Much like the rest of the world, Japan is still recovering from the economic shocks of the pandemic. However, the centrepiece of their economy is still the age-old Keiretsu or perhaps a new variant of it. Keiretsu is the organisational structure that transformed Japan into the economic superpower it is today. But this miracle slowly lost its shine post the 1990s bubble. The fascinating journey of Keiretsu from its high in the Golden 60s to the low of the Lost Decade in the 1990s provides food for thought and insights into the current situation.
Post World War 2, Japanese GDP was hardly 11% of the United States. However, it became the second largest economy after the US in roughly four decades. In the aftermath of World War 2, Japan was plagued with high levels of the unemployed labour force, an energy and food crisis and skyrocketing inflation. The Supreme Commander for the Allied Powers demilitarised Japan to supposedly “democratise” it, making it virtually helpless. But in this defeat, a cloud with a silver lining emerged-the massive reduction in government expenditure due to low military spending. The Yoshida Doctrine further capitalised on this by leaving the defence to the US army and cutting costs. This aggressive cost-cutting, constant domestic innovation and social trust led to the economic miracle of Japan. The Keiretsu developed two ingredients of this mix, constant innovation and high levels of trust, to build a robust economy from the ground up.
The Centrepiece of the Japanese Strategy
The key to Japan’s economic miracle was the popular Keiretsu. It refers to long-term partnerships and cross-shareholding between companies. The manufacturer, supplier and bank all formed a Keiretsu. The result was an economy filled to the brim with thriving companies, cutting-edge innovation and an impenetrable moat protecting it from foreign rivals. The Keiretsu allowed Japan to support all the actors in its supply chain financially, intellectually, and emotionally. Financially, the banks had full transparency, and the firms had easy access to capital. Intellectually, the innovations and decisions were shared throughout the Keiretsu, allowing instant and thorough implementation. Emotionally, the Keiretsu heavily relied on trust as the binding glue for its operations, leading to organisational-wide synergy. The economic miracle of Japan and its meteoric rise in the Golden 60s was due to Keiretsu cocooning and building stable and perseverent companies.
Toyota is a case in point for the pinnacle of Keiretsu-era innovation. It is a vertical Keiretsu with Toyota at the top and its suppliers a rung below with long-term trust-based partnerships linking the two. It rose to a position of global dominance due to its revolutionary technique of just-in-time production. It was an aggressive but effective cost-cutting technique. It involved keeping virtually no inventory and producing the cars as and when the order arrived. Years of perfecting this system led to cost reduction, elimination of waste, massive flexibility and pivotal capacity. With this method, the company could pivot and change its models and designs without worrying about inventory. The Keiretsu model allowed this innovation to flow through the whole unit and increased the efficiency of suppliers manifold, further benefiting the company. The company moved ahead at spellbinding speed, completing 1 million units by the end of the Golden Sixties and 5 million just half a decade later. Today, it has made a name for itself as the heavyweight in the automotive industry.
Continuing with the Toyota example, the intricacies of the downfall of Keiretsu can be understood. The tipping point was in the 1990s economic bubble burst. The Japanese had come to the ground almost as quickly as they rose to dizzying heights during the 1960s. Toyota’s case was no different as it was one among many going through a massive restructuring. A series of reforms in the 2000s shook the foundations of the Keiretsu for the better as its inefficiencies were becoming clearer post the bubble burst. Its iconic cross-shareholding had led to poor corporate governance and loyalty bias. Its strength of cutting off foreign bodies and having immense trust internally was now becoming its weakness. However, the final shock to the Keiretsu came in the form of the Corporate Governance Code and the Stewardship Code. This mandated the companies to give a full explanation or reduce or eliminate their cross-shareholding. The result was a sharp drop in holdings to less than 10% of their original value by 2017. Toyota survived through Keiretsu 2.0. Toyota opened itself to global companies with ‘Construction of Cost Competitiveness for the 21st Century’ or CCC21. It now chooses suppliers by comparing global competitive prices. But it still has Keiretsu-level trust and cooperation at its core, as instead of abandoning suppliers, it focuses on revamping its capabilities. Its contracts are filled with ambiguous, general and non-binding statements and targets instead of the Western approach of hyper-specific binding targets. It reduces the cost over the period of the contract but does it less rigidly.
The Way Forward
The past few years have been turbulent, to say the least. The Covid-19 pandemic, followed by the Russia-Ukraine conflict, has shaken the world. But economically speaking, Japan seems to have weathered these storms fairly well. According to a report by the Organisation for Economic Co-operation and Development (OECD), “robust government support and the reopening of the economy led to a partial bounceback. Growth is on course to regain momentum, supported by macroeconomic policies and progress in vaccination”. As the economy uncovers Keiretsu 2.0, it seems to be adopting digitalisation and further increasing its dynamism. However, this may not be a perfect conclusion, as the recent demise of Shinzo Abe seems to have thrown in another dose of uncertainty. The impact on government and economic policies, and consequently on Keiretsu 2.0, is yet to be seen. The saying “the only constant in life is change” rings truer than ever.
By Harsh Khatri