The Japanese Economy: Keiretsu System

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The term Keiretsu is a Japanese word that refers to ‘series’ or affiliated companies with significantly strong ties that bind them together (Hudec& Bhagwati, 1996). The relationship between the Keiretsu groups and the banks seemed too complex for the foreigners. This is because the network was vastly inflated with overlapping interrelationships (Jaffee, 1998). In the mix was the equity and funding relationship with main banks and by equity relationships with subcontractors (Jaffee, 1998).

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For example, Toyota was one of the most prominent of the subcontracting type of Keiretsu but also belonged to the Mitsui Keiretsu, banking Keiretsu with Sakura Bank at its core (Dunning, 1997). This complexity proved so difficult for foreigners to identity Keiretsu since cross-shareholdings were spread across members of a group of companies (Jaffee, 1998). Professor Okumura offered six criteria that defined Keiretsu: the existence of cross-shareholding; a presidents’ club in which top executives met regularly to exchange information; joint investment among member companies; the provision of financial to keiretsu member companies by keiretsu trading company, the sogo shosha; and a “densely networked industrial structure, particularly in the field of chemical industries” (Jaffee, 1998).

However, no Japanese would find any of these intricacies particularly confusing. Kotabe & Czinkota (2000) state that one way to identify Keiretsu was by going to the business section of the Japanese bookstore and investing in one of several massive directories, such as the one published at regular intervals by Toyo Keizai Shinposha, a major business publisher. Its directories broke down each of the Keiretsu by members of the presidents’ clubs and provided detailed information on when and where they met, as well as how many and what level of executive each of the keiretsu seconded to its member companies (p.29).

Although foreigners may have seen Keiretsu as enigmatic structures of doing business, the Japanese saw them as a key factor in analyzing corporate and market behavior and followed their every move (Kotabe & Czinkota, 2000). Michael Gerlach used the term “alliance capitalism” to explain this system of inter-firm linkages (Gerlach, 1992).

Historical Dimension of Keiretsu

The leading Keiretsu could trace their identity back to the 19th-century merchant clans of Osaka and Edo that turned against the Tokugawa bakufu and bankrolled the Meiji Restoration (Hudec& Bhagwati, 1996). Their reward was rich: the Meiji Government sold to its business friends the mines and factories seized from supporters of the defunct shogunate at deeply discounted prices (Hudec& Bhagwati, 1996; Jaffee, 1998). Meiji leaders then provided subsidies to strategic industries needed to support their military buildup, which was gradually incorporated into the merchant conglomerates (Jaffee, 1998). The resulting entities were called ‘Zaibatsu’, or ‘financial cliques’ (Jaffee, 1998, p.223).

By the end of the 19th century, the largest Zaibatsu had aligned themselves so closely with the government that they could manipulate Japan’s fledging political parties virtually at will (Kenichi & Russell, 1995). It was so powerful that in 1898, the then minister for education, Ozaki Yukio cynically remarked that “suppose that you dreamt Japan had adopted a Republican system of government, a Mitsui or Mitsubishi would immediately become the presidential candidate” (p.69).

After the U.S. Occupation abolished holding companies in 1946, the Zaibatsu retained their identity through cross-shareholdings and interlocking directorates (Kenichi & Russell, 1995). The new organizational model was called Keiretsu, which implied outsourcing and management through a contractual relationship rather than ownership.

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Through the 1990s recession, Keiretsu remained among the world’s largest corporate groupings. In addition to the three Zaibatsu-related Keiretsu, another three combined centered on banks: Dai-Ichi Kangyo Bank; Sanwa Bank; and Fuji Bank (Terry, 2002). Anchors for another forty Keiretsu were generally the largest companies in their industries, such as Toyota, Nissan, or NTT (Terry, 2002). All had a huge impact on the Japanese economy (Terry, 2002). In 1990, the six largest Keiretsu accounted for a staggering 61% of the Tokyo stock market’s capitalization, with corporate assets of $5.1 trillion, while some 40 smaller groupings made up 17% of market capitalization and accounted for $423 billion, incorporate assets (Terry, 2002).

Generally, Keiretsu assets represented at least double Japan’s $2.5 trillion gross national product in 1990 (Terry, 2002). The 6 big conglomerates by themselves represented 4% of Japanese employment, with 1.4 million workers, 15% of sales, and 13.7% of profits (Terry, 2002). Cross shareholdings of the six in 1990 were 25.7% of total share ownership, and while these figures declined through the end of the decade, by 1998 their piece of total share ownership was still close to 16% (Terry, 2002). The largest decline was in the first few years after the stock and real estate crash, as short selling hit even Keiretsu shares (Yoshiro & Mark, 2002).

During the bubble years, easy money encouraged a rapid expansion of cross-shareholdings, which peaked and subsequently declined (Yoshiro & Mark, 2002). By the end of the decade, bank mergers that crossed Keiretsu lines seemed to point to a breakdown of the system, but as Douglas Ostrom, cited in Yoshiro & Mark (2002) has observed the big Mitsui, Mitsubishi, and Fuyo groups were all busy aligning their financial companies to become financial supermarkets. In the meantime, Japanese Internet companies, such as Softbank Corp., were beginning to form their Keiretsu-like structure (p.169).

Types of Keiretsu System

As described earlier, Keiretsu are big conglomerates interconnected by a common buying of shares, hence form “integrated alliances across many industries” (Lincoln & Gerlach, 2004, p.314). Gerlach (1992), in his study of Japanese business enterprise, uses the term ‘alliance capitalism’ to describe the institutional pattern of relationships among corporations and other organizational actors.

At the center of this particular form of capitalism is the Keiretsu which is an inter-corporate alliance characterized by “institutionalized relationships among firms based on localized networks of dense transactions, a stable framework for exchange, and patterns of periodic collective action” (Gerlach 1992, p.3). The historical aspect and structures of Keiretsu described above typically give us two types of keiretsu systems: Vertical and Horizontal systems.

Vertical Keiretsu involves sub-contracting relationships between organizations and within a company itself, e.g. firms connecting all factors of production for a particular product (Kenichi & Russell, 1995; Yoshiro & Mark, 2002). These are firms that have coalesced around a tiered subcontracting relationship in specific industries, such as Toyota and Nissan. Horizontal Keiretsu on the other hand involves the relationship between the entities and industries as well, basically the banks, trading companies, and presidents’ clubs (Yoshiro & Mark, 2002). They include firms such as Mitsui and Mitsubishi.

The trading companies, banks, and presidents’ clubs play key roles in organizing the keiretsu (Terry, 2002). The trading companies put members of their keiretsu together in package deals- brokering supply against demand and bringing together corporate resources spread across the group for specific projects (Terry, 2002). In many instances, such arrangements include reciprocal purchasing, that is if a keiretsu member company bought goods from another, it could demand that the other company buys its products (Terry, 2002). According to Terry (2002), the banks not only provided financing but also “encouraged such mutual back-scratching through their ‘keiretsu management’ divisions” (p.401). The presidents’ clubs, with names such as the Friday Club and the White Water Society, provided information channels at a senior corporate level among key members of each keiretsu (p.140).

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The strength of the Keiretsu System

The system is accredited with many aspects of Japanese economic prosperity even during times of financial crisis. Among the most remarkable aspects of the system was its ability to tie up large amounts of the stock of member companies in rock-solid holdings that buffered the entire group during times of financial shock (Lincoln & Gerlach, 2004). For instance, a particular case study revealed that Asahi Glass, a Mitsubishi Keiretsu company, held on to virtually all of its Keiretsu shares during the high- yen crisis after 1985, while dumping shares of Matsushita and Hitachi companies, which were not related to Mitsubishi (Terry, 2002).

Aaron Cohen, a senior analyst with Daiwa Securities, was quoted saying that his study revealed that Asahi Glass kept its Keiretsu shares even when economics suggested it should give them up, that “their portfolio was one, Mitsubishi; two, their suppliers; three, their customers, and very little else” (Terry, 2002, p.401).

Some analysts believe that keiretsu is the single most feature of the Tokyo Stock Exchange (Kenichi & Russell, 1995; Kotabe & Czinkota, 2000). Kotabe & Czinkota (2000) identified that out of 1,612 companies listed on the Tokyo Exchange, 1,100 belonged to Keiretsu, stating that this is a fact that influenced the cheap cost of money, the generally low dividends paid by Japanese corporations, and the paradox of an often “wildly fluctuating stock market and robust companies” (p.198). Japanese banks were able to restrain profit and offer cheap credit because their major customers were also their chief shareholders (Kotabe & Czinkota, 2000).

Kotabe & Czinkota (2000), further highlights that the corporate dividends were low for the same reasons- the owners were not anxious to dilute their profit by paying out dividends; i.e. so many of the shares were owned by Keiretsu companies, which rarely released them to the market place (Kotabe & Czinkota, 2000).

The 1990s saw the clash between Japanese keiretsu and Western-style reach a notch higher as the economic rivalry intensified between Japan and United States. The United States had set out a standard culture for multinational business, a spawning corporate culture in which profits the main goal and shareholders held unrivaled power (Dunning, 1997). Japanese business, however, forcibly restructured along U.S. lines after Japan’s defeat in World War II, with a radically set different set of standards where shareholders’ interests were subordinate to long-range national and corporate goals (Dunning, 1997).

This became critically important during times of economic expansion, where the keiretsu supplied ‘bottomless pockets’ for new ventures (p.237). Again during times of crisis, they helped to dilute the paint and established an order of priority for rescue operations (Dunning, 1997). According to the Ministry of International Trade and Industry (MITI), cited in Kotabe & Czinkota (2000, p.17), “Japanese manufacturing industry owes its competitive advantage and strength to its subcontracting structure”. One researcher estimated that about a quarter of the cost advantage of Japanese automobile firms is due to the superior efficiency of their supplier networks (Terry, 2002).

Evidence of the efficiency-promoting effects of subcontracting relationships comes from a series of studies that ask statistically whether Keiretsu have a measurable impact on Japan’s trade volumes: Fung, 1991, cited in Terry (2002) found out that vertical keiretsu, those that involve subcontracting relationships, tend to increase exports, suggesting that the vertical keiretsu is associated with low-cost and high-quality production. These studies also found that a different kind of keiretsu, horizontal keiretsu, groups firms operating in separate markets, often with common financial links, tend to decrease imports, and therefore have a protectionist effect (Terry, 2002).

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Case study: Operations of Mitsubishi

To get insight into what strength Keiretsu is comprised of, it is important to observe one of the largest keiretsu, Mitsubishi, which also doubles as one of the largest industrial groups in the world (Yoshiro & Mark, 2002). In 1995, Mitsubishi’s total revenue was $36.5 billion, with the core resource base of the group made up of 36 factories and 15 research facilities.

About one 35% of the firms engage in ‘process manufacturing’- production of materials such as cement, chemicals plastics, and synthetic fibers- that supply the manufacturing units of the group (Yoshiro & Mark, 2002). Another 35% of the company is involved in ‘fabrication manufacturing’- the production of products such as air conditioners, automobiles, computers, electronics, and telecommunication devices (Yoshiro & Mark, 2002). The rest of the companies provide various services and specialized functions such as financial management, banking and insurance, construction, and global marketing (Yoshiro & Mark, 2002).

According to Jaffee (1998), the Mitsubishi group is not a single corporate entity with a central ‘brain’, the cross-shareholdings, interlocking directorates, joint ventures, and long-term business relationships; all underpinned by common educational and historical links; create a family of companies that do not depend on formal controls, but rather recognize their mutual interest (p.312).

He further elaborates that in keiretsu, no single company predominates, since rarely do any one member is allowed to hold more than 10%; creating a dense fabric of relationships that makes the members enjoy a family safety net that encourages long-term investment and high-tech risk-taking (Jaffee, 1998).

The network-based arrangement and the contribution of various firms to the final product, for example, can be seen in one of Mitsubishi’s automotive facilities in the United States, established in partnership with Chrysler (Lincoln & Gerlach, 2004). The vertical supply network is dominated by Mitsubishi and Mitsubishi-related firms. On the other hand, each of these suppliers is free to forge connections and establish contracts with other non-Mitsubishi companies (Lincoln & Gerlach, 2004).

Changes in Global Business Environment: Impact on Keiretsu

Over the last 10 years, several changes have occurred in the global business environment. The internationalization or rather globalization of many major companies in the world has changed the functionality and effectiveness of Keiretsu. This impact has especially been advanced by American companies who have got inroads into the Japanese economy (Business Week, 1996).

Practically, as stated earlier, U.S. firms have historically complained about the size and competitive strength of the Japanese keiretsu, and have been unable to replicate its organizational structure. However, recent developments suggest that several U.S. firms identified the potential niche into the Japanese keiretsu apparatus and have made several inroads in terms of investments. Such firms as IBM, GE, TRW, Hewlett-Packard, and Caterpillar have entered into strategic alliances with various Japanese keiretsu (Business Week, 1996). According to Business Week (1996), “the deepening web of relationships reflects a quiet change in thinking by Japanese and U.S. multinationals in an era when keeping pace with technological change and competing globally have stretched the resources of the richest companies”

Implications on Keiretsu

The relationship developed between U.S. firms and Japanese keiretsu has created various implications that are very significant to note. According to Kawai (2009), this connection has complicated the debate over the Japanese trade surplus with the United States. Official trade statistics are unable to account for the U.S. contribution and the role in the production of Japanese products that are based on the cooperative arrangements between the U.S. and the Japanese firms (Lincoln & Gerlach, 2004). For instance, while IBM and Toshiba compete in the laptop computer market, they have joined forces in the development and production of a key component of this product: the monitors (Kawai, 2009).

This kind of interrelation or alliance points to another implication: the conflict between corporate and national interests. Jaffee (1998) aptly puts it, “international competition in global product markets between firms is no longer a purely zero-sum game” (p.74). It, therefore, implies that the sale of a Toshiba rather than an IBM is no longer viewed as a total loss for IBM given its role in the production of the Toshiba component.

Structurally, the keiretsu system represents a prototypical case of an organizational arrangement combining inter-organizational networks with flexible forms of production (Jaffee, 1998). Although many analysts have concurred that this system is not easy to replicate, clear evidence has indicated that many U.S. firms have moved towards this flexible model of production that draws on a diverse assemblage of firms both within and outside the United States. Bennett Harrison, 1994, cited in Kotabe & Czinkota (2000) recently analyzed the changing corporate structure and landscape.

He highlights attempts by U.S. corporations to develop various new strategies to cope with the competitive pressures of the global economy and argues that “the most far-reaching may well turn out to be the creation by managers of boundary-spanning networks of firms, linking together big and small companies operating in different industries, regions and even countries. This development… the signal economic experience of our era” (Kotabe & Czinkota, 2000, p.258).

Harrison (1997) observes that the organization of corporate production systems rests on four central principles and practices: creating lean organizations through reduction of the number of corporate activities; movement toward a flexible system that entails the application of computer technologies that makes it possible to coordinate widely-based production sites; like the Keiretsu, corporations are constructing strategic alliance that incorporates a network of smaller firms supplying various components and services; and lastly the human resource collaboration. That is, the collaboration of the remaining and the most highly trained and highly paid employees in the organization through corporate culture strategies and organizational mission statements (Harrison, 1997).

The highlighted principles that guide business globalization have been observed to dilute key features of keiretsu in several aspects. First, it increases the number of competitors in the sub-construction list; hence the closely-knit type of relationship is eliminated (Harrison, 1997). As stated earlier, the keiretsu system did not give external firms a chance of penetrating the market. According to Harrison (1997), while each of these flexibility-enhancing strategies has different consequences for different groups, they are designed to reduce the rigidly long-term contracts that characterized Japan’s Keiretsu system. Observably, this impact has made Keiretsu vulnerable, especially during the recent adverse recession (BBC, 2002).

According to an analysis by BBC on what caused Japan’s recession, it is stated that Japan’s “bubble economy” seen before 1989-90 recession has not been seen since ever (BBC, 2002). In principle, the Keiretsu relied on the goodwill interrelationship with the banks, which had the majority of their assets in either land or cross-shareholdings (BBC, 2002). Globalization led to the wiping out of these assets and debts, subsequently creating an unprecedented burden to the banks that could no longer lend (BBC, 2002).

A typical case of change response to the changing global business environment is the big car-maker, Nissan. The recent decision by the global car-maker CEO, Carlos Ghosn uncharacteristically implemented the “Nissan Revival Plan”, where he dissolved most of the Keiretsu partnerships, setting a precedent for many lobby groups to push for other car makers like Toyota to follow suit (Kawai, Norifumi, 2009). According to Kawai, Norifumi (2009) this is meant to reduce the procurement cost through competitive contractions.


In the context of this broad analysis, it is evident that the Keiretsu phenomenon is more than just a simple particular type of organizational structure or management strategy; it is a system of inter-organizational relationships that enhance flexibility and reduce costs of core group members. Further, according to Gerlach (1992), it may also contribute to national economic performance in several ways.

The inter-corporate alliance produces an economic system that is more resilient in the face of rapid economic changes. Key business relationships among firms are both more stable and more adaptable under the keiretsu arrangement; the inter-organizational system encourages and is base upon, cross-shareholding, which provides mutual equity investment capital for a large number of firms, and also draws investment capital into productive activities due to the shared interests that are built into this arrangement; the system sets up structural barriers that prevent encroachment by foreign firms that might be interested in replacing domestic suppliers and manufacturers to the exclusion of alternative supply sources. It is noted that United States’ auto parts producers have been shut out of Japanese automaker supply networks, even within the United States.

On the other hand, from the Japanese perspective, this system sustains the economic viability of a diverse array of Japanese companies (Gerlach, 1992).

Reference List

BBC (2002). What caused Japan’s recession?. Web.

Business Week (1996). Cozying up to Keiretsu: U.S. companies are forging close ties with Japan’s big business groups. Web.

Dunning, J. (1997). Alliance Capitalism and Global Business. London, Routledge Publishers.

Gerlach, Michael (1992). Alliance Capitalism: The Social Organization of Japanese Business. Berkeley, CA, University of California Press.

Harrison, Bennett (1997). Lean and Mean: Why Large Corporations Will Continue to Dominate the Global Economy. New York, Guilford Press.

Hudec, Robert & Bhagwati, Jagdish (1996). Fair Trade and Harmonization: Economic Analysis. Chicago, The MIT Press.

Jaffee, David (1998). Levels of Socio-Economic Development Theory. Santa Barbara, Greenwood Publishing Group.

Kawai, Norifumi (2009), Keiretsu corporate networks are innate to the Japanese auto sector, but could this system finally be changing?. Japan Inc. Magazine. Web.

Kenichi, Miyashita & Russell, David (1995), Keiretsu: inside the hidden Japanese conglomerates. Chicago, McGraw-Hill.

Kotabe, M. & Czinkota, M. (2000), Japanese Distribution Strategy: Changes and Innovations. Tokyo, Cengage Learning EMEA.

Lincoln, J. & Gerlach, M. (2004), Japan’s Network Economy: Structure, Persistence, and Change. Cambridge: Cambridge University Press.

Terry, Edith (2002), How Asia Got Rich: Japan, China and the Asian Miracle. Wisconsin, M.E. Sharpe.

Yoshiro Miwa and Mark Ramseyer (2002), The Fable of the Keiretsu, 11 J. Econ. & Mgmt. Strategy, pp.169- 178.

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