ENTERPRISE HOLDINGS SYSTEM

The Keiretsu Model

    The Enterprise Holdings System is being patterned after the Keiretsu model that was originally developed in Japan. Our premise is that micro businesses in particular need to take advantage of a Keiretsu-type umbrella organization that applies state-of-the-art information and communications technologies.

    The basic idea of the Keiretsu is that companies join into an alliance where participating companies undertake specific commercial activities such as transportation, finance, trading, distribution and manufacuring.

    Below are excerpts from an article on Keiretsu published in The Antidote in 1997.  The article is important because it shows (1) that business combines can be organized, start small and become very big, (2) how they are structured, and (3) how cross-communication is promoted and facilitated.

Keiretsu - A Very Japanese Form of 'Alliance'

The name keiretsu has become increasingly familiar to managers in other countries over the last few years. But what their background is and how they work is less well known.

Japanese keiretsu have existed for nearly 50 years and can arguably be traced back much further (see historical background on pages 32-33). Because they are often taken to be a special form of alliance, this article sets out to put them in context. We have used Keiretsu: Inside the Hidden Japanese Conglomerates written by Kenichi Miyashita and David Russell, first published in 1994, as a primary source of information. Both authors live and work in okyo. This is backed up, where appropriate, with information from Japanese Business Leaders by Professor Andrew Kakabadse, Lola Okazaki-Ward and Andrew Myers, all at Cranfield School of Management in the UK, as well as material from other sources.

Miyashita and Russell point out that there is no direct translation of keiretsu into English. The nearest equivalent are words such as 'link', 'affiliate with' or 'connect to'. Keiretsu exist in two forms: horizontal (yoko) and vertical ( tate). The main horizontal keiretsu are groups of large Japanese companies, all with strong connections to the same bank, who have significant cross-holdings in each other's shares. While Japan's 11 big banks each has a cluster of companies around it, it is the Big Six ( roku dai kigyo shudan or the 'big six industrial groups'), plus the Industrial Bank of Japan, that tower above the others. While each of these Big Six keiretsu (Sumitomo, Mitsubishi Group, Mitsui Group, Fuyo Group, Sanwa Group and DKB Group) has hundreds of firms in their extended relationships, only a relatively small core form the keiretsu's inner sanctum.

Vertical keiretsu are different in that they comprise one large company, its immediate direct subsidiaries and then tiers of subcontractors. These hundreds, and sometimes thousands, of subcontractors form a hierarchical pyramid with each tier passing work down to more subcontractors, as the keiretsu fans out and the companies get smaller and smaller. These are not subcontractors in the Western sense of the word. They are committed to the keiretsu and not expected to work for anyone else. Some vertical keiretsu have distribution, as well as production, pyramids.

The interconnectedness of Japanese industry and commerce is made more complicated by the fact that each member of a horizontal keiretsu has its own vertical keiretsu, so the total number of 'linkages' or 'connections' is potentially vast. In this article, however, we will restrict ourselves to the big horizontal keiretsu, leaving the different subject of vertical keiretsu for a future issue of The Antidote on supply chains and partnership sourcing.

So what is a horizontal keiretsu? Pointing out that there are many horizontal keiretsu in Japan, Miyashita and Russell take the Big Six as the prime example. With the frequently used analogy of a convoy, they describe each keiretsu as a group of companies who have chosen to "travel together and keep an eye on each other". In the middle of the convoy is the flagship bank and normally sailing right beside it is a vast trading company ( shosha), often wielding the same degree of influence as the bank. Sometimes there is also a big manufacturer at the centre of the convoy. Around these two or three "giants" are other core members, usually a life insurance company, a non-life insurance company and a trust bank, as well as one or two more large manufacturers. This group gives the keiretsu its identity. Circling this core "are whole flotillas of firms, some clustering together and some out on their own." Still further out are yet more companies, some small and some large, who, while associated with the convoy, keep themselves at a distance.

The role of the bank The bank at the heart of a keiretsu is more than just a bank. It is the "central clearinghouse for information about group companies and the coordinator for group activities." Because the early Tokyo Stock Exchange had the reputation of being a gambling casino, Japanese banks have until recently always been the source of funds. As a result, all large Japanese companies have a special relationship with at least one bank. As well as giving access to funds, advice and valuable market information, this tacit relationship provides the company with protection and assistance in a crisis. In return, the bank gathers information and can guide or encourage the company in the choice of who it conducts business with - tending to prefer other keiretsu members. As part of the relationship, the bank is likely to be a significant shareholder in the company to provide "stability" in its shares.

Because, traditionally, corporate accounting and disclosure have been underdeveloped in Japan, the bank also acts as a credit monitor, using its knowledge of group members' performance to assess and contain risk. Since other group members have cross-shareholdings in each other and provide each other with loans, the bank oversees these flows and provides advice and guidance. Because it is so familiar with its members' businesses, it can also act as a venture capitalist, supporting R&D and important technical developments. The authors quote Sumitomo Bank's support of investments in semiconductor technology made by Nippon Electric Company (NEC). NEC "outspent its rivals in semiconductor plants by roughly two to one over a six year period in the late 1970s" but had to rely on external finance for 85% of its total capital during the period. Not only did the bank provide assistance, its recommendations meant that other

Sumitomo keiretsu companies provided about one third of all NEC's loans.

Finally, the group bank acts as a highly skilled company doctor. If trouble is looming at one of its customers, it has its own well-informed team of executives ready to replace the existing management, provide high levels of management expertise, and steer the company round - one of the reasons why very few large companies in Japan fail.

The role of the general trading company Shosha, the general trading companies of which there are many, are a uniquely Japanese institution. Trading in everything from iron ore to jumbo jets, the trading companies not only handle Japan's direct imports and exports but also operate worldwide, even when the transactions have no link to Japan. This "third country trade" means acting as the intermediary between European and US companies and handling trade when both buyer and seller are either American or European. The authors quote research which shows that the Big Six trading companies are collectively "the largest purchaser of US exports to the world", accounting for 10% of total American overseas sales. Even more surprisingly, they account for 4% of total world trade.

Once highly profitable, shosha now work on tiny margins. The authors quote Itochu (formerly C. Itoh), the shosha in the Dai-Ichi Kangyo (DKB) keiretsu, which in the year ending March 1992 had sales of $160 billion but only made $80 million profit - a margin of 0.05%. However, the shosha act as intelligence gatherers in their scores of offices round the world, providing vital information and detailed market analysis for customers. They also help clients deal with foreign governments, languages and currencies. "In Japan, they distribute what they import, and ship and store what they buy."

This means that they are critically positioned at the top of the distribution chain. However, one of the most important roles they play is as a credit provider for small- to medium-sized Japanese companies. Rather than deal with a myriad of small companies, the banks extend credit to the shosha, which in turn finance trade credit between buyers and suppliers. Because a deal is conducted through a shosha, the seller needs to know nothing about the buyer since the seller is only extending credit to a well-connected trading company. In this way, they are immensely valuable to their keiretsu because they not only smooth trade flows, they effectively take over the financing function where the big banks leave off.

The Presidents' Clubs Each of the Big Six keiretsu take the date of their formation from the founding of their own "Presidents' Club" ( shacho-kai). Generally named after the day in the month on which they originally met, these Clubs are attended by the chosen top manager (generally the chief executive rather than the president) of the inner circle of companies within each keiretsu (see Figure below). In fact membership of the Presidents' Club defines which companies form the inner core of each keiretsu. For instance, although Mazda Motors and Matsushita Electric are closely associated with the Sumitomo keiretsu, neither is represented on Sumitomo's shacho-kai - Mazda's main shareholder is Ford and Matsushita prefers an independent stance.

Highly exclusive, these monthly meetings are strictly confidential and no outsider knows what takes place. Officially, they are occasions at which top managers discuss broad subjects, such as the economy, and listen to lectures from contemporary writers and artists. However, some observers find it difficult to believe that during the course of every month around 150 top executives of Japan's leading companies make time in their heavily committed diaries for this purpose alone. Miyashita and Russell quote the head of Mitsubishi's Presidents' Club who, in 1976, disclosed that the Club aimed "to cultivate group solidarity" and that its most important role was "to determine group strategy and to plan group actions vis-à-vis external parties". It also apparently dealt with the question of whether the group should move into new industries, it enabled discussions about the group's interests with other keiretsu, and acted as mediator and adjudicator among group members. However, as the authors point out, time has moved on and such issues may now best be sorted out elsewhere. Most keiretsu also have additional clubs for other senior executives and some have a range of clubs and conferences to foster contact and information flows at various levels.

(Adapted from Miyashita and Russell 1996)

Cross-shareholding After the Second World War, some 69% of shares in Japanese companies were in private hands (see historical background above). By 1989, however, banks held 42.3% of Japanese shares and corporate holdings had risen to 24.8%, a total of over 67% in non-private hands.  A movement to create stable shareholding, beginning with car manufacturers, spread relatively quickly among horizontal keiretsu and then began in vertical keiretsu as manufacturers sought to protect their suppliers from take-over, binding them ever more closely. Toyota, for instance, managed to stabilise 70% of its total shares by selling them first to the banks and insurance companies of the Mitsui keiretsu, then to other group members and finally to parts of its own vertical keiretsu. In doing so, Toyota inevitably declared its affiliation to the Mitsui keiretsu. However, few companies have stabilised such a large proportion of their shares - more commonly stabilised cross-shareholdings are in the 15-30% range.

By the mid 1970s these cross-shareholding became institutionalised and that has remained the pattern ever since. Because of capital gains tax, there is a strong disincentive to sell assets that, in some case, have risen by 300-400%.

Apart from achieving their aim - foreign shareholding of Japanese shares peaked at 6.3% in 1983 - there were other advantages stemming from this system. Firstly, it cemented relations, acting as part of the "glue" that holds the keiretsu together. Secondly, by reducing the shares in circulation, it tended to push share prices up, thus improving everyone's ability to borrow money against these secure, rising assets. Thirdly, and most importantly, Miyashita and Russell estimate that around 25% of shares in Japanese companies are currently held as keiretsu cross-holdings, with a further 50% in the hands of banks, trust companies and insurance companies, most of whom have keiretsu connections. This has given management in leading Japanese companies a freedom to act with a longer-term perspective than most Western managements. Able to give precedence to employees rather than shareholders, they can concentrate on expanding market share rather than short-term profit.

Assigned directors As a final part of the more visible linkages between keiretsu members, there is a tradition of assigning directors. In the Big Six, the main bank, shosha and other core companies will despatch directors horizontally to other central companies, often for years. These companies, in turn, send directors down their own vertical keiretsu pyramids. As a result, constant monitoring and the acquisition of high quality information is facilitated. Both sides benefit. The banks stay in touch, learning about incipient problems early enough to respond and further increasing their huge fund of information. The company knows that instead of having to start from scratch to raise a loan, the bank will already be aware of both technical detail and likely requirements. A quiet word from the all-seeing bank also helps iron out any troubles between group members.

While it is not uncommon for directors in the West to sit on a number of boards, it is the scale of these assignments that gives the Japanese way a different perspective. Miyashita and Russell calculate, for example, that within the Fuyo keiretsu, Fuji Bank and other core companies provide a total of 31 chairmen and vice chairmen, 74 presidents and CEOs, 35 vice-presidents, 264 senior and managing directors, 319 directors and 180 'auditors' to related keiretsu companies. Including all advisers and other executive staff, over 900 senior personnel are on loan within the group. The Sanwa keiretsu has more, and DKB close to 1,200 on loan. All told, they calculate that the Big Six have "posted" over 4000 board members to other companies, including 400 presidents or CEOs.

A brief profile All the Big Six tend to have at least one representative member in most big industry sectors: in banking, insurance, mining, metals, computers, chemicals, industrial equipment, shipping or transportation, and property. At least four of them, variously, have a significant presence in cameras and optics, oil and coal, fibres and textiles, car manufacturing, cement, food and beverages, pulp and paper.

To provide a sense of scale, the main features of each of the Big Six keiretsu are shown in the Figure above, listed by the date its Presidents' Club was founded. Clearly it depends on which industry you are in as to whether you recognise the members of these groups. The Mitsui Group, for example, is a keiretsu that includes both Toyota and Toshiba. Other groups contain names that are also variously familiar in the West, such as Nissan ( Fuyo), Isuzu (DKB), Daihatsu (Sanwa), NEC (Sumitomo), Sharp (Sanwa), Nikon (Mitsubishi), Canon ( Fuyo), Suntory (Sanwa), but many of the biggest Japanese companies bear their flagship names, such as Mitsui, Mitsubishi and Sumitomo, and are less familiar to Western consumers.

As might be expected, however, nothing is straightforward. Some companies are unusual and belong to more than one group. For instance, Hitachi is a members of the Fuyo, DKB and Sanwa keiretsu. Others seek to remain independent, like Matsushita, Nippon Steel, Bridgewater ( tyres) and Sony. But most, although independent, have some level of association with a keiretsu. Honda, for instance, is an independent, but its main bank is Mitsubishi, which has a director on Honda's board and is Honda's largest shareholder, while the next two largest shareholders are also part of the Mitsubishi group. The problem is that Mitsubishi already has its own car company - Mitsubishi Motors.

It is an integral part of conducting business that Japanese senior managers are aware of keiretsu associations and know who is affiliated or connected to whom. As Miyashita and Russell put it, "Every executive of every major company knows who does business with whom in the same way he knows the names of important world capitals: he can't remember where or when he learned them, just that it's important not to forget and that you sound like an idiot if you say London is in France."