Bernhard Fietz

1.Structure of the keiretsu

The name keiretsu (in Japanese.系列) means literally "system", "series" or "line".Keiretsu are groups of companies with very close business relations (Munich Business School, 2008). The core of these conglomerates is a bank which provides them with liquidity or loans and holds equity positions in the member firms.Cross-shareholding, that means that the companies are shareholders of the most or every other company in the network without being the majority shareholder, and financial support of the bank make it nearly impossible for foreign investors to enter the Japanese market through hostile takeovers (Flath,2005, pp. 238-239).

Board members of one company are in many cases also board members,members of the supervisory board or consultants of other group enterprises.Consequently,personal connections are keeping the group together in addition to the structural connections(Kensy,2001,pp.202-203).Personal relations are more important in the Japanese society than in the Western societies like the United States (US) or Europe (Allen and Zhao,2007, pp.1-2).

Board members,the middle management and qualified employees meet periodically to examine the market performance of the group as a whole and of individual firms determining potential improvements like product quality or cost reduction (Kensy,2001,p.203).Despite all these mentioned connections inside the network most of the companies are separate legal entities (Flath,2005,pp.238).There are two different main types of keiretsu, the vertical and horizontal (intermarket) keiretsu.

1.1 Vertical keiretsu

A vertical keiretsu covers the whole value creation chain of a product and/ or service. In most cases, they are formed if the end product is made of many sub-products like in the car industry or the electrical industry. Thereby, an industrial enterprise and/ or a trading company are the centre of a vertical network. A bank can also be part of the network centre, but that is not a precondition (Argy and Stein, 1997, p.108).

Generally, its structure is like a pyramid with the core company on top. The supplying companies are supposed to provide the industrial enterprise with resources, sub products and services so that the main product can be produced (Flath,2005,p.246). Therefore, the suppliers are responsible for the first step of the value creation chain, whereby every supplier has its special task (McGuire and Dow,2008,p.337).

Some of them acquire the resources and deliver them to producing companies of the group.Japan needs to import most of its required raw materials and due to its deflationary economic development the costs have to be minimized.Consequently,the required raw materials must be purchased as cheap as possible without worsening the quality of the end product (Munich Business School,2008).

The trading company of the keiretsu, called sōgō shōsha, is also able to undertake the purchasing task.Additionally,there are vertical keiretsu without a special purchasing company. Several group firms produce the sub products(Kensy,2005,p.204).Every company provides the core producer with its special product. In the case of car producers as the core company like Toyota,its keiretsu partners produce the electrical equipment, glass, metal and so forth. Logistics service providers,cleaning service providers or headhunters can also be part of the network if these tasks are not carried out by any other network firm (Woniak,2009).

The production of the main product, e.g. a car, is the second step of the value creation chain. Afterwards, the good must be distributed what is the task of the sōgō shōsha. However, the core industrial enterprise by itself or more than one trading company are also able to take on the last step of the value creation chain (Kensy,2005, pp.204-205).

Every step in the value chain is well adjusted to reduce costs and time and to steadily improve the product (Flath,2005,p.246). Moreover, vertical keiretsu can be subdivided in seisan keiretsu (生産系列) and ryūtsū keiretsu(流通系列). Seisan keiretsu are vertical manufacturing networks which comprise the industrial entreprise and its suppliers but not a trading company.In turn,ryūtsū keiretsu are vertical distribution networks which only consist of an industrial company as the producer of the end product and a sōgō shōsha as the distributer without suppliers (Munich Business School, 2008).Famous vertical keiretsu are Toyota, Honda,Toshiba and Hitachi (Kensy,2001,p.204).

1.2 Horizontal keiretsu

Horizontal keiretsu,called kigyō shūdans (企業(yè)集団), are intermarket business groups. They are networks which cover many different economic sectors. The core of the group is a bank (Munich Business School, 2008).

A sōgō shōsha, which purchases and sells products for all group members can also be part of it. Every company is situated in a different major industry offering different goods and services to cover a wide range of the whole economy named the “complete set principle”(wan setto shugi) according to Yoshikazu (Flath,2005,p.239). If one company has no appropriate opportunities for reinvestment in its market sector, e.g. steel, it deposits surplus funds in the bank which can lend these funds to another group member with better investment opportunities in its market sector, e.g.electronics(Perner,2007).They are connected by above mentioned cross-shareholding and personal business relations. Trade between keiretsu members is very common as well.In general, up to 25 per cent sales and purchases are dealt inside the group (Kensy,2001, pp.245-246).The horizontal keiretsu has no leading company which sets the strategic direction in contrast to a vertical keiretsu.All members are more or less equal,regularly discussing the short-term up to the long-term orientated objectives of the group (Woniak,2009).

There were six big keiretsu,also called presidents clubs,which were all horizontal keiretsu covering nearly every important sector in the Japanese economy.Although all these big six companies (Mitsui, Mitsubishi, Sumitomo,Fuyo,Sanwa,Dai-Ichi Kangyo) represented just 0.007% of registered companies in Japan in 1994,they controlled a significant share of the whole Japanese economy regarding assets, paid-in capital, sales and profits.

Generally,a company is able to be a member of a horizontal and a vertical keiretsu at the same time (Watkins,2007) like Kawasaki and Furukawa in the Dai-Ichi Kangyo (DKB) keiretsu.Such companies are independent legal entities.Nevertheless,they are fully dependent on their networks.

2.Changes of corporate governance and the keiretsu system since the 1990s

The trigger for changes in the keiretsu system and the Japanese corporate governance was the burst of the Japanese bubble economy.

Many borrowers, companies as well as private investors, could not redeem their loans because of decreasing real estate and land prices after the bubble burst in 1991. Besides, the firms had overcapacities which caused high fixed costs. The consumption declined which minimized revenues causing losses for many companies.As a result,many banks struggled with loan defaults (Wood,1994,pp.102-111).Especially the keiretsu banks lent cheap credits to their group members without an appropriate risk evaluation in the booming phase in the 1980s.A number of banks were insolvent and even more banks were endangered to also file for bankruptcy. Consequently, some banks merged voluntarily. In 1995, the Japanese government passed a banking sector reform to restructure and to rehabilitate it. Bad performing banks had to merge to prevent a banking crash causing a new crisis (Iyoda, 2010,pp.83-84).

Hence,the number of banks decreased and keiretsu banks of different groups had to fuse.Examples are the mergers of Sakura Bank (from the Mitsui keiretsu) with Sumitomo Bank to create MitsuiSumitomo Bank,Mizuho Financial Group has joined with Fuji Bank (from the Fuyo keiretsu) and Dai-Ichi Kangyo Bank (from the DKB keiretsu) merged with the independent Industrial Bank of Japan (Goerzen,Isobe and Makino,2006,p.454).As a result,some keiretsu merged to bigger networks like Sumitomo and Mitsui in 2000 to become the Sumitomo Mitsui Banking Corporation as well as Sanwa became part of the Mitsubishi group in 2001.So,the number of the big horizontal keiretsu reduced from six to four (McGuire and Dow,2008,p.334).This development caused competition for cheap loans among the members of the new fused keiretsu.The banks were and are no longer able to offer cheap loans to every network firm because of increasing market pressure (Munich Business School,2008).

Nevertheless, certain keiretsu,especially smaller ones, dissolved after the insolvency or merger of their bank.Some network firms went bankrupt without the support of their home bank in the deflationary environment and the economic distress after the bubble burst (Wood, 1994,pp.75).The remaining former group members joined other networks or have been operating independently.There are following examples:Network firms such as Niigata Steel have gone bankrupt,Mitsui Mining and Japan Metals & Chemicals are reconstructing their organizations,and Toho Rayon has been integrated by another keiretsu group firm (Goerzen,Isobe and Makino,2006, p.454).

Another reason for the strongly declining bank financing of the Japanese corporate system is the easier access for companies to non-bank financial sources like the equity and the bond market due to regulatory changes by the Japanese government since the 1980s and the upcoming globalisation(Yoshikawa and McGuire,2007,p.11).Issuing bonds and shares in addition to bank financing causes lower costs in a medium-term than dependency on only one bank. Many companies have been aware of it at least since the struggling of the banking sector (Katz, 2003, pp.204-208). Moreover, the interdiction of forming a holding company was abolished in 1997.Thus,Japanese firms can organise themselves like conglomerates in other developed countries.Cross-shareholding is no longer the most important measure for building a company network.It is also heavily reduced because of the liberalisation of the Japanese equity market in times of international capital market pressures due to globalisation (Munich Business School, 2008).

The Japanese firms and the government knew that they will have to face the global competition by deregulating and opening the domestic market for foreign investors (Katz, 2003, pp. 148-149). As a result, foreign investors can enter the Japanese market through buying the majority of shares of Japanese companies. For instance, Mitsubishi Motors was taken over by DaimlerChrysler (Munich Business School, 2008). Hostile takeovers are possible since the 1990s.However, there has never been a hostile takeover of a listed Japanese company because its Japanese shareholders rejected to sell at any price (Word IQ,2010). Japanese companies have been becoming more international and also multinational.They have foreign shareholders and they invest in foreign companies as well.Joint ventures between Japanese and foreign companies are increasing.One reason is that the development of global business relations is crucial to remain competitive in globalization.As a consequence,the sōgō shōsha is shrinking in importance (Iyoda,2010,pp.91-92).

The presence of foreign investors in the Japanese economy and the mentioned deregulations and structural changes has been shifting the Japanese corporate governance model towards the Anglo-American one. Shareholder Value is becoming more important creating rationalisation and profit pressure.Hence,major principles like lifetime employment have been sacrificed (Takei,H.,1999,p.3).Inefficient keiretsu members which do not create synergy effects with the core business have been sold or separated from the keiretsu.Profit maximization is now as crucial as personal relations,loyalty and group orientation (Munich Business School, 2008).

However,the shift to shareholder-oriented corporate governance is controversial in the Japanese business society.Several business representatives believe that the competitive advantage of Japanese firms and the economic boom after the Second World War are based upon the mentioned Japanese ideals and values (Flath,2005,pp.292-293).

In sum, the Japanese keiretsu system and the corporate governance have changed due to domestic pressures after the bubble economy and foreign influences caused by globalisation. Nevertheless, the Japanese economy is still preserving its own characteristics.

About the author: Bernhard Fietz，Master student of the School of Management Shanghai University.[科]