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Are Japans keiretsu withering away?

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economic change have meant that these groups have been seen to wither away, as they no
longer represent the a significant proportion of the Japanese economic landscape, despite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 1950s to the early 2000s. (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 cant 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. Japans 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 90s (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 McGuires (2001)
work illustrates the stability of keiretsu ties, particularly in firms attached to the bank centred
horizontal keiretsu.
Japans 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.