Business | INSIDER REPORT

Diversification, integration and the roles of trader and investor

by Patrick Ryan

Contributing Writer

There are some who have explained, in somewhat academic terms, the sōgō shōsha’s upstream-downstream integration process by dividing it into two concepts: “diversification” and “integration.”

Weight of nontrading roles

Simply, what is occurring is the business divisions’ units are applying and combining such nontrading functions as marketing, logistics (especially supply chain management), finance (credit, etc.), risk management, information technology and other expertise, including new technology, to provide a package of diverse services to fit each customer’s needs at each stage of the supply chain, or what we also call the flow of trade. (Note: Some forms of logistics such as basic transport and shipping arrangements, including insurance, and import and export trade procedures, including trade settlement, can be considered part of the trading function.)

At the same time, as a strategic weapon, each division is using Marubeni’s global business and information network to coordinate and further enhance their business by looking for potential synergies between their upstream and downstream trading businesses, by searching for new business and new markets for and with their customers, partners and subsidiary companies and by making essential investments upstream and downstream in the value chain aimed at integration.

In addition, many of these nontrading functions have been developed into profitable businesses (i.e. subsidiary companies serving both the Marubeni Group and outside customers), in and of themselves, particularly in the fields of IT, logistics, insurance brokering and financial leasing (Marubeni Logistics Corp., Marubeni Safenet Co., MG Leasing Corp., etc.).

This is what is called “diversification” due to the very diverse number of nontrading functions and expertise employed and the nontrading related businesses that have been formed from them.

The combination of all these diverse nontrading functions, especially logistics, investment and global networking, and their application to the sōgō shōsha’s core role as a trader and distributor, leads to what is referred to as “integration” or the integrated upstream-downstream trade business model.

So, the business divisions, mostly through their business subsidiaries, are providing a package of value-added services to existing customers, while concurrently using the sōgō shōsha’s global business and information network to find linkages between their trading businesses. They also use this network to find new customers, partners and markets, and make new investments to further secure their position in the value chain, and both improve and diversify their earnings structure. This model is most applicable to the trading business, but also facilitates the large-scale project business as well.

Needless to say, the sōgō shōsha’s nontrading functions are crucial to expanding, enhancing and sustaining their core trading business model.

One of the other keys to their business is staying ahead of trends. So, as part of their nontrading functions the sōgō shōsha are always looking at new technologies and how they might be adapted to or utilized in an industry or across industries, or by customers or partners (new non-trading functions). Currently, Marubeni is intensively looking at artificial intelligence, the “internet of things,” 5G, blockchain technology, industry 4.0, the sharing economy, electric vehicles, the smart grid and other such new technologies and systems that are part of the digital information era. They are trying to ascertain how these might be applicable commercially to their businesses in one form or another.

For example, Marubeni is in a capital alliance with a company to develop AI solutions, meaning finding AI uses for companies across the Marubeni Group, especially in logistics and health care. Marubeni is also participating in a fintech experiment using digital blockchain to conclude international trade transactions which greatly simplifies and speeds up the process. In addition, they have teamed up with a U.S. partner to install IoT technology in power plants aimed at increasing operating efficiency.

The sōgō shōsha are not technology companies or manufacturers of any type. To survive, they, meaning their people, have to understand the industries they are involved in, from top to bottom, better than the major players in those industries. Much of this they do through their nontrading expertise.

This is why I have said that understanding the sōgō shōsha’s integrated upstream-downstream trading model is fairly easy, but implementing it is a very different ballgame. These nontrading functions are much more sophisticated than my simple description here entails, and the sheer complexity of coordinating these functions as well as creating a set of services and businesses out of them are what make the sōgō shōsha impossible to imitate.

Trader or Investor

There has been some confusion as to what path the sōgō shōsha have been taking in terms of their core business. There have been those in academia and even among the sōgō shōsha themselves who have been saying something along the lines of “the sōgō shōsha have been reducing their traditional trading activities and taking on more of a role as an investor” or have been “moving out of trading and into investment.” The first statement is closer to reality, but a little confusing, and the second is misleading to say the least.

The sōgō shōsha are not investment firms. The sōgō shōsha basically invest in the supply chain up, mid, and downstream to gain ownership and access to materials and goods at cost to protect themselves and increase their profits as traders and distributors in the supply chain. At the same time, many of these investments are value-added processes that provide extra earnings not found in the sōgō shōsha’s traditional trading scheme as just an intermediary between buyer and seller. In other words, the sōgō shōsha are investing in their core competence, their core function of trading in pursuit of their quest to integrate the supply chain as suppliers, distributors, wholesalers and even retailers. And, although they do sometimes invest in or with (joint venture) manufacturers and processors to gain ownership in that area of the supply chain, as I have mentioned, they themselves are not manufacturers. The sōgō shōsha will also sometimes invest in large-scale projects they are involved in, for example power plants, often as an independent power producer and supplier of electricity, or in water utilities as well as other infrastructure projects.

The sōgō shōsha do sometimes make investments for investment’s sake. Marubeni has invested in and set up their own leveraged buyout, private equity, corporate turnaround and venture capital funds. However, the amount invested is miniscule compared with Marubeni’s total investment.

So, the sōgō shōsha are not moving out of trading and into investment. Rather, the sōgō shōsha are reducing the amount of trade they traditionally handle as just a broker or go-between without ownership and are increasing the amount of trade they handle that they have invested in and have ownership of.

I currently translate sōgō shōsha as “diversified trading conglomerate.” I have also, in the past, termed them as “diversified trading and investment conglomerates” and “integrated trading and investment conglomerates.” While “integrated trading and investment conglomerate” might be closest to the truth, from my experience people get confused when you combine the words trade and investment. They tend to associate the word trade with investment, as in stock trading, commodity trading or foreign exchange trading. And while they do dabble in these, compared to their core businesses, it is exactly that — dabbling.

Investment though, is one of the core functions or tools, arguably the most important one, the sōgō shōsha use to improve and expand their existing businesses and develop new business, along with their global information network, logistics, marketing, credit finance, project finance, risk management and the integration of new technologies. Investment is not our core business.

So, I think when someone says the sōgō shōsha are moving from traditional trade to investment, or from trader to investor, what they really mean is the sōgō shōsha are moving more and more from trade without ownership, as strictly an intermediary, to trade with ownership.

This is the tenth part of a new series of reports written by industry specialists. The first 12 articles are about Japanese general trading companies, or sōgō shōsha.
Patrick Ryan is a senior analyst engaged in global industry research in the Marubeni Research Institute, the research arm of Marubeni Corp. He has previously worked in International HR and International Corporate Strategies for Marubeni.