Corporate Japan's Stealth Makeover

Companies are pushing through tough restructuring

Time was, Toray Industries Inc. represented what was best about Japan. Founded in 1926 as the country's first rayon producer, the company grew into Japan's biggest manufacturer of nylon and polyester for use in everything from clothing to tires. By 1997, though, Toray had lost its edge as Chinese competitors started grabbing market share. Earnings declined, and managers were unable -- or unwilling -- to rein in rampant costs and shutter money-losing operations. Then in June, 2002, Sadayuki Sakakibara took over as Toray's president. The former head of planning and research wasted little time: In his first year on the job, he cut costs by $120 million and closed unprofitable divisions. In the fiscal year ended in March, he managed to boost operating profits by 75% and cash flow by 72%. "Everyone in the company now feels a strong sense of crisis," Sakakibara told investors recently. "It's helping us achieve a recovery."

Tough talk for a Japanese executive. But get used to it. Sure, it's far from universal yet, but thanks to years of quiet restructuring there are tentative -- but real -- signs that big swaths of Japan Inc. are getting their competitive groove back. And as companies start cutting costs and shoring up their balance sheets, notions of increasing shareholder value and improving corporate governance are taking hold.

The evidence of change: Average return on equity at 400 top nonfinancial companies has increased more than fourfold since 1998, to an estimated 7% -- still low by U.S. standards but the best Japan has seen since 1989. A survey of Japan's top 300 listed companies found that they had reduced costs by a combined $9.1 billion in the fiscal year ended in March and that they're expected to trim another $8.2 billion this year. "Companies realize that to survive, they have to constantly cut costs and improve efficiency," says the study's author, Eiji Azuma, senior executive officer at Daiwa Institute of Research Ltd. This summer investors finally started to notice. Since April, the benchmark Nikkei 225 stock index has rebounded by more than 40%.

The corporate profit cushion is translating into a big uptick in capital spending. Outlays on new plant and equipment grew by an annual rate of 5.3% in the quarter ended June 30 -- the first increase since 2001 -- as companies upgraded computers and built a presence in China. "A lot of companies went through tough restructuring and now are regaining their profitability and competitiveness," says Masao Hirano, a director with McKinsey & Co. in Tokyo. Toray, for instance, is buying machinery that will double its production of polyester fiber in China, to 5 million meters a month.

One powerful new force is shareholder pressure. Japanese banks, which in 1995 owned half of all tradable shares, have been forced by regulators to sell off a big chunk of that. Today they own perhaps 25%. That's still high, but the new shareholders tend to be far more demanding about performance. Institutional investors peppered corporate chieftains with 3,500 resolutions at shareholder meetings this year, something they rarely would have bothered with in years past since they had little hope of getting anything approved.

Another benefit of the stock sales by the banks is that companies are suddenly forced to pay attention to their market performance. Because outside investors actually care about corporate governance, companies are scrambling to provide more disclosure, appoint better-functioning boards, and improve return on equity. For instance, Komatsu Ltd., Japan's largest maker of construction equipment, has cut the size of its board to eight members -- down from 26 in 1999. And two of them are outsiders, compared with none four years ago. That has helped speed up decision-making -- and has attracted investors. Komatsu's shares have jumped 63% this year.

What's more, the Japanese economy is far more open to foreign investment than it was a decade ago. Today, foreigners own 32% of shares traded on the Tokyo Stock Exchange, compared with 9% in 1989. Nor are Japanese as shocked as they once were by the notion of foreign bosses leading Japanese companies -- which has led to new blood in the executive suite. For instance, Nissan Motor Corp.'s President Carlos Ghosn, also known as "le cost killer," has been heralded in comic books for his turnaround of the carmaker.

Maybe it's a good sign that tough-guy nicknames are in vogue. Matsushita Electric Industrial Co. President Kunio Nakamura is called the "head-buster." Since taking over the consumer-electronics maker in 2000, he has shuttered 30 factories worldwide, reduced Japanese payrolls by 20%, and doubled cash flow, to $5.7 billion. That extra cash has allowed Matsushita to spruce up products such as Panasonic camcorders, DVD recorders, and flat-panel TVs, which now outsell sets sold by archrival Sony Corp. "We will always be restructuring and reforming," says Matsushita Executive Vice-President Yukio Shohtoku.

Skeptics right about now are smirking. They've seen this movie: In 1994, 1996, and 2000, market rallies and a few strong quarters led many to call an end to Japan's long swoon. In some ways, they're probably right. Huge numbers of companies -- especially in construction and retailing -- remain stuck in their old ways, living off a never-ending stream of bank loans and government handouts while doing little to make themselves competitive. In the past year, banks have forgiven some $30 billion in loans to such companies, allowing them to stumble along a bit longer.

So it's still too soon to declare Japan out of the woods. The government, despite the reformist rhetoric of Prime Minister Junichiro Koizumi, has done little to push Japan Inc. to shape up. And despite a strong second-quarter showing, Japan will be lucky to grow 2% this year and next, according to private and government forecasts. Even that paltry rate of growth, though, could take pressure off of execs, "so some of the more contentious decisions may be put off for another day," says Michael Garstka of management consultant Bain & Co.

Moreover, it takes more than a bit of corporate downsizing to really turn around many companies. After years of losses, Mazda Motor Corp. -- 33% owned by Ford Motor Co. -- slashed its plant capacity by 25% and trimmed its workforce by 20%. While profits are back and new products are being rolled out, the company needs some hits in the U.S. and Europe before it can really be said to be back on track. "It was a hard time for us," Hisakazu Imaki, Mazda's new president, says of the overhaul. "From now on we will focus on products."

Toshiba and Sony have also tried to restructure in recent years but are still struggling. On Sept. 16, Toshiba President Tadashi Okamura said he now expects his company will lose $215 million in the six months ending Sept. 30, compared with the $130 million loss the company had previously forecast. As for Sony, CEO Nobuyuki Idei was one of the first out the door with a restructuring program back in 1999. There was just one problem: Much of it was aimed overseas, not at Sony's bloated domestic operations. Now, Idei and his lieutenants are preparing to unveil a restructuring plan designed to fix Japanese operations. "Sony's situation [today] is worrisome," admits Norio Ohga, the company's honorary chairman.

Nonetheless, more than a few Japanese companies have slashed costs and spurred growth. True, Japanese executives will never be as draconian as their counterparts in the U.S. or Europe. But at some of the country's biggest and most important companies, they've shown a surprising willingness to put their organizations on crash corporate diets.

By Brian Bremner and Irene M. Kunii, with Hiroko Tashiro, in Tokyo

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