Are Japan’s keiretsu withering away?

Introduction

Throughout history, business groups in Japan have been a prominent feature of the industrial

landscape (McGuire & Dow, 2001). However the impact they have had on the economy and

the Japanese market over time has been received with very mixed opinions. They have been

seen by many as both the ‘powerhouses behind Japanese industrialisation and the culprits

behind Japans decade long inertia’ (Ahmadjian, 2008). Processes of both industrial and

economic change have meant that these groups have been seen to ‘wither away’, as they no

longer represent the a significant proportion of the Japanese economic landscape, despite

having done so from the 1950’s to the early 2000’s. (Lincoln and Shimotani, 2009). There

have been a number of driving factors playing a role in this, so called disintegration of the

keiretsu, being supported by empirical evidence. These factors namely being the

developments of; globalisation, technological change, financial consolidation, accounting

rule change, and corporate government reform (Lincoln and Shimotani, 2009)

Zaibatsu and Keiretsu Structure

Japanese business groups used to be called zaibatsu which had pyramid structure, owned

large stakes in companies below them, had large holding companies that owned up to 20-30%

of smaller firms. During US occupation the Zaibatsu were broken up by the US authorities.

They made a law in 1977 that you can’t own more than 5% of a business, so the new Keiretsu

were born, they all owned 1 or 2% of each other. Zaibatsu and subsequent horizontal keiretsu

formed around the one-set principle. The defence mechanism from takeover in zaibatsu was

the holding company structure, the defence mechanism of Keiretsu was circle like web of

cross shareholdings. These links were also used to monitor and discipline members. They

also make the boundaries of a Keiretsu very hard to define, which means they are hard to

study and empirically test.

Successes of the Keiretsu

These keiretsu benefitted from close government and financial ties as well as inter corporate

linkages that provided member firms with mutual assistance in times of difficulty, as well as

dependable customer/supplier relationships (McGuire & Dow, 2001). Apart from their

descent from the prewar zaibatsu, the keiretsu emerged from a combination of centrifugal and

centripetal processes. Independent firms fell into the orbit of a group through banking and

created within the horizontal and vertical firms were crucial to the initial success of the

groups; structured around cross-shareholding, personnel transfers and preferential business

(Lincoln and Shimotani, 2009). From an outsiders point of view the keiretsu were hugely

threatening. The United States even complained that they were functioning as non-tariff

barriers to trade, as they were only trading amongst other member firms, for instance the

keiretsu suppliers supported one another by assisting the development of products, parts,

processes and people. Which, in turn, made it virtually impossible for foreign competition

within the Japanese economy. (E.g. Kirin beer was dunk at Mitsubishi gatherings, and Asahi

drunk at Sumitomo gatherings, and Mitsubishi managers drove Mitsubishi cars)

Much of the expansion of the keiretsu was though a process of already established firms

generating new product ideas, then forming divisions amongst themselves to commercialize

them, then hiving off the divisions as separate companies expected to grow and thrive on

their own, all the while maintaining a measure of parent firm support and control (Lincoln

and Shimotani, 2009). In this sense it is necessary to acknowledge that the term keiretsu is

more generally an umbrella term (McGuire & Dow, 2001), incorporating both horizontal or

financial and vertical type business groups, with six major horizontal keiretsu dominating the

Japanese economy (Mitsubishi, Mitsui, Sumitomo, Fuji, Sanwa and Dai Ichi Kangyo).

Horizontal firms are widely diversified with the central figure being the main bank, financing

the member firms through both debt and equity. On the other hand, vertical members are

reliant on the group bank for financing, being more focused on the customer and supplier

relationships. It was these vertical firms that ensured product focus and were less diversified

than their western counterparts, and were crucial to the success of the business groups.

Downfall of the Keiretsu

The 90s was a decade of missed growth for Japan caused by a deep recession, an appreciation

of yen which made exports more expensive, a period of low interest rates led to asset price

bubbles, booms then busts, and many speculative non-productive investments. This resulted

in substantial changes in the form and functioning of the Keiretsu. Japan’s idealistic

economic setting came under attack, ‘they became an economic decelerator rather than an

engine of economic growth’ (McGuire & Dow, 2001). The vast economic growth ended

abruptly and ‘government regulators, investors and even the popular press (McGuire & Dow,

2001) turned the blame towards the keiretsu. Financial system changes were implemented to

reduce the almost oligopolistic powers shown by the business groups, mandating the

unwinding of cross holding among firms and between banks and firms. Changes in

accounting rules and more transparency (e.g. assets at market not book price) also caused

Keiretsu to breakdown because tunnelling was no longer hidden from investors. The

Olympus scandal is an example of inappropriate accounting behaviour that was rife in Japan.

The directors covered losses approving the purchase of Micky Mouse companies and

payment of huge fees. The changes preventing bailing out failing firms which cause banks to

sell cross-held shares. Banks also massively unwound their equity ties. (in 1990 financial

institution held 43% of traded companies, in 2000 it was 30%.)

A crisis in both financial institutions’ and firms’ performance weakened the ties that

bind groups (Ahamadjian, 2008). Within the banks, problems emerged due to questionable

loans, with the government having to inject public funds into the banks. This then resulted in

a number of large scale mergers across banks and across groups, and banks selling lare

proportions of their stock in public firms. For example, in 1990, financial institutions owned

43 percent of the market value of publicly traded shares, while in 2000 their share had

diminished to 30.1 percent (Tokyo Stock Exchange, 2002). This change in the power and

success of the banks through the mergers significantly reduced the the impact and control the

keiretsu had upon the economy. Revision of financial reporting requirements was another

reform initiative aimed at increasing the transparency of Japanese firms and forcing

responsiveness to shareholder interests. The accounting change also meant that banks then

appeared to be worse off than they originally had, and it decreased keiretsu practices as

moving personnel (shukko) to affiliates or the bailouts and restructuring that further depend

on clandestine resource transfers (Lincoln & Shimotani, 2009).

Recent regulatory changes regarding corporate governance may also have significant

implications for the evolution of keiretsu ties (McGuire & Dow, 2001). As along with the

financial accounting changes, there were also proposals to alter the structure and composition

of boards of directors. E.g. The mandatory inclusion of an outside auditor on company

boards. The keiretsu system of risk-sharing was no longer feasible.

The process of globalisation has had a dramatic influence on the ever changing global

economic landscape. In particular the globalisation of capital markets and financial

liberalisation in Japan meant that outside investment into the Japanese market was now

possible. In 2003 foreign ownership in listed Japanese firms increased from less than 5% in

1990 to about 18% in 2002 (McGuire & Dow, 2001). Ahmadjian (2008) argues that the

foreign investors are less likely to see the sense in holding shares and carrying out

preferential trading with familiar companies, being likely to get rid of the conventional ‘old’

ties and replace them with newer, more profitable ones, leading to a restructuring of group

relationships. With this influx of international investment, the security created between the

business groups was hugely reduced, reducing competitive advantages bestowed by keiretsu-

style management in the 90’s (Lincoln & Shimotani, 2009). Empirical evidence carried out

by Ahmadjian (2008) indicates that there were substancial decreases in relative shareholdings

between firms and many of the inter firm ties were broken. Further changes which were

inherently linked to globalisation, are technological changes. Supply chain software and

online procurement systems enabled companies to reduce the manual hands on and

interpersonal methods, which meant that the keiretsu system of strong customer and supplier

relationships were no longer as effective. Furthermore, exchange rate fluctuations, cheaper

foreign production and labor costs, and local content rules, meant that Japanese businesses

turned to foreign suppliers, in turn abandoning the domestic keiretsu suppliers.

Empirical Evidence

Ahmadjian and Robinson (2001) noted that banks and insurance companies were selling

cross shareholdings and their shares were often being replaced by foreign institutional

shareholders, played a large part in reducing the definition of groups. Lincoln and Gerlach

(2004) also show via regression analysis that many inter-corporate ties were fraying in the

80s and accelerating in the late 90s. However Ahmadjian (2008) said in the face of pressure

for change the groups are appearing to remain quite stable and Dow and McGuire’s (2001)

work illustrates the stability of keiretsu ties, particularly in firms attached to the bank centred

horizontal keiretsu.

Conclusion

Japan’s keiretsu business groups were certainly extremely successful coming out of the

postwar period. They were met with vast economic growth, with many claiming that they

were the central figures in the success of the Japanese maturing economy. However, Lincoln

& Shimotani (2009), amongst others, suggest that in recent times, due to globalisation,

internal reform and re-regulation, financial changes and other forces, ‘the horizontal groups

are, for most intents and purposes, defunct’ (p.29). They continue to argue that the vertical

groups have also been seen to have vanished in comparison to what they represented in the

70s and 80s, as western practices and structuring has infiltrated the business organisations.

Keiretsu played major role in late industrialisation process when institutional and financial

development was poor, however ‘the continued development of institutions exerts pressure

on large business groups to reduce their levels of diversification’ (Hoskisson et al, 2005) The

Japanese Keiretsu are undoubtedly withering away to some extent however, Ahmadjian

(2008), concludes, ‘while some groups are weakening and some interfirm ties are being

broken, there is little evidence that groups are disappearing completely from the Japanese

economy’, which illustrates that this is a contested topic with no definitive answer.

Some additional opinions on future of Keiretsus

Professor Okumura argues that the keiretsu need to let failing business fail and allow new

businesses to emerge, currently the groups are not letting the market mechanism work. He

argues that Keiretsus are becoming more efficient and it could be too soon to write off

the keiretsu after all.

However Mitsubishi Corp. Chairman Minoru Makihara sees this consolidations as Japan's

logical response to the mega-mergers taking place in the United States and Europe. "I think

due to global competition and the credit crunch, the ties will get stronger" among keiretsu, he

said. "I've been saying in this time of global competition and economic difficulties, we should

look again at the various companies within our own group”.

How are Keiretsu different from other business groups?

(this is only relevant if the questions asks about it)

Keiretsu Lincoln and Shimotani (2009) suggest that Keiretsu warrant the ‘group’ label least,

because their boundaries are much less clear cut that other Asian Business groups. The fluid

network of Keiretsu means it is hard to list all members, (this can be easily done in other

Asian economies). Much research tries to do this, Miwa and Ramsayer (2006) criticise

Keiretsu research because of its overreliance on such listings which use cut-off to decipher

members and non-members. Keiretsus loose and flexible network fashion is v different from

sharply bounded and centrally coordinated pyramidal business groups in rest of east Asia.

However in the post war period the Keiretsu managed to coordinate themselves very well and

fill gaps in the developing Japanese economy, and create very efficient supply chains, perfect

for manufacturing. Keiretsu were not family owned or pyramidal structures, because of the

cross ownership structure.