Understanding Japanese Keiretsu

The structure of major companies in Japan, known as keiretsu, is steeped in tradition and relationships. We can see the roots of the keiretsu organizational structure as far back as the 1600s and well into the Industrial Revolution in the 19th century. However, it wasn't until the aftermath of World War II that the keiretsu model officially formed and became the dominant partnership network that drives modern Japanese business. In this article, we take a look at the history, structure, and pros versus cons of the keiretsu system.

Key Takeaways

  • Keiretsu refers to the Japanese business structure comprised of a network of different companies, including banks, manufacturers, distributors, and supply chain partners.
  • Before the keiretsu system, the primary form of corporate governance in Japan was the zaibatsu, which referred to small, family-owned businesses that eventually evolved into large, monopolistic holding companies.
  • A horizontal keiretsu refers to an alliance of cross-shareholding companies led by a Japanese bank that provides a range of financial services.
  • A vertical keiretsu is a partnership of manufacturers, suppliers, and distributors that work cooperatively to increase efficiency and reduce costs.
  • A drawback of the keiretsu system is the easy access to capital, which can lead a company to take on too much debt and invest in risky strategies.

The Zaibatsus

Japan's corporate governance system dates back to the 1600s but was propelled by the Japanese government's newly formed Meiji Restoration in 1866 as the world entered the Industrial Revolution. These early corporate formations were termed "zaibatsu," which translates to English as "monopoly." Zaibatsus began as small, family-owned enterprises that formed in various prefectures across Japan to specialize in the separate business needs of the nation. As Japan's economy grew, zaibatsu grew to evolve into holding companies.

When the U.S. occupied Japan and rewrote the Japanese constitution after World War II, it eliminated zaibatsu holding companies and the Japanese governmental policies that perpetuated their existence. The rationale for this action was centered around the monopolistic, undemocratic nature of zaibatsus. Studies suggest zaibatsu holding companies bought politicians in exchange for contracts, exploited the poor in pricing mechanisms, and created dysfunctional capital markets, all to perpetuate their existence.

With Japan devastated after World War II, Japanese companies needed a new organizational structure. They reorganized as keiretsus, which translates to "lineage" or "grouping of enterprises" in English. Management would structure their companies with either a horizontal or vertical integration model.

Under a zaibatsu, the largest industrial groups allowed banks and trading companies to be the most powerful aspects of each of the cartels and sit at the top of an organizational chart. These banks and trading companies controlled all financial operations and the distribution of goods. The original founding families were in full control of all operations.

The Keiretsu Model

Today's keiretsu horizontal model still sees banks and trading companies at the top of the chart with significant control over each company's part of the keiretsu. Shareholders replaced the families controlling the cartel as Japanese law allowed for holding companies to become stockholding companies. Vertical integration is still a part of the more massive horizontal structure of today's keiretsu. For example, each of Japan's six car companies belongs to one of the big six keiretsus, as does each one of Japan's major electronics companies.

Modern Horizontal Keiretsus

Typical of a Japanese horizontal keiretsu is Mitsubishi. The Bank of Tokyo-Mitsubishi sits at the top of the keiretsu. Mitsubishi Motors and Mitsubishi Trust and Banking are also part of the core group, followed by Meiji Mutual Life Insurance Company, which provides insurance to all members of the keiretsu. Mitsubishi Shoji is the trading company for the Mitsubishi keiretsu.

Their purpose is strictly distribution of goods around the world. They may seek new markets for keiretsu companies, help incorporate keiretsu companies in other nations, and sign contracts with other companies around the world to supply commodities used in Japanese industry. As you've no doubt noticed, many companies within this keiretsu have "Mitsubishi" as part of their name.

Modern Vertical Keiretsus

Vertical keiretsus are a group of companies within the horizontal keiretsu. Automobile giant Toyota is one such company. Toyota's success is dependent on suppliers and manufacturers for parts; employees for production; real estate for dealerships; steel, plastics, and electronics suppliers for cars; and wholesalers. All ancillary companies operate within the vertical keiretsu of Toyota but are members of the larger horizontal keiretsu, although much lower on the organizational chart.

Without Toyota as the anchor company, these companies may not have a purpose for existence. Toyota exists as a major keiretsu member because of its history and relationship to major horizontal members that dates back to its early years of the Meiji government as the first exporter of silk.

Keiretsus and Interlocking Relationships

Banks regularly owned a small percentage of their keiretsu members' stock, and members owned a portion of the bank's stock. This formed an interlocking relationship, especially if the member company borrowed from the horizontal member bank. Interlocking relationships allowed the bank to monitor borrowings, strengthen relationships, monitor customers, and help with problems such as supplier networks.

This arrangement limited competition within the keiretsu and prevented company takeovers by outsiders of the keiretsu. These early arrangements would later lead to the supply of workers by keiretsu firms and a board of directors that would come directly from the keiretsu. All businesses involved need to ensure business sustainability within the keiretsu. But while some may see the success of keiretsu, others see problems.

The Japanese focus on societal relations, as well as cross-shareholdings, allowed keiretsus to successfully perpetuate themselves since World War II.

The Pros and Cons of Keiretsus

The limited competition within the keiretsu may lead to inefficient practices. Because a keiretsu company knows it can readily access capital, it could easily take on too much debt and overly risky strategies. On the other hand, the reduction of costs due to dealing with intra-keiretsu firms can increase efficiency within the supply chain. The automobile keiretsus' invention of the just-in-time inventory system is a prime example of this.

Information sharing within the keiretsu is another argument for increased efficiency. Information is shared among customers, suppliers, and employees. This leads to quicker investment decisions and suppliers, employees, and customers knowing the purposes and goals of those investments. However, critics charge that, because of their size, keiretsus can't adjust to market changes quickly enough for these investments to earn profits.

Some would argue the economic crisis in Japan in the late 1990s forced Japanese companies to compete for price and quality by using market-based systems instead of keiretsu relational arrangements. This occurred due to major horizontal banks' reports of profit losses. Japanese companies were forced to seek financing outside the keiretsu by borrowing from the bond and commercial paper markets.

The Bottom Line

For the first time in recent Japanese history, Japanese keiretsus found their first crack, resulting in a forced loosening of traditional standards. Globalization and technology are other aspects that would force Japanese companies to open to competition by identifying new customers, increasing the efficiency of orders, and researching new markets. The major question that remains: Is this is a permanent solution, or will the keiretsu evolve into another new entity—much as the zaibatsus morphed into keiretsus a half-century ago.

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