Decoupling denied: Japan Inc lays its bets on China

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In 1978, when Chinese leader Deng Xiaoping visited a factory belonging to what is now Panasonic in Osaka, he made chairman Konosuke Matsushita an offer he could not refuse.

That year, China’s economy lay in ruins following the Cultural Revolution. But Deng had an idea. Turning to Matsushita, his guide on the tour, he said: “You are called the god of management. Will you help us modernise our economy?”

Matsushita, fatefully, agreed. The following year he travelled to China and told Beijing factory workers, “You are working very hard to learn to make TVs. If you keep up the effort, you’ll catch up with Japan in several years and start developing new technologies.”

He was right. In 1987, Panasonic established Japan’s first Chinese joint venture in Beijing, training 250 assembly line workers in Japan for half a year to finally launch local production in 1989.

Matsushita did not live to see the fruits of this bargain: today, China accounts for ¥1.7tn ($16bn), or a quarter of Panasonic’s business, including sales within China, and exports mainly to Japan.

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But while Matsushita’s farsighted championing of China created what is today one of Panasonic’s biggest markets, it also created its most powerful competitor. Today, China churns out half of the world’s refrigerator and washing machine production and 85 per cent of air conditioners, according to Panasonic. Homegrown brands such as Midea and Haier now hold a dominant place in the global appliance market, leaving Japanese companies largely in the dust.

Tetsuro Homma has seen the story play out since the beginning. He was one of the first Panasonic employees to learn Chinese in 1986 in preparation for the company’s big China push. Today, he is chief executive of Panasonic’s in-house China & Northeast Asia Company. And he is presiding over a key decision by the 102-year-old company: whether to move its appliance headquarters, or at least some of its global business functions, to China.

“The operations have been led by Japan because it was the biggest market. The situation is different today,” Homma said. With about 52,000 employees and about 80 subsidiaries in China, Panasonic’s launch of the China & Northeast Asia Company in 2019 shows that the company is looking beyond the US-China trade war and into the next 10 to 20 years.

“I don’t think that the Japanese manufacturing industry could survive globally without being present in a market as big as China’s,” Homma told Nikkei Asia, interviewed by video link. Competition is fierce in China because it attracts players around the world. “Being able to compete in China is a ticket to competing in the global market,” he said.

Panasonic’s technology still leads its Chinese competitors, but only just. And it struggles to carve out high-end niches in the market it once ruled, in an effort to compete.

One example of such a niche is the EH-XD 30, a $620 WiFi-enabled hairdryer. Released in August, it syncs with your smartphone, achieving optimal moisture levels by adjusting the amount of electrified particles it blows into hair to the UV and humidity in the atmosphere. Then there is a smart toilet that measures body fat and urine content and sends the data to your smartphone.

“Japanese consumers tend to avoid something unusual. By contrast, Chinese consumers like a new product or a new technology,” Homma said. “Unless you have one of these, you cannot get their [Chinese consumers’] attention.”

Market squeeze, shrinking leads

Panasonic’s decision to further signify its operations is a decisive vote of confidence in a trading model that it pioneered: bargaining technology to China in exchange for access to the largest market in the world.

It is a game that it managed to stay ahead of for four decades, maintaining a technological lead over its Chinese competitors — albeit a shrinking one. Most multinational corporations are in the same boat, whether German carmakers or US communications equipment companies. They play by China’s rules and give away technology as the price of market access.

The strategy comes with its own risks. Ke Ding, a researcher at the Japan External Trade Organization, said direct investment in China does make it easier for China to catch up to Japanese companies. To avoid import duties and transport costs, “foreign companies try to procure parts locally by training local suppliers in parts production and creating a supply chain in China”, he said.

Foreign companies also serve as a training ground for local managers, who may go on to set up their own companies or, later, become recruited by Chinese rivals. But despite all that, Japanese companies are still protective of their presence in China, he said. “Fast-growing China is a more profitable market than mature economies, and more profit means more money for R&D and keeping ahead of the competition,” he said.

The other reason Japan Inc invests in China is the presence of a vast and sophisticated supply chain. Complex products such as cars require a huge number of components and a large supplier network, which exist in China but not necessarily in up-and-coming competitors such as south-east Asia. In fact, “companies that have moved to south-east Asia often have to import parts from China due to a lack of local suppliers”, he said.

But trading technology for access has its drawbacks: many Japanese industries have been sacrificed as Chinese companies turned round and used their technology to compete with them abroad. Japan’s motorcycle industry, high-speed trains and, of course, electrical appliances are some industries where Japanese investment in China created powerful international competitors. Others will undoubtedly follow.

“We are probably three to four years ahead of the Chinese,” said Norio Nakajima, president of Murata Manufacturing, the world’s largest maker of capacitors. But “their pace of catch-up is getting faster”.

Murata President Norio Nakajima Murata president Norio Nakajima: “We are probably three to four years ahead of the Chinese . . .  [but] their pace of catch-up is getting faster”  © Bloomberg

Panasonic’s example illustrates the shifting fortunes of the two largest Asian economies. In 2000, Japan’s economy was four times as big as China’s; in 2010, China overtook Japan, and today it is nearly three times as large. Even pressure from its own government and the US has not been enough to wean Japan Inc off its dependence on the China market.

In the wake of the Sino-American trade war and the “decoupling” of the two countries’ technology sectors, the US government has been pushing its multinational corporations such as Apple to move supply chains away from China. Washington expects allied governments, such as Japan, to follow suit. Washington has also banned any companies from selling US technology to Huawei Technologies, the Chinese telecommunications infrastructure giant.

But while Tokyo has tried to wean its companies off China, even offering subsidies to Japanese groups to exit the Chinese market, it is clear that leaving China is easier said than done.

Japanese companies operating in China remain bullish: just 7.2 per cent of them said they were moving or considering moving production out of China in a September survey by JETRO, down from 9.2 per cent in 2019.

Naoto Saito, chief researcher at the Daiwa Institute of Research, said: “Japan Inc is actually increasing its investment in China, while also seeking to set reasonable limits due to geopolitical risks, and remaining aware of avoiding overdependence.” He added: “It’s unthinkable for companies not to consider the Chinese market at all.”

Japan Inc is mostly strengthening its focus on China, and one prime example is Toyota. The carmaker took the opposite approach to Panasonic in the late 1970s. After Deng returned from his 1978 visit to Japan, the Chinese government asked Toyota to come to China to open local production. The Japanese automaker declined, choosing to focus on moving production to the US. Toyota now recognises this as a strategic error of historic proportions.

Toyota belatedly announced a plan in 1994 to enter China, but it took until 2000 to form its first joint venture in Tianjin. Today, its sales numbers tell the tale: at rivals Honda and Nissan, China accounted for about 30 per cent of sales volume in the fiscal year ended March 2020, but at Toyota that share was only 18 per cent.

Toyota got a second chance in 2018 as Chinese premier Li Keqiang visited its plant in Hokkaido. Li took interest in Toyota’s fuel cell vehicle, a technology he saw as key to emissions reduction. This time, Toyota did not miss the Chinese overture. “This is our last chance,” said a Toyota executive.

Toyota announced in June 2020 the establishment of a joint venture with five Chinese companies to develop fuel cell systems for commercial vehicles. The partners include China First Automobile Works and Guangzhou Automobile Group, two longtime Toyota JV partners. Then, in October, Toyota agreed to supply Guangzhou Automobile its petrol-electric hybrid system — the first time for it to be offered to a foreign company. Toyota also released a Lexus electric vehicle and an all-electric SUV in China ahead of Japan last year.

Chinese Premier Li Keqiang visits a Toyota Motor plant in 2018 Chinese premier Li Keqiang, second from left, visits a Toyota plant in 2018, after which the company speedily began partnering with Chinese companies in areas from autonomous driving to fuel cell systems © AFP via Getty Images

Toyota formed a partnership in 2019 with two Chinese autonomous driving start-ups — with Pony.ai for road testing and with Momenta for high-definition mapping. That same year, the Japanese company joined the Apollo project, the self-driving development platform spearheaded by Chinese search engine provider Baidu.

These moves are double-edged, designed to deal with both the difficulty of transferring American-developed technology to China, as well as gearing their products more towards the Chinese market.

“Toyota will continue to increase the extent of local production,” said a spokesperson.

Meanwhile, the company is also hedging its bets with investment in other markets. “We are also taking early steps” for frontier markets, the spokesperson said, referring to Toyota’s capital partnership with Suzuki to expand in India and a business expansion in Africa by Toyota Tsusho, a Toyota group trading house. In south-east Asia, it works with its Daihatsu subsidiary, which produces the most cars in Indonesia for itself and other brands, and operates the Perodua unit, the largest carmaker in Malaysia.

Many foreign companies remain confident they can stay ahead, even as they share their technology. One example is Kyoto-based Nidec, the world’s largest motor maker, which is investing in China to meet the rapidly growing demand for electric vehicles.

For Nidec, there is no substitute. Aiming to grab 40 per cent to 45 per cent of the global market for electric vehicle motors by 2030, it has no choice but to focus on China, the world’s biggest electric vehicle market. Given the stakes, they have successfully fended off the Japanese government’s push to diversify production away from the giant neighbour.

At its Dalian plant — one of two main production bases in China, and where the company set up its market presence in 1992 — a second production line for electric vehicle motors, costing close to $1bn, is under construction. So is a research and development facility with a staff of 1,000. Both are due to come online this year.

“It is my policy to do different things and ahead of other people,” said Shigenobu Nagamori, Nidec’s chairman and chief executive. He predicts China will become the company’s biggest market but added that it is also eyeing expansion in countries near China, such as Vietnam and the Philippines.

“I started doing business in Vietnam before the diplomatic normalisation between the US and Vietnam” in 1995, he said. “I was able to develop a strong business base because I went in when nobody else did.”

When Nagamori met Donald Trump in Tokyo in 2019, the then US president criticised Nagamori for being too focused on China. He replied that Nidec actually makes roughly the same amount of investment in the US as in China.

“As a business owner, I don’t have any country I like or don’t like. My company operates on a global basis,” he said. “We have operations in 43 countries.”

He observed that Japan does not have to fear China’s rise. “China isn’t good at everything,” Nagamori stressed.

“The tie I’m wearing is Italian. Japanese ties aren’t wearable,” he said, pointing to his green and gold striped tie. “Uniqueness is a strength. That’s how Japan competes against China.”

Decoupling by degrees

Not everyone is so optimistic. Japan sees manufacturing as its strength, but “it’s getting harder to differentiate from Chinese products, especially in the area of consumer electronics”, warned Murata’s Nakajima. “Chinese have a lot of money, a large labour pool and many talented people. Their pace of catch-up is very fast.”

Nakajima notes, however, that the Japanese have more experience in research and development, as well as a longer investment time horizon.

Demand for Murata’s capacitors — a tiny device that helps smooth voltage and protects the delicate electronic components in smartphones and computers — surged as mobile phone sales took off in the late 1990s. In the 2000s, Murata expanded into China by following Japanese electronics customers.

Today, Murata’s customers go beyond Japanese electronics makers to include Huawei, Xiaomi, Oppo and Vivo as well as Apple and Samsung Electronics. Greater China accounts for more than half of Murata’s sales.

But the US-China trade war is complicating Murata’s growth strategy as Nakajima warns about an emerging decoupled world. “The world would be divided into two economic spheres if US-China tensions continue under the Biden administration,” said Nakajima in an interview.

The Chinese market is “too large for us to ignore”, he added. “Given its size and the pace of growth, there would be no choice but to develop products for that market, in addition to ones for the western and Japanese market.”

That is not necessarily an easy thing to do, Nakajima points out. Some electronic devices are difficult to manufacture without American equipment, such as computer-aided design tools, he said. In order to supply to China, replacement equipment needs to be found.

Facing a rapidly decoupling world, Murata and most of Japan Inc is sticking with the Chinese market, an outcome that runs counter to the advice from the Japanese government, which has been urging Japanese companies to diversify away from China.

“It is absolutely necessary to strengthen supply chains in Japan and diversify those overseas in order to secure more sources of supply,” said then prime minister Shinzo Abe in August. Supply chain reforms “need to be implemented with a long-term perspective, and not just to reduce costs and increase profits”, he said.

His successor, Yoshihide Suga, also counselled Japanese companies in a speech in October to diversify their supply chains into south-east Asia.

Officials say that Japanese industry would be shortsighted if it clings to the Chinese market. “The pace of China’s economic growth has been slowing. Japanese companies should move to the next growth centre of south-east Asia and India,” said an official responsible for economic security issues at the Japanese Ministry of Economy, Trade and Industry, reflecting advice given to the industry.

The official noted that the US-China trade war and coronavirus have made many Japanese companies anxious to diversify supply chains away from China. Last year’s lockdown by China brought the supply of key parts to a halt and crippled Japanese supply chains.

Meanwhile, the trade war has also increased the unpredictability factor, leading to higher tariffs for products that are made in China and bans on the use of US components and equipment for items exported to China. Some Japanese manufacturers, such as video games maker Nintendo and multifunction copier producers including Sharp, Ricoh and Kyocera, have shifted production to Vietnam and Thailand.

Meanwhile, US sanctions against Huawei have caused huge sales losses for Japanese chipmakers. The US commerce department banned all exports to the Chinese telecommunications company of products made with American technology in September. Many fear this ban will be expanded, and they have begun looking for other markets to fill the gap left by a loss of sales to China’s largest telecommunications equipment supplier.

Japanese companies supplied about $12bn in parts to Huawei in 2020, according to UK research company Omdia.

Another source of uncertainty is the geopolitical environment: Chinese territorial claims in the East China Sea could turn ugly at any moment. “Japanese companies need to be aware that the Chinese market could disappear once tensions flare over the Senkaku Islands,” the METI official said.

On the state-to-state level, China-Japan relations are uneven. Chinese president Xi Jinping’s visit to Japan, originally scheduled for spring 2020, has been postponed and is yet to be fixed.

Panasonic keeps this Sino-American rivalry in mind as it plans its future. It produces industrial products, such as industrial robots and electronic devices, but it focuses on appliances in China. “We had to keep in mind the US-China conflict when we created China & Northeast Asia Company,” Homma said.

He said Panasonic has separated the businesses that do not involve sensitive technology — appliances and housing equipment — and brought them over to China. “We’ll expand aggressively in China in these businesses,” he said.

Now based in Beijing, Homma promotes Panasonic products by appearing on live streaming ecommerce programmes in Chinese. In 2020, 51 per cent of Panasonic’s appliance sales in China took place online, up 7 points from a year before.

In Japan, salespeople work at big retail outlets to promote Panasonic products. In China, salespeople work behind the computer screen, chatting online with visitors to ecommerce sites, looking for Panasonic products such as hairdryers and electric shavers, answering their questions at lightning speed, and working in shifts from 6am to 2am

Homma said ecommerce has not spread in Japan as much as in China despite the coronavirus pandemic but expected other Asian countries, such as India, to follow China’s lead and reckoned that the online business model in China will help Panasonic expand in the rest of Asia.

Meanwhile, Homma is philosophical about the future. “China was extremely lucky that until recently it was able to export anything it wanted to the US without worrying about political consequences,” Homma said. “Japan has been involved in trade disputes with the US for 50 years.”

“China has optimised its economy for large-scale manufacturing and has focused its resources on investing, producing and exporting on a large scale,” he said. “That age is over now.”

A version of this article was first published by Nikkei Asia on February 10 2021. ©2021 Nikkei Inc. All rights reserved

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