Why Are Interfirm Networks So Prevalent In Japan? Why Do They Appera To Contricute To Industrial Competitiveness? Essay, Research Paper

Katherine Kesses Comparative International Management

Why are interfirm networks so prevalent in Japan?

Why do they appear to be so effective in promoting industrial competitiveness?

Interfirm networks have grown from the history of Japan, the government action and culture. In recent years they have gained a degree of both fame and notoriety (Gerlach, 1992). These networks have appeared to contribute to industrial competitiveness. However, the real issue is to what extent have they been effective in promoting industrial competitiveness and what is their role and prevalence in Japan today.

An explanation of what interfirm networks are and the different types are important to understand the prevalence of networks and their effectiveness in promoting industrial competitiveness. There are two types of interfirm networks; horizontal groupings from a range of industries and sectors and vertical groupings where smaller firms are dominated by a major firm at the top of the industry. This distinction is necessary to understand, as they will be subject to different factors that make them prevalent and able to promote industrial competitiveness. An example of a horizontal network is Sawa and vertical is Mitsubishi.

Some of the interfirm networks are more commonly known as keiretsu, which grew from zaibatsu. These are old groupings of firms, the earliest being Mitsui which was founded in 1616. Before the Second World war Japan was dominated by three zaibatsu Mitsui, Mitsubishi and Sumitomo. These zaibatsu have gained power in finance, mining, machinery manufacture and chemicals. Already, it is perhaps possible to see that the interfirm networks have been a central part of the Japanese economy, and thus the prevalence is merely a tradition of how Japanese firms operate. The three former zaibatsu exist today in a different form, but are still dominant in the Japanese economy.

Post WW2, the occupational forces decided that these structures had to be broken up, since they constituted powerful monopolies that helped the former government to execute the war. However the advent of the Korean War alerted the allies that the Japanese economy should not weaken, in order to fight Communism. The MITI invested into the economy and encouraged firms to operate collectively. They also were promoted protectionism to guard Japanese firms against foreign competitors. Many of the former zaibatsu were reestablished. However this time the companies grouped themselves around a bank. Hence it is conceivable to argue that the interfirm networks grew out of Japanese history. They have been an integral part of Japan and have become an institution. The keiretsus on Mitsui, Mitsubishi and Sumitomo are financial institutions. However not all of the interfirm networks that exist in Japan have grown and evolved from the former zaibatsu. Others formed groups with a bank at the core such as Sanwa, Fuyo and Ikkan. These grew to compete against the other keiretsu and to reap the benefits of functioning cooperatively.

The prevalence of interfirm networks in Japan can be attributed to the culture of Japan. Their high-context culture (Hall, 1976), means that through their long-lasting relationships with individuals, shared code of communication, ability to use spoken agreements and ingrained culture are suited to work most efficiently in these interfirm networks. These interfirm networks rely on mutual trust, which is a strong characteristic of the Japanese culture. Their collectivist culture (Hofstede) means that they operate more effectively when working together, rather than as individuals. Therefore it is possible to attribute the prevalence of interfirm networks due to their collectivist values, high context power distance and their ability to function using mutual trust. Interfirm networks are prevalent as they grew and evolved from the Japanese culture

Furthermore it could be argued that interfirm networks are so prevalent in Japan because of the advantages they can offer firms. Their industrial competitiveness can explain their prevalence in the Japanese economy. The advantage of having a bank as part of the network means that raising capital is not arduous, they can acquire loans from the banks in the network. Cross-shareholdings can protect a company from the threat of take-over. Joint ventures means that firms can reduce costs considerably. Firms can benefit from economies of scale and scope in all sectors of their business. For example, they can benefit from using a joint venture in research and development can improve their products as well as save on costs. Thus interfirm networks are so prevalent in Japan due to benefits they can give a firm.

One the most logical reasons why interfirm networks promote industrial competitiveness are the costs that can be saved. Achieving economies of scope and scale has the impact that the firms can reduce costs and develop more efficient ways of operating in many areas such as management, production and marketing. Thus, again we can see that interfirm networks can be effective in promoting industrial competitiveness as they can significantly reduce cost for a firm.

However there has been much debate over the prevalence of interfirm networks in Japan. As of 1989, only 187 firms sat on presidents council in one of the six major intermarket keiretsu (Gerlach, 1992) further some firms have linked themselves with more than one keiretsu, Gerlach argues that firms have developed strong and durable affiliations with two or more groups of keiretsu. The membership of an interfirm networks is no longer mutually exclusive.

Interfirm networks prevalent in Japan due to the competitiveness that can be yielded from membership. But what factors allow industries to be competitive? There are many reasons that give these networks the appearance of being effective in promoting industrial competitiveness. One fundamental factor which makes these networks appear to be so effective is the system in which they can acquire capital. Due to the nature of these groupings, there is a bank in the middle or a big manufacturer at the top. This means firms can gain capital at an attractive rate. Also due to the mutual trust in the networks, cross-directorships and implicit contracts, firms are not credit checked and nor do they have to justify their requirement of a loan. Hence, the ability of firms to gain capital instantly and effortlessness means that Japanese firms can invest and acquire any resources that are needed to accomplish goals.

Another way in which Japanese firms can gain industrial competitiveness is through the cross-shareholdings between firms. This aspect of the interfirm network system can promote industrial competitiveness. Unlike in the UK and US where the shareholders of firms have the objective of high dividends, Japanese shareholders have different objectives. In the interfirm networks, firm s cross-sharehold, thus they are concerned with short-term profits. This allows firms to use long-term goals, such as increasing investment or market share instead of short-term profitability, thus avoiding any opportunistic behavior made by managers. This cross-shareholding characteristic of an interfirm network also protects the firm from take over. Whatever happens to the shares on the stock market, the owners will have no interest in selling them. Thus, the interfirm networks are effective in promoting industry competitiveness as they allow firms to have long-term successfulness as their objective, instead as short-term profit. This cross shareholding allows a firm to protect itself against take over. Although this is protectionist, and does not directly promote industry competitiveness, it is essential to a firm s survival.

One of the ways in which keiretsu are effective in creating industry competitiveness is through the ability to act cooperatively in research and development. Many firms act cooperatively in R&D purposes, such as Fuji and Xerox (B. Gomes, 1999). This pool of resources can facilitate learning, eliminates duplication of products, and allows firms to acquire synergy and reduce costs. Therefore interfirm networks appear to be so effective in promoting industrial competitiveness on account of their strong R&D resources, which allows them to innovate quickly and efficiently.

In a vertical keiretsu, the manufacturer at the top of the hierarchy is able to choose which suppliers to use. This means that the suppliers compete fiercely with each other to gain the contract with the manufacturer. Thus this fierce competition between the suppliers in the network results in better quality and lower costs, which make them more competitive with other firms. A car consists of 70% parts from the supplier and the manufacturer makes the rest. Consequently, if the suppliers compete for the contract on price and quality, the manufacturer will be able to obtain parts that are cheap and have high quality. Thus these savings are passed on to the consumer, making the cars produced more attractive for them. Therefore, where a manufacturer relies on suppliers for a large part of the finished good, they can earn substantial savings and produce high quality goods. This gives the manufacturer flexibility, as it will be substantially cheaper for the manufacturer to use these suppliers. Flexibility is also relevant if the firm has to change the product supplied. The small supplier will incur the costs of a change of the product. Here the interfirm networks are effective in promoting industrial competitiveness as they can produce goods at lower costs.

The nature of the terms of employment in an interfirm network can be argued to promote industrial competitiveness. In the networks, apart from small suppliers, workers are employed permanently, for life. This life time employment grew post WW2 when there was high rate of labor turnover. The Japanese were demanding pay to be linked to need, age and the size of their family. The development of life long employment was developed in the 1950s. This permanent labor allows the firm to invest in their employees. The Japanese invest heavily in training (R. Whitley, 1990), thus as the workforce of a company are long term costs or an asset, the advantages of the training given will be kept within the network. Furthermore, this life long employment allows the firm to aim for the long term. As mangers are not assessed on their ability to create short-term profit, they can concentrate on the long term goals and objectives of the firm. This benefit coincides with the concept of cross shareholding of keiretsu, both promoting long-term objectives and goals. Hence, the characteristic of life long employment in a interfirm network, could be argued to be effective in promoting industrial competitiveness as it allows firms to aim for the long term and not the short term.

One reason why interfirm networks appear to promote industrial competitiveness is the ability to spread risk. Despite the Japanese being risk-averse, interfirm networks can reduce the risks involved in specializing in a particular line of business as the Japanese system allows firms to share risks with sub-contractors, training companies and other members of the business groups (Geralch, 1990; Imai and Itami, 1984). Firms can undertake risky investment opportunities to develop new product lines with other network members which provide subsidies, technological know-how as well as captive new markets (R. Wright, 1990). This allows Japanese firms to endeavor into risky business or projects, which can promote industrial competitiveness.

R. Wright argues that keiretsu can give firms a fadeout ability . (R.Wright, 1990). This is the ability to wind down inefficient operations and free the resources and human resources into other operations in order to avoid possible layoffs and bankruptcy. This aspect of an interfirm network promotes industry competitiveness as the interfirm networks can be efficient it its allocation and redistribution of resources.

So far, the prevalence and the effectiveness of these interfirm networks in promoting industry competitiveness have been discussed. However, perhaps the real issue here is whether interfirm networks are prevalent today and if they are effective in promoting industrial competitiveness, which are both interrelated with each other. Japan has experienced many changes over the past twenty years which have resounding effects on the on the economy which then have had a ripple affect on the keiretsu. An assessment of the whether these networks advocate industrial competitiveness and their prevalence in the Japanese economy at present will indicate their real value.

The dual economies that exist in the different industries that exist in Japan undermine the success of the interfirm network system. Japan has good and bad sectors. They are particularly strong in consumer electronics, automobiles, computer games and machine tools. However they also have weak industries, being pharmaceuticals, oil, food and computer software. Thus it is possible to see that perhaps that the interfirm network system in Japan is not constantly effective in promoting industrial effectiveness, as there are strong disparities of competitive strength between sectors.

The recession in Japan over the past ten years has changed the face of the Japanese economy, even 1999 has been remembered as a period of destruction for Japan (M.Shiben, 1999). The bursting of Japan s bubble economy in the 1990s has had significant effects and ramifications on the interfirm networks of Japan. Due to Japanese accounting methods, the problems in the banks were hidden; there were huge bad debts and 1997 the problems became apparent went the banks started to go bankrupt. This startling overvaluation of Japanese bank stock (T, Watkins, 1992) lead to the disappearance of the banks in horizontal networks that were at the heart of the groupings. Thus, the interfirm networks that were affected by this loss of one of the main reasons for working cooperatively. The medium and small sized firms that belong to horizontal networks have been argued to be the largest victims of the recession and have been forced to restructure (Weekly Post, 2000). The recession also had major ramifications on some the vertical networks. One of the oldest and former zaibatsu, Mitsubishi has been extensively affected by the recession of the 1990s in Japan. Mitsubishi is a tale of distress and turmoil (Bremner and Thornton, 1999). In mid-February of last year the Head of Mitsubishi Motors Corporation admitted that the company was in a bad way that he would welcome a foreign partner. (Bremner and Thornton, 1999). There have been reported losses of Mitsubishi Motors of $330 million. Again the reasoning for this was the banks. The cheap capital from banks was plowed on until Japan was weighed down with huge over capacity in a zero growth economy. Therefore it is possible to realize that the recession of the 1990s has resulted in the decline of the keiretsu. Many horizontal interfirm networks have lost their bank. Vertical keiretsu have also been significantly affected, illustrated in the case of Mitsubishi. Due to the recession, the prevalence of the interfirm networks in Japan will decline, and it could be argued that they would have to redefine their role for survival. Perhaps even their survival is debatable, Gerlach argues that the decline in the Japanese economy has led to a decline in keiretsu effectiveness (Gerlach, 1990), perhaps condemning their possible survival.

Apart from the recession affecting the banks, the banks are undergoing a change of role in the Japanese interfirm networks. Firms are able to acquire their capital from other sources. Wright argues that companies now have greater cash resources (R.Wright, 1990), thus weaning them away from their strong dependence on banks. Furthermore firms are now free to raise investment funds through a variety of equity, bond and hybrid mechanisms (Gerlach, 1990). Thus horizontal keiretsu are operating in the same manner. The concept of a bank being central to the activities of a keiretsu is no longer a requirement. Arguably this could lead to the dismissal of horizontal banks. There is another change in role of the banks in Japan. They are no longer devoted to their keiretsu. This can be depicted through the recent mergers of Japanese banks. These mergers are also perhaps a result of the Japanese recession, but nonetheless show that the nature of keiretsu has changed and is diversifying. The merger of three major Japanese banks, Daiichi Kangyo Bank and Fuji Bank and Industrial Bank of Japan to establish a stockholding company jointly by Spring 2002 with combined assets of $1.4 trillion (N.Shima, 1999) shows that banks are metamorphosing their purpose. Hence the changing role of banks in the keiretsu leads to the questioning of the future existence and structure of keiretsu.

One of the essential parts of a vertical supplier is their interaction with small suppliers. However this is changing. Large manufacturers are using foreign companies to supply them with parts as they can offer lower prices. This is clearly illustrated in the case of Mazda terminating its contract with many of its small suppliers in favor of foreign firms that offer lower costs. (Bubble Trouble, 2000). This has resulted in the demise of many of the small suppliers. This affects the structure of vertical networks. Without the manufacturer using all the small suppliers beneath them in the network, the vertical networks will cease to exist. Thus the future prevalence of vertical interfirm networks dubious.

The recent takeover of Mazda by Ford has shown that perhaps the Japanese interfirm networks system is under fire from foreign competitors. Ford acquired Mazda last year and rescued it from retrenchment from the automobile market. Foreign competitors can bring different ways of operating and running a company. Ford has had the immense task of restructuring the company. They have abolished lifetime employment, which was justified by the high labor cost, the unnecessary amount of layers of labor. This also gave them the chance to fire many underachieving and useless workers. If this is an example that will set a precedent for the future of keiretsu, their future is indefinite. Thus it is possible to see that the prevalence of interfirm networks may decline in the near future.

The fall of the keiretsu has perhaps started. Shares are being sold, banks are no longer at the center of the networks and large manufacturers are no longer relying on small Japanese suppliers. The argument that Mitsubishi is sinking fast (Bremner and Thornton, 2000), perhaps shows that the keiretsu are already in trouble. Whether the interfirm networks are in demise or whether they are restructuring, illustrated by the bank mergers is not known. However the evidence suggest that the keiretsu are going to have to overcome many situations to survive. Only the future can determine where interfirm networks are going, if anywhere.

Interfirm networks are prevalent in Japan due the history, culture, and government action and the benefits that are gained by them. However their prevalence in the Japanese economy in changing. Changing situations such as the recession, the changing role of Banks, the influx of foreign competitors and change in manufacturer and small supplier relationships. Interfirm networks can be effective in promoting industrial competitiveness. There are many advantages of membership to an interfirm network, and these are converted in firms to be effective in industrial competition. Yet the Japanese economy is still changing. Many of the traditional elements of Japanese industry are disappearing. The once acclaimed and admired Japanese way of doing things have now under criticism. The interfirm networks are an element of the Japanese economy that has been criticized. The reality is that the future of Japan s interfirm networks is pessimistic. There are many obstacles that interfirm networks have to overcome to survive. The networks are going to have to restructure and evolve to exist in Japan s future economy.