Commentary: The Wild, Wild East

Japanese companies are benefiting from a dose of Western capitalism

Howard Stringer, Sony Corp.'s (SNE ) newly appointed chief, is the latest member of one of the world's most exclusive clubs: foreigners running Japanese companies. This group -- the Japanese call them "blue-eyed" CEOs -- includes Carlos Ghosn at Nissan Motor Co. (NSANY ), incoming Shinsei Bank head Thierry Porte, and former Mazda Motor (F ) President Mark Fields. But don't expect this tiny club to grow much bigger anytime soon. Japan remains a land where outsiders are viewed warily.

Just because the club is unlikely to expand, though, doesn't mean that the management practices its members espouse won't spread. After the wrenching contraction of the 1990s, the country is more open than ever to "Western-style" capitalism. Today execs who once sought to capture market share and revenue at the expense of profits are finally embracing shareholder-friendly yardsticks such as high profit margins and low debt ratios. Goldman Sachs (GS ) estimates average return on equity at major Japanese companies will hit 10% this year, the highest since 1989 and up from zero in 2001. "There's a big switch taking place in Japan," says James B. Rosenwald III, founder and managing partner of Los Angeles-based hedge fund Dalton Investments LLC. "Concepts like 'return on capital' have become much more widespread."

Stringer will benefit from the precedent set by the likes of Nissan's Ghosn, who was the first foreign exec to lower the boom. Once vilified for shuttering three factories and cutting thousands of jobs, Ghosn is now hailed as the savior of an auto maker that faced bankruptcy in 1999. He did that by setting ambitious cost-cutting and earnings targets and then implementing them, sometimes ruthlessly. The result of that tough love: Nissan enjoys a profit margin at the top of its peer group.

Nissan's revival has spurred others to emulate Ghosn's techniques. Even archrival Toyota Motor Corp. (TM ) instituted a cost-cutting plan under Katsuaki Watanabe -- the exec set to take over as president in June -- to match the austerity at Nissan. One result: Toyota has raised its operating profit margin from 2% in 1993 to just shy of 10% today. Canon Inc. is another company that has avoided the low profits and high debt loads that have been a hallmark of Japan Inc. That's the work of hard-charging President Fujio Mitarai, who credits his experience heading Canon's U.S. business in the 1980s for his earnings-oriented approach. "The lesson of the 1990s for Japanese firms is that they have to focus on profit growth to survive," says Hugh Patrick, a Japan expert at Columbia University.

At the same time, Japanese managers who don't share the twin goals of maximizing profits and selling off underutilized assets are coming under increasing pressure, both from longtime institutional shareholders and newer players. Japanese buyout boutiques and foreign hedge funds have noted that more than a third of the companies on the Tokyo Stock Exchange trade below the book value of their assets -- and are snapping up shares and pushing for change. In 2003, Tokyo-based activist fund M&A Consulting Inc. won the support of Japan's Pension Fund Assn. in an ultimately unsuccessful bid to force women's apparel maker Tokyo Style to dole out its $1 billion in cash reserves by hiking dividends.

Fortunately for investors, that was just an opening salvo. Steel Partners Japan Strategies LP, an American private-equity fund, forced Yushiro Chemical Industry Co. to more than triple its 2004 dividend by tapping its cash hoard. And in January, Teikoku Hormone Manufacturing Co. said it would nearly double its dividend to appease Dalton Investments, which owns more than 5% of the pharmaceutical maker.

Those were mere skirmishes compared with a battle that broke out in February. That's when Japanese startup Livedoor Co. went public with a hostile bid for Nippon Broadcasting System Inc., the top shareholder in No. 1 broadcaster Fuji Television Network Inc. Fuji and NBS have attempted to thwart the takeover, but the outcome remains unclear. Even if Fuji wins, the fight serves as a reminder to all Japa-nese companies that the rules are changing. Stringer and other "blue-eyed" execs may be lonely gaijin in the boardroom, but they'll benefit from working in a transformed Japan Inc.

By Chester Dawson

With Hiroko Tashiro in Tokyo

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