Japan’s ‘hidden champions’

Dr. Stefan Lippert - Photography by Temple University, Japan Campus

Dr. Stefan Lippert – Photography by Temple University, Japan Campus

In an earlier article titled, ‘Can Japanese firms compete in global markets?’ we examined the struggle that well-known Japanese firms have competing for global market share. How are Japanese entrepreneurial mid-sized companies fairing globally?

To answer that question, Beacon Reports turned to Dr. Stefan Lippert, a former McKinsey & Company consultant who teaches business studies at Temple University in Tokyo. Dr. Lippert researches ‘hidden champions’ – entrepreneurial firms which have a clear business focus and that go global early in their lives. There are about 2,700 such firms worldwide, including 230 in Japan, which form the core of Dr. Lippert’s interest.

‘Hidden champions’ are important because they give backbone to a number of export-oriented economies, including those of Germany, Switzerland, Austria and to some extent the US. In the German-speaking world, they represent the elite players among the Mittelstand, small to medium-sized firms with a deep but narrow product focus. Many dominate their global market niche. Japan too has its fair share. About 8% of the world’s total ‘hidden champions’ are Japanese, a ratio consistent with the nation’s share of global GDP. According to Dr. Lippert, they represent Japan’s “world-class corporations beyond Toyota.”

The professor’s preliminary research findings suggest that ‘hidden champions’ around the world look remarkably similar. What separates Japan’s from the rest, is that Japanese ‘hidden champions’ lose their entrepreneurial drive to globalize on succession of the founder. So while Mittelstand firms continue their outward global expansion on change of top management, like Japanese firms fail to do so.

Dr. Lippert points to the nation’s low and declining rankings in the export league table as evidence that Japan’s entrepreneurial fledglings fail to grow into true global competitors. Japan exported roughly $700 billion in 2013 while two countries with much smaller populations, Holland and South Korea, exported $500 billion and $550 billion respectively. The discrepancy is widest in the service sector. Most of the wealth created in advanced economies comes from services, yet Japan exports virtually none.

Typically ‘hidden champions’ are founded by idiosyncratic entrepreneurs in their 30s or 40s who, after gaining experience in their field at a large company, leave to start their own businesses. Soon after launch, founders try to grow their firms’ foreign sales by opening small overseas offices. These are often staffed by two or three people. Firms may expand into one or more countries each year, testing new markets as they grow. They follow this course for perhaps 20 or 30 years until the founder is ready to retire. By then, yearly sales may have reached 250 – $500 million.

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On or near succession of the founder, Japan’s ‘hidden champions’ follow a different course than those based in other countries. Western firms typically manage succession by grooming entrepreneurial top talent who continue to drive global growth after the founder departs. These intrapreneurs are incentivized with offers of privately held shares and stock options. In Japan on the other hand, there is a dearth of intrapreneurs to incentivize and no culture of doing so. When founding entrepreneurs near retirement, firms are forced to publically list to attract top talent.

One reason for the lack of suitable successors is that Japanese top talent prefers to work for big, powerful and prestigious companies that garner the respect of society. For instance, “When top managers from a prestigious firm go to the bank, they are treated with the highest regard,” notes Dr. Lippert. Those representing smaller companies are treated less politely. Indeed few unlisted firms can get a bank loan, for instance, without first signing a personal guaranty.

Top talent also may find it difficult working for idiosyncratic and authoritarian entrepreneurial founders. “Entrepreneurs usually are ‘misfits’, like Steve Jobs in a positive sense,” says Dr. Lippert. “They often come from large companies. In their early 30s they realize they will never make it to the top or that they will have to wait another 20 years to get there. Instead they leave to start their own businesses, usually against massive pressure from their families,” he says, highlighting that entrepreneurship is still not seen as a socially acceptable career path. “There are corporate managers and there are entrepreneurs,” says Dr. Lippert, leaving Japanese ‘hidden champions’ with a lack of suitable successors.

To attract top talent, Japanese ‘hidden champions’ often seek a public listing on a stock exchange earlier than in Europe or in the US. After listing, the professor suggests, firms run more bureaucratically like at other big Japanese companies. They institutionalize and develop a corporate culture that is not appreciative of failure. “Once firms create more formal corporate structures, ‘hidden champions’ lose their entrepreneurial drive,” he notes, adding, “The drive to globalize weakens and firms focus on servicing the domestic market.” The result is that beyond the handful of truly global companies like Nissan, Toyota and Kubota, mid-sized Japanese firms more often fail to develop into effective global competitors.

Dr. Lippert points to the increased role that human resource departments (HR) play after a firm lists as one example of institutionalization which undermines the drive to globalize. After listing, HR departments seek to build a more traditional and harmonious village community (mura) typical of Japanese corporate culture. It is one where “aggressive globalizers are not welcome,” he says.

The professor believes Japanese HR systems are still rooted in the 1950s and 1960s, a time when Japan’s economy grew at the average rate of 10% per year. They were designed to keep factories running and not to nurture creativity or entrepreneurship. “The same incentive systems are operating today under which managers need to meet quality, efficiency, and output targets,” he says, adding, “The incentive system gives 100 points to an employee upon entering a company. Points are deducted for every ‘mistake’. When aged around 35 years, those who have the most points get promoted. Those that have fewer points are left behind.” The result is that top managers are not incentivized to take risks. “In Japan, top managers manage, they do not lead,” quips Dr. Lippert.

To solve the problem he thinks Japan needs to develop corporate cultures that are more accepting of failure and risk taking. He recounts the famous case of General Electric’s Jack Welch. As a young country manager, Welch accidentally blew up a factory in the Netherlands. Afterwards Welch got a call from the CEO, Reggie Jones. Jones asked him what he learned from the experience. He expected to get fired. “Instead, Welch was promoted to CEO,” says Dr. Lippert, “not because of his failure – but despite the failure.”

Frustratingly, the professor teaches students who arrive at Temple University’s Fox School of Business at the end of the educational cycle. They’re mostly in their 30s, by which time he says, “There is little you can do to change their personality,” highlighting the indoctrination to avoid risk, mistakes and possible failure that is taught much earlier on.

Under the traditional educational system in Japan, students are taught from a young age there is only one right answer to a question. Everyone has to reach the same conclusion to maintain harmony in the classroom. Those that fail to do so are punished. That differs from Western educational systems, where the thought process behind an answer is often more important than the answer itself. Although the two systems each have their strengths and weaknesses, the Western system arguably better prepares graduates to adapt to a rapidly globalizing world in which the only constant – is change.

Dr. Lippert muses that policymakers should plant the seeds of cultural reform by providing primary and secondary school students with a multicultural educational experience. He suggests that 100,000 foreign teachers be encouraged to come to Japan to teach a range of subjects – not just English – to all age groups on three-year employment contracts. The best and brightest teachers who wished to stay in Japan could do so. As a next step, he further muses, “Chinese could be introduced into Japanese classrooms.”

Dr. Stefan Lippert

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