Why Japanese companies do so many different things

From the article:

But Toto’s remarkable year doesn’t have much to do with toilets or bidets. Toto might have been founded in the 1910s to “provide a healthy and civilized way of life” through affordable toilets, and in the decades since might have become the global leader in the bathroom game. But Toto also does a lot of other things. Toto manufactures not just bidets and toilets but also bathroom tiles, prefabricated bathroom modules, faucets, modular kitchens, photocatalytic coatings for buildings, and assistive equipment for the elderly. And, most importantly, Toto has a very lucrative sideline in the fabrication of memory chips.

Since 1988, in a once-obscure corner of the company called the “advanced ceramics division,” Toto has been producing a very particular component called the electrostatic chuck, or the “e-chuck.” The e-chuck is a sort of high-precision ceramic plate, about the size of a steering wheel, that uses electrostatic force to hold a silicon wafer perfectly flat and thermally stable while memory chips are etched into it with bombardments of plasma. Making these components is extraordinarily difficult, since the ceramic body needs to have near-zero particle generation and be polished to submicron flatness: and this means that there are only a few companies in the world that are capable of manufacturing e-chucks reliably. Almost all of them—Shinko Electric, NGK, Toto, Kyocera, Sumitomo Osaka Cement, Niterra—are based in Japan.

For most of its history, the advanced ceramics division was a rounding error on Toto’s balance sheet: the money maker, as it had been since the 1910s, was the toilet and bidet business. But we’re in a new era. Demand for AI is exploding, meaning that demand for the high-bandwidth memory that AI data centers require is exploding, meaning that demand for memory chips is exploding, meaning that demand for e-chucks is exploding. And so Toto’s advanced ceramics division is suddenly the company’s largest business, generating the majority of its operating profit. Toto’s leadership, suddenly awash in AI-driven revenue, announced that they would double down by investing hundreds of millions in expanded electrostatic chuck production: the toilet company had become, quite unexpectedly, a supplier to the semiconductor supply chain.

The Toto story is a fun and interesting illustration of corporate diversification and how strange bets can pay off. But that type of diversification—a toilet company that also produces photocatalytic coating and high-precision components for semiconductors—isn’t really unique to Toto. Practically every company in Japan seems to do a thousand very different things.

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Here is the answer I want to suggest: Japanese companies excel in lots of very different domains because it’s inherent in how they’re structured. The form of the corporation that we know and love in the United States—specialized, market-oriented, governed by shareholders—is just one form that the corporation can take; but it’s not the only way to coordinate capital and labor in a successful and profitable way. The protean corporations of Japan are best understood as a different species of thing altogether: better at some things, worse at others, but still highly adapted to their particular environment. And the things that they’re very good at turn out to be extraordinarily helpful for all sorts of things in which American companies tend to struggle.

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Here’s an illustration. Let’s say you run a factory. You decide that you want your lines to produce fewer defective goods: maybe you want to improve your yield from 95 percent to 98 percent. So you decide to invest in better training for your workers: maybe training now lasts six weeks instead of two weeks. This works, and now your yield is higher; but that change makes other things more attractive too. For example: now that your yield is higher, it makes sense for you to reduce your inventory, since fewer defects mean you no longer need a large buffer of spare parts to replace the bad ones. So now you’ve cut your inventory: but now it makes sense for you to shorten your production runs and switch more frequently between products, since without a mountain of inventory to work through you can afford to change what the line is making. And if you’re switching frequently between products, then it makes sense for you to invest in flexible, reprogrammable machinery instead of dedicated, single-purpose equipment. So one relatively small tweak shifts the entire calculus of what you do.

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So if we want to know why Japanese companies have one apparently unusual practice—why they’re so diversified into countless unrelated industries—we can’t really answer the question in isolation. We need to ask which bundle of practices they employ.

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And this means that Japanese companies strive to avoid financial pressure from outsiders. Relationships with suppliers are longstanding and entrenched: many Japanese companies have been working with the same suppliers for 50 years or longer. Outside investors seeking to interfere in this happy picture will find few avenues for influence. A standard Japanese firm’s board of directors is composed almost exclusively of the firm’s own senior managers; a large fraction of the firm’s equity is held not by outside investors but cross-held by other Japanese firms; and most of the firm’s financing comes from a single “main bank” that provides loans and monitors performance.

And as a result, Japanese companies don’t really try too hard to return profits to shareholders. Earnings are mostly reinvested, and investor dividends are kept low. For a long time, Japanese firms would spend as much entertaining the managers of other firms as they would on dividends to shareholders.

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And the complete Japanese bundle, I should say, ends up producing something with entirely different objectives and interests than the American bundle. The H-firm exists to make money, or rather to return money to shareholders; but the J-firm, run by its employees and largely indifferent to the interests of shareholders, exists simply to continue existing. That’s why Japanese companies are so protean and willing to change what they do. Nintendo was founded in 1889 as a maker of handmade playing cards; in the 1960s, it was pushed out of the playing cards game by a wave of competition; and it spent several years experimenting with new markets—taxi services and instant rice, though contrary to the rumors not love hotels—before finding its way to video games. Fujifilm, which faced a near-total collapse of photographic film in the 2000s, simply used its expertise in chemical coatings and fine optics to pivot into cosmetics, pharmaceuticals, LCD films, and semiconductor process materials.

And that basic impulse toward survival is why Japanese companies are so insistent on diversification. If you’ve made a commitment to keep people employed for life, then you need to create jobs for them if their current jobs stop making sense: indeed, you might need to keep them employed even if you can’t find anything for them to do. If you’re not very worried about profitability, and have lots of well-trained generalist employees, then it makes perfect sense to reinvest your company’s earnings by expanding into new industries: doing so not only allows your company to survive longer—your company’s portfolio of bets is now more diversified and thus lower-risk—but also ensures that you’re able to keep your surplus workers busy in one way or another.

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And this system, as it turned out, was really good at particular things. Aoki’s key insight was that the J-mode had a comparative advantage in environments of moderate volatility: situations where conditions changed frequently enough that rigid central plans would be outdated before they were executed, but not so radically that only top-down strategic intervention could cope. In an environment of stable, predictable demand, the H-firm did fine; in an environment of extreme disruption, where the whole product line had to be rethought, centralized authority was indispensable, and the H-firm also did fine. But in between—where the challenge was to make constant small adjustments in a changing but recognizable paradigm—the J-firm excelled.

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But catch-up growth, by definition, has to end: at some point you’ve caught up, and the challenge at the frontier is not only to refine what’s already known but to invent what is not known. And paradigm invention is precisely the sharp discontinuity for which the J-mode has no particular gift. Consensus-driven, horizontally coordinated organizations are very good at refining what already exists: but they are very bad at deciding what should exist.

That basic weakness is why Japanese firms are so dominant in some domains and entirely absent in others. Japan excels in automotive manufacturing, machine tools, industrial robotics, optics, and precision materials: domains characterized by incremental refinement. But they have very little to add in software, internet platforms, artificial intelligence, or electric vehicles. The architecture of the Japanese firm is built to perfect a domain through progressive advancement; it’s quite poorly suited to sharp discontinuity.