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Quality issues in Japan?

Home / EOS Blog / Quality issues in Japan?

Japanese companies, sometimes collectively known as Japan Inc, have made negative headlines of late. While some may argue there is no such thing as bad publicity, the scandals shine a rather embarrassing light on what seems to be routine practice. Several industrial companies, such as Kobe Steel, have been accused of falsifying test results on their products. Before that, car manufacturers such as Toyota and Honda have had to recall millions of their vehicles. And in a case that is still pending a favourable outcome, industrial giant Toshiba came close to bankruptcy following a string of events that included misreported earnings and the failure of its US nuclear power branch.

Looking back
A generation ago, Japan was the business school textbook case of efficient management. Its factories were rolling out affordable and flawless products that were flooding the world and routinely putting established Western companies out of business. Despite the cries of foul play, as exporters to Japan faced stringent barriers, Sony and Co were marching towards world economic domination. Inebriated by its own success, Japan gorged on cheap funds and never-ending gains in the stock and real estate markets until it burst at the seams in the early 1990s.

Since then, the country has experienced two decades of no growth and has had to digest a mountain of bad debt. But does this mean that the quality that once was the hallmark of its companies has suddenly evaporated?

The facts rarely lie. In customary Japanese fashion, the management of Kobe Steel has apologised publicly. It posted on its website a banner in large typeface that read: “We are extremely sorry for our improper conduct.” Since then, it has published regular updates as it uncovered additional cases of test result tampering. Other companies have come out with similar revelations. In all these cases, the quality of the goods shipped to clients did not match the agreed specifications. The issues were not limited to metals, as in the Kobe Steel case, but extended to non-metal products such as carbon fibre and chemical components too.

In fact, as some cases have shown accounting irregularities and falsification of financial results, the issue goes beyond product quality. Although few have led companies to the brink of bankruptcy, as in the case of Toshiba, they seem to indicate that tampering with reality is a widespread problem.

Since the issues have come to light, we have been asking the Japanese companies we engage with, and not only the ones involved in quality issues, for an explanation. The company representatives we met, however, gave several unconvincing explanations. Some argued that the clients were to blame, demanding an impossible to produce quality. Others suggested that the large number of specifications made the controlling nigh impossible. Some faulted the training of the inspecting teams, others the government for lack of supervision. All, however, agreed that this bad publicity was harmful, and we found that it was a powerful argument in favour of better governance.

While the issues are real, damaging and embarrassing, scandals are not confined to Japan. Europe has faced much worse scandals and even coined the word Dieselgate to describe the systematic tampering of emissions test by a car-maker. China also has a history of supplying contaminated goods, sometimes deadly, for example when melamine was found in infant formulas in 2008. In Brazil, a massive tainted-meat scandal led many countries to ban imports from South America’s biggest economy.

As with petty criminality, it is impossible to eliminate all corporate misdeeds. Employees, from the lower ranks to the board level, will always be confronted with multiple opportunities to do wrong. Motivations are often financial, whether directly by embezzling funds or diverting goods or indirectly, for example by padding sales or production sheets to guarantee bonuses. Checks and controls are indispensable but just as the real life presence of police does not eliminate the occurrence of crimes, solid company policies can at best reduce the chance of scandals taking place. They are, however, useful for a company to prove its good faith when attributing scandals to bad apples among its workforce.

Better functioning systems?
The seeming increase in these incidents is not necessarily an indication of looser morals. The world today is more connected and more information-rich. It is more difficult than before to hide shady dealings. Additionally, companies are better equipped to detect misdeeds and there are more outsiders within companies to raise issues. So the fact that these scandals come to light could merely be an indication that the system is functioning better, not worse. Companies own up more easily to their deeds in a bid to ultimately regain customer confidence even if the moral and financial pain is acute in the short-run. We are engaging with companies across the world to ensure they have the right structures in place to avoid these incidents occurring in the first place but are also equipped to learn the lessons from any scandals that might happen.

Nevertheless, looking at the output of domestic and overseas factories alike in Japan, I believe the quality remains good. According to Interbrand’s 2017 ranking, Toyota is still the world’s top car brand and of the four electronics companies in the top 100 brands, three are Japanese. While the automakers are indeed challenged by their German counterparts and the electronics giants are fighting their Asian neighbours, the country’s production remains of the highest calibre. Furthermore, all else being equal, Japan is still a country that enjoys an unrivalled level of low criminality and corruption. The society prides itself on honesty and generally doing the right thing. If anything, it is now pilloried for having been a little ambitious and overly proud of its corporate organisations and zero-default culture a generation ago. In my opinion, it does not alter a core characteristic of its people, the urge to deliver the best service and quality possible.

So while admittedly there have been issues with quality in Japan, they have not been worse than elsewhere. Only the perception may be different because it involves a country that has always been intent on perfection. As we find in our engagements, Japan is fixing these, at its own pace and in its own way.

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Frédéric Bach Frédéric Bach focuses on engagements with companies based in Japan, where he lived for seven years at the beginning of his career. He has 25-year experience as a trader, analyst, head of research and portfolio manager in equity and fixed income markets and also worked in Switzerland and the UAE. Before joining Hermes EOS, he was a contractor with AODP, an NGO raising awareness of climate change issues and their impact on the valuation of financial assets with investors such as pension funds and insurance companies. Frédéric holds an MSc in telecommunication engineering from ENSTBr in Brest, an MBA from ESSEC, near Paris, and the CFA Institute's Chartered Financial Analyst designation. In addition to his native French and fluency in Japanese, he can also work in German, Italian and Spanish and communicate in Portuguese and Arabic.
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