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Emerging Technology Report #5: May 7, 2002

A Key Turning Point for Japanese Technology Firms

Louis Ross (Director, Global Emerging Technology Institute, New York)

Hitachi and Matsushita have lost billions over the past year. NTT is planning to cut thousands of jobs. While Docomo`s revenues and profits have climbed, its investments overseas led to losses and, recently, its number of mobile cell phone subscribers for 2.5g (I-Mode) services has leveled off, while its 3G (FOMA) business has grown slower than expected. Its competitors are delaying 3G deployments as well. Toshiba, Fujitsu, NEC, Matsushita, Sharp and Sanyo all suffered significant losses in 2001, along with Matsushita and Mitsubishi. Matsushita turned in its worst numbers ever. Though these firms have previously announced restructuring efforts at times over the past decade, the new batches of announcements are much different. This time, there is no crutch of a foreign export market to help soften the blow to earnings, at least through the end of the current year.

All of this appears to bode ill for Japanese technology firms, which thrived somewhat during the past decade based on steady exports and stable, though not exciting, domestic demand. However, observers should remember relative comparisons are more valuable than looking at these firms in a box. Japanese tech companies are in no worse shape than their foreign counterparts. A global cut in IT spending has translated into significant losses for companies. The US Federal Reserves effort to prop up the economy with 11 interest rate cuts has failed to stem the tide of bad news for the U.S. macro-economy. The NASDAQ, a bell weather for technology stocks, has shed a great deal of value since the beginning of 2002 and though recent earnings results for Cisco somewhat met analysts expectations, the stock is still down by 50% from a 52 week high. Foreign telecom firms are laden with debt and electronics manufacturers are going through a reckoning of their own. The severe scaling back of IT spending is a global phenomenon with global implications. All four baby bell companies in the U.S. posted losses. European firms such as Nokia and Ericsson are cutting jobs and restructuring as well. The investors themselves are biting the bullet. A Japanese fund manager covering technology companies recently lamented that now his overseas trips consist of harried economy class flights to visit many more companies within a much shorter time period, much shorter.

Investors are waiting to hear about restructuring stories and how Japanese technology firms will return to profitability. It is clearly a turning point for these firms as they intensify their search for the next revenue generating business, plowing money into R&D as they also look to cut expenses. This time, their backs are against the wall as they cannot completely rely on a quick U.S. recovery or respectable pick up in global IT spending for at least two more quarters, if not longer. In Japan, it is clear that firms recognize what led them to the large losses they are now experiencing. Besides the downturn in the economy, they recognized the large amount of overlap among business units and the need to specialize. It is clear that they must streamline or spin-off non-core assets and those that are performing poorly. A create deal of value could be created by spinning off such companies. They must also effectively communicate these plans to investors, especially foreign investors, and, more importantly, execute them. Announcing restructuring plans and failure to implement them, in the absence of a very strong recovery over the next year or so, could be disastrous for these companies in terms of the bottom line. Even successful restructuring would translate into digging them out of their current hole, and the failure of the global economy to recover could mean further, more stringent steps will be necessary. On top of job cuts and rationalizing business units, expect firms to eventually engage in more M&A activity and, as mentioned before, spinning-off non-core assets.

Sony, the only firm to register a profit in 2001, is a decent model for these firms to follow. Sony globalized operations and its investor base a long time ago, and, arguably, has been preparing for the digital revolution. Sony decided to specialize in convergence, or converging a number of different products into one unit or creating a seamless way to connect these units. Though analysts are concerned about Sony`s next hit products(s) which will drive revenues in the future, the mindset at Sony is conducive to weathering the current storm. It reacts relatively quickly for the need for structural changes and has been sharpened by its presence overseas.

Japanese electronics manufacturers are the best positioned for the convergence trend. They are innovators, they excel at design, producing and pricing products that people demand and they maintain cutting edge, high-value added manufacturing skills. They also have a history of collaboration and cooperation, which is essential for developing the capabilities of producing `converged` advanced technologies on a mass scale and be first to market them. The costs and risks are evident, but, once again, one needs to value Japanese companies in relation to their foreign competitors, as well as the relationships with foreign partners. People should expect the current round of restructuring to breed very lean and competitive firms over the next several years. Investors should keep their eyes on what is in the pipes for R&D and new product development and how these firms control costs in the meantime. Of course, monitoring real restructuring efforts is also very important.

Expect the IT slump to continue over the next several quarters, at least through the end of the year and expect that advanced mobile communications networks and associated sectors and converged devices to help spur the next boom. The switch from 2G to 3G and beyond takes time, especially when many firms are saddled with debt, product prices are falling and global demand is weak.

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