Some experts have observed that the current global financial crisis resembles the collapse of Japan’s bubble economy in the early 1990s. And indeed, the underlying behavior was the same: Financial institutions, looking for fast returns, provided financing without enough restraint. This capital in turn fueled sectors of the real economy, such as durable consumer goods, along with the housing boom, and caused them to overdevelop as they competed for customers. Before Japan could return to prosperity, its business community had to learn three critical lessons.
• The dangers of excess supply. From the 1950s through the 1970s, the Japanese economy grew largely through exports. Then, after a steep rise in the value of the yen in 1986, Japanese policymakers increased deregulation and added more government supports to business, actions aimed at stimulating domestic demand. The relaxation of constraints on financial activity spurred investment; industrial companies, as well as real estate developers, expanded their businesses by relying on their increased ability to borrow. This business growth, in turn, drove up the Nikkei stock index.
Only after the bubble collapsed in 1991 did the underlying problem with this growth strategy become evident: The consumer market in Japan was limited, and the perception of high demand was mistaken. But many companies had invested in anticipation of future demand, and now the country had too much supply capacity and too much debt. Many borrowers ended up with debts that exceeded the value of their collateral assets.
In our current economic crisis, the global financial community has fallen into the same set of traps. A surplus of financing drove the excess supply in the industrial sector, which drove fierce competition to fulfill future demand, leading to long-term overcapacity.
• Customers as scarce resources. After the collapse of the Japanese bubble, industrial companies had to recognize that customers are scarce resources. Among the first to see this were the Japanese automotive companies, for whom “follow the customer” has been a core strategy — especially valuable when the demand for new cars is declining. In their home market, Japanese auto companies emphasize downstream revenues, including insurance, loans, inspections, maintenance, parts, and accessories. Those revenues, stable even in recessionary times, are essential to keeping the dealer network alive. In overseas markets, Japanese automakers “follow the car,” offering used high-quality vehicles as weapons against the cheap new automobiles being introduced by upstart Asian competitors. By building relationships with consumers through service and support, these moves create a market for the future.
Today’s global companies are not necessarily doing a good job of following the customer or the car (or any other product). Throughout the early 2000s, they pursued the familiar business model of churning customers by focusing on new sales. Now they must redefine their global business models, changing the focus from making and selling to making, selling, and servicing — seeking more revenue from the same customer base rather than chasing new and uncertain growth. Making the most of an existing customer base is an effective strategy in a recession, and it will remain effective even in growing markets, especially for the long term.
• Inevitable consolidation. In Japan, after the Asian financial crisis in 1997, 13 banks merged into four groups. Something similar will happen in the U.S. and Europe during the next year or two — not just in financial services, but in all sectors. Large companies will have to consider consolidating their excess capacity by acquiring (or allying with) overseas companies and their potential customer bases.
In Japan, this was a particularly important lesson for the financial and industrial sectors; both had to solve excess capacity problems. But whereas the banking sector consolidated, Japanese industrial companies have been slow to follow suit. Instead, they have largely continued competing with one another. There are only a few models of constructive consolidation, such as the global alliance between Renault SA and Nissan Motor Company. The two parties jointly pursued real synergies (for example, in reducing sourcing costs) rather than one seeking full control of the other party (as Daimler-Benz AG sought with the Chrysler Corporation).
Some might argue that the Japanese consolidation was unique, because of the unusually close relationships between banks and borrowers. But even though that part of the context is different, multinational companies today face a similar challenge: excess supply caused not only by financial leverage, but also by excessive competition. Once again, consolidation is needed to provide stability. That consolidation will probably be driven by those with strong R&D leadership. Global access to R&D capabilities in, for example, energy or environmental innovation will drive demand in the future.
The global financial-services industry will also face consolidation, but geopolitical factors rather than innovation will determine the results. In the past, banks did not compete across state lines (in the U.S.), across national borders (in the E.U.), or across some prefecture and province boundaries elsewhere. But with the advancement of global economies, and increasing cross-market competition among global players, banks no longer secure high enough profit margins in their home territories. Credit default swaps, high-risk solvency and leverage ratios, and other excesses were the products of a short-lived effort to compete through innovation, and they will all be regulated in the future. Banks and other financial-services firms will have to refine their business models: Low cost structures, global economies of scale, internal risk management capability (as opposed to risk transfer technology), and a sufficient capital base will be hallmarks of this new, more mature business model.
During the 1990s, many Japanese business leaders waited years for recovery. After all, the fundamentals of the world economy were solid. Productivity and quality were increasing, and global markets were expanding. Only a few companies took the measures that helped them rebuild: reducing supply, building a business based on repeat customers, and embracing consolidation. Many global companies, unwilling to forget the boom times, will make the mistake of waiting for recovery. Others will learn to be more proactive — and they will be the corporate leaders of the next decade.
Yoshiyuki Kishimoto is a senior executive advisor to Booz & Company based in Tokyo. He has broad-based financial-services experience, having spent more than 20 years consulting to banking, securities, insurance, and nonbank financing firms.
Hiroyuki Sawada is a partner with Booz & Company based in Japan. He specializes in business transformation, especially the strategic and competitive dynamics of industrial reconstruction, including acquisitions, alliances, and the integration of organizations.
Chieko Matsuda is a partner in Booz & Company’s Tokyo office. She focuses on strategic finance and business strategy for top management, including the fields of business portfolio management, financial decision making, mergers and acquisitions, investor relations, and credit ratings.