Japan's High Tech Hope

Kyoto's entrepreneurship and can-do exuberance are unmatched by any other city in the country

Osamu Murata, armed with little more than a junior-high education, saw the future in ceramics. Sickly as a child, he dropped out of school to work as a salesman for his father's ceramic shop in Kyoto. But the enterprising son soon steered the company away from traditional tableware. As electronics boomed in the 1970s, Murata churned out innovative ceramic components to control the flow of electricity in household products and electronics. Murata Manufacturing Co. is now the world leader in such components, found in notebook computers, palmtops, cell phones, and handheld audio gear. Last year, Murata had almost $3 billion in sales, posted $500 million in operating profits, and has a market capitalization of $9.2 billion.

Murata is a legend in Kyoto. And Kyoto itself is a city of many legends. Japan's former capital has a historic reputation for traditional arts, scenic beauty, and austere sensibilities. But a new spirit has infused Kyoto's narrow streets and cloistered gardens. It's a mood of high-tech entrepreneurship and can-do exuberance unmatched by any other city in Japan. At a time when Tokyo-based blue chips such as Hitachi, Toshiba, NEC, and Mitsubishi Electric are awash in red ink, Kyoto boasts scores of successful ventures and hundreds of budding high-tech businesses.

NIMBLE STARTUPS. The likes of custom chipmaker Rohm Co. and giant Kyocera Corp., a world leader in ceramic packages for semiconductors, are already sure values. And in a category all by itself stands Nintendo Co., whose astonishing Pokemon cartoon-and-game franchise is a $5 billion global phenomenon. But beside these giants, scattered among Kyoto's world-famous gardens, castles, temples, and shrines, are scores of startups making their name in chips, new materials, chemicals, computer equipment, and even software.

None approaches Tokyo's high-tech titans in terms of fame, size, or research and development spending. But many have miraculously escaped the ravages of Japan's drawn-out financial crisis. Kyoto's nimble startups "are setting an example for the big companies," says Mahendra Negi, a senior analyst at Merrill Lynch & Co. in Tokyo. "They're more entrepreneurial, they are much more aggressive, and they're not afraid of breaking the rules." If these companies keep up their stellar record, they could one day write a new definition of excellence for companies in Japan and Asia. And they could cut a path for executives looking to pull their businesses out of recession.

How did Kyoto avoid Japan's economic quicksand? Mainly by keeping an intense focus on defined niches that play to the region's traditional strengths. Kyoto has 1,200 years of experience in ceramics, fine arts, and design, which turn out to be an apprenticeship for the painstaking detail of chip fabrication and software engineering--including billions of dollars worth of game software that is virtually bug-free.

Perhaps just as important, Kyoto's myriad small ventures have avoided "big company disease." Japan Inc.'s obsession with size and market share has all too often resulted in overcapacity, a bloated workforce, and low profit margins. But instead of expanding recklessly, Kyoto's best companies have concentrated on core businesses while targeting a global market. So, though once derided as marginal to the high-tech efforts of the titans, they are now showing their real strength, says Ryuichi Hayashi, an analyst at Nomura Securities' Financial Research Center.

The disdain of Japan's heavy hitters toward Kyoto proved to be a blessing in other ways. In the 1970s, Kyoto's tiny startups were ignored by the powerful Ministry of International Trade & Industry (MITI), which sponsored massive efforts to develop chips, fast computers, and smart software. So Kyoto didn't get dragged along as MITI drove its chosen cadre of high-tech giants--NEC, Fujitsu, Hitachi, and the rest--into orgies of capital spending on memory chips and suchlike that turned out to be commodity products.

GRACIOUS. MITI's misguided policies never generated the profits they sought. They were also a big turn-off to smart, nonconformist engineers, many of whom migrated to Kyoto. No surprise there. Year after year, Kyoto tops opinion polls as the place most Japanese would prefer to live. A gracious city of 1.4 million, it has no fewer than 33 universities and 11 colleges--the highest concentration in the country, on a per capita basis. Four of Japan's five Nobel laureates in science come from the famed Kyoto University. "Just like Stanford University, we are nurturing independent-minded people," says Kazumi Matsushige, director of Kyoto University's Venture Business Laboratory.

Foreign investment houses such as Merrill Lynch were among the first to spot and profit from Kyoto's industrial rebirth. While foreigners own less than 10% of Tokyo's Toshiba Corp., for example, non-Japanese account for fully a quarter of Nintendo stock, 40% of Rohm, and 40% of Murata.

Kyoto may not yet rival California's Silicon Valley with its myriad companies at the forefront of software and Internet technology. But a scan of Japan's depressed landscape reveals few other regions with as much potential. In all, Kyoto officials estimate that about 300 high-tech ventures have sprouted in recent years. Of these, several dozen will probably make initial public offerings within the coming year or two.

The city is actively encouraging new businesses, not just in hardware but also in fields such as software and Internet applications, where Japan trails the U.S. Local government officials have teamed up with business leaders and universities to promote new ventures and provide badly needed funds for startups. Thanks to local business initiatives, Kyoto is the only Japanese city to boast a privately operated research park in its downtown district. And the city is home to one of the country's first technology-licensing organizations to speed the transfer of technology from university labs to venture businesses.

Japan desperately needs a new gusher of innovation, which such initiatives aim to stimulate. The heavy industry that has driven domestic growth for the past two decades, centered on memory chips, autos, and heavy machinery, is running out of steam. The country's preoccupation with high-cost, labor-intensive industries is a major reason the nation lags behind in booming, knowledge-based sectors such as software, information technology, and the Internet.

STRONG INDIVIDUALS. For months, the picture in Japan as a whole has been unremittingly bleak. By comparison, Kyoto's ventures look light-years ahead. In a recent survey of Japan's best stock performers, the influential Nikkei Financial Daily rated Kyoto's Nidec Corp.--a maker of miniature motors--as No. 1. And it praised founder Shigenobu Nagamori as the chief executive who has done the most to raise his company's share value on the Tokyo Stock Exchange. Kyotoites Rohm, Murata, and Nintendo all followed close behind in the ranking.

Corporate Japan has much to learn from Kyoto's small and tightly focused operations. Consider Sanyo Chemical Industries Ltd., a leading manufacturer of specialty materials. Founded in Kyoto in 1943, it's a member of the Mitsui keiretsu that escaped the complacency typical of these Japanese conglomerates. Sanyo's managers watch the bottom line and concentrate on profitable, original products. "Kyoto's successful companies tend to be run by strong individuals, often the founders, who value originality," says Sanyo President Tetsuo Kakehi.

Meanwhile, the credit crunch that is taking its toll on Japanese companies large and small is of little concern to Kyoto's established ventures. Nichicon Corp., the world's largest maker of the aluminum electric capacitors used in everything from cars to computers, for instance, has steadily built up its cash reserves while cutting costs. "Suddenly, cash flow management is the thing to do in Japan, but we've been doing it for 30 years," says President Ippei Takeda. With $375 million in cash and zero debt, Nichicon can afford to boost plant investment by 50% to 60% this year while competitors struggle to borrow.

If there is one thing that crystallizes the Kyoto spirit, it's a driving commitment to originality. Most of the successful corporations are manufacturers, but not the low-tech sort. Many of their developments are driving the electronic revolution, albeit in ways the uninitiated can't see. Take Osamu Tsuji, a specialist in plasma technology who had worked in the U.S. at NASA. Twenty years ago, he launched SAMCO International in a rented garage in Kyoto to develop equipment for manufacturing semiconductors. His thin-film technology is used not only in chip fabrication but also in production of flat-panel displays and microsensors. "Even though the technology changes rapidly, we stay ahead of it," Tsuji says.

Now, he is developing thin films for fuel cells and superconductors. One product being tested by a major Japanese brewer, for example, is a special coating that enables plastic bottles to be reused 10 to 15 times. SAMCO also cranks out specialized chips, but it shuns dynamic random-access memories (DRAMs) and other commodity products. "That business is for dummies with money," scoffs Tsuji.

Ken Sato, the founder of Rohm, is inclined to agree. When he was still a university student, he developed the smallest, lightest resistor available and spun it into a business in 1958. Later, steering clear of cash-guzzling DRAMs, he built Rohm into a leading global maker of custom integrated circuits that go into finished electronics. Now, Rohm has a long list of accomplishments to its name: It was the first to commercialize an exotic new chip known as an FRAM, for ferroelectric random-access memory, which stores information even when the electricity is turned off. And it developed the world's first semiconductor laser for optical-magnetic disks used in computer storage.

"WHAT RECESSION?" There is one refrain that is heard repeatedly in Kyoto: "Be independent." That was the key to success for Hisatoshi Kojima, the president of KOFLOC, a pioneer in flow controls that are used in semiconductor production and research laboratories. In 1966, when he joined his father's company, which was then a supplier of meters to a local precision electronics maker, he saw that the business was heading nowhere by selling its entire output to Shimadzu Corp. First, he cut the proportion going to the local giant down to 70% of sales. Then, he started agitating to develop more sophisticated devices. By 1978, he had taken over the company and made it an independent organization. The $35 million company is now growing 10% a year and will soon make an IPO. "What recession?" asks Kojima. "Business has never been better."

For Kyoto's companies, hewing to international markets is critical. Three-quarters of Nidec's business is overseas. The ratio is more than 50% at both Rohm and Murata. "Tokyo companies dominate the domestic market," explains Nobuo Hatta, a Rohm board member in charge of overseas sales. "So we had to become global to survive."

Also to compete, Kyoto companies have had to stay cost-competitive--something coddled companies such as Hitachi and Toshiba are just learning. By establishing themselves in overseas markets, they've also become much more attuned to clients' needs. They emphasize short lead times, speedy delivery, and zero defects. Five years ago, Nichicon's Takeda cut lead time at his main plant from 22 days to 11. Recently, it reduced that further to 7 days--a standard that is now imposed companywide. Nichicon had planned to release an organic capacitor, made of a special polymer compound, in September. But with computer makers eagerly awaiting it, Nichicon engineers worked seven-day shifts to advance the launch by half a year.

UNSCATHED. Kyoto's first crop of ventures got their start just after the war. Although it ranked as one of Japan's six largest cities, Kyoto alone was spared the U.S. bombings that leveled homes and factories in Tokyo, Osaka, Nagoya, and other big centers. It was the only city that could quickly resume production in its factories. Refugees streaming back to Japan from other parts of Asia flocked to the city in search of work. It was in this period that Kazuo Inamori, a native of Kagoshima in southern Japan, found work in a ceramics company. Some years later, when Inamori's employer rejected his idea to build a cathode-ray tube for the fledgling TV industry, Inamori bolted. In 1959, he founded Kyocera, and built it into the world's largest maker of ceramic chip packages.

Kyoto startups like Kyocera had all the energy and intellectual resources needed to spawn a Silicon Valley-style phenomenon. But they still made mistakes, such as poor and costly diversifications. Their successors, such as Nidec and Nintendo, strove harder to break the mold. But they couldn't easily overcome Japan's twin liabilities--its dearth of venture capital and physical distance from the U.S., where key trends in communications take shape.

Now, the city's entrepreneurs want to create a new wave of breakaway ventures. Takayuki Kimura, managing director of Kyoto Research Park, believes some of its budding software makers have a shot. Koji Furukawa, the 38-year-old president of Video System, is building a successful game-development house with $58 million in sales last year--much of it aimed at the Nintendo and Sony PlayStation markets. And a flourishing production studio called Capriccioso has created a "virtual studio," where 20 young staff use supercomputers to craft a weekly TV animation series. The team is also working on a full-length animation film in English, aimed at the world market.

To bolster such activities, Ritsumeikan University offers interdisciplinary management courses for budding engineers, scientists, and even art majors. The school also promotes student internships at venture businesses. "We're creating the eggs right now," says Ritsumeikan director Mitsuhide Kohga, an economics professor. "In the next few years, you'll see some of them begin to hatch."

Japan needs these success stories, and Kyoto yearns to provide them. The old practices that regulated Japan Inc. are finally dissolving under the pressures of recession and global competition. The tumult may provide Kyoto's new breed of entrepreneurs a chance to write the rule book for Japan's new economy.