Riding the wave of digital transformation and strengthening the earning power of Japanese companies

※Below is an excerpt from "Perspective 1", "ABeam" Public Relations Report 2018-19.

Masato Miyamaru  Hiroyuki Aitani

Return on Equity (ROE), which is a measure of profitability based on shareholder equity, is gradually improving at Japanese companies; compared to global corporations, however, the standard of ROE remains low. On the other hand, due to the accelerating development of digital technologies, the uncertainty surrounding corporate management is growing. What, then, must Japanese companies do in order to further increase their earning power? We spoke to Masato Miyamaru, leader of ABeam Consulting’s Strategy Business Unit, and Hiroyuki Aitani, leader of the Manufacturing & Consumer Business Business Unit, to find out more.

Masato Miyamaru
Executive Officer, Principal
Head of Strategy Business Unit
Head of Management Planning Group

Hiroyuki Aitani
Executive Officer, Principal
Head of Manufacturing & Consumer Business
Business Unit

Advances in digitalization are shortening corporate lifecycles

The Ito Review defined a clear ROE goal of eight percent or more and has had a significant influence on “ROE Management,” which focuses on capital efficiency. Perhaps as a consequence of this review, in recent years the ROE of Japanese companies has been improving. In fiscal 2017, ROE exceeded 10 percent for the first time and Japanese companies are now increasingly attractive propositions, even from the perspective of overseas investors. However, compared to companies in the West, where the median ROE hovers between 12 and 15 percent, improvements in the earning power of Japanese companies are unexceptional.

Indeed, despite achieving record revenues and net income, Japanese companies remain inferior when it comes to basic earning power?why is this so? One possible reason is that cash earnings are not invested into new projects. Although corporate performance has been relatively strong, the profits that remain inside the company-also known as “retained earnings”?have hit record highs for six years in succession. While more and more companies are increasing shareholder returns via share buybacks or higher dividends, companies typically achieve sustained improvements in earning power by reinvesting the cash they have earned in growth areas.

The negativity of Japanese companies when it comes to investment is also evident from their research and development costs. Companies in advanced countries around the world-in the U.S. and in China in particular-are steadily increasing their investments in research and development; at Japanese companies, however, such investments are stagnating.

Masato Miyamaru, executive officer and principal, and head of the Strategy Business Unit, comments: “There can be no doubt that the advance of digital technologies, increased uncertainty, and other unprecedented changes in business environments have led to a paradigm shift in the competitive environments at Japanese companies. Indeed, waves of creative disruption are causing game changing upheaval across all industries.”

宮丸正人

As the waves of digital disruption grow stronger, so corporate lifecycles are growing shorter. In 1960, companies listed on the U.S. S&P500 stock index remained listed for an average of 60 years or so; by 2025, this duration is expected to have decreased to just 15 years as a result of the advance of digitalization and the shortening of product cycles. The competitive advantage enjoyed by Japanese companies also appears to be dwindling. If we define “competitive advantage” as “possessing an operating profit ratio that exceeds the industry average,”the duration for which Japanese companies have been able to maintain a competitive advantage has decreased by a third or so between 2000 and 2015.

According to Miyamaru: “What this shows is that the length of time for which existing businesses can generate sufficient customer value is decreasing, and that age has arrived which, by necessity, requires the generation of new competitive advantages with shorter lifecycles. Of course, Japanese companies are also attempting to acquire new competitive advantages-through open innovation initiatives, for example, or by accelerating investment into start-ups via corporate venture capital (CVC). Nevertheless, it is still a fact that few successful case studies exist.”

When a company’s intrinsic earning power is presented in the form-“size of creative value” x “length of existence value”-Japanese companies focus on business optimization and business site improvements, and seek to prolong their longevity while maintaining profit levels. In other words, they have a strong tendency to try and safeguard the “length of existence value.”

However, creative disruption is putting pressure on both “creative value” and “length of existence value.” It not only destroys business, but also destroys the very structure of the industry itself and redefines it. We are now entering an age in which disruption is the norm: “In order to maximize the equation ‘size of creative value x length of existence value,’” says Miyamaru, “management must define what sort of company they want their company to be in 10 to 15 years’ time. The core question facing Japanese companies is whether their management can generate new competitive advantages of their own accord in order to maximize their earning power.”

Comparison of ROE by country (distribution)

“Imaginative power” reconstructs business models and provides new values

In order to ride the wave of digital transformation and maximize their earning power, what, then, must Japanese companies do?

First, they must develop “imaginative power.” This can be defined as “the ability to formulate visions and stories.” Companies will be required to identify changes in their industries, create customer value from the perspective of customer jobs, construct new business models, and thereby provide unprecedented new value to end customers.

Hiroyuki Aitani, Executive Officer and Principal, and head of the Manufacturing & Consumer Business Business Unit, explains: “We are living in an age in which corporate lifecycles have shortened. Companies wishing to sustain their businesses are now required to continually review and create value from the perspective of their customers’ jobs. At ABeam Consulting, we propose the concept of Connected Enterprise® through our ecosystems; we believe that by fusing both internal and external assets, technologies, and human resources, and by creating new offerings based on market trends, we can provide Connected Enterprise® to our clients. In my opinion, this new “imaginative power”-which is not a mere extension of existing policies-will lead to the maximization of the earning power of Japanese companies.”

Akio Toyoda, president of Toyota, said of the automotive industry: “We are undergoing a once-in-a-century period of major change.” It seems that traditional industry boundaries are in the process of being torn down. Previously, the automotive industry comprised complete car manufacturers, parts manufacturers, and dealerships. Now, new ideas such as Connected, Autonomous, Shared & Services, and Electrified are making their presence felt, and electronics companies, high-tech companies, infrastructure companies, insurance companies, IT companies, and a variety of start-ups have entered the automotive industry. This is, as they say, “beyond mobility.”

Aitani explains: “Customer behavior is now shifting from ownership to use, and if companies wish to survive in these highly competitive markets, leaders of companies involved in the automotive industry must not only sell cars but also car-related services. In other words, these companies must envisage how they can provide Mobility as a Service (MaaS) from an end customer-centric point of view.”

四十谷裕之

The digital disruption that transcends industry boundaries is also occurring in the logistics and retail industries. In Japan, sales have fallen at integrated supermarkets and shopping centers that remain stuck in the past, while even in the U.S. the long-established Sears department store is at risk of collapse; meanwhile, the online retailer Amazon continues to go from strength to strength. Learning from these examples, Japanese retailers are starting to enter the e-commerce business and are engaged in a variety of initiatives aimed at defending against the “Amazon effect.” However, the efforts of the majority of these retailers are limited to increased product line-ups and reduced prices-they have no point of differentiation. What, then, should the leaders of Japanese companies that are battling against the threat of Amazon do? “

Let me take one of our clients as an example,” said Aitani. “This company had a clear vision of providing ‘the ultimate, traditional Japanese purchasing experience.’ The idea comprised two facets: first, the realization of the user experience; second, the establishment of a service structure that enabled this user experience to be realized. The company actively invested management resources into both these facets, and is currently realizing strong growth.”

With regard to user experience, the company in question has acquired various licenses to expand its product line-up, which even includes products that are typically difficult for general e-commerce sites to deal in. With regard to service foundations, the company focused carefully on customer convenience for both payments and deliveries, and established a logistics platform which provided delivery services that were both flexible and conscientious.

The company’s logistics center fully utilizes AI and robots, and features systems that enable many product types to be delivered the following day. At the same time, during delivery the company pays attention to the customer’s family environment: for homes with small children, the company takes care to ensure the doorbell is not rung; for those living alone, the company considers appropriate delivery times. Indeed, the company does not rely on the independent judgment of its delivery drivers but, instead, utilizes customer data to provide fine-tuned services.

Aitani commented: “This case provides suggestions for ways in which Japanese logistics and retail companies can survive. The effective use of data is becoming increasingly important?how companies can utilize this data in uniquely Japanese one-to-one communications will prove to be crucial, not least in their fight against the threat of Amazon.”

Adopting management strategies that focus on the generation of new competitive advantages

The “power to implement” is the means by which ideas are permeated, and is a source of new competitive advantages

Both Miyamaru and Aitani believe that the “power to implement”is also key to maximizing the earning power of Japanese companies. It is essential that companies encourage both internal and external sympathies via the visions and stories formulated by the aforementioned “imaginative power,” and also ensure that capabilities, resources, organizations, and processes are kept pointing in the appropriate direction, with a focus on customer value. Miyamaru points out: “Except for the core elements of a business, it is important that companies effectively utilize external resources and co-create. In addition, how companies make use of AI, VR/AR, robotics, and other digital technologies to generate speed will have a significant impact on their future competitiveness”

In the end, in this increasingly uncertain digital age, in order to improve their competitiveness Japanese companies ought to create policies based around “imaginative power” and “the power to implement,” and shift toward management approaches that focus on the creation of new competitive advantages.

Miyamaru says: “When Japanese companies establish new businesses, they are often hindered by conflicts with their existing businesses?this is even true of companies that recognize the importance of new business. In addition, when it comes to the development of new business at Japanese companies, there are frequent interruptions between the 0→1 research period, the 1→10 establishment period, and the 10→1,000 acceleration period. In order to realize non-linear growth, management teams must assume responsibility and resolve these conflicts and interruptions.

Miyamaru explains there are three approaches that can be used to increase the likelihood of a new business succeeding. The first is the “carve-out approach.” This is an independent portfolio-type approach in which a new business department is carved out from headquarters and established as an independent business; Google (Alphabet) is a prime example. The “company-wide digital transformation approach” stands in direct contrast. GE is an archetypal example of this approach, in which the entire company engages in generating new competitive advantages for the digital age.

“For Japanese companies,” advises Miyamaru, “the ‘segregation approach’ is ideal. Here, companies engage in the creation of new competitive advantages in environments removed from existing headquarter business. Adopting a segregated environment encourages co-creation, facilitates increased speed of action, plus, it enables the aforementioned conflicts and interruptions to be resolved.” The new business is left to develop and grow in a segregated environment; if the core business declines, the segregated business can be reincorporated, resources can be shifted, and business integration or restructuring is also possible.

Aitani agrees: “The ‘company-wide digital transformation approach will likely take Japanese manufacturers more than 10 years to achieve, since they are burdened with successful past experiences and legacy assets. The risks are high, and the probability of success, low. The ‘carve-out approach is typically achieved via the strong commitment of charismatic founders such as Masayoshi Son and Shigenobu Nagamori; for this reason, such a pattern does not suit Japanese companies particularly well. Taking the ‘segregation approach’ makes the outcome easier to predict, and makes it easier to proceed to the next stage if it is successful.”

Cut off from headquarters in an environment with different rules, cultures, and processes, management teams must demonstrate vision if they want to generate new competitive advantages via new business; moreover, in each period?namely the 0→1 research period, the 1→10 establishment period, and the 10→1,000 acceleration period-the management teams must claim responsibility and demonstrate a “power to implement.”

(Excerpt from "Perspective 1", "ABeam" Public Relations Report 2018-19).

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