NEWS ANALYSIS : For a Japanese <i> Keiretsu,</i> It’s a Family Affair : Networking: Companies that own shares in each other give and receive preferential treatment on contracts, providing a safety net in troubled times.
When Sumitomo Bank chose recently to upgrade its massive computer system, the decision to replace American-made NCR Corp. equipment with large mainframes from NEC Corp. seemed illogical.
For one, NEC is among the weakest companies in an already troubled mainframe business. NEC computers cannot run software developed for machines made by other companies. And the Japanese company does not have the depth of experience of NCR or International Business Machines in building systems for large financial customers.
But to those who follow the elaborate network of ties that bind Japanese companies, the bank’s decision made perfect sense. NEC is a valued member of the Sumitomo Group, or keiretsu, a sort of extended family of companies that own shares in each other and give each other preferential treatment in awarding contracts.
The NEC deal demonstrates how keiretsu ties can be an important safety net for Japanese companies in troubled times. At the same time, those ties place even the best qualified U.S. companies at a disadvantage in competing for contracts with a keiretsu member firm.
Sumitomo Bank will buy 24 of NEC’s largest machines for $270 million--a significant bit of income for a company that lost $420 million in the year ended March 31, and a major boost to NEC’s struggling mainframe division.
On the other hand, NCR will lose its largest customer worldwide.
“NEC is close to us and is part of our group,” a Sumitomo Bank manager involved in the decision said privately. “We hope our order will lead to more NEC mainframes being used in banks. We want their business to expand.”
Japanese officials have argued that keiretsu groups have declined in importance with modernization and deregulation of the economy. For example, in a recent report, the Japan Fair Trade Commission cited a slight decline in cross-shareholding ties among grouped companies. The report also said the average company in a group made only 10.8% of its sales to another company in the keiretsu group, down from 11.7% in 1981.
But the keiretsu system continues to distort the way decisions are made in the Japanese market, and it is likely to be a topic of discussion in the upcoming negotiations aimed at narrowing the growing trade imbalance between the United States and Japan.
American insurance companies complain that keiretsu members deal almost exclusively with companies in their own group. And, U.S. auto parts makers say they are locked out of the auto industry’s vertical keiretsu (a vertical group consists of a major company and its suppliers).
The fact that group members own each other’s shares and rarely sell them also make it virtually impossible for foreign companies to enter the Japanese market through acquisitions, as Japanese companies have done in the United States. Consequently, foreign firms hold just under 1% of the corporate stock in Japan, while foreign firms control more than 20% of U.S. corporate stock.
The power of the six major horizontal keiretsu, which, like the Sumitomo Group, are centered around a major bank, is inestimably large. When the group members’ affiliates are included, these keiretsu account for about 25% of all sales in Japan.
Three of the groups are descendants of the prewar, family-run zaibatsu , or conglomerates.
The Sumitomo Group began 300 years ago as a copper mining company. After World War II, Sumitomo and the other zaibatsu were broken up by Allied occupation forces, which blamed the conglomerates for backing the war. Within a decade the companies had regrouped as bank-centered organizations with large holdings of each other’s shares--the ultimate anti-takeover defense.
To maintain a common identity, the Sumitomo Group has its own principles of behavior and rituals. The group’s presidents gather each year with Sumitomo family members at a special, temple-like hall built to honor the group’s founders. Every month, the presidents of the 20 core companies in the Sumitomo Group meet in what is called the Hakusuikai (white water group) to discuss group affairs. In good times, the group explores ways to cooperate on risky new ventures. In bad times, the group seeks ways to help troubled members.
When Mazda auto sales collapsed after the oil crisis of the 1970s, employees of the Sumitomo Group were asked to buy Mazdas. Sumitomo Bank gave special loans to Mazda and converted its 1,500-car corporate fleet to Mazdas. Later, when group member Asahi Beer began to fall behind in sales, the group companies’ more than 350,000 employees were urged to buy Asahi Beer.
Recently, when $9 billion in bad real estate debt came close to bankrupting trading company Itoman, Sumitomo Bank swallowed the losses and the group arranged to have the company merged into a minor trading subsidiary of group member Sumitomo Metal.
The bank’s computer deal is somewhat more complicated. The group has long been a solid backer of NEC. Nearly half of the computers used by group companies are made by NEC, but it has been an embarrassment to NEC that the group’s main bank depended on NCR computers.
Sumitomo Bank began using NCR machines in the early 1960s, long before NEC manufactured competitive mainframes. The high cost of switching to a new system kept Sumitomo Bank a loyal customer of NCR. When NCR shifted strategies, requiring Sumitomo to rewrite its software if it wanted to upgrade to the latest NCR machines, Sumitomo took that opportunity to rewrite its software to accommodate NEC machines. The cost of the switch, including both the new hardware and software development, could come close to $1 billion.
NEC’s largest computers will be used for transaction processing, the workhorse operations of handling more than 20 million bank accounts. The decision to go with NEC for these functions is unusual, since Sumitomo also chose IBM machines to handle a smaller, but nonetheless important function of the bank’s information system. As a result, the company will have to maintain and develop software for two incompatible systems.
Experts say Sumitomo was forced to include IBM in its plans because of IBM’s superiority in software for managing information systems.
Although Sumitomo showed favoritism to NEC by choosing its computers, that doesn’t mean NEC will make big profits on the deal. Industry executives say that in exchange, NEC had to agree to supply the machines at rock-bottom prices.
Even so, the deal may not represent such a bargain for Sumitomo Bank. The bank’s information systems manager admits that the switch holds risks for the bank, since NEC has little experience in the banking business. “For this big a project there is a lot of risk,” he said. “The performance may not be as high as we expected.”
