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Datawatch

The $100bn ceiling Japanese companies cannot shatter

Growth stalls as CEOs hesitate to cut off unprofitable units

Japan Inc. could learn a thing or two from the West about focusing on core competencies and divesting unprofitable businesses.

TOKYO -- At the end of 1989, with Japan's bubble economy blindly approaching the cliff's edge, Japanese companies made up about half the world's 100 most valuable corporations.

Now the country's only representative on that list is Toyota Motor.

The biggest factor behind Japanese companies' lackluster market performance is corporate chiefs' inability to make tough calls and focus resources on strategically important businesses. They are falling behind even as technological innovations and strategic acquisitions drive brisk corporate expansions across the world. 

The remarkable rise of Procter & Gamble's market value compared with such Japanese companies as Fast Retailing and Rakuten serves as a prime example.

The American multinational consumer goods company has sold off its Pringles potato chip and Duracell battery brands and instead focused on laundry detergent, skin care and eight other core businesses over the past 20 years. Shareholders rewarded the company by lifting its value to $300 billion from $100 billion in that time. 

On the other hand, the operator of the Uniqlo casual clothing brand has not been able to hit $70 billion, and Rakuten, Japan's leading e-commerce company, has lost steam after reaching $20 billion.

Similarly, the market value of Kao, a major Japanese consumer goods maker, has doubled, but just to $39 billion during the same period.

The Tokyo Stock Exchange is planning an overhaul of its market categories to bring back investors. It aims to create a "prime" market for selected blue chips, a category reserved for companies with strong investor appeal.

The move would remake TSE's swollen first section into a board for elite companies that can power the market's advance.

But such superficial changes may not be enough to lure back capital.

The exchange already has an index tracking the cream of the crop: the Topix Core 30 Index. It is composed of 30 of the first section's largest companies in terms of sales or market capitalization. The stocks constituting the index are reviewed annually to ensure that only high-growth companies are on the list.

Despite being made up of the bluest of chips, however, the Topix Core 30 has actually underperformed other indexes.

Currently, the Core 30 is slightly below 80% of the value it held on April 1, 1998, while the Topix is 40% higher. The Topix Small Index, composed of first section issues not among the 500 largest ones, is 120% above its April 1998 level.

The data leaves little doubt that the principal factor behind the Japanese stock market's failure to climb has been the wobbly performance of the leading stocks.

Japanese companies tend to stop growing earlier than their Western and Chinese rivals. Many of the country's corporate giants struggle to rise past 10 trillion yen ($100 billion) in market capitalization.

According to data from QUICK-FactSet from 1985 onward, of the companies that exceeded $10 billion (approximately 1 trillion yen), 20% reached $50 billion in Japan, but only 3. 9% of the companies reached $100 billion.

Only eight Japanese companies have ever cleared the $100 billion bar. This is far below the 86 in the U.S., 53 in Europe and 18 in China.

Japanese companies tend to mature early, according to a return on assets analysis conducted by a researcher group led by Hiroshi Shimizu of Waseda University. The results show Japanese companies' average return on assets, or ROA, an indicator of a company's profitability relative to its total assets, peaks at slightly above 10% about 10 years after it is founded, then starts dropping.

The ROA picture at Japanese companies stands in sharp contrast to that of their U.S. counterparts, which keep ROA figures at 10% to 12% for extended periods.

Shimizu says the biggest factor behind the difference is that Japanese companies are unable to shift resources away from unprofitable ones toward strategically important businesses.

Kazushige Okuno, chief investment officer of Norinchukin Value Investments, says growing companies can maintain momentum by concentrating resources on core competencies and shooting for overwhelming dominance in the market.

There are some encouraging signs. Sony's stock has surged to a 17-year high as the company has invested in its highly competitive image sensor business while scaling down its consumer electronics operations.

Keyence makes automation sensors, measuring instruments and other industrial-use products. It has excelled in its ability to meet detailed customer needs and is approaching the 10 trillion yen threshold.

Dynamic management that can make strong businesses even stronger is the only way to escape the doldrums Japanese companies remain stuck in.

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