companies as well. Japanese companies
are able to survive in this intense competition because
of the social insurance mechanisms I have described.
However, many non-Japanese companies lack patient
shareholders, committed suppliers, and employees
with no alternative to intense commitment, and find
it difficult to deal with Japanese-style competition.
This leads to severe trade friction and generates the
image of “unfair Japanese competition.”
The intensely competitive domestic market also
raises the entry barriers for non-Japanese firms, and
consequently, non-Japanese companies experience se-
rious difficulties penetrating the Japanese market.
This can, however, hardly be seen as a trade barrier in
the normal sense, because even new Japanese entrants
face an equally difficult challenge. In some industries,
A
s the growth rate of the
economy and companies
has leveled off, many
middle managers are finding their
careers truncated by early retirements
and transfers to subsidiaries.
such as airlines and long-distance telecommunica-
tions services, the U.S. market has higher entry barri-
ers in the form of intense domestic competition.
The Sustainability of the Japanese Business
System
Economists in the 1980s almost unanimously por-
trayed the Japanese business system as having been
produced by a long period of economic growth and
superbly adapted to thrive in a growth environment.
However, the strong yen, the collapse of the “bubble
economy,” and the continued Japanese recession have
led many observers to conclude that Japan is now fac-
SLOAN MANAGEMENT REVIEW/WINTER 1997
ing an extended era of zero or near-zero economic
growth. This raises the specter of three serious prob-
lems for the Japanese business system: the growing
importance of operational profitability, the erosion of
lifetime employment, and generational conflict.
• Operational Profitability. In the late 1980s, the
lower profitability of Japanese companies was overrid-
den by the spectacular growth of their assets. Between
1985 and 1991, total operational earnings of publicly
traded Japanese companies grew by 44 percent, while
earnings from stock sales and the disposal of land as-
sets grew by 78 percent and 56 percent respectively.
The Japanese Economic Planning Agency calculated
that, in the 1980s, the total value of Japan’s stock and
land property increased by ¥700 trillion and ¥1,600
trillion respectively. This asset value increase account-
ed for more than 70 percent of the total GDP growth
generated in Japan during that period.22 The prosper-
ity of Japanese companies rested to an unrecognized
degree on the accumulation of wealth during the
higher growth period in the past. With the collapse
of the bubble economy, as much as ¥233 trillion of
land asset value and ¥178 trillion of stock value was
eradicated in 1992 alone. Japanese companies in the
future must profit from their operations and justify
their investment on the basis of projected future op-
erating profits, not on continuous asset inflation due
to growth in the economy as a whole.23
• Erosion of Lifetime Employment. The second
trend that may affect the business system is the ero-
sion of lifetime employment caused by the globaliza-
tion of production. Japanese offshore manufacturing
is currently only 5.7 percent of total GNP, while the
figure for the United States in 1989 was 23.8 percent.
The appreciation of the yen has stimulated many
Japanese companies to significantly expand their pro-
duction outside Japan, especially in Asia. And the
past five years of recession saw a growing number of
Japanese companies struggling to reduce costs by cut-
ting back employment. Nissan reduced its employ-
ment by 6.7 percent between 1990 and 1993. The
five major Japanese steel companies reduced the com-
bined total of their employees by 23,000 between
1993 and 1995. And, as in the United States, much
of this reduction is in the managerial and white-collar
labor force. Moreover, some companies have announced
plans to introduce new promotion systems focusing
SLOAN MANAGEMENT REVIEW/WINTER 1997
on individual performance rather than seniority. Life-
time employment and the seniority-based promotion
system have begun to erode.
• Generational Conflict. Both trends in turn will
bring more intense generational conflict to Japanese
society. In the traditional system, young people with
little seniority contributed to their companies with
lower rewards than their productivity warranted. How-
ever, secure in the knowledge that they would be re-
warded as they gained seniority and the company ex-
panded, young people remained intensely committed.
Now they are beginning to suspect that present sacri-
fices will not produce larger future rewards. As the
growth rate of the economy and companies has lev-
eled off, many middle managers are finding their ca-
reers truncated by early retirements and transfers to
subsidiaries. Young employees see the sacrifices of the
senior generation going unrewarded and may no
longer tolerate the low level of their compensation rel-
ative to their contribution.
There has been virtually unprecedented criticism of
the current top management in big Japanese corpora-
tions. As executives sell assets inherited from past
management in order to maintain profitability on
paper, they seem to be sacrificing the future. They
seem reluctant to undertake the painful restructuring
that many Japanese believe is necessary to remain
competitive. For young managers, the actions — and
inaction — of current management threatens their fu-
ture. Restructuring the company to make it competi-
tive in a high yen environment would be much more
valuable to young employees than manipulating as-
sets to hide or postpone problems. Young executives
know that their lives will be much more difficult and
their rewards far less than those of current senior ex-
ecutives.
What Should Japan Do?
The Japanese economy is now facing the prospect of
fundamental transformation, not because of U.S.
pressures on trade issues but because of the challenges
in adjusting to a very low-growth era. The bursting of
the bubble economy is evidence that the Japanese
economic system, symbolized by industrial policies,
the keiretsu, and lifetime employment cannot func-
tion without rapid real growth. Even if Japanese com-
TEZUKA 91
panies want to continue the old “no losers” domestic
competition, they cannot.
It is inevitable that Japanese firms give up their
traditional keiretsu linkages, lifetime employment,
seniority-based promotion, and the myth that big
corporations will not disappear. Instead, there will be
an increase in corporate contracts based on an eco-
nomic rationale, demanding and critical shareholders
and debt-holders, performance-based promotion and
wage systems, term-contract-based employment, and
industrial consolidations, mergers, and acquisitions.
Shareholders have realized that they cannot auto-
matically expect capital gains created by economic
growth, so they will demand higher dividends; they
will no longer be “silent” partners. Japanese banks
cannot give low-interest loans to keiretsu companies;
their positions are now too precarious to adopt any
but sound economic rationales for loans. Mergers,
acquisitions, and consolidation of companies are al-
ready increasing; witness the recent wave of large
mergers in banking and in the paper industry. The
asset base value of a company has become less im-
portant, and the flow base — that is, operating prof-
its — is much more important.
In the future, individuals and companies will chase
their own economic advantages, and the traditional
mutual insurance system will disappear. Strong compa-
nies will gain, at the expense of weak companies. Can
Japan continue to have ten auto companies, five inte-
grated steel producers, and ten large-scale semiconduc-
tor manufacturers? The focus of government policy
must change from helping to sustain weak companies
to helping strong companies become stronger by al-
lowing competitive forces to eliminate weak competi-
tors. This is completely opposite to the government’s
traditional role, and, instead of changing that role, the
government may take a much less active one.
At least in the short term, increased unemploy-
ment in Japan is inevitable, as companies strive to
lower costs and move production abroad. But the
pain of the transformation can be reduced if the
white-collar job market becomes more flexible. Under
the traditional lifetime employment system, when
mid-career managers lose their jobs, they cannot find
new opportunities; there is no white-collar labor
market in Japan. But as more and more people are un-
employed, Japan must develop more flexible white-
92 TEZUKA
collar and blue-collar labor markets. First, companies
must replace seniority-based promotion and wages
with a merit system to avoid discriminating against
employees with previous experience outside the com-
pany. Matsushita Electric, for example, recently an-
nounced that it would recruit mid-career scientists
and engineers for a new R&D lab on a five-year con-
tract basis at individually negotiated wages. Nissan
has also decided to introduce a merit-based promo-
tion system. In addition, the company-specific re-
tirement bonus (which is linked to length of service
and is not transferable if an employee moves to anoth-
er company) must be replaced by a portable pension
system.
As Japan follows the United States in the creation
of strong, lean companies in the traditional manu-
facturing industries, it must also pay attention to the
development of new ventures. But the barriers to en-
trepreneurship in Japan have been high. In 1989,
there were 160,000 companies newly incorporated in
Japan, while, in 1988, more than 690,000 were set up
in the United States. New Japanese companies face
the same difficulties in obtaining financing, attracting
good workers, and breaking into markets that con-
front foreign companies in Japan. But, as the keiretsu
structure weakens, as the employment system erodes,
and as financing becomes less relationship-based, en-
trepreneurs will face fewer structural barriers. A sud-
den upsurge in Japanese entrepreneurship, however,
after decades in which it was discouraged, is doubtful.
Essential to a society that fosters new ventures are en-
trepreneurs who are willing to take risks. However, the
strong Japanese mutual insurance system was designed
to eliminate the risks of companies or individuals being
“losers.” Business managers were protected by social
risk sharing from facing real business risks. After so
many decades of a “low risk, stable returns” environ-
ment, where will Japan find entrepreneurs who will
face repeated failures before meeting with success?
As the Japanese business system changes, the short-
age of risk takers will be its most serious challenge. Most
Japanese companies are simply trying to endure the re-
cession by taking identical measures such as cost reduc-
tion, moving production to other Asian countries, and
outplacing employees. They are expecting the govern-
ment to end the recession with fiscal stimulation and tax
reduction. But these typical risk-reduction behaviors
SLOAN MANAGEMENT REVIEW/WINTER 1997
cannot be the main foundation for future competi-
tiveness. Only risk takers can start successful new busi-
nesses.
Because Japan has utilized its traditional risk-sharing
systems so well for so long, and because the system has
produced one of the most successful economies in the
world, the entire society has adapted to competition
without losers. The people and the firms in this system
have been unparalleled in producing high-quality au-
tomobiles and memory chips. But they are not the
source of new businesses and future Silicon Valleys.
The tragedy for Japan is that, as a result of adaptation
to the Japanese business system, there are too few risk
takers to revitalize the Japanese economy and generate
workplaces for future generations. A traditional Chinese
saying holds that “failure is the source of success.” Is
success going to be the source of failure in Japan? ◆
References
An early version of this paper was presented in 1995 at the annual meeting
of the Association of Japanese Business Studies in Ann Arbor, Michigan. I
would like to acknowledge the help of Professor Eleanor Westney in pro-
ducing this version.
1. Data from W. Adams, The Structure of American Industry (New
York: Macmillan, 1990).
2. The number of auto manufacturers in Japan is variously counted as
ten or eleven, depending on whether Nissan Diesel is counted sepa-
rately.
3. H. Odagiri, “Profitability and Competitiveness,” in K. Imai and R.
Komiya, eds., Business Enterprise in Japan: Views of Leading Japanese
Economists, translated by R. Dore and H. Whittaker (Cambridge,
Massachusetts: MIT Press, 1994), pp. 179-193. Odagiri admits that
the time frames of the Japanese and the U.S. and British data do not
quite match — the British and U.S. data are from a comparable time
period about half a decade earlier.
4. H. Itami, Nihon no keiei to wa nani ka? (What Is Japanese Manage-
ment?) (Tokyo: Nihon Keizai Shimbunsha, 1982).
5. Data presented and discussed in Odagiri (1994).
6. A recent article in the Nihon Keizai Shimbun, using data on all pub-
licly listed manufacturing firms in the United States and Japan from
1980 through 1995, showed that the U.S. firms consistently outper-
formed the Japanese firms on return on equity by a considerable mar-
gin. In 1995, for example, the ROE for Japanese firms was 4.5 per-
cent; for U.S. firms, 16.5 percent. See:
Nihon Keizai Shimbun, 17 April 1996, p. 1.
7. Michael Porter, for example, attributes much of Japan’s industrial
success in key industries to domestic competition: “The proliferation
of domestic rivals, coupled with demand-side pressure and goals heavi-
ly oriented toward market share, creates a tinderbox of innovation and
change” (p. 412). However, as Porter points out, where Japanese in-
dustries have seen fewer players and less competition — telecommuni-
SLOAN MANAGEMENT REVIEW/WINTER 1997
cations services and airlines, for example — there has been less innova-
tion, greater profitability, and a performance level below international
standards. See:
M. Porter, The Competitiveness of Nations (New York: Free Press, 1990).
8. C. Johnson, MITI and the Japanese Miracle (Stanford, California:
Stanford University Press, 1982).
9. “Picking Losers in Japan,” The Economist, 26 February 1994, p. 69.
10. See, for example: “Mighty Mitsubishi,” Business Week, 24 September
1990, pp. 98-107.
11. Kosei Torihiki Iinkai (JFTC), Kigyo shudan no jitai ni tsuite (“On
the Current Structure of Business Groups”) (Tokyo, 1991).
12. Kosei Torihiki Iinkai (JFTC), Gyoumu-teikei ni kansuru houkokusyo
(“Special Survey on Business Tie-ups”), 16 November 1976.
13. Nihon Keizai Shimbun, 13 April 1996. At the time, Sumitomo
Bank’s own financial problems precluded it from providing the help
for Mazda.
14. I. Nakatani, “The Economic Role of Financial Corporate Group-
ing,” in M. Aoki, ed., The Economic Analysis of the Japanese Firm
(Amsterdam: Elsevier, 1984), pp. 227-258.
15. See, for example:
J. Womack, D.T. Jones, and D. Roos, The Machine That Changed the
World (New York: Rawson Associates, 1990); and
T. Nishiguchi, Strategic Industrial Sourcing: The Japanese Advantage
(New York: Oxford University Press, 1994).
16. Womack et al. (1990), p. 157. The recent problems of General
Motors, when a strike at a small brake supplier closed down produc-
tion lines, illustrates the perils of a single-supplier policy, which the
Japanese system avoids.
17. K. Sakai, “The Feudal World of Japanese Manufacturing,” Harvard
Business Review, volume 68, November-December 1990, pp. 38-49.
18. J. Abegglen, The Japanese Factory (Glencoe, Illinois: Free Press,
1958).
19. V. Pucik, “Promotion Patterns in a Japanese Trading Company,”
Columbia Journal of World Business, volume 20, Fall 1985, pp. 73-79.
20. See, for example:
R.E. Cole, Japanese Blue-Collar: The Changing Tradition (Berkeley,
California: University of California Press, 1971); and
Strategies for Learning: Small-Group Activities in American, Japanese,
and Swedish Industry (Berkeley, California: University of California
Press, 1989);
T. Abe, Hybrid Factory: The Japanese Production System in the United
States (New York: Oxford University Press, 1994).
21. See, for example:
I. Nonaka, “Toward Middle-Up-Down Management: Accelerating
Information Creation,” Sloan Management Review, volume 29, Spring
1988, pp. 9-18.
22. Nihon Keizai Shimbun, 26 April 1995.
23. According to an article in the Nihon Keizai Shimbun (26 April
1995, p. 1), the accumulated pretax operating profits of Japanese pub-
licly traded nonfinancial companies between 1976 and 1990 was ¥52
trillion. During the same period, the total value of Japanese stocks
traded on the Tokyo Stock Exchange (Section 1) increased by ¥17
trillion.
Reprint 3826
Copyright © 1997 by the
SLOAN MANAGEMENT REVIEW ASSOCIATION.
All rights reserved.
TEZUKA 93
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