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They're getting pummeled by price erosion, shrinking markets, and smaller, nimbler outfits

Hidetaka Yamamoto, a computer engineer at Toshiba Corp., heads an elite product development unit with a long list of achievements. Backed by an annual budget of $100 million, his group helped Create Toshiba's hit digital videodisk (DVD) players, its Libretto notebook PCs, a clever interactive TV scheme, and two dozen other digital offerings.

These triumphs have generated a lot of buzz inside Toshiba. There's just one small blot on Yamamoto's record: None of the products cascading from his unit has contributed a penny in profits to Toshiba, whose Japan operations just posted a $53.3 million loss for the first half of fiscal 1998, ended last September. (Revenues were down 12%, to $11.9 billion.) Now, to cut costs, Yamamoto is slashing the number of projects by two-thirds and reducing his staff of 130 by nearly half. ''We've just started to develop a new business,'' he laments. ''But in the current climate, we have to be profitable or die.''

It's a lament heard all across Japan's high-tech landscape. Fierce competition has stripped away profit margins on most consumer products--even glamorous new gizmos such as DVDs. Foreign companies, led by Microsoft(MSFT), dominate personal-computer software and networking. Japanese giants still have a tight grip on big-ticket items such as electric power plants, high-speed trains, and mighty mainframe computers. But after six years oF economic funk, demand for these products has shriveled.

That has taken a toll on heavy industrial suppliers and gadget makers alike. Hitachi Ltd.(HIT), the tech sector's biggest basket case, slid $1.03 billion into the red for the first fiscal half. The loss could double by the time Hitachi closes its books on Mar. 31, 1999. Fujitsu Ltd. and Mitsubishi Electric Corp. are struggling to eke out slim profits, while NEC Corp. (NIPNY)will probably show a loss next March. Even Sony Corp.(SNE), which posted record profits in 1997, expects pretax profit for the full year to sink 62%.

The contrast with the U.S. couldn't be more stark. Just look at market capitalization. Between 1990 and 1997, the value of America's top 10 information-technology companies soared 300%, according to merger-and-acquisition investment bank Broadview International in Fort Lee, N.J., from $230 billion to $915 billion. Market cap for Japan's top companies in this sector actually dropped 5% over the same time, from $380 billion to $362 billion, Broadview reports.

Although the specifics vary, all of Japan's major electronics players are struggling with similar challenges: bloated payrolls and bureaucratic management hierarchies, severe price erosion in consumer markets, and a lack of new, drop-dead products that stand out from the noise.

But the worst is yet to come. With the financial sector stagnating and consumer confidence at an all-time low, Japan's domestic economy may shrink 2% this year. Prices on memory chips--a vital concern to Toshiba, Hitachi, Fujitsu, and NEC--are poised to recover next year, according to America's Semiconductor Industry Assn. But few benefits will flow to Japan, where chip companies have been closing plants. In Korea and Southeast Asia, meanwhile, recession has squelched demand for Japanese electronic components and capital goods. Without that outlet, Japan's electronics makers have little hope of exporting their way back to health.

''SCRAP AND BUILD.'' Now, for the first time, economists are discussing the possibility of bankruptcies among blue-chip sogo manufacturers--vertically integrated electronics giants like Toshiba, Hitachi, and Mitsubishi, that make everything from chips and batteries to power plants and automated assembly plants. ''The old system isn't working, so we have to scrap and build,'' says Masahiro Akutsu, a senior researcher at the Mitsubishi Research Institute and author of several books on the industry. ''For that to happen, we need some failures among the sogo companies.'' Unlike Japan's ailing banks, the electronics giants aren't considering mergers, much less acquisition by foreign rivals. But that day could come. ''Toshiba and Hitachi have a lot of expertise that would be very attractive for U.S. computer companies,'' notes Hiroshi Inose, director general of the National Center for Science Information Systems and head of the Education Ministry's Science Council.

For decades, the sogo makers grew and diversified through internal expansion. Constantly adding new manufacturing units for parts, products, and assembly systems, they became industrial one-stop shopping centers, cushioned all the while by dependable contracts from government agencies and from companies in their respective keiretsu--interdependent chains of tightly linked businesses.

Superficially, these giants resembled General Electric Co. (GE)and IBM(IBM). But there was no Jack Welch or Lou Gerstner to keep an unforgiving eye on the bottom line. In Japan, top brass didn't worry much if a few units posted losses. As long as the economy grew, they could offset red ink in one division with profits in another. Sony, Matsushita Electric(MC), and Sharp managed to stay focused on consumer electronics, thus avoiding bloat. But today even the consumer players juggle far more divisions than a typical highflier in Silicon Valley.

For sogo makers and consumer companies alike, the long recession has ripped the logic from this integrated business model. By the mid-1990s, unable to mask the red ink, all the large players had shut some production lines. But top management was paralyzed. Bound by social and cultural constraints, none has carried out the necessary bloodletting. In September, Hitachi President Tsutomu Kanai declared that his company was facing ''its worst crisis in history.'' But his plans to restructure the workforce involved shedding just 4,000 jobs out of 71,000.

Toshiba's reform-minded president, Taizo Nishimuro, hasn't done much better. For two years, he has toiled to rejuvenate the 94-year-old company by cutting costs and eliminating managerial layers. Ultimately, he'd like to carve the company into smaller, independent business units linked to a holding company. They'll need to find new survival strategies, or sink. But Nishimuro alone doesn't have the power to eliminate whole divisions or scrap the lifetime employment system that protects the company's 66,000 employees.

Smaller electronics players are in better shape. Sanyo Electric Co.(SANYY), a midsize Osaka-based company, has weathered the recession by hewing to a few key components, such as solar cells and pickups for CD-ROMs. To survive, says Fusao Terada, head of Sanyo's research and development, ''companies must concentrate on core areas of business.'' That has worked in Sanyo's case. With no exposure to memory chips, it has managed to keep sales at least flat, and its shares are suddenly looking attractive to investors.

Without the crippling overhead that vertical integration brings, small and fleet high-tech companies have outmaneuvered the giants in burgeoning niches. High performers include Advantest Corp., one of the world's top manufacturers of chip-testing equipment, TDK Corp., which dominates the global production of magnetic tapes, and Nidec Corp., a leader in specialized motors. ''The all-round makers have become department stores,'' observes Takayuki Hirano, director of the governmental Micromachine Center, which promotes applied research in microdevices. ''But we have plenty of smaller makers who are world leaders when it comes to precision and miniaturization.''

The growing gap between large and small was on display at the annual Japan Electronics Show in October. Sony, Fujitsu, and Matsushita Electric Industrial Co., maker of Panasonic goods, wowed the crowds with innovative gadgets, from ultrathin PCs and palm-size cell phones to dazzling flat-panel displays. But the real stars were the smaller, specialized companies like Murata Manufacturing Co., which employs 4,500 staff in Tenjin, near Kyoto. Japan's largest maker of ceramic capacitors, or condensers, used to control electric flow, Murata showed off its latest devices for digital television and next-generation cell phones.

LASER SHOCK. Increasingly, the most important breakthroughs are happening at companies whose names are barely known outside Japan. One of them is tiny Nichia Chemical Industries Ltd., from the western island of Shikoku. Two years ago, Nichia shocked competing research teams at all the sogo makers, as well as Sony and IBM, by unveiling the first viable blue laser diodes. These will eventually replace red lasers used to read information on CD-ROMs, vastly increasing the amount of data that can be packed onto disks.

Another star is Futaba Corp. of Mobara, Chiba Prefecture. With just $845 million in sales and 2,350 employees, it has edged out mammoth NEC, with 40,000 employees, to grab an 80% share of the world market in fluorescent indicator tubes, used in car displays. And in Nagano, Kyoden Co. dominates Japan's market for printed circuit boards with a 50% share. It boasts a return on equity of nearly 30%, compared with the national average of about 5%. Its 484 employees, whose average age is 30, don't have any lifetime assurances. And they excel at quick responses to rapid-fire changes in the electronics sector.

Players large and small, however, are struggling to become more competitive globally. In this task, their problems begin with an education system that--despite calls for reform--stresses rote learning at the expense of creativity. That worked fine when all a large company required was obedient, self-sacrificing workers. But now, businesses need talented engineers and managers who can take risks.

Japan has an abundance of gifted scientists and engineers. But it fails to exploit them, according to U.S. experts familiar with Japan's industrial science. Phaedon Avouris, a top physicist at IBM's T.J. Watson Research Center in Yorktown Heights, N.Y., travels to Japan often, and is disappointed with what he sees. ''Japanese are very good technologists,'' he concedes, ''but there is a lot of shallowness in basic science and a tremendous waste of money.'' This view is widely shared in Japan. All too often, notes the Micromachine Center's Hirano, talented engineers end up in large corporations, where they have little leeway to realize their talents. ''The sad fact is that they're underutilized by the companies,'' he says.

If the large electronics makers hope to bounce back, they need to expand their science and technology base. The government sponsors some next-generation research in sophisticated robots, new materials, and manipulation of atoms. But private companies account for 80% of the country's R&D spending. And they pour the bulk of it, 62%, into projects aimed at commercial products, according to the Management & Coordination Agency in Tokyo. Only 24% of the funds go to foster precommercial knowhow, with basic research receiving a measly 14%. In the U.S., by contrast, universities and government institutes account for 64% of total R&D spending. ''Japanese industry developed new technology from the basic research of the U.S. and Europe,'' points out Hiromichi Kamitsubo, director of the governmental Synchrotron Radiation Research Institute. ''But in these highly competitive times, we have to develop new technology based on our own ideas.''

It will be some time before universities can fill the gap. While the Education Ministry is sprucing up university research laboratories and providing funding to boost the number of PhDs awarded, schools still lack sufficient funds to conduct breakthrough research.

On this front, there are some signs of progress. In one well-timed move, the ministry last year scrapped its regulation preventing academics from accepting corporate funding. That has encouraged Kenichi Arai, a molecular biologist who heads the University of Tokyo's Institute of Medical Science, to seek $20 million in public and private funds for a new center for frontier medicine. He hopes to hatch biotech ventures that are almost nonexistent in Japan today.

But the former Stanford University professor doesn't hold out much hope. ''Japan still has a feudal mind-set,'' he says. ''That was fine during the catch-up period, but it's not going to help us to develop new industries for the next century.'' Time for the feudal era to end.

By Irene M. Kunii in Tokyo


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Updated Nov. 19, 1998 by bwwebmaster
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