Indian Institute of Management...

Contemporary Concerns Study - 4th Term: 2006 -08

‘KEIRETSU’ MODEL IN JAPANESE INDUSTRY AND ITS IMPLICATIONS

This CCS analyzes ‘Keiretsu’ model in Japanese Industry and explains its implications. Conclusions include learning for industries and economies at various stages

Under the guidance ofProf V. Ravi Anshuman

Area of Finance & ControlIIM Bangalore

ByMohit Kumar 0611028Naresh Kumar 0611029

2007

Japanese “Keiretsu” Model and Its Implications

Executive SummaryThe most common Japanese meaning of keiretsu is close to the English verbs “link”, “affiliate with” or “connect to”. In corporate culture, keiretsu refers to a uniquely Japanese form of corporate organization. A keiretsu is a grouping or family of affiliated companies that form a tight knit alliance to work towards each other’s mutual success. There are 2 most ways to classify keiretsu. One classification is Yoko (horizontal) and Tate (vertical). A horizontal keiretsu is a group of very large companies with common ties to a powerful bank, united by shared stockholdings, trading relations. The vertical or pyramid keiretsu is made up of one very large company and hundreds or thousands of small companies subservient to it. The keiretsu are a result of the Ministry of International Trade and Industry’s reformation of the economy after the Occupation of the allies. Shortage of capital in the economy was one of the main reasons why MITI promoted the development of the main banks.

There has been a lot of research in the field of understanding how a keiretsu operates and whether it adds any value to a firm which wants to affiliate itself with a keiretsu. This study tries to answer the following questions in this regard:

Does affiliating to Keiretsu guarantee excellent results?

Does affiliating to Keiretsu guarantee stability in results?

Does the Capital Structure of Keiretsu firm have some impact on the firm?

Is there something to learn from the Japanese Keiretsu System?

Our analysis is based on 97 Japanese companies, categorizing them into old keiretsu, new keiretsu and independent firms across four industries. The Hexagon Criteria evaluates both the corporate governance as well as operational performance parameters for the firms. Our study has resulted in following conclusions:

1. Independent firms show better performance over the decades across industries indicating that affiliation to Keirestu doesn’t ensure better profits and in fact lowers the same.

2. Affiliation to a keiretsu has however provided stability of returns over the independent firms. This is referred to as ‘Mutual Assurance Scheme’ in earlier studies.

3. Clear differences in capital structure of Keiretsu and Independent firms indicate easier access of debt to Keiretsu firms over Independent firms.

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Moreover, our analysis when applied to an Industry in different stages, we see that it is beneficial for a firm to follow keiretsu model in new industry or turnaround industry while following independent route in a mature industry. Similar conclusions can be drawn at the economy level in emerging & developed.

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Contents

Introduction.................................................................................................................................................5

Understanding the Keiretsu Structure.....................................................................................................5

Horizontal Keiretsu..................................................................................................................................6

Vertical Keiretsu......................................................................................................................................7

The Old versus the New...........................................................................................................................8

The History of Keiretsu..............................................................................................................................10

Dawn of the Modern Era.......................................................................................................................10

The Zaibatsu are born............................................................................................................................10

The Zaibatsu and World War II..............................................................................................................11

Reforming the Japanese Economy.........................................................................................................11

The Heart of the Keirets............................................................................................................................13

The Main Bank.......................................................................................................................................13

The Sogo Shosha....................................................................................................................................14

The Study...................................................................................................................................................16

Earlier Studies........................................................................................................................................16

The Answers We Seek...........................................................................................................................17

Research Methodology..............................................................................................................................18

Data collection.......................................................................................................................................18

Methodology.........................................................................................................................................18

Results.......................................................................................................................................................20

Results – Chemical Industry...................................................................................................................20

Results – Automobile Industry...............................................................................................................21

Results – Electrical Machinery Industry.................................................................................................22

Results –Machinery Industry.................................................................................................................23

Results: Variation of profitability over Decades for different groups....................................................24

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Capital Structure: Different groups over decades..................................................................................24

Conclusions............................................................................................................................................25

The “Keiretsu Problem”.............................................................................................................................26

The learning from Keiretsu & its Strategic implications.............................................................................27

References.................................................................................................................................................29

Appendices................................................................................................................................................30

Appendix 1: List of companies considered............................................................................................30

Appendix 2: Summary of Values Obtained............................................................................................32

Appendix 3: RoS performance of different groups over the years.........................................................33

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Introduction

We are surrounded by the keiretsu and we deal with them everyday – every time we turn on the TV, pick up a paper, eat at a fast-food chain or go to work. Quietly, secretly, without warning, keiretsu have infiltrated our daily lives and engulfed in almost everything we know. Unbeknownst to many of us, we too have become a part of various keiretsu. The work keiretsu does not translate neatly into English and that is the beginning of the problem. The most common Japanese meaning is something close to the English verbs “link”, “affiliate with” or “connect to”. If this sounds like a pretty broad definition, it is. The term is vague. It merely shows that people or things are connected in some way. In corporate culture, keiretsu refers to a uniquely Japanese form of corporate organization. A keiretsu is a grouping or family of affiliated companies that form a tight knit alliance to work towards each other’s mutual success1.

Then why all the fuss about keiretsu?

The answer is that certain large Japanese keiretsu are not merely loose connections between a company and a few of its related firms, but groups of thousands of companies all working for a single large firm. Other keiretsu are made up of dozens of these huge firms (together with their thousands of smaller companies) bound together as a gigantic industrial combines. Even this would not in and of itself merit much attention, but against the background of US-Japan trade friction, the term keiretsu, replacing the more colorful, but less accurate expression of Japan, Inc., has become a label for fraternal collusion to keep foreign goods and services eternally locking at the door.

Understanding the Keiretsu StructureNo one knows how many corporate keiretsu there are in Japan. Over 2000 companies are listed on the stock exchanges, and almost all of them have at least one group of subsidiaries and/or affiliates connected to their business. These are all keiretsu. There are probably at least that many firms that are big enough to list their shares but choose not to. Most of them have keiretsu. There is no accurate way of counting all the corporate groups in Japan but the figure must certainly run into thousands and possibly much higher. We will focus on those keiretsu which have grown to great size and which have become powerful both domestically and internationally. In other words, we will look at keiretsu whose names might be some what familiar outside Japan.

There are various ways to classify keiretsu, but the two most common classifications cover all the groups and that we will be looking at. Although the two types of keiretsu are very different, everyone tends to get them confused. The Japanese call them yoko (horizontal) and tate (vertical). A horizontal keiretsu is a group of very large companies with common ties to a powerful bank, united by shared stockholdings, trading relations and so on. The Mitsubishi Group of companies would be one example. The vertical or

1 http://searchsmb.techtarget.com/sDefinition/0,,sid44_gci518852,00.html6


pyramid keiretsu is made up of one very large company and hundreds or thousands of small companies subservient to it. A good example would be a large manufacturer like Toyota with twin vertical keiretsu within its total group: one pyramid producing goods and the other pyramid distributing and selling those goods

Horizontal KeiretsuThe horizontal keiretsu revolve around a financial core, which always includes a major bank. Although mergers are continuously shrinking the number of commercial banks in Japan, there are 11 large “city” banks. However, only six of them (Dai-Ichi Kangyo, known as DKB, Sakura, Sumitomo, Fuji, Sanwa and Mitsubishi) and the leading long term credit bank, the Industrial Bank of Japan, are commonly referred to as the centers of their own keiretsu. In Japanese, the keiretsu led by these six city banks have a special name, the roku dai kigyo shudan, or Six Big Industrial Groups.

The big six are the strongest and most representative horizontal groups. One way to think of them is corporate convoys, large groups of companies that for one reason or another have chosen to travel together and keep an eye on each other. At the center of the horizontal keiretsu there is always a nominal “flagship”, which is the city bank. However, there is often another behemoth – a trading company (shosha) – which is roughly equivalent to the bank in influence, sailing right beside it. There may even be a third firm, a giant manufacturer, also in the nucleus of the convoy. Around there two or three giants circle the core members, usually three financial firms – a life insurance company, a non life insurance company, and a trust bank – and one or two very large manufacturers. Together the financial firms, the trading company and the group’s key manufacturers give the keiretsu its identity. Look at figure 1, it describes the Mitsui Group.

Figure 1: Mitsui Group of Companies – A Horizontal Keiretsu2

2 Source: http://www.wtec.org/loyola/polymers/c7_s7.htm7


Around the periphery of these core companies are whole flotillas of firms, some clustering together and some out on their own. At the far edge of this periphery is a scattering of companies, usually smaller ones, but sometimes a few large firms, which choose to remain, associated with the group, but at a distance. Toyota is an example of one such firm, officially a member of the Mitsui Group, but operating at the periphery of group affairs. And just to make things interesting, there are a few very large companies that claim allegiance to more than one group. Hitachi is the best known example that considers itself above the keiretsu and boldly flies the flag of three different groups.

Vertical KeiretsuMuch of the confusion in talking about the keiretsu arises not from the simple distinction between the horizontal and vertical because the two classifications overlap to a large extent. That is, many of the biggest vertical keiretsu lie inside the borders of the Big Six. Almost of the Big Six companies are also the head of their own vertical keiretsu. Beneath Toyota, Toshiba, Sumitomo Chemical, Mitsubishi Heavy Industries, Mitsui Bussan and all the rest, there are hundreds and thousands of small firms. There more or less invisible companies are stacked, wedding cake style beneath the famous big-name firms that lead their keiretsu. Thus, the Big Six are like a collection of icebergs viewed from the above. Beneath each member of the horizontal grouping is a giant, unseen mass of smaller companies.

The arrows shown in Figure 1 represent the existence of a vertical keiretsu within the periphery of horizontal keiretsu.

It is relatively easy to imagine a horizontal keiretsu, a group of big companies of more or less equal status in orbit around a key bank. But do the vertical keiretsu look like?

Beneath most listed companies, there may be a half dozen or so major subsidiaries. In the case of the manufacturing industry these are usually the first tier factories producing goods for the “parent” company up above. Below each factory are usually dozens of smaller firms. All of these companies produce some part of subassembly which ultimately works its way up the pipeline to benefit the company at the top of the pyramid. The parent may allow its first tier subsidiary to use its name, and if it is quite large, perhaps the second tier firms as well. In a society as status conscious as Japan, where simply wearing a lapel pin of a known corporation is a symbol of success, this bestowing of the parent’s name is often more than paying out better salaries.

The Old versus the NewMitsui, Mitsubishi and Sumitomo are the best known groups in Japan and are sometimes referred to as the “old” group while Fuyo, Sanwa and Dai-Ichi Kangyo groups are referred to as the “new” group. In a strict historical sense, this is inaccurate. It is true that the Mitsui and Sumitomo businesses are older than the rest, but the Mitsubishi zaibatsu3, the Yasuda zaibatsu (the core of today’s Fuyo Group) and the

3 The zaibatsu (literally financial cliques) were the diversified family enterprises that rose to prominence in the Meiji Era.

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Shibusawa zaibatsu (what became the Dai-Ichi Kangyo Group) are all about the same age. It is only the establishment of dates of their formal sancho-kai that can be so neatly divided into old and new.

The main difference between the image of the two groups is certainly historical: whereas Mitsui, Mitsubishi and Sumitomo are thought to have helped build modern Japan a century ago and followed into war half a century later, Fuyo, Sanwa and DKB came together in their present form only after 1964 Tokyo Olympics (the unofficial starting point for contemporary Japan in the minds of many Japanese), and to some extent are still evolving today.

It is not that all these keiretsu work independent of each other or don’t have common companies. Figure 2 shows the interactions that take place between the big six groups.

Figure 2: Interactions between major Keiretsu and other Groups4

We have used the same classification of firms into old and new keiretsu for our analysis as defined above.

4 Source: http://www.wtec.org/loyola/polymers/c7_s7.htm9


The History of Keiretsu

To look at the keiretsu today simply as large corporate groups with little connection to their respective pasts would delight their public relation departments no end. The three big groups that have proudly retained their names of privately owned prewar companies (called zaibatsu) to which they once belonged – Mitsui, Mitsubishi and Sumitomo – have no choice but to make the best of it and urge the modern observer to see them for what they are rather than what they were. Many other companies consider themselves fortunate not to have one of those three immediately recognizable names over their front doors, for they wish to forget all about the past.

Dawn of the Modern EraThe arrival of the American Navy in the 1850s started a chain reaction in Japan, releasing the pent up political forces which ultimately overturned the old regime. In 1868, this culminated in one of the most dramatic turning points in all the world history – the Meiji Restoration. Japan began an overnight transformation from a government by hereditary shoguns acting in the name of the emperor to a government by elite civil servants acting in the name of the emperor. Where the old feudal government was concerned with increasing the rice harvest and collecting taxes, the new government was intent on building railroads, steel mills and battleships. This was not modernization for modernization’s sake, but a frantic rush to save Japan from what its leaders perceived as rampant Western Imperialism.

At the same time Westerners were crowding in China like hungry wolves, trying to get their hands on anything that was possible. It these powers could simply carve up China like a Christmas turkey, the Japanese islands, defended by the brave young men with swords, would fall overnight. And that was something the new Japanese Government wanted to avoid at any cost. Hence it decided to build a Western army and navy, equip them with Western weapons, and support them with a strong Western Industrial base. Industrial developments overseas were regularly relayed by Japanese students to Tokyo where they could be evaluated and, where feasible, copied.

The Zaibatsu are bornThe Japanese leaders noticed that in the capitalist nations they studied wealth was often concentrated in the hands of few families. Not just the old aristocracy, but nouveau rich industrialists and financiers. These families controlled vast empires of oil, mining, steel, railroads and finance. If this was the way Europeans and Americans built up their industrial might, the Meiji leaders reasoned, there must be something to it. Unfortunately, many of Japan’s wealthiest merchant families had not successfully navigated to the post-Restoration world, although there were still some thriving businesses. Obviously all that was needed was to establish a few key industries, and then encourage some of these wealthy nations to invest in and manage these businesses and Japan would have created its own Rockefellers. In

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time, the families would profit from their new businesses while the state would acquire the industries it needed for economic expansion and military development. The problem with the plan was that they wealthy merchants were led by uneducated men who had made their fortunes under the old regime.

Hence the government had no option but to start investing on its own and it put its hands into various industries. In the Japanese war against Taiwan, Japan had no ships to carry its soldiers to Taiwan and Mitsubishi family offered its help at heavy costs. Since the government had no other option they acceded to the demands made by Mitsubishi, thereby transferring a lot of money in the hands of the family. At the same time, the businesses that the government had entered into did not fare well and soon enough the government coffers were running low. The result was a massive government sale in the 1880s. And it was at this time that four major buyers emerged which led to the formation of zaibatsu.

The Zaibatsu and World War IIFrom the sales of businesses in 1880s to the later 1930s, Japan saw its growth under the flagships of the four zaibatsu, namely Mitsui, Mitsubishi, Sumitomo and Yasuda along with other thousands of smaller groups. To later observers, the 1930s were the heyday of the zaibatsu, a time when they reigned supreme in the Japanese economy. Later on, the leaders of these groups became risk averse and concentrated on effectively managing their empires. They convinced the Prime Minister Kato to cut down on military expenses. This was taken by press and intelligentsia as “unpatriotic” and this started the unpopularity of zaibatsu within the Japanese society.

The public outcry against such a selfish stance on the part of nation’s leading businesses combines grew stronger year by year. And during the World War II they put the muscle in Japanese military advances. However despite of this, the military still looked as the four Big Zaibatsu as unprincipled capitalists and found ways to strike back at them even as they placed more orders for equipment with the zaibatsu firms.

The initial purpose of US occupation was to assure that a former enemy would never again become a threat to world peace. To do that, it was deemed necessary both to disband the military and to eliminate the industrial forces that had supported it, that is, the zaibatsu. However, that the Americans would eliminate all traces of family control was considered inevitable by the Japanese. And as a result even though zaibatsu became weak, they could not be destroyed completely.

Reforming the Japanese EconomyWhen the Occupation started, its job was to secure Japan so that it could never again become an aggressor. By the end of 1947, global political realities were beginning to change. Communism was spreading in both Europe and Asia. By 1948, the Pentagon began to see Japan as a strategic buffer between the United States and the Communist mainland. At the same time, other American interests – both commercial and political – began attacking the SCAP’s5 attempt to implant New Deal ideologies in a

5 SCAP was the Supreme Commander of Allied Powers formed after World War II.11


country that needed a strong industrial base more than trust busting. The end result of this complex debate was a growing consensus that what American needed was a strong Japan rather than a weak Japan. From 1948 onwards, the new theme was rebuilding the economy, both to ensure the continuation of the democratic government and to make the country safe for foreign investment. In sum, fewer than two dozen of the several hundred zaibatsu companies originally targeted for dissolution were ever broken up.

In the Antimonopoly law, SCAP created a Fair Trade Commission (FTC), a watchdog to keep an eye on Japanese business and to make sure that zaibatsu like activities would never again. Had the FTC been allowed to do its job, the Big Six keiretsu would not exist today. Early in 1952, as the Occupation forces were packing their bags, Ministry of International Trade and Industry (MITI) pressured a group of textile makers to limit their production and stick to official quotas. This was exactly the kind of production cartel that had been common among the zaibatsu companies before the war. The FTC responded just as it was designed to, denouncing MITI’s organization of a government run cartel as illegal and improper under the Antimonopoly law. “Not so”, replied the bureaucrats,”We issued no orders. We merely gave the industry a little friendly advice. The law doesn’t say anything about giving advice, does it?”6

From then on the ministry’s “unofficial” but unequivocally imperative “administrative guidance” became a principal tool for reorganizing the economy and forcing uncooperative firms to get with the program. And the program that MITI had in mind aimed at exactly the kind of results the zaibatsu had produced: a rapid development of big industries supported by an army of smaller, cooperative subcontractors. And this slowly led to the formation of keiretsu as we see today.

6 Kenichi Miyashita and David Russell, “Inside the Hidden Japanese Conglomerates”, Page 3512


The Heart of the Keiretsu

There are certain elements that are common to al large horizontal keiretsu, including of course the Big Six. The most important elements are the two kinds of companies in the nucleus of the largest groups, companies which do not have the counterparts in the United States. These are the main bank and the general trading company (sogo shosha). Other important elements are cross shareholding relationships, assigned directors, and intra group finance and intra group trade.

The Main BankIn the United States and Europe, corporations have commonly used a variety of means to fund their operations, including both bank lending and equity-linked financing. Until 1990s, Japanese companies did not have this range of options. Throughout the early history the Tokyo Stock Exchange (TSE) was little more than roulette wheel and only began to gain some respect as a vehicle for corporate financing before the war. It was closed during the war and then when it reopened, it could not respond and adjust to the changing Japan. As a result, the TSE was not a company’s first choice for fund raising. Because the government wanted to control the limited flows of capital in the economy, the Ministry of Finance also devised strict regulations to make sure that the stock market would not mature and rival the banks. Thus the government helped to build and shape the new bank-led keiretsu and the banks became the source of funds for post war industry. This primacy remained essentially unchallenged until the late 1990s.

The primary functions of a main bank are:

Lender: The most important role of the main bank is that which originally led to growth of the companies in its group – supplying funds.

Stockholder: It is well known that large Japanese companies tend to hold each other’s stock in a pattern known as stable cross-shareholdings. The big city banks are among the nation’s largest shareholders and certainly among the best-known stable shareholders.

Credit Monitor: The banks can be viewed as “a substitute for the kind of screening and monitoring institutions that are prevalent in other capital markets, such as bond- and credit-rating institutions and security analysis institutions.

Venture Capitalist: The main bank is not merely a lender, but also a well-informed and risk-averse venture capitalist. Because of this kind of information gathering necessary to perform its role as a lender, stockholder, and credit monitor, the bank knows the companies in its group intimately.

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Company doctor: There is a well known adage in business circles, one that Japanese executives are of fond of quoting to foreign visitors: “Japanese companies do not go bankrupt.” This is so because banks are there to bail out companies if they are running short of funds.

The Sogo ShoshaThe other kind of firm that is vital to the operations of the keiretsu is a uniquely Japanese institution, the general trading company or sogo shosha. There are hundreds of small and medium sized shosha but only nine of them are big enough to take notice of. And even among those nine, the top six are disproportionately large.

“A sogo shosha is like no other type of company. It is not defined by the products it handles or even by the particular services it performs, for it offers a broad range and changing array of goods and functions. Its business goals are equally elusive, for maximization of profits from each other transaction is clearly not the major goal, at either the operating or philosophical level. There are really no other comparable firms, although important businesses and government leaders in the United States and elsewhere have become convinced that there should be. The six affect the lives of most participants in the world economy.”7

Hence to understand the importance of sogo shosha lets use an example. This example is sourced from an article by Paul Sheard in Journal of the Japanese and International Economies. Have a look at figure 3.

Figure 3: Relevance of Shosha in the Japanese Economy8

7 Michael Yoshino and Thomas Lifson, “ The Invisible Link: Japan’s Sogo Shosha and The Organization of Trade”8 Source: Article by Paul Sheard in Journal of the Japanese and International Economies

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The shosha here acts as an intermediary between a buyer and seller. The goods involved could be anything from chopsticks to rolled steel. The process looks like this: The buyer places an order and seller delivers the goods on credit, perhaps knowing nothing about the buyer, but knowing that a “name” shosha is handling the deal. The buyer then issues a bill A to the shosha, which in turn issues its own Bill B to seller. The seller can obtain immediate cash for this transaction by taking the shosha’s bill B to any bank in the country (something you could never do with a note from the buyer). The shosha must pay its Bill B when it comes due at the bank and collect payment from buyer when Bill A becomes due.

By intermediating the transaction, the shosha eliminates need for the seller to extend credit to some tiny firm it has never heard of; instead, it extends credit to a giant trading company. Similarly, the buyer is in debt not to the supplier but to large, well-connected trading company which can manage risk much better than the seller.

Convoluted as this system may sound at first, it has enormous impact on the ability of small companies to do business smoothly. Where small firms would have to pay in cash, possible by putting up collateral for short term loans, or take large risks in dealing with companies whose financial status they know little about; instead they buy and sell freely and obtain the goods they need immediately on credit. Nor are the benefits limited to small firms. The banks, which would normally have to perform innumerable credit checks on thousands of small companies, can relax and expand their guaranteed loan base because the shosha has done all the credit checking in advance and so assumes the risk itself.

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The Study

Keiretsu networks have always been under research from various authorities to look at how this firms work and whether they deliver to a firm what they have promised. Until recently it was safe to say that a keiretsu firm would not go bankrupt. But as one could see in the case of Yamaichi Shoken (which was close to enough Fuyo to participate in the regular kondankai meetings of the group), things are changing at the frantic pace in Japan9. One needs to ask whether this is just one off case or has the trend set in?

We have performed the study at two levels:

Corporate Governance: Corporate governance is understood as the process and mechanisms by which the market monitors the action of corporate management. For this we have used the following parameters:

o Return on Sales

o Return on Equity

o Return on Invested Capital

Operational Efficiencies: Operational efficiencies define how the operations of the company are and disclose details on how well the company is performing when checked upon the day to day parameters. The parameters that have been used in this area are:

o Inventory Turnover

o Accounts Receivables

o Asset turnover Ratio

Earlier StudiesSome of the interesting studies in the same area are:

It has been frequently suggested that affiliation to a keiretsu should be seen as a competitive advantage (Eli 1988, 1994; Nakatani 1984; Sydow 1991).

Firms within a keiretsu have the advantage of economy of scope (Sheard 1998: 9)

9 Lapavistas and Costas. “Transition and Crisis in the Japanese Financial System: An Analytical Overview”16


They can rely on support from the other member firms and especially the bank in times of crisis (Nakatani 1984: 229). This “mutual insurance scheme” is said to be the reason for the lower, but more stable profitability of the keiretsu firms (Ito and Hoshi 1992: 87).

But things have been changing over time, and so Lincoln, Gerlach and Ahmadjian suppose that “… the combination of deregulation, structural change, and macroeconomic shocks explains the fast decay of the redistribution pattern among the big-six keiretsu after 1985” (1996: 81).

According to Nakatani, “group formation makes it possible for individual firms to insulate themselves from the imperatives of market forces” (1984: 245).

Keiretsu firms have a different relationship to their main bank, which allows them to operate with a lower equity ratio and ensures the flow of capital. They pay out income more heavily in wages, while independent firms have to attract the capital market.

During the phase of high economic growth, Japan's industrial policy has been one of the main factors for the success of Japanese firms, especially the keiretsu. A constant information flow between bureaucracy and industry has been maintained through the employment of retired bureaucrats by the enterprises, called amakudari (Schaede 1994, van Wolferen 1989).

Keiretsu has been a key element in driving Japan’s industrial growth and development (Calder 1993: 142)

Firms within the keiretsu provide parts to the firms above at lower costs due to relation specific investment (Aoki 1998)

The Answers We SeekClearly the research is divided on whether the keiretsu is good for Japan or not. Hence some kind of analysis needs to be done to find out the effectiveness of the Keiretsu system. The questions we asked while reading the above studies are:

Does affiliating to Keiretsu guarantee excellent results?

Does affiliating to Keiretsu guarantee stability in results?

Does the Capital Structure of Keiretsu firm have some impact on the firm?

Is there something to learn from the Japanese Keiretsu System?

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Research Methodology

Data collectionTo achieve answers to above questions, 97 Japanese companies are picked up from the Kaisha Database10. There are 31 companies from Chemicals, 32 from Electrical Machinery, 27 from Machinery and 7 from Automotive industries. The selection of these companies for current analysis is based on the fact that Japanese industry is manufacturing based and the industries selected form the core of the same.

The financial data for the above companies is sourced from DataStream11 for the years 1987 to 2007. During data collection, few companies from the above list were found to have changed, closed or acquired. These are then classified into Old Keiretsu, New Keiretsu and Independent firms based on their affiliation. The final list of companies (classified by Industry and Keiretsu affiliation) considered for study are attached as Appendix 1.

MethodologyFrom the financial statements of the companies considered, the following ratios are obtained

1. Return on Sales (RoS)

2. Return on equity(RoE)

3. Return on Assets (RoA)

4. Inventory Turnover days(ITO)

5. Accounts Receivable days(AR)

6. Asset Turn over (ATO)

The first three ratios are taken as indication on corporate governance and the latter three as indication of operational efficiency. These values are then averaged out across the Keiretsu affiliations over the two decades industry wise. Along with these six parameters, capital structure of the companies analyzed is by using to debt to common equity ratio.

All these values obtained are tabulated in Appendix 2. Average values for 2 decades for Old Keiretsu, New Keiretsu and Independent groups across the Industries could be found. The parameters used are

10 Kaisha Database consists of annual accounts of Japanese manufacturing firms. The same are listed according to industry 11 DataStream database is accessed from IIM Bangalore Library during the course of study

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then integrated into radar chart similar to hexagon criteria12 developed by Albach. The advantage of this method is that the performance of the company can be viewed as a combination of all the factors by comparing areas of the radar chart for various groups rather than individual dimensions. For the purpose of making radar chart, following formulae are considered to develop scores on a scale of 0-10 from the above parameter values obtained.

1. ITO score = ITO/15

2. AR score= 500/AR

3. RoS score = RoS* 2.5

4. RoE score =RoE

5. RoA score = RoA

6. ATO = ATO*5

12 From “Does Governance matter? Performance and Corporate Governance Structures of Japanese Keiretsu Groups”, Andreas Moerke, Social Science Research Centre, Berlin, 1997

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ResultsThe results for different industries are considered in this section along with important observations from the same while the overall conclusions are listed in the next section.

Results – Chemical Industry

The following radar charts depict different groups within the chemical industry in two decades.

Figure 4: Chemical Industry 1987 - 1997

Figure 5: Chemical Industry 1998-2007 20


From the above radar charts, it could be seen that Chemicals industry is growing over the two decades and Independent firms outperform Keiretsu firms in both the decades. Old Keiretsu firms have performed better on ITO parameter but Independent firms are fast catching up.

Results – Automobile IndustryThe following radar charts depict different groups within the Automobile industry over the two decades.

Figure 6: Automobile Industry 1987-1997

Figure 7: Automobile Industry 1998-2007

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The above radar charts indicate that Automobiles industry has experienced moderate growth over the two decades and Independent firms rank highest on most parameters.

Results – Electrical Machinery IndustryThe following radar charts depict different groups within the EM industry in two decades.

Figure 8: EM Industry 1987-1997

Figure 9 Fig 6: EM Industry 1998-2007

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The above radar diagrams point out that Electrical machinery industry has not growth significantly over the two decades. Independent firms show better relative profitability

Results –Machinery Industry The following radar charts depict different groups within the Machinery industry in two decades.

Figure 10: Machinery Industry 1987-1997

Figure 11: Machinery Industry 1998-2007

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The above radar charts indicate that Machinery industry has declined over the two decades and Independent firms put up a weak performance in contrast to the earlier scenarios.

Results: Variation of profitability over Decades for different groups

The variation in profitability of different groups over the decades has been tracked through standard deviation of RoS. The results are tabulated below.

Table 1: Standard Deviation in Return on Sales for various industries over the two decades

It could be seen that the variation for Independent firms is higher than Keiretsu firms in most industries if not all. The graphs indicating the profitability over the span of 20 years or different industries are attached as Appendix 3.

Capital Structure: Different groups over decadesThe capital structure differences between the groups are studied through the ratio debt to common equity (in %). The observations for the same are shown as the following graphs.

Figure 12: Fig9: Debt to Equity (%) 1987-1997

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Figure 13: Fig10: Debt to Equity (%) 1998-2007

It is clearly visible that keiretsu firms have higher debt to equity ratio indicating that they have better access to debt across the industries.

ConclusionsThe following conclusions can be made from the results obtained in the above study as answers to the questions we started with.

1. Independent firms show better performance over the decades across industries indicating that affiliation to Keirestu doesn’t ensure better profits and in fact lowers the same.

2. Affiliation to a keiretsu has however provided stability of returns over the independent firms. This is referred to as ‘Mutual Assurance Scheme’ in earlier studies.

3. Clear differences in capital structure of Keiretsu and Independent firms indicate easier access of debt to Keiretsu firms over Independent firms.

The contrast scenario of Independent firms’ performance in Machinery industry can also be explained from latter two conclusions. In a declining industry where access to capital is naturally difficult, Keiretsu firms have better performance owing to their ease of access to capital. Similarly the mutual assurance of a Keiretsu affiliate firm allows it to show stable profit in declining period.

Another important conclusion can be made about the inefficacy of new Keiretsu affiliates. This would lead us to answering the question 4 about learning from the Keiretsu system. But before we do that, let us understand why Keiretsu is considered a problem by other developed nations especially US.

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The “Keiretsu Problem”

Why is it that Keiretsu has become such a huge rage amongst the research community? Is there something substantial to this problem or is it another tactic of the United States to control the fast paced growth of the Japanese industries in United States and all over the world?

The very first comment that needs to be made about the “Keiretsu Problem” is that the name we have given to the “problem” is telling. Most of the rhetoric about keiretsu refers to the horizontal groups, which are in no way unique to Japan. The idea of financial/industrial combine is common throughout Europe and Asia as well as United States. Some examples which come to mind are:

Deutsche Bank of Germany which owns more than a quarter of equity in some of that country’s leading auto, machinery and retailing operations

Dresdner Bank and Allianz provide similar examples

The same structure exists in one form or another in Sweden, France, Italy among others

One World and Star Alliance in United States

Tatas, Ambanis, Birlas and Mahindras in India

The question then becomes: Why is keiretsu an issue, and why is it only an issue against Japan? Why do we get hot under the collars about Japanese banks’ industrial groups but ignore the Germans? Are we implying that the Germans banks are just being efficient, while Japanese banks are doing something evil? For that matter, why do we use the work Keiretsu? We have a phenomenon that is common all over the world and was even common in the United States long ago and is again coming back, but when we make an issue of it we tag it with the Japanese word. What’s the message?

Some of the reasons that come to mind are:

The expanding United Stats’ trade deficit with Japan and its growing fear that the nation’s seemingly powerful industries – especially as it relates to their declining economic prowess.

Misunderstanding of the problems in entering the Japanese Economy as a foreign player. However, the biggest problems that foreign firms find in Japan are not the domination of a single business by the keiretsu companies, but rather control by industrial cartels, often condoned and sometime supported by the government. Just as one example, the ongoing US-Japan debate over Dango (the private arrangement by which Japanese construction firms decide which companies will compete and which will “win” bids for the new public contracts) is not a problem of keiretsu-controlled dealings.

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The learning from Keiretsu & its Strategic implications

Keiretsu has good side of providing stability through mutual assurance scheme and better access to capital even in declining periods. Bad side of Keiretsu is the reduction of performance as compared to independent firms and hence wealth destruction for shareholders and economy in general. Also as seen from the above section, it is not Keiretsu but the cartel formation which is the ugly side of Keiretsu model. Also an important conclusion from the study is that new keiretsu firms are unable to leverage keiretsu benefits while missing the performance of independent firms at the same time. This shows that while Keirestu model is beneficial in certain situations, it is a baggage at others.

Figure 14: Implication of Keiretsu model to Industry stages

The above implication when applied to an Industry in different stages, we see that it is beneficial for a firm to follow keiretsu model in new industry or turnaround industry while following independent route in a mature industry. This is depicted in the above figure. While it is not easy for a firm to get aligned with a Keiretsu for a while and then get away from the same, It is important for the central player (here central bank) to know when to take control of individual firms in the conglomerate and when to operate them as loosely bound market.

Similarly, the same conclusion when applied to an economy in different stages, we see that it is beneficial for the economy to follow keiretsu model in emerging stage, where capital investment has to be done majorly by few players (like Government & Keirestu in earlier Japan or Government in current China). This enables the economy to grow in these initial stages without fear of assault of other developed economies. But when the same economy when reaches developed stage, it is right for it operate under market model than to be protective and destroy wealth. This suggested path is shown in the following figure.

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It is here current Japan economy looks to have lost the edge it created by following keiretsu model in its emerging stages. It would be beneficial for Japanese economy to move from Keiretsu model to Independent firm model in all matured Industries. Similarly earlier India seems to have lost an opportunity to have grown faster than it had (in contrast to China). It could have been better for India to have approached investment and industrialization with a clear authority lying with few players along with Government. But India seems to have taken right step for the coming time when it becomes more developed economy than emerging economy. It might score over China with this strategy in the coming time.

Figure 15: Implication of Keiretsu model to Economy stages

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References

1. “Keiretsu – Inside the Hidden Japanese Conglomerates”, Kenichi Miyashita and David Russell

2. “Does Governance matter? Performance and Corporate Governance Structures of Japanese Keiretsu Groups”, Andreas Moerke, Social Science Research Centre, Berlin, 1997

3. “Alliance Capitalism: The Social Organization of Japanese Business”, M Gerlach, University of California Press, 1992

4. “Corporate Structure, Liquidity and Investment: Evidence from Japanese Industrial Groups”, T Hoshi, A Kashyap, D Scharfstein, The Quarterly Journal of Economics, Volume 106 (1991)

5. “The Venture Capital Keiretsu Effect: An Empirical Analysis of Strategic Alliances Among Portfolio Firms”, Laura Lindsey, Stanford Institute for Economic Policy Research, November 2002

6. “From Keiretsu to Startups: Japan’s push for High Tech Entrepreneurship”, Henry S Rowen and A Maria Toyoda, Asia Pacific Research Centre, Stanford University, October 2002

7. “Keiretsu and Relationship Specific Investment: A Barrier to Trade”, Barbara J Spencer and Larry D Qiu, University of British Columbia, Canada, and the NBER Hong Kong University of Science and Technology, Hong Kong, March 2000

8. “The Fable of Keiretsu”, Yoshiro Miwa and J Mark Ramseyer, Harvard Law School, March 2001

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Appendices

Appendix 1: List of companies considered

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Appendix 2: Summary of Values Obtained

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Appendix 3: RoS performance of different groups over the years

Automobile Industry

EM Industry

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Chemicals Industry

Machinery Industry

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