March 19, 2017 1:00 pm JST

What GE saw but Toshiba didn't

Japanese icon ended up on the wrong side of the information divide

ATSUSHI NAKAYAMA, Nikkei commentator

Toshiba President Satoshi Tsunakawa apologizes for his company having to delay its earnings report on Mar. 14.

TOKYO -- The links and parallels between General Electric and Toshiba go way back. Today, however, it is their glaring differences that perhaps stand out most.

Thomas Edison, the American inventor who founded GE, used to say "make money" a lot. Ichisuke Fujioka, a Toshiba founder, learned how to make an incandescent lightbulb from Edison and began mass-producing it in Japan.

Neither GE nor Toshiba produces incandescent lightbulbs anymore, and both have sold off home appliance businesses. Today, GE is the world's 11th-largest company by market capitalization. Toshiba, in contrast, is on the verge of collapse due to fraudulent accounting practices and massive losses stemming from its nuclear operations.

Why did Toshiba stumble? The difference between the two old lightbulb makers appears to lie in their current business models -- how they make money.

Meltdown

Hideki Wakabayashi, an electronics industry analyst, has written a book on the Management Center of Gravity, his trademarked analytical tool. "The strike zone for Japanese companies making few mistakes," he said, "is where they produce items with a life cycle of five to 10 years and the volume comes to anywhere between a few thousand and a few dozen million."

In Toshiba's case, nuclear power plants -- the very source of its ongoing crisis -- have a lengthy 20- to 40-year life cycle. But Toshiba faced no competition from South Korea, Taiwan or China in this sector.

Confident that it had a good shot at filling its coffers by making reactors, Toshiba acquired Westinghouse Electric, a major American nuclear plant builder, in the mid-2000s. The Japanese electronics industry had already begun to sink into a funk by then.

The industry's fall was aptly explained by the "smiling curve" theory, which was popular at the time. The amount of value companies add to their products or services tends to be unevenly spread across different manufacturing sectors, the theory goes. When companies are plotted on a chart in terms of value-added and area of business, a curve that resembles a smiley face emerges.

Upstream businesses, such as product designers and key component producers -- chipmaker Intel is one -- cluster on the left end of the curve. Their downstream cousins, those that make money mainly through sales and after-sales services, sit on the right end -- think of Apple.

Midstream assemblers, including most Japanese electronics makers in the mid-2000s, fall somewhere in-between and create less value.

Japanese electronics makers wanted to escape this plight. They streamlined operations to concentrate on a select few areas, shifting focus to heavy electric equipment such as power generators. Though still assemblers, Toshiba and its Japanese peers were optimistic because they faced little competition from elsewhere in Asia. Stable revenue was expected.

Another set of beliefs also fed their optimism. They disdained the digital industry, the constant pressure to quickly make big, expensive investment decisions. The heavy electric industry, they thought, would offer a better chance for success because it lent itself to suriawase -- the traditional, often time-consuming practice of keeping in contact with client companies so as to tailor products to meet their demands.

This proved easier said than done.

By contrast, GE was already starting to restructure its businesses during the 1980s and 1990s -- when the Japanese electronics industry was at its peak. GE gradually branched out to financial and broadcasting services.

But GE also experienced a setback. The 2008 global financial crisis forced the company to cut its dividend for the first time in 70 years. Having lost its AAA credit rating, GE was unable to issue bonds other than those backed by the government. Its financial unit, which had been generating 30% of the group's sales, suddenly became a drag.

Around the same time, Toshiba's finances were also in tatters because of its $5.4 billion acquisition of Westinghouse. Regulators and Toshiba even discussed a possible third-party share allotment to a Middle East sovereign fund.

GE and Toshiba narrowly avoided the worst. What happened afterward set the two on different paths.

After the March 2011 meltdowns at a nuclear power station operated by Tokyo Electric Power Co. Holdings in Fukushima Prefecture, Toshiba's nuclear plant orders dried up. The company then bought a nuclear plant builder, thinking it might bring in some orders.

In effect, a desperate Toshiba was dipping its toes in unfamiliar waters without making careful calculations, only to get deeper into trouble.

Now it's trying to swim away from the mess.

GE charted its way out of the smiling curve by repositioning itself, selling most of its financial operations and becoming a manufacturer again. It now tries to make money off of services that connect the internet and heavy machinery.

Its aircraft engines have sensors to collect noise, vibration and other data while the engines cross the world's skies. In a single flight between Tokyo and New York, the sensors collect some 2 terabytes of data, the equivalent of 2,000 years of newspapers. GE analyzes the information and teaches airlines how they can minimize delays or other problems. The operating profit margin for GE's manufacturing unit was among the world's highest last year, at 15%, thanks largely to its after-sales services.

Information asymmetry

GE's new business model is built on information asymmetry in terms of both quantity and quality. GE has gained an advantage over clients by holding information they cannot access. Furthermore, by analyzing vast amounts of big data, GE has also acquired a better understanding of what to do with the information.

Holding all that data helps GE reduce risk. If artificial intelligence can identify the expected life and certain tendencies of products or parts, GE can reflect this "knowledge" in its quality assurance or maintenance contracts to minimize its own risks.

Kazuhiko Toyama, at Tokyo-based consultancy Industrial Growth Platform, said GE is the definition of a competitive company, which he described as "one that can write contracts that do not result in losses."

Toshiba, in contrast, signed contracts to acquire businesses or supply goods too hastily without gathering as much information as the counterparties had. Toshiba thus overlooked hidden risks.

Making money, which Edison once described as something both solemn and glorious, benefits from information asymmetry. Throughout human history, we have both accelerated and corrected this asymmetry through such inventions as the printing press, the telegraph, the telephone and the internet. Some say the internet has finally fixed this imbalance, but advances in AI will create huge asymmetry between humans and machines.

GE realized the value and importance of information somewhere along the way and built a system to take advantage of it. Japan got left behind. Toshiba's fall shows this.

 

Toshiba Corp.

Japan

Market(Ticker): TKS(6502)
Sector:
Industry:
Consumer Durables
Electronics/Appliances
Market cap(USD): 10,860.70M
Shares: 4,237.60M

Tokyo Electric Power Co. Holdings, Inc.

Japan

Market(Ticker): TKS(9501)
Sector:
Industry:
Utilities
Electric Utilities
Market cap(USD): 6,616.24M
Shares: 1,607.01M

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