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No.1 ,Economy  Jun 01, 2010

CAN JAPAN EXPORT ITS WATER BUSINESS?

Late last year the news that a Korean-led consortium had won a major order for a nuclear power project in Abu Dhabi brought further gloom to an already downbeat Japan. The Japanese media noted that South Korea’s President Lee Myung-bak had visited Abu Dhabi repeatedly in support of the Korean bid and suggested that the Japanese government did not have an adequate setup to back Japan’s bid. A senior official at the Ministry for Economy, Trade, and Industry offered this postmortem: “This is a defeat for the Japanese business model. Japan was trying to sell Abu Dhabi nuclear power plants. But Korea was offering to provide a steady supply of electricity for sixty years. The Koreans were selling electricity.”

The South Korean government and the company leading the bid shared the same objective and conducted repeated top-level sales in order to achieve it. They also shared a strategy of not insisting on using just Korean firms or Korean technology. Their goal was to secure leadership in the provision of electric power infrastructure, and they promised to supply Abu Dhabi electricity by drawing on the world’s top technologies and the companies able to provide it–not just Korean companies. For example, one of the companies supplying technology as a member of the Korean-led consortium is Westinghouse, an American company that is a subsidiary of Japan’s Toshiba.

Next, the Russians won a nuclear power plant order in Vietnam, beating out both Japan and France, the two countries that supposedly have the world’s most advanced nuclear power technology.

The days of being able to sell a stand-alone technology are over. This is because the customers are no longer in the developed countries but rather the emerging countries, which do not have the ability to manage and operate stand-alone technologies or plants by themselves.

Infrastructure: A Shrinking Domestic Market

Japan is said to have one of the world’s highest levels of technology in the area of power plants and other types of infrastructure. And in addition to the underlying technology for plants and the like, domestically Japan has a superbly functioning total management setup–highly efficient productivity supported by meticulous maintenance, low environmental loads, and other features based on cooperation between companies in different industries covering both production and operational management. Our country has many infrastructure industries that are globally unmatched, including its expressways and railways as well as its electric power system.

We now hear calls from every direction for Japan’s infrastructure industries to develop international business. The rise of the emerging countries offers export opportunities, while the scale of the infrastructure business within Japan is shrinking. A prime expression of this domestic shrinkage is the slogan “From concrete to people” that the new administration led by the Democratic Party of Japan has adopted. Investment in new infrastructure (“concrete”) is declining, and infrastructure industries need to shift their main focus from the building of new facilities to the maintenance of existing ones. If we look, for example, at the composition of the sales of Ebara Engineering Service Co., a major firm in the water infrastructure business, we find that the share coming from construction of new water plants has been shrinking and is now less than half the total. And if we look at the sources of the company’s profits, we find that operation and maintenance activities already account for 70%. Under these circumstances, the opportunities for Japanese companies to develop new technologies are contracting. Export sales in the infrastructure business thus offer not just opportunities for increased profits but also important opportunities for the enhancement of technologies, something that is essential if Japan is to succeed as a science-and-technology-based nation over the long term.

The government is naturally conducting deliberations with this in mind. METI has established a forum to discuss integrated strategy for overseas expansion of infrastructure-related industries, and in April this year it came out with a draft report. I had a look at it, but it struck me as lacking somehow. One does not get the sense that this is going to lead to action. So what is missing? In order to find out, I sought interviews with people at companies that are moving into the global market in the water business.

Trading companies play an essential role in this sort of infrastructure business. The case of the Abu Dhabi nuclear power plant seems to suggest that attempting to sell stand-alone products is an outdated approach. In this connection, Fujiyama Tomohiko, a senior vice president at Mitsubishi Corporation, one of Japan’s top sōgō shōsha (integrated trading companies), remarked, “Sales of stand-alone products sometimes end up being mainly a matter of price competition.” He explained to me, “If one wants to get involved in the infrastructure business overseas, it’s essential to rank high and have competitive strength on each of four levels: first, equipment and underlying technology; second, the ability to construct systems and complete construction; third, the ability to manage and run a business safely and economically–in other words, operation; and fourth, the ability to raise funds and minimize risks.” But an organization that measures up on these four levels cannot consist of just a single company; it must span multiple enterprises. Within Japan, infrastructure operations are commonly handled by utility companies or local governments. So it is essential to get such utilities or government bodies involved as part of a cooperative setup, meaning that it is necessary to put together a consortium that includes them as members. Japanese trading companies have experience serving as coordinators in arranging this sort of setup, and their role is likely to become even more important henceforth.

What is required of a consortium strategy appropriate to development of overseas infrastructure business? Fujiyama identifies finding the right members and getting support from the government as key elements. The ideal is for all of the members of a consortium to be number one in the world in their respective fields. If the group includes a member that is competitively weak, it will be dragged down to that member’s level. This is the same as the thinking that applies to a value chain, where the capability of the chain will match that of its weakest link. So in cases where limiting the consortium to Japanese companies would make it less competitive internationally, it is necessary to draw on overseas talent.

One issue in this connection, however, is government support. The atmosphere generated by the media may act as a drag. For example, if a consortium includes non-Japanese members, some may argue that it should not be the target of backing from the Japanese government. There may be complaints that Japanese taxpayers’ money should not be used to support foreign companies. But the most important point in overseas infrastructure undertakings is the identity of the consortium’s leader. We need to understand that what is most important in terms of Japan’s national interest is that the leadership position be held by a Japanese company; the nationality of the member firms is a lesser concern. And it is crucial to promote consortium strategies with a solid recognition of the essential nature of the ability to access and coordinate human resources, technologies, and enterprises globally.

Fujiyama made a further point about the importance of involvement of the government and related issues: “When backing efforts to win overseas infrastructure business, three conditions must be met in terms of concrete support: top-level diplomacy by the government, industrial policy to heighten export competitive strength, and financing and insurance support from government-affiliated financial institutions.”

What is especially important for Japan to tackle is the issue of coming up with optimal industrial policy to heighten the competitive strength of exports and the ability to compete globally. In South Korea the process of regrouping and consolidation within industries has been taken to an extreme, and a clear pattern has emerged in which supporting an industry means supporting the leading company in that industry. In Japan, by contrast, several leading companies exist in each industry. Domestic competition may sap companies’ strength, but people note that it can also have substantial benefits, such as leading to improvements in the quality of products and services. Furthermore, uniform consolidation within an industry can mean the loss of the fruits of independent research and development activities.

The efforts to win overseas infrastructure business thus present Japan with the prospect of a major revolution in values. But at least one company has already started down the road toward this sort of revolution: Ebara Corporation, which is seeking to win a place as a Japanese player among the world’s major water companies.

Building a Japanese “Water Major” Partnership

In February this year Ebara Corporation announced that Mitsubishi Corporation and JGC Corporation were each taking one-third equity stakes in its subsidiary Ebara Engineering Service Co., a company in the water business. In the press release announcing this development, the three companies presented their ambition of building a “water major” partnership, declaring, “The ‘Japanese water major group’ formed by the three companies will aim for growth in the expanding field of the water market in Japan and abroad, and it will contribute to dealing with the global issue of water through such businesses as water infrastructure and clarification.”[1. The quote is a translation from the press release in Japanese. An English-language version with different wording is available at
http://www.ebara.co.jp/en/news/2010/news20100223.html.–Ed.]

Not only the water business but almost all of Japan’s social infrastructure industries have reached the saturation point. New business activities are said to be shrinking in tandem with the contraction of the population, and the weight is shifting from construction of new facilities toward follow-up activities, such as work to prolong the life of existing facilities, repair them, or rebuild them. Heading overseas to markets in emerging countries is the only way companies can hope to grow as before by winning contracts for construction of new plants and securing new business maintaining and managing facilities.

I asked Iwaizumi Takashi, managing executive officer at EES, about the aim of establishing this three-way partnership to build a Japanese water major. He explained: “If rival companies from the same industry head overseas together, it’s hard for them to achieve mutual benefits. In order to go international, it’s only natural to tie up with a trading company [like Mitsubishi], which has information network power, sales power, and funding power. And when building plants and the like overseas, transporting products from Japan is not competitive in cost terms; also, it’s necessary to hire local labor. In terms of overseas procurement power and project management power, JGC is tops.” Mitsubishi, however, has already taken an equity stake in Manila Water Company and owns Japan Water Corporation as a domestic subsidiary. And JGC does not need to enter into a joint venture just for the sake of winning plant construction orders overseas. These two companies have apparently taken stakes in EES in partnership with Ebara, a company that has long made its way on the basis of its water-related technologies, not as portfolio investments or investments in plant construction but as business investments, aiming to become actively involved in the water business.

Iwaizumi continued, explaining the flexibility within the three-way partnership among these companies, each with its own strengths: “The biggest objective of the three companies’ partnership in this joint venture is to have it grow into a leader in the water business in Japan and overseas, but the agreement among them is designed so as not to prevent them from finding the best possible schemes for themselves and working with the optimal partners on each occasion.” This differs from the traditional Japanese idea of safety in numbers. The partners will not pass up opportunities outside the partnership that will allow them to tap their own strengths. It is a nimble sort of partnership. And one might say that the need for this sort of flexibility is a sign of how fierce the competition is in the world of the water business.

Getting the Government Into the Act

The rise of the emerging countries has made the bright prospects of the water business visible to all. Unlike electric power generation, for example, water supply projects entail relatively small amounts of investment, and the level of technology required is not that high. Furthermore, having the best technology is not a guarantee of getting the business. This makes it a fiercely competitive field. Some 30 water majors have already entered the Chinese market. Unfortunately there is not a single Japanese company among them.

The leading overseas water majors are France’s Veolia Environnement and Suez Environnement. These companies were created through the privatization of France’s publicly operated water utilities, and they have histories of over 100 years; they have built up a store of know-how in the water business ranging from upstream to downstream, all the way from the construction of facilities to the collection of water fees and the handling of customer complaints. In addition, with track records dating back to the colonial era, they have rich stores of business experience in developing and emerging countries. How can a Japanese water major hope to compete with such formidable rivals?

This brings us back to the idea of a consortium. Iwaizumi noted: “The terminal portion of the water business, including collection of fees and the like, is handled by the water bureaus of local government bodies in Japan. This know-how is essential.” The Bureau of Waterworks in the Tokyo metropolitan government is now seeking to become a partner in this sort of international business. Tokyo Waterworks Service Co., a company managed by the bureau, is gearing up in cooperation with the Innovation Network Corporation of Japan to handle water supply and sewerage operations in emerging countries and elsewhere. The INCJ’s activities include support for companies in international bidding through the provision of risk capital and advice concerning management strategies. And Tokyo Waterworks Service has operational know-how. The INCJ and the Bureau of Waterworks had been discussing whether it might be possible for them to work together in international bidding for orders involving the integrated handling of water business overseas, particularly in emerging countries.

I spoke with Asakura Haruyasu, chief operating officer of the INCJ, who explained: “The Tokyo metropolitan waterworks bureau has know-how in operating waterworks for over ten million users. It has high technological capabilities within Japan, and it can offer highly distinctive strengths in international bidding, so by including it with a Japanese water major in a consortium, it should be possible to form an even more superlative team.”

The idea of local government bodies going into business may worry some people. “Bureaucracy” has a bad name, and there are liable to be concerns that such business will mean even greater waste of taxpayers’ money. Also, though the aim of the INCJ is to promote industrial innovation and creation through the provision of funding and expertise, it is a company established with money from the public sector and major corporations and with strong ties to the national government, so there may be concerns about its functioning and effectiveness. But the many of the people there are experts who have worked at domestic and foreign investment funds in the fields of corporate revival and mergers and acquisitions, and they have sharp eyes and professional know-how. The idea of a local government body heading overseas in tandem with human resources of this sort represents a fresh challenge. I am hopeful that this organization will take the lead in pursuing a bold strategy untrammeled by the bonds of Japan’s old customs.

The Competition to Set International Standards

The INCJ’s Asakura is one of the members of the organization with impressive credentials as a professional, having worked for a leading US investment company. He noted three major issues relating to the subject of using consortia to win international infrastructure business. One is the long-term nature of the contracts and the risk involved in getting back the funds invested. Iwaizumi at Ebara Engineering Service Co. raised a related point: “The more I study Veolia and Suez, the more I wonder how they make their profits. For example, they enter into fifty-year contracts with China. Who knows what will happen fifty years from now? But they put together carefully considered contracts that will allow the French side to avoid losses and make proper profits for fifty years into the future.” His research into rival organizations made him all the more aware of the difficulty of this issue. It is necessary to include various provisions in the contract in order to keep the money coming back without interruption. And it is not a matter of imposing conditions unilaterally; the contents of the contract are determined through negotiations with the other side. So a high level of skill is obviously required. Even at leading organizations like Veolia and Suez, there are apparently only two or three people working inside the company who have this sort of capability. Do Japanese corporations have such human resources? If not, can they boldly hire such people? One fears that traditional corporate culture of Japanese businesses may act as a barrier preventing them from doing so.

On top of that, last year’s Dubai shock drew renewed attention to the issue of repayment. Payments for a railway project were delayed when the country ran short of cash. Infrastructure projects require massive amounts of money, and repayments are spread over a long period. A contract that will assure the money comes back clearly needs to be accompanied by diplomatic initiatives setting forth appropriate conditions. So, on top of support from the government in the form of long-term funding and insurance for the consortia involved, infrastructure business exports require government backing through diplomatic dealings that will guarantee proper execution of the bilateral contract.

The second issue Asakura noted is the need to turn Japanese standards into international standards. As we have been seeing in the news, the United States and Europe have been beating Japan in the process of setting international standards in a variety of fields, such as smart electric power grids and the connecting terminals and formats for consumer electronics and electric vehicles. Infrastructure is the base for various things, and in a sense we can say that it is the domestic standard. If Japanese companies hope to combine forces with global leaders and participate in building this infrastructure, they need to enhance their international competitive strength, and for this purpose it is extremely important for them to offer specifications corresponding to global standards, which will mean broad opportunities to do business around the world.

For example, if a Japanese company seeks to participate in international bidding for a project by setting up a joint venture with a local firm, one of the key factors in the local firm’s decision whether to enter into the partnership will be the question of whether the company offers international standards. The local firm is likely to opt for a partner that offers international standards over one that does not, even if the latter is superior in terms of technology and quality.

Asakura declared, “International standards have to be strategically pursued. The way they are set is through standardization committees in a variety of fields to which countries send various talented individuals to represent their interests.” The Europeans are skilled at this sort of strategy, and the standards that have been adopted internationally in such fields as electric power infrastructure and telecommunications infrastructure are mostly European.

So how can we go about pursuing international adoption of Japanese standards? Asakura explained, “First of all it’s crucial to turn our view outward, though this alone won’t guarantee success.” In cases where the course toward adoption of a standard is close to becoming set, one possible approach is to seek a position close to the international standard, such as by setting up a joint venture with a European partner. Acquisitions are another option. It is no longer enough for companies to compete with their domestic rivals and win top place in Japan; they need to be looking at the global market from the outset. And of course there are bound to be any number of fields where it is still possible to seek international acceptance of standards from Japan. The issue of how to pursue such opportunities will be a matter of urgency.

Asakura noted, “It’s necessary to take a strategic approach to standardization committees. For the most part the participants in meetings are from the private sector, but it’s essential for the government and business to cooperate closely in providing support. In France, Britain, the United States, and of course South Korea, the government and the private sector work together to make industrial policy, and seeking to win international acceptance of their standards is considered a natural part of their joint efforts. I worked for an American investment fund for about ten years, and there, just as in other major industries, the actions that private-sector firms took were fundamentally in perfect keeping with national policy. So I’ve been a bit surprised by the distance between the public and private sectors in Japan.” This sort of frank observation could come only from someone with actual experience.

It seems to me that the path to winning international standards will continue to be forbiddingly long if people in the government keep coming out with remarks that seem to identify the business world as the enemy, such as suggestions that companies are making excessive profits.

Supporting Those Who Stand Out

The third issue to which Asakura referred was a question that is an undercurrent to the previously mentioned issues: Can the national government and businesses truly recognize that infrastructure industry exports are in Japan’s national interest? He put it this way: “It may be easier to understand if we use the analogy of the Olympics. The Korean approach is to sharply limit the number of athletes who can participate in the Olympics and to have the government and other organizations back them up vigorously so that they can win gold medals without fail. The Japanese approach is to send more athletes to the Olympics and be happy if they place, even if they don’t get medals. That’s the sort of difference I’m talking about.”

Will the Japanese people accept the idea of having the government concentrate all its support on a single industry? Can the government make up its mind and pick a single corporation as a target for its support? And within corporations, can management resolve to focus the entire company’s energies on a challenge being undertaken by a single division? Japan has a tradition of imposing conformity, as seen in the so-called convoy system long applied to the regulation of banks and other institutions; this tendency is seen throughout society in general and also within corporations, where to this day those who excel outstandingly get pulled down. Will it be possible for Japan to break away from this culture of conformity and switch to rooting for those who stand out?

Since last year’s change of government we have been hearing even greater emphasis than before on words like fairness and equality. At the same time we hear incipient talk of infrastructure business exports. In a sense these involve accepting inequality over the short term so as to gain fairness, an economic return, over the long term. Support will not be provided to all: Some industries, companies, and local governments will get it, while others will not. Without such differentiated treatment, it will not be possible for Japan’s infrastructure industries to win international business.

The government’s decisions are, broadly viewed, a mirror image of the will of the people. I believe it is extremely important at this point to understand that it is in Japan’s national interest to promote infrastructure business exports, which can lead to economic revival and to additional revenue for local governments, and to encourage the formation of a culture that focuses on long-term fairness.

Translated from “Infura yushutsu no mirai o hiraku ‘mizu bijinesu’ saizensen,” Voice, June 2010, pp. 68-75. (Courtesy of PHP Institute) [June 2010]

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