Commentary from the Center for Innovation, Trade, and Strategy
Japan’s “Lucky Moment”
Business Reinvention and the Digital Transformation
Ulrike Schaede describes how Japan’s business reinvention makes many Japanese companies essential in global trade and made Japan a leader in digital transformation. She argues that this reinvention has provided Japan with an advantage that helps balance power relations in Northeast Asia and globally.
Even though many observers gave up on Japan after the collapse of its bubble economy in the early 1990s and the subsequent banking crisis and apparent stagnation, a quiet yet methodical business transformation has occurred, allowing Japan’s leading companies to reinvent their competitive repositioning. This reinvention explains why Japan remains the third-largest economy in the world, even though it is only the eleventh-largest country by population. It also explains why the country’s politics have been stable and its society safe and comparatively affluent, even after three decades of seeming economic stagnation. The reinvention makes many Japanese companies essential in global trade. It also makes Japan a power to reckon with in the digital transformation, or what in Japan is called the “DX.”
The DX refers to the arrival of new technological capabilities in hardware (e.g., connectivity, storage, computing power, robotics) and software (e.g., big data collection and analysis, artificial intelligence and machine learning, also known as AI/ML). The disruption these capabilities cause in manufacturing has been labeled “Industry 4.0,” as they enable machines to operate autonomously and parts and machines to communicate. Japan’s government has also coined the concept of “Society 5.0” to refer to how humans interact with machines and with each other and how societies are organized within smart cities and around the new challenges of privacy and data security. The arrival of these technologies is disrupting manufacturing and service sector processes, methods of information gathering and distribution, and even warfare.
Many countries view the DX as a threat to jobs, human connections, and reliable information. But in Japan the arrival of the DX coincides with the first impact of the aging society, and these two challenges may well produce a positive outcome. As the country faces labor shortage, new technologies may present not so much a threat but a solution to shifting societal needs. Furthermore, over the past two decades, Japan’s leading companies have pivoted their strategies by moving into a growing number of essential technology niches that are critical to global supply chains, including DX hardware and software.
Japan’s business reinvention entails a pivot from the old conglomerates that manufacture consumer products and commodities toward more focused and nimble competitors in distinct high-tech categories. It has proceeded quietly, with limited bankruptcies and job losses, thanks to a slow, methodical path that took two decades to allow society to adjust to changing employment systems. But while quiet, this deliberate remodeling has brought about a new industrial architecture and changed the competitive thrust of Japan’s largest companies.
THE REINVENTION: MOVING UPSTREAM FOR “JAPAN INSIDE”
Japan’s erstwhile dominance in mass-manufacturing high-end consumer and household electronics was wiped out in the late 1990s, first by South Korea and then by Taiwan and China, which acquired mastery of Japanese manufacturing techniques but with lower labor costs. From electronics, the shift expanded to commodities such as basic steel, glass, and paper. Blindsided at first, Japan’s top companies slowly found a new opportunity in upstream technologies—i.e., difficult-to-make, difficult-to-copy input materials that are critical to improve end products. This includes fine chemicals and other materials needed for next-generation cell phones and batteries, vision technologies for robotics, production machinery and chemicals for semiconductor production, power steering and microcontrollers, carbon fiber, and specialty steels. Some of Japan’s former household names, such as Fujifilm, Hitachi, or Nikon, underwent drastic strategic repositioning, while lesser-known competitors, such as JSR, TOK, Shin-Etsu Chemical, and Showa Denko (now Resonac), emerged. These reinvented companies make input materials and machines that are critical for a wide range of essential products, from semiconductor manufacturing to infrastructure installations, cell phones, computers, cars, and next-generation household gadgets. These end products depend on high-end materials from Japan, but they do not carry a “Japan Inside” sticker. Yet, even though the input materials are invisible to the user, Japan’s role in global supply chains is all the more powerful for them.
I have labeled this pivot Japan’s new “aggregate niche strategy.” Many of the product markets that Japan now dominates are relatively small. According to a study by the Japanese government which looked at around 900 product and materials categories, these segments averaged some $5 billion each in 2018. Japanese companies held more than 50% of the global market share in 431 of those categories. But while each niche is small, in the aggregate they add up to significant economic activity and trade dependencies.
Importantly, most of the companies that occupy these niches are large. This is not a small company, or “hidden champion,” play; rather, it has become the strategic anchor of Japan’s leading, large, listed companies today, and thus represents a core facet of the country’s new global competitive thrust. It allows Japan not only to escape competitors in Northeast Asia but to profit from their rise by occupying the frontier in advanced technologies that earn higher margins, require less labor, and are based on deep and often unwritten knowledge and intellectual property.
Japan’s dominance of these input material niches has created new trade dependencies, especially in Northeast Asia, as reflected in trade data. In 2019, trade between Japan and China (including Hong Kong) was roughly equal, while South Korea and Taiwan both reported a trade deficit with Japan and a trade surplus with China. Thus, Japan anchors the regional trade in materials and components, which are shipped to South Korea and Taiwan for the manufacture of input parts that were then shipped to China for final assembly.
JAPAN’S “LUCKY MOMENT”: THE DX AND THE LABOR SHORTAGE
Japan is a trailblazer in demographic change. Its working-age population is forecast to shrink from 74 million people today to around 50 million by 2050. A labor shortage is thus imminent. Yet the timing of these shifts may present a lucky moment, as Japan’s shrinking workforce happens to coincide with the arrival of the DX. Together, these two trends can help solve the problems each of them create. For example, to address the labor shortage, the arrival of autonomous systems can be framed not as a threat to jobs but rather as a facilitator of new forms of transportation or manufacturing. Agrotech will fill the gaps created by a fast-aging farming population, just as blockchain-based logistics will replace an antiquated system of wholesalers, most of whom are beyond retirement and cannot find successors in their declining industries.
The DX also offers new opportunities to compete, just at a time when Japan’s best companies are undergoing the “aggregate niche” reinvention. Where other countries may encounter resistance from workers and their unions, or middle managers unhappy with strategic shifts, in Japan’s lucky moment opportunities abound, and hope for new growth often matches an easier acceptance of automation and digitization as a solution for social shifts. Any company willing to invest in change can seize this moment.
JAPAN’S ROLE IN INDUSTRY 4.0 AND DIGITAL MANUFACTURING
As indicated above, the DX will create opportunities across countless sectors and products. Under the banner of Industry 4.0, Internet of Things–enabled connectivity, new computing powers and storage, and unstructured (“big”) data collection and analysis will revolutionize manufacturing. Smart-city infrastructure and vast amounts of data, transmitted by the ubiquitous connectivity provided by 5G networks and analyzed through AI/ML, will usher in Society 5.0. All of this information from connected sensors and systems will be stored, scraped, and analyzed in the “cloud.”
The central question is which countries and companies will achieve a leading role in these areas. Many think that the United States—and possibly China—will reap the most benefits, given the dominance in software and AI/ML by Alphabet, Microsoft, Amazon, Meta, Apple (AMAMA) as well as a robust innovation ecosystem that attracts the world’s best talent. But there are also pockets of the DX that are currently dominated by Japanese and German companies, in particular in the so-called digital manufacturing or Industry 4.0.
On the digital shopfloor of Industry 4.0, all parts and machines will be equipped with sensors and in constant communication. All production information will be known in real time, including where parts are in what stage of the supply chain. Production will be machine-run and governed by machine-learned “digital kaizen” (constant improvement). In the future, the final product will even have a “digital twin”—a data file with all information regarding a part throughout its lifetime. Parts can be followed after they have been combined into end products, sold, and used.
This new world is an engineer’s dream. Everything is known at all times, and holdups and downtime are minimized. Robots do not sleep, eat, or go on strike, nor do they need light. Indeed, so-called dark factories already exist, where robots assemble simple consumer products around the clock, without the need for any lighting. All this opens up new business opportunities, from autonomous systems and advanced system solutions to the requisite infrastructure components. As 5G is still being rolled out and many technologies are in development, factories embodying the full spectrum of possibilities enabled by the DX are rare. However, the blueprints and prototypes have been created, and leaders have emerged.
Japan is globally known for leadership in monozukuri—literally, the “art of making things”—including manufacturing equipment. Since the middle of the twentieth century, Japan has honed its core competencies in factory automation, robotics, mechatronics, and system engineering. This strong base enables Japanese companies to compete in the design of the technology frontier of digital manufacturing and to create the first real “use cases.” In combination, this will afford Japanese companies—together with competitors from Germany—a first-mover advantage.
Currently, profit potential in plant design, equipment, and operations is assessed separately for each of these categories: there are providers of hardware and software that each contribute a small piece, stitched together by multiple additional layers of software. On the digital shopfloor, these will all be meshed into one combined system. Complete factory automation can be accomplished only through integrated systems with advanced manufacturing solutions. The highest profit potential accrues in advanced equipment and plant installations, new production process solutions, logistics, customization and single-unit production (as opposed to mass production), and the creation of synergies achieved through platforms providing total connectivity and optimization through all steps of these processes.
Thus, the winners of the shopfloor revolution will be the providers of these platforms, and currently Japanese and German companies are in the leading position. None of this is yet related to the cloud. While eventually cloud players—such as AMAMA—will enter the fray, the current space is dominated by digital manufacturing leaders. In Japan, these include Keyence, FANUC, Omron, Okuma, Mitsubishi Electric, Yaskawa, Fuji Electric, Yokogawa Electric, and several midsized companies on the software side, as well as many smaller companies that dominate certain aspects of this technology. Any country that aims to manufacture at the cutting edge will need to turn to Japan and Germany for equipment.
POLICY IMPLICATIONS: THE AGGREGATE NICHE STRATEGY IN THE DX
There is of course a question of whether Japanese companies will be able to seize their lucky moment. The global competitive dynamics are increasingly volatile, and there will be unexpected winners and losers. But Japan is positioned to play a critical role in the DX—and not only on the hardware side. Japanese companies are shaping the DX technology frontier and will be a force to reckon with as smart cities arise, communication modes evolve, dark factories become the norm, and knowledge creation and information exchange advance.
Three main takeaways emerge. First, Japan’s economy is generally underestimated, as is Japan’s clout amid fast-shifting global geodynamics. Even though many think of the DX as a software game that is played in the cloud, we will always need hardware to build the stadium (or factory). Without Japanese inputs, there would be no advanced semiconductors, fewer sensors, and less-capable robots.
Second, one might think that it is only a matter of time until other countries (notably, South Korea and China) catch up with Japan. But this presupposes that Japan’s leading companies are standing still, which of course they are not. Rather, these leaders are shaping the technology frontier by contributing breakthrough innovation combined with continuous improvement. Some Japanese companies may be too slow and lose. But while the athletes may change and the technologies advance, Japan’s ongoing business reinvention means that the country will be in the game as a strong competitor.
Third, the aggregate niche strategy has already created dependencies. As concerns about economic security rise, the business reinvention has provided Japan with an advantage that helps balance power relations in Northeast Asia and globally. Some of this is already playing out between Japan, South Korea, and China, and one hopes that pragmatic business needs can help balance the geopolitics of the region.
Ulrike Schaede is Professor of Japanese Studies and Director of the Japan Forum for Innovation and Technology at UC San Diego’s School of Global Policy and Strategy. She is a member of the Board of Advisors at the National Bureau of Asian Research. Dr. Schaede is an expert on Japanese business and management strategies, author of The Business Reinvention of Japan: How to Make Sense of the New Japan and Why It Matters (2020), and co-author of The Digital Transformation and Japan’s Political Economy (2022).
 For an exposition of this new strategy, see Ulrike Schaede, The Business Reinvention of Japan: How to Make Sense of the New Japan and Why It Matters (Stanford: Stanford University Press, 2020). For details on the “lucky moment” of the coincidence of demographic change and the DX, see Ulrike Schaede and Kay Shimizu, The Digital Transformation and Japan’s Political Economy (Cambridge: Cambridge University Press, 2022).
 For details on this reinvention and the “aggregate niche strategy,” see Schaede, The Business Reinvention of Japan, chap. 4.
 Schaede, The Business Reinvention of Japan, chap. 4.
 National Institute of Population and Social Security Research (Japan), “Population Projections for Japan, 2001–2050,” January 2002, http://www.ipss.go.jp/pp-newest/e/ppfj02/ppfj02.pdf.
 For more examples, see Schaede and Shimizu, The Digital Transformation and Japan’s Political Economy.
 For a more detailed discussion of digital manufacturing, see Schaede, The Business Reinvention of Japan, chap. 10.