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Unlike blue chips, services firms’ Japan quirks thwart global reach

by Jochen Legewie

Japan’s firms are on an unprecedented shopping tour overseas. The value of January-October M&As hit a record ¥6.7 trillion, nearly four times more than a year earlier. The largest was Mitsubishi UFJ Financial Group’s $9 billion investment in Morgan Stanley.

Another deal was Nomura’s acquisition of key units of Lehman Brothers, which made even more global headlines. And, last December — before the financial crisis — Millea Holdings bought U.K. insurer Kiln in the largest buy of a foreign firm by a Japanese insurer to date.

Do these acquisitions mean Japanese service firms are set to rival Japanese manufacturers, long established players on the global stage?

To answer this question, let’s look at some figures: Seven of the 10 largest Japanese manufacturers have overseas sales ratios of 50 percent or more. For Japan’s five top carmakers as well as Sony and Canon, it’s 75 percent or higher.

But among Japanese service firms, there is not a single one with overseas revenues exceeding 50 percent. The general trading houses are the most international, with Marubeni leading the pack at 45 percent overseas sales. Other than this particular group, however, Japanese service firms are clearly lagging their global peers in terms in internationalization.

MUFG is the largest bank in Japan but only No. 10 worldwide. Indeed, its overseas sales ratio of 9 percent is dwarfed by the 60 percent of HSBC from the U.K. In insurance, Tokyo Marine — part of Millea — is Japan’s biggest player, but is only 24th globally. Its overseas sales stand at 23 percent. Dutch ING Group and Allianz of Germany each stand at 65 percent.

In telecom, retail or transportation the picture is similar. Japan’s largest firms — NTT, Aeon and JR East — are domestic-focused with overseas revenues around 10 percent or less. Even Dentsu, the world’s largest ad firm, still makes more than 90 percent of its sales in Japan.

Reasons for this low degree of internationalization of service firms are manifold. They are related to the low productivity of the Japanese service sector, which is below all major OECD countries and estimated only at 60 percent to 70 percent of the U.S.

We also must not forget that there was ample reason for Japanese service firms to focus on the ever-growing home market, as the underdeveloped markets elsewhere in Asia did not offer a real alternative for service imports.

But this situation is rapidly changing with Asia’s growth. Also, rules in Japan have eased, competition is rapidly increasing and the labor markets are getting more and more flexible.

Does this mean we will soon observe the emergence of global players from Japan’s service sector?

Some cultural and company-level factors do not make this scenario a likely one. Service firms need a high level of productivity, skills and specialization to stand out from their competitors. But it is in precisely these areas that Japanese service firms are very often lacking.

Japan is first of all a country focused on producing goods. Services are traditionally not attributed a value. Rather they are often bundled with products and are essentially free.

Second, services are often internalized; they are produced and purchased in-house or from within the keiretsu group. The major banks all have several group firms that engage in R&D, consulting, IT or HR services.

This business model has and often still makes sense in Japan, where business relations are focused on building trust and developing ties that emphasize long-term growth over short-term profits. But such an environment does not help develop highly specialized service providers that also can succeed abroad.

The secret of the global success of Japan’s trading houses lies exactly in internalization and the bundling of products and services.

Ironically, however, it is the very success of this business model that is hindering the emergence of highly specialized service firms from Japan.

Finally, service businesses are about people. And overseas, this means English and communications skills, which puts Japanese firms at a disadvantage. It also means the necessity of localizing top management, a concept Japanese firms are embracing only reluctantly.

If Nomura can successfully integrate its Lehman purchase, it could become a showcase for Japanese service firms.

But Japanese firms from other service industries will struggle to internationalize anytime soon.

In the past, Japan’s manufacturing has helped the country out of poverty to the pinnacle of economic triumph. Whether the service sector will become the new national — and international — champion is another question altogether.

Jochen Legewie is president of German communications consultancy CNC Japan K.K.