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Emerging Technology Report #31: November 7, 2002

Japanese Electronics Firms Continue to Restructure

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

In the beginning of May of 2001, we mentioned how the losses logged by Japanese electronics firms in 2001 would lead to substantive restructuring and cost cutting. Since that time, a great deal of activity has occurred, and companies have begun to reverse their losses and return to profitability. Still, the macro environment will put a limit for now on the ability to expand operations. Japanese electronics firms should be expected to continue restructuring activities while, at the same time, carefully position themselves for growth opportunities in certain key areas while also carefully reducing risks by diversifying their operations (both by product line and geographically).

Japanese electronics firms must adapt to the environment as aggregate overseas sales have increased considerably, comprising nearly 45% of company earnings. The increased dependency comes at a time of tremendous risk. The global IT meltdown led to huge losses and desperate attempts to cut costs and restructure. Of these firms, several have done a decent job at adjusting to the circumstances. Toshiba, for example, is being justifiably lauded for its restructuring activities, which included divesting itself of an unprofitable semiconductor division. This led to a significant reduction in net losses previously posted. Toshiba, unlike its peers Fujitsu or Hitachi, was not as dependent on U.S. business. It also is arguably much more focused. Hitachi still has yet to slim down its product line and has much more room to increase profitability. Still, Hitachi managed to post a net profit recently and, like NEC, reversed previous losses. NEC also spun off loss producing semiconductor operations, wishing to initiate a plan to focus on its core computer systems and solutions. Hitachi has announced that it will reduce the number of subsidiaries it has be nearly 300 firms but this is planned over the next 3 years. Mitsubishi Electronic also posted strong gains. The company did well in foreign markets because it scaled down its unprofitable mobile phone business in the U.S.

These firms will attempt to bolster profitability to whatever extent possible beyond gains made through cost cutting and restructuring, by maintaining competitiveness in certain key areas. For example, the demand for small and medium-sized TFT screens and system LSIs helped Hitachi to offset losses. Increased demand for next-generation handsets continues to aid new growth for components companies, OEMs and IC suppliers. According to the study, "3G/Cellular Integrated Circuits," the total available cellular integrated circuit (CIC) market will double from $13.9 billion in 2001 to $26.4 billion in 2006. The growth in 3G and beyond will largely take place in industrialized countries, especially in Japan, South Korea, several markets in Europe and, potentially, the United States. The market will continue to be lucrative for component manufacturers. The bill of materials for 3G phones will warrant a 79% increase from today's basic GSM model. Additionally, the semiconductor value is estimated to be 49% greater than that of 2.5G devices. Eventually, carriers will be forced to migrate subscribers to these networks as older ones become more incapable of handling increasing voice and data traffic. Unsurprisingly, many IT companies, from carriers to electronics firms are betting heavily that growth in next-generation wireless and fixed wide-band networks in Japan will bolster earnings. The electronics firms can avoid competition from other countries by sticking to these high-value added areas and divesting themselves of commodity-type businesses. Another expected area of growth for chipmakers is select LAN and CPE equipment, both of which are expected to grow in the high double-digits next year. LAN pieces include wireless capabilities including a ramp up in 802.11a and 802.11g products. LAN and fixed-line broadband services in Japan are experiencing very strong growth, so expect firms to attempt to capitalize on this trend.

Japanese firms are cautiously, and wisely, hedging their bets against perceived growth in certain markets. Japanese companies, though increasing their presence in China by stepping up investment and utilizing local firms in the area of domestic marketing, are smart enough to diversify their investments and will maintain a division of labor between China and other Asian countries. This is being done since China really is and will continue to be an export platform to cater to third-country markets for some time, with the domestic Chinese market a long way from generating the type of domestic demand that would warrant greater amounts of investment and a commitment of more resources. In regard to the U.S., firms that were over-exposed to U.S. IT and telecoms sector demand learned a lesson on the importance of diversification. Companies should expect the U.S. 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.

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