Japan’s economic integration with China

The economies of Japan and China are integrating. This started with Japan supplying China’s demand for heavy industrial goods — goods that China needed to build its manufacturing infrastructure. Export sales of capital goods from Japan to China were followed by foreign direct investment (FDI) by the large Japanese manufacturers — e.g., Honda, Toyota and Nissan, who built factories there. Now Japanese consumer companies are taking aim at the Chinese consumer market, which is set for explosive growth. Beacon Reports spoke to Stephen Harner, a China expert, who worked there from 1994 as a commercial banker and now runs a China consulting and M&A advisory service. Harner believes that continued Japan-China economic integration is essential for the financial well-being of many Japanese firms.

According to Harner, Japan was a quick and aggressive supplier of capital goods to China. They could do so because, among the advanced nations, only Japan and Germany were able to supply China with the capital goods it needed. The two countries together produce much of the world’s machine tools and heavy equipment. “In China, any steel mill you go into, you will see Kawasaki Heavy Industries or Demag AG machines,” said Harner. “Japanese companies look at China from the position of a supplier of capital goods; U.S. companies look to China as a place to manufacture consumer products, but not for the sale of capital goods.”

Driving the market for capital goods is China’s investment into expansion of the country’s roads, power stations, steel mills, and the like. Even today, China’s growth is investment led– 48% of China’s GDP in 2011 was the result of investment in infrastructure as shown below.

FDI into China, however, was slow in coming. Japanese companies would manufacture at home and sell abroad. Referring to the automobile industry, Harner said, “Japan’s auto industry only started manufacturing in China ten to fifteen years ago. Volkswagen was the first to invest and was followed by GM. Finally, everyone else came late.” The reasons were: First, the Japanese auto industry was risk averse.  Second, they were afraid of transferring technology to China. Third, they were suspicious of Chinese intentions, as Japan had already experienced Korea as the “student” that came to be more competitive than the “teacher”. Also, Japan, better than many other nations, understood “the game” as they themselves had benefited greatly from technological transfers after WWII.

By the 1990s, Japan could no longer delay FDI into China. China ceased accepting Japanese exports without demanding technological transfer and/or imposing local content requirements. China, in any case, was fast becoming an important strategic market. By 2009, China’s automotive industry had become the world’s largest:

Until 2005, the U.S.A. led the world in total automobile production… when the world had 32 million automobiles in use, and the U.S. automobile industry produced over 90% of them.  In 2006, Japan narrowly passed the U.S. in production and held this rank until 2009, when China took the top spot with 13.8 million units. By producing 18.3 million units in 2010, China produced nearly twice the number of second place Japan (9.6 million units), with the U.S. in third place with 7.8 million units. – wikipedia.org

In a shift of strategy towards greater economic integration, Honda announced in April ’12 it would make available its core hybrid car engine technology to other Chinese automakers. Harner commented, “These are Honda’s family jewels. Manufactures, like Honda, are admitting that they are no longer able to protect their most advanced technologies without compromising global market share.”

What is new and important, Harner said, is that Japanese companies are taking aim at the Chinese consumer market. This market, as this graph produced by McKinsey & Company shows, is seeing explosive growth, in stark contrast to Japan’s domestic consumer market, where the expectation is for stagnation at best:

According to McKinsey, only 18 million Chinese “mainstream” urban households, representing 8% of all Chinese households, earned more than $16,000 in 2010. They predict by 2020 the number earning more than $16,000 will mushroom to 169 million households, equivalent to 400 Million consumers.

Multinational corporations, like Unilever and Proctor and Gamble (P&G), are targeting these consumers. According to The Economist, P&G aims to add 1 billion new customers by 2015, up 25% from 2010.  “Emerging markets are crucial to achieving those goals,” it reported. Unilever and P&G have “promised to invest heavily in distributing and marketing their established products in developing countries and in creating new ones tailored to the tastes and pockets of poorer consumers at the “bottom of the pyramid” – where, according to the late C.K. Prahalad, a management guru, a fortune lies.”

Harner believes Japanese companies are well positioned to compete for their share of that fortune through export to, and local production in, China. “The products of Japanese consumer goods makers have been refined to appeal to the exacting standards and tastes of domestic consumers,” said Harner. “In case after case, these products are highly appreciated by Asian consumers, but they tend to be expensive relative to local substitutes. As China’s consumer purchasing power increases, it will be a huge market for Japanese products, and a savior for Japanese companies that make the effort to serve this market.”

A case in point is Dydo, an Osaka based company that sells canned coffee through vending machines. It recently invested in a Shanghai company that leases vending machines. Harner said that Dydo sees all its future sales growth in canned coffee coming from China.

Oki Denki is a manufacturer of ATM machines that was financially in bad shape until a few years ago when they began selling ATM machines to China. They redesigned their ATM’s for the Chinese market, so they are now highly sensitive at detecting counterfeit banknotes — a problem in China. Having perfected the technology, over 50% of Oki Denki’s installed base of ATMs is in China.

“Japan has the most competitive Asian products and services in so many markets across the entire breadth of the value chain,” said Harner. “This gives them a big advantage. China has 10 times the population of Japan, is located just next door, shares a common written language, and is growing in purchasing power. It’s a no-brainer. Every company for their survival and growth must be thinking about how to integrate their operations and become successful in China.”

Stephen Harner, President, Yangtze Century Ltd. Stephen is a former commercial banker who now provides consulting and M&A advisory services to companies in China and Japan.  Stephen’s profile here.

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