[talk] The Challenges and the oppotunities of Japan's Reform

Donald P.Kanak: President and CEO of AIG Companies, Japan & Korea

Donald P. Kanak is a President and CEO of AIG Companies, Japan & Korea. He joined American International Group, Inc. (AIG) in 1992, elected Executive Vice President and appointed to member of the Office of the Chairman in 2002. He holds a B.A. degree in Economics from University of North Carolina, a Juris Doctor degree from Harvard Law School, and a Master's degree in Management Studies from Oxford University, England.

Mark Norbom: President & CEO,General Electric Japan

Mark Norbom is a President & CEO of General Electric Japan, he spent several years in business development roles focusing on Europe and Asia, President & General Manager of GE Capital Taiwan, Country President of GE Capital Indonesia, National Executive of General Electric Thailand and he was appointed as President & CEO of GE Capital Japan in 2001. He attended Pennsylvania State University and graduated magna cum laude with a B.S. degree in Economics in 1980.

Jesper Koll: Managing Director Chief Economist Japan Research Department of Merrill Lynch Japan Securities

Jesper Koll is a Chief Economist of Merrill Lynch Japan Securities, his work includes Nihon Keizai korekara Ougonkihe. Graduated from Johns Hopkins University.

Koll:
Thank you very much for taking time out of your busy schedule to discuss your views with GENRON today. We have a big agenda. I want to talk about Japan's government policies, corporate governance, the financial Big Bang and your insights into Japan's business environment, were you see the challenges and where the opportunities. But to start, perhaps you could tell me a little bit about your background, what brought you to Japan and your responsibilities here.

Norbom:

I'm Mark Norbom. I am the President and CEO of GE Japan. General Electric has all of its global businesses represented in Japan. Some of them have been here for over 100 years. We now have more than 15,000 employees in Japan. I have been here for about two years running the country organization and supporting all our various industrial and financial businesses. My background: I have been with GE for 22 years; in Asia for the last 9 years -- two here in Japan, with assignments in Thailand, Indonesia, and Taiwan as well. Prior to that I was working in the United States in the business development area. I have worked in various GE businesses, but I started out in finance.

Kanak:
I am Don Kanak. I am president and CEO of AIG Companies of Japan and Korea and Executive Vice President of the parent company. I came to Japan for the first time in 1981. I was working at a consulting firm and managed to get myself on a study that included Japan as a part of a global strategy study for a client.
I came to Japan in 1986 to help a consulting client start an insurance company. The client was Equitable Life of the United States. That was my first business experience in Japan. We started the company, built it up, and in 1991, sold the company to Nihon Shinpan. At that time, I joined AIG in Japan. I have been at AIG for over 10 years and now oversee the operations for Japan and Korea. We have 5 insurance companies in Japan. Alico Japan, a life insurance company, another life insurance company called AIG Star formerly Chiyoda Life. Three non-life insurance companies. AIU, American Home Direct, and a joint venture with JTB called Japan International specializing in Travel Insurance. We also have an asset management company, a small consumer finance company and several other members of the financial AIG group. I have now been here for over 15 years.

Koll:
So here we are in the year 2002. You both are living and working in Japan, running large, successful and growing businesses. From your perspective, where do you see the biggest obstacles to a prosperous future for Japan?

Norbom:

I would look at the current situation and focus first of all on the positive signs that have emerged recently. The Yen has stabilized, deflation is easing, exports seem to be picking up, but there are still huge issues here that cannot be ignored. The-Non Performing Loans (NPL) probably are the largest obstacle to a prosperous future. Also, government debt is very high. In my mind, what is really unclear is the path to a strong vibrant economy and also what is the vision of what you have once you get there. I think what has to happen is some of these huge problems have to be faced straight-on and then quickly try to put them behind you. I am not sure how to do that in every detail, but you have to put the problems behind you and focus on the future. Japan should articulate a clear vision for what the Japanese want the country to be, and set policies geared towards getting to that vision as quickly as possible.

Kanak:
We jump right into obstacles so we are leaping over what has changed and what has gotten better over all the years that I have been here. Let me go back to when I first got here. In 1981, the consulting project that I was working involved a very traditional distribution system, nothing related to financial services. It was actually straight-forward consumer products, actually spirits and liquor. It was a very traditional distribution system. At that time, it was the rule rather than the exception to have multiple layers of distribution between manufacturer and consumer. Now, over the past twenty years, that has begun to change very significantly. Now more and more distribution systems are flat and more efficient.
Also, 20 years ago, foreign companies could not hire good Japanese students out of good Japanese universities. I remember students would say, "I would love to join your company but I would not be able to get a good wife because my potential wife's mother would not have heard of the company and it is much safer for me to go to a well known company." This has changed fundamentally. Today I think companies like GE and AIG and others are able to present good careers to young people and get them to join. Moreover, think of the tremendous change in financial services that has happened. Deregulation has been going on. New types of capital markets and financial products have been created, often against the opposition of many who said that they should not exist.
For example, powerful people argued that securitization couldn't happen in Japan. The idea that Japanese banks would be thinking about returns on equity rather than the number of branches they had was deemed unthinkable. But in reality, there has been - and continues to be - tremendous changes in behavior. None of that in my view, or very little of that was accomplished by a national consensus of a clear vision. It was a combination of companies, and government bureaucrats, and politicians, and opinion leaders, and others who were working on different agendas and different scales and different reasons. That is the way countries are. Countries are complicated and change happens all the time.
Of course, there are the laws of gravity of economics. Old obstacles disappear and new ones emerge. I think that the problem with the NPLs is definitely a big problem. It is not going to go away for a quite a period of time but I don't think that is the core problem. The core issue is corporate profitability.
Think about it - each problem has two sides. With the NPLs, there is the lender and there is the borrower. If the borrower is not making profits, he is not going to be able to pay the loan back. Fundamentally, corporate return on assets and profitability is just too low in Japan. This is why the stock market is weak, which of course has all sorts of ripple effects on consumer confidence and investor confidence. Moreover, it then ripples through bank capital, which ripples through the economic system.
So, I would say that above everything else, the major issue is how to stimulate better corporate performance. And some of the people who are supporting Genron are people who are trying to work on this. It is important to discuss the idea of independent directors, the idea of shareholder democracy, of better disclosure and better corporate governance in general. In the end, however, the final goal of all this is to create corporations that are striving to make better returns. I think that is the core issue here. If corporations make better returns, you have a better stock market, you have more healthy banks, you have less non-performing loans you, have more confident consumers, you have the ability to have returns on pension funds that can pay for an aging society, you have a recovery in real estate prices. Without corporate profitability at the center, none of this can happen.

Norbom:

I think this point is absolutely right. I think the whole focus on creating shareholder value, which walks hand in hand with Don's comments, is absolutely essential to creating a more vibrant stock market and increase the value of assets across the board.

Koll:
Why do you think this is so difficult in Japan? We know that in the 1960's, in the 1970's, even in the early part of the 1980's the performance the Japanese corporations was excellent, that even on a rate of return basis many of Japan's companies were amongst the best on the world. Then, of course, Japan had the bubble economy, which meant that everything became to easy and corporate managers lost focus. Many stopped improving their companies core businesses and instead ventured into real estate speculation and "Zaitech" money games. From here, were would you start the attack to turn things around? What should Japanese managers focus on?

Norbom:

That is a very good question. What I see is that many of the advantages that Japan has had in the past are still here - the quality of products is high, productivity is good, technology is excellent and there is great public infrastructure. The managers' problem is not that Japan's competitive advantages have gone away, but that many of these advantages have been globalized. You can now do many of the things that you used to only be able to do in a place like Japan in China for a fraction of the cost. The world has changed. It is open and has become more global. How do you respond to that is the big question.
There has always been a very strong social aspect of Japanese businesses that have gone along with Japan's competitive advantage. Now the competitive advantage has been globalized, you're still left with the social benefits and social responsibilities of companies. Trying to bring up new competitive advantage and still keep the strong social responsibility that is ingrained in the companies is a huge challenge.

Kanak:
I don't expect to add much new to this debate. There are many scholars who have already commented on it. But I do think that all the success and all the advantages of Japanese management skills were developed during the high growth era. Now, it is inevitable that during periods of high growth the one skill, the one expertise you do not develop is the skill of restructuring. The core skills in a growth era were how to improve quality, how to expand market share, how to create new market segments, how to modify and invent small innovations in products to reduce the lifecycle of products so people would replace them more frequently. There was no need for thinking through radical changes in cost structure. That's the kind of change that you face when suddenly a competitor emerges with one tenth of the labor cost, like China. U.S. companies just happened to face that competitive threat a little earlier in history than Japanese companies did.
This reminds me of another consulting project I worked on. I was working for an industrial supplier who thought they were leading the world in a particular product. And then a Japanese competitor appeared within a few years and virtually took away their entire market share by reducing the cost of the product by about two thirds. So all of a sudden my client had to restructure very fundamentally. In fact they went out of that business and went into a new business. They had to do it to survive and had to do it very quickly.
I think what maybe has taken too long is for Japan to develop the skill of restructuring. The skill of restructuring requires new capabilities. Dealing with issues directly rather than indirectly. Bringing bad news into the office of the President or the Chairman and being prepared to talk about it frankly. I think that is not very easy to do for many people in Japan. It is not easy to do in the United States either, or in France or Germany or anyplace really, but I think the historical communication practices and organization decision making processes of corporations here which serve very well in a steady growth environment, impeded that kind of frank discussion, frank decision making, and radical change.
Now this is starting to change too but it is changing slowly. On a macro level, there are many good trends for deregulation. There are many good trends for restructuring, and in a sense there is progress on structural reform. But again it is a question of pace. How quickly can those decisions be made, how quickly can visions be set, and actions taken? To me it is more a question of timing and pace. I think, as far as I can see, there are many, many people who agree on what needs to be done. But it is how quickly is acceptable for this country? And that is a national decision. This is Japan's decision how fast Japan wants to make those changes because those changes come at a cost.

Koll:
Do you really think Japanese companies are slow to change? Look at some of the restructuring success stories that have been coming through. Everyone always says "Nissan this, Nissan that." Well actually, if you look at some of the restructuring that happened at Toyota in terms of cost by cost, they have achieved just as much, if not more. I think there are many companies here who have got excellent corporate governance, take very fast, very solid decisions, are hyper competitive, very globalized, have excellent R&D and are not at all afraid to make hard decisions. What amazes me is the growing gap between some very excellent companies getting better all the time against so many bad companies getting worse all the time.

Norbom:

Yes, there are several global first-rate companies in Japan. There are companies that have done the right things to compete in a global economy. You mentioned Toyota. The car industry is almost a commodity business. Yes, there are distinctions about quality and brand, but to achieve leadership in this market is quite a feat. Sony is the leader in consumer electronics. Canon and Ricoh have presented a huge challenge to Xerox in office equipment. So there are great examples of companies who have figured out how to deal with the global realities. Figured out how to do some of their manufacturing in China, figured out how the product technology and engineering can indeed be competitive. On a global basis, these are great examples of companies that have not just adapted to globalization, but have actually spear-headed it. And what I admire is that many of these same companies have been able to hold on to their traditional values and corporate culture while adapting to the changing market.

Kanak:
If the economy were composed of all Sonys and Toyotas, we wouldn't be having this discussion. That is true of any country. You have your stronger companies. I think the issue is how to have more strong companies.

Koll:
I think this gets us goes back to the fundamental divide in Japan's economy, the non-performing loans. Let's discuss the banks for a moment. I want to start with the year 1999, the year the banks did all the "mega mergers". The end result is an unprecedented concentration of power amongst four financial groups. All are so big that they are clearly too big to fail. And indeed, three years later it seems that the management strategy of the bankers was indeed primarily defensive, designed to prevent nationalization rather than becoming a catalyst for pro-active change. So we've got the world's largest bank starting out with a truly spectacular demonstration that neither top nor middle management can actually build a modern bank with a properly functioning computer settlement system. If you cannot even get the very basics of your business right, how can you be expected to gain the trust of the people or re-gain global competitiveness?

Kanak:
I think it is much more complicated than that. We cannot just fault bank management and I certainly wouldn't use the example of the recent problems at Mizuho as anything that is symptomatic of the non-performing loans. I think that anytime you try to merge organizations that have different computer systems that are very complicated and vast, it is an extremely complicated and difficult implementation. And if you are under a time schedule that puts more risk into it, mistakes could happen easily. That is a really unfortunate thing to happen, but I wouldn't say that was an unprecedented event. There have been systems problems in mergers probably in many other places as well.

Norbom:

And other problems than just systems problems do happen all the time. Those things happen in large-scale mergers.

Kanak:
Certainly the banking industry has a lot of difficulty but look at the total of loans that were written off last year. It is extraordinary. There was a huge amount of write offs, a huge amount of loan sales. They are doing a lot, but they are in a business that is a very difficult business right now. When you have deflation, how can you run a profitable banking business? Has anyone ever done that in the world?
Koll: Oh, I very much agree. From a macro perspective, ultimately it is not possible for a corporation to be better than its customers. That's especially true for banks.

Norbom:

It goes back to the point that Don made earlier about getting the focus on profitability so you can stop the new inflow of NPLs. In Japan, the inflow outpaced the outflow last year. And corporate profitability and a focus on that, and shareholder value is really the key to stemming the inflow of new problems. The banks have tremendous strength and they can last for a while trying to work through this problem. And with the low interest rates that they are paying, the burden of carrying the problems for a long time is low and trying to work them over time is a perfectly legitimate approach. If you think the economy will recover, and asset values will increase, and profitability of companies will increase, then it may indeed turn out to be a viable approach.

Koll:
I don't want to put words into your mouth, but the banks are a convenient scapegoat for the rest of corporate Japan not getting its act together and running proper companies. Or is that overstating it?