Japanese Interfirm Networks: Adapting to survive in the Global Electronics Industry (Sheffield Centre for Japanese Studies Routledgecurzon)

Interfirm Networks in the Japanese Electronics Industry

Interfirm Networks in the Japanese Electronics Industry analyses changes in production networks in the Japanese electronics industry. Japan’s postwar success in the assembly industries (automobiles, electronics, etc.) is frequently attributed to innovative approaches to the organization of production: instead of relying on full-scale vertical integration or arm’s-length market transactions like their Western competitors, Japanese assemblers forged intricate networks of long-term interfirm business relationships that have provided them with greater flexibility and quality of production. Traditionally, such networks have been characterized by hierarchical interfirm relationships resembling a pyramid. Paprzycki argues that as a result of global industry dynamics, such monolithic ‘pyramidal’ production networks have come under mounting pressure and are giving way to an increasing diversity of network arrangements. A major contributing factor is the growing cost and complexity of technology, which forces even the largest manufacturers to look beyond traditional network boundaries in order to gain access to complementary (technological) assets and capabilities. At the same time, customer-specific assets and capabilities, and with them traditional keiretsu and subcontracting relationships, are declining in importance. Paprzycki’s study shows how network arrangements have adapted in order to cope with profound changes in the competitive environment and how, as a result, many of the traditional elements of Japanese industrial organization described in the literature have begun to unravel. Dr Ralph Paprzycki is currently a research fellow at Hitotsubashi University, Tokyo.

Sheffield Centre for Japanese Studies/ RoutledgeCurzon series Series editor: Glenn D. Hook Professor of Japanese Studies, University of Sheffield

This series, published by RoutledgeCurzon in association with the Centre for Japanese Studies at the University of Sheffield, both makes available original research on a wide range of subjects dealing with Japan and provides introductory overviews of key topics in Japanese Studies. The Internationalization of Japan Edited by Glenn D. Hook and Michael Weiner Race and Migration in Imperial Japan Michael Weiner Japan and the Pacific Free Trade Area Pekka Korhonen Greater China and Japan Prospects for an economic partnership? Robert Taylor The Steel Industry in Japan A comparison with the UK Hasegawa Harukiyo Race, Resistance and the Ainu of Japan Richard Siddle Japan’s Minorities The illusion of homogeneity Edited by Michael Weiner Japanese Business Management Restructuring for low growth and globalization Edited by Hasegawa Harukiyo and Glenn D. Hook Japan and Asia Pacific Integration Pacific romances 1968–1996 Pekka Korhonen

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Grassroots Pacifism in Post-War Japan The rebirth of a nation Mari Yamamoto Interfirm Networks in the Japanese Electronics Industry Ralph Paprzycki

Interfirm Networks in the Japanese Electronics Industry

Ralph Paprzycki

First published 2005 by RoutledgeCurzon 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN Simultaneously published in the USA and Canada by RoutledgeCurzon 270 Madison Ave, New York, NY 10016 This edition published in the Taylor & Francis e-Library, 2005. “To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk.” RoutledgeCurzon is an imprint of the Taylor & Francis Group © 2005 Ralph Paprzycki All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data A catalog record for this book has been requested ISBN 0-203-42233-3 Master e-book ISBN

ISBN 0-203-68047-2 (Adobe eReader Format) ISBN 0–415–33674–0 (Print Edition)

Contents

1

List of figures List of tables Acknowledgements

xi xiii xv

Introduction

1

Problem setting 1 Research approach and outline 2 The keiretsu, subcontracting and the development of the electronics industry 6 2

The organization of production: theoretical considerations on networks and innovation

15

Introduction 15 Industrial organization and network theory 17 Networks, technology and innovation 26 The morphology of networks 29 3

‘Pyramidal’ production networks in the Japanese electronics industry

33

Introduction 33 Network members and the division of labour 35 Relationships: coordination and transaction linkages 41 Resources and (technological) capabilities 48 The pyramid 50 Concluding remarks 54 4

The Japanese electronics industry in the context of domestic and global challenges Introduction 56 Macroeconomic factors 57

56

viii

Contents Shifting competition and the growing strength of foreign rivals 63 Technology and the rules of competition 66 Declining Japanese competitiveness – some quantitative indicators 70 Concluding remarks 77

5 Pyramids under pressure: some evidence on aggregate trends in network arrangements

79

Introduction 79 Internationalization 80 The subcontracting system under pressure 90 Technology and networking beyond the keiretsu 94 Concluding remarks 99 Appendix 100 6 Overseas production of low-end consumer products

103

Introduction 103 Background 104 Company profiles 105 Network patterns 107 Analysis 113 Concluding remarks 116 7 Personal computers

118

Introduction 118 Industry background 119 Company profiles 122 Network patterns 124 Analysis 132 Concluding remarks 135 8 Digital cameras Introduction 137 Industry background 137 Company profiles 143 Network patterns 145 Analysis 151 Concluding remarks 153

137

Contents 9

Conclusion

ix 155

Introduction 155 Summary and assessment of findings 155 Outlook 162 Notes Bibliography Index

164 173 181

Figures

1.1 3.1 3.2 3.3 4.1 4.2 4.3 4.4 4.5 4.6 7.1 7.2 8.1 8.2 8.3 8.4

The Toshiba group Classification of suppliers The organization of TV production at Matsushita Electric Industrial Co. Production chart of TV manufacturing at Matsushita’s Ibaraki factory Yen/US$ exchange rate Japanese outward FDI in the electrical machinery sector, 1977–2002 Overseas production ratios, 1985–2001 Real GDP growth, 1981–2002 Japan’s total electronics production and exports Electrical machinery production: Japan and US NEC’s PC history Fujitsu’s network of suppliers Worldwide digital camera production Key functions and components of a digital camera Konica’s procurement network Fujifilm’s procurement network

9 37 38 39 57 58 59 61 62 71 125 130 138 139 148 150

Tables

1.1 1.2 1.3 2.1 3.1 3.2 4.1 4.2 4.3 5.1 5.2 5.3 5.4 5.5 6.1 7.1 7.2 7.3 7.4

The top vertical production keiretsu Length of product life cycles in Japan and the UK during the 1980s Relative market shares of national clusters Types of organization and their characteristics The structure of parts procurement and interfirm relationships of Matsushita Industry’s Ibaraki factory Main features of the pyramid network Shares of leading electronics exporters, 1980–2001 Shares of leading electronics exporters by product category, 1982–2001 Sales and relative market share of country/regional cluster Overseas affiliates’ procurements by origin and group membership The origin of Japanese overseas subsidiaries’ supplies Production, exports and imports by product category Share of imports in domestic demand Share of small and medium enterprises engaged in subcontracting Purchases by HEPM for April to September 1999 Worldwide PC shipments PC shipments in Japan Procurement patterns of NEC’s PC division Procurement patterns of Hitachi’s PC division

7 11 13 31 51 53 72 73 76 82 84 88 89 91 109 119 121 126 128

Acknowledgements

This book would not have been possible without the help, support and comments of a number of people. First and foremost, I would like to thank Professor Christopher Howe of the School of Oriental and African Studies, University of London, whose guidance throughout my PhD – out of which this book grew – was invaluable. I am also grateful to Professor Kyoji Fukao of Hitotsubashi University, Tokyo, for his help during my field research in Japan, which was made possible through a Japanese Government (Monbusho) scholarship. Furthermore, I would like to thank Atsushi Iwai and Jun Yoshino of what was then the MITI Research Institute who kindly arranged the interviews for the case studies, and the interviewees at the various companies who all gave, generously, their time. Finally, a big thank you goes to Kazuko Morohashi, who provided humour, inspiration and much more throughout the writing of this book.

1

Introduction

Problem setting Japan’s postwar economic success is to a considerable extent the story of its assembly industries. A major protagonist, together with the automotive industry, has been the electronics sector, where the country gained a dominant position in one market segment after another. Today, a large number of Japanese electronics companies – such as Sony, Hitachi, Toshiba or Matsushita (with its Panasonic brand) – are established household names.1 Central to the competitive success of Japan’s manufacturing companies have been innovative approaches to the organization of production. Epitomized by the car industry, the country’s assembly industries pioneered organizational arrangements during the 1960s and 1970s that proved superior to the rigid mass production strategies (‘Fordism’) then dominating in the West. Incorporating aspects such as flexible manufacturing techniques, subcontracting and ‘just-in-time’ production and delivery, the Japanese approach (‘Toyotism’) afforded increased flexibility while retaining the main advantages of mass production. This enabled firms to compete on the basis of both cost and product differentiation including high rates of incremental product innovations. Though in the first instance associated with Toyota and the Japanese car industry in general, the main features of this production system can similarly be found in the electronics industry.2 Crucial to this approach is how interdependent activities are organized. Rather than relying on either full-scale vertical integration or arm’s length market transactions, production is organized through a web of cooperative arrangements. The most conspicuous aspect of such arrangements is the group networks – the socalled keiretsu – consisting of a lead manufacturer and its affiliates. A further aspect of the organization of production in Japanese assembly industries is the so-called subcontracting system. Japanese assemblers tend to buy in parts and components rather than make them in-house; moreover, a large share of the parts and components bought in are customized. Close, long-term and stable relationships with dedicated suppliers (‘subcontractors’) therefore play a crucial role. There is a considerable overlap between keiretsu members and subcontractors, and taken together, this approach to organizing production may be labelled the keiretsu subcontracting system, though studies of the Japanese production system

2

Introduction

usually approach the subject either from the keiretsu or the subcontracting angle.3 In either case, production arrangements are typically portrayed as forming a hierarchical structure in terms of interfirm relationships and the division of labour. A frequently used metaphor is that of a production pyramid, with the parent company at the apex followed by major subsidiaries that are typically first-tier assemblers and/or parts suppliers, and below these, further tiers of smaller and smaller subcontractors each serving, and coordinated by, the firms in the tier immediately above. Concentrating on the electronics industry, the purpose of this study is to show that this popular image is losing its validity: the production pyramids are crumbling. However, this does not mean that collective manufacturing arrangements are disappearing – on the contrary. Rather, monolithic hierarchical organizational structures are being replaced by a growing diversity of network arrangements that are characterized by greater openness and flexibility than in the past. The questions addressed in this study therefore can be summarized as follows: how are collective manufacturing arrangements changing? What are the underlying reasons? And how do the answers to these questions reflect on the pyramidal keiretsu subcontracting system that, after all, had been considered fundamental to the success of Japan’s assembly industries? The argument put forth here is quite straightforward: Japanese production arrangements are changing because traditional hierarchical structures are no longer adequate in a competitive environment that has changed considerably over the past 10 or 15 years. With the strength of the yen and the prolonged domestic recession exerting additional pressure, adjustments are primarily driven by global industry dynamics, with the ever-increasing cost and complexity of technology playing a central role in shaping collaborative manufacturing arrangements. Whilst in the traditional keiretsu subcontracting system suppliers’ customer-specific capabilities provided the main rationale for interfirm cooperation, what manufacturers are looking for these days are suppliers’ independent technological capabilities. Consequently, firms are increasingly looking beyond established keiretsu boundaries, forging ties that differ from the old hierarchical structures.4

Research approach and outline The study is divided into three major parts. The first deals with background and conceptual issues. Further below, a brief overview of the history of interfirm networks in Japan, an outline of the keiretsu subcontracting system and of developments in the electronics sector will be provided. This is followed by a discussion of production networks, consisting of theoretical considerations in Chapter 2 and the presentation of actual network practices in the Japanese electronics industry in Chapter 3. The second part of the study (Chapters 4 and 5) offers a bird’s-eye view of the sector: the major dynamics shaping the global electronics industry as well as some evidence on aggregate trends in Japanese network arrangements are presented. The third part, finally, consists of three case studies of production networks in different market segments based on interviews with major Japanese

Introduction

3

electronics companies (Chapters 6 to 8). The findings are summarized in the concluding Chapter 9. To begin with, however, it is necessary to first look at some theoretical issues relating to the organization of production, which is the purpose of the following chapter. Of particular interest are the economic rationale for relational contracting and networking as well as their link with technology and innovation issues. Owing primarily to research begun by Imai and his collaborators (Imai and Itami 1984; Imai 1985, 1988, 1992, 1994; Imai and Baba 1991; Imai and Yonekura 1991), it was the study of the keiretsu that has led to the recognition of networking as a distinct form of organizing production, though in recent years, relationships between firms and the interconnectedness of their activities have also been studied in many other settings, giving rise to what summarily may be labelled the ‘network approach’. This approach typically emphasizes the gains obtained through interfirm cooperation over and above the elimination of transaction costs, that is, the costs involved in using the market that had hitherto served as the most widespread explanation for the existence of such relationships. In addition to the smooth functioning of economic actors vis-à-vis their business partners on a daily basis, such benefits typically centre on the way in which new technologies are developed and adopted. The discussion shows that keiretsu subcontracting arrangements in fact represent only one particular manifestation of a more general pattern. The change in organizational arrangements in the Japanese electronics industry therefore does not signal the end but an adaptation of ‘networking’. Turning from theoretical considerations to empirical issues, Chapter 3 presents an outline of the actual workings of the keiretsu subcontracting system or what will alternatively be labelled the ‘pyramid network’. Itself the result of an evolutionary process, the network pattern that will be described represents a snapshot of production networks found in the Japanese electronics industry during the 1980s. It is this period that most of the literature on the organization of production in Japan’s assembly industries refers to and which will be used to create a ‘base-line’ against which later developments are compared in order to illustrate the changes taking place. The outline will concentrate in particular on the identity of constituent members of such production networks, their activities and their links with each other, which, taken together, provide the defining characteristics of the ‘pyramidal network’. The study proceeds with an overview of the contextual parameters that have shaped developments in the Japanese electronics industry. These may be divided into two major areas: the macroeconomic environment in which Japanese firms had to operate, and global industry dynamics. On the macroeconomic front, Japan’s electronics industry has had to contend with rapid yen appreciation during the latter half of the 1980s and the early 1990s, which has triggered the internationalization of production and procurements; partly overlapping with yen appreciation and continuing until the present, Japan’s economy has entered a prolonged recession. Parallel to these macroeconomic developments, competition in the global electronics industry has intensified. The US electronics industry has seen a remarkable resurgence, while South Korea and Taiwan have grown into

4

Introduction

increasingly potent competitors. The upsurge in competition, in turn, crucially hinges on subsectoral dynamics: while traditional consumer electronic products such as radios, TV sets, etc. – Japan’s forte – have reached the mature stage of the life cycle, industrial electronics (computers and communications equipment) – an area in which US firms maintained a strong position throughout – have been booming. Moreover, with the rise of digital technology, there has been a convergence of consumer and industrial electronics. A further trend has been that components are becoming ever-more technology intensive, raising entry-thresholds, yet, at the same time, are also turning into commodities, opening the door for new entrants using such components and threatening established market positions. Against this background, US and Taiwanese firms have built up their own supply networks that are characterized by greater openness and flexibility than their Japanese counterparts. Thus, at least four major overlapping industry developments can be observed to which Japan’s electronics manufacturers had to respond: (a) stronger competition from the US, Taiwan and South Korea linked with (b) a shift from consumer electronics to industrial electronics and their convergence; (c) the growing cost and complexity of technology; and (d) the emergence of rival networks. As a result, if global market and export shares are taken as a yardstick, Japan’s competitive position appears to have declined markedly. Chapter 5 begins the investigation of changes in network patterns. The shift to international production and the internationalization of procurements is described and documented using a range of published statistics. In addition, evidence from various sources, including an unpublished survey on interfirm relationships by the Small and Medium Enterprise Agency of Japan, is presented that gives an indication of the growing pressure on traditional subcontracting practices. A major reason for this pressure, it emerges, is customers’ need for suppliers who possess independent technological capabilities. What is more, the growing cost and complexity of technology is forcing electronics manufacturers to form joint-ventures or strategic alliances with rival companies, thereby transcending traditional keiretsu boundaries. Chapters 6 to 8 then present the three case studies. The central aim of the case studies is to outline network configurations by tracing what types of parts and components are procured from what type of suppliers. Taking the stylized production pyramids from Chapter 3 as a reference point, the role of affiliates and subsidiaries, traditional subcontractors and common suppliers in overall procurements as well as the nature and content of interfirm relations are examined. Representing products at different stages of their respective life cycles, the case studies provide clear evidence for the changing role of different types of suppliers and hence customers’ changing requirements of suppliers. The cases thereby illustrate how network configurations are increasingly based on considerations dictated by the growing cost and complexity of technology. The first case study (Chapter 6) concentrates on traditional audio–video (AV) products such as TVs, video-cassette recorders (VCRs) and mini-stereos. With the exception of top-of-the-range products, AV appliances are now typically

Introduction

5

manufactured overseas, with the majority of production bases located in the rest of Asia. The case study therefore examines production arrangements by tracing network patterns of the Malaysian subsidiaries of major Japanese electronics manufacturers and larger component suppliers. The study finds that, despite the relocation of production, the keiretsu system with its main features has remained more or less intact. The second case study (Chapter 7) examines production networks in the personal computer (PC) industry. In this segment, significant changes in network patterns can be observed, brought about by the switchover from proprietary PC architectures to the standard IBM architecture. Until the early 1990s, the Japanese PC industry was highly fragmented, with manufacturers each offering PCs, software and accessories that were incompatible with those of their rivals. However, compatibility and cost considerations forced Japan’s PC maker to adopt the standard architecture, opening up the road for increased procurements of cheaper standard parts and components, often from Taiwanese manufacturers. As a result, production networks have come to incorporate a large number of both foreign and domestic common suppliers, that is, suppliers that serve the industry as a whole rather than being tied into a particular keiretsu. The increased role of common suppliers means that traditional keiretsu subcontracting relationships have declined in importance. The third case study (Chapter 8) finally concentrates on the production of digital still cameras. Digital cameras represent a comparatively new market segment and provide a perfect example for the convergence of electronic products on a common digital standard. Incorporating, moreover, a combination of different types of technology (digital and optical), they also exemplify the importance of technological complementarity. The case study shows how production networks primarily rely on large, independent suppliers for a diverse range of high-tech components. Again, traditional subcontracting relationships play at best a marginal role. The concluding Chapter 9 ties together the various findings of this study and suggests that the traditional production pyramids are crumbling. Though formally the vertical production keiretsu with a parent company at the top and its numerous subsidiaries and affiliates (so far) remain intact, the actual networks for production have become much less monolithic. While the pyramid network almost exclusively relied on subsidiaries, affiliates and traditional subcontractors, the role of these captive suppliers in network arrangements is decreasing, with a corresponding increase in the role played by independent common suppliers. These findings suggest that whereas networking remains vital, the particular approach found in Japan – and many of its purported advantages as described in the literature – were only of temporary relevance. In particular, the heavy reliance on dedicated suppliers reflected a competitive strategy that was based on incremental innovation which appears more and more outdated in a competitive environment that is increasingly characterized by disruptive innovations and the ensuing need to bring together a diversity of technological capabilities in a cost-effective and speedy manner. As a result, the observed trends are expected to continue.

6

Introduction

The keiretsu, subcontracting and the development of the electronics industry Interfirm networks in Japan: a brief history In Japan, probably more so than in many other countries, relationships and networks constitute a central parameter of social interaction – be it in the life of the community, politics or business. Relationships and networks in an industrial context can therefore be considered the natural concomitant of a wider social phenomenon.5 In addition to their cultural origins, however, interfirm networks also have deep historical roots going back to the dawn of Japan’s industrialization towards the end of the nineteenth century. It was during this period – following the Meiji Restoration in 1868 – that the first modern enterprises appeared in Japan and the so-called zaibatsu (financial cliques) emerged. These began as family-run businesses that diversified into unrelated activities as a result of the devolution of government-owned interests during the 1880s and 1890s. For the most part, these activities were commercial and service-related and provided economies of scope in areas such as financing, transport, purchasing and distribution. By the turn of the century, the zaibatsu had turned themselves into holding-companies with many of the trappings that would characterize their successors after the Second World War, the keiretsu or kigyo shudan (business groups) with their interlocking directorates and shareholding among group enterprises.6 Manufacturing activities did, in general, not play a significant role in the zaibatsu’s business portfolios until the early 1900s and then were usually grafted onto existing interests, for example in the transport sector. The first precursors of interfirm ties in the manufacturing sector therefore are to be found among independent rural enterprises, where during this early period local factories were occasionally used as subcontractors to larger works, though the degree of coordination was small (Fruin 1992: 106). However, during and after the First World War, Japanese industrialization entered a new phase, with firms adopting Western production technologies in areas such as textiles, machinery or fertilizer. However, lacking the resources and hence unable to reach the economies of scale of their Western counterparts, they were forced to concentrate on a limited range of core competencies and to develop strategies of ‘interrelating production and distribution functions through interorganizational coordination’ (Fruin 1992: 127). Both the zaibatsu, which increasingly extended their activities into manufacturing during this period, as well as a spate of new companies that followed a similar approach of forging interfirm relationships flourished, and subcontracting practices, especially in the machinery industry, became widespread. Following the Second World War, the zaibatsu were dismantled by the Allied Forces but soon re-emerged in the form of the keiretsu that subsequently came to dominate the Japanese economy. Similarly, subcontracting practices also made a quick return as Japanese industry benefited from international munitions demand for the Korean War (1950–53). Setting up full-scale mass production facilities and expanding their subcontracting base, manufacturers adopted multiple sourcing strategies that

Introduction

7

strengthened their bargaining power and forced first-tier suppliers to segment their jobs and assign simpler, more labour-intensive tasks to second-tier suppliers (Nishiguchi and Brookfield 1997: 91), giving rise to the hierarchical structure of tiered subcontractors. As Japan’s postwar recovery continued and gathered pace during the 1960s and 1970s, large producers faced difficult challenges in manufacturing complexity, while at same time, small firms were constrained in terms of their financial and technological resources. This prompted large manufacturers to invest heavily in their subcontractors and delegate increasingly complex tasks to them (ibid.: 92). Thus, the central elements of the keiretsu subcontracting system were born. The keiretsu subcontracting system The keiretsu have played a major role in the development of the Japanese economy and remain a distinctive feature until this day. In the first instance, the term keiretsu refers to the inter-industry groupings that consist of the country’s corporate giants and have one of the major banks at their centre. Linked through crossshareholdings, financial loans, interlocking directorships and preferential trading relationships, these horizontal keiretsu have dominated industry in postwar Japan. According to one source, the members of the six principal inter-industry keiretsu at one stage accounted for more than 50 per cent of total sales in all the major industries, with the share exceeding nine-tenths for sectors such as shipbuilding, electrical machinery and non-ferrous metals (Okimoto 1989: 146).7 In contrast to the inter-industry groupings, the so-called vertical keiretsu are hierarchical associations consisting of a single, large parent firm and its affiliates and subsidiaries, which are typically engaged in related industries. The vertical keiretsu may be distinguished into capital, distribution and production keiretsu (e.g. Gerlach 1992: 68–9). The largest production keiretsu, which are of interest here, are listed in Table 1.1. The table indicates that, with the exception of NTT (Nippon Telegraph and Telephone Corporation, the former government monopoly), Table 1.1 The top vertical production keiretsu Parent company

1 2 3 4 5 6 7 8 9 10

Toyota Motor NTT Hitachi Matsushita Electric Ind. Sony Nissan Motor Honda Toshiba Fujitsu NEC

Turnover (billion yen; 1998) 12,749.0 9,729.6 7,977.4 7,640.1 6,794.6 6,580.0 6,231.0 5,300.9 5,243.0 4,759.4

Source: Toyo Keizai Shinposha (1999, 2000), Kigyo Keiretsu Soran.

No. of affiliates 1998

1994

343 33 1,010 325 1,041 203 295 321 518 162

194 30 844 346 895 170 231 294 423 127

8 Introduction the country’s top industrial groups all hail either from the automotive or the electrical machinery industry. In both industries, the number of affiliates often goes well into the hundreds and the largest of these affiliates are frequently big enough to be listed on the First Section of the Tokyo Stock Exchange. In the case of Hitachi, for example, Imai (1994) distinguishes three subgroups of enterprises that make up the Hitachi group. These are, first, major enterprises that have been separated from the parent and can no longer be labelled subsidiaries but are independent firms, though the parent – either alone or through its affiliates – typically holds on to a majority share of the capital; second, enterprises that have been integrated into the keiretsu through tie-ups, acquisitions and start-ups; and, third, troubled firms rescued through equity participation. Finally, the proliferation of affiliates and subsidiaries in recent years appears to be primarily the result of the overseas expansion of Japanese companies. Figure 1.1 provides a more detailed illustration of the broader pattern. A general electrical machinery keiretsu, the Toshiba group forms a network of companies that revolves around the parent, Toshiba Corp., and is active in all fields of the electrical machinery sector (heavy electrical machinery, consumer electric appliances, consumer electronics, industrial electronics, and devices and components). Affiliates tend to be engaged either in one or more of these fields or in industries that provide intermediate materials such as chemicals or ceramics. According to the 2003 annual report, the sales composition of Toshiba Corp. and its consolidated affiliates was as follows: Information and Communication Systems 13.7 per cent, Social Infrastructure Systems 15.5 per cent, Digital Media 28.4 per cent, Power Systems 9.1 per cent, Home Appliances 11.2 per cent, Electronic Devices and Components 19.3 per cent, Others 2.9 per cent. Because of their pervasiveness, the keiretsu and their role in Japan’s postwar economic development have been the subject of a wide range of studies. As for the bank-centred horizontal keiretsu, the purported advantages that have been highlighted in the literature include companies’ improved access to capital, which in turn is the result of banks’ privileged access to inside company information (Gerlach 1992). In other words, the ‘main bank’ system creates effective channels of capital allocation and provides a mechanism to deal with market failures relating to information issues. Moreover, it has also been suggested that the keiretsu provide a means of spreading risk among constituent members and provide implicit insurance in case a firm should find itself in financial difficulty (Nakatani 1984; Aoki 1988; Sheard 1989). The argument that has probably received the most attention, however, and that regards both the horizontal and the vertical production keiretsu, is that such collective organization offers an efficient solution for the problem of transaction costs. Goto (1982), for example, argues that the disadvantages associated with fullscale integration – such as diseconomies of scale or management control losses – are avoided while transaction costs are minimized. Imai (1992, 1994) expands on this approach. Viewing the keiretsu as a hybrid form of organizing economic exchange that lies between impersonal markets and internal organization, he argues that they introduce market-like properties in organizations and organization-like properties in markets.

Introduction

9

Toshiba Research Center

Toshiba Corp.* Heavy electrical

Nishishiba Electric Toshiba Eng. & Constrn. Kitashiba Electric Kawamata Seiki

49%* 54* 80 100

Machinery

Consumer electronics

Toshiba Machinery Toshiba Medical Systems Tokyo Electronics Industry Toshiba Information Equipm. Tec Electronics Topcon Corp.

Shibaura Engineering Works 63%* 43* TEC Corp. Harrison Electric 50 Toshiba Heating Machines 100 Toshiba Sound Systems 100 Toshiba EMI 50 Toshiba Lightech 100 Toshiba Equipment 100 Onkyo 69.4

Materials

Services

Toshiba Sogo Lease Toshiba Credit Toshiba Insurance Services Toshiba Distribution Toshiba Information Systems Toshiba Tourist Toshiba Building

48%* 96.3 75 100 51* 41

44% 50 100 100 88 100 100

Toshiba Steel Tube 50%* Toshiba Tungaloy 43* Toshiba Chemicals 57* Showa Electric Wire & Cable 21* Marcon Electronics 94 Hokuto Electronics Inds. 40 Toshiba Glass 97 Toshiba Ceramics 49*

Figure 1.1 The Toshiba group. Source: Ohsono (1995: 25). Notes Figures show percentage of capital owned by Toshiba Corp. * Indicates a listed company.

Applied to the organization of manufacturing production, the keiretsu approach represents a different breed of corporate organization from the one dominating in the West during the 1960s: ‘Fordism’, which relied on a highly developed division of tasks combined with a high degree of mechanization and economies

10

Introduction

of scale and resulted in ever-increasing vertical as well as horizontal integration. The inherent rigidity associated with large-scale integration contrasted sharply with the flexibility provided by the inter-corporate alliances found in Japan. In other words, the country’s export offensive during the 1970s and 1980s also involved a clash of production systems: the highly integrated industrial behemoths of the West versus the ‘network firm’ of Japan, with the latter seemingly winning hands down. While the keiretsu play a central role in this network approach, they represent only the most visible aspect of a wider phenomenon: forms of interfirm interaction that differ from pure market exchange are widespread and not only restricted to companies within enterprise groups where capital and/or personnel relationships provide the glue. Elements such as ‘just-in-time’ production and ‘total quality’ manufacturing require close cooperation between firms and their suppliers, giving rise to the so-called ‘subcontracting system’, where subcontractors are dedicated suppliers providing customized parts and components and customer–supplier relationships are characterized by long-termism and stability. Due to the pervasiveness of such arrangements, firms at all stages within the production chain are part of a wider network of more or less institutionalized relationships. Compared with the ‘Fordist’ mode of production, this approach offered a host of advantages. Retaining the main benefits of mass-production, it afforded increased flexibility and quality of production. Comparing the performance of suppliers in the automotive industry, Womack et al. (1990) found that compared with their American or European counterparts, Japanese suppliers were able to: ●

● ●

set up their machines fifteen times faster, making flexible small-lot deliveries possible; make dies three times more quickly, thereby reducing time to market; hold a fifteenth of the stock, meaning that quality problems were quickly discovered.

The list continues. Taken together, these and other features meant that continuous product and process improvements, cost reductions and innovations were built into the system. Table 1.2 demonstrates clearly how far Japanese manufacturers, by 1989, had surged ahead of their UK counterparts in terms of developing, manufacturing and marketing new products in rapid succession: Japanese companies managed to shorten product life cycles considerably in the space of only four years from levels that UK firms had not even reached eight years later. In sum, Japan’s industrial development and the keiretsu, the organization of production in networks, and the strong competitive position gained in the assembly industries through judicious pricing and high rates of incremental innovation are all closely interconnected. In fact, it has been with regard to technology and innovation issues that the ‘network mode’ has caught the interest of economists as a distinct form of organizing interdependent activities among firms. Sparked by the

Introduction

11

Table 1.2 Length of product life cycles in Japan and the UK during the 1980s Industry

Life cycle ( years)

Percentage of products Japan

Electrical engineering

Motor vehicles

Mechanical engineering

All industry

0–1 1–2 2–3 3–5 5⫹ 0–1 1–2 2–3 3–5 5⫹ 0–1 1–2 2–3 3–5 5⫹ 0–1 1–2 2–3 3–5 5⫹

UK

1981

1985

1989

3 18 11 25 43 7 7 10 32 44 4 3 4 32 57 4 9 9 28 50

8 26 29 16 21 7 10 28 17 38 3 7 29 22 39 6 15 26 19 34

0 3 13 47 36 0 14 0 14 71 0 0 0 31 69 3 4 8 30 55

Source: Adapted from Tidd (1991: 9–10).

success of Japan’s assembly industries, a host of studies have analyzed such production arrangements or different aspects thereof in great detail. Surprisingly, however, most focus on the automobile sector (e.g. Asanuma 1985a,b; Womack et al. 1990; Miwa 1994; Helper and Sako 1995; Sako 1996), while comparatively little has been written about the electronics industry. However, as will be shown in Chapter 3, many of the organizational features found in the automotive industry also apply to the electronics sector. The growth of the electronics industry A few figures help to illustrate the important role that the electronics industry plays in the Japanese economy today. According to the Electronics Industry Association of Japan (1998), capital investment in the sector8 accounted for 19.4 per cent of the manufacturing industry total, ahead of the automobile industry with a share of 16.0 per cent. The electric machinery sector also spends by far the most on industrial research, accounting for well over a third of the manufacturing industry total (37.7 per cent), with the chemical and transportation machinery

12 Introduction sectors coming a distant second and third with shares of 17.2 per cent and 16.3 per cent, respectively. Finally, as already mentioned, the industry also accounts for a quarter of the country’s merchandize exports. Though its roots date back to the nineteenth century, it was from the 1950s onwards that the Japanese electronics industry made rapid headway. Still lagging well behind the United States in electronic technologies and heavily dependent on foreign suppliers during the 1960s, the country became a major player during the 1970s. By 1978, Japan was among the top-five exporters in all fourteen product categories examined in a detailed study by Kozmetsky and Yue (1997). It ranked first in terms of export share – defined as the percentage of a nation’s export value in the total export value of the world for a particular electronic commodity – in eight categories: optical instruments, telecommunications equipment, sound recorders and VCRs, transistors, TV tubes, TV sets, radios, and office machines. The global export share in fact exceeded 50 per cent for sound recorders and VCRs as well as radios, demonstrating the commanding position the country had gained in the consumer electronics sector. Thus, within less than two decades, Japan’s electronics industry had managed to catch up with, and in a range of market segments actually wrest the lead from, the US. While it is a matter of debate to what extent government policy can claim responsibility for this success, it certainly promoted and protected the industry vigorously.9 MITI, for example, played a hand in the selection and purchase of foreign technology, the adoption and refinement of that technology, and initiated cooperative research projects involving government, industry and academia and supported these with substantial funds. At the same time, foreign investment was strictly controlled and imports of electronic goods restricted through tariffs, quotas, and foreign exchange allocations. Rapid advances in productivity, quality and product development were achieved through high rates of investment that were encouraged by low capital costs.10 This enabled Japanese firms to sustain investments in design and development activities where competitors had to abandon such efforts, and to invest heavily in automation to achieve high-volume production at low cost (Kozmetsky and Yue 1997: 13). The result of these efforts was that, by the 1980s, the Japanese electronics industry had attained world-class status, ahead of Western Europe and on par with the United States. By the early 1990s, Japan was export leader in 9 out of the 14 market segments in the study by Kozmetsky and Yue, and in areas where it continued to trail behind the US, such as integrated circuits or computers, it had considerably closed the gap. The shift towards these high-tech products and components also illustrates how Japan’s electronics industry managed to upgrade from comparatively low-tech items such as radios or TV tubes and TV sets, where the country’s export share declined. However, export figures tell only part of the story. Beginning in 1985, after the Plaza Agreement, the yen appreciated rapidly, forcing Japanese manufacturers to shift production overseas. FDI in the electrical machinery sector exploded, rising tenfold from only US$513 million in 1985 to US$5.68 billion in 1990. Thus, while Japan’s export share in certain product categories may have decreased, the

Introduction

13

Table 1.3 Relative market shares of national clusters (%)a Cluster and group

1984

1985

1987

1989

1991

1992

Change (84–92)

Electronic components Japan (25)b United States (21) Germany (1)

38.05 49.39 5.91

39.35 48.09 5.92

48.24 38.15 6.69

50.21 34.98 6.48

52.43 31.83 7.48

51.93 31.71 7.92

13.88 ⫺17.68 2.01

Computer manufacturing United States (48) Japan (8) Germany (2)

56.16 32.19 9.42

54.04 34.12 9.37

46.46 40.67 9.89

46.50 40.49 8.90

42.62 41.97 12.24

42.59 41.69 13.15

⫺13.57 9.50 3.73

Computer software United States (45) Japan (7) France (1)

65.08 32.40 NA

64.51 32.54 0.17

56.84 39.19 0.36

55.45 40.20 0.44

52.87 43.20 0.66

53.18 42.95 0.79

⫺11.90 10.55 0.79

Telecommunications equipment United States (14) Japan (19) Germany (3)

47.87 20.68 12.52

45.52 22.06 12.79

33.12 29.73 16.48

31.62 30.69 15.18

30.17 31.10 16.75

29.87 30.58 17.65

⫺15.23 9.90 5.13

Industrial instruments United States (29) Japan (20) France (4)

72.49 17.39 3.73

73.11 17.74 3.25

66.90 20.71 3.84

67.39 20.75 3.32

64.97 22.64 3.41

64.10 23.17 3.48

⫺8.39 5.78 ⫺0.25

Consumer electronics Japan (15) United States (21) Sweden (1) South Korea (2)

55.03 26.45 8.67 NA

53.56 27.51 8.73 NA

54.79 20.54 12.36 NA

52.24 18.85 10.80 3.40

56.03 17.14 8.99 3.36

55.83 17.21 9.04 3.79

0.80 ⫺9.24 0.37 3.49

Source: Kozmetsky and Yue (1997: 169). Notes a Market share of national cluster of electronics companies in total sales of companies subject of the study. b Number of companies included in national cluster.

market share of Japanese companies did not necessarily follow suit: whereas Japan’s export share in consumer electronic goods such as sound recorders and VCRs, TV sets, and radios declined, the relative market share of Japanese companies in consumer electronics remained virtually unchanged at around 55 per cent during the period from 1984 to 1992, as shown in Table 1.3.11 The table also provides further evidence for the gains in Japanese market share achieved during the 1980s. The Japanese electronics industry in the 1990s The rapid growth enjoyed both by Japan’s economy overall and its electronics sector ground to a sudden halt in the 1990s. Triggered by the burst of the

14

Introduction

speculative bubble in financial and real estate markets that had built up during the second half of the 1980s, average annual GDP growth fell from 4.1 per cent during the 1981–90 period to 1.5 per cent in the ten years that followed. The macroeconomic developments were mirrored by output levels in the electronics industry: domestic production contracted in 1992 and 1993, and fell again in 1998, 2001 and 2002. As a result, total output in 2002 was about 15 per cent lower than ten years earlier. However, the dire economic circumstances at home as well as yen appreciation and the ensuing relocation of production are not alone to blame. In addition, there is mounting evidence that Japan’s electronics sector has also suffered a relative loss in competitiveness as a result of the structural changes in the global electronics industry which have already been hinted at. Thus, the country’s electronics giants, once regarded as models to be emulated the world over, have in recent years come to be seen as relics of an age gone by: [By 1994, US electronics companies’] once formidable Japanese competition appeared disorganized, dismayed and decidedly on the defensive. Instead, US industry leaders are now so certain of continued success that many dismiss the Japanese giants as competitive dinosaurs, ill-adapted to the raucous, fast, changeable, idea-intensive electronics market of the future. (Borrus 1997: 140) Though the comparison to competitive dinosaurs most likely is as exaggerated as similar statements about US firms during the 1980s, there is little doubt that Japan’s electronics industry has lost in strength vis-à-vis its international rivals. By analyzing network arrangements, this study focuses on what has long been considered a central element underlying Japan’s success in the assembly industries such as the electronics sector. The study shows that – as with so much else of the country’s economic system – many of the particular features that worked so well in the past have now outlived their usefulness. Changes in the Japanese electronics industry are clearly afoot, though it remains to be seen whether they are sufficient to reverse the decline in the country’s competitiveness.

2

The organization of production Theoretical considerations on networks and innovation

Introduction The greatest improvement in the productive powers of labour, and the greater part of skill, dexterity, and judgement with which it is anywhere directed or applied, seem to have been the effects of the division of labour. (Smith 1986: 109) Thus Adam Smith more than two hundred years ago, when he identified the division of labour as the wellspring of economic growth. When Japanese industry made its impressive advances during the postwar period, this, too, can be attributed to the division of labour and the way it was conducted, that is, the way in which production was organized. Generally, three different but closely related kinds of division of labour can be identified, and in each of these, the approach pioneered in Japan offered solutions that differed markedly from those found in the West. They are the social division of labour related to the division of society into occupations and professions; the intrafirm differentiation of labour through subdividing individual activities and the displacement of labour through machines; and the interfirm specialization of production (Corsi 1991: 21). It is this final aspect, the industrial division of labour relating to the scope of activities engaged in by individual firms in industrial systems, that is the main theme of this study.1 Rather than being a given, the industrial division of labour is the outcome of the complex interaction of a wide variety of forces. It is rooted in the social, political, institutional fabric of its time and place; and it is, of course, the result of a dynamic interaction of economic factors. In order to appreciate the novelty and significance of the Japanese approach of network production, it is helpful to consider the historical context in which it arose. Essentially, this means juxtaposing network production with the ‘Fordist’ mode of mass production, which dominated industry for much of the twentieth century but fell victim to its inherent rigidity to which ‘Toyotism’ provided an answer. In terms of the division of labour, ‘Fordism’ was characterized by progressively decreasing interfirm specialization due to growing vertical integration and increasing intrafirm specialization. This development manifested itself in a strong

16

The organization of production

emphasis on economies of scale, growing mechanization using highly specialized equipment and unskilled or little-skilled workers. However, ‘Fordism’ encountered mounting difficulties from the mid-1960 onwards, for which three main factors have been identified (OECD 1992: 92–4): the progressive exhaustion of the technological paradigm underlying the ‘scale intensive’ automotive as well as mechanical and electrical engineering industries most closely associated with the ‘Fordist’ mode of production; workers’ declining acceptance of monotonous assembly-line tasks involved in Taylorist manufacturing techniques; and its lack of flexibility in the face of uncertain macroeconomic conditions as well as rapidly changing markets. Network production as pioneered in Japan, in contrast, relied on a high degree of interfirm specialization but only moderate intrafirm specialization. In terms of the latter, it departed from ‘Fordism’ in significantly reducing the compartmentalization and hierarchical organization of functions such as R&D, design, production engineering and marketing as well as the reorganization of work at the factory and production levels. General-purpose machinery was favoured over specialized machinery, and workers were multi-skilled as their jobs were less specialized and job-rotation was the norm. Most importantly and in contrast to the ever greater vertical and horizontal integration that characterized ‘Fordism’, however, firms heavily relied on the organization of production across firm boundaries in the form of subcontracting and networking arrangements. The result was much greater flexibility while the main advantages of standardization were maintained. Constant adaptations, improvements (kaizen) and innovations were thus built into the system. The purpose of this chapter is to provide the conceptual framework that will inform the analysis in the remainder of the study. The discussion is divided into three sections. The first of these considers theories of industrial organization. It will be argued that neither mainstream economic analysis nor transaction cost theory can provide a satisfactory account for the existence of production networks. Concerning an area of economic activity on which neoclassical economics has little to say, and providing benefits over and above the elimination of transaction costs, network production requires a theoretical approach that reflects the multidimensionality of the underlying phenomenon itself. Such an approach is offered by the emerging field of ‘network theory’ which explicitly focuses on the positive benefits generated by interfirm collaboration. The second section homes in on these benefits, looking at what many consider the most important aspect, the link between networking and innovation: in addition to providing an organizational mode that maximizes the efficiency of everyday operations, a major advantage of networks lies in their dynamics, especially with regard to innovation and technical change. Third and finally, since the present study aims to show how and why Japanese production networks are changing, different possible types of arrangements are considered. Networks may be described, for example, as tightly or loosely integrated depending on the nature and content of the underlying relationships that serve to coordinate activities across firm boundaries. Moreover, it will be suggested that these aspects are likely

The organization of production 17 to have a bearing on a network’s ability to deal with different kinds of innovations and changes in the competitive environment.

Industrial organization and network theory The recognition of networking as a distinct form of organizing production and hence the study of production networks represents comparatively new ground in the field of economics. Networks constitute an organizational form of production that differs markedly from the assumptions underlying conventional economic theory where interfirm transactions are governed solely by the market mechanism: firms in networks, rather than dealing with anonymous buyers and sellers, engage in relational contracting with a limited number of counterparts they know well. The existence of relationships implies that companies are interlocked with one another, transcending the market and blurring the boundaries of the firm. The reasons for the existence of such interfirm relationships are manifold. A widely applied approach used to explain relational contracting has been transaction cost theory, which focuses on the cost of using the market mechanism. According to transaction cost theory, relational contracting represents an efficient means of minimizing or eliminating such costs. However, the explanations offered by this approach have come under increasing attack in recent years and the focus has shifted onto the gains – over and above the elimination of transaction costs – to be reaped from relational contracting. Some researchers therefore speak of ‘transaction benefits’ – such as in the context of technological innovations – that provide the main rationale for relational contracting and networking. The following survey provides an overview of the growing understanding of these issues. Classical and neoclassical theory The topic of the opening paragraphs of Adam Smith’s The Wealth of Nations, the division of labour represents a fundamental principle in economic activity, though this has often been lost out of sight. While the classical economists favoured a description of general principles, this was subsequently replaced by the desire for theoretical rigour based on a limited number of axioms in the neoclassical approach. As a result, the division of labour and hence the organization of production increasingly turned into a ‘black box’. It is therefore the classical rather than the neoclassical economists that provide the more useful insights into the organization of production. Treating economic issues with an impressive breadth of vision, Smith typically considered each of them in connection with a wide range of related phenomena. Therefore, specialization and the division of labour were not only identified as the wellspring of economic growth. They were also viewed as contingent on the extent of the market. Instead of taking the market as an abstract given – as neoclassical economists later would, making a whole range of efficiency assumptions – it was understood in very concrete terms. Reflecting the time and age in which he lived, Smith’s concept of the market was equal to the

18

The organization of production

marketplace, the extent of which was determined by physical limits that could be expanded through improvements of transport. The presence of a market where the products of labour can be exchanged has a very real bearing on the division of labour: As it is the power of exchanging that gives occasion to the division of labour, so the extent of this division must always be limited by the extent of that power, or, in other words, by the extent of the market. When the market is very small, no person can have any encouragement to dedicate himself entirely to one employment, for want of the power to exchange all that surplus part of the produce of his own labour, which is over and above his own consumption, for such parts of the produce of other men’s labour as he has occasion for. (Smith 1986: 121) Expanding on Smith’s idea of the division of labour being determined by the extent of the market, the physical aspect of transportation must not be the only constraint. Other constraints can be a lack of information, so that specialization and economic growth would, for example, follow in the footsteps of improvements in telecommunications. Alternatively, the extent of the market and hence the division of labour may depend on the level of wealth in an economy, introducing a dynamic aspect into Smith’s framework: economic growth may enhance the division of labour generating, in turn, more growth. Taking Smith’s ideas on the division of labour as their cue, later classical economists added to the conceptual understanding of the gains to be reaped from specialization. Babbage (1832), for example, pointed out the associated scale and learning economies: specialization allowed employers to purchase only the precise amount of each higher-skill labour, and no more, that was required by different work processes. The larger the factory, the more precisely could the amount of differently skilled labour be adjusted to the specific requirements. Consequently, no worker was paid at a rate that was higher than that appropriate to his assigned activity and, hence, labour costs were kept at a minimum. A further benefit of specialization is that it reduces the time required for learning and therefore shortens the period during which a new labour force entrant is employed in a relatively unproductive and unremunerative way. Among Marshall’s contributions, the notion of the ‘internal’ and ‘external’ economies of the firm stands out. Whereas the former arise from scale and learning effects, the latter derive from the clustering of economic activity. He notes: Many of those economies in the use of specialized skill and machinery which are commonly regarded as within the reach of very large establishments, do not depend on the size of individual factories. Some depend on the aggregate volume of production of the kind in the neighbourhood [. . .]. (Marshall 1920: 265)

The organization of production 19 These he labels ‘[. . .] external economies which can often be secured by the concentration of many small businesses of similar character in particular localities’ (ibid.: 266). Examples cited for such ‘external economies’ are access to skills and information found in industrial districts and means of communication that grow with the industry as a whole to the benefit of all businesses in the vicinity. In addition, clustering enhances the opportunities for a deeper division of labour: For subsidiary industries devoting themselves each to one small branch of the process of production, and working it for a great many of their neighbours, are able to keep in constant use machinery of the most highly specialized character, and to make it pay its expenses, though its original cost may have been high, and its rate of depreciation very rapid. Again, in all but the earliest stages of economic development a localized industry gains a great advantage from the fact that it offers a constant market for skill. (ibid.: 271) The classical economists thus displayed a keen awareness of the dynamic aspects linked to the way activities are divided and organized. Specialization depended on the existence of a market and would flourish with the growth of the market. Moreover, such a market could arise through the clustering of certain activities, which would provide the stimulus for the growth of individual companies and hence give rise to further specialization. In contrast with classical economics, neoclassical theory has been more concerned with the way known and given resources are allocated and the object of analysis is the efficient functioning of exchange rather than production. Consequently, despite its pivotal role in the sphere of economic activity, production and the organization of production have, for the most part, been treated as a ‘black box’ phenomenon: ‘theories of production’ typically begin with ‘the production function’, an equation establishing the relationship between the quantities of factors employed and the amount of product obtained. Producers thus simply engage in choosing cost-minimizing factor input combinations in order to maximize profits, taking input and output prices as well as production techniques as given. Though this model does capture some basic forces operating in the economy, it sheds little light on how production is actually organized and few real-life producers (‘firms’) would recognize this theory as a description of the activities they are engaged in. Transaction cost analysis Transaction cost analysis departs from the assumptions of neoclassical theory and explicitly addresses questions of industrial organization. Central to this approach is the recognition that in practice markets rarely function in the way posited by neoclassical theory. Rather, there are costs involved in using the market mechanism, and these costs explain under what circumstances productive activities

20

The organization of production

are coordinated within the firm or by the market. It is the relative costs of coordinating production that determine the degree of vertical integration and, in fact, the existence of firms. In his original article, Coase raises the question ‘why coordination is the work of the price mechanism in one case and of the entrepreneur in the other’ (Coase 1937: 389) and answers it by suggesting that there ‘is a cost to using the price mechanism’ (ibid.: 391). Such costs include discovering what the relevant prices are, the costs of negotiating and concluding contracts, etc., which are avoided or reduced if resources are organized under the direction of an ‘entrepreneur’. Hence, firms exist because they offer a cost-efficient way of organizing production and their size is determined by the relative magnitudes of the costs of using the market and of organizing additional transactions within the firm. Drawing on Coase’s concept of transaction costs, Williamson (1975, 1985, 1986) uses this approach to consider when and why activities are coordinated within or outside the firm. Using the concept of governance modes, the two alternatives are ‘hierarchies’ and ‘markets’. The magnitude of transaction costs determines which one prevails. If transaction costs are high, the firm will choose internalization, that is, hierarchy will be the preferred governance mode. Transaction costs come in many guises. They may derive from market failures based on ‘bounded rationality and uncertainty/complexity’, that is, economic actors’ inability to foresee all possible contingencies and formulate contracts accordingly, and ‘opportunism and small numbers’, that is, situations where the absence of rivalry between a large number of bidders allows opportunistic behaviour to flourish (Williamson 1975). Further variables that determine the governance mode are considered. These concern asset specificity and the frequency of contracting. In both cases, vertical integration is likely to prevail when they are high: the more specialized human and physical assets are, the greater are not only buyers’ and sellers’ economies of scale but also the ‘lock in’ effect of transaction-specific investments. Given the existence of transactionspecific assets, large transactions of a recurrent kind may then give rise to specialized governance structures that ultimately may lead to integration (Williamson 1985). The technological interdependence of production processes is also considered. However, in Williamson’s view, this rarely represents a determinant of the governance mode in its own right. Arguing that in, any case, ‘[. . .] technical complimentarity is probably more important in flow process operations (chemicals, metals, etc.) than in separable component manufacture’, he maintains that ‘the substitution of internal organization for market exchange is attractive less on account of technological economies associated with production but because of what may be referred to broadly as ‘transactional failures’ in the operation of markets for intermediate goods’ (Williamson 1985: 85–6). In other words, though technological economies may be present, the choice of governance mode ultimately boils down to transaction costs. Langlois and Robertson (1995), whose work also considers but is not confined to transaction cost analysis, propose a further variant of the concept, namely

The organization of production 21 ‘dynamic transaction costs’. These they define as ‘the costs of persuading, negotiating, co-ordinating and teaching outside suppliers [as well as] the costs of not having the capabilities when you need them’ (Langlois and Robertson 1995: 35). Possible sources of such costs are asset specificity or a high degree of interdependence among different stages of production in the context of economic change or innovation. Under such circumstances, the decentralization of markets makes it difficult to coordinate a reorientation of production. The need to be able to access ancillary capabilities at the right time may therefore be another reason for vertical integration. Though most of the discussion on transaction costs is couched in terms of the two alternative governance modes of market versus hierarchy, ‘relational contracting’ is also considered. Having already acknowledged in passing the ‘Japanese Zaibatsu form of organization’ in his first study (Williamson 1975: 162), Williamson addresses the phenomenon more explicitly in his later work. Relational contracting is viewed as an ‘intermediate mode’ between market and hierarchy that emerges when the frequency of transaction is high and asset specificity is present, but only to a limited extent. In such circumstances, when price or quantity adjustments are required, buyers will not seek alternative supply from other sources, because these would incur high set-up costs, while suppliers will not withhold supply, since their assets have a specialized character and sales to alternative buyers would incur higher costs. Yet, transactions are not sufficiently idiosyncratic to justify integration (Williamson 1986: 101–18). Using Williamson’s approach in his discussion of Japanese business groups, Goto (1982: 61) adds a further aspect: by forming or joining a group, a firm not only economizes on transaction costs, but at the same time avoids the scale diseconomies or control loss that would be involved in expanding internally and performing that transaction within the firm. The transaction cost approach thus views questions of industrial organization as determined by the relative magnitudes of costs incurred in using the market or writing contracts that contain a sufficient range of contingencies and the costs of organizing an activity internally, the latter being similarly subject to variables such as ‘bounded rationality’, opportunism, etc. Wholly independent processes are coordinated through the market, while interdependent processes are coordinated internally or the ‘between mode’ of ‘relational contracting’. However, while claiming to be dynamic – for example, because questions of sequential contracts are considered – the approach does not take into account the possibility of learning within a stable environment, as a result of which transaction costs diminish. Langlois and Robertson (1995) consequently view transaction costs as short-term phenomena, the result of transient frictions. What is more, the approach appears static when considered in the light of changing costs of production: The reigning transaction-cost theories of vertical integration provide illuminating snapshots of possible institutional responses to a momentary situation. But they do not place those responses in the context of the passage

22

The organization of production of time. [. . .] They take the circumstances of production as given and investigate comparatively the properties of market-contract arrangements, internal organization, and sometimes other modes of production. What happens, however, when the technologies of production – and perhaps other environmental factors are changing rapidly? (Langlois and Robertson 1995: 30)

Imai and Baba (1991: 397) argue along similar lines: [Transaction cost theory] is likely to entail a static entity, in that it is probable that the organisational form will be chosen on the basis of transaction costs in terms of the given alternatives of market transactions and internal corporate transactions. However, in dynamic industries, frequently neither of these modes exists ex ante; they are, rather, gradually developed in the process. Transaction cost is unlikely to be calculable until the transaction mode assumes its specific form. Moreover, the concept of ‘relational contracting’ as an intermediate governance mode between the ‘pure’ governance modes of ‘market’ and ‘hierarchy’ leaves unanswered the question what this ‘between’ actually looks like.2 It would seem that relationships between firms represent quite a distinct mode of coordination. Discussing the role of network governance, that is, the governance of a multitude of relationships, the OECD (1992: 78), for example, observes the following: In terms of transaction cost theory, the network mode offers firms a new way of handling market imperfections, in particular those related to innovation. In certain circumstances, this mode is superior to markets and hierarchies, but it is so because it is different from both and not somewhere ‘in between’ [emphasis in original]. While transaction cost theory does provide some important insights into issues relating to industrial organization and the coordination of production, the mileage of the approach appears limited when applied to the network mode. This is because relational contracting contains dimensions over and above the elimination of transaction costs and therefore sets it apart from the market-versus-hierarchy dichotomy. It is aspects such as these that ‘network analysis’ tries to address. Network analysis Network analysis can be considered as the outgrowth of a spate of studies that emerged during the 1960s and 1970s that questioned the assumption that activities were coordinated either within the firm or through market exchange. Instead, they focused on the relationship between firms, describing the observed phenomena as ‘interfirm co-operation’ (Richardson 1972) or ‘vertical quasi-integration’ (Blois 1971). The latter was defined as situations ‘where some firms are gaining the advantages of vertical integration without assuming the risk or rigidity of ownership’ (Blois 1971: 253).

The organization of production 23 Subsequent studies during the 1980s and 1990s – both Western and Japanese – have elaborated on the analysis of relationships between firms and their interconnections in the context of wider ‘networks’ of relationships. Referred to here as ‘network analysis’, this approach has tended to focus on the dynamic aspects of the organization of production, with adaptation and innovation issues occupying a central role. Reflecting the diversity, complexity and multidimensionality of networks themselves, however, no fully fledged economic theory of networks has yet emerged. Rather, the concept tends to be applied to a variety of phenomena using a variety of theoretical approaches. Consequently, no particular model can be presented as the network approach. The aim here, therefore, is primarily to provide an overview of the major theoretical issues involved and develop a working definition of the ‘network mode of production’ that serves the purpose of this study. Central to the concept of production networks is the conduct of transactions based on business relationships such as those between suppliers and customers that create an interdependence between the parties involved. Firms tend to interact with each other in a variety of dimensions and, rather than being numerous and anonymous buyers and sellers, counterparts tend to be known and specific (Dubois 1998). The importance of business relationships has been highlighted in a number of empirical studies that show the high concentration ratios both on the buying and selling side. For example, a study on 123 medium-sized Swedish companies showed that the ten largest customers on average accounted for 72 per cent of total sales, while the ten largest suppliers accounted for 70 per cent of the purchase value (Håkansson 1989). A study on Japanese subcontracting practices showed an even higher concentration ratio: the top three customers on average accounted for between 76 and 99 per cent of suppliers’ sales (Nishiguchi 1994). Interfirm relationships in such settings tend to be characterized by a number of features that have been summarized by Dubois (1998: 15–16). These characteristics include the following: ● ●

● ●

●

●

continuity (i.e. relationships tend to be long-lasting); complexity (relationships between firms involve contacts among a range of individuals with various functions); a low degree of formalization; a symmetry of resources and initiative (both sides control resources of importance to the other and engage in maintaining and developing the relationship); adaptations (in technical, administrative and/or logistical matters to function better vis-à-vis the other side); and connectedness (particularly with regard to technical matters, of which, for example, asset specificity represents but one important aspect).

Within transaction cost analysis, relationships among firms are basically viewed as market imperfections. The market and the hierarchy are viewed as ‘pure’ governance modes, while the relationship mode is seen as an intermediate or hybrid mode. From the viewpoint of network analysis, however, markets and hierarchies tend to be regarded as extreme forms of governance, with networks representing

24

The organization of production

the natural form of organization (Piore 1992). Imai and Itami (1984: 286) describe network relationships as an ‘interpenetration of market and organization’: [R]esource allocation in the market as the arena is done not only by the market principle but also, to a great extent, by the organization principle. On the other hand, the market principle is used to a certain extent in the resource allocation within the firm as the arena alongside the organization principle. Thus, both in the market and within the firm, two principles coexist [emphasis in the original]. The result, however, is a coordination mechanism that is quite a different animal from either the market or hierarchy. Arguing forcefully against the ‘continuum view’ of economic exchange, Powell (1990: 299), for example, stresses that such a notion fails to allow for alternative governance mechanisms such as reciprocity and collaboration that fall outside the market–hierarchy dichotomy: ‘By sticking to the twin pillars of markets and hierarchies, our attention is deflected from a diversity of organizational designs that are neither fish nor fowl, nor some mongrel hybrid, but a distinctly different form.’ Therefore, while networks do combine aspects of markets and hierarchies, they incorporate characteristics that neither of the other two governance modes offer. Markets, hierarchies and networks therefore are increasingly seen as three complementary models of coordination distinguished by different government mechanisms, each with their respective advantages and disadvantages. The special characteristics of the relationship mode become clearer when one looks at the multidimensionality of such links. Håkansson (1987) distinguishes three important functions that relationships fulfil. The first such function is to increase productivity or technical efficiency through adaptations with regard to products, production, deliveries, storing, etc. Such adaptations occur at the early stages of a relationship as well as in day-to-day operations. The second function of relationships is their role as communication channels for accurate, detailed and multifarious information which can only be obtained from actors that have the knowledge and are prepared to share it. The third function is to increase control, that is to make the business environment more stable and controllable through a wide network of relationships. These functions become especially important in the context of industrial systems, that is, embedded and interdependent relationships. Dubois (1998) highlights this aspect when she points out that in such cases one change might improve one particular relationship but reduce overall efficiency through a negative impact on other relationships. The network mode therefore provides an organizational approach that takes into account the complexity and mutual dependence of the activities that firms are engaged in. Powell (1990: 303) therefore suggests that [a] basic assumption of network relationships is that parties are mutually dependent upon resources controlled by another, and that there are gains to be had by

The organization of production 25 the pooling of resources. In network forms of resource allocation, individual units exist not by themselves, but in relation to other units. [. . .] Complementarity and accommodation are the corner-stones of successful production networks. As a result of this complementarity, relationships become important assets in themselves. While firms may not possess particular resources themselves – in the form of human, physical or knowledge resources – the ability to access such resources through business relationships can be an asset in its own right and thus becomes an important tool for value creation. Imai and Baba (1991) therefore speak of ‘positive-sum’ situations and the ‘transaction benefits’ accruing from network organization. These aspects are particularly relevant in the context of technology and innovation issues, given that innovative activity frequently consists in combining existing knowledge and resources in novel ways. Further aspects that have been emphasized in the context of networks and interfirm alliances are speed, flexibility and reversibility. Porter and Fuller (1986: 328), for example, stress speed as an important factor when they observe that the time required to build expertise or gain market share internally is likely to exceed the time required with a coalition. As product life cycles have shortened and competitive rivalry has intensified, the timing advantages of coalitions are increasingly important. Similarly, flexibility and reversibility carry high premiums in areas where future (technological) developments are unclear and risky, such as biotechnology, new materials or, in fact, electronics and information technology. In such cases, interfirm agreements are advantageous because they are easier to dissolve than internal developments or mergers, involve smaller sunk costs, commitments are less definite and inertia is lower (OECD 1992). Innovation, speed, flexibility, reversibility – considerations of these aspects highlight that the most important feature of networks lies in their dynamics, that is, how resource utilization changes and develops. While traditional economic models consider economic efficiency in terms of given resources for given purposes, the network approach regards resources and purposes as given only at a particular moment. However, as resources interact, new resources and resource combinations are created and purposes adapt. Håkansson and Snehota (1995: 383–4) observe that the resources are used for activities the scope and purpose of which is not ‘given’, by actors whose identities, perceptions and intentions are never fully ‘given’. While the single actors pursue purposes they see very much as given, the ‘purpose’ of resource utilization cannot be seen as generally given. What stands out, in other words, are considerations concerning resource utilization in a truly dynamic context. Apart from the optimization of productive efficiency, networks play a central role in the innovation process by linking up diverse economic actors with control over heterogeneous and complementary

26

The organization of production

resources, offering transaction benefits beyond the simple reduction or elimination of transaction costs. The following section considers these aspects in greater detail.

Networks, technology and innovation The discussion thus far has highlighted that the division of labour and specialization require mechanisms by which production is coordinated. The alternatives that have been presented are coordination through the market, through integration (‘hierarchy’), or through networks. This section shows that innovation often necessitates substantial interfirm interaction and therefore gives rise to governance modes that neither rely on the market mechanism nor on hierarchy (alone), but on cooperative arrangements between firms that form the basis of the creation of network structures. Conceptually speaking, cooperation aids innovation in two ways: it removes barriers to innovation and acts as a source of innovation. In an industry characterized by a vertical division of labour, where the product of one firm is the input of another, the information problems surrounding innovative activities provide one major reason for the presence of interfirm relationships. In neoclassical theory, the only information exchanged in a market of anonymous buyers and sellers regards the price and the quantity of a given product. With innovation, however, both buyer and seller in this type of exchange operate under extreme uncertainty, as producers have no information about potential user needs, while users have no information about the use-value characteristics of new products. Lundvall (1988: 350) therefore argues that ‘[i]f the real economy was constituted by pure markets, product innovations would be haphazard and exceptional.’ Similarly, in the transactions cost approach, ‘we would expect product innovation to be exceptional’, because the uncertainty surrounding product innovations would lead to vertical integration, as a result of which product innovations would be internalized and transformed into process innovations. Hence, both ‘pure markets’ and ‘pure organizations’ cannot explain the high incidence of product innovation. Lundvall concludes that ‘[t]he fact that product innovations are frequent in the real world demonstrates that most real markets are “organized markets” rather than pure markets.’ Organized markets are characterized by information exchange beyond price and quantity and involve various forms of interfirm relationships that help to overcome uncertainty. A further reason for cooperation rests on the appropriability of the profits arising from innovation. This aspect was highlighted by von Hippel (1988) in his study on the sources of innovation, where he categorized firms in terms of their functional relationship to a given product, process or service innovation. Distinguishing between users, manufacturers and suppliers, he found that the functional source of innovation can vary. Though in many cases, the manufacturers were responsible for innovations, in others, it was the (lead) users of a product. A good example for the latter are scientific instruments, which are frequently adapted by researchers to their particular purposes. In yet other cases, suppliers are the

The organization of production 27 innovators, for instance when the supplier of an industrial gas develops new applications for the use of those gases that result in an increase of gas sales. The actual functional source of an innovation generally depended on many different factors, though the expected profits typically played a decisive role. In the case of user innovation, for example, users would innovate by altering product characteristics in important ways to fit their needs. Manufacturers were either unaware of those needs or they would have failed to profit from such an innovation: while for a user this constitutes a process innovation that probably can be ‘hidden behind their factory walls’, a manufacturer would most likely have to reveal it to potential adopters if he is to profit from it. However, by cooperating, or what von Hippel calls ‘know-how trading between rivals’, both sides can benefit: a user can purchase a product that correspond to his needs while the manufacturer can protect his innovation from imitators. The foregoing examples highlight how cooperation can give rise to innovations by overcoming uncertainty and information deficiencies and changing the distribution of prospective innovation-related profits. The examples have in common that they show how cooperation removes barriers to innovation. A further potential barrier to innovation is the interdependence of activities already referred to earlier. Using the concept of ‘activity chains’, Dubois (1998) emphasizes that since firms specialize, production activities are mutually dependent. It could therefore be argued that certain innovations would not be forthcoming if they require adjustments along the entire ‘activity chain’ but no coordinative mechanism for such adjustments exists. Relationships therefore form the basis for the smooth and efficient implementation of innovative ideas where activities are mutually dependent. Turning to interfirm cooperation as a source of innovation – as opposed to the removal of barriers of innovation – at least two effects can be discerned. The first of these concerns the pooling of knowledge and capabilities that leads to interaction between different ‘knowledge bodies’ from which innovative ideas may be generated. Håkansson (1987: 4) argues that new knowledge concerning product or process ideas is created at the interface between different knowledge areas. The combination or confrontation of different kinds of knowledge gives rise to ‘innovative situations’ in which, for example, technical solutions for one situation may prove useful for another. In particular, in the case of buyer–seller interaction, the confrontation of the buyer’s needs with the technical capabilities of the seller gives rise to opportunities in which needs and possible solutions are redefined, leading to product and process innovations. The second effect derives from the fact that innovations are frequently based on the combination of several existing technologies. Interfirm cooperation brings together existing capabilities on which new products can be based. In this context, Teece’s concept of complementary assets, and especially complementary technologies, is particularly useful (Teece 1986, 1991). He observes that an innovating firm or consortium that has developed a new product or process with good commercialization prospects has taken only the first step.

28

The organization of production It must then secure access to complementary technologies and complementary assets on favourable terms in order to successfully commercialise the product or process. (Teece 1991: 411)

Of course, the firm could attempt to integrate such complementary technologies, either through building or acquiring them. But even in the case of modestly complex technologies this is likely to be costly and often unnecessary. It is also likely to be time-consuming, so that the value of the initial innovation might erode as competitors get a chance to develop an identical or similar product or process. Similarly, apart from complementary technologies, Teece also stresses the need for access to other complementary assets such as competitive manufacturing, distribution and services supporting a firm’s core technological know-how in innovation. All of these ancillary factors can play a decisive role in determining the commercial success of an innovation, and the value of one firm’s assets to be enhanced by a combination with the assets of another firm. Thus, in addition to optimizing the efficiency of mutually dependent dayto-day operations, the network mode provides an organizational mechanism that is conducive to innovative activity. On the one hand, interfirm co-operation removes barriers such as the uncertainty or the difficulty of appropriating profits that impede innovative activity within a particular firm. On the other hand, the information exchange and linking of complementary assets fostered by interfirm co-operation actively contribute to innovative activity. In fact, some scholars view the existence of network arrangements exclusively in the context of innovative activity. Imai and Baba (1991: 389), for example, define network organization as ‘[. . .] a basic institutional arrangement to cope with systemic innovation. [. . .] The network enables corporations to identify emergent opportunities for linking flexible specialisation across the boundaries of firms, and for triggering continuous interactive innovation’. Systemic innovation here is understood as a series of chain reactions in a total system, that is, new combinations of systemic elements. While technological ‘fusion’, that is, the combination of existing technologies, gives rise to innovative products and processes, technological ‘fission’, brought about by the emergence of a generic technology (such as information technology), transforms a whole range of existing products and services, generating a ‘new combination of physical products, software and human services’ (ibid.: 390), which require interaction between firms with diverse capabilities in these different areas. In sum, in entering into business relationships, firms gain the advantages of integration without incurring the cost, rigidity or risk of ownership. Network organization provides a mechanism to deal with constant change and uncertainty in the surrounding business environment in general and to cope with and exploit technological change and innovation in particular. It is likely to prevail under circumstances where the gains from cooperation, such as speed, flexibility and reciprocity outweigh the costs associated with coordination.

The organization of production 29

The morphology of networks As networks fulfil a variety of functions and interfirm relationships take a variety of forms, so a large variety of network configurations can be found. Cooperative arrangements can concentrate on areas such as R&D, production, or marketing and include many or only a very small number of partners. They may involve purchase agreements, market or manufacturing rights, technology exchange or joint R&D, etc. Depending on the nature of such agreements, as well as the characteristics and number of constituent members, networks may be characterized by weak or strong linkages, be relatively closed or open to outsiders, revolve around a clearly defined core or be multipolar, etc. Empirically, therefore, networks may be said to be characterized by certain morphological features such as the identity and composition of constituent members or the nature and intensity of the linkages between them. Such morphological characteristics, in turn, define a range of subsidiary qualities associated with a particular network type. Though by no means exhaustive, the following discussion aims to consider a possible ‘morphology’ of network types in an industrial setting and links these with a range of qualitative characteristics. For this purpose, networks may be said to be defined in terms of their constituent members as well as the nature and content of the links between them. These will be considered in turn. In the study of economics, the term ‘networking’ has been applied in a variety of contexts. Historically, it has first been used in studies on the Japanese keiretsu, or kigyoshudan (business groups), where the concept originated. However, even in this confined context, the notion has been applied rather loosely to describe a range of institutional arrangements for varying purposes. Citing Imai (1988), the OECD (1992: 101) highlights three overlapping uses: (a) the intra-group ‘affiliated’ or keiretsu networks, (b) hub firms’ supplier networks, and (c) R&D networks consisting of cooperative R&D relationships, which ‘can be (either separately or simultaneously) inter-group, intra-group or external (e.g. with universities or public laboratories).’ The same study also talks of ‘intra-corporate networks’ and the ‘network firm’, while elsewhere, the subject of network analysis is interfirm cooperative arrangement. In other words, ‘networking’ can be found in a confusing variety of arrangements which transcend the traditional concept of the firm with clearly demarcated boundaries that underlies both neoclassical and transaction cost theory. Confining the discussion to industrial network arrangements (i.e. excluding, for example, R&D networks) and taking into account the fluidity of the concept of the firm in network arrangements, it seems useful to view a network as web of relationships between ‘business units’, where these are understood as discrete organizational entities that may range from the division of a large company via subsidiaries and affiliates to entirely unrelated companies.3 Taking the business unit thus defined as the basis for analysis, it is then possible to speak – at least conceptually – of intrafirm, group and interfirm networks, where the first consists of the various business divisions of a large firm, the second includes its subsidiaries

30

The organization of production

and affiliates and the last encompasses unrelated firms. In practice, of course, such distinctions will depend on definitions of the boundaries of the firm. Nevertheless, networks may be broadly described in terms of the identity of their constituent members, though this identity, in turn, will frequently depend on the relationship of the members to each other. In addition to membership, network structures are defined by the nature of the relationship linking its various members. Such relationships may be described as agreements between parties in which one party agrees to secure X from the other party in exchange for Y, where both sides understand that arrangement and are aware that future transactions depend on the observance of the agreement on which the cooperation is based. Such agreements may be implicit or explicit, they may be contract-based or involve ownership arrangements. Especially in the latter case, cooperation tends to blur the boundaries of the firm. In order to classify various types of (collective) cooperative arrangements Langlois and Robertson (1995) make the useful distinction between ownership integration and coordination integration. While the property-rights view of the firm defines the boundaries of a firm in terms of ownership titles, the nexus-ofcontract view of the firm holds that organization within the firm is just as much a matter of contractual arrangements as organization through the market. The firm represents simply a particularly dense intersection of contracts. Langlois and Robertson view these definitions of the firm not as mutually exclusive, but rather as two dimensions along which to categorize organizational forms. The first dimension is the degree of ownership integration, and the second the degree of coordination integration. Using this scheme, various types of cooperative arrangements can be distinguished. At the one end of the spectrum stands full-scale integration with full ownership control and central coordination, at the other the so-called ‘Marshallian districts’ – clusters of highly specialized firms that benefit from the geographic concentration of relevant skills and the exchange of information through various channels, though both ownership and coordination integration are low or non-existent. Other arrangements with varying degrees of both types of integration can also be classified following these criteria, including, for example, holding companies or venture capital networks such as those found in Silicon Valley (Langlois and Robertson 1995). The degree of coordination and ownership integration is likely to determine a host of further, secondary network characteristics. Abstracting from Borrus (1997) and Borrus et al. (2000: 14–21), who compare Japanese, US and Taiwanese network arrangements in the electronics industry, network characteristics may also be classified in terms of their permanence, accessibility, responsiveness and degree of centralization. Following from the considerations above on the rationale for relational contracting and networking, it may be hypothesized that the lower the degree of coordination and ownership integration, the more fluid and disposable are the relationships, the more open is the network to new members, the faster and more opportunistic are network members and the network as new opportunities arise, and the less centralized is the governance structure likely to be. Conversely,

The organization of production 31 tighter coordination and ownership integration suggests more stable and longterm relationships, less openness to new members, greater caution and a centralized governance structure. These features, in turn, may be linked with the functions that relationships fulfil as well as the appropriateness of one particular network configuration against another under different competitive circumstances. In this context, Langlois and Robertson (1995) offer a number of interesting considerations that link the ability of various kinds of organizational arrangements to cope with different types of innovation. They argue, for example, that ‘Marshallian districts’, consisting of small firms that are highly specialized in a particular activity and in which competition is mainly via price characteristics, may cope well with what they label ‘parametric change’, that is, change within known variables and known boundaries. A second type of change, ‘strategic change’, which is more radical and requires a fairly drastic rearranging of skills, but within a familiar framework, however, would overtax networks of the ‘Marshallian district’. Vertically integrated networks, though, are well-suited to redirect capabilities in a coordinated fashion that would be superior to either organization through the market principle or more loosely integrated network types. Yet, when innovations are ‘structural’, that is, when there is a great degree of uncertainty and the entire framework in which firms operate is in a state of flux, decentralized ‘Innovative Networks’ are likely to prove most successful. Citing the personal computer as an example, Langlois and Robertson (1995: 136) argue that ‘[h]ere the ability of a decentralised Innovative Network to generate a wide diversity of information signals and to move rapidly may be an overwhelming advantage’. Table 2.1 offers a simple schematic representation of the different types of organization, their characteristics, and ability to deal with change.

Table 2.1 Types of organization and their characteristics Formally integrated firms

Vertically integrated Japanese production networks

Loosely integrated US-style production and innovative networks

Degree of ownership and coordination integration

High

Intermediate

Low

Characteristics of interfirm relationships

Market based

Closed, long-term and stable relational contracting

Open, fast, flexible and disposable formal relationships

Type of change best suited to deal with

Parametric and limited strategic change

Strategic and limited structural change

Strategic and structural change

Source: See text.

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The organization of production

The foregoing considerations suggest that there exists a trade-off between the degree of integration and the degree of flexibility and linked to that the ability to initiate and react to various types of innovation. While a high degree of integration fosters information exchange that facilitates incremental and to a limited extent also more radical innovation and change, in instances of structural innovations and change, that is, when the entire framework of operation is undergoing significant change, a high degree of integration can act as a constraint. However, periods of high uncertainty and a high rate of innovation are typical of the early stages of the product life cycle. Once the preparadigmatic phase, in which product characteristics are fluid, gives way to the paradigmatic phase, innovative activity moves down the hierarchy of product characteristics and, moreover, increasingly focuses on the production process. At this stage, more closely integrated networks are likely to be at an advantage again. To summarize, for the purpose of this study, networks may be defined as a web of relationships linking various and heterogeneous business units that provide transaction benefits through the coordination of mutually dependent activities. Moreover, providing means for the exchange of information as well as access to complementary assets, networks play a central role in the innovation process. Empirically, network configurations can be distinguished in terms of the degree of ownership and coordination integration linking constituent members. Finally, the extent of integration may have an impact on the ability of networks to initiate and react to different kinds of change.

3

‘Pyramidal’ production networks in the Japanese electronics industry

Introduction Both the keiretsu and the subcontracting networks that have been outlined in Chapter 1 represent central features of the organization of industry in Japan and as such have been studied extensively. A wealth of detail regarding their history, organization, economic foundations and consequences has been expounded. However, from the perspective of network theory, it proves quite difficult to bring the subject into focus when asking simple questions such as what is the structure of such networks and how is production organized? And more specifically, what is the identity of network members, what is their relation to each other, and how are activities coordinated? Trying to answer such questions, it emerges that none of the studies provides a satisfactory answer. The literature on the keiretsu, for example, typically only provides the crudest outline of the organization of production. Studies on subcontracting arrangements, in contrast, do focus on production arrangements but, importantly, tend to disregard the role played by common (i.e. non-dedicated) suppliers and fail to consider whether subcontractors are or are not corporate affiliates. In other words, even though keiretsu and subcontracting networks clearly overlap, descriptions of the organization of production in terms of either of these provide only a partial account and their relation to each other remains unclear. This situation is further exacerbated by the fact that few studies have concentrated on production arrangements outside the automotive industry. While the latter has been studied extensively (Asanuma 1985a,b, 1989; Cusumano 1985; Mutoh 1988; Womack et al. 1990; Clark and Fujimoto 1991; Smitka 1991; Sako 1996; etc.), surprisingly little research has been carried out on such arrangements in other sectors – even though relational contracting is common across all assembly industries in Japan. Thus, with regard to the electronics industry, the number of case studies describing interfirm relationships and production arrangements is rather limited. The lack of a wider perspective on organizational arrangements that views the keiretsu and subcontracting relationships as part of a more general phenomenon and the lack of detailed case studies on such arrangements means that far-reaching changes in the organization of production – at least as far as the electronics industry

34

‘Pyramidal’ production networks

is concerned – have largely gone unnoticed. A central argument of this study therefore is that just as the rise of the network approach to organizing production – of which keiretsu and subcontracting arrangements form a part – represents an evolutionary process, so network arrangements themselves adapt, are shaping and shaped by industrial dynamics, and make commonly held views regarding the organization of industry in Japan appear increasingly out of date. What is necessary is a perspective that transcends, but at the same time encompasses, traditional portrayals of the organization of industrial production in Japan. It is the purpose of this chapter to develop such a perspective in order to analyse the structure of production networks and their evolution over time. Methodologically, this involves the development of a stylized network that serves two functions. First, it presents a view of network patterns that is more inclusive than conventional accounts which concentrate either on keiretsu or subcontracting relationships alone. For this purpose, the focus of the enquiry is on the sourcing pattern for parts and components or, in other words, the supplier networks of the large assemblers in the electronics industry. Building on empirical evidence from a host of sources, the network is analysed in terms of its constituent members as well as the nature and content of members’ relationship with the final assembler. The picture that emerges is one of ‘pyramidal production networks’, that is networks that are characterized by a hierarchical structure, with the final assembler at the apex and parts divisions, affiliates and independent suppliers in subordinate positions as determined by ownership and coordination arrangements as well as the distribution of resources. The second function of this stylized network is to serve as a ‘base line’ against which later developments can be compared. Most of the literature on production arrangements that will be used is based on observations from the early to late 1980s;1 the stylization of a pyramidal network that will be developed therefore depicts patterns as they would be found during that period. The 1980s, of course, were a decade when Japanese industry was still going strong, there was considered to be much to be emulated, and academic interest in the origins of the country’s manufacturing prowess flourished. The various elements of pyramidal networks – especially subcontracting arrangements – were thus analysed in considerable detail and held up as examples to be followed elsewhere, as suggested by the titles of Nishiguchi’s Strategic Industrial Sourcing: The Japanese Advantage or Hines’ Creating World Class Suppliers. The stylization also contains observations regarding practices that are frequently seen as more general elements in the Japanese business world, such as the impression that markets or, in this context, networks tend be closed to outsiders as a result of long-term and exclusive business relationships. Thus, the stylized pyramid network represents and confirms a widespread image of the organization of Japanese industry. An important part in understanding network structures consists in unravelling the tangle that results when taking into consideration the multidimensionality involved in networking. Consisting of actors, relationships and resources, networks gain their structure through the particular configuration of these

‘Pyramidal’ production networks 35 components. However, these elements are interdependent and cannot be seen in isolation: transactions in relationships are closely connected with the resources that actors control. Consequently, the label by which an actor is identified in a network setting may already indicate the nature of a particular relationship (as in ‘subcontractor’). It is therefore impossible to clearly separate the part from the whole, though for the purpose of clarity of presentation, this seems advisable. The remainder of the chapter therefore looks at the structure of production networks from three different, though complementary angles, where overlaps are unavoidable. Each of these angles, moreover, illustrates the pyramidal structure that characterizes the Japanese electronics industry during the 1980s. The first angle from which the topic shall be approached is that of the ‘actors’: the constituent members of the network, the division of labour between them, and hence the structural organization of production are outlined. This is followed by a more detailed exposition of the relationship types that can be found in such networks, linking production issues with the institutional arrangements for purposes of coordination. A brief discussion of the general type of resources and capabilities that different types of members contribute to the network provides the third angle. In the discussion of each of these dimensions, the hierarchical properties of such networks – with the final assembler as the hub where production, coordinative control and resources are concentrated – become increasingly clear and should be borne in mind. However, the complete structure and pyramidal nature of the network fully come into view only by looking at the whole rather than the different elements in isolation. An important indicator in this respect is provided by the procurement patterns of the parent company: by analysing the types of parts and components supplied by each of the different types of network members, the heavy concentration of resources and control within the parent company and its group-network can be shown. It will finally be suggested that these arrangements represent the result of a strategic choice in order to deal with the challenges of the time as they arose during the postwar period up until the 1980s.

Network members and the division of labour There are a number of ways in which members (‘actors’) in Japanese production networks can be ascribed their particular identity. This may be in terms of their place in the division of labour, ownership arrangements or the mode of interaction with other network members, to name but a few examples. In each case, their identity to some extent is defined by the nature of activity they are engaged in as well as their relationships with other network members. The first task, however, is to provide a general classification of the different types of constituent network members and outline their respective roles. Production in the modern economy is typically characterized by a high degree of division of labour. This is especially the case in the assembly industries where

36

‘Pyramidal’ production networks

final products often consist of a large number of discrete parts and components. Whether to make or to buy such parts and components represents a crucial decision. In the Japanese case, the odds are typically highly in favour of the latter, with purchases of parts and components often accounting for around 70–80 per cent of manufacturing costs.2 Similarly, manufacturers may also choose to outsource either subassembly or even final assembly processes. While the former is quite widespread in the Japanese context, the latter – that is, reliance on the so-called original equipment manufacturers or OEMs – until quite recently has been rare as final assembly is one of the areas which Japanese companies typically have regarded as one of their competitive strengths. To begin with, network members in assembly industries can be divided into the lead manufacturer and the suppliers of parts and components and/or assembly services. The lead manufacturer – frequently also labelled ‘set-maker’ or ‘final assembler’ (though final assembly could, in fact, be sourced out) – forms the core of the network and is typically responsible for functions such as product definition and development, the coordination of production and service activities such as marketing, distribution, after-sales services, etc. As for the suppliers, these are typically classified according to the characteristics of the parts and components they sell to the customer: parts can be divided into those that are of a standardized nature, and those that are customized, that is, made to the specifications of the assembler and not sold to other customers. Traditionally, suppliers of standard parts and components are labelled ‘common suppliers’ or ‘makers’. Typically, they develop their products independently and sell these to any number of customers. Production tends to be largescale and transactions rely on the market mechanism. The second type are suppliers of customized components usually referred to as ‘subcontractors’. Parts are made to order, specifically and uniquely for the customer and may have been developed either by the customer, by the supplier, or in cooperation between the two. Thus, subcontractors are identified by two distinguishing features: first, a subcontractor’s dependence on a customer in regard to a given product is almost total and the product cannot be sold to several customers. Second, a subcontractor does not have as much control over product design as the common suppliers (e.g. Uekusa 1987). Actors in Japanese production networks may thus be classified into three broad types: the lead manufacturer representing the core or hub of the network, the common suppliers and the subcontractors. A further feature of the high degree of division of labour in the Japanese assembly industries, however, is the fact that it is not only the final assemblers that heavily rely on suppliers. Rather, the latter in turn have their own suppliers, giving rise to a tiered structure of suppliers resembling a pyramid in terms of subprocess and subassembly stages as well as the number and size of establishments: each successive tier is characterized by more basic processes carried out by a larger number of increasingly smaller firms. Firms in each tier are responsible for coordinating their supplies from the tier immediately below. At least for the larger suppliers, their own suppliers may also be divided into common suppliers and subcontractors (Hines 1994; Nishiguchi 1994). Thus far, network members have been defined in terms of their role and place in the division of labour. Often, though, subcontractors are also divided into

‘Pyramidal’ production networks 37 independent and partially integrated ones, that is, those with equity links with the customer. Figure 3.1, borrowed from Hines (1994), shows a representative classification of suppliers in Japanese production networks. However, in studies of Japanese subcontracting practices, the role of common suppliers is rarely considered and the distinction between integrated and independent subcontractors or their respective roles largely ignored. Hence, the image that emerges is a monolithic one where production arrangements are dominated by subcontracting relationships which are all more or less of a similar nature.3 In reality, however, suppliers – of custom or standardized parts, integrated or independent – differ considerably in their characteristics and the role they play in the division of labour. A number of case studies by Wu (1991), Hiramoto (1992), and Chen (1994), as well as my own in Chapters 6–8, clearly illustrate these differences which play an important role in giving Japanese production networks their distinct morphological characteristics. The following example is based on Chen’s comprehensive study of the production of TV sets at industry giant Matsushita. Figure 3.2 represents the extended core of this network, that is, the Matsushita group network as well as its first-tier suppliers. The overall coordination of TV production rests with the TV department of the parent Matsushita Electric Industrial Co. (MEI), which controls the company’s dedicated TV factories (the Ibaraki and Utsunomiya factories) as well as TV production at its subsidiaries Kyushu Matsushita, Matsushita Kotobuki and Taiwan Matsushita. These are responsible for the final assembly of TV sets. Parts and components are supplied by a total of 50 companies: the two affiliates Matsushita Electronics Co. and Matsushita Electronic Components Co.; 12 common suppliers and 36 subcontractors (the kyoryokugaisha, i.e. member firms of the subcontractors’ association orchestrated by Matsushita for the purpose of coordinating TV production). Each of these three types of suppliers can be described in terms of their relationship with the final assembler, their firm characteristics and their role in the division of labour. Beginning with the two group companies Matsushita Electronics and Matsushita Electronic Components, these affiliates are spin-offs from MEI that Partially integrated subcontractors

Make in-house Make to order

Total production

Independent subcontractors

Buy in Off the shelf parts (standardized components)

Figure 3.1 Classification of suppliers. Source: Hines (1994: 53).

Common suppliers

38

‘Pyramidal’ production networks

Matsushita Group

Matsushita Electric Industrial Co. Matsushita Electric (Taiwan) Co.

Makers 12 companies

TV division Ibaraki Factory Utsunomiya Factory

Matsushita Electronics Co.

MatsushitaKotobuki Electronics Industries

Matsushita Electronic Components Co.

Final production of TV sets

Kyushu Matsushita Electric Co.

–

Kyoryokukai 36 companies

Production of parts and components for TV sets

Figure 3.2 The organization of TV production at Matsushita Electric Industrial Co. Source: Chen (1994: 66); author’s translation.

enjoy a particularly close relationship with the parent. In fact, spin-offs such as these frequently have been established simply to lower wage costs rather than to allow the management greater independence. They continue to be majority owned and, as in the case of the two subsidiaries here, often are unlisted. Nevertheless, they are of substantial size, with capital in excess of ¥10 billion and more than 10,000 employees. In contrast, the common suppliers are strongly independent of the final assembler and are typically listed on the stock exchange. Their capital tends to be in excess of ¥6 billion and the number of their employees surpasses 5,000. The kyoryokugaisha (subcontractors) are considerably smaller in scale: in most cases, their capital is below ¥1 billion and their employment below 1,000 people. Though they may be formally independent, a considerable share of their business depends on MEI and as members of the assembler kyoryokukai (subcontractors’ association) they are at least under indirect control. In order to look at the role the different types of network members play in the division of labour, it is useful to classify parts and components into three categories:4 first, key components – such as cathode ray tubes (CRTs), video-heads, integrated circuits (ICs), micro-chips, etc. – that determine product performance and therefore form the basis for product differentiation. These are typically manufactured within the parent company or by an affiliate.5 In the second category are general electronic parts such as resistors, coils, condensers, etc., but also ICs and micro-chips, that are of a standardized nature and which are obtained from the independent ‘makers’ (common suppliers). In the final category are plastic

‘Pyramidal’ production networks 39 parts and press parts, which are designed by the assembler and supplied by the subcontractors. Typically, the assembler provides design drawings as well as moulds. A similar and partly overlapping classification would distinguish between mechanical, electronic, and structural parts and components, where the first category includes various mechanisms as well as switches and tuners, the second semiconductors, CRTs, condensers, resistors, etc., and the third chassis, cabinets and other plastic and press parts. Mechanical and electronic parts are typically supplied by group companies as well as common suppliers, while subcontractors concentrate on structural parts as well as subassembly processes. Figure 3.3 provides an illustration of the overall organization of production in the Matsushita case study, which can be considered as fairly representative: the flow of parts and components can be divided into five channels.6 These include the supply of printed circuit boards (PCBs) by Matsushita Electronic Components (I) as well as mechanical (II) and electronic parts (III) by the two affiliates as well as the common suppliers. These parts are then assembled using sophisticated automatic insertion/surface mount technology developed by the final assembler.7 Component subassembly as well as manual insertion processes are then outsourced to some of the subcontractors (IV), while other subcontractors supply structural parts manufactured according to design specifications provided by the parent (V). Final assembly of subassemblies and structural parts using assembly robots, as well as final inspection, are again carried out within the set-makers’ facilities (Wu 1991: 66–7; Chen 1994: 68–71).

Matsushita Group Matsushita Electric Industries

Matsushita Electronic Components

Mechanical parts

Electronic parts

Structural parts

II Inspection

Assembly

Automatic insertion

PCB

I

Sales division TV division

IV

III

V

Makers 12 companies

–ryokukai Kyo (36 companies) Hand-insertion, subassembly

Figure 3.3 Production chart of TV manufacturing at Matsushita’s Ibaraki factory. Source: Chen (1994: 69); author’s translation.

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Network membership in terms of different types of firms and their role in the overall organization of production may thus be summarized as follows. Production networks in the electronics industry consist of four distinguishable types of firms: (1) The parent company/final assembler which serves as the hub of the network. It is responsible for product definition and development, the major assembly processes and the management of its supplies, that is, the coordination of its network of suppliers. It is a major industrial corporation with tens of thousands of employees and a large number of subsidiaries and affiliates. (2) The quasi-integrated corporate affiliates and subsidiaries (kanren kigyo and kogaisha). In this category should also be included major divisions of the parent company that operate as stand-alone business units. While there may be legal differences between these different types of corporate organization, for all practical purposes, with industry giants like Matsushita, Hitachi or Toshiba, it usually makes little difference whether a particular entity has the status of a business division, an affiliate or a subsidiary.8 Kanren kigyo (and business divisions) supply key mechanical and electronic components that play a decisive role in determining product performance. Together, the parent company and the kanren kigyo make up the keiretsu (group) network. (3) The kyoryokugaisha. These are the subcontractors (shitauke kigyo) typically referred to in the literature on industrial organization and network practices in Japan that are organized by the set-maker in the so-called kyoryokukai (subcontractor associations). They supply plastic and metal parts and components that are customized according to specifications and often detailed design plans provided by the set-makers. Frequently, a considerable share of their business depends on one or only a few large assemblers. Compared with the kanren kigyo or common suppliers, the subcontractors are relatively small. (4) The common suppliers or so-called ‘makers’. These are large, independent parts manufacturers as well as parts divisions or affiliates of other industry giants. They typically supply general (i.e. standardized) mechanical and electronic parts that are sold to a wide range of companies. Of course, the distinction between kanren kigyo and non-affiliated subcontractors cannot always be made so clearly. Nishiguchi (1994: 114) observes: In general, the division of labour between keiretsu firms and nonaffiliates was that the former took responsibility for technically advanced, proprietary products, and the latter were usually in charge of simpler products and processes. But the differences were not always so distinct and were often further blurred by intermediate arrangements such as ‘weak’ (e.g., a single digit as opposed to 100 per cent) ownership by the parent firm. Overall, however, the classification holds and differs somewhat from conventional descriptions of the subcontracting system. Here we have three distinct types of

‘Pyramidal’ production networks 41 suppliers: affiliates, common suppliers and non-affiliated subcontractors (kyoryokugaisha). In contrast, in conventional descriptions, there are typically only two general types: common suppliers and subcontractors. Though it is acknowledged that some of the latter are (partially) integrated while others are (formally) independent, the differences remain unexplored. However, failing to clearly distinguish between affiliated and non-affiliated subcontractors invites the danger of a distorted conceptualization of the organization of production. For example, looking at firm size, the type of part or component supplied or, as will be elaborated later, technological capabilities, there are considerable differences between corporate affiliates and kyoryokugaisha-type subcontractors; in fact, often there seem to be more similarities between the affiliated suppliers and the independent ‘makers’. For instance, semiconductors are frequently sourced from within the group network as well as from common suppliers, depending on the particular specifications required.9 In the remainder of the study, the term ‘subcontractor’ therefore will refer to suppliers of the type described under (3). Affiliated suppliers will be labelled as such, irrespective of whether their work content resembles that of a subcontractor or a common supplier.

Relationships: coordination and transaction linkages In industrial networks, customers and suppliers are linked through lasting relationships which represent a mutual orientation towards each other. Activities are coordinated in order to ensure a smooth functioning vis-à-vis the other, leading to a blurring of the boundaries between the firms involved. Recalling Langlois and Robertson’s distinction discussed in Chapter 2, relationships may be classified according to the degree of ownership and/or coordination integration involved. Network patterns, in turn, may then be described in terms of the prevailing relationship types found among network members. This section outlines the main features of modes of integration that are closely associated with Japanese network practices. To a considerable extent, the nature of relationships found in production networks form part of a wider pattern of industrial organization in Japan: crossshareholdings and preferential interfirm trade form part and parcel of the keiretsu system that has pervaded the Japanese business world throughout the postwar period (e.g. Gerlach 1992). Significantly, however, the vertical keiretsu and the subcontracting system as a mode of organizing production became widespread only during the late 1950s and early 1960s. Against the background of high-speed growth and increasing complexity, large manufacturers sought to concentrate their resources on strategically important products and processes, outsourcing the production of parts, components or subsystems as well as the assembly of more mature products to subcontractors. In order to meet these challenges (as well as to prepare for the impending liberalization of foreign investment in Japan), manufacturers invested in their suppliers, ranging from 100 per cent owned subsidiaries to partially owned kanren kigyo (related firms) to simply providing loans or

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loan guarantees, depending on the particular requirements. The general objective was to boost their control over some of their major subcontractors – which, moreover, were increasingly stretched in terms of technology and finance – in order to guarantee reliable flows of supplies that attained the same quality standards as in-house operations (Nishiguchi 1994: 113–15; Nishiguchi and Brookfield 1997). These developments are reflected in the proliferation of kanren kigyo during this period. Thus, while Hitachi, for example, had only 21 related firms in 1956, by 1963, this number had risen to 74. Similarly, for Matsushita, the number of related companies rose from 70 in 1956 to 274 in 1963 (Nishiguchi 1994: 113).10 Today, these numbers, of course, are even higher: at the end of fiscal 1998, the Hitachi keiretsu consisted of 1,010 kanren kigyo, while the number of related companies in the Matsushita keiretsu stood at 325 (Toyo Keizai Shinposha 2000). Moreover, while in 1950, only 0.7 per cent of large electrical companies had capital relationships with suppliers, by 1968, this share had risen to 28.1 per cent (Nishiguchi 1994: 114). Similarly, the share of electrical manufacturers that extended capital loan guarantees to their suppliers had climbed from 15.8 per cent to 57.9 per cent (ibid.). Thus, even in cases where assemblers may have no equity stake in their suppliers and the latter appear to be formally independent, the assemblers may nevertheless effectively control their suppliers’ business decisions. The resulting pattern was one of close business relationships. One corollary is that many subcontractors heavily depend on their main customer. Nishiguchi (1994: 153), for example, found in his study that 72.4 per cent of first-tier electronics subcontractors’ business depended on their top customer. The share was even higher for second-tier subcontractors at 88.2 per cent. (For comparison, UK electronics subcontractors depended on their top customer for only around 30 per cent of their business.11) Another consequence is that contractual relations tend to be long-term and stable. Nishiguchi (1994: 117) found that in 1983, Fuji Electric, for instance, had been doing business for more than ten years with almost half of its subcontractors (48.5 per cent) and for five years or fewer with only 22.3 per cent. The proliferation of kanren kigyo and the evolution of the subcontracting system are thus closely intertwined: given their heavy reliance on customized parts and components, large manufacturers tended to establish their own dedicated suppliers or forge lasting relations with existing ones which sometimes involved capital participation. However, even though kanren kigyo and non-affiliated dedicated suppliers are frequently grouped together in the literature under the same ‘subcontractor’ label, notable differences exist. The most fundamental of these regards ownership integration which forms the basis for the distinction between kanren kigyo and nonaffiliated subcontractors. The following sections describe the relationship between the parent and the various types of suppliers in greater detail. The relationship between parent and group companies As suggested earlier, the core of the production network in terms of parts and components production as well as assembly processes is formed by the parent and its

‘Pyramidal’ production networks 43 relevant divisions as well as its subsidiaries and affiliates. Regarding the relationship between group members, the parent tends to exert tight management control: in the case study discussed earlier, both Matsushita Electronic Components Co. and Matsushita Electronics Co. are majority-owned by the parent Matsushita Electric Industrial Co. (98 per cent and 65 per cent, respectively, when Chen conducted her case study). As parts suppliers for the Matsushita group, the two subsidiaries do not even have their own marketing division. Rather, they function as the parent’s parts and components factories: production of parts is commenced only once the relevant division at the parent has given approval to design specifications provided by the affiliate. This does not mean that they are completely captive suppliers as their sales to the parent do compete with independent common suppliers and their marketable (i.e. non-customized) output is also sold to non-group customers (Chen 1994: 71). Nevertheless, they possess little to no independence from the parent in terms of decision-making processes. This pattern found at Matsushita can be considered representative of the hierarchical nature of relationships in the vertical keiretsu. Equity participation is usually one-way, that is from the parent to the affiliate, rather than mutual; ownership typically exceeds 50 per cent and often reaches 100 per cent. Moreover, parents exert direct management control by dispatching directors to their kanren kigyo: Directorship connections between firms are most likely to involve parent companies and their satellites and banks and their clients. Within the large vertical keiretsu, representative directors are usually dispatched from the parent manufacturer to its subcontractors. Toyota Motors, for example, sends an average of three to six representative directors to each of its first-line satellites, as do Nissan, Hitachi, Matsushita, and other large parent industrial concerns […]. Gerlach (1992: 135) Given this ownership and control structure, relationships permeate all dealings between parent and affiliate: Within the vertical keiretsu, exchange between the parent and satellite firms is embedded in a dense network of ongoing relationships, as various forms of information, technical and financial assistance, and managerial experience are provided on a reciprocity basis. Gerlach (1992: 70) Relationships between the final assembler, that is, the parent, and the kanren kigyo thus consist of multiple dimensions, though at their core they are based on ownership integration that also involves tight coordination integration. As a result, when considering the difference between affiliated suppliers and parent divisions, organizational issues fade into the background, given the high incidence of fully owned subsidiaries and the custom of dispatching directors. Instead, legal or tax issues as well as the fact that affiliates typically have to pay lower wages than the

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parent seem to play a greater role. Overall, then, the group network consists of a dense web of multiple relationships which, however, are based on an underlying hierarchy in terms of ownership and coordination structures. The relationship between parent and non-affiliated subcontractors In contrast with the kanren kigyo, subcontractors as defined earlier (p. 40) have no equity linkages with the parent. Keeping in mind that the boundaries of the classification of suppliers are fluid and in some cases ‘weak’ equity linkages – that is ownership ratios well below 50 per cent and/or simultaneous equity linkages with a number of competing assemblers – can be present, the vast majority of subcontractors nevertheless are formally independent from the keiretsu parent. However, in practice, the extent of this independence may be quite limited: In not a few cases, the vertical division of labour is internalized to such an extent that de facto it approaches the coordination mode of firm-internal organization. Most final assemblers in Japanese industry not only have numerous subsidiaries (kogaisha), but also associated companies (kanren gaisha), that are closely tied to [the parent] in their decision making. Similarly, in the case of many subcontractors (shitauke kigyo) it is doubtful whether it is de facto possible to speak of independent businesses. However, this is impossible to discern without closer examination; formally, these companies appear to be independent. Hemmert (1998a: 170; author’s translation) The main reasons for this dependence have already been mentioned: not only have most parent companies extended loan guarantees to at least some of their subcontractors; the subcontractors also tend to depend heavily on the keiretsu companies for a significant to overwhelming share of their business. While most statistics on subcontracting companies (shitauke kigyo) refer to small and medium enterprizes (SMEs), which in Japan are defined as firms with up to 299 employees and which tend to rely on subcontracting business to a greater extent than larger firms, the overall pattern nevertheless seems quite clear: according to a survey conducted in 1985, 24.1 per cent of all subcontractors in manufacturing industry worked for only one customer (oya kigyo, literally ‘parent firm’), and slightly more than half (54.4 per cent) for up to four parent firms.12 In the electrical machinery sector, the shares are slightly higher than these overall figures: 25.4 per cent of subcontractors supplied only one parent firm, while the share of companies that had no more than four customers stood at 60.6 per cent. More indicative of the concentration of business, that is the exclusiveness of business relations with one parent are the following figures, though unfortunately no breakdown for firms from the electrical machinery sector alone is available: even among the larger subcontractors (those with 100–299 employees), 29.8 per cent of firms responded that more than 80 per cent of their business depended on only

‘Pyramidal’ production networks 45 one customer, with a further 15.1 per cent of firms reporting a dependence of between 60 and 80 per cent. The dependence on the parent is higher still for smaller and very small subcontractors (with 20–99 and 1–19 employees, respectively) that make up the lower tiers of the production pyramid. The Matsushita case study further confirms this pattern: though out of 15 kyoryokugaisha, 9 reported that less than 30 per cent of their business depended on MEI’s TV division, when MEI as a whole is considered, the figure falls to only 6 out of 16; in other words, 10 out of 16 companies reported a dependence of more than 30 per cent, with two relying on MEI as the sole customer for their output. Consequently, while the assembler may have no direct control over its non-affiliated subcontractors, it is typically able to exert considerable influence. Of course, the dependence is, at least to some extent, mutual. After all, subcontracting relations are based on assemblers’ reliance on customized parts and components and it is in the interest of the assembler to ensure that subcontractors thrive in order to play their part. It is this interdependence which forms the basis on which the close coordination of activities rests and of which the socalled kyoryokukai (suppliers associations) are probably the most noticeable manifestation. In the first instance, these suppliers associations serve as communication channels for the assembler to coordinate activities (such as production schedules) within the network of subcontractors. They also serve, more generally, as a forum for the exchange and development of ideas and as such are frequently credited with playing a major role in creating an atmosphere of trust on the basis of which customer and supplier engage in joint problem-solving, continual improvement and supplier-led innovation (e.g. Hines 1994: 107). While assemblers forge long-term relationships with their subcontractors, this, however, does not mean that there is no competition between subcontractors. On the contrary, part and parcel of the production system are dual or triple sourcing practices. Having more than one supplier for the same part not only minimizes risks such as an interruption in the flow of required parts but also allows assemblers to compare suppliers on aspects such as quality, cost, delivery, and managerial competence. Assemblers, moreover, employ complex mechanisms for the grading of suppliers which determines the amount of work allocated to individual subcontractors (Hines 1994: 102–5; Nishiguchi 1994: 133–6; Fruin 1998: 264–9). The subcontracting system thus strikes a balance between cooperation and competition. Relationships are based on the tacit understanding that the assembler will […] neither attempt to hire away the supplier’s best people nor steal a supplier’s innovations in production and delivery. A large share of the motivation of suppliers to lower costs and improve quality and delivery is the knowledge that such improvements will increase their profit margins at the expense of contractors, at least until the next major renegotiation of the terms of price and delivery. Thus, suppliers work hard to lower costs and thereby improve their margins within the life cycle of models and products. Fruin (1998: 267)

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‘Pyramidal’ production networks

Under such circumstances, it pays for the subcontractor to commit considerable resources to the relationship. The assembler similarly benefits – from subcontractors’ cost reductions and customer-specific know-how combined with more general advantages such as subcontractors’ lower wage costs, quicker response-time to market and technological change, etc. Given the mutual benefits, contracts are typically automatically renewed and, as already indicated, relations consequently tend to be long-term. Though subcontractors may be formally independent, that is, no ownership integration is present, transactions are hardly at arm’s length as is indicated by the organization of subcontractors in kyoryokukai, long-term contractual relations and, in some cases, capital loan guarantees. Subcontractors are closely linked with the parent in multidimensional ways, leading to a high degree of coordination integration. Meetings of kyoryokukai members are typically convened by the parent on a monthly basis, various kinds of information are exchanged and technology is either developed jointly or technological assistance extended to the subcontractor by the supplier. However, even if the benefits of such contractual relations may be evenly distributed, overall coordinative control clearly rests with the parent firm. As in the case of the kanren kigyo, relationships are hierarchically structured. The relationship between parent and common suppliers The relationship between final assemblers and the ‘makers’ has attracted hardly any research interest. Studies on the organization of production in Japan have almost exclusively concentrated on those aspects that set the country apart, implicitly assuming, supposedly, that interfirm relations outside the keiretsu/subcontracting-framework must be either negligible and/or based on text-book style market relations that require no elaboration. However, as for example Lazonick (1991) argues, even in the US economy, which tends to be regarded as the epitome of a market-based economy, few business transactions actually conform to the economist’s model of pure market exchange. It should therefore come as little surprise that in the case of Japanese production networks, those transactions that come closest to approximating market exchange are also characterized by relational contracting. Studying manufacturer-supplier relationships in TV manufacturing in Japan, Hiramoto (1992) describes assemblers’ dealings with the large parts-manufacturers supplying general electronic parts as follows: These [general electronic parts] are articles on the market, but their prices are not made public. The manufacturer tries to search for the ‘proper price’ at which the supplier will sell. When the manufacturer begins to buy new parts, its quality assurance department develops a capability test and gives its purchasing department permission to buy them. The principle of the manufacturer is basically to buy from multiple vendors, allotting a share to each vendor based on its performance. The price of the parts is negotiated once

‘Pyramidal’ production networks 47 every six months in conjunction with the manufacturer’s budget planning. The parts makers compete with each other for larger shares. Although the share of each supplier can change as, for example, a lower price is offered, the transaction itself tends to be long term. Hiramoto (1992: 227) Returning to Chen’s case study of TV manufacturing at Matsushita, a similar picture emerges. Of the marketed parts and components (shihan buhin), semiconductors represent the most important category. These are manufactured by one of the subsidiaries, but also procured from outside ‘makers’. In the latter case, however, Matsushita has forged close links with the ‘maker’ either through equity participation and/or guarantees from the ‘maker’ regarding the supply of next-generation semiconductors. The common suppliers (the 12 ‘makers’ in Figures 3.2 and 3.3) are assembled by Matsushita’s TV division once every six months in order to discuss matters such as new electronic parts and components, efficiency issues, and upcoming business plans. Moreover, the allotment of procurement shares to the different suppliers is also discussed. Companies that are present at these meetings of MEI’s ‘discussion group’ (shukai) include electronics giants such as NEC and Mitsubishi Electric, large independent ‘makers’ such as Murata Manufacturing or Rohm and members of the MEI keiretsu such as Kyushu Matsushita Electric and Matsushita Kotobuki Electronics Industries (Chen 1994: 79–80). To some extent, supplies from rival electronics giants, independent ‘makers’ and group companies complement each other. In the case of semiconductors, for example, there is such a large variety that there would be little point in manufacturing everything within the group network. However, an element of competition between group companies and outside suppliers is also present. While it is in the interest of the group to possess a wide range of technologies within the keiretsu network, such matters have to be weighed against cost considerations.13 Thus, as for the procurement of marketed parts and components, two types of suppliers and hence relationships can be distinguished: first, affiliated companies that belong within the group network and, second, other electronic giants as well as large independent parts ‘makers’. The relationship with the kanren kigyo has already been discussed. However, in the case of standard part and component supplies, tight coordination integration seems less pertinent; ownership integration consequently plays a subordinate role. Relationships thus tend to resemble those with the second type of supplier, that is, the non-affiliated common suppliers. In the case of the latter, no ownership integration is present and they are clearly independent of the assembler given that the parts and components in question are sold to the entire industry, nationally and globally. A certain degree of coordination is nevertheless present. Relational contracting makes the business environment more stable and predictable. The assembler is assured of a steady supply of essential parts and components, while the supplier is able to base business decisions (output levels, investment in equipment, R&D, etc.) on more reliable projections of future demand conditions. However, in

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contrast with relations with affiliates and subcontractors, relations with non-affiliated common suppliers (i.e. other electronics giants as well as independent parts ‘makers’) are based not only on mutual benefit but also on a degree of equality that is lacking in the other cases: suppliers are neither owned nor dependent – financially (through loan guarantees) or in other ways (high sales concentration; technical assistance, see below) – on the assembler.

Resources and (technological) capabilities Resources and their distribution among constituent members represent the third aspect determining the structure of production networks. With the division of labour based on the premise of specialization, network members complement each other in the resources they control and the capabilities they command. These include the traditional factors of production, that is capital and labour, as well as more intangible resources and capabilities such as a diverse range of management skills, product- and production-related know-how, legal titles such as patents, etc. Through relational contracting, network members gain privileged access to resources and capabilities they do not own. As can only be expected following the description of the different types of firms in terms of size and their role in the organization of production in the network, constituent members differ considerably in their resources and capabilities. For example, one of the assembler’s functions, by virtue of its role in the overall network, consists in product definition requiring appropriate R&D capabilities as well as resources for market research, marketing and distribution. In contrast, the smaller subcontractors can, for instance, often do without a dedicated marketing division and, in the case of those that only supply parts according to detailed designdrawings provided by the customer, even without any R&D effort to speak of. Needless to say, constituent members’ role in the division of labour in the network is closely linked with their resources and capabilities. Some observations regarding network members’ resources and capabilities follow directly from the general firm characteristics elaborated earlier. Final assemblers typically are large multinational corporations that consequently control substantial resources in all relevant areas (financial, managerial, technological, etc.) and across a wide spectrum of products and parts and components through their various divisions and/or their subsidiaries and affiliates. While the parent’s divisions span a wide spectrum of products, subsidiaries and affiliates tend to be more specialized and their resources and capabilities consequently more confined.14 As for the common suppliers, given that this group includes other electronics giants as well as the more specialized, though nevertheless fairly large, parts and components makers, these also possess substantial resources. Manufacturing goods that are sold on the market, common suppliers develop and market their own, original products. With regard to the particular part or component in question, the relevant resources can therefore be expected to include significant technological capabilities based on in-house R&D as well as production know-how, related management skills, etc.

‘Pyramidal’ production networks 49 In contrast, subcontractors tend to be considerably smaller in size and their resources limited. Rather than independently developing and marketing (original) parts and components, they concentrate their efforts on optimizing production capabilities in response to their customer’s requirements. In other words, their resources are geared towards complementing those of the assembler. In this respect, subcontractors do possess capabilities that are valuable to the customer: in a MITI survey, subcontractors’ ‘specialized technical knowledge not held by own company’ was the most prominent reason for using subcontractors, cited by 57.6 per cent of subcontractees.15 Yet, in the same survey, the ‘difficulty to design and develop products by oneself ’ and the ‘difficulty to obtain orders by oneself ’ (quoted, respectively, by 45.8 per cent and 42.4 per cent of respondents) represented the second and third most important reason why subcontractors engaged in subcontracting work (Hines 1994: 56). Moreover, given that the parts and components supplied by subcontractors typically are plastic and metal parts, and detailed design-specifications, and in some cases even moulds, are provided by the customer, subcontractors’ specialized technical knowledge in the main refers to a particular process rather than a product that, moreover, is geared to the customer’s particular requirements. Subcontractors’ chief contribution to overall production arrangements thus lies in the development of relationship-specific resources and capabilities. These are typically described in terms of resources dedicated to a particular customer, leading to a high degree of asset specificity. Such asset specificity may be subdivided into physical and dedicated asset specificity (i.e. investment in customer-specific capital equipment and production capacity), human asset specificity (the extent to which employees are trained specifically to fulfil the requirements of one particular customer), and site asset specificity (the proximity with which manufacturing sites are located to each other). Comparing subcontracting patterns in the Japanese and the British electronics industry, Nishiguchi (1994: Chapter 5) shows the high degree of asset specificity found in the Japanese case, which is a consequence of the close relations between customer and subcontractor. Another feature that figures prominently in the literature on Japanese industrial organization, technology and innovation, is subcontractors’ contribution to product design and development (e.g. Hines 1994: 81–92; Nishiguchi 1994: 125–33; Liker et al. 1995). However, aspects such as bilateral or black box design, resident engineers, etc. seem primarily confined to the automobile industry, from which these studies draw most of their examples. Hemmert (1993: 173), for example, notes that in the electronics industry, […] cooperation between final assemblers and first-tier suppliers is far less uniformly organized than in the automobile industry […] There are a number of independent parts manufacturers whose production is not customerspecific and who sell standardized products to the final assemblers. On the other hand, a large number of those suppliers that produce customer-specific goods and services are not technologically independent. [translated by author; emphasis added]

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In the pyramidal production network, the distribution of resources and capabilities – and especially technological capabilities as manifested in terms of original products based on in-house R&D and design efforts – thus is highly unequal: the parent with its specialized divisions, subsidiaries and affiliates is responsible for product definition typically based on key components developed within the group network. These key components determine product performance and differentiate the product from those of rival manufacturers. Parts and components as well as subassembly services that do not serve this purpose are procured from suppliers and subcontractors, freeing parents’ internal resources for strategic activities such as state-of-the-art product development and process innovation (Nishiguchi 1994: 137). The common suppliers provide general electronics parts whose technological sophistication may range from fairly low such as for simple condensers to quite high as in the case of semiconductors. The suppliers’ competitive strength typically rests on specialized process technologies and know-how and, depending on the product in question, proprietary product technology. Serving the entire industry, such ‘makers’ also enjoy considerable economies of scale.16 Subcontractors, in contrast, tend to concentrate on comparatively simple parts and processes. Given the rather low-tech nature of, for example, metal and plastic parts and components, subcontractors’ strength lies in their ability to quickly respond to the assembler’s needs. Rather than concentrating on economies of scale, their forte is flexible small-lot production that is closely linked with the customer’s demands for customized parts and components.

The pyramid Having discussed each of the features that give networks their structure – actors/members, relationships, and resources – it is now possible to put the different pieces together in order to arrive at a picture of the whole. As was already remarked at the outset of this chapter, studies of the Japanese production system rarely distinguish between affiliated and non-affiliated subcontractors, nor do they discuss the role of the common suppliers. Yet, making such a distinction and looking at the relative importance of the different types of suppliers and hence relationship modes in the overall set-up yields surprising results. At least for the electronics industry, such an analysis confirms, on the one hand, the view of Japanese production networks as hierarchically structured, that is, as ‘pyramids’. On the other hand, once suppliers are distinguished into the quasi-integrated kanren kigyo, subcontractors and common suppliers, subcontractors as typically described in the literature play a much less pivotal role than one would think judging on the basis of such accounts. Rather, it is the group network that occupies centre stage. The clearest indicator in this respect is the dominance of group purchases in total procurements. Earlier, it was pointed out that Japanese industry was characterized by assemblers’ heavy reliance on parts and components purchases instead of in-house production. However, the procurement share, which has frequently been cited as hovering between 70 and 80 per cent, would be considerably lower once purchases

‘Pyramidal’ production networks 51 from kanren kigyo were excluded. Comparing vertical industry structure in Japan and Europe, Hemmert (1998b: 15), for example, observes that while in Japan component and final assembly are frequently outsourced to group firms, these processes are typically formally integrated in German and other European companies. Differences in in-house value-added ratios disappear once the quasi-integrated kanren kigyo are included. Wu (1991: 69), in a study of an unnamed TV manufacturer, finds that group companies account for 64 per cent of total procurements on a cost basis, while non-group companies were responsible for only 35 per cent. Similarly, with regard to portable personal computers at Fujitsu, ‘up to 80 per cent of a typical model’s value is derived from in-house design and production’.17 Returning to the case study of TV production at Matsushita Electric Industrial adds further detail to this pattern. Table 3.1 illustrates the parts procurement pattern at the company’s Ibaraki Factory. It shows that only about 20 per cent of all purchased parts and components are ‘marketed’, that is standardized goods (condensers, semiconductors, resistors, etc.), and purchased primarily from the ‘makers’ (common suppliers). The remaining 80 per cent of all parts and components that are bought in are manufactured according to specifications provided by the core firm, that is they are customized goods. The large majority of these are key components that have been developed and/or designed by the two group Table 3.1 The structure of parts procurement and interfirm relationships of Matsushita Industry’s Ibaraki factory Parts manufactured according to specifications by the core firm (‘ordered goods’) Parts manufactured according to drawings provided by the core firm 25%

Parts manufactured according to drawings provided by the supplier 55%

Cabinet, sub-assembly, plastic parts, remote control, etc. Kyoryokukai subcontractors, 36 companies

Switches, CRT, trunk, deflection yoke, tuner, wires, cords, etc. Group companies, 2 companies

Share of procurements on cost basis: 25% Frequency of meeting: Once a month Degree of dependence on contractor varies according to technical capabilities

Parts offered by catalogue (‘marketed goods’) 20%

Condensers, semiconductors, resistors, etc. Common suppliers, 12 cos.

60%

15%

Once every two months

Once every six months

Production and sales controlled by MEI’s TV division

Source: Translated and adapted from Chen (1994: 81).

Independent companies

52

‘Pyramidal’ production networks

companies (CRT, tuner, deflection yoke, etc.). The remainder is made up by structural parts, subassembly and the remote control, which are supplied by the subcontractors according to detailed design drawings provided by the core firm. The division of these three different types of parts is for the most part congruent with the division of labour between common suppliers, group companies, and subcontractors: the common suppliers account for 15 per cent, the group companies for 60 per cent, and the subcontractors for 25 per cent of total procurements on a cost basis. These figures clearly demonstrate that TV production in the Matsushita network is concentrated in the group network, where the two group companies may be different legal entities, but production and sales is controlled by MEI’s TV division. What is more, all key components are manufactured within this tightly controlled group. In contrast, the subcontractors are responsible for merely a quarter of total procurements. Though they certainly play a role in the overall efficiency of production, their contribution is limited to non-key components and processes. What is more, comparing subcontracting strategies of Japanese companies at home, in Asia and in Europe, Hiramoto (1992: 239) found that […] large wage differentials in Japan, or the dual structure of the labour market, constitute a very important basis for the wide-spread subcontracting system in Japan. The dual wage structure influences a great deal the ‘makeor-buy’ problem of the firm; that is, it sets the boundaries of the firm, as seen in in-house production of PCB assembly in transplants. Moreover, as the trend towards naiseika (bringing production in-house) over the course of the recession during the 1990s with the aim of keeping factories in work shows, it requires comparatively little effort on the part of the assembler to acquire the necessary capabilities to do so. Common suppliers, finally, play a marginal role in overall procurement patterns. Linking now firm characteristics (‘actors’), relationship types and resources/capabilities with their respective role in the overall network, the hierarchical structure becomes readily apparent (see Table 3.2). At the apex of the pyramid sits the core (parent) firm, a multinational giant that orchestrates the entire network. Directly beneath it is the group network of subsidiaries and affiliates. Ownership and coordination integration with these is naturally strong. Large firms in their own right, they possess – in conjunction with the parent – substantial technological capabilities and supply key components that make up the lion’s share of the parent’s total procurements. Lower down the hierarchy are the nongroup suppliers, consisting of subcontractors and common suppliers. The former are comparatively small, and though no formal ownership integration is present, coordination integration, for example through the kyoryokukai, is strong, based on subcontractors’ heavy dependence on the parent in terms of sales and technology. Their capabilities tend to be customer specific. Their share in the parent’s procurements lies between that of group companies and common suppliers. The latter, finally, are fairly large and specialized companies (for some product

Source: See text.

Common suppliers

Subcontractors

Independent Capital: ⬎¥6 bn No. of employees: ⬎5,000

Kyoryokukai member Capital: ⬍¥100 mn No. of employees: ⬍1,000 None

None

Strong

Spin-off from parent Capital: ⬎¥10 bn No. of employees: ⬎10,000

Affiliates (Divisions)

Integration Ownership

Type of firm

Supplier

Dimension

Table 3.2 Main features of the pyramid network

None/weak

Strong

Strong

Coordination

Low to high

Low to medium

High

Level of technology

General electronic parts

Plastic and press parts, subassembly processes

Key components

Type of parts

Original technology

Customerspecific

Customerspecific/ original technology

Type of capabilities

Low

Medium

High

Procurement share

54

‘Pyramidal’ production networks

categories: other electronics giants) that are strongly independent of the assembler in all respects – that is, in terms of ownership, customer base, product development capabilities, etc. While their dealings with the assembler do not necessarily resemble pure market relations, coordination integration is absent or weak. These companies often do possess considerable original technological capabilities, but their role in the overall network tends to be marginal. In the pyramid network, therefore, key resources and capabilities as well as coordinative control are strongly centralized through tight ownership integration in the group network which accounts for the bulk of network sourcing. Supplementary customer-specific resources and capabilities are provided by the subcontractors, which are subordinate due to their firm size and limited capabilities, and subject to coordinative control by the parent. The ‘makers’, finally, supply non-key, non-customer-specific goods and in that capacity play a marginal role, both in terms of their share in total procurements and in terms of their integration into the network. The pyramid network, thus, is characterized by a hierarchical structure in terms of its membership and division of labour, ownership integration, coordinative control and resources and capabilities.

Concluding remarks The network type described here represents the outgrowth of an evolutionary process that has its roots in the high-speed growth era. The frenzied development that both the country and individual companies underwent during that period posed considerable coordination and governance challenges. One strategic response was to spin off satellite firms with continuing parent company support that aimed to exploit new growth opportunities; another was to (partially) integrate and hence bring into the fold of the keiretsu outside firms such as important suppliers. Gerlach (1992: 219) observes: In the cases of both spin-offs and consolidations, a formal separation is seen as imparting a stronger spirit of independence of operation than would complete internalisation within a corporate hierarchy, and as maintaining a degree of de facto control for the parent company through equity, management, and other linkages. The result was the proliferation of kanren kigyo. In addition to this development, assemblers forged stable, long-term relations with their most important nongroup suppliers. Nishiguchi (1994: 211) has summarized the evolution of Japanese subcontracting practices as follows: Structurally, subcontractors were reorganized over time into hierarchical ‘clusters,’ through a concentration of orders, intensified specialization, and increased dependence on particular customers. This resulted in turning the traditional semi-arm’s length (or loosely tiered) structure of subcontracting into a clustered control (or tightly tiered) structure, in which manufacturing

‘Pyramidal’ production networks 55 control functions are systematically concentrated on select first-tier subcontractors who control their own lower-tier subcontractors under their own regime. This relieves those on top of the hierarchy of the increasingly complex control function typical of external manufacturing organizations. The pyramid network may thus be described as an organizational arrangement that evolved during the postwar period in response to rapid growth opportunities, where coordination challenges were met by devising governance modes that helped to nurture or preserve entrepreneurial attitudes and flexibility while at the same time maintaining centralized control. Yet, as such it represents a response that was geared to the particular needs of the time. At the outset of this chapter, it was suggested that in Japanese industrial organization, the make-or-buy decision was strongly biased in favour of the latter and that, moreover, a large share of the parts and components purchased from other companies were of a customized nature and hence relied on customer-specific assets and capabilities. Centralized control, it might therefore be concluded, is an inevitable result of the heavy dependence on suppliers and subcontractors. However, in this context, it is crucial to note that the concentration of production of key components within the group network and the reliance on customization represent a strategic choice. Nishiguchi (1994: 211) summarizes his in-depth study as follows: An important finding from this examination was that it was producer strategy that converted subcontractors into highly asset-specific entities. The producers’ strategic choices shifted the high-specificity assets to the subcontractors. […] The results of our historical research […] suggest that asset specificity is not the cause but the consequence of subcontracting strategy. It follows that if the heavy reliance on custom-made parts and components – be it within the group network or by the subcontractors – no longer represents a viable competitive strategy, then customer-specific assets and capabilities lose in importance and other factors come to play a growing role in determining business relationships. The network type described in this chapter represents an organizational and governance mode that addresses the challenges of the period in which it arose. However, beginning from around the mid-1980s onwards, the competitive environment in which the Japanese electronics industry found itself has changed considerably. As a result, the foundations of the pyramid network have been undermined and new network configuration begun to take shape.

4

The Japanese electronics industry in the context of domestic and global challenges

Introduction Both the Japanese economy as a whole and the country’s electronics industry enjoyed immense success during most of the postwar period. However, with the collapse of the asset bubble that had developed during the second half of the 1980s, the fortunes turned: the 1990s were characterized by minimal growth or outright recession – the result of a mixture of deep-seated structural problems and inadequate economic policies. In fact, the entire Japanese way of doing business and steering the economy has come under intense criticism and many facets that were once considered as clear competitive advantages have now come to be viewed as impediments. In the words of one observer, the economic system that had driven Japan’s success has ‘soured’ (Katz 1998). The Japanese electronics industry is no exception to the general malaise. Though still in comparatively good shape when seen against the rest of the economy, the country’s electronic giants are no longer the formidable competitors they once were. Developments in three major areas can be identified to account for this relative loss in competitiveness. The first of these – discussed in the following section – are macroeconomic trends, beginning with the rapid appreciation of the yen from 1985 onwards which undermined the competitiveness of production in Japan and forced companies to move overseas. In the wake of the collapse of the bubble economy, this was followed by domestic recession triggered by the collapse of the bubble economy, which resulted first in declining profits and, more recently, in sometimes substantial losses, diminishing the resources available for investment in R&D, production facilities, etc. The second trend has been the growing strength of foreign rivals just as these developments were weakening the ability of Japanese companies to compete. Together with a shift in competition from audio–video consumer products to computers and telecommunications, the US electronics industry resurged, companies from East Asian countries – especially South Korea and Taiwan – grew into serious contenders, and even the European electronics sector staged somewhat of a comeback. The shifting balance in the global electronics industry is closely linked with fundamental changes in the nature of competition. Essentially the consequence of various technology-related issues, competition in the electronics industry these days increasingly concentrates on the ability to be first to the

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market, leading firms to engage in strategic games in order to set market standards. Innovative requirements thus have shifted from an emphasis on processes to a combination of both product and processes. Indications are that US firms have been better-suited to this kind of environment than their Japanese counterparts, as the discussion of the role of technology and the changing rules of competition will show. Having provided anecdotal evidence of and the underlying reasons for the deterioration of Japanese electronics companies international competitiveness, this chapter then proceeds to present some quantitative indicators of this development. Though, on their own, each of the indicators do not provide conclusive evidence for such a deterioration, taken together, the picture they paint is quite clear: while the 1970s and 1980s were characterized by steady advances by the Japanese electronics industry at the expense of its rivals, the 1990s saw a clear reversal of those trends.

Macroeconomic factors Yen appreciation and internationalization If one had to choose a single date or event that has determined the course of the Japanese economy over the past decade and a half, it would have to be the Plaza Agreement struck by the G-5 leading economic powers (the US, Japan, Germany, France, and the UK) in February 1985. Reflecting Western, and particularly American, concerns about the ballooning Japanese trade surplus, the accord aimed at bringing about a depreciation of the US$. The result was a massive gain of the Japanese yen, which within the space of only three years doubled in value vis-à-vis the US currency from ¥259/US$ in February 1985 to ¥125/US$ in March 1988 (Figure 4.1). However, as Japan continued to register massive current 50 100 150 200 250 300

19

7 19 3 7 19 4 7 19 5 7 19 6 7 19 7 7 19 8 7 19 9 8 19 0 8 19 1 8 19 2 8 19 3 8 19 4 8 19 5 8 19 6 8 19 7 8 19 8 8 19 9 9 19 0 9 19 1 9 19 2 9 19 3 9 19 4 9 19 5 9 19 6 9 19 7 9 19 8 9 20 9 0 20 1 02

350

Figure 4.1 Yen/US$ exchange rate. Source: Bank of Japan. Available at http://www2.boj.or.jp/en/dlong/stat/data/cdab0780.txt (24 September 2003).

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The Japanese electronics industry

account surpluses, the country’s currency continued to rise relentlessly during the first half of the 1990s, shooting beyond the ¥100/US$ mark – a period that came to be known as super endaka. The rapid appreciation of the yen served as a catalyst that set off a deluge of Japanese foreign direct investment. Until the mid-1980s, overseas production had been comparatively small-scale, consisting primarily of the ‘barrier-hopping’ type, that is, the establishment of production facilities in order to serve local markets otherwise shut off by import barriers. The epitome of Japanese overseas activities were the so-called ‘mini-Matsushitas’, factories that manufactured a wide range of diverse goods aimed exclusively at the local market. Apart from such operations, however, foreign markets were served through exports from Japan. This changed dramatically during the second half of the decade: their export competitiveness rapidly eroded by the appreciation of the yen, Japanese firms quickly moved to shift production overseas on a massive scale. Annual FDI outflows in the electrical machinery sector jumped eleven-fold from only US$513 million in 1985 to US$5.68 billion in 1990 (Figure 4.2). A host of other factors

18.0 16.0 14.0

North America Europe Asia Other Total

12.0 8.0 6.0 4.0 2.0

19 7 19 7 7 19 8 7 19 9 8 19 0 8 19 1 8 19 2 8 19 3 8 19 4 8 19 5 8 19 6 8 19 7 8 19 8 8 19 9 9 19 0 9 19 1 9 19 2 9 19 3 9 19 4 9 19 5 96 19 9 19 7 98 19 9 20 9 0 20 0 0 20 1 02

0.0

Figure 4.2 Japanese outward FDI in the electrical machinery sector, 1977–2002 (US$ billion). Sources: Ministry of Finance (various issues), Zaisei Kinyu Tokei Geppo [Financial Statistics Monthly]; Ministry of Finance. Available at http://www.mof.go.jp/english/fdi/reference02.xls (25 September 2003). Notes (a) Figures are published in US$ only until 1994. Following the example of JETRO’s White Papers on Foreign Direct Investment, later figures were converted from Yen to US$ at the Bank of Japan’s interbank average rate for the period. (b) The trend-distorting spike in Japanese electronics FDI to North America in 1999 was caused by two mega-deals in the telecommunications sector: the acquisition of a US$9.8 bn stake in AT&T by NTT DoCoMo and the US$5.7 bn acquisition of internet service provider Verio by NTT Communications.

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59

amplified the trend. At home, the inefficiency of the sheltered sectors of the economy such as construction and utilities, driving up investment and operating costs, contributed to the loss in competitiveness (Katz 1998). Abroad, friction with the major Western trading partners continued over the huge deficits in trade with Japan. Electronic products represented one of the main targets of anti-dumping lawsuits and higher tariff-barriers, and the establishment of the European Common Market in 1992 caused apprehension about the prospect of a ‘Fortress Europe’. Finally, the rise of the ‘bubble economy’, which allowed companies to raise capital at negligible cost, provided the necessary funds to finance the investment-drive. Taken together these factors provided the impetus for the rapid expansion of overseas production. Afraid to be shut out of their most important markets because of trade friction, Japanese electronics companies saw little choice but to move to local production in the US and Europe. Their main thrust, however, was into the rest of Asia, which provided a cheap manufacturing base for standardized massconsumption products. While the US continued to be the main destination for Japanese FDI, the share going to Asia increased from 9.9 per cent in 1985 to 37.9 per cent in 1991. Conversely, North America’s share dropped from 78.6 per cent (1985) to 37.8 per cent (1991) (Ministry of Finance, various years). As a result of the investment surge, production abroad rose rapidly. For Japanese manufacturing industry as a whole, the overseas production ratio increased from only 3.0 per cent in 1985 to 16.7 per cent in 2001. The breakdown by industry shows that for the electrical machinery sector, the overseas production ratio during this period climbed from 7.4 to 27.6 per cent (Figure 4.3). However, Japan was comparatively late to internationalize and only a few years ago still noticeably lagged behind other industrialized countries. Thus, in 1997, the last year for which METI provides comparable figures, the overseas production ratio for the Japanese electrical machinery industry stood at 21.6 per cent, while the Electrical machinery Transport machinery General machinery All manufacturing

19 85 19 86 19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01

50.0 45.0 40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0 0.0

Figure 4.3 Overseas production ratios (in %), 1985–2001. Sources: METI (2001), Dai-31-kai Kaigai Jigyo Katsudo Kihon Chosa. Available at http://www.meti.go.jp/statistics/downloadfiles/h2c402dj.pdf; METI (2002), Dai-31-kai Kaigai Jigyo Katsudo Kihon Chosa. Available at http://www.meti.go.jp/statistics/downloadfiles/h2c402ej.pdf (24 September 2003).

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The Japanese electronics industry

equivalent ratios for the US and Germany were 25.7 and 32.6 per cent, respectively (METI 1999a). Moved overseas, in the first instance, was primarily the production of low-end consumer products and parts and components. Domestic production and exports of colour TV sets, for example, peaked in 1985 and the overseas production ratio rose from 33.0 per cent in 1980 via 60.1 per cent in 1990 to 95.8 per cent in 2001.1 In 1987, overseas production of this product for the first time exceeded domestic production, and in 1996 domestic production was overtaken by imports. Similar trends can be discerned for the production of video tape recorders (VTRs) and, more recently, for other consumer electronic products such as stereo sets, CD players, car stereos, etc. As for parts and components, offshore production also jumped markedly. While Japanese overseas production had traditionally heavily relied on parts and components procured from Japan, the second spell of yen appreciation in the period from 1990 to 1995 prompted final assemblers to transfer their in-house parts production as well and/or urge their Japanese suppliers to set up local operations. As a result, parts and components manufactured overseas increasingly also came to be used in domestic production: during 1990–2000, imports of parts and components rose by a factor of 3.5, jumping from 14.3 per cent of the value of domestic parts production in 1990 to 36.0 per cent in 2000.2 Rapidly rising overseas production ratios for low-end consumer products and the burgeoning trade in parts and components consisting of exports to and imports from Japanese-affiliated companies abroad illustrate the growing internationalization of the Japanese electronics industry triggered off initially by the appreciation of the yen. In the first instance, it was low value-added final assembly operations that were shifted abroad during the second half of the 1980s. With the persistent strength of the yen, this was followed by efforts to localize parts procurements during the first half of the 1990s in order to fully exploit the cost advantages of overseas production. By the late 1990s, overseas procurements had come to play a significant role in the domestic operations of Japanese electronics firms as well. These trends alone would already have led to tangible changes in the structure of the industry in Japan – as will be discussed in the next chapter – but they were amplified by a number of further developments to which the discussion will now turn. The ‘bubble period’ and ensuing domestic recession Despite – or rather, because of – the rapid appreciation of the yen after the Plaza Agreement, the Japanese economy experienced a boom during the second half of the 1980s, with GDP growth rates accelerating from around 3 per cent per annum to a peak of 6.5 per cent in 1988. Concerned about the potentially contractionary impact of currency appreciation, the Bank of Japan had considerably loosened monetary policy and, in the absence of consumer price inflation, allowed a massive bubble in financial and real estate assets to build up. At the time, of course, this bubble was not recognized as such; rather, it was another case of Japan’s ‘miracle

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economy’ outperforming its Western competitors: manufacturing firms, including those from the electronics sector, were investing massively in capital equipment, technology and R&D and were continuing to wrest market share from their rivals. In 1990, however, the Japanese central bank finally did raise interest rates and within only a few months, the Nikkei Index almost halved in value, falling from a peak of 38,586 points to a low of 20,222. The dynamics that had driven growth – capital investment and private consumption spurred by debt finance and unrealized capital gains3 – now reversed and the economy entered a prolonged recession: though outright contraction was registered only in 1998, the average annual rate of increase in GDP during 1991–2002 was only 1.3 per cent – well below the 4.1 per cent achieved during 1981–1990 and arguably below potential, therefore justifying the label ‘recession’ for the entire period (see Figure 4.4).4 Analysts disagree whether the main cause for economic stagnation during the 1990s is primarily the result of mistaken macroeconomic and financial policies (e.g. Posen 1998) or a breakdown of the national economic system (e.g. Katz 1998). What is clear, however, is that the country’s banks continue to creak under mountains of non-performing loans, while the corporate sector until this day is suffering from the so-called ‘three excesses’ – excess debt, excess capacity and excess labour – that are a hangover from the ‘bubble period’. The recession has had a clear impact on the country’s electronics sector. Total production, which had surged during the second half of the 1980s, slumped during the early part of the 1990s. After a slight recovery, production dropped again when the economy contracted in 1998. It surged once more carried by the worldwide boom in the information technology sector, but with the collapse of the global high-tech bubble, production fell back to the lowest level in more than a decade (see Figure 4.5). As a result of the prolonged domestic recession, profitability in the Japanese electronics sector deteriorated despite the worldwide

7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 –1.0 19 81 19 82 19 83 19 84 19 85 19 86 19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02

–2.0

Figure 4.4 Real GDP growth (annual rate of change in %), 1981–2002. Source: Economic and Social Research Institute (ESRI). Available at http://www.esri.cao.go.jp/jp/ sna/qe032-2/ritu-jcy0322.csv (25 September 2003).

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The Japanese electronics industry

30.0 Production

Exports

25.0 20.0 15.0 10.0 5.0 0.0 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Figure 4.5 Japan’s total electronics production and exports (trillion yen). Source: EIAJ (1997), Facts and Figures on the Japanese Electronic Industry 1997; JEITA (2003), Data Map for the Electronics and Information Technology Industries in Japan.

boom in the industry. The ‘Big Five’ industrial-electronics firms, Hitachi, Toshiba, Mitsubishi Electric, Fujitsu and NEC, for example, saw their combined net income turn from a profit of ¥230.7 billion in FY1992 to a combined loss of ¥560.3 billion in FY1999.5 Just like companies in other sectors of the Japanese economy, those from the electronics sector have been slow to adjust and suffer – like the rest – from excess capacity and labour. Consequently, capital investment has remained sluggish and research expenditure in relation to sales has declined. The effect of the economic boom and bust during the past decade and a half on the Japanese electronics sector can be summarized as follows. Strong domestic demand and access to cheap capital during the ‘bubble period’ allowed Japanese electronics companies to invest massively in state-of-the art plant and equipment as well as in R&D, thereby supporting their international competitiveness. However, these factors also allowed firms to remain involved in a wide range of staple consumer goods and parts and components rather than seeking to upgrade to more profitable areas. Given that the country’s electronics giants continue to rely on the domestic market for the majority of their business,6 the deterioration of economic conditions poses a serious threat to their competitiveness: slower growth means that capital and technology are turned over more slowly in production, posing a constraint on the traditional Japanese approach to competition via aggressive manufacturing innovation and incremental product improvements. At least in the long-run, such pressures should lead to greater specialization in the Japanese electronics sector as well as industry rationalization. Thus far, however, though the recession has already lingered for a decade, most firms have been slow to adjust their strategies, to exit unprofitable business areas, to divest themselves of subsidiaries, or to lay off workforces (FEER, 1 April 1999). Thus, not much has changed since Tsuda and Shinada (1995: 47) summed up the

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response as follows: ‘[…] Japanese companies in general, at least for the short-term, are thinking along the lines of as much as possible keeping operations in Japan in order to guarantee employment rather than maximise profits.’ Electronics firms’ financial position has consequently further deteriorated, and it has done so at a time when a range of closely related dynamics have drastically altered the nature of competition in the global electronics industry.

Shifting competition and the growing strength of foreign rivals Over the past three decades, the structure of the world electronics industry has undergone considerable change. The most prominent feature of the 1970s and 1980s was the seemingly relentless advance of the Japanese described in the introduction. The 1990s, however, present quite a different story line – they have been characterized by a strong revival of the US electronics industry as well as the growing strength of a host of Asian competitors. Most recently, even European electronics companies have staged something of a comeback based on their strength in the telecommunications sector. While the impact of recession on Japanese companies at least partly explains their relative weakness, the growing strength of foreign rivals owes primarily to two major shifts – one in the market, and one in the organization of production. Together, they help account for many of the changes in the balance of the global electronics industry. The shift in the market was caused by a change in the nature of electronic products. This will be addressed in greater details in the following section, but basically consists in a shift from consumer to industrial electronic products: by the late 1980s/early 1990s, traditional consumer products such as the VCR, the walkman or the CD-player – Japan’s forte – had matured. Instead, new electronics products had begun to converge on a common open, ‘networkable’ microprocessor-based technology, of which the PC is emblematic (Borrus 1997: 141). In the words of one commentator writing in 1990, [w]e are witnessing the digitization of everything. Previously unrelated industries – cameras, computers, stereos, photocopiers, typewriters – are converging to form a huge, unified information technology sector, itself based on common digital components and standard interfaces. Ferguson (1990: 57) The blurring of the boundaries between the formerly segregated fields of consumer electronics and industrial electronics (i.e. computers and telecommunications) shifted competition back to areas in which the US had never (quite) ceded its lead and opened up opportunities for new entrants in market segments where Japanese firms possessed no entrenched positions.7 The principal launch market for such computer- and telecommunications-related digital products and the principal terrain where the battles for market leadership are fought has been the US rather than the Japanese market. Consequently, with few exceptions – such as

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video games, video camcorders and digital still cameras dominated by Japanese companies and mobile telecommunications led by European ones – it has been US firms that have defined the product, set and controlled the standards, and subsequently achieved a dominant position in world markets. This success, however, crucially depended on an organizational shift as well, consisting of a move away from integration and towards the creation of network forms of organization. In particular, such production networks relied on the development of an Asian supply base that rivalled that of the Japanese, for by the end of the 1970s, US electronics firms had become almost completely dependent on competitors from Japan for the provision of many of the underlying component technologies. The roots of this alternative supply base in the first instance can be found in the transfer of American assembly operations to low-cost Asian countries during the 1960s and 1970s, followed by the upgrading of such operation to include more value-added during the first half of the 1980s.8 These moves coincided with indigenous efforts to develop the electronics sector, which was seen as a strategic industry. Asian governments therefore conceived of a host of policy initiatives, including FDI incentives and/or industrial and technology policies. As a result, Asian firms – especially those from Singapore, Taiwan and South Korea – were able to steadily develop and upgrade their capabilities.9 Throughout the period, the division of labour between American and Asian companies deepened. US affiliates in the region increasingly relied on local companies for parts and components, including mechanical parts, monitors, discrete chips and power supplies. These trends fully came into their own during the 1990s, when leading computer firms such as Apple, IBM, Hewlett-Packard and Compaq transferred even design operations to their Asian affiliates and increasingly outsourced production to local original equipment manufacturers (OEM) such as Taiwan’s Acer and Tatung or Singapore’s Creative Technologies. In 1999, American computer manufacturer’s Apple, Compaq, Dell, Gateway, Hewlett-Packard and IBM together were planning to spend more than US$17 billion on components and goods and services from Taiwanese companies (Electronic Buyers’ News, 26 August 1999). Asian suppliers thus have become an indispensable element in the organization of production in networks led by American firms, where the former now provide much of the hardware, while the latter concentrate on new product definition and associated skills. As a result of these dynamics, Japan’s competitive position in the industry looks increasingly fragile. In the important semiconductor market, for example, Japanese manufacturers find themselves squeezed by the vibrant American chip industry and the growing capabilities of Korean companies. Sumita and Shin (1996: 21) summarize the trends as follows: […] American producers ceded world leadership [in world semiconductor production] to Japan in 1985 but drew even with Japanese producers in 1992 and regained the lead in 1993. This change in market share has been stunningly swift, as Japanese producers had 50 per cent of the world market, 10 percentage points more than American chip makers, as late as 1990. [What

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is more,] Japan’s five main chip companies have started to lag behind their American and Korean counterparts in terms of operating margin and operating profits. Regarding the growing prowess of Korean firms, they observe (ibid.): Samsung Electronics is the world’s biggest producer of dynamic random access memory chips, and leads the global industry in the mass production of state-of-the-art 16 M-DRAMs. Samsung is not the only Korean company with formidable strength in semiconductors, and Korea today is a major world player in the industry. By 1999, Samsung Electronics not only led Japanese manufacturers in terms of DRAM-output, but had also become the undisputed technology leader in this field (FEER, 21 January 1999). Further anecdotal evidence suggests that American as well as Asian competitors have closed the gap in production technology for a host of other electronic devices, including, for example, liquid-crystal displays and rechargeable batteries (Takeshita 1998: 60). What is more, even in the field of consumer electronics – once their almost exclusive domain – Japanese companies face increased competition from Asian rivals. Ernst (1997b: 226), for example, observes that ‘Japanese firms still dominate most markets in the region, but firms based in Korea, Hong Kong, and China have rapidly caught up, and they are now aggressively moving up-market’. Meanwhile, Europe, which appeared to have been completely left behind, managed to regain a foothold in the global electronics industry through the strength it had retained in the telecommunications sector. France, for example, was the first country to move to digital switching, with Alcatel providing the technology;10 and the Scandinavian countries have led from the outset in the diffusion of cellular telephones, giving companies such as Ericsson (Sweden) and Nokia (Finland) a head start (e.g. The Economist, 12 October 2000). The most decisive advantage, however, has come from the early adoption of a single technical standard for wireless communications by the European Union (Bach 2000; The Economist, 27 April 2000). This guaranteed that mobile phones could talk to each other, contributed to rapid penetration across the continent and provided equipment manufacturers with economies of scale. In contrast, no such standard emerged in the US, seriously hampering growth, while in Japan, mobile communication was held back by, among other things, government restrictions.11 Overall, therefore, Japanese companies today are faced with considerably tougher competition than they were at the beginning of the 1990s. The shift from traditional consumer products to computers and telecommunications equipment opened up new entry opportunities for American and European companies that had retained latent strengths in the latter segments, while competitors from other Asian countries such as South Korea and Taiwan have begun to grow into serious rivals. The extent of the relative decline in the competitiveness of Japanese firms will be discussed later. First, however, it is necessary to look in greater detail

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at the changes in the nature of competition that have played a considerable role in shaping these trends.

Technology and the rules of competition The capacity to continuously innovate and upgrade and to maintain innovativeness represents a major factor sustaining both firms’ and nations’ competitiveness (e.g. Porter 1990). Technological innovation plays a central role in this context, and in few other industries is this so obviously the case as in the electronics sector.12 Japan’s impressive postwar record consequently is inseparable from the ability of its firms to constantly generate innovations both in product and process technologies. In fact, so successful were they that by the late 1980s, there was considerable concern in the US that the country was losing the technology race to Japan.13 Yet, less than a decade later, American firms once again were the undisputed technology leaders. What happened? As indicated earlier, the major contributing factor to the reversal in fortunes has been a shift in the market as a consequence of a change in the nature of electronics products. Traditional (analogue) consumer products had matured and competition shifted to computer and communications products that were increasingly transformed into consumer goods. Relying on common digital components and standard interfaces, they gave rise to a new family of open, ‘networkable’ products forming a huge unified information technology sector. This shift has been accompanied by two other, more long-term trends: the growing cost and complexity of technology and the shortening of the product cycle. Combined, these developments have fundamentally changed the nature of competition in the electronics industry and Japanese companies have struggled to adjust. Examining the evolution of industries, Abernathy and Utterback (1978) observed that in the early stages in the development of an industry – the preparadigmatic design phase – product designs are fluid, that is, there are frequent major changes in products as firms experiment with alternative designs, and production processes tend to be flexible and rather inefficient. Competition among firms focuses on functional product performance and their designs differ considerably. However, over time, one design or a narrow class of designs begins to emerge as the most promising. Production processes become more rigid and competition shifts to product variation. Once this transitional phase has brought forth a dominant design, that is, a design that has gained acceptance in the market by fulfilling the requirements of many classes of users and that has come to define the features expected of a particular product, competition shifts to price. In this paradigmatic design phase, product innovations may occur lower down the design hierarchy, but the stress is on cost reduction. The emphasis of innovative activity thus shifts from the product to the production process and the latter is increasingly characterized by greater efficiency, capital-intensity and rigidity. Thus, over the product or industry life cycle, the rate of major product innovations is high in the preparadigmatic phase, but levels off as a dominant design emerges. The rate of process innovation, on the other hand, is comparatively low at first, then accelerates, before eventually declining as well.

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67

This broad outline of the industry cycle helps to account quite well for competitive strategies in the electronics sector. Traditionally, these used to follow one of two fairly distinct patterns. In the computer industry, competition tended to centre on product differentiation based on proprietary computer designs and market segmentation. Thus, it closely resembled the pattern of an industry in the preparadigmatic stage, requiring capabilities that provide leading-edge innovations. In contrast, for consumer electronics and electronic components, competition used to concentrate on cost reduction and judicious pricing, while non-price competition was confined to a few high value-added market niches. In other words, the consumer electronics segment was characterized by more mature products where competition focused on innovations lower down the design hierarchy and on the production process (Ernst 1997a). Incidentally, these different modes of competition closely resembled the different innovative capabilities found in the US and in Japan. As the undisputed industrial leader, the US has been at the forefront of most technological developments of the twentieth century. Central to this leadership has been the country’s underlying strength in basic scientific research that has allowed its engineers to push the frontiers of technology. Innovation in the US therefore is frequently said to be of the ‘breakthrough’ type. In contrast, for historical, social and institutional reasons, Japan is considered to be comparatively weak in fundamental research. Its companies, instead, excel in the commercialization of technologies developed elsewhere as well as ‘incremental’ innovation, that is, small improvements on an existing paradigm.14 With the rise of digital technology and the convergence of previously unrelated consumer and industrial electronic products into a unified field of information technology, the neat separation of patterns of competition by sector or market segment no longer holds. Concurrently, moreover, there has been a distinct acceleration in product cycles (Higashi and Okawa 1994; Ernst 1997a).15 As a consequence, electronic products have increasingly turned into ‘high-tech commodities’. As such they combine characteristics of mass production that traditionally were found in later stages of the industry cycle with extremely short product cycles and trajectorydisrupting innovations akin to the preparadigmatic stage in earlier days. The change in the nature of electronics products therefore does not simply imply a shift from an area in which the Japanese excelled (i.e. consumer products) to one where US firms had maintained the upper hand (i.e. computers). More fundamentally, it also involved a shift in the nature of competition away from the traditional forte of Japanese companies, that is, the commercialization of existing technologies and incremental product and process innovation in order to compete on cost. Higashi and Okawa (1994: 67) observe in this context: Due to the growing pressure to bring new products to market as quickly as possible […], it is becoming more difficult to do precisely what Japanese companies have historically excelled at – the pursuit of long-term strategies aimed at expanding market share on the assumption that the learning curve and larger economies of scale will lead to lower and lower costs.

68

The Japanese electronics industry

In sum, to compete in the electronics industry requires a growing range of capabilities. These range from fundamental research and ‘breakthrough innovation’ to the ability to commercialize innovative technologies. What is more, these capabilities must be combined with speed-to-market and rapid cost reductions. Further amplifying the impact of the described trends has been the growing cost and complexity of technology. Both the costs of developing new products and the amounts of capital investment in plant and equipment required to produce new products are rising rapidly. For example, since the appearance of the 1 M DRAM chip, the R&D expenditure required for each new generation has roughly doubled (Tsuda and Shinada 1995: 71). In 1994, the cost of a production line for 64 M DRAMs was estimated at ¥120 billion (approximately US$1.17 billion) (Higashi and Okawa 1994: 67). What is more, the human resource requirements are stretching the capacity of even the largest companies.16 The upshot of these trends is that firms increasingly seek strategic alliances to combine existing technologies or engage in joint R&D efforts (Higashi and Okawa 1994; Tsuda and Shinada 1995; Nabeyama and Shinada 1996). In fact, competition in the electronics industry these days is frequently described in terms of strategic games aimed at erecting entry barriers and establishing de facto market standards (Ernst 1997a,b; Borrus 1997; Borrus and Zysman 1997, Borrus et al. 2000). Ernst (1997a) distinguishes four types of entry barriers as a result of which an incumbent’s temporary monopoly profits may prove quite persistent. These include (1) production-related barriers based on scale and learning economies as well as high investment thresholds; (2) barriers related to intangible investments required for the underlying knowledge base; (3) barriers to entry and exit of supplier networks; and (4) barriers related to sales and marketing. Despite these barriers, which in some cases such as the examples given from the memory chip sector can be formidable, technical change as well as changes in demand continuously create new entry opportunities. Thus, competition in the high-tech sectors of the industry can not only be extremely costly, but also very risky. Ernst (1997a) characterizes the competitive environment of recent years as follows: Mass production implies large investment thresholds that are necessary to reap economies of scale. Short product cycles imply the rapid depreciation of plants, equipment, and R&D. Only those companies who are able to get the right product at the right time to the highest volume segment of the market can survive. Entering a new market right on time can provide substantial profits. Being late is a disaster which quite frequently may force a company out of business. Probably of greatest importance, however, is the increasing uncertainty that results from periodic trajectory-disrupting innovations: established leadership positions can no longer be taken for granted, and the target of competition becomes fuzzy and can change at any time. Under these circumstances [n]o firm, not even a dominant market leader, can generate all these different capabilities internally, let alone deploy them on a global scale. This necessitates

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a shift from individual to increasingly collective forms of competition, ‘from the legal entity known as the firm to the contractual network of firms tied together by mutual long-term interest.’ Japanese firms, of course, have already engaged in collaborative manufacturing arrangements for decades. For their American counterparts which had pursued strategies of ever greater vertical integration, this represented a considerable shift in tack. Increasingly outsourcing production to contract manufacturers, they began to build production networks of their own. In fact, in typical American fashion, they went from one extreme to another: in a move that began in the mid1980s but gathered pace during the 1990s, many well-known electronics companies (including, for example, Apple, IBM, ATT and Hewlett-Packard) abandoned internal manufacturing operations and turned to turnkey contract manufacturers, both at home and abroad. At the same time, a large number of younger firms such as Sun Microsystems or Cisco Systems relied on contract manufacturers from the start (Sturgeon 1997). In fact, many of the strongest competitors in the semiconductor industry are ‘fabless’ Silicon Valley companies that specialize in chip design but posses no chip fabrication plants of their own and instead rely on outsourcing – often to Taiwanese companies (FEER, 23 September 1999). What is of particular interest in this context is how the change in the competitive environment appears to have changed the nexus between the organization of production and innovative capabilities. When Japanese companies seemed to be gaining the upper hand in the technology race, their success was seen to be closely linked with a number of organizational issues. For example, the comparatively diversified nature of many Japanese electronics giants was considered to give rise to cross-industry benefits, with the integration of high technology and consumer electronics within the same company facilitating the transfer of technical developments to mass market production (Chon 1997). Another decisive strength of Japanese electronics companies was regarded to be the close link between R&D and manufacturing operations: factory-centred R&D is stressed as one of the key features of Japanese innovation strategy, for example, by Kodama (1991a) and Branscomb and Kodama (1993), while Kenney and Florida (1993) even presented the Japanese practice of ‘harnessing knowledge at the point of production’ as a central aspect of the industrial model of the future. Yet, as the examples given here indicated, the revival of the American electronics industry is based on exactly the opposite trend, that is the ‘organizational delinking of production from innovation’. As Sturgeon (1997) argues, [ i ]nnovation […] has been freed from the shackles of large-scale investment, allowing the innovating firm’s resources to be more tightly focused on the ongoing process of new product development. On the other hand, the market positions of dominant firms are not protected by large-scale, firm-specific investments in plant and equipment, making market penetration more feasible. Thus, it seems that the close linking of R&D and manufacturing serves as an underpinning for competitiveness when innovative challenges are primarily associated

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with the manufacturing process. This is usually the case for comparatively mature product markets. However, with the rise of digital technology not only has competition shifted to products at an earlier stage in the life cycle; with the acceleration of technological change, product cycles themselves have also been compressed to such an extent that it is increasingly impossible to distinguish different phases as suggested in the model by Abernathy and Utterback. Under these circumstances, possessing or having access to cost-efficient manufacturing capabilities represents a necessary competitive determinant, but it is not a sufficient one. More decisive, it seems, are abilities in the fields of R&D and product definition. The organization of production by US electronics firms reflect these competitive requirements clearly. The division of labour found in the production arrangements of computer manufacturers such as Hewlett-Packard, Dell, Apple, etc. is one whereby the lead firms increasingly concentrate on the development of next-generation products, supply chain coordination, marketing and support services. Actual production, however, is carried out by contract manufacturers, either at home or in East Asia. In contrast, Japan’s electronics giants continue to rely on a large share of production being carried out in-house and/or within the confines of the tightly controlled group-network.17 This difference clearly reflects the different genealogies of US and Japanese production arrangements in terms of the types of products (i.e. computers versus consumer electronics) produced. It also reflects the different types of innovative capabilities that are found in American and Japanese networks and are required in their respective traditional areas of strength. While the 1990s have seen a clear shift away from traditional consumer electronics to industrial electronics and the convergence of these different segments based on a common digital technology, it remains to be seen whether the mode of competition that has arisen with it is of a lasting nature. On the one hand, this rise of a new generation of electronic products may simply represent the early phase of a new industry cycle. After spurring a whole new range of applications, digital technology, too, may gradually settle into a more predictable pattern, and innovative skills of the Japanese type may once again carry the day. On the other hand, the growing pace of technological change and the compression of the product cycle may mean that the traditional industry cycle has indeed disappeared. In that case, the competitive advantage may have permanently shifted, putting those firms at a clear advantage that possess the capabilities necessary for ‘breakthrough’ innovation and new product definition. Firms lacking these capabilities are consequently bound to be left behind.

Declining Japanese competitiveness – some quantitative indicators The preceding discussion has suggested that the Japanese electronics industry has had to contend with a range of competitive challenges over the past decade and a half or so. These included unfavourable macroeconomic developments, the

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71

growing strength of foreign rivals, and the shift in competition based on a change in the nature of electronic products. The considerations suggested that the competitive strength of Japanese electronics firms vis-à-vis their foreign rivals appears to have suffered considerably. While no generally agreed-upon criteria of a firm’s or country’s competitiveness exist, a variety of statistics give support to such a conclusion. Taken together, the indicators that will be presented here leave little doubt that the competitiveness of Japan’s electronics firms has suffered markedly over the past decade or so. The first of these indicators is the value of electrical machinery production. Figure 4.6 shows the trend in production for the two principal rivals, the US and Japan. While the former was the uncontested leader at the beginning of the 1960s, the gap gradually shrank during the 1970s until, in 1986, production in Japan overtook that in the US. From that year onwards, electrical machinery production in the two countries closely parallels business trends as a whole – which is hardly surprising given that in both cases the electronics sector represents a major component in overall economic activity and as such both affects and is affected by general economic conditions. Consequently, as the Japanese economy went from boom to bust in the 1990s, so growth in electrical machinery production faltered. At the same time, the US economy embarked on its longest expansion in post-war history and electrical machinery production surged ahead, jumping far ahead of Japan in 2000. The growing strength of Japan’s other competitors can be clearly seen in Table 4.1, depicting different countries’ shares in worldwide electronics exports. The table shows that Japan’s share rose strongly during the first half of the 1980s,

600

Japan US

500 400 300 200 100

99

97

19

95

19

93

19

91

19

89

19

87

19

85

19

83

19

81

19

79

19

77

19

75

19

73

19

71

19

69

19

67

19

65

19

19

19

63

0

Figure 4.6 Electrical machinery production (US$ billion): Japan and US. Source: United Nations Industrial Development Organisation (2003), Industrial Statistics Database 2003 3-Digit ISIC, CD-ROM. Note No value available for the US for 1996.

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Table 4.1 Shares of leading electronics exporters (in %), 1980–2001

United States Japan China Taiwan Malaysia Korea UK Singaporea Germany Netherlands Hong Konga

1980

1985

1990

1995

1998

1999

2000

2001

20.4 21.3 0.1 3.2 1.4 2.0 6.5 2.5 10.0 4.0 2.0

20.2 28.1 — 3.3 1.7 2.8 6.0 — 7.5 2.9 1.7

17.3 22.4 1.0 4.7 2.7 4.8 6.5 4.9 7.5 3.4 1.6

16.3 17.7 2.4 5.4 5.4 5.5 6.1 6.7 5.3 3.4 1.0

16.3 12.2 3.6 5.5 5.0 4.6 6.2 5.3 5.1 4.3 0.6

16.1 11.7 3.9 5.7 5.7 5.5 5.6 4.9 4.9 4.3 0.5

16.3 11.5 4.6 6.2 5.5 6.1 5.3 4.4 4.8 3.8 0.4

15.3 10.0 6.3 5.5 5.4 5.3 — 3.8 — — 0.4

Source: Data for 1980–90 are from GATT (1994), International Trade; data for 1995–2001 are from WTO (various years), International Trade Statistics. Available at http://www.wto.org/english/res_e/ statis_e/statis_e.htm#top (16 October 2003). Note a Domestic exports only.

but then – after peaking around the middle of the decade – fell back again and contracted further during the 1990s. By 2001, Japan’s global export share was less than half of what it had been a decade earlier. The figures for the US provide a stark contrast: while the country’s global export share suffered during the second half of the 1980s, it stabilized at the beginning of the 1990s and has remained almost unchanged since. Japan’s two strongest regional competitors, South Korea and Taiwan, meanwhile, managed to expand their export shares. The largest gains during the 1990s, though, were registered by China and Malaysia, which have served as major export bases for Japanese and other foreign companies. Undoubtedly, the decline in Japan’s export share and the parallel rise in the export shares of countries such as Malaysia and China to a considerable extent owe to the large-scale relocation of production by Japanese electronics manufacturers. However, what is striking is that the decline in Japanese export shares affects electronic products across the board, ranging from consumer goods to industrial electronics (e.g. office machines, computers, and telecom equipment) and parts and components (computer parts, transistors, valves, etc.). Moreover, at the same time that Japan’s export share has plunged, that of the US, for example, has remained comparatively stable, even though American firms have relied on overseas production to a similar or even greater extent than their Japanese counterparts. Similarly, in those product groups where European countries still play a tangible role (such as office machines or telecom equipment), their export shares have held fairly stable or even increased despite the growing strength of East Asian rivals. These detailed trends are shown in Table 4.2. The figures show how Japan’s once overwhelming global export share in consumer electronics such as radios, TV sets and sound recorders has been eroded; instead exports in these product

Table 4.2 Shares of leading electronics exporters by product category (in %), 1982–2001 1982

1984

1986

1988 1990

1992

1994 1996 1998 2000 2001

751 1 2 3 4 5 6 7 8 9 10

Office machines Japan 43.2 54.0 53.0 36.3 33.2 China n.a. n.a. n.a. 1.3 1.4 Hong Kong 1.9 2.6 3.2 4.6 5.3 USA 10.3 8.8 5.2 6.2 7.7 Netherlands 6.5 7.6 6.6 6.7 9.6 Germany 11.0 7.8 11.4 10.3 9.7* UK 7.9 4.8 5.6 8.4 7.9 Singapore 2.6 1.4 1.3 2.1 2.9 France 1.7 1.6 3.4 3.5 4.5 Mexico n.a. n.a. n.a. 0.8 0.7**

31.2 2.0 6.2 8.4 9.8 9.7 8.1 3.1 5.1 1.8**

28.3 23.0 22.3 25.0 20.2 4.0 7.5 8.9 10.9 13.1 8.7 9.2 9.8 10.1 11.5 6.9 7.9 8.4 8.4 8.6 11.3 10.5 8.3 7.0 7.4 7.6 8.1 9.2 6.8 6.9 7.7 7.4 8.7 8.2 6.6 3.8 3.6 3.2 3.1 2.9 4.6 4.7 3.7 2.7 2.7 2.8 2.6 2.8 2.1 2.5

752 1 2 3 4 5 6 7 8 9 10

Automatic data processing equipment USA 36.0 29.9 23.5 20.2 22.4 Singapore 0.5 2.6 4.1 6.5 9.7 Netherlands 2.5 3.1 3.2 2.9 3.2 China n.a. n.a. n.a. 0.1 0.1** Japan 9.3 18.9 21.9 19.8 17.4 UK 9.1 7.5 5.7 9.4 9.8 Ireland 4.3 4.7 5.2 3.2 3.6 Mexico n.a. n.a. n.a. 0.6 0.5** Germany 10.3 8.2 10.6 7.6 7.4* Malaysia n.a. n.a. n.a. 0.0 0.0

21.5 11.9 3.5 0.4** 19.3 8.2 2.1 0.6** 6.3 0.4

20.9 18.0 16.4 15.0 16.5 13.0 5.7 7.0 8.9 1.0 2.6 4.5 16.3 11.3 10.0 8.9 8.5 8.7 3.8 4.4 5.6 1.3 1.9 2.8 5.9 5.0 5.6 1.2 2.8 3.4

16.9 10.6 8.3 6.0 8.1 7.5 5.3 4.4 5.3 3.9

16.0 9.6 9.4 7.6 7.4 7.1 5.9 5.7 5.0 4.5

759 1 2 3 4 5 6 7 8 9 10

Office, automatic data processing machines parts, accessories USA 43.4 40.7 33.0 30.0 22.3 Japan 8.5 9.6 13.3 17.3 17.5 Hong Kong n.a. n.a. n.a. 3.1 3.9 Singapore 0.7 2.7 2.4 3.5 4.1 Ireland 2.3 2.8 3.0 3.8 4.1 Malaysia n.a. n.a. n.a. 0.1 1.1 China n.a. n.a. n.a. 0.1 0.2** Netherlands 5.1 4.8 6.0 4.8 6.6 UK 9.6 10.8 11.8 7.5 7.2 Thailand n.a. n.a. n.a. 1.0 2.4**

19.9 17.5 5.6 4.6 4.4 3.1 1.0** 5.5 6.3 2.9**

19.2 20.1 18.8 16.7 20.9 16.4 13.2 11.0 6.2 6.8 7.3 7.1 10.1 9.8 8.9 7.4 3.3 4.2 5.0 5.3 5.0 6.2 5.7 8.7 1.5 2.0 3.2 4.0 4.1 4.2 5.1 4.6 6.4 5.1 5.4 4.5 2.2 3.2 5.4 4.3

15.4 9.7 8.5 7.6 7.3 6.5 6.4 5.6 4.4 4.4

761 1 2 3 4 5 6 7 8 9 10

Television receivers Mexico n.a. n.a. n.a. 0.0 0.0 Japan 35.8 39.3 29.9 15.3 11.9 Malaysia n.a. n.a. n.a. 1.6 3.0 China n.a. n.a. n.a. 2.5 3.5** Korea 8.4 12.8 12.5 12.2 8.6 France 0.7 0.8 1.6 2.5 4.6 USA 5.7 4.6 4.3 4.9 3.4 UK 2.2 2.5 3.6 4.5 6.4 Spain n.a. n.a. n.a. 0.8 1.9** Thailand n.a. n.a. n.a. 0.1 1.5

7.4 13.3 4.7 4.4** 8.5 4.6 4.3 5.5 2.7** 3.7

13.0 11.9 8.4 3.5 8.3 3.4 4.3 6.0 2.3 4.3

14.3 21.0 20.6 22.3 8.7 10.4 11.9 11.6 8.9 5.8 7.2 6.5 3.4 2.9 4.7 5.7 9.4 4.8 5.7 5.5 3.9 5.4 5.1 5.4 3.9 5.8 5.3 5.2 8.0 6.8 4.8 4.2 3.6 4.5 3.4 3.6 4.4 3.9 3.9 3.3 (Table 4.2 continued )

Table 4.2 Continued 1982

1984

1986

1988 1990

1992

1994 1996 1998 2000 2001

762 1 2 3 4 5 6 7 8 9 10

Radio broadcast receivers China n.a. n.a. n.a. 7.8 10.7 Hong Kong 13.6 11.5 9.9 11.4 15.8 Malaysia 1.1 2.2 3.7 5.5 8.2 Mexico n.a. n.a. n.a. 0.0 0.0 Singapore 9.2 8.7 8.5 11.6 11.8 USA 3.1 3.1 3.2 2.8 2.9 Japan 49.2 45.8 40.5 20.0 18.5 Indonesia n.a. n.a. n.a. 0.1 0.3** Belgium n.a. n.a. n.a. 1.8 1.2 Portugal n.a. n.a. n.a. 0.7 1.2**

9.3 16.4 11.0 5.8 11.0 2.9 18.2 1.0** 1.1 1.9**

11.6 20.3 14.3 4.6 11.6 3.2 11.7 1.4 2.0 2.1

763 1 2 3 4 5 6 7 8 9 10

Sound recorders, phonographs Japan 75.7 80.5 72.0 59.4 56.0 China n.a. n.a. n.a. 0.2 0.7 Hong Kong 1.8 2.2 2.2 3.0 4.6 Malaysia 0.0 0.1 0.1 0.9 2.6 Korea 1.9 1.4 5.3 11.5 8.6 USA 4.3 2.3 2.3 3.1 3.3 Indonesia n.a. n.a. n.a. 0.0 0.0 Singapore 1.7 1.9 1.5 4.5 6.8 Hungary n.a. n.a. n.a. 0.0 0.0** Germany 4.3 4.3 7.2 4.3 2.1*

43.4 1.8 4.9 5.7 8.2 3.8 0.4 7.5 0.1** 6.0

30.9 22.6 33.3 36.6 31.1 3.8 5.4 7.1 10.6 15.8 6.5 8.9 7.4 7.7 9.2 11.0 13.2 9.4 8.8 8.9 8.4 8.3 5.2 6.3 6.4 3.8 4.6 5.6 4.7 4.4 3.0 4.0 2.4 3.0 3.2 11.2 8.5 4.2 2.9 3.0 0.0 0.0 3.8 3.1 2.6 4.3 5.3 3.9 3.0 2.5

764 1 2 3 4 5 6 7 8 9 10

Telecom equipment, parts, accessories USA 17.4 16.2 13.6 12.6 13.9 UK 6.7 5.0 4.8 4.4 5.0 Germany 10.6 8.2 8.8 7.5 7.5* China n.a. n.a. n.a. 0.5 0.9 Hong Kong 1.7 4.0 3.9 5.1 5.5 Korea 1.5 2.0 2.8 3.4 3.3 Japan 22.6 29.6 33.3 31.9 25.1 Mexico n.a. n.a. n.a. 0.1 0.1** France 5.5 5.3 5.3 4.2 4.6 Finland n.a. n.a. n.a. 0.9 1.6**

14.5 4.6 7.6 1.9 6.0 3.3 24.5 2.1** 4.0 1.1**

15.3 15.0 5.2 6.9 7.1 7.6 3.0 3.8 7.7 7.5 3.8 3.5 19.4 12.0 2.4 2.7 3.4 4.1 1.9 3.2

776 1 2 3 4 5 6 7 8 9 10

Transistors, valves, etc. USA 29.2 25.3 22.7 19.5 22.0 Japan 17.7 22.9 23.0 23.0 21.0 Singapore 7.6 6.5 6.1 5.9 5.8 Malaysia 8.9 8.2 8.2 6.2 6.8 Korea 4.3 5.3 5.8 7.2 8.4 Hong Kong 3.8 4.0 3.6 4.6 4.0 Philippines n.a. n.a. n.a. 0.9 0.7** Germany 6.6 5.9 6.5 6.4 5.8* UK 4.4 4.1 5.1 4.2 4.9 France 4.2 3.5 4.6 4.1 3.8

20.6 21.4 6.7 6.9 9.5 3.9 0.8** 4.9 4.6 3.2

20.8 20.2 20.7 21.7 21.3 23.0 19.3 14.7 14.7 13.4 9.5 10.7 10.0 11.9 12.2 7.5 7.6 7.2 6.5 7.1 9.3 9.4 10.0 8.5 6.6 4.1 4.1 4.1 4.9 6.1 0.9 3.3 6.7 5.8 5.6 4.7 4.0 4.6 4.5 4.9 5.0 4.2 3.2 3.2 4.2 2.9 3.3 3.9 2.9 3.0

12.1 19.4 15.5 5.6 9.7 4.0 7.7 2.3 2.8 2.9

15.6 19.3 11.6 7.3 7.1 4.6 7.3 1.2 3.7 3.2

15.4 8.7 7.1 4.2 6.7 3.1 8.6 3.6 5.6 4.2

15.4 17.7 13.4 7.5 5.4 5.5 5.9 3.2 3.2 3.3

13.4 7.4 6.4 5.7 6.3 4.8 7.4 5.2 5.4 4.4

15.9 15.8 12.3 8.8 5.8 5.5 4.5 3.9 3.9 3.8

12.9 8.3 7.6 7.6 6.6 6.1 5.9 5.4 4.4 4.0

Source: United Nations (various years), International Trade Statistics Yearbook. Notes (a) Data with an asterisk (*) are for 1991. (b) The data are from various editions of the Yearbook. While the absolute export values for each country are identical across editions, the shares differ slightly due to different (presumably updated) totals. Generally speaking, the values for 1982–88 are from the 1991 edition, those for 1990–96 are from the 1998 edition, and those for 1998–2001 are from the 2003 edition. In those cases where a country was not among the top-ten exporters (for which, up to the 1998 edition, ten-year export share series are given), export shares were calculated by the author based on absolute export values from the 1994 edition. These values are indicated by a double asterisk (**).

The Japanese electronics industry

75

categories are now increasingly dominated by emerging economies such as Mexico, China, or Malaysia, showing that these product categories have matured. Yet, the continuing predominance of brand-names such as National/Panasonic (Matsushita) or Sony suggests that Japanese firms continue to lead in this field despite inroads by, for example, Korean companies such as LG and Samsung.18 Japan also continues to dominate exports in office machines (photo copiers, fax machines, etc.), though here, too, the country’s share has declined considerably. However, in computers, where Japan had almost caught up with the US during the 1980s, the country has fallen into fifth place, trailing not only the United States but also Singapore, the Netherlands and China. Similarly, Japan’s share in computer parts and peripherals is below its peak and now again trails that of the US by a sizeable margin. What is more, both Singapore and Hong Kong (the latter due to its role as a trade hub for China) have managed to expand their shares considerably during the 1990s. Unfortunately, the statistics do not include data for Taiwan (as it is not a member of the UN), which holds significant world market shares in a range of computer parts and peripherals.19 Likewise, Japan’s export share in telecom equipment, parts and accessories has fallen markedly over the past decade and a half, shrinking from 33.3 per cent in 1986 to only 5.9 per cent in 2001. Conversely, the US has expanded its share on the back of its leadership in internet technology and in 1996 in fact gained a commanding position for the first time since the 1970s. Meanwhile, European countries such as the UK, Germany and Finland managed to maintain or increase their shares during the 1990s, mirroring the continent’s strength in the sector in general and in mobile telecommunications in particular. Finally, in electronic parts and components such as transistors, valves, etc., the pattern resembles overall developments. Japan’s export share rose substantially during the 1980s and, during the second half of that decade, exceeded that of the US, only to fall back again during the 1990s. The share of the US, in contrast, having fallen to around 20 per cent in the late 1980s, has remained more or less unchanged at that level, while Singapore, Hong Kong and the Philippines managed to increase their shares. The production and export data strongly suggest that Japan’s competitiveness vis-à-vis its rivals in the electronics industry has deteriorated noticeably. Of course, to a considerable extent, the observed trends are the result of increased production abroad and consequently do not necessarily adequately reflect the strength of Japanese companies in the sector. Rather than production or export data for Japan, the best indicator of Japanese firms’ competitiveness would be their market share in the global electronics industry. Because such data unfortunately are difficult to obtain, Table 4.3 instead presents the aggregated sales of the world’s top electronics companies grouped by country or region.20 The data, depicting sales by the top Japanese, American and European companies, clearly indicate the rapid growth registered by European and especially American companies throughout the 1990s which only came to a halt with the bursting of the global high-tech bubble in 2001. In contrast, sales by Japanese companies also shrank in 1993 and 1998, reflecting the severe economic conditions at home, and in 2001 were only about a quarter

Table 4.3 Sales and relative market share of country/regional cluster 1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

(a) Japan, US and Europe Sales (US$ billion) Japan 298.6 USa 134.1 Europe 97.8 Total 530.4

292.7 309.1 335.4 367.5 378.8 371.6 381.2 404.8 370.0 140.0 158.6 188.6 214.1 239.9 263.9 294.5 325.7 282.1 101.3 108.7 114.1 122.4 142.5 143.0 163.6 204.5 197.9 534.1 576.4 638.1 703.9 761.2 778.4 839.3 935.0 850.0

Relative share (%) Japan 56.3 54.8 USa 25.3 26.2 Europe 18.4 19.0 Total 100.0 100.0 1994

53.6 27.5 18.9 100.0

1995

52.6 29.6 17.9 100.0

1996

52.2 30.4 17.4 100.0

49.8 31.5 18.7 100.0

47.7 33.9 18.4 100.0

45.4 35.1 19.5 100.0

43.3 34.8 21.9 100.0

43.5 33.2 23.3 100.0

1997

1998

1999

2000

2001

(b) Japan, US, Europe, Korea and Taiwan Sales (US$ billion) Japan 309.1 USa 158.6 Europe 108.7 Korea 9.8 Taiwan 3.2 Total 589.3

335.4 188.6 114.1 15.5 6.1 659.7

367.5 214.1 122.4 16.5 7.9 728.3

378.8 239.9 142.5 18.8 8.6 788.7

371.6 263.9 143.0 21.4 10.7 810.5

381.2 294.5 163.6 26.6 13.7 879.6

404.8 325.7 204.5 36.1 19.4 990.6

370.0 282.1 197.9 38.5 16.5 905.0

Relative share (%) Japan 52.5 USa 26.9 Europe 18.4 Korea 1.7 Taiwan 0.5 Total 100.0

50.8 28.6 17.3 2.3 0.9 100.0

50.5 29.4 16.8 2.3 1.1 100.0

48.0 30.4 18.1 2.4 1.1 100.0

45.8 32.6 17.6 2.6 1.3 100.0

43.3 33.5 18.6 3.0 1.6 100.0

40.9 32.9 20.6 3.6 2.0 100.0

40.9 31.2 21.9 4.3 1.8 100.0

Notes Sales represent the sum of the sales by the cluster of companies chosen from each country or region. The companies for each country or region were chosen according to their revenue ranking as provided in Cahner’s Yearbook 2002, ‘The Top Global 300 Electronics Companies’ (Available at http://www. einsite.net/index.asp, 31 January 2003). Sales data were obtained from Wright Investors’ Service (Available at http://profiles.wisi.com/, 31 January 2003). Relative shares were calculated by dividing the combined sales for the companies from each country or region by the total sales of all the companies included in the sample. The companies for each country or region are: Japan: Matsushita Electric Industrial, Fujitsu, NEC, Sony, Toshiba, Hitachi, Canon, Sharp, Mitsubishi Electric. USA: IBM, Hewlett-Packard, Lucent Technologies, Motorola, Intel, Dell Computers, Microsoft, Nortel Networks (Canada), Cisco Systems. Europe: Siemens, Philips Electronics, Ericsson, Nokia, Alcatel. Korea: Samsung Electronics, LG Electronics, Samsung Electro Mechanics, Samsung SDI. Taiwan: Acer, Tatung, Taiwan Semiconductor Manufacturing Corporation (TSMC), United Microelectronics Corp., Hon Hai Precision Industry. a Including Nortel Networks, which is a Canadian company.

The Japanese electronics industry

77

higher than in 1992, while American and European companies’ sales had more than doubled. The relative share of Japanese companies in global sales consequently declined considerably. Using the group of companies making up this sample as a yardstick, the share of Japanese companies fell from 57.0 per cent in 1991 to 40.4 per cent in 1999. Conversely, the share of American firms increased considerably from 24.6 per cent to 39.4 per cent, while that of European companies rose slightly from 18.4 per cent to 20.2 per cent. Unfortunately, comparable data for a meaningful number of major South Korean and Taiwanese companies is available only for the shorter period from 1993 to 1998. The figures that are available, however, show that the sales of companies from these two countries grew at breakneck speed, outperforming even the group of American companies, though, of course, they started from a lower base. If the sales data of the companies from South Korea and Taiwan are included, then the share of the European companies also fell, though to a much smaller extent than that of the Japanese companies. The sales data therefore add further evidence that Japanese companies have been losing ground to their American, Asian and even European rivals. In sum, viewing the data presented here and the anecdotal evidence considered in the foregoing sections in combination, there is little doubt that Japan’s once seemingly dominant position in the electronics industry has been seriously eroded. Of course, Japan continues to be a major producer and exporter in all electronics categories and its companies remain major players. Yet, the contrast with less than two decades ago is stark: in 1986, Japan was the world’s undisputed number one producer and exporter of electronics goods. The country was the top exporter in six out of eight product groups and second in the remaining two. By 1998, however, Japan’s total electrical machinery production had been overtaken by that of the US, while electronics export shares had declined across the board, with the number of product groups in which Japan led reduced to only two. What is more, during the 1970s and 1980s, it was Japanese companies that stunned their rivals with impressive growth rates; during the 1990s, however, Japanese firms lingered while their American, Taiwanese, South Korean and even European counterparts registered impressive growth rates.

Concluding remarks The preceding account of the dynamics in the global electronics industry over the past few decades – and the Japanese place in these dynamics – is hardly exhaustive. However, the evidence presented leaves little doubt that following the success of the 1970s and 1980s, when Japanese companies caught up and gained a substantial and often dominant position in many segments of the industry, they have fallen on hard times. It now seems clear that, at least to some part, the stellar rise was built not on the intrinsic strength of Japanese electronics companies, but on external factors that were not sustainable in the long-run. These include the usual suspects such as a sheltered domestic market, a favourable exchange rate (until 1985) and, during the bubble period, strong home demand and access to cheap capital.

78

The Japanese electronics industry

Together, these factors cushioned Japanese companies from competitive pressures to exit or move abroad unprofitable business areas and led them to rely on domestic production and exports to a much greater extent and much longer than their Western counterparts. To some extent, therefore, the decline in Japan’s global export share simply represents an adjustment from levels that did not reflect companies’ underlying strength but temporary favourable factors in the economic and institutional environment. Conversely, Japanese companies now appear at a distinct disadvantage because of the dreadful state of the domestic economy that is gradually eroding their financial position, constraining their ability to invest in R&D and new plant and equipment. At the same time, Japan’s rivals have capitalized on the new opportunities that have opened up by the change in the competitive environment: American firms, for example, have established dominant positions in the computer industry and related fields, whereas Europe has gained a leading position in mobile telecommunications (though Japan and the US seem to be catching up). This shift in the balance in the global electronics industry goes hand in hand with developments in the field of technology, including its growing cost and complexity, shortening product cycles and the prevalence of trajectory-disrupting innovations. As a result, to compete in the electronics industry, it is necessary to combine a growing number of capabilities. The traditional Japanese forte of generating incremental process innovations in this context represents only one of the requirements. Increasingly, this must be married with a host of complementary capabilities such as product definition and design, including the ability to set market standards through a combination of technology leadership and marketing. As it is increasingly difficult (and often too costly and time-consuming) to generate all the necessary resources within the confines of one firm, network forms of organization are flourishing in order to pool the diverse resources and capabilities of different firms; companies engage in strategic games, forging alliances in order to gain an advantage over their rivals. Although many of these developments have been shaped outside Japan, and Japanese companies, overall, seem to have fallen behind in the competitive race, they have not been idle. There is little doubt that they have been slow to rid themselves of excess capacity and workforces at home. Yet, as the rapid increase in overseas production shows, they have reacted quickly to the appreciation of the yen. What is more, though it is not always easy to detect, traditional network practices – as, for example, exemplified by the production pyramid – have begun to change. The following chapter will present some evidence for such change at the aggregate level, that is, it will look at industry-wide evidence, before the case studies in Chapters 6–8 analyse such changes in greater detail.

5

Pyramids under pressure Some evidence on aggregate trends in network arrangements

Introduction Shaped by the interplay of a variety of market forces, the structure of an industry is subject to continuous change not dissimilar to an evolutionary process. Under such circumstances, it would be surprising if the challenges confronting the Japanese electronics industry had not changed its structure, including in particular the organization of production and network arrangements. The growing reliance on overseas production, the increasing strength of foreign rivals, the mounting cost and complexity of technology, shortening product cycles and trajectory-disrupting innovations – each of these trends on its own provides challenges and opportunities. Arising concurrently, these developments have often reinforced each other and led to a profound transformation in network patterns in the Japanese electronics industry. Probably the clearest sign that the traditional pyramid networks are becoming a thing of the past would be a break-up of the vertical keiretsu. An unequivocal indication for this would be if electronics giants such as Hitachi, Matsushita or NEC were divesting themselves of their subsidiaries and affiliates, which would visibly reduce the control over their production networks. However, thus far, no such trend can be observed.1 In other areas, however, there is mounting evidence that points to significant changes in interfirm relationships. Such evidence includes the procurement patterns both of the overseas and the domestic operations of Japanese electronics companies which indicate a greater openness of network arrangements, the decline in subcontracting in Japan, and previously unthinkable alliances between domestic rivals. While the actual structure of networks is best presented in individual case studies, the purpose of this chapter is to bring together evidence of ‘aggregate’ trends that show industry-wide developments. These trends can be looked at from various angles. The next section addresses the impact the internationalization of the Japanese electronics industry has had on network arrangements. Based on a number of surveys, changes in production and procurement patterns are analysed. For clarity of presentation, the section is divided into two parts – one on overseas production and procurements, and one on domestic production and procurements – though these clearly reflect two sides of the same coin. Among other things, the data show that along with increased

80

Pyramids under pressure

overseas production, procurements from non-Japanese suppliers have increased considerably, indicating that production networks have opened up to members that are clearly outside the fold of the traditional pyramid. The third section of this chapter deals exclusively with subcontracting in Japan. Based primarily on data from an unpublished survey by the Japanese Small and Medium Enterprise Agency, it shows how subcontracting arrangements have come under mounting pressure. Though the main culprit is internationalization – that is the relocation of production and increased overseas procurements – there are also indications that the growing demands of contractors are weakening traditional subcontracting relationships. The fourth section develops the theme of the impact of technologyrelated changes on production networks further, suggesting that as the cost and complexity of technology rise and the pace of technological change accelerates, no firm – not even the largest keiretsu – can assemble within its confines all the necessary capabilities and resources. Consequently, cooperative arrangements with large independent firms beyond the traditional boundaries of the pyramid are gaining in importance. Due to the type of firms and their objectives involved in such arrangements, interfirm relationships are, overall, becoming less hierarchical and more open and flexible. Finally some concluding observations are offered that consider how the developments described in each of the sections are linked.

Internationalization Perhaps the most visible aspect of the transformation in Japanese network patterns lies in their internationalization. Until the mid-1980s, production in the Japanese electronics industry was very much a domestic affair: both overseas production and imports of parts and components played a negligible role; there were no foreign suppliers in Japan to speak of. Network members therefore were almost exclusively Japanese companies located in Japan. However, along with spiralling foreign direct investment (FDI) from 1985 onwards, overseas production in the Japanese electronics industry rose significantly. In one sense, therefore, the internationalization of networks simply refers to the growing geographic dispersion of production. However, along with the spread beyond Japan, internationalization has also involved an opening up to firms that were previously outside the boundaries of established production networks. This can be seen both in the procurement patterns of Japanese overseas operations and operations at home.

Overseas production and procurement patterns The history of overseas production by Japan’s electronics companies can be divided into four distinct phases that go hand in hand with particular procurement patterns (Industrial Bank of Japan 1994: 3–6; Tsuda and Shinada 1995: 27–9; Teranishi and Yamasaki 1995: 31–2). The first phase – spanning the 1960s and 1970s – is the era of the so-called ‘mini-Matsushitas’, that is, facilities located

Pyramids under pressure 81 in the Asian NIEs and ASEAN countries to jump trade-barriers in order to serve local demand. Operations were comparatively small-scale and consisted primarily of the assembly of a wide range of low-end consumer products. However, as a result of growing trade friction with the US and Europe, Southeast Asian operations also began to serve as export platforms to the West. The overwhelming share of parts and components was imported from Japan. The second phase – covering the period from the late 1970s to 1985 – was marked by a weakening of the yen that undermined the competitiveness of offshore operations. Yet, trade friction with the US and Europe further intensified and now also included exports from production bases in Asia. Japanese electronics firms consequently were compelled to move to local production in the US and Europe, the principal markets for their products. Again, most parts and components were imported from Japan. However, as indicated in the previous chapter, the Japanese overseas presence during this period was almost negligible when compared with the deluge of FDI, the third phase, that followed the rapid appreciation of the yen beginning in 1985. Companies shifted production overseas on a massive scale, with the ASEAN countries serving as export platforms to the major markets in the West. In contrast with earlier periods, though, this time around it was not only final assembly but also parts production that was moved overseas. Yet, as offshore production had to be ramped up quickly and local suppliers were rarely found, the share of imports from Japan in total procurements actually jumped. Gradually, however, local procurements were increased while the reliance on imports from Japan decreased. The final period – beginning in 1993 and continuing until today – was ushered in with the second bout of yen appreciation. By this stage, increased overseas production had created a momentum of its own that the renewed exchange rate pressures only exacerbated: firms had already invested in sophisticated production facilities that further accelerated the transfer of more advanced products (Teranishi and Yamasaki 1995: 28). What is more, in order to fully exploit the cost advantages of overseas production, firms were not only raising local content but increasingly organizing parts procurements on a global scale. A comprehensive survey by Japan’s Ministry of International Trade and Industry (MITI) on the overseas activities of Japanese firms (Kaigai Jigyo Katsudo Kihon Chosa) conducted every two to three years underlines the trends in procurement patterns described here. Part (a) of Table 5.1, showing the origin of procurements by Japanese overseas affiliates in the electrical machinery industry, clearly illustrates how offshore operations in 1983 (the first year in which the survey was carried out) primarily relied on parts and components imported from Japan: they accounted for 58.8 per cent of total procurements. As FDI jumped after the onset of yen appreciation and firms had to quickly ramp up production, this share soared to 73.6 per cent in 1986 but then gradually declined to less than 50 per cent during the second half of the 1990s. Conversely, local procurements accounted for little more than a third of total procurements in 1983 and this share dropped further in 1986. However, parallel to the subsequent decline in the

82

Pyramids under pressure

Table 5.1 Overseas affiliates’ procurements by origin and group membership Local

Japan

Third countries

Total

(a) Origin of overseas affiliates’ procurements (share in %) 1983 35.2 58.8 1986 22.6 73.6 1989 25.1 66.2 1991 25.4 61.2 1994 26.6 53.8 1996 34.2 42.2 1999 37.1 44.5

6.1 3.8 8.7 13.4 19.6 23.6 18.4

100.0 100.0 100.0 100.0 100.0 100.0 100.0

(b) Share of procurements from companies of the same business group in procurements from each origin (in %) 1983 — 93.2 1986 — 91.0 1989 56.6 77.3 1991 13.3 90.5 1994 16.6 76.0 1996 22.8 86.7 1999 19.2 91.2

— — 50.9 49.6 67.4 53.2 58.2

(c) Share of procurements from companies of the same business group in overall procurements (in %) 1983 — 54.8 1986 — 66.9 1989 14.2 51.2 1991 3.4 55.4 1994 4.4 40.9 1996 7.8 36.6 1999 7.1 40.6

— — 4.4 6.6 13.2 12.6 10.7

— — 69.8 65.4 58.5 56.9 58.4

Source: Data for tables (a) and (b) are from MITI (various years), Kaigai Jigyo Katsudo Kihon Chosa. The figures for table (c) were calculated by the author (see note). Notes The figures in Table 5.1(a) are the shares of local procurements, procurements from Japan and procurements from third countries in the total procurements of Japanese overseas affiliates worldwide. The figures in Table 5.1(b) represent the shares occupied by procurements from companies of the same business group in the total procurements from each origin. Thus, in 1999, for example, 44.5 per cent of all procurements by Japanese overseas affiliates were imported from Japan (Table 5.1(a) ). Moreover, of that amount, 91.2 per cent came from companies in the same business group (Table 5.1(b) ). Table 5.1(c) combines the information from Tables 5.1(a) and 5.1(b) by multiplying these shares. Hence, as 91.2 per cent of the 44.5 per cent of procurements from Japan derive from companies of the same business group, 40.6 per cent of total procurements consisted of supplies obtained from companies of the same business group in Japan.

share of Japanese imports, the share of local procurements rose gradually. To a considerable extent, this trend owes to the growing local presence of Japanese parts manufacturers that followed their customers overseas. Even faster, however, has been the increase in the share of third country imports, which jumped from a low of 3.8 per cent in 1986 to around a fifth during the 1990s and illustrate the increasingly global approach to organizing supplies.2

Pyramids under pressure 83 The overall trend throughout the last two phases of Japanese overseas production (i.e. since the mid-1980s), then, has been a steady movement away from imports from Japan and towards local and third-country sourcing. In this respect, it may be said that Japanese production networks have been internationalizing. However, to a considerable extent, the increase in local and third-country sourcing has been the result of the increased overseas presence of Japanese parts companies. Teranishi and Yamasaki (1995: 23–4) for example, speak of a ‘symbiotic relationship between systems companies and parts companies’ in their Asian operations, observing: Systems companies have been able to make their Asian-made products more cost-competitive by using more local parts and materials, which has been possible because Japanese parts companies have been expanding their local production in Asia in tandem with the systems companies. The efforts of Japanese parts companies to strengthen their cost-competitiveness by shifting production to facilities in Asia – and to expand the quantity and types of parts they make in Asia (reducing their dependence on parts made in Japan) – have exactly matched the needs of systems companies to strengthen their own cost-competitiveness by going offshore. Conversely, the accelerated buildup of production facilities in Asia by the systems companies has opened up important new business opportunities for the parts companies. Detailed data on procurements by Japanese overseas affiliates published in the Kaigai Hojin Risuto by the Electronics Industry Association of Japan illustrate the pattern (Nihon Denshi Kikai Kogyokai, various issues). The survey asks companies to indicate the share of supplies sourced in the host country from Japaneseaffiliated and other suppliers, from Japan and from other countries. These data, which are available on a company basis, were used to compute the average share of each type of supply source for the years 1991 and 1994 and are presented in Table 5.2. (Unfortunately, later surveys no longer give these shares.) The averages for different countries and regions were also calculated in order to show regional variations in procurement patterns. Regarding procurements and, by extension, network patterns, the data are quite revealing in a number of respects. First, the data confirm the finding from the Kaigai Jigyo Katsudo surveys that at the beginning of the 1990s, imports from Japan accounted for the largest share of overseas affiliates procurements, but declined over the following years. Conversely, procurements from other countries as well as host country procurements increased: in the sample, the average share of host country procurements rose from 36.62 per cent in 1991 to 44.87 per cent in 1994, with the larger part of the growing share of host country procurements accruing to Japanese-affiliated suppliers (3.73 percentage points versus 2.52 percentage points). The data thus bear out the observation that the increase in local procurements was primarily due to the growing presence of Japanese-affiliated parts makers. For different reasons, this is most clearly the case for the ASEAN countries and Europe, as is illustrated by the breakdown of procurement patterns by region.

39.14 43.77 10.00 12.20

7.62 8.50 26.00 13.30

12.50

10.22

6.86

Europe (16)

USA and Canada (25)

Mexico and Brazil (7)

42.71

53.46

60.38

51.71 46.69 49.00 74.50

54.14 55.11 53.72 59.00 48.85

54.13

19.00

5.48

3.38

1.52 0.96 15.00 0.00

7.49 12.89 16.03 4.17 1.75

7.13

6.86

10.84

18.50

7.10 9.46 26.00 16.50

19.56 27.82 26.58 31.28 9.13

17.85

40.29

32.64

14.69

45.67 49.77 7.50 15.50

26.72 13.59 12.58 16.39 46.42

27.02

33.43

48.00

52.06

45.00 33.95 46.50 68.00

43.22 42.74 42.63 43.06 38.99

44.25

Japan

Abroad

19.43

8.52

14.75

2.24 6.79 20.00 0.00

10.42 15.70 18.02 9.28 5.43

10.81

Other

3.04 0.43

⫺5.46 ⫺9.29 0.00

0.62

8.86

1.80

11.38

⫺8.31

⫺9.06 6.00

0.71 5.82 5.00 0.00

⫺6.71 ⫺12.74 ⫺2.50 ⫺6.50 6.52 6.00 ⫺2.50 3.30

2.94 2.81 1.98 5.11 3.69

⫺10.92 ⫺12.37 ⫺11.09 ⫺15.94 ⫺9.86 ⫺0.52 0.96 0.00 3.20

3.68

Other

⫺9.88

Japan

3.78 2.27 2.49 1.67 5.88

2.52

Other

Abroad

4.28 7.43 6.80 9.17 0.31

3.73

Japanaffiliated company

Host country

Change 1994/1991

Notes Author’s calculations based on Nihon Denshi Kikai Kogyokai, Kaigai Hojin Risuto (various years). The survey asks overseas affiliates for the share of procurements from each category. The figures here represent the averages of these shares. Only data for companies that provided information in both surveys (i.e. 1991 and 1994) were used. The change between 1991 and 1994 was derived by calculating the difference in shares between the two years. The number of firms in each category is given in parentheses.

31.43

30.84

23.75

22.94 11.32 10.09 14.72 40.54

15.27 20.40 19.78 22.11 8.82

Asia (129) ASEAN (68) ASEAN-4 (50) Singapore (18) Korea, Taiwan, Hong Kong (51) Korea (21) Taiwan (28) Hong Kong (2) China (10)

24.50

14.12

Total (178)

Other

Japan

Japan- Other affiliated company

Japanaffiliated company

Host country

Abroad

Host country Other

1994

1991

Table 5.2 The origin of Japanese overseas subsidiaries’ supplies (in %)

Pyramids under pressure 85 The thrust of overseas investment by Japanese companies during the first half of the 1990s has been into the Southeast Asian countries and the share of procurements from Japanese-affiliated companies located in the host country consequently jumped from 20.40 to 27.82 per cent in the space of only three years. In contrast, procurements from non-Japanese local companies only rose from 11.32 to 13.59 per cent. In the European case, procurement patterns are likely to have been shaped by the introduction of the Common Market and associated concerns about a ‘Fortress Europe’: the share of imports from Japan dropped markedly; and again, the share of local Japan-affiliated suppliers rose strongly.3 To some observers, the heavy reliance on Japanese-affiliated suppliers suggests that the internationalization of the Japanese electronics industry primarily has consisted of a relocation of production, with established network patterns, however, remaining more or less intact. Borrus (1997: 155), for example, suggests as much when stating that ‘[…] Japanese networks rely on a largely domestic and affiliated supply base with little value-added by other Asian producers’. In other words, networks seem to have been unaffected by the move to international production, with long-established interfirm relationships continuing to play a central role. While this certainly seems to be true especially when comparing Japanese production networks with their American counterparts, it does not mean that things are not changing. Ernst (1997b: 211), for example, argues that a clear-cut distinction between closed Japanese and open US production networks only existed for a fairly short period from 1986 to around 1992 and that Japanese firms, too, have moved to establish a regional supply base in Asia. In his opinion, the heavy reliance on affiliated suppliers largely owes to the fact that Japanese firms were relative late-comers to international production. Their initial strategy to cope with yen appreciation thus was to transplant features of the Japanese production system ‘with as little change as possible’ (ibid.: 216). The heavy reliance on Japanese-affiliated suppliers thus may be the result of what Ernst (1997a, 2000) labels the ‘vintage factor’, that is, the fact that it takes time to develop the capacity to manage international production networks. The data in Table 5.2 support this argument: Japanese investments in Korea and Taiwan, which have a much longer history than those in Southeast Asia, to a much lesser extent rely on procurements from local Japanese-affiliated companies.4 Instead, local nonJapanese companies make up a large share of supplies, which also indicates that in countries that have a strong indigenous electronics sector, Japanese companies are quite prepared to make use of existing local capabilities. What is more, even where local procurements substantially rely on Japanese affiliates, relationships with suppliers may nevertheless differ from the patterns prevailing in Japan. While in Japan parts procurements often are influenced by companies’ existing business relationships, companies are much more willing to forge new ties overseas: Parts procurement in Japan is often influenced by companies’ existing business connections. Manufacturers are not always free to buy from those who offer them the most favourable terms. Business relations are often inflexible,

86

Pyramids under pressure which prevents the companies from dealing through the market […] On the other hand, in the ASEAN countries, transactions are conducted principally through the market, without the entanglements of Japan-based business obligations. (Industrial Bank of Japan 1994: 22)

Evidence for the growing use of market-based relations are the increasing number of international procurement offices (IPOs), which typically organize the purchase of parts and components on a regional basis. Thus, while the share of local procurements from Japanese-affiliated companies may be quite high, the nature of the business relationships often differs markedly from those at home. This observation is borne out in part (b) of Table 5.1, which presents the share of procurements from companies belonging to the same business group in total procurements from each origin: while 91.2 per cent of the supplies imported from Japan in 1999 came from members of the same business group, the equivalent share for local procurements was only 19.2 per cent and that for third country procurements was in-between at 58.2 per cent. These differences are not only quite instructive in themselves. Even though the figures display no clear trend over time, the different levels are also highly significant for overall procurement patterns: for, if one takes into account the declining share of imports from Japan and, conversely, the growing share of local and third-country procurements where suppliers are much less likely to belong to the same business group, then the overall share in procurements from members of the same business group has clearly fallen, from 69.8 per cent in 1989 to around 57–59 per cent during 1994 –99. In other words, Japanese companies overseas are relying less and less on members of the same keiretsu and more and more on unaffiliated firms for the supply of parts and components, suggesting a gradual dissolution of established network arrangements. Overall, then, procurement patterns for the overseas affiliates of the Japanese electronics industry have varied considerably over the years. With the internationalization of production taking on significant proportions only from the mid1980s onwards, Japanese firms lagged considerably behind their Western competitors and initially transferred key features of the domestic production system. This involved a heavy reliance on imports from Japan, the overwhelming majority of which derived from companies belonging to the same business group. However, over time, procurements diversified: local sourcing and imports from third countries increased, relying both on Japanese-affiliated parts companies that had also moved offshore and on non-Japanese suppliers. In contrast, the reliance on supplies from companies of the same business group has declined. The change in sourcing patterns has direct implications for network arrangements. Borrus (1997: 154), for example, has described the international production networks of Japanese companies as relatively closed to outsiders, as cautious, centralized, and based on long-term and stable business and keiretsu relationships – and contrasted these with the production networks of US companies which he labelled as ‘open, fast, flexible, formal, and disposable’.5 However, Japanese

Pyramids under pressure 87 production networks are changing: as demonstrated by the declining share of group companies in overall procurements and, conversely, the rising share of nongroup companies, Japanese firms abroad are increasingly willing to use companies with whom no previous business relationship has existed. The Export–Import Bank of Japan (cited in Ernst 1997b: 220) has observed the following in this context: It is noteworthy, in particular, that reinforcing parts procurement bases overseas is the most important strategy for the automobile assembling industry and the electric/electronic industry […] Japanese companies have tried to reconstruct their advantages internationally through building more flexible and open networks between parts suppliers and assemblers [italics added]. What is more, there also appear to be moves to a decentralization of operations, with greater responsibilities accruing to overseas affiliates to manage their own affairs (Ernst 1997a, 2000; Ernst and Ravenhill 2000). In sum, therefore, the move to international production has also involved a growing role for firms – independent Japanese part companies as well as non-Japanese suppliers – that were not part of the established network back at home: the traditional pyramid has been opening up, with a smaller proportion of production under tight control by the hub firm.

The impact of internationalization on domestic production and procurement patterns The move to international production and the greater openness in network arrangements in due course began to have a wide-ranging impact on the domestic structure of the industry. In the first instance, the rapid transfer of production has affected the structure of domestic production. On a popular level, this development has often been linked with the fear that Japanese industry may be ‘hollowing-out’ (kudoka) (Ekonomisuto, 14 November 1995; Pohl 1996; Okina and Kohsaka 1996; Industrial Bank of Japan 1994; Satake 1994). Looked at from a different angle, however, the same trends may simply be described as a deepening in the international division of labour that has bolstered the competitiveness of Japanese companies. Whichever interpretation one prefers, what is clear is that activities in Japan and abroad are increasingly tied up with one another: offshore production has given a significant boost to Japanese exports and imports of parts and components as well as imports of finished products. The most visible impact of the internationalization of the Japanese electronics industry has been on the consumer goods sector. The assembly of low-end mass consumption products was among the first activities to be moved overseas and for products such TV sets or VCRs, first overseas production and then also imports soon exceeded domestic production. Partly as a result of the shift to offshore production, the domestic production of consumer electronics has declined both

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Table 5.3 Production, exports and imports by product category (billion yen; share in % in italics) 1988 (a) Production Consumer electronics Industrial electronic equipment Electronic components and devices Total (b) Exports Consumer electronics Industrial electronic equipment Electronic components and devices Total (c) Imports Consumer electronics Industrial electronic equipment Electronic components and devices Total

1990

1995

2000

2002

4,260.2 19.9 9,906.6 46.2 7,262.4 33.9

4,154.0 17.3 11,563.6 48.0 8,352.8 34.7

2,440.0 10.9 10,515.1 46.9 9,479.1 42.3

2,191.2 8.8 11,374.6 45.4 11,469.0 45.8

1,978.1 11.0 7,502.8 41.6 8,553.2 47.4

21,429.2 100.0

24,070.5 100.0

22,434.3 100.0

25,034.7 100.0

18,034.0 100.0

2,207.8 24.2 2,988.3 32.8 3,924.1 43.0

2,617.8 23.8 3,442.7 31.3 4,933.4 44.9

1,313.3 11.3 2,959.7 25.5 7,340.3 63.2

1,530.9 10.7 3,224.9 22.6 9,509.3 66.7

1,629.5 13.3 2,539.3 20.7 8,087.6 66.0

9,120.2 100.0

10,993.9 100.0

11,613.3 100.0

14,265.1 100.0

12,256.4 100.0

145.4 8.6 586.2 34.7 960.0 56.8

113.1 5.7 692.4 34.6 1,195.1 59.7

333.3 8.4 1,440.9 36.3 2,198.5 55.3

530.1 7.3 2,537.3 34.7 4,235.0 58.0

610.1 8.8 2,409.5 34.8 3,898.6 56.4

1,691.5 100.0

2,000.6 100.0

3,972.7 100.0

7,302.4 100.0

6,918.1 100.0

Source: EIAJ (1997), Facts & Figures on the Japanese Electronics Industry, and JEITA (2003), Data Map for the Electronics and Information Technology Industries in Japan.

absolutely and as a share in overall production (see Table 5.3). It has been trends such as these that have given rise to the notion that Japan is facing ‘hollowing-out’ and industrial decline and that this is closely linked with the shift to offshore production. However, while domestic production of consumer electronics indeed halved during the 1990s (and that of industrial electronic equipment more or less stagnated), the production of electronic components and devices continued to grow – at least until the global recession of 2001–02. In fact, the increase in the domestic production of components and devices to a considerable extent is the direct result

Pyramids under pressure 89 of the increase in overseas production.6 It therefore seems justified to argue that offshore production is sustaining production in Japan rather than undermining it: because of the deterioration of the domestic economic environment, it is doubtful that Japanese companies could have held on to their global market shares and maintained overall production levels to the extent they did without the move to offshore production; moreover, production in Japan is aided not only by the export demand of offshore operations but also by the availability of cheaper parts and components through reverse imports. A number of figures illustrate the growing international integration of the Japanese electronics sector. Traditionally rather self-contained, the share of imports in relation to domestic demand in the industry stood at only 13.3 per cent as late as 1990 (Table 5.4).7 By 2002, however, this had risen to 54.5 per cent. A significant factor in this development has been the surge in (re-)imports of consumer products from Japanese overseas subsidiaries. Yet, equally dramatic has been the large increase in the share of imported components and devices, which in 2002 reached almost nine-tenths of domestic demand. Thus, in tandem with the increase in overseas production there has also been a substantial increase in overseas procurements by Japan’s domestic electronics sector. Unfortunately, few data are available that allow a further analysis of such import patterns. In particular, it would be interesting to see what share of imports derives from Japanese companies abroad and of this, what share from companies belonging to the same business group, and the trends over time. What is available are statistics from the Kaigai Jigyo Katsudo Kihon Chosa that clearly show that the share of reverse imports in Japan’s overall imports for the manufacturing sector as a whole – of which electrical machinery in fact makes up the largest share – has been rising throughout the decade, with the rest of Asia as the major area of origin of such reverse imports (METI 2001).8 The survey also shows that in the electrical machinery sector, 51.0 per cent of firms’ imports derived from their

Table 5.4 Share of imports in domestic demand (in %)

Consumer electronics Industrial electronic equipment Electronic component and devices All

1988

1990

1995

1999

2000

2001

2002

6.6 7.8

6.9 7.9

22.8 16.0

42.1 20.3

44.5 23.7

58.9 26.6

63.6 32.7

22.3

25.9

50.7

63.7

68.4

82.0

89.3

12.1

13.3

26.9

35.8

40.4

46.2

54.5

Source: Author’s calculations based on EIAJ (1998), Facts & Figures on the Japanese Electronics Industry and JEITA (2003), Data Map for the Electronics and Information Technology Industries in Japan. Note Share of Imports in Domestic Demand ⫽ Imports/(Imports ⫹ Domestic Production ⫺ Exports) * 100.

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overseas subsidiaries.9 Apart from the rather unsurprising observation that the increase in imports to a large extent owes to companies’ procurements from their own offshore facilities, aggregate data can convey little else about the nature of supply networks for operations in Japan. What is clear, however, is that these supply networks have become increasingly international. The implications of the internationalization of procurements on the domestic supply arrangements are twofold. First, and most obviously, the underlying reason for increased parts and components imports is their cost-competitiveness. Consequently, greater reliance on imports exerts cost-pressures on existing parts suppliers at home. Second, as part of their growing overseas experience, Japanese firms are getting used to conducting business on a basis that more closely resembles market transactions, resulting in a greater willingness to abandon traditional relational contracting. Regional procurement arrangements in Asia, for example, often mean that domestic parts manufacturers have to compete with their own overseas affiliates, as systems companies have demanded and obtained discounts for locally produced parts, which they then can also use to lower production costs in Japan. What is more, the reliance on arm’s length transactions overseas may potentially also change an existing relation between contractors and subcontractors in Japan. Satake (1994: 56) therefore observes: ‘It is thus easy to see how the use of discounted parts in Japan could lead to the unraveling of the entire structure of long-term commercial relationships in Japan.’ As the following section will show, this is in fact exactly what is happening. Put differently, this ‘unravelling’ can also be interpreted as a move to greater openness and flexibility of the supply networks for production in Japan. Though the internationalization of procurements is by no means the only aspect, it probably represents the most readily visible change and challenge to the traditional keiretsu-subcontracting system that had hitherto been a very domestic Japanese affair.

The subcontracting system under pressure Long considered one of the main underpinnings of Japan’s competitiveness in the manufacturing industries, subcontracting in the Japanese production system in recent years has come under increasing strain. Yen appreciation, strengthened competition from abroad and sluggish domestic demand have forced companies to cut costs drastically. At the same time, owing to the growing cost and complexity of technology, customers increasingly demand independent technical capabilities of their suppliers. Both trends have served to erode traditional subcontracting relations. Given the resistance to sweeping restructuring measures within large firms, their first recourse to deal with growing cost-pressures typically has been to exert ever greater pressure on subcontractors. Recounting the troubles of long-term subcontractors that have been squeezed to such an extent that they have exhausted all cost-cutting opportunities, Miyashita and Russell (1994: 199–202), for example, argue that the keiretsu are coming apart as subcontractors are either

Pyramids under pressure 91 going bankrupt or serving a larger number of clients and crossing keiretsu lines. JETRO (1996a) makes a similar observation: Japan’s manufacturing structure, traditionally characterized by close, longterm ties between manufacturers and their keiretsu suppliers, is showing signs of major change . . . [S]uppliers are increasingly taking matters into their own hands, moving into new markets and shifting production abroad . . . [M]ore and more [manufacturers] are working to build new ties with other suppliers, both foreign and domestic . . . [W]hile traditional supplier relationships still exist, they are growing more open, as illustrated on the manufacturers side by the emergence of new suppliers and, on the suppliers side, by the pursuit of business with new manufacturers. These observation are borne out in a number of surveys. Thus, according to the Ministry of Economy, Trade and Industry (1999b), the share of small and medium enterprises in the electrical machinery sector engaged in subcontracting work hovered around 80 per cent during the period from 1966 to 1987. However, by 1998, that share had dropped to 65.2 per cent (Table 5.5). Even more dramatically, subcontracting business as a share of electrical machinery SMEs’ total turnover fell from an average of 85.6 per cent in 1988 to only 33.7 per cent ten years later.10 An unpublished survey by the Small and Medium Enterprise Agency, Heisei 9-nendo Kigyo-kan Kankei Jittai Chosa [1997 Survey on the Structure of Interfirm Relationships] provides revealing background detail to the decline in subcontracting arrangements.11 The survey is divided into two parts – one on large companies that typically are the customers in subcontracting relationships, and one on small and medium enterprises (SMEs), that is, the subcontractors. First of all, the survey among large companies confirms most of the observations regarding the impact of internationalization. Thus, the vast majority of large companies (81.7 per cent) had increased their overseas production ratio and most (67.1 per cent) expected further increases in the future. Approximately one-third (32.8 per cent) of companies saw their domestic production decline as a result, while only 9.0 per cent reported an increase and 46.3 per cent no change; and 38.2 per cent indicated that their domestic procurements had decreased due to increased overseas sourcing (7.6 per cent reported an increase; 42.0 per cent no change).

Table 5.5 Share of small and medium enterprises engaged in subcontracting (in %)

Manufacturing average Electrical machinery

1966

1971

1976

1981

1987

1998

53.3 81.4

58.7 78.9

60.7 82.3

65.5 85.3

55.9 80.1

47.9 65.2

Source: METI (1999b). The particular table can be found online at: http://www.meti.go.jp/ statistics/data/h2d5k2aj.html (16 October 2003).

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Regarding subcontracting arrangements, the survey reveals that changes are more pronounced for small and medium companies (the subcontractors) than large companies (the customers). Thus, the overwhelming majority (97.5 per cent) of large firms continued to rely on subcontractors and for almost two-thirds, there had been no change in the number of subcontractors they did business with. However, slightly more companies saw a decrease in their number of subcontractors than an increase (23.0 per cent versus 15.1 per cent). Moreover, even though more firms reported an increase than a decrease in the value of subcontracting business compared with three years earlier (34.8 per cent versus 24.3 per cent; with no change for 40.8 per cent), slightly more firms indicated a decrease rather than an increase in their dependence on subcontractors during that period (22.4 per cent versus 18.5 per cent with no change reported by 59.2 per cent). A somewhat clearer trend emerges from Small and Medium Enterprise Agency data referred to in JETRO (1996a), according to which during the period from 1985 to 1995, the share of electric and electronics manufacturers that reported a dependence on subcontractors for more than 30 per cent of their total sourcing from other companies declined from 56.8 to 52.0 per cent. Moreover, the share of those that depended on subcontractors for more than 60 per cent shrank from 27.1 per cent to 23.5 per cent. The picture from the viewpoint of large companies then is one of some but not dramatic change: most large companies continue to make use of subcontractors, though overall there has been a slight decrease in their reliance on them. Interesting in this context are the reasons given by those companies that have reported a decrease in the business they give to subcontractors. By far the most frequent explanation (54.1 per cent) was a decrease in overall outsourcing due to moves to bring production in-house (the so-called naiseika), followed by the increase in overseas procurements (37.8 per cent), a shift to overseas production which has led to a reduction in domestic outsourcing (29.7 per cent), and a decrease in domestic production due to a decline in demand (29.7 per cent).12 These answers show how outsourcing to subcontractors has suffered as a result of both the internationalization of production and procurements on the one hand and sluggish domestic demand on the other. Against the background of these trends, large companies first and foremost have been concerned with keeping their own facilities in work rather than maintaining business relationships with subcontractors. Turning to small and medium firms, the survey shows a much more noticeable impact on subcontracting relationships. Even though three-quarters of SMEs continued to be involved in subcontracting work, its role has clearly diminished: compared with three years earlier, twice as many SMEs saw a decrease in their ratio of subcontracting business than an increase (23.7 per cent versus 11.2 per cent), with 8.2 per cent reporting a large drop. Confirming that in this tougher business climate, subcontractors have begun to look beyond their traditional clientele, 18.7 per cent of them report an increase in the number of oya kigyo (literally: ‘parent companies’) they do business with. The main reasons for this increase are the establishment of new business links due to a decline in orders from the main contractor(s) as well as deliberate attempts to reduce the risk

Pyramids under pressure 93 resulting from too great a dependence on the main customer. At the same time, however, 12.9 per cent of SMEs report a decline in their number of oya kig yo, with the main reason being the termination of business relationships because their customers relocated production overseas. Significantly, almost one-third of subcontractors said that within the preceding three years their dependence on their most important oya kigyo had declined (in contrast with only 17.5 per cent that experienced an increase). Moreover, regarding subcontracting plans for the future, by far the most popular strategy was to try to increase the number of oya kigyo and reduce the dependence on the main oya kigyo. On the whole, the survey data unambiguously point in one direction: though subcontracting continues to play a role, its importance has been eroded as a consequence of the internationalization of production and procurements as well as sluggish domestic demand. However, this is not the whole story. Viewed from a slightly different perspective, the described trends represent the growing international division of labour found in the Japanese electronics sector. As such, the relocation of low value-added functions and/or their demise in Japan represent an upgrading of the overall industry structure: consequently, only those companies can survive in Japan and are attractive as suppliers/subcontractors that offer their customers more than just lower costs for labour-intensive activities. Given the ever-increasing sophistication of electronic products, contractors instead expect their suppliers to possess independent technical capabilities or original technological know-how that complements their own resources. Confirming the ‘increasing fluidity of subcontracting relationships’, the White Paper on Small and Medium Enterprises in Japan 1997, for example, shows that while during the 1980s, the need for additional production capacity represented the main motive for using subcontractors, by 1996, the importance of this reason had declined considerably (Small and Medium Enterprise Agency 1997a: 57 and 62).13 At the same time, access to subcontractors’ specialist technology had registered a marked increase and together with subcontractors’ lower wage costs was considered the most important benefit of using subcontractors. Yet, in general it seems that few subcontractors actually possess original product development capabilities: according to the Japanese version of the 1997 White Paper on SMEs, only 19.8 per cent of subcontractors in the electrical machinery industry were selling their own products (Chusho Kigyo Cho 1997). Unfortunately, the surveys do not explore this topic further. Nevertheless, these findings do support the view that technology issues are playing an increasingly important role in determining customer–subcontractor/supplier relationships: considering the tension between customers’ growing demands for specialist technologies and subcontractors’ frequent lack of independent technological capabilities, this mismatch would seem to be a further potent reason for the weakening of traditional subcontracting patterns. Customers would be forced to look for new suppliers/subcontractors, while those subcontractors that do possess their own technical capabilities are able to expand their customer base and become increasingly independent of any single client. In this context, it

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is interesting to note that regarding their future relationship with the oya kigyo, 13.4 per cent of the firms subject of the survey responded that they were planning to develop marketable products and leave the subcontracting business. The result of this trend, of course, is that former subcontractors increasingly turn into independent suppliers, thereby undermining traditional pyramidal network arrangements. JETRO (1996b) sums up the observations made in this section as follows: The rapid international division of labor, as manifested by the shifting of production overseas and the increase in imports of manufactured goods, is having an impact on the domestic system of subcontracting. MITI indicated in its annual report on trends in SMEs that subcontracting in the Japanese manufacturing sector has traditionally been characterized by constant business dealings with specific major clients. […] With the growing international division of labor, however, major clients have been more selective in their subcontractors and are demanding much more from them, while the SMEs have been phasing down their subcontracting work and seeking orders from a broader range of clients. The Small and Medium Enterprise Agency confirms this in its survey of the structure of subcontracting in Japan. Its questionnaire survey revealed that a growing number of major firms believe that ties between major clients and subcontractors are showing signs of weakening or are continuing to weaken. In the field of electrical and electronic machinery, where this trend is particularly marked, 26.1 percent of the major clients responding indicated that they felt signs of these ties weakening, while 47.9 percent felt that signs of the ties weakening would probably be seen soon and 16.0 percent felt that they would weaken in the future. Clearly, the previously close-knit relations between major clients and subcontractors will gradually loosen. The changes in procurement patterns and subcontracting relationships discussed so far represent only the most visible and easily quantifiable aspect of the fundamental transformation of the Japanese production system. In parallel to the weakening of traditional network linkages, firms have also reached out to establish new linkages in the form of more loosely tied supply and production arrangements as well as strategic alliances for the purpose of technology exchange or joint research and development. The following section shows how apart from internationalization, technological issues have played an equally crucial – if not even more important – role in transforming production arrangements.

Technology and networking beyond the keiretsu The issue of technology and innovation has been a central theme of the discussion in this study. In Chapter 2, it was suggested that networks offer gains over

Pyramids under pressure 95 and above the elimination of transaction costs, consisting of the access to complementary resources that network relationships provide. Outlining network patterns as they were found in the Japanese electronics industry during the 1970s and 1980s, Chapter 3 painted a picture of a hierarchical organization in which technological capabilities were heavily concentrated and dominated by the hubfirm of the keiretsu pyramid. Chapter 4, finally, highlighted how global industry dynamics in the electronics sector have been closely linked with technology and innovation issues. In particular, it was argued that changes in the nature of technology have been responsible for a change in the rules of competition: as a result of the increasing speed of technical change as well as the growing cost and complexity of technology, keiretsu-based hierarchical production networks no longer appear adequate. And indeed, a host of changes in network patterns are occurring that support this assumption. Traditionally, it was argued, Japanese competitive strategies involved a longterm approach that aimed at expanding market share on the assumption that the learning curve and larger economies of scale will lead to lower and lower costs. Innovation and technical change was a cumulative ‘step-by-step’ process and most sophisticated technical capabilities were concentrated within the core network of parent and affiliates. Close cooperation between network members contributed to learning economies both in the production process and in the smooth coordination of activities. In the presence of a high degree of customization of parts and components, subcontracting arrangements provided flexible access to dedicated production capacity at low cost. However, with the emergence of the new rules of competition described earlier, these advantages of pyramid networks appear increasingly irrelevant to the type of capabilities actually required. To give an example, traditional subcontracting arrangements provide a competitive advantage only where a high degree of customization is present. The use of customized parts and components, in turn, only makes sense where these offer a competitive advantage. Where this is not the case, the use of customized parts actually prevents the exploitation of economies of scale that can be reaped by parts makers acting as industry-wide suppliers. Consequently, in their efforts to lower costs, one avenue pursued by assemblers has been to decrease their reliance on customization and instead move to greater standardization of parts and components, opening the way for more open supply-relationships.14 Conversely, the need to exploit economies of scale may originate from the supplier, which would equally have a centripetal effect on network patterns. This is especially the case in the high-tech sector where development and fixed capital costs are high. Discussing the case of semiconductor manufacturing equipment, Chon (1997), for example, argues that in this sector costs have reached levels that make it difficult even for the largest semiconductor producers to come up with the necessary capital outlays to purchase equipment for future investment which – reaching billions of US dollars – has to be depreciated over increasingly shorter time periods because of rapid changes in semiconductor technology. Under these circumstances, the captive market of the keiretsu is insufficient to attain the necessary economies of

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scale. Thus, in order to expand their market and sell to companies of rival groups, firms like Hitachi and NEC have spun off their equipment divisions into separate enterprises. In itself, such spin-offs with the aim of serving a larger market are nothing new and, after all, account for the proliferation of Japanese electronics subsidiaries and affiliates. However, Chon (1997: 32) sees these steps as a first move towards consolidation in a market that has hitherto been segmented along keiretsu lines making it difficult to keep pace with the economies of scale required in order to achieve reasonable profitability. Signs of such a consolidation can already be seen. Even though Japan’s electronics giants so far have been reluctant to actually sell off divisions, subsidiaries or affiliates, they have begun to pool their operations.15 In a string of announcements in 1998/1999, a number of unprecedented tie-ups between domestic rivals were revealed. In what was the first joint venture by two Japanese semiconductor manufacturers, Toshiba and Fujitsu joined forces for the development of nextgeneration DRAM chips (FT, 4 December 1998). Hitachi and NEC followed closely on the heels, similarly announcing a ‘ground-breaking’ joint venture to design and develop future generations of memory chips (FT, 24 June 1999). Shortly thereafter, Hitachi also linked up with Fuji Electric, explicitly citing ‘formidable’ facility and development costs (Hitachi press release, 31 August 1999).16 By early 2001, such agreements between Japanese electronics giants had become commonplace, with Toshiba and Sony, for example, planning to jointly develop process and design technologies for cutting-edge system LSI (large-scale integration) chips. What is more, the same argument for consolidation can be made for other high-tech components that involve large development and fixed costs such as TFT-LCDs (thin film transistor liquid crystal displays). Here, too, Japan’s electronics giants have begun to join forces. Toshiba and Matsushita Electric Industrial, for example, recently announced a joint venture for the construction of the world’s largest TFT-LCD factory in Singapore (Toshiba press release, 24 April 2001).17 In one respect, this proliferation of joint ventures as a result of the increasing cost and complexity represents the continuation of a long-established trend. Both Higashi and Okawa (1994) and Nabeyama and Shinada (1996) report on the growing number of joint ventures and other forms of strategic alliances found in the Japanese electronics industry. Particularly interesting in the context of this study is a detailed classification of alliances by six Japanese electronics firms (Hitachi, Toshiba, NEC, Fujitsu, Matsushita Electric Industrial and Sony) by purpose and type provided by Higashi and Okawa (1994: 66). This shows that in the period from 1945 to 1989, these six companies entered a total of 774 alliances. In the much shorter period from 1990 to 1994, the number reached 515. What is more, while pre-1990, ‘increasing market presence’ was by far the most common purpose of such tie-ups, accounting for 55.6 per cent of the total, for the 1990–94 period, that share decreased to 37.5 per cent. Instead, acquiring technology had taken centre stage: already the second most important motive during 1945–89 with 29.1 per cent, it gained top position in 1990–94, accounting for 39.4 per cent of all alliances.18 Compared with these two motives and with the exception of

Pyramids under pressure 97 ‘adding to the product line’ (16.9 per cent in 1990–94), all other motives (‘cut costs’, ‘set standards’, ‘withdraw from business’) were insignificant. These figures clearly demonstrate that firms increasingly look beyond their established keiretsu network to forge new business relationships, and technology is the major driving force behind this trend. While strategic alliances are nothing new in the Japanese electronics industry, what is new is the proliferation of such alliances between domestic rivals. The rationale behind such domestic alliances, however, differs from those with foreign companies. Higashi and Okawa (1994) observe that strategic alliances with foreign partners – which in fact during the period they studied made up roughly twothirds of the total – typically involved a give and take of technology or a joint project to develop a new technology. However, [i]n Japan’s electronics industry, the big companies possess the lion’s share of technological resources and generally have an oligopoly in R&D, and little interchange exists between the big companies. So companies that want to overcome the limitations in their technology often have no choice but to develop ties with a foreign company. That alliances between domestic rivals are only a recent phenomenon is also shown by a study by Nabeyama and Shinada (1996). Discussing the rising number of tie-ups found in the semiconductor sector, they provide a long, detailed list of international joint ventures entered into by Japanese semiconductor manufacturers. However, no mention of such alliances between two Japanese firms is made. The observed pattern in strategic alliances suggests that co-operation with foreign companies is primarily based on the complementarity of the technology base and capabilities of the firms involved. In contrast, in the case of joint ventures among Japanese companies, technologies and capabilities typically overlap; instead, the main motive seems to be the pooling of financial and human resources.19 It is therefore no coincidence that co-operation among Japanese rivals has mushroomed only over the past few years: the outright contraction of the Japanese economy in 1998 further eroded electronics companies’ financial strength and hence weakened their resistance to cross keiretsu lines. A further aspect of how the technology issue is acting as a catalyst on interfirm relationships is the ever-increasing pace with which technologies are changing. By their very nature, strategic alliances such as joint R&D efforts or the pooling of technologies typically occur at the early phases of the product cycle. This is the stage when technologies are most fluid and an incumbent’s edge may be quickly undermined. Under these circumstances, being locked into a business relationship with one supplier may be detrimental to a firm’s competitiveness, as it would impede access to the most sophisticated or cost-efficient technology available.20 Given the growing cost and complexity of technology coupled with the accelerating pace of technological change, it would not only be uneconomical but virtually impossible for even the largest keiretsu to combine within their established networks all the capabilities necessary to compete at the leading edge.

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Pyramids under pressure

Consequently, as the pace of change has accelerated and technologies have become increasingly unstable, so networks have come to reflect the need for increased diversity and flexibility. Strategic alliances for the purpose of R&D and co-development efforts are one indication of this trend; another is the growing reliance on common suppliers as the case studies in the following chapters will show. Overall, the increase in strategic alliances has had a profound impact on the structure of Japanese production networks, and the role played by technology has been a major catalyst in this process. The growing prevalence of collaborative arrangements, initially primarily with foreign companies but, more recently, also with domestic rivals, shows how Japan’s electronics giants are reaching out beyond the confines of their traditional pyramids. No firm, not even Japan’s electronics giants, can sustain within the fold of their established networks all the capabilities and resources necessary to compete in today’s business climate that is characterized by increasingly rapid technological change. However, these new business relationships differ quite markedly from the pattern in the traditional production pyramid. Partners in a strategic alliance typically are firms of more or less equal standing where both sides bring (part of) their capabilities and resources to the table.21 What is more, other than for the purpose at hand (such as a joint venture), no ownership or coordination integration exists, and both the specific project and the resources committed to it typically represent only a fraction of the overall operations of the firms involved. Thus, while interfirm relationships in the production pyramid were of a vertical, hierarchical nature characterized by dependence and control, strategic alliances are based on a horizontal relationship of independent equals. Being limited and project-oriented, relationships also tend to be more disposable. Strategic alliances, of course, are not the only possible response to the challenge to stay abreast of the technology race. In many instances, parts and components incorporate technologies that are essential to product performance but not central to differentiating it from rival products.22 In such cases, the same logic as the one that has driven the growing prevalence of technology-motivated strategic alliances applies: the growing cost, complexity and pace of change of technology make it increasingly impossible even for the largest keiretsu networks to cover the whole range of parts and components in a timely and cost-efficient manner. Thus, to gain access to state-of-the-art components, assemblers are increasingly forced to broaden their supplier-base and often enter more flexible arrangements in order not to be locked into a particular relationship should the technological advantage shift elsewhere. Again, the relationship with such a supplier – a large firm independent of the assembler – is likely to be one between equals rather than one characterized by hierarchy and dependence. Yet, in contrast with strategic alliances, such changes have hardly been examined and consequently form a central part of the case studies in the following chapters. Interesting in this context are the findings of a study by Helper and Sako (1995) on the automotive industry, which reveals a trend among assemblers towards severing relationships with established suppliers. The reason given was that their suppliers’ efforts at continuous improvements were no longer paying off; assemblers therefore planned to

Pyramids under pressure 99 increase their total number of suppliers to tap the new supplier capabilities that they had discovered in purchasing for their overseas operations.

Concluding remarks The various data presented in this chapter provide some important evidence regarding changes in the overall structure of the Japanese electronics industry. The surveys on the sourcing patterns of Japanese overseas affiliates, for example, indicated that along with the growing experience in offshore production, procurements from non-affiliated and non-Japanese companies have generally risen. What is more, the internationalization of production has had a profound impact on procurement patterns in Japan, where the share of imported parts and components has been rising rapidly. On the one hand, trends such as these indicate that Japanese firms are taking an increasingly international approach in organizing their production, including the organization of their supply networks. On the other hand, established networks of domestic suppliers have suffered as a result. Though both assemblers and SMEs continue to rely on subcontracting arrangements, this mode of interfirm co-operation is weakening, suggesting that the bottom rungs of the production pyramid are beginning to disintegrate. The main single factor behind this development unquestionably are the cost pressures on domestic operations against the background of lower production costs abroad. However, of greater importance for the relationship between the parent firm and its kanren kigyo and hence for the pyramidal network type as a whole are the changes induced by the described technology-related trends. As no single firm or keiretsu can hope to develop internally all the capabilities necessary to compete in today’s fast-paced global market-place, co-operation with firms beyond the boundaries of established networks is spreading. The most visible aspect of this is the growing number of strategic alliances, though assembler–supplier relationships increasingly follow the same logic. For clarity of presentation, internationalization, the weakening of subcontracting links, and the proliferation of interfirm alliance beyond the keiretsu have been discussed in separate sections. Needless to say, these trends are in fact all closely intertwined. The connection between internationalization and domestic subcontracting arrangements has already been touched upon. Probably of equal if not even greater significance, however, is the link between internationalization and technology issues. In this context, a number of observers have noted that Japanese companies have been lagging behind in harnessing the technological potential of local firms especially in the East Asia region, though in recent years they have also intensified their efforts in this direction (Borrus 1997; Ernst 1997b; Ernst and Ravenhill 2000). Discerning a ‘new strategic thrust’ of Japanese firms in the Asia Pacific, Simon and Jun (1995), for example, observe that they have increasingly come to regard their regional counterparts as strategic partners. Thus, largely as a result of OEM (original equipment manufacturing) arrangements by Japanese companies, tiny Taiwan overtook Japan in 2000 as the world’s number one notebook computer manufacturer and became the number two producer of DRAM computer chips,

100

Pyramids under pressure

demonstrating at the same time the growing capabilities of Asian electronics firms and their increasing importance in the production networks of Japanese companies (FT, 7 June 2000; The Taiwan Economic News, 23 August 2000). Trends such as these, however, are difficult to discern from the aggregate data presented and discussed here. What is more, the electronics industry, rather than being a monolithic entity, comprises a wide variety of market segments, ranging from traditional consumer products such as TV sets and stereos via computers and telecommunications equipment to still evolving new gadgets such as personal digital assistants (PDAs) or digital cameras. Each of these market segments, has its own product cycle and technology trajectory that play a large role in shaping industry structure. In order to understand the overall developments outlined here more fully, it is therefore useful to look at particular market segments and trace their specific organizational patterns. This will be the task of the case studies in the next three chapters.

Appendix The following tables are reproduced from the unpublished Kigyo-kan Kankei Jitta Chosa [Survey on Interfirm Relationships] by the Small and Medium Enterprise Agency (1997b) and present the results for firms from the electrical machinery industry (author’s translation).

Survey of interfirm relationships (large companies) Companies using subcontractors (no., %) Total

Using subcontractors

Currently not using subcontractors

No subcontractors used either in past or at present

No answer

158 100.0

154 97.5

— —

4 2.5

2

No. of subcontractors compared with three years earlier (no., %) Total

Increase

Decrease

Almost no change

No answer

152 100.0

23 15.1

35 23.0

94 61.8

2

Dependence on subcontracting compared with three years earlier (no., %) Total

Large increase

Increase

Unchanged

Decrease

Large decrease

No answer

152 100.0

1 0.7

27 17.8

90 59.2

29 19.1

5 3.3

2

Pyramids under pressure 101 Reason for decrease in subcontracting work (multiple answers allowed)

Total Subcontractor became independent and no longer accepts subcontracting work Procurement from supplier other than subcontractor due to quality or price considerations Increase of overseas procurement Decrease of outsourcing due to increased in-house production (naiseika) Decrease in production due to decline in demand Subcontractor went bankrupt, closed business, moved or changed line of business Decrease of domestic outsourcing due to move to overseas production Other

No. of firms

Share in %

37 —

100.0 —

2

5.4

14 20

37.8 54.1

11 1

29.7 2.7

11

29.7

4

10.8

Survey of interfirm relationships (small and medium enterprises) Percentage of SMEs involved in subcontracting work (no., %) Total

Involved in subcontracting

Involved in subcontracting in the past but not now

Involved in subcontracting neither in past nor at present

No answer

629 100.0

483 76.8

19 3.0

127 20.2

8

Ratio of subcontracting work compared with three years earlier (no., %) Total

Large increase

Increase

No change

Decrease

Large decrease

No answer

489 100.0

5 1.0

50 10.2

318 65.0

76 15.5

40 8.2

13

Number of oya kigyo compared with three years earlier (no., %) Total

Large increase

Increase

No change

Decrease

Large decrease

No answer

480 100.0

4 0.8

86 17.9

328 68.3

47 9.8

15 3.1

22

Background to the increase in the number of oya kigyo

Total Spread risk resulting from heavy dependence on main oya kigyo by establishing new business links Developed business with new customers because of decrease ease in orders from existing oya kigyo Developed business with new customers because of idle manufacturing capacity It became possible to develop business with new customers outside the keiretsu because the keiretsu-based trading system was abolished Other

Number

Share

85 26

100.0 30.6

43

50.6

9

10.6

2

2.4

5

5.9

Background to the decrease in the number of oya kigyo

Total

Number

Share

52

100.0

3

5.8

5

9.6

Business with other customers became impossible because keiretsu ties with special oya kigyo were strengthened No capacity to accept orders from other companies because order from special oya kigyo increased Business with existing oya kigyo ceased because unable to meet the latter’s requests Business with existing oya kigyo ceased because the latter moved production overseas Cancelled business with existing oya kigyo because it was unprofitable Developed original product and left subcontracting business Other

11

21.2

16

30.8

6 5 6

11.5 9.6 11.5

Dependence on oya kigyo compared with three years earlier (no., %) Total

Large increase

Increase

No change

Decrease

Large decrease

No answer

487 100.0

11 2.3

74 15.2

260 53.4

104 21.4

38 7.8

15

Plans regarding subcontracting in the future (no., %) Total

Concentrate on small no. of contractors; strengthen relationship

Increase no. of contractors; reduce reliance on main contractor

Develop marketable original products; leave subcontracting business

No particular plans; continue present situation

No answer

486 100.0

93 19.1

207 42.6

65 13.4

121 24.9

16

Note The term oya kigyo literally means ‘parent company’ which in English suggests a financial link. However, in Japanese, the meaning of the term is quite fluid, ranging from ‘major share holder’ to ‘major customer’ in the context of a subcontracting relationship that may or may not involve a financial link.

6

Overseas production of low-end consumer products

Introduction Looking at the various developments that have had an impact on Japanese production networks in the electronics industry, the shift to international production represents a major contributing factor. This move took off in earnest during the second half of the 1980s, triggered by increasing overseas competition, growing protectionism against exports from Japan, and the rapid appreciation of the yen. A large proportion of Japanese FDI in the electronics sector thus consisted of the relocation of production of low-end consumer products to export bases in the rest of the region, especially Southeast Asia. As a result, offshore production of colour TV sets and video tape recorders (VTRs), for example, first overtook domestic production in the early 1990s and by 2001 outstripped it by a factor of 23.0 for TVs and 7.7 for VTRs.1 The only production of this type of consumer products that remains in Japan is that of top-end models incorporating leading-edge technologies. Consequently, in order to study the production of low-end consumer products involving traditional procurement patterns, it is necessary to look abroad. Given this background, the case study in this chapter consists of a detailed analysis of the activities and procurement patterns of four Japanese electronics companies operating in Malaysia.2 Following the approach introduced in the previous chapters, the aim is to elucidate network configurations by focusing on the way the supply of parts and components is organized. The companies that are examined comprise two multinational set-makers (i.e. manufacturers of final products) and two large independent parts companies. The rationale for the inclusion of the parts companies is as follows: while the set-makers are well known, the parts makers remain comparatively obscure. The first objective therefore is to shed some light on the nature of these companies such as their size and scale of operation, the business environment in which they operate and their relationship with the set-makers. The studies of the two companies here thus provide concrete examples for the category of ‘common suppliers’ introduced in Chapter 3 that will play a prominent role not only in this but also in subsequent chapters. Overall, the case studies in this chapter bear few surprises and confirm the patterns described in the substantial body of literature on the Japanese electronics

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Overseas production of low-end consumer products

industry in Asia that has sprung up over the past decade: set-makers were found to source a large share of their supplies from group companies and other Japaneseaffiliated suppliers with whom they have had long-established business relations, and local embeddedness – despite efforts in that direction – remains low. It therefore seems fair to say that despite internationalization, pyramids have remained largely intact and at most are fraying at the fringes. However, what became clear during the case studies is that such arrangements lie in the logic of the nature and design of the products in question. The remainder of the chapter is organized as follows. The next section provides a background description of Japanese electronics production in Malaysia. It is followed by brief profiles of the companies that were studied. The main part of the case studies begins with the fourth section on network patterns, which outlines the set-makers’ procurement patterns as well as the parts makers’ sales and procurement patterns, thereby providing an indication of overall network arrangements. The fifth section offers an analysis of the observed configurations and puts them into a larger perspective, while the final section presents some concluding remarks.

Background Investment in Malaysia by the Japanese electronics industry has a comparatively long history: the first production bases here were established as early as the late 1960s. However, it was during the second half of the 1980s, in the wake of rapid yen appreciation and increased trade friction with the West, that Malaysia became a major destination for Japanese overseas investment. As a result, as of December 2001, there were in all 144 Japanese electronics production facilities in Malaysia, equivalent to slightly more than 10 per cent of the total of all Japanese overseas facilities in the electronics sector and behind only the United States (160 facilities) and China (330 facilities) on which the next wave of Japanese FDI during the 1990s concentrated.3 The choice of Malaysia – before it was eclipsed by the opening up of China – as the preferred destination for export production was based on a number of factors. Along with other countries in the region, Malaysia offered lower overhead costs such as land and utilities and low labour costs when compared with Japan. The main reason behind the selection of Malaysia over other ASEAN countries, however, seem to have been the political and social stability in the country and the general system of preferences (GSP) quota offered to Malaysia by industrialized countries under GATT rules (Guyton 1995). Tax and other investment incentives were also provided by other governments in the region and therefore probably less decisive. The main thrust of Japanese investment in the Southeast Asian region has been in the assembly of consumer electronic products for export as well as the production of associated parts and components. Consequently, in Malaysia, facilities engaged in the production of consumer electronic goods outnumber those dedicated to industrial electronics, while in North America and Europe the reverse is

Overseas production of low-end consumer products

105

the case. However, in recent years, Japanese companies have also begun to move offshore the assembly of low-end computer components and peripherals such as cathode-ray tube (CRT) monitors, floppy disc drives (FDD) and CD-ROM drives. As a result, offshore facilities are frequently engaged in the manufacture of more than one product category, that is, both consumer products such as colour TV sets (CTV) and video tape recorders (VTR) and industrial electronic products such as CD-ROM drives. In the case of facilities for final assembly, these are frequently located in designated Export Processing Zones. It is therefore not unusual for the export ratio of facilities operating here to reach 100 per cent. In contrast, a large proportion of the turnover of independent Japanese parts suppliers often derives from sales to local Japanese-affiliated final assemblers. The companies studied in this chapter are all located in various industrial estates around the capital, Kuala Lumpur. They consist of the Malaysian subsidiaries of two major multinational corporations, Hitachi Electronic Products Malaysia and JVC Electronics Malaysia, engaged primarily in the assembly of consumer electronic products and related parts and components, and the subsidiaries of two large independent parts companies, SMK Electronics Malaysia and Omron Malaysia. The former of the two parts companies concentrates mainly on the manufacture of remote control units for the large set-makers, while the latter produces relays and sockets for various electronic appliances. The companies that were chosen thus offer a fairly representative picture of the main thrust of Japanese activity in the country.

Company profiles This section provides brief profiles of each of the companies that were studied.4 The aim is to give a general idea of the respective nature and scale of operations that underlie the organization of production. Procurements as an indicator of network patterns will then be addressed in the following section. Hitachi Electronic Products Malaysia Hitachi Electronic Products Malaysia (HEPM) is a wholly owned subsidiary of Hitachi, Ltd. The Japanese parent is one of the undisputed industry giants with activities ranging from heavy electrical (such as nuclear power plants and highspeed trains) via so-called white goods (refrigerators, washing machines, etc.), industrial electronics (telecommunications equipment, PCs, etc.) to consumer electronics. HEPM, the conglomerate’s third out of four Malaysian subsidiaries, was established in 1989. Its initial purpose was the assembly of printed circuit boards (PCBs) for VTRs and CTVs as well as the assembly of VTR sets. In later years, the assembly of CTV sets as well as core components such as cylinders, deflection yokes and integrated tube components followed. Operations were further expanded in 1998 to include the assembly of CD-ROM drives, though VTR components and the final assembly of VTR sets continue to constitute by far the largest share of overall production.

106

Overseas production of low-end consumer products

The scale of operations is quite large. By 1997, the total number of VTR sets produced had surpassed 5 million, while the number of employees (in 1998) had reached 1,700. Paid-up capital amounted to Malaysian Rupees (RM) 30 million. Given the type of products that are assembled here, state-of-the-art technology is used. For example, a semi-automatic manufacturing system is employed for the assembly of VTR sets, including micron-level manufacturing technology for the production of VTR cylinder heads. Moreover, fully automated mounting technology is used for the production of CD-ROM PCBs. JVC Electronics Malaysia Established in March 1988, JVC Electronics Malaysia ( JEM) is a wholly owned subsidiary of the Victor Company of Japan Limited. The parent is one of the country’s larger consumer electronics manufacturers that, after having run into financial troubles, was bailed out in 1954 by the electronics giant Matsushita Electric Industries, which now owns 52 per cent of the company’s shares. With paid-up capital amounting to RM93 million, JEM employs approximately 3,000 workers. Hundred per cent of its production is designated for export. Operations at JEM concentrate primarily on the manufacture of audio products like radio cassette recorders with CD players, Hi-fi cassette decks and mini-stereo systems with CD players. According to the company brochure, JEM is ‘probably the leading plant in the manufacturing of audio products for JVC’. In addition, the company produces key parts for video-players such as capstan motors, drum motors and drums, and assembles VTR heads. Approximately 70 per cent of these parts (in value terms) are sold internally, that is to other JVC companies, primarily JVC Indonesia, which concentrates on VTR assembly. Recently, the assembly of FDD motors has been added. Reflecting the central role JEM plays in JVC’s overall audio production, assembly lines are highly automated. Similarly, given the high degree of precision required for the manufacture of motors and other parts, production relies on a line-up of sophisticated machinery such as wiring machines and SMT (surface mount technology) system lines. SMK Electronics Malaysia SMK Electronics Malaysia is a wholly owned subsidiary of SMK Corporation in Japan. Established in 1925, the parent company is one of the country’s large independent suppliers to the electronics industry, specializing in a range of parts and components including general electronic parts such as jacks and plugs, power supplies, radio frequency components, connectors and switches as well as components such as remote control units, keyboards and pointing devices. In 2001, SMK Corporation achieved a turnover of ¥60.75 billion (around US$500 million) and had an overseas network incorporating production facilities in the US, Mexico, the UK, Hungary, Korea, Taiwan, Hong Kong, China, the Philippines and Malaysia.

Overseas production of low-end consumer products

107

The Malaysian subsidiary was established in 1989 with paid-up capital amounting to RM30 million. It has approximately 1,200 employees and engages primarily in the manufacture of remote control units, which make up around 70 per cent of total production, as well as CRT sockets, control panels, game controllers, etc., and general electronic parts such as jacks, connectors and adaptors. Among its customers are many of Japan’s electronics giants, including Sony (the most important single client), Aiwa, Hitachi, JVC, Sharp, Toshiba, Sega, etc., as well as a small number of non-Japanese companies, including Hewlett Packard and Xerox. Similar to the set-makers described earlier, SMK Malaysia employs stateof-the-art equipment like chip mounters, mould injection machines, printers for solder cream and tampo print machines. Moreover, in 1997, an R&D centre for the development of remote control units was set up in Malaysia in order to be able to respond more quickly to customers’ requirements, with R&D activities consisting of the development of electric circuitry as well as mechanical parts. Omron Malaysia Set up in 1973, that is, well before the other Japanese overseas subsidiaries considered here, Omron Malaysia represents the first step into Asia by its Japanese parent, Omron Corporation. The latter was established in 1933 and these days is active primarily in areas such as industrial automation, service automation, healthcare automation and information processing, providing components as well as systems and support services. In 2001, it had about 25,400 employees in over 35 countries around the world and a turnover of US$4.0 billion. Omron Malaysia is 90 per cent-owned by Omron Corporation and forms part of the parent’s industrial business group, which, among other things, manufactures and supplies electronic control components to manufacturers of consumer and other electronic products. The Malaysian subsidiary is principally involved in the manufacture of relays and sockets (i.e. general electronic parts) for the use in appliances and equipment like personal computers, TV sets, VTRs, air-conditioners, fax machines and photocopiers, and communication relays used in telephone exchanges. Employment in 1999 stood at 1,200 workers. As in the other cases, state-of-the-art equipment and machinery are being used, though the technological know-how is provided by Omron Corporation in Japan.

Network patterns Regarding procurement patterns and hence network configurations, the four case studies yielded few surprises and in general confirmed the accounts presented in the literature: while set-makers were attempting to localize and/or regionalize procurements, imports from Japan continued to play a significant role, especially for many of the core components. In contrast, though hardly surprising given the considerably lower complexity of their operations, the parts suppliers displayed much lower import ratios from Japan, though their local embeddedness also remained limited.

108

Overseas production of low-end consumer products

The set-makers The overseas operations of the two set-makers span a considerable range of activities. Though initially established for the assembly of consumer electronic products, the production of some parts and components and, more recently, of industrial electronic products were added over the years. As a result, in tracking procurement patterns it is not always possible to neatly separate between purchases for consumer goods and purchases for industrial goods. The evidence provided here therefore offers a combination of information on procurements for the overseas subsidiary as a whole as well as for individual products. However, taken together such information yields a fairly detailed mosaic of general network arrangements. Starting with JVC Electronics Malaysia ( JEM), one indicator of overall network arrangements is the regional sourcing pattern of parts and components for the company’s audio products. Broken down by country of origin and on a value basis, local supplies (i.e. from Malaysia) in 1999 made up 48.7 per cent of the total – by far the largest share. This was followed by imports from Japan which made up 38.6 per cent. The remaining 12.7 per cent accrued to a number of countries led by Singapore (5.0 per cent) and followed by China (3.7 per cent), Thailand (1.8 per cent) and Indonesia (1.0 per cent). While a further breakdown for audio parts alone was not available, overall procurements could be subdivided as follows. Of the local supplies, approximately 60 per cent were obtained from Japanese-affiliated companies with which JVC already had had business relationships back in Japan and which, in general, had followed JVC to Malaysia. The remaining 40 per cent of local purchases derived from local companies. In terms of the type of parts supplied, there were considerable differences between Japanese-affiliated and local suppliers: Japanese-affiliated firms tended to supply whole components. In contrast, local firms typically supplied plastic and metal parts. In the case of new products, the required plastic and metal parts were developed in Japan as was the tooling die, which JEM then provided to the local firms. Regarding purchases from Japan, approximately 50 per cent derived from JVC group-companies, with the optical pick-up for CD-players – a key component – being the single most important item. The other half of procurements from Japan was obtained from unaffiliated Japanese companies with which, however, JVC had in most cases been doing business for 20 or 30 years. Parts and components – so-called ‘semi-kits’ – were purchased by JVC Japan and then sent to JEM. Referring back to the distinction between mechanical, electronic and structural/cosmetic parts introduced in Chapter 3, the procurements for a ‘Minicomponent’ (mini-stereo tower) on a value-basis can be broken down as follows: ●

25% – mechanical parts: mechanisms and PCB for CD-, MD- and cassetteplayers; of these: –

10% come from Japan; 90% from Malaysia; of the latter: ●

60% from Japanese-affiliated firms; 40% from local firms (see above);

Overseas production of low-end consumer products ●

60% – electrical/electronic parts: PCB for amplifier; power, tuner, etc.; of these: –

●

109

90% approx. from Japanese-affiliated firms; 10% from local firms;

15% – cosmetic (plastic) parts; of these: –

100% from local firms.

Taking the various figures together, clear differences can be seen in the roles played by Japanese firms in Japan (group and otherwise), Japanese-affiliated firms in Malaysia, and local Malaysian firms, in terms of the type of parts and components they supply. Key components (such as CD optical pick-ups) were procured from the parent in Japan. Other sophisticated components (‘semi-kits’ such as mechanisms as well as PCBs) were either imported from non-group companies in Japan or procured from Japanese-affiliated suppliers in Malaysia. With only a few exceptions (relatively basic general electronic parts) local companies were primarily involved in the supply of plastic cosmetic parts and, to a smaller extent, plastic and metal mechanical parts. Moreover, the relatively sophisticated process of tool die-making remained in the hands of the set-maker. Procurement patterns at Hitachi Electronic Products Malaysia (HEPM), if anything, show an even greater reliance on group companies – reflecting the monolithic nature of the Hitachi keiretsu – and on other Japanese companies. Table 6.1

Table 6.1 Purchases by HEPM for April to September 1999 Country of origin

%

Part type and supplier ( Japanese, Hitachi group)

Total Knock-down Procurement

100.0 9.2 90.8

Video head (Hitachi Japan)

Japan

33.5

Malaysia

27.5

Thailand

7.3

Singapore

4.7

China

12.7

India Others (Korea, Taiwan, Vietnam)

2.2 3.2

IC, Semiconductors (custom parts from NEC, Panasonic, etc.) 14⬙ picture tube (Taiwanese), tuner, remote control, metal stamping and plastic parts (50:50 Japanese and local), standard electric parts (e.g. capacitor, resistor), motor VTR mechanism semi-assembly (Hitachi Japan designed) PCB (designed by Hitachi Japan and sometimes HEPM), standard electric parts 21⬙ picture tube, optical pick-up unit for CD-ROM, LCD display for VTR, VTR motor 14⬙ picture tube, speaker Mechanism assembly, front panel assembly (plastic)

Source: Author’s interview. Note Shares add up to more than 100.0% due to rounding.

110

Overseas production of low-end consumer products

provides a breakdown of the purchases of parts and components for production at HEPM for April to September 1999 for all products. Of the total purchases during that period, 9.2 per cent in value-terms were classified as knock-down parts, that is, parts that are supplied by the mother factory in Japan. In HEPM’s case that is Hitachi’s Tokai Works (currently falling under the Digital Media Products Group) or the Yokohama Works (currently falling under the Digital Media Systems Group) and the parts in question were video heads. The remaining 90.8 per cent of purchases by HEPM were considered procurements, consisting of supplies from other companies, including Hitachi subsidiaries in Japan or elsewhere. (In the table, parts procured from Hitachi group companies are bold and underlined, parts obtained from Japanese-affiliated but non-Hitachi-group companies are bold.) In addition to the video-heads sourced from the mother factory, a third of total purchases consisted of imported parts and components from Japan, bringing the share of imports from Japan to 42.7 per cent of total purchases. Procurements from Japan primarily consisted of integrated circuits obtained from Hitachi group companies and other semiconductors sourced from rival giants such as NEC or Panasonic. Local procurements from within Malaysia accounted for 27.5 per cent of total purchases. Major items were motors bought from another Hitachi subsidiary; tuners, remote controls and standard electric parts (such as capacitors, resistors, etc.) supplied by Japanese-affiliated firms; metal stamping and plastic parts, with Japanese-affiliated and local firms accounting for about 50 per cent each; and 14inch cathode-ray tubes for colour TV sets supplied by a Taiwanese firm. The remainder – 30.1 per cent of total purchases – was sourced from various countries in the region, again with a heavy concentration on Hitachi group companies as well as other Japanese-affiliated companies. Thus, 21-inch CRTs (as well as the optical pick-up units for CD-ROMs) were obtained from Hitachi subsidiaries in China, while other parts and components were obtained from Japanese-affiliated companies: the VTR mechanism semi-assembly – designed by Hitachi Japan – was sourced from a parts maker located in Thailand; PCBs – also designed either by Hitachi Japan or sometimes HEPM – and standard electric parts were procured from Japanese affiliates in Singapore, and LCD displays for VTRs, VTR motors, speakers and mechanism assemblies came from Japanese parts suppliers in China, India and other countries in the region. In fact, the only third-country procurements from non-Japanese-affiliated companies were 14-inch picture tubes and plastic front panel assemblies for VTRs. The general pattern that thus emerges regarding the type of supplier and type of parts supplied can be summarized as follows. Sophisticated key parts and components such as optical pickups, video-heads, larger-sized (i.e. 21-inch) CRTs and integrated circuits were procured from group companies either in Japan or abroad. General electric and electronic parts – most of them of a standard nature, though some were custom-made such as semiconductors supplied by other electronics giants – as well as custom-made electronic and mechanical components (such as PCBs or mechanism assemblies designed by the set-maker) were sourced from fairly large independent Japanese makers either back in Japan, in Malaysia,

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111

or in third countries. A small number of relatively non-sophisticated components were sourced from non-Japanese firms in third countries or in Malaysia. Finally, local companies supplied metal stamping and plastic parts, for which, however, they frequently relied on the parent company to supply the tooling dies. Turning to the nature of interfirm transactions, these were generally characterized by long-term relational contracting. Typically, a business relationship with Japanese-affiliated suppliers located in Malaysia or in third-countries had already existed back in Japan, sometimes dating back a number of decades. Moreover, HEPM has a local kyo¯ryokukai just as a Hitachi firm would in Japan: approximately 100 of its most important suppliers are regularly invited to meetings at which production plans and future developments are discussed. The invited companies are almost exclusively Japanese and with 9 out of 10 of them Hitachi already used to do business in Japan. In other words, only about a tenth of the kyo¯ryokukai members in Malaysia are companies that are new to the Hitachi network of suppliers. Price negotiations between HEPM and its suppliers are usually conducted on a semi-annual, sometimes on a quarterly basis. In contrast with HEPM, JEM does not have a local ky¯oryokukai. However, the group’s various Asian operations – in addition to JEM these include JVC Electronics Singapore ( JES), JVC Electronics Indonesia ( JEIN) and JVC Shanghai ( JSC) – assemble their suppliers at an annual ‘ASEAN purchasing meeting’ in Johor Bahru (Malaysia). At this meeting, JVC introduces and explains to its suppliers its policy and business plan for the coming two years and requests suppliers to prepare the necessary resources (man-power, technological skills, etc.) for new projects. Thus, while there is no ky¯oryokukai, the ‘purchasing meeting’ closely resembles the ‘discussion group’ (shu¯kai) for common suppliers described in Chapter 3, so the approach of orchestrating procurements through the established mechanism of annual meetings with suppliers in the region in this case, too, resembles patterns found in Japan. The parts companies In order to illustrate in greater detail network patterns not only in Malaysia but also in Japan it is quite instructive to shift the vantage point for a moment and have a closer look at the large independent suppliers of general electronic parts. Though often ignored in the literature on the Japanese production system, the independent parts makers do in fact play a tangible – and growing – role in overall network arrangements, not only simply in terms of the share of parts and components procured from them but also through the contribution of their specialized know-how in the design and production of certain components. The local subsidiaries of the two parts makers examined here are a case in point. The first of these, Omron Malaysia, was established as early as 1973 and is primarily engaged in the production of general electric parts. Reflecting its comparatively long history in the country as well as the nature of its parts, Omron Malaysia’s customer base is quite diverse, with European, American, and Japanese companies each making up approximately one-third of total sales.5 In contrast, SMK Electronics (Malaysia) was set up much later, in 1989, and

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forms part of the wave of Japanese foreign direct investment triggered by rapid yen appreciation and growing trade friction during that decade. While about a quarter of SMK Electronics’ production (in value terms) also consists of general electronic parts, by far the largest share is made up of the production of wireless remote control units for audio–video (AV) equipment, air conditioners, etc., which are sold to Japanese set-makers such as Kenwood, JVC, Aiwa and Yamaha. The remainder (approximately 5 per cent) of production is accounted for by panels for printers, faxes, etc., for which Hewlett-Packard and Xerox from the US were the main customers. Both companies described their business situation in fairly similar terms, stressing, for example, that theirs were highly competitive markets with a considerable number of rival firms. While they developed their own products, their competitive strength primarily rested on their production engineering capabilities for general electronic parts rather than the particular specifications of their products. Apart from offering a competitive combination of quality, price and reliable delivery, their success very much depended on the ability to deal quickly and effectively with problems and/or special requests as they arise. Omron Malaysia, for example, would typically develop a standard component that would then be sold on to the parent company’s sales division with its worldwide offices. However, such standardized parts that were sold directly to the market only accounted for half of the company’s sales. The other half consisted of customized parts that would be adaptations of these standardized types using, for example, different contact materials, colours, or special materials for greater heat resistance. Specifications for such customized parts (as well as ideas for new products) would be supplied by the company’s sales engineers after discussions with customers that would frequently also involve visits of customers’ factories. A particularly instructive case is the production of remote controls by SMK Electronics (Malaysia). These are either of a standardized nature, that is, developed by SMK and then sold directly to various set-makers where only the name plate would be different. (However, none are sold on the open market.) Or they are customized, in which case the set-maker provides various rival suppliers with design and other general specifications. SMK and its rivals then develop prototypes and submit these with a quote, from which the set-maker then makes its choice. This way of going about outsourcing component production is quite different from the past. While there is nothing new in the fact that set-makers take their potential orders to various suppliers in search for the lowest costs, until the end of the 1980s/beginning of the 1990s, set-makers would have developed the component in question and then asked the supplier to manufacture it according to the detailed design and circuit plans provided. However, over the past decade or so, as component technologies have become more complex, set-makers have also gradually handed over the task of detailed product development to the suppliers. Consequently, SMK Malaysia set up a local R&D centre in the late 1990s in order to speed up the development process for remote control units.6 In 1999, approximately 60 per cent of all remote controls manufactured by SMK Malaysia were developed locally, with the remaining 40 per cent developed in Japan.

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These examples illustrate clearly how large independent parts makers such as Omron and SMK Electronics act as common suppliers to the electronics industry that are bound to no particular parent company and sell to all set-makers alike. Yet, at the same time, the examples also show that as soon as customization is required, transactions can no longer be defined as approximating market exchange. Instead, elements of relational contracting enter the picture that, however, are not based on ownership integration or other forms of dependence. On the contrary, as the outsourcing of remote control units has shown, set-makers and common suppliers stand more or less on an equal footing where both sides gain from the information flow and the stability and predictability that relational contracting afford. Turning briefly to the procurements of the parts makers themselves, the patterns for the two companies were quite different. Omron’s local content ratio was almost 90 per cent, though of this, approximately 70 per cent was produced by the company’s internal parts manufacturing operations, with the remaining 30 per cent being procured from Malaysian companies. The reason for the high in-house production ratio is that especially until the late 1980s, it was difficult to find suitable local suppliers. The remaining 10 per cent of parts used by Omron Malaysia were imported from the parent company in Japan. These were particularly commonly used parts that were not necessarily high-tech and could also be manufactured in Malaysia, but were cheaper to produce in Japan due to the higher volume. In contrast, SMK Electronics’ procurements resembled more closely those of the set-makers in that they also relied to a considerable extent on Japaneseaffiliated firms in Malaysia and the region: approximately 40 per cent of the company’s parts supplies were sourced locally, with about a quarter of this share accruing to Japanese-affiliated firms. A further 50 per cent of total parts supplies derived from the rest of Asia, with purchases of standard electronic parts such as ICs, LEDs and condensers from the regional sales offices of Japanese companies in Singapore making up about nine-tenths of this share. The remaining tenth of this share hailed from Korea and Hong Kong. Finally, the remaining 10 per cent of the total consisted of imports from Japan. Thus, while overall displaying a slightly greater local embeddedness than the set-makers, the share of parts procured from Malaysian or third-country firms remained nevertheless quite low: in neither of the two cases studied here did the share of local firms in total purchases exceed 30 per cent. Moreover, as in the case of the set-makers, procurements from local firms entirely consisted of plastic moulding and metal stamping parts, with the parts designed by the Japanese parts maker which typically also supplied the tooling dies.

Analysis As a whole, the network patterns that have come to light in the case studies presented here correspond closely to the findings of other studies on Japanese electronics production in the rest of Asia. This can be described almost as a wholesale

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transfer of the Japanese production system with much of the pyramidal organizational structure remaining intact. Tsuda and Shinada (1995: 51), for example, found that […] almost all the [suppliers] of locally produced parts and materials are Japanese affiliated local plants; furthermore, virtually 100% of the production equipment is from Japan. Therefore, even if it is called overseas process production, one could say that the entire Japanese production system has been transferred overseas, since Japanese affiliates handle practically every step from start to finish, including supplying the supporting industries. Guyton (1995: 65), who also conducted research on Japanese consumer electronics production in Malaysia, observed: Fieldwork conducted for this study found that while the Japanese subsidiaries are creating forward and backward linkages through Malaysian procurement and local sales, this is minimal compared to the amount of linkages occurring between subsidiaries of the same company, or between firms of the same keiretsu group. Not all observers of the Japanese electronics industry would subscribe to this view. Ernst (Ernst 1997b, 2000; Ernst and Ravenhill 2000), for example, thinks that by the mid-1990s some Japanese networks had begun to open up, to become more embedded in the local economy and to develop a regional supply base. However, his examples are mainly drawn from the computer rather than the consumer electronics industry where, as the following chapter will show, Asian suppliers are indeed playing a much greater role. In contrast, in the consumer sector, the part played by non-Japanese firms remains extremely limited. In the cases presented here, with the exception of a small number of comparatively low-end standard components (such as small-sized picture tubes), the participation of non-Japanese firms was limited to plastic moulding and metal stamping parts. Teranishi and Yamasaki (1995: 26fn) describe the transfer of production in the wake of the continued yen appreciation during the second half of the 1980s and the early 1990s itself in terms of a pyramid: [A]s the yen continues to strengthen, more and more operations by captives or other suppliers (typically low-wage, labor-intensive operations) are shifted out of Japan; since February 1993, in fact, the structure of Japanese electronics manufacturing activities overseas has increasingly come to resemble a pyramid. In terms of the production pyramid outlined in Chapter 3, such low-wage, labour-intensive operations have traditionally been supplied primarily by smalland medium-sized third- or fourth-tier subcontractors in Japan. However, few of these companies can afford to move overseas. Consequently, Japanese companies

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overseas have either set up in-house parts production (as in the case of Omron Malaysia) or have gradually begun to build up a network of local suppliers that engage in the low-value-added operations of plastic moulding and metal stamping. However, all four companies examined here indicated that while their aim was to further increase local procurement ratios, progress has been hampered by the scarcity of indigenous firms that were able to meet their demanding quality and reliability requirements. Efforts to increase local procurements thus have primarily meant a greater reliance on Japanese-affiliated parts suppliers in the country or the region. Consequently, while there is now some local participation in Japanese production networks, this remains limited to the fringes. However, this does not mean that production pyramids have remained completely unaffected by the move to overseas production. In Chapter 5, it was argued that Japanese companies overseas were more willing to disregard existing business relationships and engage in new ones. For example, customers of companies such as SMK Electronics Malaysia or Omron Malaysia may have had established business relations back in Japan. In Malaysia, however, as suggested by the broad customer base of these two parts-makers as well as the manner in which contracts are awarded, set-makers appear to choose their suppliers quite freely. Instead of any existing business links, what increasingly seems to matter are suppliers’ independent technological capabilities. The outsourcing not only of the production of certain parts and components but also of their development can only further contribute to this trend. In contrast with other segments of the industry, however, the trend towards looser business relationships as exemplified by a greater reliance on common suppliers remains rather limited in the production of traditional consumer electronic products. Overall, networks in this field continue to be dominated by keiretsu ties and other long-standing business relationships as is evidenced by the fact that 9 out of 10 of HEPM’s most important suppliers in Malaysia were companies with which the parent had already done business in Japan. This persistence of a hierarchical network approach closely resembling the production pyramids in Japan raises the question as to why this organizational structure has endured. The explanation, it seems, lies in the nature of the products and the history of competition. Traditional AV-products such as (conventional CRT) TV sets, VTRs or stereos are based on analogue technology and tend to be comparatively bulky. As a result, mechanical and structural parts make up a substantial proportion of the total. In the case of JVC’s ‘mini-component’ stereo-tower mentioned earlier, mechanical and cosmetic (i.e. plastic) parts together made up around 40 per cent of the cost, while in the case of Hitachi’s VTRs approximately 40–50 per cent of the cost is occupied by mechanisms and cylinders and a further 10–15 per cent by cosmetic parts. What is more, from the beginning, Japanese firms have pursued competitive strategies that build on model proliferation to suit (and generate) a large variety of tastes. HEPM’s VTRs, for example, are adapted to suit local tastes as well as different tastes in different overseas markets. As a result, in order to meet diverse preferences, the company

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sells different models or different versions of the same model in the US market, in the European market, and in the Asian market (in addition to the Japanese market which is controlled from Japan), where both the outside appearance and the parts inside differ. The upshot of the high share of mechanical and structural/cosmetic parts and model proliferation is this: the number of different plastic and metal parts, semi-assemblies (of various mechanisms, for example), but also of PCBs, required to produce such a large variety is high or, conversely, the share of standard components is rather low. The large share of and heavy reliance on customized parts and components in turn, however, necessitate a closely integrated network of dedicated suppliers, which explains why pyramidal production networks in Japan took the shape they did and why there has been little change when the production system was transferred overseas. Though companies had certainly thought about increasing the share of standardized, ‘off-the-shelf ’ parts in order to be able to choose suppliers more freely, this rarely proved practical: other considerations such as quality and delivery conditions also came into play, suggesting that local business conditions such as the lack of sufficiently skilled local firms were also responsible. Against this background, standardization efforts rather take another shape, consisting of attempts to minimize the number of different parts needed for different models. In the case of Hitachi’s VTR, for example, approximately 80 per cent of all parts were used in all models and the target was to use one common PCB (rather than the three or four used in 1999) and one chassis as well as only one or two front panels for each of the different markets. However, these aims were described as very difficult to achieve. Moreover, such parts would still be company-specific rather than off-the-shelf, meaning that they would still have to be procured from dedicated suppliers. Certainly a host of other reasons – such as the ‘vintage factor’,7 the lack of suitable local firms, business culture, etc. – are likely to have contributed to the wholesale transfer of the Japanese production system for the manufacture of traditional consumer electronic products. However, a major reason seems to be that pyramidal network structures are based on an internal logic that is determined by the nature of these products as well as the trajectory of competition in the industry.8 Consequently, the observed network patterns are likely to persist and any change will at best be gradual.

Concluding remarks The case studies in this chapter have shown that as far as the production of traditional consumer electronic products such as TVs, VTRs or stereo-systems in Malaysia is concerned, network arrangements closely resemble those outlined in Chapter 3: the pyramidal structure has remained intact, both ownership and coordination integration were tight. In the case of the set-makers, the parent as well as other keiretsu members supplied key and a large share of other components. Other suppliers were primarily Japanese-affiliated companies in Malaysia and the

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region, with which the set-makers had already been doing business in Japan – for 20 or 30 years in some instances. Moreover, both set-makers had institutionalized mechanisms for coordinating their suppliers: in one case (HEPM) there was a ky¯oryokukai just as in Japan; in the other ( JEM), a regular regional suppliers meeting was organized that fulfilled a similar function. Local or other non-Japanese firms played a negligible role in overall network arrangements. These patterns, however, do not mean that set-makers were not considering using suppliers outside their established networks. As the examples of the independent parts makers have shown, there exists considerable competition between such companies, and their role in overall network arrangements is anything but negligible. However, while set-makers may have felt less constrained by existing business relationships when choosing their suppliers in Malaysia, the overall impact on network patterns has remained peripheral. In the analysis, it was suggested that apart from reasons such as the lack of suitable local suppliers, the nature of the products involved played a critical role in determining network patterns. In particular, it was highlighted that traditional consumer electronic products relied on analogue technology, were comparatively bulky and, in cases such as VTRs or mini-stereos incorporating cassette players, contain a considerable share of mechanical parts. In contrast, more recent products such as PCs or digital cameras, display considerably different configurations of attributes. The importance of these attributes, that is, the nature of the product involved, for network patterns will become clearer as the discussion progresses to address these market segments in the following two chapters. These will show that the configuration of networks has changed where this was necessary. The implication for the production of traditional consumer products is that the pyramid network appears to remain the most efficient organizational structure for the purpose at hand.

7

Personal computers

Introduction Traditionally counted as an industrial electronic product, the personal computer (PC) is also a consumer product that has changed the way people work, live and play, and acted as a catalyst for far-reaching changes in the electronics industry. As the pioneering product of the digital era, it is both central to and emblematic of the convergence of the various segments of the electronics industry on or around a common, digital, standard. The technologies the PC has spurred – microprocessors (computers on a chip), memories, etc. – today can be found in a large range of other products that blur the traditional boundaries between industrial and consumer electronics, and its open architecture and interconnectivity have given rise to a large, unified information technology sector. As a result of such sweeping changes, the structure of the global electronics industry has not remained unaffected. The rise of the PC has led to a resurgence of American leadership in the industry and the emergence of countries such as Taiwan and South Korea as serious competitors; meanwhile, Japan’s once seemingly unstoppable conquest of world markets has stalled or even reversed (see Chapter 4). What is more, while American firms have regained the initiative and set the global industry standards – in which they were greatly helped by the successful creation of their own production networks in the East Asia region – Japanese PC manufacturers, as this chapter will show, were forced to completely overhaul their competitive strategy and remodel their network configurations. The story of the PC therefore clearly shows up the limitations of the traditional Japanese business approach as manifested in the production pyramids. The remainder of this chapter is organized as follows. The next section offers an overview of the developments in the Japanese PC industry over the past decade. The main reasons for Japan’s limited success in this industry segment as well as the implications for competitive strategies are presented. The section thus provides the background information necessary to understand the radical overhaul in procurement strategies that one Japanese PC manufacturer after another was forced to undertake. Case studies of this overhaul represent the core of this chapter, consisting of brief profiles of the PC operations of the three companies studied – NEC, Fujitsu and Hitachi – followed by a detailed investigation of the

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procurement patterns for each of these companies around 1990 and 2000 and the analysis of the findings based on interviews carried out by the author with executives in the PC divisions of the three companies.1 The final section offers some concluding remarks.

Industry background Personal computers represent a market segment in which Japanese companies – despite great strides during the 1970s and 1980s and in contrast with consumer electronics – never managed quite to catch up with their American counterparts. While Japan’s global export share in automatic data processing equipment drew almost level with that of the US during the second half of the 1980s (see Table 4.2), these exports consisted primarily of mainframe rather than personal computers.2 What is more, during the past decade, the gap with the US in terms of global export share has widened again and American firms clearly dominate the industry: in 2002, the top three global PC vendors were all from the US, accounting for over a third of worldwide PC shipments between them, while the Japanese market-leader NEC came in fourth place with a market-share of only 3.4 per cent (see Table 7.1). Japan’s comparatively weak position in the global PC market confirms the impression that the country has generally lagged behind in the adoption of information technologies and particularly of downsized computer systems (e.g. Kokuryo 1997). The reasons are numerous, though the single most important factor appears to have been the Japanese language. When PCs were first introduced, the singlebyte operating systems that Western countries had adopted were insufficient for representing the thousands of characters (kanji) of the Japanese writing system. Manufacturers therefore had to develop double-byte operating systems that could run Japanese-language software. With the US-leader Microsoft too busy with the home market to develop a fully fledged Japanese version of its operating system

Table 7.1 Worldwide PC shipments (share in %; million units) Company

1999

2000

2001

2002

Hewlett-Packard Dell IBM NEC Toshiba Gateway Others Total Million units

20.4 9.7 7.9 5.1 — 4.0 53.2 100.0 117.63

20.4 10.8 6.8 4.3 — 3.8 53.9 100.0 134.74

18.4 13.2 6.4 3.8 2.8 — 55.4 100.0 128.93

16.2 15.2 6.0 3.4 3.2 — 55.9 100.0 132.35

Source: Gartner Dataquest (various online press releases). Note Data include desk-based PCs, mobile PCs and PC servers. The Hewlett-Packard shares for 1999–2001 include those for Compaq, which merged with HP in 2002.

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MS-DOS, manufacturers ended up each adapting the nucleus of MS-DOS to their own purposes (Boyd 1997). This also allowed Japanese PC manufacturers to continue pursuing their traditional competitive strategy which aimed to ‘enclose’ end-users by locking these in through the purchase of proprietary products that had little compatibility with other firms’ products. Emblematic of the situation in the Japanese market was the fact that software stores would have separate shelves for each major PC manufacturer (Kokuryo 1997). This lack of compatibility stunted the growth of the Japanese PC market. Development costs both for hardware and software were high and domestic prices markedly above those in Europe or the US, meaning that Japanese firms missed the chance to position themselves in the global market as it took off. The result was an inward-looking industry, where only a small share of total production was exported and one firm, NEC, controlled over 50 per cent of the domestic market.3 However, at the beginning of the last decade, American PC makers began to make serious inroads into the Japanese market. In 1990, IBM Japan developed a software- rather than hardware-based solution for handling kanji input, taking advantage of more powerful microprocessors coming from Intel. The result was an alternative operating system, DOS/V, which the company made available to the rest of the industry in order to gain support for its Open Architecture Developers’ Group (OADG) which it set up in 1991. The aim was to rally the industry behind a common standard which ultimately would create a more level playing field. Even greater upheaval followed the so-called ‘Compaq Shock’ in 1992, when the American company launched its series of low-priced PCs on the Japanese market, costing only about half as much as an average locally made PC. IBM quickly followed suit with its own line of inexpensive PCs and domestic manufactures such as NEC had no choice but to lower prices as well. Within three years, PC prices in Japan were driven down by 37 per cent and the Japanese market finally took off (BusinessWeek, 19 February 1996). Overall PC sales skyrocketed: American firms seized about one-third of the market, while at the same time annual PC production in Japan tripled from around 3 million units in the years 1990–93 to almost 9 million in 1996 (EIAJ 1997). The American assault on the Japanese market led Fujitsu, the number two in Japan, to abandon its proprietary architecture and in late 1993 switch camps to join the IBM-led OADG. Competition in Japan thus basically had been transformed into a three-way race between market-leader NEC with its PC98 series, the DOS/V group, and Apple Japan. NEC’s continued go-it-alone strategy was built on the belief that the far greater number of Japanese-language applications that had been developed for its PCs would act as a sufficient defence of its market position (Fransman 1995: 275). However, the company’s market share continued to decline relentlessly and after the successful introduction of Microsoft’s Windows 95 operating system, NEC finally surrendered and in 1997 also switched over to the standard IBM-architecture. Nevertheless, the company’s domestic market share – which in 1992 had stood at 54.3 per cent – continued to slide and now hovers around 20 per cent (see Table 7.2).

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Table 7.2 PC shipments in Japan (share in %; million units) Company NEC Fujitsu IBM-Japan Sony Toshiba Hitachi Apple Japan Compaq Sotec Dell Other Total Million units

1992 (Gartner)

1998 (Gartner)

1999 (Gartner)

53.4 9.8 6.1 — 7.6 — 8.3 — — — 14.8 100.0 2.23

24.6 23.3 10.2 — 7.1 5.5 — — — — 29.3 100.0 7.75

22.0 21.5 9.9 6.9 7.4 — — — — — 32.3 100.0 10.54

1999 (IDC)

2000 (IDC)

22.2 20.7 10.1 6.8 7.2 4.3 5.9 4.2 3.0 3.7 12.0 100.0 10.83

21.7 20.4 9.8 8.8 6.2 4.0 3.9 4.9 4.8 4.2 11.3 100.0 14.13

Sources: IDC Japan (various online press releases); Gartner Dataquest (various online press releases).

As a result of their pursuit of proprietary architectures for the domestic market, Japanese companies failed to establish themselves in the global PC scene at an early stage. By the time they did switch over to the international architecture, the market position of American firms had become so entrenched that it proved virtually unassailable. Japanese attempts to enter Western markets through acquisitions have shown at best mixed results. NEC, for example, entered an alliance with US computer manufacturer Packard Bell in 1995 and gradually built up an 88 per cent stake in the company. In 1999, however, most US operations of the company, which had been a drag on NEC’s results for years, were closed. Somewhat more successful was Fujitsu, which set up a joint-venture in 1999 with the computer division of Germany’s Siemens group. In 2002, Fujitsu–Siemens held a market share in Europe, the Middle East and Africa of 7.1 per cent, behind only Hewlett-Packard (with 19.0 per cent) and Dell (9.4 per cent), though globally Fujitsu’s share has remained much smaller.4 The only Japanese PC maker that has been doing well internationally is Toshiba with its line of portable computers, where the company for many years has been the market leader even in the US (Boyd 1997). Thus, overall, the success of Japan’s electronics companies in the PC market has been limited. What is more, within less than a decade, the PC industry has been radically transformed as a result of competitive pressures from foreign firms: at the beginning of the 1990s, the industry was characterized by a large diversity of non-compatible proprietary architectures and was, moreover, heavily dominated by NEC. By the end of the 1990s, however, all Japanese companies had succumbed to market pressures to switch over to the standard open architecture initiated by IBM. The only company that has managed to retain its own original architecture has been another American firm, Apple Computers.

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Company profiles The companies examined in the case studies in this chapter – NEC, Fujitsu and Hitachi – have, as this brief overview of the industry background has shown, all played a significant role in the Japanese PC industry. All three of them, moreover, are among Japan’s top ten industrial keiretsu with over a thousand affiliated companies between them. Personal computers therefore represent only one of the many business areas in which they are engaged. This section aims to provide a short profile of each of the companies and of the role that PCs play in their overall operations. NEC Established in 1899 as Nippon Electric Company, NEC began as a joint venture with Western Electric Company of the US, engaging in the production, sales and maintenance of telephones and switching systems. Since then, the company has grown into a multinational giant with 142,000 employees worldwide and net sales of ¥5.1 trillion (US$38.4 billion) in the financial year ending in March 2002. According to the research firm Cahners, NEC is the world’s sixth-largest electronics company.5 Following the latest reorganization of its activities, the company now sees itself primarily as an ‘Internet Solution Provider’. Its operations are divided into three ‘in-house companies’. The first of these, NEC Solutions, is responsible for internet solutions in enterprise and consumer markets and includes the company’s computer business (supercomputers, PCs, printers, solutions, e-business, etc.), which in FY2002 accounted for 40 per cent of total sales. The second ‘in-house company’, NEC Networks, provides ‘internet solutions’ for network operators, internet service providers (ISPs) and broadcasters and includes network systems and equipment; it made up 37 per cent of total sales. The third one, NEC Electron Devices manufactures memories, systems LSI (large-scale integration), compound semiconductors, etc., that are sold to internet infrastructure equipment and information equipment vendors and accounted for 14 per cent of sales. The remaining 9 per cent accrued to various other activities.6 As this breakdown indicates, PCs represent only one of NEC’s many business areas. In fact, in FY2002 personal products (i.e. PCs and peripherals) accounted for no more than ¥737.1 billion (US$5.5 billion) or 14.5 per cent of the company’s net sales.7 By the standards of most American PC manufacturers, NEC represents a highly diversified conglomerate, though among Japan’s electronics giants, the company probably has been the one most clearly focused on the computer market. In fact, its company slogan for many year was ‘C&C’ – computers and communications. However, as an integrated electronics manufacturer, electronic components featured prominently and the company continues to be one of the world’s major manufacturers of high-tech components including dynamic random access memory (DRAM) chips. Semiconductors, in fact, were the company’s springboard into PCs. In April 1972, NEC made Japan’s first domestically produced microprocessor. The company’s first

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PC followed in 1979, though Hitachi was the first Japanese company to introduce a PC in 1978 (Fransman 1995: 273–5). One of the reasons for NEC’s success in gaining a dominant market share was its early recognition of the importance of software and compatibility across its different models. Another was its early decision to separate the PC business from its semiconductor division (Fransman 1995; Boyd 1997). However, as indicated earlier, in recent years the company’s fortunes have been slipping: its market share in Japan has steadily dropped, and in 1999 the company pulled out of the US market.

Fujitsu Founded in 1935 from the communications division of Fuji Electric Co., Fujitsu Ltd. is Japan’s other industrial electronics conglomerate and, overall, the country’s biggest computer manufacturer. Consolidated net sales in the financial year ending March 2002 amounted to ¥5.0 trillion (US$37.6 billion). Employment at Fujitsu stood at 170,000. Cahners ranks the company as the fourth-largest electronics manufacturer worldwide.8 The activities of Fujitsu and its subsidiaries are divided into four major business segments: Services and Software, which accounted for 41.7 per cent of total net sales; Information Processing (comprising servers, storage systems and PCs) responsible for 27.7 per cent of net sales; Telecommunication (switching systems, transmission systems, mobile communications systems and mobile phone handsets) that made up 12.6 per cent; and Electronic Devices (primarily logic ICs, memory ICs and liquid crystal display panels) that accounted for 10.9 per cent of net sales.9 Personal computers in the financial year ending March 2002 reached net sales of ¥502.1 billion (US$3.8 billion) or 10 per cent of total net consolidated sales.10 As this includes PC sales only rather than PCs and peripherals as in NEC’s case, the figures are not directly comparable. However, as Table 7.2 shows, at least in the Japanese market, Fujitsu has drawn almost level with NEC which once commanded such a dominant position. A major reason for the company’s relative success in the domestic PC market is likely to have been the early switchover to the standard architecture. Just like other Japanese manufacturers, Fujitsu had developed its own proprietary line of FM Towns multimedia PCs that never managed to reach critical mass, though. However, in 1993 – four years before rival NEC – the company made the transition to the standard architecture. As a result, the company was able to ‘overhaul […] its supply network, dumping locally made parts in favor of foreign components 20% to 30% cheaper’ (BusinessWeek, 19 February 1996). In 1996, the company launched an aggressive price war that was labelled the ‘Fujitsu shokku’ (shock) by the press and enabled it to gain market share at the expense both of NEC and foreign PC makers such as Compaq and Apple. However, other firms accused Fujitsu of dumping practices and by 1999 the company’s domestic market share was sliding again.

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Hitachi Established in 1910 as an electrical repair shop, Hitachi Ltd. today is Japan’s largest general electrical machinery and electronics company. Its turnover in the financial year ending March 2002 reached ¥8.0 trillion (US$60.1 billion). Its workforce stood at 321,500 employees worldwide. However, because electronics make up only a fraction of the company’s total business, Cahners ranks Hitachi only as the world’s eleventh-largest electronics manufacturer.11 The scope of Hitachi’s activities is truly breathtaking. The products of the company’s Power & Industrial Systems division, for example, range from nuclear power plants via elevators and escalators to high-speed trains, and in the financial year ending in March 2002 accounted for 22.7 per cent of net sales. The second largest division with 18.3 per cent was Information & Telecommunications Systems, which includes PCs, but also offers systems integration, software, servers, mainframes, etc. Third in line is the Electronic Devices segment, including systems LSI, memories, semiconductors, LCDs, semiconductor manufacturing equipment, etc., and accounting for 14.9 per cent of net sales. Further segments include Logistics, Services & Others (14.3 per cent), High Functional Materials & Components (wires, cables, magnetic materials, etc.; 12.5 per cent), Digital Media & Consumer Products (TVs, VCRs, mobile phones, refrigerators, washing machines, etc.; 11.7 per cent) and Financial Services (5.7 per cent).12 Given this breadth of activities, PCs play only a small role in the company’s overall business. In the financial year ending March 2001, Hitachi’s PC sales amounted to ¥125.8 billion (US$1.0 billion) or 1.5 per cent of total net sales.13 This, though, does not mean that Hitachi has played an insignificant role in this market. On the contrary, as already mentioned, it was Hitachi that introduced the first Japanese PC in 1978. Like many of its Japanese rivals, however, Hitachi was slow to grasp the importance of the PC. Thus, even in the domestic market, the company had fallen to sixth place by 2000 and according to a Hitachi executive from the PC division, the main reason for the company to stay in the PC business at all is to be able to offer systems integration for its business customers.14

Network patterns The implications of the described developments in the Japanese PC market during the 1990s for the organization of production have been far-reaching. Broadly speaking, along with the switch-over from proprietary architectures to the standard IBM-compatible architecture, there has been a major shift from custom to standard parts and components, which in turn has brought about a significant change in network arrangements: previously dominated by keiretsu suppliers and subcontractors and hence just as tightly-knit and hierarchical as those in the consumer sector, networks for PC production today incorporate a large number of non-affiliated common suppliers, many of them foreign.

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The shift to standard components – the example of NEC In order to fully appreciate the implications of the switchover from proprietary architectures to the standard architecture for network practices, it is useful to first look at the relationship between PC architecture and the type of parts and components required. Figure 7.1 provides a simple schematic depiction of the evolution of PC models at NEC. The vertical line on the left represents the time axis, beginning at 1982, when NEC commenced the production of its PC 9800 series. This series incorporated NEC’s own original architecture. All parts and components were developed either by NEC or its affiliates. This is represented by the bar, where the horizontal dimension represents the share of standard components: basically, at the outset, no standard parts were used; 100 per cent were original NEC parts. This situation remained more or less unchanged with one exception: beginning with the PC 9821, NEC’s own central processing unit (CPU), the NEC V30, was replaced by microprocessors from America’s Intel Corp. The shift to the standard IBM architecture occurred with the introduction of the PC98 NX. With the exception of NEC-developed graphic accelerators and sound accelerators, all the parts used for this series were standard parts, that is parts as they were used by all the other PC manufacturers as well. Soon, even NEC’s graphic accelerators and sound accelerators were replaced by standard ones. The switch-over from NEC’s original architecture to the standard architecture thus Date PC 9800 (16 bit desk top)

1982 NEC V30 (CPU) ... Intel

(PC9821) Graphic accelerator Sound accelerator

1997 PC98NX

Standard parts

Present Share of standard parts

0%

Figure 7.1 NEC’s PC history. Source: Author’s interview. Note See text for explanation.

100%

NEC architecture; parts developed by NEC and affiliated companies Change of architecture

Standard architecture

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essentially involved, in a very short time, a complete overhaul in the structure of NEC’s PC parts procurements.

Procurements at NEC and Hitachi The change of architecture and hence from custom to standard parts and components meant that PC makers no longer needed to develop and manufacture all components within the existing supplier network but were free to ‘shop around’. This opportunity to shake up the organization of parts procurements, to reduce research and development costs and to benefit from the lower prices offered by specialized suppliers at home and overseas, of course, was a major reason why companies decided to drop their original architectures in the first place. The change in procurements patterns consequently is quite dramatic. This is borne out in Tables 7.3 and 7.4, which compare the patterns of parts procurements for PC production at NEC and Hitachi around the years 1990 and

Table 7.3 Procurement patterns of NEC’s PC division (a) 1990 Domestic (80–90%) Parent divisions – memory chip – semiconductors – HDD – FDD – motherboard – modem – keyboard

Overseas (10–20%) Long-term suppliers/ subcontractors – CRT monitor – memory – semiconductors – structural parts

Intel – CPU

Affiliates – CRT monitor (b) 2000 Domestic (40%) Parent divisions – motherboard – memory chips

Affiliates – LCD monitor (30% of total) – CRT monitor – modem

Other – memory chips – HDD – CD-ROM – structural parts

Source: Based on author’s interview.

Overseas (60%) Parent (20% of total) – HDD – FDD (Philippines) Affiliates – CRT monitor (China) – LCD monitor (Taiwan) – CD-ROM (Malaysia) – modem – speakers

Japanese vendors (10% of total) – HDD – FDD – CD-ROM – keyboard – mouse

Foreign suppliers (30% of total) – memory chips – CPU – semiconductors – HDD – CD-ROM – modem – motherboard – keyboard – mouse – speakers – structural parts

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2000.15 Beginning with NEC, the table adds further detail to the observations from the previous section. Relying on its proprietary architecture, in 1990, the company sourced almost all of its parts and components for PC production domestically. The only exception were Intel microprocessors, which accounted for between 10 and 20 per cent of the purchasing costs of the PC division. By far the largest share of procurements derived from NEC’s in-house parts operations (including memory chips, semiconductors, hard disk drives (HDD), floppy disk drives (FDD), motherboards, modems and keyboards). An NEC affiliate supplied CRT monitors. CRT monitors, memory chips and semiconductors were also sourced from longterm suppliers (with whom business relations had existed for at least five years). Structural parts, finally, were supplied by traditional subcontractors. By the year 2000, that is, after the changeover to the standard architecture, the picture had changed completely. The share of domestic procurements had shrunk to approximately 40 per cent. The parent had shed the production of most parts and components and was only engaged in the manufacture of motherboards and memories. The production of modems had been handed over to an affiliate. An affiliate also continued to manufacture CRT monitors, but by far the largest share of parts purchases from within the group – accounting for 30 per cent of total purchases by the PC division – consisted of LCD monitors manufactured by an NEC affiliate.16 Declining domestic procurements mean that the share of overseas procurements had risen to around 60 per cent. Out of this, approximately a third (i.e. 20 per cent of total purchases) derived from overseas facilities set up by the parent, NEC Corporation (HDDs and FDDs), or its affiliates (CRT monitors, LCD monitors, CD-ROM drives, modems and speakers) around East Asia. More significantly, about half of all procurements derived from non-group companies. At home in Japan, procurements from non-group companies included memory chips, HDDs and CD-ROM drives, components that in the past would solely be procured from group-companies (memory chips, HDDs) or were not around in 1990 (CD-ROM drives) and that were now procured from multiple sources. These multiple sources include Japanese ‘vendors’ (other electronics giants as well as independent parts companies) that also supplied HDDs and CD-ROM drives as well as FDDs, keyboards and computer mouses that together made up approximately 10 per cent of the parts purchases by NEC’s PC division. In a clear sign of the opening up of the supplier base, an even larger share – 30 per cent – of total parts purchases accrued to foreign suppliers, which delivered almost the whole range of PC components: memory chips, CPUs, other semiconductors, HDDs, CD-ROM drives, modems, motherboards, keyboards, mouses, speakers, and structural parts. In sum, while in 1990, the large majority of parts and components were manufactured within the NEC group network, this share had fallen markedly a decade later. Instead, so-called Japanese ‘vendors’ and foreign suppliers had taken a share of more than 40 per cent in overall procurements, providing a clear indication of the opening up of NEC’s network of suppliers which now significantly extends beyond the keiretsu group.

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Table 7.4 Procurement patterns of Hitachi’s PC division (a) ~1990 Domestic (>90%)

Taiwan (