Business | INSIDER REPORT

Global challenges lie ahead as sōgō shōsha hunt for growth

by Patrick Ryan

Contributing Writer

While many global companies, including the sōgō shōsha, face similar political, economic, social, technological, managerial and other risks — much too many to cover here — Japan’s nearly complete dependence on natural resource and raw material imports from overseas and its shrinking domestic market are posing some distinctive challenges for the sōgō shōsha.

Dependence on resources

One of these challenges is a byproduct of the sōgō shōsha being resource-starved Japan’s primary importer of raw materials and commodities. For many years now, the sōgō shōsha’s net earnings have been highly dependent on commodity prices, especially those of metal, mineral and energy resources.

In the five years to 2014, more than 60 percent of the net earnings of the top five sōgō shōsha came from metal, mineral, energy and other resources, a reflection of the high resource prices during that period. Among the sōgō shōsha, this ranged from a high of 90 percent to a low of about 40 percent. On the other hand, the deep drop in commodity prices following this period culminated in billions of dollars in write-offs in fiscal 2014 and 2015 by the sōgō shōsha.

This reliance on resource prices has been an issue for some time now. In fact, things could have been much worse for them in 2015 and 2016, however, they have been tackling this dependency problem for several years.

While the commodity markets will always be inherently volatile and subject to risk, the challenge for the sōgō shōsha is not to necessarily decrease their presence in the resource markets given their broad experience and expertise in the field, but rather to strengthen and expand their other non-resource business segments and reduce the overall ratio of profits stemming from metals, minerals and energy resources in the process.

Certainly, they want to strategically protect and even selectively expand their position in that industry, but at the same time bring more balance to their profit structure through higher earnings from the other business divisions. This is exactly what they have been doing in recent years by bolstering their operations in nonresource-related segments.

In the last two fiscal years (ended March 2017 and March 2018), there has been a general recovery in commodity prices, but still below the peak levels seen between 2009 and 2014. Yet, all the sōgō shōsha had very strong net profits in fiscal 2017 and record net profits last year, with nonresource-related earnings making up 60 percent of those profits.

And while not all of the sōgō shōsha are completely out of the woods yet, they have been making strong progress in reducing their resource-related dependency. The challenge going forward is whether they can continue to maintain this momentum in their nonresource-related businesses.

Capturing growth overseas

Another challenge facing the sōgō shōsha will be their ability to further capture growth in overseas markets. Facing a mature Japanese domestic economy and a population already in decline, there are limitations to growth opportunities for the sōgō shōsha in the Japanese market. Surely, the seven existing sōgō shōsha will not be able to survive by depending on Japan’s economy and market alone, and they know it. This is why “overseas growth” has been something of a rallying cry for them in recent years.

As such, the challenge is whether the sōgō shōsha can effectively adapt their upstream-downstream supply chain business model in either or both overseas national and regional markets.

Up until now, this integrated upstream-downstream business model has been most prevalent domestically in Japan. To give you an example, Marubeni Corp. has about 430 business division subsidiary and affiliate companies operating upstream, midstream and downstream in the supply chain in various industries. These represent most of Marubeni’s total investment. Approximately two-thirds of these companies are overseas, while about one-third are in Japan. While these overseas companies represent a strong global presence, they are dispersed in numerous countries around the world, in contrast to the third that benefit from being concentrated domestically.

Still Japan centric

What this means is that, on average, most of the 16 business divisions in Marubeni in Japan, representing different industries, have 10 or more domestic companies operating upstream and downstream in the supply chain in Japan, while in Marubeni America and Marubeni China, the world’s two largest economies, each business division might have only about two to three companies, possibly four, in their respective market. Furthermore, many of these companies overseas are supplying Japan with goods and materials or representing a Japanese manufacturer in an overseas market or region. So, while this upstream-downstream business model is very strong in Japan, it is still in the relatively early stages in overseas national and regional markets. In other words, it is still relatively Japan-centric.

In addition, while the sōgō shōsha’s participation in large-scale infrastructure projects takes place mostly overseas, many of these projects have been dependent on Japanese government official development assistance for financing. Japan was the world’s largest ODA donor throughout the 1990s, but in 2017 it sat in fourth place, with the amounts being flat and below the levels seen up until 2000. This means that there have been somewhat fewer projects financed by Japan’s ODA, with accessibility to this financing having become more competitive.

Therefore, the challenge for the sōgō shōsha will be to build some version of this integrated upstream-downstream supply chain business in overseas national and regional markets, as well as continue to find more diverse sources and schemes to finance large-scale projects — not only so they can further expand their business and capture growth overseas, but to make this growth sustainable as well.

Global power shift

There is a further challenge for the sōgō shōsha in terms of capturing future overseas growth. Most growth, both in terms of population and the economy, will come from developing countries, both emerging economies and less-developed nations. In the next 12 years, the population of developing countries is expected to rise by about 1.125 billion people, with an annual GDP growth rate of around 5 percent, while advanced countries will see a population increase of about 35 million people, with GDP growth hovering around 1.7 percent a year. This means that developing countries’ total GDP growth over the next 12 years will be nearly double that of developed countries — $18 trillion versus $10 trillion.

However, both population and economic growth in advanced countries will be mostly bolstered by the U.S., which means if you take that nation out of the developed country equation, the population will actually decrease and growth in the advanced countries will be stagnant. Furthermore, developed country markets are saturated and competitive, while those in developing countries may still present new and unfettered opportunities.

Therefore, it is obvious that the sōgō shōsha will have to more aggressively target emerging economies and less developed countries to capture future growth overseas. Nevertheless, while the middle classes in developing countries are growing rapidly, the per capital income gap with the advanced countries is still extremely wide, which means the markets in advanced countries can’t be completely ignored.

Having said that, of Marubeni’s current total investment, more than 80 percent is still in developed countries. Obviously, this is because investing in developing countries is a much riskier proposition than investing in developed countries.

This may be an issue for Japanese companies in general. For example, in sub-Saharan Africa, the world’s last frontier, Japan’s foreign direct investment stock is not among the top ten foreign investors, putting it well behind the U.S., many European countries and China, although it has been increasing in recent years.

So, the challenge will be to increase investment in developing countries by finding ways to minimize the risks (or determining if the benefits outweigh the risks), while maintaining one’s position or finding niche opportunities in advanced countries.

This is the 11th 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.