I Was Wrong. Startups Are Not the Future of Innovation in Japan

This is a rather personal episode. We have no guests this time.

It’s just you and me.

We talk a lot about Japanese startups on this show and the role they will play in shaping Japan's economic future.

Well, today we are going to look at this from a different angle; one that puts the hype aside and looks at some cold hard numbers. The result is sobering, surprising and, believe it or not, kind of inspiring

So let's get right to it.

[shareaholic app="share_buttons" id="7994466"] Leave a comment Transcript Disrupting Japan Episode 91 Welcome to Disrupting Japan straight talk from Japan’s most successful entrepreneurs. I’m Tim Romero and thanks for listening Once again, I’ve got a special show for you today. There will be no guests, no beer, no playful banter with someone speaking English as a second language. Today it’s just you and me. For the next 20 minutes, I’ll be whispering in your ear about something I consider very important, but that not enough people are talking about. It’s been a while since we’ve done one of these solo shows. They tend to among my most popular episodes, I get a lot of requests for them and I love doing them. I would like to do more, but you might be surprised at the amount of research and revisions that go into these solo shows. Not to mention the times when I get two-thirds of the way putting one together only to realize the primary thrust of my argument is flawed and the whole thing needs to be reworked. Unfortunately, I’m not really smart enough to just turn on the microphone and talk for 20 minutes. It’s so much easier sitting down and talking to amazingly creative Japanese startup founders and innovators who are doing and saying crazy things. Well, today, I’d like to share something with you that first occurred to me about a year ago. And the more I research it, and the more people I speak with, the more I become convinced it’s right. I’ve haven’t talked about it a lot before, because well, frankly, it’s something that a lot of people in the startup community here will disagree with — and some will disagree in very strong terms. But it’s important, so let’s strap in and get right to it. [pro_ad_display_adzone id="1404" info_text="Sponsored by" font_color="grey" ] Over the next twenty years, startups are not going to revive the Japanese economy, nor are they are they going to be the primary driver of innovation in this country. Don’t misunderstand, startups have a role to play, a very important role to play, but they will not be the primary drivers of change. No. Japan’s mid-sized companies will be the primary drivers of both large-scale innovation and economic growth over the next ten years. For this to make sense, we are going to look at the role that mid-sized companies play in the Japanese economy today, we’ll then step back in time both to see how things get this way and to understand why Japan is at such a pivotal juncture today, and then look at how thing are likely to shake out over the next 15 years or so. Now, to the average podcast listener, this would sound like a dry topic, but you as a DJ listener are a special breed, and you’ll be rewarded for coming with me deep, deep into the weeds. If you come along, I promise that in twenty minutes you will have a new way of looking at mid-sized companies in Japan, and perhaps a new way of looking at Japanese startups as well. You see medium-sized enterprises are the middle child in Japan’s corporate family. The large companies, the brands you know Toyota, Mitsubishi, Panasonic, Mitsui. For the most part are the remnants of the once incredibly powerful keiretsu groups. These companies are the oldest child. Everyone knows who they are. They are in the news. They have influence. They work closely with the Japanese government, both the legislators and the bureaucracy, to ensure that the needs of Japan’s large corporations are reflected in national policy and international trade agreements. And of course, the vast majority of government grant money, primary contracts, and economic stimulus programs are directed at these large corporations.

Japanese startups are the little brother. Startup companies have captured Japan’s hearts and imagination not because of their economic impact, but because they are new. They say, do and build crazy things and the country loves them for it. Startups get fawning press attention from the smallest of achievements. “Oh wow! You shipped a product! That’s awesome. We’re so proud of you. Here. Have $1million.” Japan’s medium enterprises, however, have been stuck in the middle. For the past fifty years. they have quietly and reliably formed the backbone of the large companies’ supply chains, employing most of the workers and often thanklessly providing a steady stream of innovation. Doing the bulk of the work and getting almost none of the attention. And, you know, every time Japan faces economic problems it’s the medium enterprises that bear the brunt of the sacrifices. They lack the connections needed to arrange government bailouts, and when the large enterprises are hurting, they relentlessly squeeze their medium enterprise suppliers. A bit later on we’ll talk about why they’ve traditionally been able to get away with that, and how this power dynamic is about to change. But first, let’s look at the simple reason why the economic future of Japan depends much more on the medium enterprises than on the large enterprises or startups. OK, so let's nail down what exactly we mean when we talk about large, medium and small enterprises. For today’s discussion, I’m going to use METI definitions because, well because they’re METI and they are the ones that decide on how these things are defined. For manufacturing companies, METI defines a medium enterprise as one with between 20 and 300 employees. Firms with less than 20 employees are small enterprises and those with more than 300 are considered large enterprises. For non-manufacturing industries, medium enterprises are those with between 5 and 100 employees. So medium enterprises are defined as a bit smaller in Japan than they are in much of Europe or the United States. Now, with the definitions out of the way, the most important thing to understand about the influence of medium enterprises on the Japanese economy is that medium enterprises are the Japanese economy. They employ 54% of the Japanese workforce, so more than large and small enterprises put together, and they account for 48% of all corporate revenues in Japan. So, with medium enterprises responsible for so much economic impact, what explains their lack of influence over economic policy and their lack of bargaining power with their customers? Well, we need to step back a few decades to understand how Japanese medium enterprises got themselves into this mess before we examine how they are going to get themselves (and the rest of Japan) out of it. It goes back to the keiretsu, or I suppose the zaibatsu if you really want to go way back. Basically, after the war, Japanese industry was organized into competing corporate groups called keiretsu. Each keiretsu had it’s own major bank, trading company, real estate company, heavy manufacturer, etc. The major firms in the keiretsu were bound together by cross-shareholding and interlocking directorships. And these large firms were supported by a vast array of lesser-known large and medium enterprises that made up their supply chain. These supply chains were tightly controlled and, with only a handful of well-known exceptions, a medium enterprise that was part of one keiretsu’s supply chain would not sell outside of it’s keiretsu group. The fortunes of these companies were inextricably linked to those of the keiretsu itself. Now, this arrangement sounds terrible for the supplier, but it was not as bad as it sounds. Particularly in the early days. The large keiretsu companies took an almost paternal interest in the medium enterprises that formed their supply chains. [pro_ad_display_adzone id="1653" info_text="Sponsored by" font_color="grey” ] The large firms would provide technology transfer and training. They would often partially fund research and development at these firms, and best of all, they would guarantee them a certain level of sales and revenues. The owners and employees of these firms did not become wealthy, but their business was simple. They were protected from most market forces and never needed to develop sales or marketing functions, so they could focus on product development and production. This arrangement worked well for everyone, particularly the large companies. As long as the economy was expanding rapidly, There was always enough money to go around. But things began to change in the 90s. The yen become stronger, and that pushed up the price of Japanese goods overseas, and the large Japanese firms were no longer innovating the way the had been in the 60s and 70s. With money tight, the big keiretsu firms began to squeeze their supply chains. They made other cuts as well, but these mid-sized companies bore the brunt of the suffering within the keiretsu groups. Not only were these firms pressured to relentlessly cut costs, but the dominant firms looked to these mid-sized companies as a way to solve their new staffing problem. You see, the large Japanese corporations had basically promised their entire workforce lifetime employment. Now this made sense when labor was in demand. Since no large firms accepted mid-career transfers, it kept salaries low and employees loyal. Sure, there was always some deadwood who couldn’t pull their weight, but since there never seemed to be enough staff, you could always find something for them to do. All that changed when sales started slumping, these unproductive employees became a real problem both in terms of morale and productivity. Well, the leaders of the keiretsu came up with a perfect solution.