What ails Japan’s once formidable manufacturing sector?

The third largest economy in the world, Japan, was once the powerhouse of manufacturing; be it cars, machines or hi-tech electronics. Japan was at the forefront of manufacturing technology. Japanese firms were at the helm of global markets. Electronic firms like Sony and Panasonic; car manufacturers Toyota, Honda and Nissan were the pride of the nation. The decades of 70s and 80s were Japans decade of dominance in world trade. But the Japanese castle began to crumble and fall in the 90s; also known as the ‘lost decade’ of Japan. A strong Yen and rising costs made Japanese firms less competitive. Rise of neighbouring countries like South Korea and China further diminished Japans position of strength. Today, Japan’s manufacturing industry is in a crisis and questions are being asked about how it will survive in this highly competitive world market.

Japan’s problems are a plenty, some internal and some external. A strong Yen has been a pain for the Japanese economy since a very long time. Bank of Japans sporadic attempts to control the currency have been far from successful. The countries corporates also suffers from a peculiar cultural effect, called the Galapagos effect. Japanese companies tend to focus too much on the local consumers unique needs, and thereby end up making sophisticated and over-engineered products which can’t be sold elsewhere in the world. Its labour friendly laws also hamper local investment. Government policies have always favoured manufacturing sector, neglecting other areas of economy like financial services etc. Monopolies in power sector have resulted in high electricity prices, which dent the profitability of these firms. All these factors have contributed to the fall of the Japanese economy and the Japanese corporates.

Nowhere else has the problem been more significant than in the countries electronics industry. Sony, Panasonic, Hitachi and Toshiba had a combined market capitalization of $256 billion at the end of year 1999. By 2011 their combined market cap had fallen to $79 billion. This is a very alarming drop. The gravity of the situation is more evident when we look at how the competition has progressed over the same time period. Apple and Samsung had a combined market cap of only $51 billion. However at the end of 2011 their combined market cap had zoomed past $500 billion. Further, the operating profits of Japans major electronics companies will come to only 2% in the year ended March. This is dismally low compared to the double profits of Apple and Samsung.

Japanese corporates are known to spread their resources too thin over a number of products. That is a problem faced by many of these companies which were once leading innovators in their field today have lost product focus and competitive advantage. Overseas technology collaboration deals with Taiwanese and Korean firms have also been blamed for loss of competitive advantage of Japanese firms.

Many a steps are being proposed and taken to prevent further decline of the manufacturing industry. An idea that has been gaining ground is the merging of companies to form national champions which will have the scale and financial muscle to compete with global rivals. The recent merging of the small and medium sized businesses of Sony, Hitachi and Toshiba to create Japan Display is a classic example. The combined entity will sit on 20% market share which is more than the combined market share of Samsung and LG display. Plans are on to merge more such struggling units to create more national champions. But merging struggling units is not the only way forward.

Japan needs to take steps to liberalize its economy. It must open up its corporates to foreign competition. Its policies have long supported the weak corporates from falling. The extremely labour friendly policies need to be liberalized too. Japan has one of the highest corporate tax rates in OECD nations. Monopolies in sectors like power needs to go to reduce the input costs for the industry. However, what many observers of Japan feel is that there is need to bring a shift from manufacturing to service industry.  This is easier said than done, as manufacturing was brought about Japans miraculous recovery post the World War II. Even then, as the world economics change and major companies are going beyond their countries boundaries, seeking cheaper destinations of manufacturing, more and more Japanese firms will have to do the same. Statistics also say that companies which have moved part of their operations overseas are in a better shape than those who haven’t. Maybe going beyond manufacturing is where the future lies for Japan.