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GE shows where Toshiba went off track

For the U.S. manufacturer, unlike its Japanese rival, knowledge is power

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The headquarters of Toshiba in Tokyo   © Reuters

TOKYO The links and parallels between General Electric and Toshiba go way back. Today, however, it is their glaring differences that 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 incandescent light bulbs from Edison and began mass-producing them in Japan.

Neither GE nor Toshiba makes light bulbs anymore, and both have sold off their home appliance businesses. Today, GE is the world's 11th-largest company by market capitalization. Toshiba, by contrast, is on the verge of a breakup due to fraudulent accounting practices and massive losses stemming from its nuclear business.

Why did Toshiba stumble? One key difference between the two venerable companies lies in how they make money.

MELTDOWN Hideki Wakabayashi, an electronics industry analyst, has written a book titled "The Management Center of Gravity." Said Wakabayashi, "The strike zone for Japanese companies making few mistakes lies in making products with a life cycle of five to 10 years, with production volumes between tens of thousands and tens of millions of units."

In Toshiba's case, nuclear power plants -- the source of its ongoing crisis -- have a lengthy 20- to 40-year life cycle. But the company 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 bought Westinghouse Electric, a big U.S. nuclear plant builder, in the mid-2000s. Electrical equipment, long a mainstay of Japanese industry, had already fallen into a funk by then.

The plight of Japanese manufacturing is aptly illustrated 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 parts of the manufacturing process, the theory goes. When companies are plotted on a chart in terms of value-added and the type of business they are in, a curve resembling a smile 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 electrical machinery and electronics makers in the mid-2000s, fell somewhere in the middle and created less value.

Japanese manufacturers, who wanted to escape this trap, streamlined their operations to concentrate on a select few areas. Some shifted to heavy electrical equipment, such as generators, for example. Though they were still in the business of assembly, Toshiba and its Japanese peers were optimistic because they faced little competition from elsewhere in Asia. They expected the shift to bring stable revenue.

Although their products had long service lives -- meaning replacement demand would be limited -- they preferred this business model to the digital industry, with its constant pressure to quickly make big investments. The heavy electrical equipment business, they thought, offered a better chance for success because it lent itself to suriawase -- the traditional and time-consuming practice of keeping in constant contact with clients so as to tailor products to their needs.

This proved easier said than done.

By contrast, GE had begun restructuring its businesses in the 1980s and 1990s, when the Japanese electronics industry was at its peak. GE gradually branched out into financial services and broadcasting.

But GE also had 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 group sales, suddenly became a financial drag.

Around the same time, Toshiba's finances were also in tatters because of its over 600 billion yen ($5.4 billion) acquisition of Westinghouse. The company and Japanese regulators even considered selling a stake to a Middle Eastern sovereign wealth fund.

And while GE and Toshiba both narrowly avoided the worst, what happened afterward set the two on different paths.

After the March 2011 meltdown at the Fukushima Dai-ichi nuclear power plant operated by Tokyo Electric Power Co. Holdings in northeastern Japan, Toshiba's nuclear plant orders dried up. The company had bought Westinghouse thinking it might bring in orders. A desperate Toshiba was swimming in unfamiliar waters, heedless of the danger. Now it is floundering.

GE, by contrast, turned the smiling curve upside down by selling most of its financial operations and becoming a manufacturer again, but this time with a focus on sales of heavy equipment and bringing in continued revenue through services delivered online.

Its aircraft engines, for example, have sensors that collect data on noise, vibration and other parameters while in flight. During a single trip from Tokyo to New York, the sensors collect some 2 terabytes of data, equivalent to 2,000 years' worth of a daily newspaper. GE analyzes this vast trove of information and shows airlines how to use it to minimize delays and prevent problems. Such after-sales services helped lift the operating profit margin of GE's manufacturing unit to a world-beating 15% last year.

INFORMATION GAP GE's new business model is built on information asymmetry in terms of both quantity and quality. GE has gained an advantage over its clients by collecting information they cannot get for themselves. Its ability to analyze that data effectively further sharpens its edge.

That helps GE reduce risk. Artificial intelligence can be used to determine the expected life span of products or parts, for example. The company can use this knowledge in its quality assurance and maintenance contracts to minimize its risk. Kazuhiko Toyama, at Tokyo-based consultancy Industrial Growth Platform, calls GE the epitome of a competitive company. It is "one that can write contracts that do not result in losses."

Toshiba, by contrast, has signed deals to buy companies or supply goods too hastily, failing to gather as much information as its counterparties had. Toshiba thus overlooked hidden risks.

Making money, which Edison once described as both solemn and glorious, is easier when one has the advantage of asymmetrical information. Throughout history, inventions such as the printing press, the telegraph, the telephone and the internet have been used to widen or narrow these information gaps. Some say the internet has finally redressed these imbalances once and for all, but advances in artificial intelligence are creating huge asymmetries between humans and machines.

GE realized the value of these information gaps early on and developed the analytics to take advantage of them. Toshiba's fall shows what a disadvantage Japanese companies are operating under by being late to this game.

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