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Matsushita Electric Industrial Co., known for its Panasonic brand, embarked this month on a drastic reform of its groupwide business by gradually dismantling its “business unit” system, established by founder Konosuke Matsushita.

Traditionally, each of its business units were self-contained, handling product design and development to manufacturing, marketing and sales.

However, realizing that operational efficiency needed to be improved, President Kunio Nakamura is taking bold measures — spinning off some factories from business units, regrouping distribution and marketing of home appliances, and downsizing its head office.

As a result of streamlining of the home appliance business and other traditional areas, about 13,000 white-collar employees have been transferred to growing business areas such as digital audio visual products and mobile communications.

With the protracted economic slump and declining stock prices over the past decade, employers are beginning to realize that the Japanese-style corporate system, which helped Japan achieve rapid economic growth from the 1960s through the 1980s, no longer works.

Japanese firms are lagging behind their U.S. and European rivals in meeting the new needs arising from economic globalization and development of information technology.

Matsushita’s effort is one example of a Japanese firm trying to build a new business model and restore its competitive edge.

In the postwar period, Japanese companies established internationally competitive business styles, adopting the so-called main bank system and just-in-time production management.

The main bank system — under which a company established close ties with a main lender through cross-shareholding — has long provided financial stability for Japanese firms, enabling them to make large-scale investments based on long-term plans. The presence of main banks and other financial institutions as stable shareholders has effectively protected the firms from hostile takeovers by foreign companies.

Meanwhile, the “kanban” just-in-time production system created by Toyota Motor Corp. — in which parts arrive at a plant in time for their assembly schedule and are not kept in inventory — contributed to the quick economic recovery from the oil crisis in 1973. To make optimum use of this method, close relationships among group companies were built, typically through cross-shareholdings and steady parts-supply contracts.

Lifetime employment with a seniority-based salary system also fitted into this lean system of production because a network of long-serving employees could effectively accumulate and pass on technical knowledge to improve the quality of products and services.

Such business models, however, have proven to be inept — or even an obstacle — in coping with the drastic changes in the business environment that began in the early 1990s when the asset-inflated bubble economy burst.

Industrial globalization in the post-Cold War period and innovations in IT have created a business environment

where money and information circulate around the world in a moment, said Kazuaki Harada, chief economist and senior adviser at the think tank SRIC Corp.

While Japanese banks and other financial institutions — which have long served as stable shareholders regardless of firms’ business performance — are now moving to unload their cross-shareholdings, powerful foreign institutional investors are increasing their presence in Japan’s financial markets.

Thus, many Japanese firms believe they will inevitably have to take on the U.S.-style corporate system, which places priority on stockholders’ interests, Harada said.

The key for Japanese companies to survive global competition is to improve profitability by raising their market-based value or stock prices, he said.

Although the Japanese-style corporate system was still admired in the 1980s, the reality was that Japanese firms boasted about sales and market share but their profitability remained low.

According to the Tokyo Stock Exchange, major Japanese companies’ return on equity — a key measurement to show how effectively shareholders’ money is being employed — declined from 8.46 percent in 1983 to 1.2 percent in 1999. Corresponding figures for U.S. firms rose from 12.36 percent to 17.88 percent during the same period after hitting a low of 9.18 percent in 1991.

Harada pointed out that excessive investment in equipment, facilities and pay raises, backed with large loans from banks, has deteriorated Japanese companies’ ability to remunerate shareholders.

To reverse the trend, Japanese firms need to do away with the old system and build a new one to introduce efficient management, personnel and groupwide business structures. The ability of firms to survive global competition may rest on whether top management can achieve this.

Financially troubled Nissan Motor Co., for instance, is recovering under the strong leadership of President Carlos Ghosn, a former executive at French carmaker Renault S.A.

Speed also counts.

While Matsushita has finally begun a full-scale reform of its business under President Nakamura, rival Sony Corp. is running ahead by applying strategies to optimize the efficiency at its affiliates and reforming its board of directors.

Sony spearheaded the adoption in part of U.S.-style corporate management in 1997 by reducing the number of board members from 38 to 10 and reinforcing the roles of board members outside the group. Now its board consists of three outside members and nine inside members.

In 1998, the electronics giant also set up a nominating committee — consisting of one outside and five inside board members — responsible for selecting executives, and a compensation committee — comprising two outside board members and a Sony counselor — responsible for determining how much money executives receive.

The new board system was designed to reflect shareholders’ interests because the performance of executive officers is checked by the board, said Yusho Shichijo, a Sony spokesman. Also, the speed of decision-making is improved in order to not miss any business chances, he added.

A traditional Japanese board has about 30 or more inside members who are responsible for executing corporate strategies and supervising performance.

On the other hand, a typical U.S.-style board is comprised mainly of independent directors who can work to reflect shareholders’ interests by checking corporate policymaking and pressuring executives to take necessary business measures.

Problems with Japanese-style corporate governance have been pointed out since the early 1990s. With firm’s auditors selected by top management, many critics said that Japanese firms have effectively no self-checking function.

Calls for reform escalated after a slew of corporate scandals, including those involving mismanagement and wrongdoing by top management.

As was the case with the outbreak food-poisoning that devastated sales of Snow Brand Milk Products Co. and Mitsubishi Motors Corp.’s massive coverup of auto defects, scandal-hit companies have had to deal with huge declines in sales and profits, undermining the interests of shareholders.

According to a TSE survey conducted last year, about 21.3 percent of 1,310 companies listed on the exchange had introduced the so-called corporate officer system, which is often accompanied by a sharp cut in the number of board members. This was up 17.8 percentage points from the previous survey in 1998. Serving as chief of certain operations, such officers concentrate on executing policies determined by board members.

The survey also found that nearly 20 percent of respondents have outside board members, down 15.7 percentage points.

Because the Commercial Law sets no limit on the amount of compensation that board members have to pay when subjected to a shareholder’s lawsuit, observers say few people may want to become outside directors on boards. In one case, the Osaka District Court on Sept. 11 ordered former Daiwa Bank executives to pay 83 billion yen in a derivatives lawsuit.

Hiroyuki Itami, a management professor at Hitotsubashi University, however, said the current reform of boards is superficial because top officials gain overwhelming power over companies.

“It seems difficult for outside board members, with little knowledge about various businesses, to offer meaningful opinions that can affect policymaking,” he said.

He also said Japan should pursue a third way, rather than trying to emulate the United States.

Although the introduction of U.S.-style corporate management may appeal to the market, Itami said Japanese firms should create a system that takes care of other stakeholders, especially employees who have a long-term commitment, rather than shareholders who commit to companies on a short term.

Many Japanese companies are now offering stock options — a right to purchase a firm’s stock at a designated price — to executives and employees to motivate them to perform better.

Harada of SRIC, however, said such incentives alone cannot improve the business performance of firms.

Even if companies design competitive business models, strong leadership is necessary to push employees toward the same goal, he said.

In reality, this is like trying for the moon, as the presidents of most Japanese firms got to the top post with help from the seniority-based promotion system.

But some companies are trying to change that.

Hitachi Ltd. introduced last autumn an elite education system to foster future leaders who can make proper policy to survive cutthroat global competition.

Under the system, about 5 percent to 10 percent of employees are selected each year from four groups — subsection chiefs, section chiefs, department directors and general managers.

Four- to five-year training programs are designed for each employee on the course so they can garner the necessary experience and management skills. The programs include studying at American or European business schools.

About 2,500 employees, in their late 20s to early 50s, have been selected from the 56,000-strong workforce.

What is unique about this system is that those involved must prove they can make the grade. The performance of the participants is reviewed every year and members can be replaced, said Hiroaki Ito, general manager of Hitachi’s education planning and development department.

“Under the system, employees screened out can still be selected and those who drop out from the course due to failure have a second chance to come back,” he said. “We hope this system will produce rejuvenated executives capable of winning the global competition.”

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