Japan’s Middle Market: Crucial. Competitive. Concerned.

Japan’s middle market Crucial. Competitive. Concerned.An Economist Intelligence Unit report

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1© The Economist Intelligence Unit Limited 2013

Japan’s middle market: Crucial. Competitive. Concerned.

Contents

Executive summary 3

Introduction 5

1: Characteristics of Japan’s middle market 8

More productive than its international counterparts 8

More resilient than large companies… 8

…but struggling to maintain employment levels 9

A changing industrial profile 9

Three distinct segments 10

2: Gauging sentiment in Japan’s middle market 12

Economic backdrop 12

Headline results 12

Revenues outlook shows mid-market resilience 12

Export earnings expected to rise 13

Staffing levels to remain flat 14

Financing conditions look brighter 14

A gloomy outlook for middle-market manufacturers 15

Healthcare is the best performing and most optimistic sector 16

OncoTherapyScience: Going it alone 17

Construction and real estate companies are bullish 17

Financial and professional services expect overseas earnings growth to continue 17

Smaller mid-market firms are unhappier 18

Younger firms are much more optimistic 18

Lifenet: A new face in insurance 19

Outlying regions are more pessimistic—but Tohoku sees improvement 20

3: Challenges to growth 21

Macro environment 21

Combating poor domestic conditions 21

Navigating the regulatory environment 22

Strategy 23

Establishing a growth strategy 23

Understanding changing demand 24

Montbell: The power of kinobi 25

People 25

Finding and developing talent 25

Ensuring leadership succession 26

Nakashima Propeller: The world is our market 27

Financial management 28

Securing affordable funding 28

2 © The Economist Intelligence Unit Limited 2013


4: Internationalisation and its challenges 30

Still mostly focused at home 30

Outsourcing but in-selling 31

China and South-east Asia are the biggest draws 32

Finding talent remains the principal challenge 33

Honeys: Playing the long game in Myanmar 34

5: Middle market growth champions 35

Growth champions are flexible and diversified 35

Growth champions have less bureaucratic management 36

Growth champions invest in innovation, IT and human capital 36

Growth champions keep closer control of costs and working capital 37

Growth champions are more likely to have an international strategy 37

Livesense: Growth through entrepreneurial spirit 37

Conclusion 39

Appendix I: Sentiment indices 40

Appendix II: Survey results 51



Japan’s middle market—comprising companies with global annual revenues of between ¥1bn and ¥100bn—is a vital part of the economy. Yet, like its counterpart in other countries, it receives comparatively little attention—arguably far less than it deserves given the middle market employs a quarter of the workforce, earns around a third of gross revenues and has demonstrated remarkable resilience amid the difficult economic conditions of recent years.

This paper, sponsored by GE Capital, seeks to remedy that deficiency. The paper examines the characteristics of Japan’s middle market, gauges the sentiment of senior managers at mid-market firms, examines the key challenges they face in growing and seizing opportunities abroad, and identifies the factors differentiating those that have grown steadily in recent years from those that have struggled. The paper also includes case studies based on in-depth interviews with the heads of a number of innovative and notable mid-market firms at the forefront of their industries. It paints a picture of a sector of Japanese business that is crucial to the future of the economy, competitive compared to its international peers and yet concerned about its future.

The key findings of the paper include:

l Japan’s middle market is more productive than its international counterparts The middle market accounts for a relatively small proportion of Japan’s total enterprises (just 2.1%) but over a quarter of employment and around one-third of total revenues. In comparison with its developed-economy peers Japan’s middle market is less significant in terms of employment (as may be expected, given the recruiting power of Japan’s giant enterprises) but matches them in terms of revenues, suggesting it outperforms in terms of productivity (revenue per employee).

l It is more resilient than Japan’s large companies… The middle market has proved itself to be resilient in the face of the economic problems Japan has faced in recent years. Average nominal revenues earned by middle-market companies between 2008 and 2011—years which saw the nadir of the financial crisis and the devastating Tohoku earthquake and tsunami—fell just 7.5%, while those at large companies (with revenues over ¥100bn) fell 10%. In addition, according to the survey results, executives at mid-market firms thought demand for their goods and services fared better in each of the past three years than the national economy.

Executive summary



l …but employment levels have been hit harder Comparing average employment among middle-market firms from 2008-11, the sector has been hit harder than the small and big sectors—suggesting many have faced tough decisions about cost-cutting to protect margins. Average employment levels at mid-market companies fell 15% in the period 2008-11, compared to a 5% drop among large companies. Small enterprises (excluding sole proprietorships) performed best, with average employment growing 9% in the same period. The survey suggests that despite an optimistic growth outlook at middle-market companies, staffing levels in the sector are likely to remain flat in 2013.

l Middle-market manufacturing is the least optimistic industry Middle market companies in Japan’s manufacturing sector suffered the worst performance of any mid-market industry in 2011 and 2012 and are the most pessimistic about 2013. The sentiment index for mid-market manufacturers’ total revenues has indicated steadily contracting revenues year on year, on average, since 2010. Although mid-market manufacturers are marginally more upbeat about 2013, the index still shows that more expect revenues to contract than expect growth—the only industry group among the middle market for which this is true. Increasing competition and concerns about the continued “hollowing out” of Japanese manufacturing are the most likely culprits for the pessimistic outlook.

l Healthcare, construction and real estate are the most optimistic sectorsAt the other end of the range, the healthcare, pharmaceutical and biotechnology industry group is the middle market’s most bullish sector. The sentiment index for total revenues shows growth in each of the past three years and optimism for continued expansion in 2013. The sentiment index for total revenues is the highest of any industry, followed closely by the construction and real estate sector. Optimism

in these sectors reflects a positive outlook for domestic demand. For healthcare this is due partly to the continued ageing of the population, while the construction and real estate sector is presumably upbeat about reconstruction spending and the re-election last year of the Liberal Democratic Party, with which it has historically close ties.

l Poor domestic conditions are a major concern, but the middle market remains focused at home Regardless of a brighter domestic outlook for the healthcare and construction sectors, three-quarters of mid-market firms say that a slowdown in domestic demand will be a major challenge in the year ahead. Meanwhile, more than half cite increasing competition in their industry as a concern. However, only 26% of mid-market companies derive 10% or more of their total revenues from foreign markets, and only 42% actually have investments outside Japan. Younger mid-market companies are the exception: 38% of those under 10 years old earn more than 10% of their revenues from abroad.

l Finding and developing talent are major challenges to growth Worryingly, only about a third of mid-market executives feel their firms can attract the talent they require, reflecting perhaps the dominance of big firms in Japan’s regimented graduate recruitment process. As a consequence, just 41% of middle market respondents believe their firms are committed to developing young talent who will stay for their entire careers. Meanwhile, the most pressing challenge for mid-market companies that venture abroad is the attraction and retention of suitable staff to manage those investments. This is seen to be a challenge by over 80% of mid-market companies.

l Many mid-market firms face a leadership succession challenge Less than 30% of mid-market firms feel they have a well defined succession plan—a particular concern given that many smaller mid-market



firms remain family owned and run. Executives at mid-market firms generally have confidence in their current management teams, though: more than half of respondents believe their management teams lead effectively, while only about a fifth feel they do not have the skill set to meet the challenges ahead.

l Successful mid-market firms have clearer strategies, more flexible management and invest more in innovationMiddle market “growth champions”—companies that recorded three successive years of revenue growth in 2010, 2011 and 2012—are identifiable by certain characteristics not shared by their less successful peers. Growth champions are much more likely to have a clear growth strategy: some 71% says their firms have such a strategy in place compared to just 32% of the poorer performers. They are more flexible: two-thirds agree that they are well positioned to take advantage of changes in their markets, compared to just one third of the remainder. Moreover, some 57% of growth champions regard their success and adaptability as a result of a less bureaucratic management

style while just 29% of the poorer performers say the same thing. Finally, growth champions are more likely to invest in product development and process innovation in the coming year, and are putting greater emphasis on acquiring new talent and advanced IT.

These findings demonstrate that Japan’s middle market is crucial to the economy and concerned about its future. The research also demonstrates that successful firms in this sector have the potential to be Japan’s most internationally competitive. The case studies show that many middle-market firms have the entrepreneurial drive, flexibility and determination to succeed in expanding their horizons. Moreover, the fact that they operate in the exacting Japanese market can give them an edge internationally. Finally, their competitiveness rests on occupying a sweet spot between small-scale (and capital-poor) craftsmanship on one hand, and somewhat inflexible, highly diversified conglomerates on the other. Japan’s middle market can therefore play an important role in the long-awaited recovery of the country’s economic fortunes.



1 See, for instance, US middle market firms and the global marketplace, Economist Intelligence Unit, 2012; as well as The Mighty Middle: Why Europe’s Future Rests on its Middle Market Companies, and Leading from the Middle, The Untold Story of British Business, GE/Essec Business School, 2012.

In Japan, as in other developed economies, micro and small businesses receive a lot of media attention and policy support, embodying as they do the nation’s entrepreneurial spirit. Japan’s largest companies, meanwhile, use their success and influence to command constant media coverage, control over leading industry bodies and significant lobbying power. The middle market—the focus of this report—falls between these two stools, and is consequently often overlooked, yet represents a crucial part of the Japanese economy, employing a quarter of the workforce and earning a third of gross revenues.

In this report we include any firm with global annual revenues of between ¥1bn and ¥100bn in the middle market. This definition was derived from several sources, including analysis of the latest economic census and the characteristics of various groups of companies in a large database of 1.3m Japanese firms. This revenue definition also broadly matches definitions of the middle

market in comparable economies in Europe and the US (adjusted for yen earnings).1

This revenue range includes a wide variety of subsectors and company types, each crucial for the future health of Japan’s economy. At the lower bound, while it excludes very numerous, very small enterprises—sole proprietorships and many family-run service sector firms, for instance—it includes innovative and fast-growing small businesses at the cutting edge of many industries. These include, for example, new companies like web portal Livesense and online grocery Oisix, both headed by young entrepreneurs. At the upper bound it includes many well-established firms that are leaders in their industries—such as Honeys clothing, for instance, or Nakashima Propeller. What role these smaller growth champions and more established middle-market stalwarts play in the economy, what challenges they face, and whether they have the potential to become Japan’s next giants is what this research set out to answer.

Introduction



The findings of this report are based on three research methods. The first involved detailed analysis of the Orbis/Bureau van Dijk database of 1.3m Japanese firms. Middle-market firms were identified as those with annual revenues of between ¥1bn (US$12.5m at end-2012) and ¥100bn. Discrepancies or gaps in firm-level information in this database were resolved through comparison with the most recent national Economic Census for Business Activity (2012). Secondly, in December 2012 and January 2013, the Economist Intelligence Unit (EIU) conducted a survey of 1,000 senior executives from middle-market firms headquartered in Japan. Among the respondents, 50% were board members or C-level executives, while the remainder were directors, heads of business units and other senior managers. Thirdly, the EIU

About the research

conducted face-to-face interviews with a range of senior executives from middle-market companies in Japan, as well as with business associations and industry groups. Our thanks are due to all interviewees for their time and insights.

David Line was the author of the paper. Takato Mori PhD and Amie Nagano PhD led research and reporting in Japan, while Andrew Hutchings and Sudhir Thomas Vadaketh provided additional survey analysis. Our special thanks for his input are due to Professor Ashwin Malshe of ESSEC Business School, Singapore.

The English version of this paper should be regarded as definitive. The Japanese translation was edited by Takato Mori and Amie Nagano.



More productive than its international counterpartsThe middle market occupies a crucial place in Japan’s economy, accounting for a relatively small proportion of the total enterprises (just 2.1%) but over a quarter of employment and around one-third of total revenues earned (Figures 1.1-1.3). By these calculations, the middle market in Japan is slightly less significant in terms of employment than in comparable economies—as one might expect,

given the preponderant recruiting power of Japan’s giants—but it outperforms in terms of productivity, or revenue per worker (Figure 1.4).

More resilient than large companies…Middle-market firms in Japan are mostly stable and well established: according to our survey, just 7% were incorporated within the past 10 years, 58% are between 11 and 50 years old and 35% are more than 50 years old. They have also proved themselves to be resilient in the face of

Characteristics of Japan’s middle market1

The middle market in Japan’s economy

Figure 1.1-1.3

97.9%2.1%

Middle market

Companies(% enterprises)

74.7%25.3%

Middle market

Employment(% of workforce)

68.3%31.7%

Middle market

Revenue(% of private-sector revenues)

Sources: Orbis/Bureau van Dijk, Japan economic census, Economist Intelligence Unit estimates

Figure 1.4: Middle-market sectors in comparison

Share of employment (%) Share of total companies (%) Share of revenues (%)

Japan 25.3 2.1 31.7

EU4 (Germany, UK, France, Italy) 32.6 1.52 31.7

US 34 3 33

Sources: Orbis/Bureau van Dijk, Japan economic census, Economist Intelligence Unit estimates, papers cited in footnote 1



the economic problems Japan has faced in recent years. This is evident if one looks at the change in average revenues earned by middle-market companies between 2008 and 2011, years which saw the nadir of the financial crisis and the devastating Tohoku earthquake and tsunami. Through this period, average nominal turnover at mid-market companies in Japan fell just 7.5%, while that at large companies fell 10% (Figure 1.5).

…but struggling to maintain employment levelsHowever, when one compares average employment among middle-market firms over the same period, the sector has been hit harder—suggesting many have faced tough decisions about cost-cutting to protect margins. Average employment levels at mid-market companies fell 14.6% in the period 2008-11, compared to a 5.2% drop among large companies. Small enterprises (excluding sole proprietorships) performed best, with average employment growing 9.3% in the same period, doubtless as workers sought alternative jobs in the face of a tougher employment market. Smaller companies may also have benefitted more from official support schemes, of which there have been a plethora in recent tough times, and from which many mid-market firms may have been excluded owing to their size.

Figure 1.5: Comparative average characteristics, 2008-2011

2008 Small (< ¥1bn in revenues)a Middle market (¥1bn-100bn) Large (>¥100bn)

Turnoverb 49.5 6,361 594,606

Assetsb 15.6 15,113 2,264,114

Employees 7.5 144 9,411

2011 Small (< ¥1bn in revenues)a Middle market (¥1bn-100bn) Large (>¥100bn)

Turnoverb 51.2 5,885 533,330

Assetsb 15.8 15,709 2,271,768

Employees 8.2 123 8,921

% change 2008-11 Small (< ¥1bn in revenues)a Middle market (¥1bn-100bn) Large (>¥100bn)

Turnover 3.4% -7.5% -10.3%

Assets 1.3% 3.9% 0.3%

Employees 9.3% -14.6% -5.2%a Excludes sole proprietorships b Nominal ¥m

Sources: Orbis/Bureau van Dijk, Japan economic census, Economist Intelligence Unit estimates

A changing industrial profile By industry, manufacturing dominates the middle market, accounting for over a quarter of the sector overall. Financial and professional services, construction and real estate, and IT, technology and telecoms are the next biggest sectors (Figure 1.6). However, the industrial profile of middle-market companies in Japan is changing. Manufacturing, among the most pessimistic of industry groups across the middle

Middle-market industries(% respondents)

Figure 1.6

26.2%9.2%

7.3%

4.8%

19.5%

12.4%

10%

10.6%

Manufacturing

Financial andprofessional services

Healthcare, phamaceuticalsand biotechnology

OtherConstruction and

real estate

IT, technologyand telecoms

Source: Economist Intelligence Unit survey

Logistics anddistribution

Consumer goods and

retail



2 See Motohashi et al, “Open Innovation in R&D—New Possibilities of the Japanese Economy Found in Medium-Sized Enterprises”, Keidanren 21st Century Public Policy Institute, June 2012. The paper focuses on companies with annual revenues of ¥100m-¥1bn.

market (see Part 2), is not among the top-three industry groups in younger companies, while it remains at the top of those in the established and older brackets (Figure 1.7).

Three distinct segmentsThere are three distinct groups of firms within Japan’s middle market. As in the economy as a whole, smaller firms are more numerous in this sector: some 88% of mid-market companies have revenues under ¥10bn per year. In this paper the middle market is therefore further subdivided into small, medium and large sub-groups, the characteristics of which are outlined in Figure 1.8. These illustrate changing economies of scale; among the largest of the middle-market groups, with average annual revenues of ¥70bn, the average profit margin is almost 5%.

As the sentiment indices in Part 2 show, the fortunes and outlooks of these sub-groups vary considerably. Firms in the large subgroup have been more resilient in weathering the recessions of recent years: 50% of this group reported that revenues grew in 2012, compared to just 38% of the smallest middle-market firms.

Middle-market industries by age cohort(% respondents)

Figure 1.7

34.9%22.9%

5.1%

11.1%10%

6.3%

9.7%

Manufacturing

Professional services

Healthcare, phamaceuticals

and biotechnology

Other

Construction andreal estate

Retailing



Old (over 50 years old)

18.9%29.3%

17.9%

12%6.4%

5.2%

10.4%

Manufacturing

Professional servicesRetailing

Other


Financialservices

IT and technology

Established (11-50 years old)

16.4%28.8%

15.1%

13.7%8.2%

6.8%

11%

ManufacturingProfessional

services

Other


Financialservices

IT andtechnology

Emerging (up to 10 years old)


The three sub-groups are also characterised to some degree by their strategy and aptitudes. Understandably, smaller companies are more likely to target niche segments (nearly half of this sub-group does so), but they are much less confident about innovation: a greater proportion of small middle-market companies does not think they innovate in products and services than thinks that they do so. The large subgroup, those earning annual revenues above ¥50bn, are the most confident about their capacity to innovate—and also about their ability to seize opportunities and take advantage of change (Figure 1.9).

Smaller firms may nevertheless have the flexibility to make the most use of new trends in innovation. Kazuyuki Motohashi, a professor at the University of Tokyo who led a research project on medium-sized businesses for the 21st Century Public Policy Institute at Keidanren, an industry association, emphasises the importance of smaller midmarket companies in open innovation—that is, innovation in collaboration with external firms and academic institutions. “Mid-sized companies with sophisticated technologies are playing an active part in driving



Advantages of size?(% respondents)

Figure 1.9

Agree Disagree

NB: Excludes neutral responses.Source: Economist Intelligence Unit survey

0

10

20

30

40

50

Total Large

We target niche segment(s) We are innovators in new products and services

We feel that companies our sizeare uniquely advantaged to

maximise opportunities

Our size allows us to takeadvantage of changes when

they occur

Medium Small Total Large Medium Small Total Large Medium Small Total Large Medium Small

38.6

26.6

37.1

26.3

33.3

29

42.9

25

32.2

30.8

32.2

30.4 34.8

17.5

37.1

15.7

46.9

13.7

37.7

16.2

31.9

25.8

3322.6

41.7

18.9

3423.526.3

36

48.6

17.1

Middle-market subgroupsSmall = annual revenues ¥1bn-9.99bnMedium = annual revenues ¥10bn-49.99bnLarge = annual revenues ¥50bn-100bn

collaborative innovation,” Professor Motohashi says. “They have more limited resources than bigger firms. So they tend to be very goal-oriented and often produce outputs more effectively.”2

To some degree, then, the middle market in Japan is characterised by its diversity. To gauge the diverse opinions among this group of companies, the Economist Intelligence Unit conducted a survey of 1,000 senior executives from middle-market firms across Japan. The survey questions covered their companies’ overall performance and sentiment (analysed in Part 2), their ability to manage challenges to growth (Part 3) and their plans to internationalise (Part 4). Part 5 examines differences in strategy and operations between middle-market “growth champions”

and their less successful peers. The picture that emerges from this analysis is of a resilient, stable sector, but one that is concerned about the national economy and for which future growth opportunities may well lie outside of Japan.

Figure 1.8: Middle market sub-groups by revenues

Middle-market subgroupsSmall = annual revenues ¥1bn-9.99bnMedium = annual revenues ¥10bn-49.99bnLarge = annual revenues ¥50bn-100bn

Middle market subgroup:

Small Medium Large

Proportion of total middle market by number of enterprises (%) 88 11 1

Average number of employees 90 472 1,476

Average profit margin (%) 3.12 3.86 4.99

Average annual revenues (¥bn) 2.7 20.5 69.9

Source: Orbis/Bureau van Dijk



Gauging sentiment in Japan’s middle market2

Economic backdropJapan’s economy struggled in the years after the global financial crisis, with exporters hit by weakness in major overseas markets, a loss of competitiveness vis-à-vis their rivals and diplomatic tensions with China. The domestic economy, meanwhile, was battered by persistent deflation, policy uncertainty and the biggest natural disaster in modern Japanese history, in the form of the 2011 Tohoku earthquake and tsunami. GDP growth, which had rebounded to 4.7% in 2010 following the global nadir of 2009, shrank 0.5% in real terms in 2011 and registered only 1.8% growth in 2012, despite a boost from reconstruction spending, with the economy slipping back into recession towards the end of the year—its third in five years (Figure 2.1).

Nevertheless, the mood has brightened considerably. Optimism has built over the economic policies of the Liberal Democratic Party (LDP), which returned to power after a sizable victory in the general election of December 2012. “Abenomics”, combining a sizeable fiscal stimulus package, dramatic efforts by the Bank of Japan (the central bank) to get tough on combating deflation, and various structural reforms, has generated the most excitement about Japan’s economic prospects in decades. With the yen—the strength of which had long been the bane of Japan’s exporters—falling 27% between November 2012 and May 2013 and the Nikkei stock market index rising some 37% in the first four months of the year, superficially the prospects for Japan’s economy look promising.

However, macroeconomic prospects for 2013 remain mediocre, with the EIU forecasting real GDP growth of just 1.2%. Concerns remain about both the impact of ongoing problematic relations with China and the effect on Japan’s colossal public debt of yet more fiscal stimulus. Nevertheless, the sentiment indices, despite being derived from a survey conducted before excitement about “Abenomics” had really taken off, reflect optimism about prospects for Japan’s mid-market firms, and the economy at large, compared to the performance of both in recent years.

Headline results

Revenues outlook shows mid-market resilience

Japan’s mid-market companies are faring better than the economy as a whole, according to the

Real GDP(% change year-on-year)

Figure 2.1

Source: Economist Intelligence Unit

-6

-5

-4

-3

-2

-1

0

1

2

3

4

5

2008 2009 2010 2011 2012 2013

-1.1

-5.5

4.7

-0.5

1.81.2



Total revenues(Sentiment index: all respondents)

Figure 2.2

9092949698100102104106108110

2013201220112010


In fact, mid-market firms appear to be among Japan’s most resilient. Executives at mid-market firms thought demand for their goods and services—as well the fortunes of their industry sectors overall—fared better in each of the past three years than the national economy (Figure 2.3), despite net negative sentiment persisting. This shows a continuation of the trend in average mid-market revenues from 2008-11, revealed in Part 1, showing mid-market firms fared comparatively well compared to large firms (although still suffering from a drop in average nominal revenues overall).

Export earnings expected to riseAmong mid-market exporters, sentiment is bullish for 2013, with the index for overseas revenues rising to 104.2 compared to 102.6 for domestic revenues (Figure 2.4). This is likely to be linked to the fortunes of Japan’s currency, which for much of 2011 and 2012 remained overvalued compared to those of Japan’s main competitors, particularly the South Korean won (Figure 2.5). In the weeks

The sentiment indices in this report were compiled from the results of survey questions asking respondents to rate, first, whether quantifiable performance indicators such as revenues and staffing levels had risen or fallen in the past three years, and whether they expected them to rise or fall in 2013. Secondly, they were asked to rate whether qualitative factors such as overall demand, market conditions, the health of their industries, and the broader economy had improved or deteriorated in the past three years, and what their expectations were for 2013. For all of these questions, respondents ranked their answers from 1 to 5, where 1=substantial improvement (or growth), 2=moderate improvement, 3=no change, 4=moderate deterioration (or contraction) and 5=severe deterioration.

To produce a single index number for each factor in each year, the percentages of respondents

picking each score from 1 to 5 were multiplied by 1.5, 1.25, 1, 0.75 and 0.5 respectively. The sum of these figures was multiplied by 100. Therefore any number above 100, to a possible maximum of 150, indicates net positive sentiment (eg growth) in that year, and any number below 100, to a possible minimum of 50, indicates net negative sentiment (eg contraction).

Although the standardised methodology makes results between sub-groups in this survey comparable, it should be noted that data for the years 2010, 2011 and 2012 are based on performance while data for 2013 reflect expectations as of January 2013. Thus it is unsurprising that in many cases 2013 data show an expected upturn, reflecting the enduring hope of many executives that things will be better tomorrow than they were yesterday.

Index methodology

survey results. Although in 2011 revenues among the entire sample contracted on average, top-line growth returned in 2012, with an index score of just over the break-even point of 100. Projections for 2013 show sentiment about revenues improving to 103.3, perhaps reflecting optimism about the new government’s bold economic policies (see Figure 2.2).



Company, industry and economy(Sentiment index: all respondents)

Figure 2.3


80

90

100

110

120

2013201220112010

Your industry as a wholeDemand for your company’s products and services

Japan’s economy

Domestic v overseas revenues(Sentiment index: exporters only)

Figure 2.4


90

92

94

96

98

100

102

104

106

108

110

2013201220112010

Domestic revenuesOverseas revenues

before the survey for this report, however, the yen weakened considerably as the government increased pressure on the Bank of Japan to increase the scope of its monetary easing, giving Japan’s exporters a much-needed boost in competitiveness.

Staffing levels to remain flatRising revenues are not likely to mean increased hiring across the mid market, however; staffing levels were unchanged in 2012 and are likely to remain flat in 2013 (with an index score of 100.8). This runs counter to a separate question posed in the survey about whether mid-market

US$ spot exchange rate

Figure 2.5

Source: FT/Haver Analytics

70

75

80

85

90

95

100

J2013

DNOSAJJMAMFJ2012

DNOSAJJMAMFJ2011

DNOSAJJMAMFJ2010

Yen, left-hand side Won, right-hand side

1,000

1,050

1,100

1,150

1,200

1,250

1,300

firms in general will be placing more emphasis on hiring new talent over the coming year: 47% said they would and only 9% said this would receive lesser attention. Regardless of whether companies focus more on hiring new talent, net employment in the mid market seems unlikely to grow even if expectations about revenues are borne out (Figure 2.6).

Financing conditions look brighterWith regard to external factors affecting mid-market companies, expectations for 2013 are more muted. In general, mid-market firms expect flat or poorer competitive and regulatory



Total revenues(Sentiment index)

Figure 2.8

85

90

95

100

105

110

115

2013201220112010

Manufacturing Construction and real estateConsumer goods and retail Financial and professional servicesLogistics and distributionIT, technology and telecoms

Healthcare, pharmaceuticals and biotechnologyOther


environments to endure through 2013, although sentiment has improved somewhat from 2011-12 (Figure 2.7). One brighter area is sentiment about financing conditions: both in 2012 and for 2013 optimists marginally outnumbered pessimists, with the index rising from 101.8 to 103.9.

This rise is somewhat surprising given the end of the SME financing facilitation law in March 2013. The law, which went into effect in December 2009, required financial institutions to try to accommodate requests from SMEs to extend repayment periods or reduce interest rates on loans. While it certainly helped many small

Staffing levels(Sentiment index: all respondents)

Figure 2.6

9092949698100102104106108110

2013201220112010


External factors(Sentiment index: all respondents)

Figure 2.7


90

92

94

96

98

100

102

104

106

108

110

2013201220112010

Financing conditionsCompetitive environment

Regulatory environment

companies, many middle-market firms would also have benefited from its provisions.

Despite the imminent expiration of the act when the survey was conducted, macroeconomic policy suggested better financing terms may be on the horizon. Interest rates in Japan have remained low for many years, but with persistent deflation, real rates remained in positive territory. In early 2013 there was considerable excitement about an expansion of quantitative monetary easing by the Bank of Japan and a commitment to battle deflation, which doubtless led to more optimism among mid-market executives about financing conditions in the coming year.

A gloomy outlook for middle-market manufacturersMiddle-market companies in Japan’s manufacturing sector—the largest industry group, accounting for 24% of the total—suffered the worst performance of any industry in 2011 and 2012 and are the most pessimistic for 2013. The index for mid-market manufacturers’ total revenues fell from 98 in 2010 to 96 in 2011 and 93 last year, indicating steadily contracting revenues year on year, on average. Although mid-market manufacturers are marginally more upbeat about 2013, at 98.6 the index still shows that more



expect revenues to contract than expect growth—the only industry group in the middle market for which this is true (Figure 2.8).

This pessimism is perhaps to be expected. Manufacturing in Japan has suffered a variety of hardships in the past three years. In particular, the strength of the yen cut export competitiveness—and mid-market manufacturers are among the most dependent of any industry on external markets. Some 59% receive a portion of their total earnings from overseas, compared to 42% among the middle market as a whole. The survey also shows that 37% of manufacturers receive more than 10% of their total revenues from overseas, while across the entire middle market this is true of just 26% of firms.

But depressed earnings from direct exports are only part of the story: many manufacturers in Japan’s middle market are suppliers to Japan’s major exporters, for instance in the auto sector. Falling exports at these giants in recent years—whether down to the strong yen, or rising anti-Japanese sentiment in major markets like China—meant fewer orders for suppliers in Japan. Given this, it is encouraging that a majority of those who do earn revenue in overseas markets expect conditions to improve. The index for

overseas revenues climbs into positive territory in 2013, at 102.4 (although manufacturers are still the most pessimistic industry).

Healthcare is the best performing and most optimistic sectorAt the other end of the range, the healthcare, pharmaceutical and biotechnology industry group is the middle market’s most bullish sector. The index for total revenues shows growth in each of the past three years, and optimism for continued expansion in 2013. At 107 (the highest for the total revenues index, along with financial services and construction and real estate), this is a slight deterioration from a strong performance in 2012 (109) and an even stronger one in 2011 (112), although optimists still outnumber pessimists by some margin.

This is optimism borne principally on conditions in the domestic economy. A glance at Japan’s ageing population, coupled with policy steps to encourage innovation and investment in the sector, suggest healthcare is one of the most promising growth industries in Japan’s middle market. This can be seen in these companies’ expectations about demand for their products and services in 2013: the index number of 108 for this variable suggests considerably more optimism than in manufacturing, for instance (at 99). Healthcare, pharma and biotech firms are also the most bullish about the competitive environment, which after a tough 2012 is forecast to improve in the coming year.

This translates into a particularly marked difference between healthcare and other sectors with regard to staffing levels. In each of the past three years the index for staffing in the healthcare industry group does not fall below 108. In no other sector does the index go above 104 (Figure 2.9). Some 60% of mid-market healthcare, pharma and biotech companies are putting a greater emphasis on hiring new talent in the coming year, compared to 47% across the whole sample. Moreover, some 52% agree with the statement “We are committed to developing

Staffing levels(Sentiment index)

Figure 2.9


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young talent who will stay with us for their entire careers”, compared to 41% across the entire middle market.

Construction and real-estate companies are bullishOne other sector in Japan’s middle market that is notable for its optimism is construction and real estate. Indeed, in terms of the outlook for total revenues in 2013 the index for this industry, at 107.7, is second only to the healthcare, pharma and biotech sector. Middle-market firms in this sector are also the most bullish about conditions for their industry overall in the coming year, with the index for 2013, at 106, well above even the healthcare sector. This follows three years in which a much greater percentage of respondents in the industry reported worsening conditions than improving ones—despite a presumed boost

A biotech venture that sprung from the University of Tokyo’s Institute of Medical Science in 2001, OncoTherapy Science (OTS) specialises in discovering novel anti-cancer therapies with minimal side-effects, based on human genome research. OTS, which had forecast sales of ¥6.3bn in 2011/12, listed on the Tokyo Stock Exchange’s Mothers Index in 2003. Its business model is based on licensing new cancer treatments to pharmaceutical companies, which carry out clinical trials on them. So far, OTS has only licensed to Japanese companies, though it is currently also negotiating with pharmaceutical firms from overseas.

OTS operates out of the Kanagawa Science Park in Kawasaki, a facility that receives some support from the prefectural government, though it is mostly directed at new start-ups. CEO Takuya Tsunoda says the financial support that is available to mid-size firms comes with so many obligations and restrictions, it’s mostly unworkable. “For example, budgets that come from public bodies usually have to be used up by the end of the financial year in March,” says Dr

Tsunoda. “And then, if we make any money from it, that has to be paid back quickly, but we need the funds to reinvest in our research.”

Although OTS faces some of the same challenges as other mid-level companies and ventures in attracting talent, its close links with the University of Tokyo does mean that hiring from Japan’s top academic institution is easier than it otherwise might be. However, Dr Tsunoda points out that for a biotech venture, unconventional thinking is often more important than high test scores.

Dr Tsunoda says OTS would consider acquisitions to strengthen its pipeline and grow its business, but it is not interested in becoming a “big pharma” company, preferring to remain a developer of innovative treatments. He says that part of the problem for biotech ventures in Japan is the lack of role models that have grown into larger companies. “We would like to become that model case, without any help from the government.”

OncoTherapyScience: Going it alone

from reconstruction spending in the tsunami-hit north.

Partly this sector’s newfound optimism reflects short-term considerations: given the historically close ties between the LDP and the construction sector, its victory in the general election buoyed sentiment in the industry. Indeed, a large part of the new government’s ¥10.3trn fiscal stimulus plan, unveiled in January, was allocated to infrastructure and construction spending. Consequently, it is no surprise to see the middle-market construction and real-estate sector also bullish about hiring this year, with the EIU index for staffing levels rising to 104—second only to the healthcare sector.

Financial and professional services expect overseas earnings growth to continueAll mid-market sectors that earn revenues from



overseas are, on average, positive about export earnings rising this year, thanks no doubt to the weakening yen. Among the most optimistic are financial and professional services firms, of which 35% in the middle market earn revenues overseas. Although moderating from a strong 2012, more firms in this sector expect growth in the coming year than expect contraction, with an index score of 107 (Figure 2.10).

These companies have fared better in the recent past than other mid-market exporters (for instance manufacturing and retail firms), in part because of the increasingly acquisitive nature of large Japanese companies. By mid-December 2012, when the survey for this paper launched, Japanese companies had bought 489 foreign firms since the beginning of the year, beating a calendar year record of 463 set in 1990. Cumulatively these deals were worth ¥6.89trn (US$8bn), the third-highest figure on record according to Recof, an M&A advisory firm. Each of these deals entails the involvement of both financial and professional services firms, and those in the middle market with the capability to support acquisitive clients abroad have been rewarded.

Smaller mid-market firms are unhappierIt is no surprise that smaller mid-market companies, in the main, are less happy with their recent performance and more pessimistic about future conditions than larger ones. In this sense the index results follow similar surveys of corporate confidence, such as the Bank of Japan’s headline Tankan Index (published quarterly). Indeed, although in the EIU index in 2012 large mid-market firms (those with annual revenues of between ¥50bn and ¥100bn) fared worse than medium-sized ones (with revenues of ¥10bn-¥50bn), their outlook for 2013 is much more optimistic, with an index number of 109 for total revenues—compared to around 102 for both medium and small (¥1bn-¥10bn) mid-market companies.

Younger firms are much more optimisticThe indices reveal that emerging mid-market companies—those up to 10 years old—are considerably more optimistic about their prospects for the coming year, and had a far better 2012 than older, more established firms (Figures 2.11-2.14). This optimism is evident for both domestic and overseas revenues, for respondents’ industries as a whole, and with regard to demand for individual companies’ products and services. Even in external factors such as the regulatory and competitive environments, and financing conditions—a factor not commonly better for new firms than for more established entities—youthful firms are more bullish.

Several points should be made about the apparent brighter outlook for younger mid-market companies. One is that the result comes from a much smaller dataset: only a minority of middle-market firms in Japan is young—just 7.3% were established within the past decade. In addition, it is true that earnings are considerably more volatile in younger companies and industries than in their more mature counterparts, so there is no guarantee that their optimism will be justified.

Overseas revenues(Sentiment index: exporters only)

Figure 2.10


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Established in 2008, Lifenet Insurance Company was the first new independent insurance company in Japan since the second world war. With 90% of households already covered by life insurance policies and the industry dominated by giant, venerable firms with colossal resources, the prospects for a new entrant would not appear to be great. But the 100% internet-run business has achieved a rapid growth rate (with the annualised premiums of policies in force worth approximately ¥6.3bn as of end-2012) with a gamechanging strategy.

In Japan’s struggling economy, “There is strong demand for more affordable insurance products, especially from younger generations,” claims Lifenet’s president and founder, Haruaki Deguchi. In order to exploit

this niche, the company has reduced policy premiums drastically by using the internet as its only sales channel and targeting computerliterate young consumers. Mr Deguchi is scathing about the established giants, saying they are “dependent on the business model of the 20th century premised on high economic and population growth—selling highly priced products through extensive sales networks.”

Lifenet isn’t worried about the market’s 90% saturation rate. “We currently have about 170,000 policies in force, for 100,000 policyholders. But this is only a small proportion of the younger population in Japan given that the country has about 1.2 million new adults this year,” Mr Deguchi says. “The life insurance market in Japan is a ‘blue ocean’ for us.”

Lifenet: A new face in insurance

Total revenues(Sentiment index)

Figure 2.11-14: Youthful optimism


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Of course, older companies that have remained in the middle-market bracket, rather than graduating out of it, are unlikely to be identifiable as growth champions, or notable for the gung-ho optimism of their managers. Still, they are marginally the most optimistic group concerning Japan’s economy as a whole in 2013. This may well reflect their satisfaction at the return to power of the LDP after three years of Democratic Party rule. Executives at older companies that established themselves in the post-war years under a long period of LDP rule may feel more sanguine now the party is back in power.

Outlying regions are more pessimistic—but Tohoku sees improvementWhile in the Bank of Japan’s most recent quarterly report of regional economic conditions (the Sakura report) only Hokkaido reported signs

of a pick-up after a national recession, the middle market there is less bullish. In fact, Hokkaido is one of only two regions—the other being Kyushu & Okinawa—where the total revenues expectations index for 2013 is below the 100 break-even mark and pessimists outnumber optimists.

Things are, however, looking up for the Tohoku region’s middle market. Although for obvious reasons companies there are far from bullish (and reported the worst index score for revenues and staffing levels in 2012), sentiment is improving somewhat from a low base. Indeed, in 2012 middle-market companies in the region have the highest index score for domestic revenue growth (at 107.4) and the second-highest for total revenues (at 106.1). They are also very optimistic about improving financing conditions in 2013, with an index score of 110.8 on this factor.



The mixture of confidence and concern revealed in the sentiment indices suggests Japan’s middle market faces some pressing challenges. This section looks more closely at the strategies employed by Japan’s middle-market companies as they grow and the problems they face in doing so. The section is split into four parts, looking at the macro situation—including the regulatory and policy environment—strategy, people and financial management.

Macro environment

Combating poor domestic conditions

Japanese mid-market firms are clearly nervous about macro challenges to their business. Three-quarters of respondents say that a slowdown in domestic demand will be the biggest challenge in the year ahead (see Figure 3.1). Meanwhile, more than half cite increasing competition in their industry. This suggests that mid-market firms expect a difficult and tricky year ahead with challenges on multiple fronts—lower domestic demand will hurt revenues, while increasing competition could, among other things, lead to price wars as companies battle for a dwindling customer base.

Higher taxes and inflation are the next two major economic challenges. Worse, almost half of respondents feel they cannot pass on higher commodity costs to their customers. Issues such as exchange rates, a slowdown in export demand and worsening relations with China are of less concern.

The impact of these challenges varies by industry. Some 73% of manufacturing firms, for instance,

are concerned with a slowdown in domestic demand. The “hollowing out” of Japanese manufacturing, faced with cheaper overseas competition, is one major reason. Akinori Tsuji, president of Tosa Denshi, a Shikoku-based manufacturing firm specialising in electronic components and LCD devices with annual revenues of around ¥1.6bn, calls this “a real and deepening crisis” for firms like his. “The time will come when the management team of the next generation is forced to seriously consider moving our operations offshore in order to survive.”

Related to this problem, many manufacturers are also worried about exchange rates (44%) and a slowdown in export demand (30%). However,

Challenges to growth3

Economic challenges to growth(% respondents selecting challenge in top three)

Figure 3.1

Slowdown in domestic demand

Increasing competition in industry/market

Operational risks (eg, natural disasters, fraud)

Slowdown in demand for exports

Inflation (higher input prices)

Exchange rates

Higher taxes

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13Source: Economist Intelligence Unit survey

Worsening diplomatic relations with China



only 18% are worried about worsening diplomatic relations with China, suggesting either that it is not a key market for them or that they believe that their warm corporate relationships will supersede any international hostility.

Pharmaceutical firms, meanwhile, are most concerned with higher taxes, with 71% of respondents believing that that will be their biggest economic challenge in the year ahead. Almost as many are worried about rising competition in their industry. But the sector appears inward-looking: only 13% are concerned with exchange rates and only 4% with a slowdown in exports.

Among larger mid-market firms (those with annual revenues of ¥50bn-100bn), there is less worry about competition (44% of respondents) and operational issues (14%) but more concern with a slowdown in export demand (35%). This indicates that as mid-market firms grow in size, they start to dominate their sector a bit more and become better at mitigating operational risks.

Regulatory challenges to growth(% respondents selecting challenge in top three)

Figure 3.2

Uncertainty about Japanese national economic policy

Unstable politics in Japan

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Uncertainty about Japanese local/prefectualeconomic policy

Keeping up with changing domestic regulations(excluding taxation)

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Dealing with taxation requirements in overseasmarkets

Navigating the regulatory environmentWhen asked about the biggest regulatory challenges to the growth of their companies, some two-thirds of executives cited uncertainty about Japanese national economic policy (see Figure 3.2). A similar proportion worries about unstable politics in Japan. Almost half middle-market firms believe that keeping up with changing domestic regulations (excluding taxation) might hobble their progress.

These fears were perhaps exacerbated by the timing of the December 2012 general election, which took place while the fieldwork for our survey was being conducted. But it is fair to say that the political turbulence Japan has experienced over the past five to seven years has created an extremely uncertain operating environment for mid-market firms. They do not wield the economic influence of large corporations, or command the political cachet of the SME sector, and therefore perhaps feel more vulnerable to sudden shifts in the political and policy landscape.

To make matters worse, less than a third of respondents feel the government looks favourably on their business or industry. In particular, within the consumer goods sector, only 23% of respondents say the government looks favourably on them—the imminent higher consumption tax presumably weighing heavily on their minds. Despite positive sentiment about the economic policy of Shinzo Abe, the new LDP prime minister, it is likely to take a long period of stability to assuage middle-market fears about political and regulatory capriciousness.

There are some interesting differences at the sector and firm level. For instance, almost half of respondents from construction firms worry about local policy. This could be because success in the Japanese construction sector depends a lot on local political relationships. Newer mid-market firms are much more likely to worry about local taxation requirements, with some 40% of



respondents citing it as the biggest regulatory challenge ahead. This suggests that, as young firms, they have yet to figure out the most tax-effective corporate structure and strategy.

Strategy

Establishing a growth strategy

Despite the macroeconomic challenges the middle market faces, when it comes to marketing, positioning and growth strategies, Japan’s mid-market firms present a mixed picture. Less than half the executives surveyed believe their firms have a clear growth strategy (see Figure 3.3). Relatedly, fewer than 40% of them claim to target niche segments, and less than one third says their firms are innovators in new products and services.

This suggests that the average Japanese mid-market firm is caught somewhat in the middle of a long corporate growth cycle. Though they have outgrown the start-ups and small, niche producers in their industries, relatively few are committed or prepared to grow beyond their middle-market position. This may be an issue if they remain focused only on their core business, warns Naohiro Nishiguchi, executive managing director of the Innovation Network Corporation of Japan (INCJ), an investment fund financed in part by the Japanese government. “If companies only look after their existing business, at a

certain point in time they will most likely face stagnation as they remain unprepared for rapid changes,” he says. “It’s important to prepare for the next step, especially when things are positive with existing business.”

To be sure, many see the distinct advantages of their middle-market position. Koji Yoshida, president of Sun Ace of Kanagawa prefecture—a manufacturer of polyvinyl chloride stabiliser, with sales of ¥17.2bn in 2011-12—sees the merits of specialisation. “Big companies tend to diversify their operations and cover vast business areas,” he says. “It could mean that the quality of their products and services in each business area is disproportionate. Unlike our bigger counterparts, we are more of a specialist that focuses on limited business areas of strength. That enables us to win the confidence of our clients.”

The survey suggests that as middle-market firms grow bigger, their strategies crystallise, they start to innovate more, and they begin to offer a wider range of products (see Figure 3.4). Furthermore, when asked about their product development investment plans over the next year, 43% of respondents from larger mid-market firms say they will be investing more—compared to an average of 31% across the sector as a whole.

This is partly in response to the problem of being squeezed by cheaper competition from

Diverse strategies(% respondents)

Figure 3.3

We have a clear growth strategy

We target niche segment(s)

We are innovators in new products and services

We offer a wide range of products

426 28 20 3

327 35 21 6

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284 37 24 7

Strongly agree Agree Neither agree nor disagreeDisagree Strongly disagree




abroad—especially in cases where middle-market companies operate as undifferentiated suppliers or service providers. Tosa Denshi’s Mr Tsuji warns that the company has to move up the value chain to survive. “It is becoming increasingly clear that we cannot continue to make a profitable business for long just by providing high-quality production and assembly services as a subcontractor. Which is why we are currently trying to strengthen our capability to develop quality-sensitive products”, he says.

The transformation from subcontractor to independent product developer is crucial to success, reckons Professor Motohashi of the University of Tokyo. Listing the three most crucial attributes of a successful mid-size company,

Growing up(% responding “Strongly agree” and “Agree”)

Figure 3.4

We are innovators in new products andservices



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he also stresses the need for speedy decision-making and the need to develop products in line with the needs of clients.

Understanding changing demandThe research suggests, however, that understanding changing demand is a challenge for many middle-market companies. Japanese mid-market firms do not currently seem to be conducting exhaustive market research. Less than a third of them invest in market research to understand their customers’ current and future needs (see Figure 3.5). As a result, more than a third struggle to adapt to new ways of communicating with their customers and more than 40% find it hard to forecast changes in demand.

Struggling to be flexible

Figure 3.5

We invest in market research to understand ourcustomers’ current and future needs

We are struggling to adapt to new ways ofcommunicating with our customers

We find it hard to forecast changes in demandfor our products or services

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Isamu Tatsuno started Montbell, now the largest outdoor clothing manufacturer and retailer in Japan, in 1975. The company, which had revenues of ¥42bn in 2012, offers integrated outdoor services, from apparel and equipment to travel-agency services and insurance.

Mr Tatsuno notes that while the outdoor sports industry is stable and relatively “recession-proof”, Montbell’s success is founded on the Japanese tradition of kinobi, which evokes beauty through functional simplicity. “The quality of our monozukuri [production] is certainly one of our key assets,” Mr Tatsuno says.

Mr Tatsuno also stresses the importance of responsible business practices, embodied in the company’s CSR programme and also in the values espoused by the 400,000-strong

“Montbell Club” of like-minded outdoors enthusiasts. “In mature markets, value judgments carry increasing weight. People are not just interested in buying a jacket per se. They want to know the story behind it and the message that it carries.”

Montbell enjoys the best of both worlds as both a market leader and a mid-sized company, including the entrepreneurial drive of its founder-president as well as the kind of favourable access to resources that benefits bigger companies. “As we grow bigger, our challenge is to maintain a good level of intra-company communication,” Mr Tatsuno says. “I will be relying a lot on those with whom I have had direct contact to carry and pass on the company spirit and culture.”

Montbell: The power of kinobi

Large firms are more likely to invest in market research, possibly because almost half of them admit to having trouble adapting to new ways of communicating with their customers. By contrast, only about a quarter of small firms have trouble with this—they are probably more nimble and easily able to adjust their customer touchpoints.

The ability to incorporate feedback from clients is crucial to innovation at some middle-market firms. One such example is Weathernews of Chiba prefecture—the world’s largest private weather service company, with offices in 40 cities across 15 countries and revenues of ¥12.9bn in 2011/12. As well as weather forecasting, the company transforms weather information into services tailored to the needs of individual users in various industries, including shipping, transport, media and energy. “Our competitive advantage rests on the ability to engage in interactive communication with clients and create a positive cycle of continuous feedback and service innovation,” says Chihito Kusabiraki, global chief executive officer and president of the company. Such feedback has been greatly

enhanced with the advent of the internet and social media.

People

Finding and developing talentWorryingly, only about a third of executives feel their firms can attract the talent they require, reflecting perhaps the dominance of big firms in Japan’s regimented graduate recruitment process. As a consequence, just 41% of middle-market respondents believe their firms are committed to developing young talent who will stay for their entire careers.

These trends are partly a reflection of the changing dynamics of the Japanese workplace—away from lifelong employment towards more flexible career paths, including more temporary stints at different firms. But these new work ethics and practices can be detrimental to organisational harmony: executives cite “low staff morale” and the “difficulty of attracting and retaining talented employees” as the biggest organisational challenges to the growth of their firms (see Figure 3.6).



Organisational challenges to growth(% respondents selecting challenge in top three)

Figure 3.6

Low staff morale

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Difficulty providing competitive compensationand benefits

Difficulty providing sufficient training

Poor internal communication

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Japanese mid-market firms hope to address these issues head on. Over the next year, hiring new talent is the most important strategic initiative, with almost half of respondents saying their company will be putting greater emphasis on it.

The talent challenge is more acute in some industries than others. For instance, 60% of respondents in the mid-market pharmaceutical sector consider the difficulty of attracting and retaining talented employees as the biggest organisational challenge to their company. As a result, they believe they are more focused on developing young talent who will stay with them for their entire careers and are placing relatively higher emphasis on hiring new talent. This could be because they are the most ambitious and successful of mid-market firms with the brightest growth prospects (as the sentiment indices illustrate).

Meanwhile, larger middle-market companies are generally more able to secure the talent they need, suggesting that Japanese employees prefer the security of a big firm. However, that

does not imply that they necessarily prefer older companies—almost half of “emerging” mid-market firms (up to 10 years old) say they can attract the talent they require, compared to an overall average of 34%.

According to Haruaki Deguchi, founder and president of Lifenet Insurance Company, an internet-based insurance firm that began operations in 2008, the key to competing with large established companies for talent is to promote diversity and create a supportive working environment. Lifenet employs fairly flexible working policies, at least by Japanese standards. Male and female employees can take maternity/paternity leave, for instance, and it has an “age-free” recruitment policy. “You have to demonstrate by actions that you really care about diversity, not just saying it,” Mr Deguchi says. “Job applicants can sense it if a company advocates [diversity] just as a PR stunt.”

Ensuring leadership successionExecutives at mid-market firms generally have confidence in their current management teams. More than half of respondents believe their management teams lead effectively, while only about a fifth feel they do not have the skill set to meet the challenges ahead (see Figure 3.7). However, less than 30% of mid-market firms feel they have a well defined succession plan—a particular concern given that many smaller mid-market firms remain family owned and run.

The respondents’ broad confidence in their management reflects the belief that continuity in leadership can be a good driver of growth. Yoshihisa Ejiri, president of clothing chain Honeys—with revenues of nearly ¥60bn in 2012—is keenly aware of the need not to rest on his laurels, precisely because he was the founder of the company in 1978. “Our task is to find the next business model for success,” he says, emphasising the fighting spirit characteristic of mid-size companies that still have the founder as the company head.



Problems for the next generation of leaders?(% respondents)

Figure 3.7

We have a management team that leads effectively

We can attract the talent we require

We have a well defined succession plan

We are committed to developing young talentwho will stay with us for their entire careers

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Our management team has the skill set to meetthe challenges we face 397 34 17 4



Nakashima Propeller, headquartered in Okayama, produces propellers of all sizes and for all types of vessels, from small pleasure boats to tankers and container ships. It is now the biggest propeller maker in Japan and has an approximately 30% world market share in large propellers—recording ¥25bn in sales in the financial year 2011-12.

The company’s growth strategy has had several elements, but the core is diversifying the company’s client base. “The future is not bright if one subscribes to the culture of subcontractor and becomes a mere servant” to a particular client, says Motoyoshi Nakashima, president of the company. “This is true regardless of company size.” Mr Nakashima explains that his company always thinks and acts as an equal player. “We do not limit ourselves to supplying one or two companies. In the same regard, we do not limit ourselves to Japan. We actively seek to win contracts beyond borders, in China and Korea… The world is our market.”

The significance of global markets has grown as Japan’s post-war dominance in shipbuilding has waned. Mr Nakashima stresses the importance of exposing all staff to the company’s international business. He is abolishing an operational system that distinguishes between domestic and foreign markets, with the aim of quickly ensuring that all workers deal with clients worldwide.

Arguably, for any middle-market company that sees the world as its market, developing international management expertise is increasingly important—especially considering the importance of managing succession issues. Mr Nakashima is confident his company’s future is secure, and not only because his son works at the company. “Young staff are well exposed [to the international business],” he says, “and are endeavouring to gain a range of experience and skills in their daily work.”

Nakashima Propeller: The world is our market



Prudential management(% respondents)

Figure 3.8

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The INCJ’s Mr Nishiguchi agrees that leadership continuity can definitely be an advantage. “In the case of mid-size companies, it is not unusual to find the entrepreneurial founder of the company to be still heading the organisation. Given that growth comes from creation of new businesses, these companies are generally better placed to attain growth,” he says.

However, Mr Nishiguchi also warns that the “key issue” for those companies still headed by their founder is to “secure an eco-system before [the founder’s] retirement that will ensure the health of the company after the founder leaves. For instance, the company will need to secure talent to innovate and those who support innovation… as well as the management capacity to leverage external resources.”

Financial management

Securing affordable fundingJapanese mid-market firms are generally able to exercise prudent financial management. Some 40% of firms are able to manage working capital effectively; a similar number are able to manage costs effectively (see Figure 3.8). By contrast, less than a quarter of respondents admit to having problems with either of those issues. Meanwhile, some 45% of firms are able to access funding at an affordable cost of capital.

That said, when asked about the biggest financial challenges to the growth of their companies, some 54% of respondents cited “Having sufficient working capital”, followed by “Having predictable cash flow” (49%) and “Securing a low cost of funds” (46%). Therefore, although mid-market firms are generally stable financially, they still worry about their financial future.

Unsurprisingly, larger mid-market firms find it easier to manage costs and access funding. However, 29% of respondents from these firms say they find it hard to get favourable financing terms, compared to an overall average of 19%. This could be because their expectations are too high; or possibly also because creditors are less willing to lend to largish middle-market firms with uncertain growth prospects (as opposed to smaller, more focused companies).

However, it is not surprising that younger mid-market firms are still less likely to be able to access funding at an affordable cost of capital: 38% of emerging firms have this complaint compared to 16% overall. This shows that while they might be able to attract talent (see section above), the lack of a long track record counts against them in Japan’s capital markets.

This situation itself provides opportunities for adventurous entrepreneurs. Masami Komatsu



spotted one of these in establishing Music Securities, an investment company “with a touch of social entrepreneurship” that finances a range of enterprises through collaborative investment funds. Mr Komatsu, a drummer himself, devised the platform first to help struggling musicians by allowing fans to invest in them directly.

Financing problems are common across middle-market firms, Mr Komatsu says, especially for regional businesses. “Bank loans are the biggest funding channel in Japan, but sufficient capital has not flowed into regional businesses.” Equity-based venture capital, meanwhile, is relatively small-scale, and many small and medium-sized

companies prefer not to go public. “So there is a big demand-supply gap.”

Music Securities has received an increasing number of enquiries from regional banks that are eager to support promising local businesses but are not able to do so on their own. Many of them are also keen to act as over-the-counter distributors of his funds. Meanwhile, Mr Komatsu says, the government is also paying more attention to this type of investment platform as a “third funding channel” that can take full advantage of abundant personal savings in Japan, and it is discussing how to promote such funding as a part of regional revitalisation.



Internationalisation and its challenges4

Conventional wisdom might suggest that Japan’s diverse mid-market companies would have a strong commitment to developing markets abroad and investing outside the country. The need would appear to be particularly acute given the fact of Japan’s relative decline in competitiveness, and shrinking population. Indeed, some 75% of middle-market executives identify slowing domestic demand as a top economic challenge to growth. Naohiro Nishiguchi of the INCJ describes this as the core challenge facing companies of all sizes. “The time is gone when it was fine to stay singularly focused on the domestic market,” he warns.

Why internationalise?Principal factors driving overseas investments(% respondents selecting factor in top three)

Figure 4.1

To enhance long-term growth prospects

To replace sales lost in Japan

To keep up with competitors

To increase access to talent

To lower operating costs

To gain better access to raw materials

To diversify risk

62.3

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20.2Source: Economist Intelligence Unit survey

To take advantage of less stringent regulations(eg, on labour)

Still mostly focused at homeMid-market companies have therefore had the motivation to pursue foreign opportunities. However, few have taken this step: the majority are entirely domestic businesses and only 42% actually have investments outside Japan. Those companies that do have foreign investments are motivated by a number of factors. As Figure 4.1 shows, 62% of the companies with foreign investments identify the enhancement of long-term growth prospects among the top three reasons for internationalising. Just under half want to replace sales lost in Japan.

One of the reasons why, collectively, mid-market companies are ambivalent about investing outside Japan is that few of them do much business overseas. Only 26% of mid-market companies derive 10% or more of their total revenues from foreign markets (Figure 4.2). For smaller companies (with revenues of between ¥1bn and ¥10bn) the figure is even lower—at just 15%. Younger companies, though, are the exception. In the “emerging” cohort (under 10 years old), 38% earn more than 10% of their revenues from abroad.

Unsurprisingly, the greatest numbers of export-oriented companies are found in the manufacturing sector—in which Japan’s competitive advantages are well established, particularly in high-precision and niche sectors. One such example is Sun Ace. The company generates about 90% of its sales from overseas markets and allows its overseas subsidiaries, which account for 90% of total employees, a fair amount of autonomy.



Figure 4.2: Few exportersProportion of middle market deriving 10% or more of revenues from outside Japan

All middle market 26%

Large 48%

Medium 29%

Small 15%

Manufacturing 37%

IT, technology & telecoms 32%

Logistics & distribution 26%

Financial & professional services 22%

Consumer goods & retail 21%

Construction & real estate 13%

Healthcare, pharmaceuticals and biotechnology 8%

Emerging 38%

Established 25%

Old 24%


That said, it is reluctant to give up on Japan. Ryo Sasaki, chairman and CEO, thinks there are good reasons to retain Sun Ace’s Japanese base. “This is a market where we have to meet expectation of excessively demanding clients at the highest global standards, in terms of product/service quality and technological sophistication. We may be able to generate only a small proportion of our revenue, but this market gives us a vital competitive edge that we need for doing business globally.”

At the other extreme, only 8% of middle-market healthcare, pharmaceuticals and biotechnology companies derive more than 10% of their revenues from outside Japan. Japan’s demographics, and the growth of the already large numbers of elderly people, presumably means that for many companies in this sector the opportunities at home are irresistible. The regulatory difficulties of exporting healthcare products and pharmaceuticals also make growing internationally a harder proposition for this sector.

Outsourcing but in-sellingAs Figure 4.3 indicates, the number of mid-market companies that have investments outside

Figure 4.3: Overseas investmentProportion of middle market with investments outside Japan


Large 70%

Medium 48%

Small 27%

Manufacturing 59%







Emerging 59%

Established 44%

Old 38%


Japan is boosted by the 70% of larger mid-market companies with foreign investments: conversely only 27% of the small cohort have invested outside Japan. The implication is that, for many of the small companies, the challenges associated with foreign investment are overwhelming.

Comparing Figures 4.2 and 4.3 shows middle-market firms across the board are more likely to have foreign investments than to derive a large proportion of their revenues from outside Japan. The obvious implication is that many mid-market companies (although not the majority) have responded to the general strength of yen over recent years by sourcing from outside Japan.

Mid-market manufacturing and IT, technology and telecommunications industries are the most likely to invest overseas in order to procure from suppliers outside Japan. Manufacturing especially has long faced competitive pressure and the need to reduce costs by shifting production abroad. Almost one-half of manufacturers with investments overseas cite cost reduction as a major driver. Conversely, companies in the most domestically-focused industries (construction and real estate and



healthcare, pharmaceuticals and biotechnology) appear to be less inclined to invest in foreign suppliers.

Some 44% of older companies (those aged 50 or more) and some 38% of established companies (which are 10-50 years old) have foreign investments. The implication is that at least some of the established companies have focused entirely on domestic opportunities even though they were founded during Japan’s “lost decades”. Younger companies, though, are the exception. In the “emerging” cohort (under 10 years old), some 59% have made investments overseas. This suggests that though many across the middle market recognise that growth opportunities lie outside Japan, seizing them requires taking the kind of risks that more mature companies are less likely to tolerate.

China and South-east Asia are the biggest drawsFor the mid-market companies that have ventured abroad, the lure of China is enormous. Some 34% of all companies—but 60% of the larger subgroup, 47% of manufacturers and

Figure 4.4: (Greater) China firstProportion of middle market with actual or planned investment in Greater China, South Korea and SE Asia

China HK/Taiwan South Korea South-east Asia

All middle market 34% 24% 21% 31%

Large 60% 53% 49% 59%

Medium 39% 25% 23% 36%

Small 21% 13% 9% 16%

Manufacturing 47% 31% 26% 42%

IT, technology & telecoms 45% 31% 26% 29%

Logistics & distribution 37% 25% 21% 29%

Financial & professional services 36% 22% 18% 26%

Consumer goods & retail 28% 22% 18% 25%

Construction & real estate 18% 12% 15% 20%

Healthcare, pharmaceuticals and biotechnology

15% 10% 10% 10%

Emerging 51% 41% 29% 40%

Established 37% 26% 20% 32%

Old 30% 21% 20% 28%


45% of IT technology and telecommunications companies—have actual or planned investments in that country. The details are shown in Figure 4.4. One conclusion is that geopolitical tensions between Japan and China have been seen to be largely irrelevant—although whether investment flows this year will continue remains to be seen.

If Japan’s mid-market companies are not actually investing in China proper, many are still doing business there—whether selling or sourcing—through Hong Kong/Taiwan or South Korea. Interest in other parts of the world is relatively low. Across all mid-market companies, just 13% have investments in North America and another 8% plan to invest there. In Western Europe, the numbers are 8% and 8%. In each of Eastern/Central Europe, South America and Africa, the numbers of companies that actually have investments are in low single-digit figures.

Outside Greater China, the emerging markets that really appeal are those of South-east Asia. As Figure 4.4 shows, the numbers of companies that have, or are planning, investments in South-east Asia are almost as large as the proportion invested in mainland China. This is broadly true of the mid-market companies regardless of their size, industry or age.

Those mid-market companies that are seeking opportunities outside Japan are, therefore, actors in three major trends across the Asia-Pacific. One is the growth in domestic demand in China, whether they are investing directly in the mainland or in nearby locations. The second is the domestic demand-led growth of South-east Asia. The third is the continuing growth in intra-regional trade.

The overseas investments of King Jim, a stationery and office equipment company founded in 1927 with expected revenues of ¥30bn in 2012, exemplifies these trends. In recent decades it has shifted all of its production offshore, reducing costs and leading to unexpected new business opportunities. King Jim Indonesia was established in 1996 to produce



plastic files, and opening a factory there was “easier than we’d expected,” says Hideto Yokota, managing director of R&D and overseas business. Facilities for stationery production have since been opened in Malaysia (in 1998) and Vietnam (in 2007), while manufacture of office electronic gadgets remains outsourced to China.

As labour costs have risen in China, King Jim has seen its plants elsewhere attract new business. “In the last two to three years, we’ve started getting a lot of orders from companies around the world to produce office supplies for them in our factory in Vietnam,” says Mr Yokota. “We’ve expanded the plant, which was initially built just to make King Jim products.” The economic development of Indonesia and Vietnam has meant that King Jim also now sells the products it manufacturers there, locally. “When I first went to Indonesia, most people were still walking around barefoot,” he recalls. “We never imagined they would become markets when we opened factories there.”

Finding talent remains the principal challenge The fact that fewer than half of the mid-market companies actually have investments outside Japan suggests that, collectively, they find foreign investment difficult. This is in spite of the fact that for some, their size carries distinct advantages in operating abroad. Sun Ace’s Mr Sasaki says being mid-sized gives the company the three traits required for successful international business: capital strength, organisational agility and speedy decision-making. Yet it is fair to say that this highly internationalised manufacturer is atypical of Japan’s middle market in general.

The survey asked companies to comment on nine issues that could pose challenges. Of these, the most pressing is clearly the attraction and retention of suitable staff to manage foreign investments. Across all mid-market companies, this is seen to be a severe challenge by 40%. Another 41% see it as a moderate challenge.

Figure 4.5: Finding the right talent: easy for fewProportion of middle market that says attracting suitable talent is NOT a challenge to internationalising


Large 21%

Medium 17%

Small 16%



Other 26%





Manufacturing 11%

Emerging 22%

Established 19%

Old 19%


Only 19% believe that it is not a challenge at all. As Figure 4.5 shows, the figures are fairly consistent regardless of the size or age of the company in question. However, the (perceived) problem varies quite markedly from industry to industry. At one extreme, 31% of healthcare, pharmaceuticals and biotechnology companies do not see the attraction and retention of suitable staff as a challenge. At the other, this is true of only 11% of manufacturing companies.

The problems faced by Tosa Denshi are typical. Around 10 years ago the company decided to establish a manufacturing base overseas in order to maintain and improve cost competitiveness. Mr Tsuji says that although China was the first choice, he felt the company lacked the scale and capital strength to succeed there. He turned instead to Vietnam. The company opened a branch office in Hanoi in 2003 and built two factories there, in 2006 and 2009, which now employ about 150 workers in total.

Attracting qualified staff is not a problem, Mr Tsuji says, but retaining them is—particularly since competition between Japanese companies for high-quality workers in the country is



rapidly increasing. Since language training new Vietnamese recruits is a long and painstaking process (requiring two to three times as much time and money as for Chinese recruits, Mr Tsuji reckons), many Japanese companies take the short cut of headhunting capable Vietnamese staff from competitors. Tosa Denshi has lost a third of its Vietnamese workers to its Japanese competitors, Mr Tsuji says.

Human-resources issues are therefore likely to be a big reason why middle-market companies are reluctant to take the plunge abroad. If manufacturers like Tosa Denshi, who have been operating abroad for years, cannot solve the problem, the challenge for new entrants must be even more daunting.

Yet staying at home—especially given mid-market pessimism over the Japanese economy—carries its own risks, particularly in terms of missed opportunities. Despite the difficulties he describes, Mr Tsuji says Tosa Denshi’s Vietnam venture paid off in unexpected ways, including the rare direct offer of a supply contract from a major Japanese conglomerate. “Knowing that Vietnam could offer low-cost production, they were looking for Japanese companies with reliable local operations,” Mr Tsuji says. “If we were stuck in the domestic market, a small regional company like us would never have an opportunity to make a deal with a major firm, especially through a direct enquiry.”

Headquartered in Fukushima, Honeys, a clothing chain, has grown rapidly since it started in 1978 and boasts revenues of ¥59.9bn in 2012, with over 6,300 employees (on a consolidated basis). Having hit a ceiling in Japan with over 800 stores, Honeys moved into China in 2006 with an ambitious plan to open 1,000 stores within 10 years. By December 2012 they had opened more than 500. Honeys also recently moved part of its fully integrated supply chain into Myanmar—their first factory there began operating in April 2012.

Yoshihisa Ejiri, president, explains that the firm selected Myanmar as the second location for direct investment partly because labour costs were rising in China. But he accepts

that Myanmar has only just opened up. The investment was made with the view of the country’s mid- to long-term potential, with the hope— “eventually”—of securing the factory to deliver a stable supply of quality products at low cost. “It could take around five years for the country to secure a reasonable level of infrastructure,” Mr Ejiri reckons.

Honeys’ stability and solid finances are beneficial in playing the long game. Although speed of stock turnover is a key feature of their business model, one of the company’s mottos is “making steady efforts and solid steps”, Mr Ejiri says. “We don’t have to deal with the kind of pressure that you might face if your company was too well known,” he jokes.

Honeys: Playing the long game in Myanmar



Although stable as a whole, clearly not all middle-market companies in Japan are equally successful. Indeed, some have been considerably more successful than others in recent years. In this section we identify Japan’s middle-market “growth champions” and seek to identify what about their operations and strategy marks them out from their peers.

Our definition of “growth champion” is a company that has recorded three successive years of global revenue growth in 2010, 2011 and 2012—years in which the Japanese economy experienced multiple contractions and setbacks. Such performers are comparatively rare: growth champions make up just 17.6% of the middle market as a whole. By industry, it is not surprising to see they are most numerous in the relatively non-cyclical healthcare, pharmaceuticals and biotechnology sector: more than a third of such middle-market firms are growth champions (Figure 5.1). However, higher-beta firms such as those in financial and

Middle-market growth champions5

Figure 5.1: Growth champions in Japan’s middle market (% in each sector)

Middle market overall 17.6%

Healthcare, pharmaceuticals and biotechnology 37.5%

Financial and professional services 22.6%

IT, technology and telecoms 22.0%

Construction and real estate 19.8%

Consumer goods and retail 17.4%

Logistics and distribution 13.7%

Manufacturing 9.5%

Other 16.1%


professional services, and IT, technology and telecoms are also relatively successful: more than a fifth of the middle-market companies in each of these sectors are growth champions. Manufacturing has the fewest high performers.

It is significant that the distribution of smaller, medium-sized and large middle-market firms is the same among growth champions as among the overall middle market, as is the distribution of emerging, established and old firms. This suggests that firms of a particular size and age are not more likely than others to be successful. Rather, operational and strategic factors are likely to determine which companies among Japan’s middle market have best weathered the economic storms of recent years.

Growth champions are flexible and diversifiedFirstly, and unsurprisingly, growth champions are much more likely to have a clear growth strategy: some 71% says their firms have such a strategy in place compared to just 32% of the poorer performers. Secondly, they are more flexible: two-thirds agree that they are well positioned to take advantage of changes in their markets, compared to just one third of the remainder.

This flexibility is borne partly of diversity in product and service offerings. While many in the middle market are still filling niches, some 52% of growth champions claim to offer a wide range of products and services, compared with just 31% among the rest. Importantly, growth champions understand their clients’ changing needs better: 47% invest in market research to understand



these shifts, while just 22% of the less successful cohort do so.

Interestingly, growth champions also have far better relationships with their supply chain partners than less successful mid-market companies, with 59% characterising these relationships in a positive light compared to just 30% of the remainder. In some sectors this speaks perhaps to the importance of keiretsu, or close networks of allied firms linked together in particular industries such as the auto and manufacturing sectors.

However, while keiretsu-type relationships might promote stability, they also reduce flexibility in terms of being able to negotiate with major clients when times are tough. Indeed, growth champions are actually less likely to think they can pass on higher commodity costs to their customers—53% do not think this is possible, compared to just 44% of the less successful cohort.

The INCJ’s Mr Nishiguchi warns of the danger for mid-market companies of this inflexibility. “If the company is a subcontractor and operates only within a value-chain, it tends to be more exposed to volatility, compared with those that operate more independently,” he says. Clearly, though, for growth champions this does not impair performance. Successful middle-market companies in Japan are therefore able to absorb shocks to a greater degree than their peers, which explains their resilience in recent challenging years.

Growth champions have less bureaucratic managementThough it may be a truism that executives at better performing companies have a higher regard for their managers, there is a striking split in terms of perceived management competence between Japan’s middle-market growth champions and the rest. Some 71% of growth champions agree that they have a management team that leads effectively, compared to just over a third at less successful companies that think the same. Flexibility here, too, is key: 57% of growth champions regard their success and adaptability as a result of a less bureaucratic management style while just 29% of the poorer performers say the same thing (Figure 5.2).

Growth champions invest in innovation, IT and human capitalIn keeping with a greater diversity of product and service offerings, growth champions are twice as likely as their less successful middle-market peers to be innovators. Some 43% characterise themselves as innovators in terms of products and services, compared to 22% of the remainder. Internal innovation in processes and efficiencies—a competency long associated with successful Japanese companies—is also important. Among growth champions nearly half (48%) claim to innovate in these areas, compared to 29% of less successful middle-market firms.

Figure 5.2: High performers: strategy and management(% respondents agreeing)

Growth champions The rest

Clear growth strategy in place 71% 32%

Positioned to take advantage of changes in markets 65% 33%

Diversified products and services 52% 31%

Invest in market research to understand changing client needs

47% 22%

Have effective management 71% 38%

Adaptable because less bureaucratic 57% 29%


Figure 5.3: High performers: innovation and investment(% respondents agreeing)


Innovators in products and services 43% 22%

Innovators in processes and efficiencies 48% 29%

Greater emphasis on investing in product development in coming year

40% 22%

Greater emphasis on investing in process innovation in coming year

34% 14%

Investors in advanced IT infrastructure 38% 22%

Greater emphasis on investing in upgrading technology in coming year

36% 15%




In terms of investment priorities, growth champions seem far more willing to devote resources to areas that might lead to fruitful innovation (Figure 5.3). Not only are they more likely to invest in product development and process innovation in the coming year, they are putting greater emphasis on acquiring new talent and advanced IT. Some 59% of middle-market growth champions will put more emphasis on hiring new talent in the coming year, compared to just 33% of the rest. One-third of growth champions is likely to upgrade technology and equipment over the same period, double the proportion of the poorer performing cohort that is planning to do so.

Growth champions keep closer control of costs and working capitalOf course, having the resources to reinvest goes hand in hand with profitability—success breeds success—but close financial management plays an important role in ensuring consistent growth. The survey suggests growth champions amid Japan’s middle market are far more likely to follow the business basics of managing costs and working capital effectively than their less successful peers (Figure 5.4). Consequently,

Livesense, an internet-based media and affiliate marketing firm, is a poster child for Japan’s high-growth middle market. Founded in 2006 by entrepreneur Taichi Murakami when he was just 19, the company doubled its annual revenue from ¥1.1bn in FY2011 to ¥2.3bn in FY2012, recording an operating profit margin of 49.9%. Mr Murakami became the youngest-ever entrepreneur in Japan to take a business public when Livesense listed on the first section of the Tokyo Stock Exchange in October 2012.

Competing with Japan’s larger established firms is far from easy, but Mr Murakami reckons the trick is to turn their assets into liabilities. “Our competitors have succeeded by taking advantage of their massive sales capabilities,”

he says. “So we came up with a business model that offered services via the internet and relied less on an on-the-ground sales force. That enabled us to implement drastic cost cutting and compete strongly with our more labour-intensive counterparts.”

There are several challenges to maintaining growth, though. Mr Murakami points to the recruitment of talent and the maintenance of organisational dynamism as the two biggest. He cites difficulty finding candidates with the required quality and skill sets in particular. “Candidates with creative thinking and the passion to play an active role in growing the business are particularly in short supply.”

Livesense: Growth through entrepreneurial spirit

Figure 5.4: High performers: financial management(% respondents agreeing)


Manage costs effectively 59% 32%

Manage working capital effectively 57% 30%

Access funding at affordable cost of capital 59% 33%


they are more likely to be able to access funding at an affordable cost of capital, something of a perennial problem for struggling mid-market companies given the conservative lending habits of many Japanese banks.

Growth champions are more likely to have an international strategyFinally, while growth champions are no more likely to be internationalised than other less successful middle-market firms, they are more advanced in strategising to take advantage of overseas markets.

Growth champions are only slightly more sanguine than their less successful peers about prospects for Japan’s economy: two thirds identify slowing domestic demand as a top economic challenge to growth, compared



to four-fifths of the poorer performers. Nevertheless, they are not yet more exposed to overseas markets, with around three-quarters reporting that less than 10% of their overall revenues come from overseas. For those that have internationalised, motivations for doing so are commonplace, with the same proportion of high performers as mediocre ones likely to cite “enhancing long-term growth prospects” as the principal reason.

Nevertheless, growth champions are more likely to have invested or made plans to invest in every overseas market included in the survey (Figure 5.5), suggesting that they are further down the road to internationalisation than their less successful peers. Regarding potential barriers to investing abroad, while growth performers (perhaps unexpectedly) are no more optimistic about the capabilities of their managers to make a success of such investments, far fewer worry that the poor performance of previous such

Internationalisation strategyMiddle market companies that have invested or plan to invest in:(% respondents)

Figure 5.5

China

South Korea

Taiwan/Hong Kong

South-east Asia

Western Europe

Eastern/Central Europe

North America

South America

Africa

38.630.3

25.616.3

30.218.8

38.126.3

20.512.8

18.210.3

251616.5

914.8

7.3Source: Economist Intelligence Unit


forays will hold them back. Some 37% of growth champions say underperforming investments in the past would not be a challenge to further expansion abroad, compared to 30% of less successful companies.

Zoff, a manufacturer and retailer of spectacles, with revenues of ¥9.7bn in 2011, is one mid-market company that saw the need to expand abroad to compensate for declining demand at home. According to Takeshi Ueno, founder and president of the company, the domestic market has shrunk by 20% in the past decade. Yet Zoff is still growing, with overseas sales a big part of their growth strategy. Zoff opened its first store in China in 2010 and plans to have 29 there by the end of this year (compared to 142 in Japan). “We believe our business model is effective in markets around the world,” Mr Ueno says. “China is the biggest market in Asia and the sales there will soon overtake those of Japan.”



The encouraging thing is that many middle-market firms have the entrepreneurial drive, flexibility and determination to succeed in expanding their horizons. In addition, the very fact that they operate in the exacting Japanese market can give them an edge internationally. “Japan has an environment in which suppliers can interact with clients throughout the R&D process and innovate unique products that meet the needs of user companies,” Professor Motohashi explains. “Suppliers also have to serve very demanding Japanese clients and consumers, which means that they need to refine their technology and products continuously. This is one of the reasons that you can see many companies in Japan that have a dominant global share in a particular market with very sophisticated and unique technology.”

Indeed, the middle market in Japan occupies a sweet spot between small-scale (and capital-poor) craftsmanship on one hand, and somewhat inflexible, highly diversified conglomerates on the other. This is summed up eloquently by Mr Sasaki of Sun Ace. “There are many smaller firms that have excellent workmanship,” he says. “But they tend to suffer from lack of capital strength to leverage it on a larger scale. On the other hand, bigger firms with more resources do not necessarily have sufficient flexibility to provide products and services that meet the requirements of individual customers. Perhaps it is our unique advantage as a mid-size company to be able to achieve all of these.”

The research has shown that Japan’s middle market is crucial to the national economy. It employs a quarter of the workforce and accounts for a third of gross revenues earned, revealing a striking productivity compared to the middle markets of other developed economies. It is also stable, resilient and competitive. However, despite relatively bullish sentiment about the coming year—perhaps surprising considering the privations the country has endured in the recent past—the majority of the middle market is concerned about the long-term prospects for Japan’s economy.

This is worrying given the relatively strong domestic focus of companies across the middle market. The majority earns only a small fraction of revenues from abroad, and only a minority has taken the plunge to invest abroad. To be sure, some middle-market industries are likely to continue to do well focusing on the domestic economy—particularly the construction and healthcare, pharmaceutical, and biotechnology sectors. On the one hand, a construction-friendly (and relatively stable) government has no doubt improved the mood of executives in construction businesses, while on the other, Japan’s increasingly elderly population makes healthcare one of the few certified growth sectors in the country. Nonetheless, the success stories outlined in the case studies in this report, not to mention the more advanced internationalisation strategies at middle-market “growth champions”, suggest that Japan’s middle market will have to look outside the country to grow.

Conclusion



Mid-Market Sentiment Index: Total revenuesSize (revenues)

90

95

100

105

110

2013201220112010

Large Medium Small

Mid-Market Sentiment Index: Total revenuesIndustry

85

90

95

100

105

110

115

2013201220112010



Mid-Market Sentiment Index: Total revenuesRegion

90

95

100

105

110

2013201220112010

Kanto Kansai ChubuHokkaidoChugoku

Kyushu & OkinawaTohoku

Mid-Market Sentiment Index: Total revenuesAge

85

90

95

100

105

110

115

2013201220112010


Sentiment index: total revenues

Sentiment indicesAppendix

I



Size (revenues)

90

95

100

105

110

2013201220112010

Large Medium Small

Industry

90

95

100

105

110

2013201220112010



Region

90

95

100

105

110

2013201220112010



Age

85

90

95

100

105

110

115

2013201220112010


Sentiment index: staffing levels



Size (revenues)

90

95

100

105

110

2013201220112010

Large Medium Small

Industry

85

90

95

100

105

110

115

2013201220112010



Region

90

95

100

105

110

2013201220112010



Age

85

90

95

100

105

110

115

2013201220112010


Sentiment index: domestic revenues



Size (revenues)

90

95

100

105

110

2013201220112010

Large Medium Small

Industry

85

90

95

100

105

110

115

2013201220112010


Other

Region

90

95

100

105

110

2013201220112010

Kanto Kansai Chubu

Age

80

85

90

95

100

105

110

115

120

2013201220112010


Sentiment index: overseas revenues



Size (revenues)

80

85

90

95

100

105

110

115

120

2013201220112010

Large Medium Small

Industry

70

75

80

85

90

95

100

105

110

115

120

2013201220112010



Region

70

75

80

85

90

95

100

105

110

115

120

2013201220112010



Age

80

85

90

95

100

105

110

115

120

2013201220112010


Sentiment index: the global economy



Size (revenues)

70

75

80

85

90

95

100

105

110

115

120

2013201220112010

Large Medium Small

Industry

70

75

80

85

90

95

100

105

110

115

120

2013201220112010



Region

70

75

80

85

90

95

100

105

110

115

120

2013201220112010



Age

70

75

80

85

90

95

100

105

110

115

120

2013201220112010


Sentiment index: Japan’s economy



Size (revenues)

80

85

90

95

100

105

110

115

120

2013201220112010

Large Medium Small

Industry

80

85

90

95

100

105

110

115

120

2013201220112010



Region

80

85

90

95

100

105

110

115

120

2013201220112010



Age

80

85

90

95

100

105

110

115

120

2013201220112010


Sentiment index: your industry as a whole



Size (revenues)

90

95

100

105

110

2013201220112010

Large Medium Small

Industry

85

90

95

100

105

110

115

2013201220112010



Region

80

85

90

95

100

105

110

115

120

2013201220112010



Age

85

90

95

100

105

110

115

2013201220112010


Sentiment index: demand for your company’s products and services



Size (revenues)

90

95

100

105

110

2013201220112010

Large Medium Small

Industry

85

90

95

100

105

110

115

2013201220112010



Region

85

90

95

100

105

110

115

2013201220112010



Age

90

95

100

105

110

2013201220112010


Sentiment index: financing conditions



Size (revenues)

90

95

100

105

110

2013201220112010

Large Medium Small

Industry

85

90

95

100

105

110

115

2013201220112010



Region

85

90

95

100

105

110

115

2013201220112010



Age

90

95

100

105

110

2013201220112010


Sentiment index: competitive environment



Size (revenues)

90

95

100

105

110

2013201220112010

Large Medium Small

Industry

90

95

100

105

110

2013201220112010



Region

85

90

95

100

105

110

115

2013201220112010



Age

90

95

100

105

110

2013201220112010


Sentiment index: regulatory environment



Note: Percentages may not total 100 due to rounding or the ability of respondents to choose multiple responses

Appendix II: Survey results

Do you agree or disagree with the following statements?(% respondents)


We target niche segment(s)


We are innovators in new products and services

6

35327

33335

37284

42 28 20 3

21 6

24 4

24 7

Our processes are efficient37274 27 5

We have invested in an advanced IT infrastructure35245 28 9

We are able to manage inventory efficiently42304 21 4

We are able to manage working capital effectively40364 18 3

We are able to manage costs effectively37355 20 3

We are able to access funding at an affordable cost of capital40396 13 3

We find it hard to get favourable financing terms45163 27 9

We have good relationships with our supply chain partners47385 10 1

The tsunami and nuclear crisis of March 2011 had a severe impact on our business34195 29 13

Strongly agree 1 Agree 2 Neither agree nor disagree 3 Disagree 4 Strongly disagree 5




We have a management team that leads effectively

We can attract the talent we require

We are committed to developing young talent who will stay with us for their entire careers

We have a well defined succession plan

6

40304

34365

36245

46 28 16 4

22 4

19 6

26 9

We are able to effectively navigate and comply with regulation43375 13 2

The government looks favourably on my business/industry49284 17 3

We are able to adjust to market conditions because we are less bureaucratic41347 15 3

Our management structure gives us the ability to quickly take advantage of opportunities when they arise40294 22 5

We feel that companies our size are uniquely advantaged to maximise opportunities43304 20 4

We don’t want to change the way we manage the company even if it threatens our ability to grow45304 18 3


Over the next year, will your company be putting greater, equal or lesser emphasis on the following areas?(% respondents)

Upgrading equipment and technology

Hiring new talent

Securing advantageous financing conditions

Investing in product development/innovation

26

4447

6623

5631

59 13 2

9 1

9 3

9 4

Investing in process innovation6324 10 2

Increasing supply chain efficiency6516 13 6

Investing in traditional marketing6610 18 6

Investing in new media/social media marketing5916 16 8

Ensuring succession planning6025 11 3

Greater Equal Lesser N/A

Over the next year, what will be the biggest economic challenges to the growth of your company? Pick the top three.(% respondents)

Slowdown in domestic demand

Increasing competition in industry/market

Higher taxes

Inflation (higher input prices)

Exchange rates

75

55

45

37

30

Operational risks (eg, natural disasters, fraud)26

Slowdown in demand for exports19

Worsening diplomatic relations with China13



Over the next year, what will pose the biggest organisational challenges to the growth of your company? Pick the top three.(% respondents)

Low staff morale

Difficulty attracting and retaining talented employees

Lack of clear growth strategy

Difficulty providing sufficient training

Poor internal communication

45

42

40

38

37

Lack of managerial experience/skills36

Difficulty providing competitive compensation and benefits31

Difficulty developing future leaders31

Over the next year, what will pose the biggest regulatory challenges to the growth of your company? Pick the top three.(% respondents)

Uncertainty about Japanese national economic policy

Unstable politics in Japan

Keeping up with changing domestic regulations (excluding taxation)

Dealing with national taxation requirements

Uncertainty about Japanese local/prefectural economic policy

65

63

49

37

36

Dealing with local/prefectural taxation requirements24

Navigating regulations in overseas markets20

Dealing with taxation requirements in overseas markets7

Over the next year, what will pose the biggest financial challenges to the growth of your company? Pick the top three.(% respondents)

Having sufficient working capital

Having predictable cash flow

Securing a low cost of funds

Getting advantageous terms in financial agreements

Securing sufficient funds to take advantage of opportunities that may arise

54

49

46

45

42

Being able to manage our debt levels31

Having access to short term lines of credit20

Having access to finance providers who know our business14




Our management team has the skill set to meet the challenges we face

Our company is properly positioned to take advantage of changes in our markets

We invest in market research to understand our customers’ current and future needs

We are struggling to adapt to new ways of communicating with our customers

7

38396

39265

47315

39 34 17 4

14 3

24 6

15 3

We find it hard to forecast changes in demand for our products or services45374 13 2

Our size allows us to take advantage of changes when they occur46344 14 3

We cannot pass on higher commodity costs to our customers403710 12 2

We are innovators in products and services42274 22 6

We are innovators in processes and efficiencies44324 15 5


Do you have operations overseas, or plans to invest overseas? Select all that apply.(% respondents)

China

South Korea

Taiwan/Hong Kong

South-East Asia

24

912

916

17 14

10 66

79

76

69

Western Europe88 84

Eastern/Central Europe94 86

North America813 79

South America4 8 88

Africa82 90

Have investments Plan to invest No investments and no plans

Approximately what proportion of your revenues currently comes from overseas markets?(% respondents)

Less than 10%

10%-25%

26%-50%

51%-75%

More than 75%

74

14

9

2

1



What are the principal challenges to expanding investments abroad?(% respondents)

Lack of knowledge about foreign markets/unfamiliar legal environment

Difficulty in managing risk in target markets

Difficulty understanding overseas corporate culture

Lack of managerial experience to expand in overseas markets

26

4523

4528

27 40

45 29

32

27

33

Attracting suitable talent4119 40

Securing finance for the necessary initial investment4335 22

Our investments overseas have been less successful than expected4431 25

Poor awareness of Japanese brands overseas32 39 29

Expanding overseas would distract us from focusing on high quality and service levels necessary to succeed in Japan4435 22

Not a challenge Moderate challenge Severe challenge

What are the principal factors driving your overseas investments? Pick the top three.(% respondents)

To enhance long-term growth prospects

To replace sales lost in Japan

To diversify risk

To lower operating costs

To gain better access to raw materials

26

19

18

17

17

To keep up with competitors11

To increase access to talent9

To take advantage of less stringent regulations (eg, on labour)8

N/A: We have no investments outside Japan58



Which of the following best describes your title?(% respondents)

Board member

CEO/president/managing director

CFO/treasurer/comptroller

CIO/technology director

Other C-level executive

SVP/VP/director

Head of business unit

Head of department

Manager

Other

18

9

6

4

13

2

6

8

35

0

What are your main functional roles? Choose up to three.(% respondents)

General management

Customer service

IT

Human resources

Finance

Marketing and sales

Operations and production

R&D

Strategy and business development

Legal

Risk

Procurement

Supply-chain management

Other

Information and research

27

17

16

16

15

13

11

11

10

5

4

1

6

10

3



What is your company’s current ownership status?(% respondents)

General corporation (privately owned)

General corporation (publicly listed)

Limited liability corporation (privately owned)

Commercial or limited partnership (privately owned)

Sole proprietorship

Government owned corporation

Family business

71

23

2

2

1

1

0

What is your company’s primary industry?(% respondents)

Manufacturing

Professional services

Construction and real estate

IT and technology

Logistics and distribution

Retailing

Financial services

Healthcare, pharmaceuticals and biotechnology

Transportation, travel and tourism

Consumer goods

Automotive

Government/Public sector

Education

Telecommunications

Chemicals

24

14

11

9

7

6

5

5

3

3

2

1

Entertainment, media and publishing1

Agriculture and agribusiness1

Energy and natural resources1

Aerospace/defence1

1

3

2



How many employees does your company have?(% respondents)

Fewer than 10

10-50

51-100

100-300

301-500

501-1,000

1,001-5,000

1

9

14

27

14

15

17

More than 5,0005

When was your firm established?(% respondents)

Less than two years ago

2-5 years ago

6-10 years ago

11-20 years ago

21-50 years ago

More than 50 years ago

1

2

5

14

43

35

What is your firm’s capital?(% respondents)

Less than ¥20m

Equal to or greater than ¥20m, but less than ¥100m

Equal to or greater than ¥100m, but less than ¥1bn

Equal to or greater than ¥1bn

Don’t know

7

32

36

23

2

While every effort has been taken to verify the accuracy of this information, The Economist Intelligence Unit Ltd. cannot accept any responsibility or liability for reliance by any person on this report or any of the information, opinions or conclusions set out in this report.

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Date post:	14-Sep-2014
Category:	Business
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