JAPAN'S COMEBACK PLAN With the yen up 36% in a year against the dollar, Japanese companies are slashing costs, squeezing suppliers, and -- as long as they can stand it -- taking losses to hold markets. They are even buying finished goods from low-price producers like the U.S.
By Joel Dreyfuss REPORTER ASSOCIATE Frederick Hiroshi Katayama

(FORTUNE Magazine) – AFTER YEARS of generating prosperity through a single-minded emphasis on exports, Japanese companies are discovering that the old strategy isn't working the way it used to. The yen is worth 36% more against the dollar than it was a year ago, and the economy of the U.S. -- Japan's biggest export market -- is crawling along. The roll of Japanese blue-chip companies with shrinking earnings reads like failing grades in a tough exam. In the year ended March 31, Nippon Steel's profits were down 20%, Nissan Motor's 56%, and NEC's 60%. The new reality of endaka (the high yen) has Japanese companies scrambling to shape and manage more complex business strategies. They are rushing to build and expand plants near their major markets, to find sources of cheap labor and parts abroad, to nurture new businesses, and to fend off competition from the newly industrialized countries, the NICs, which they once held in contempt. Says Minoru Kobayashi, chief economist at the Industrial Bank of Japan: ''The high yen will shake our industry from top to bottom.'' In the end Japan may well have to embrace some of the reforms Western countries have been urging for years. Protected industries are likely to get a thorough shakeout, and consumer product manufacturers will pay more attention to the Japanese home market. Even so, a lot of small low-tech companies could go bust. Japan's gargantuan trade surplus will shrink, and unemployment will rise. The U.S. and Europe will benefit but not as much as you may think. A lot of the gains will go to those fast-growing NICs. The quickest response a Japanese company can make to the high yen is to raise prices. But to recover the full value of the exchange rate losses since September 1985, it would have to jack up prices drastically. No one has dared do that for fear of losing hard-earned overseas market share. Most increases have been in the 10% to 20% range. Even modest price hikes can be hazardous. Toshiba raised U.S. prices for videocassette recorders 3% in February, but American wholesalers rebelled. ''We got no orders at all at that level,'' says managing director Kiyohiko Kasuya. The company canceled the increase. Because of strong competition from Korea and from other Japanese VCR makers, Kasuya says, prices for its VCRs are lower now than they were in February. Is the company making a profit on video recorders? Says Kasuya: ''Frankly, no.'' Managers of other companies admit they are taking losses on some products. So they have to worry about dumping charges in countries where they do business, and about the bottom line back home. Mitsubishi Motors, Japan's fourth-largest carmaker, has raised prices only 9% because it is bucking giants Toyota and Nissan in the export markets that take 60% of its production. A company official says flatly that the company can't make money at the current yen rate. Mitsubishi Motors, 24% owned by Chrysler, says it can stand the heat for 12 to 18 months, but, asks the official, ''then what?'' Komatsu, Japan's biggest construction equipment manufacturer, with sales of $4 billion last year, has long been locked in an epic battle with Caterpillar. Komatsu says it has raised its prices to dealers 18% since last November, but Caterpillar officials say competition has kept the actual price to the customer unchanged in the U.S. Presumably, Komatsu and its dealers are giving up margins to keep market share. In the first six months of this year, Komatsu's profits dropped 44% although sales were up 6%. Caterpillar says the prices paid by its customers have held steady in the U.S. and have risen in Australia and Southeast Asia. Komatsu President Shoji Nogawa says he is surprised Caterpillar has taken this tack. ''They could have attacked us, using the high yen, even if they were hemorrhaging,'' he says. ''But they went for the profits.'' Despite the bad news, big Japanese companies, rich in cash and resources, have a lot of maneuvering room before they start losing money. The most immediate victims of endaka are the small and medium-size companies that still produce a large chunk of Japan's GNP. These are not the slick companies of the country's high-tech industrial image but the small family-run businesses that make and export such low-tech products as flatware, dishes, and eyeglass frames. Kazue Asakawa, head of an association of small exporters, estimates that 20 of the group's 51 members are on the verge of bankruptcy. Some of these businesses have been in the same families for three generations. Hong Kong companies can duplicate their products at half the price. Asakawa's own company, K. Asakawa Metal Works, is typical. The company is headquartered in a working-class neighborhood on the industrial fringe of Tokyo, with workshops scattered along a narrow street among a jumble of traditional tile-roofed homes, nondescript concrete buildings, and noodle shops. It turns out silver- plated candelabra, napkin holders, enameled trivets, and peanut-shaped candy boxes. Asakawa says he has no orders for delivery after October. Some Japanese officials think such a company, dependent on exports for 70% of sales, is an anachronism in a land of high wages. The government has offered low-interest loans to help businesses like Asakawa's redirect their efforts. ''The government tells us we should change to the domestic market,'' says Asakawa, ''but we ask them, 'What shall we do?' This is the industry our fathers and grandfathers started.'' For big Japanese companies, one answer is offshore production. Direct Japanese investments in overseas plants came to $12 billion in 1985, some 60% of it in the U.S. and Western Europe. The original motive was fear of protectionism. Now endaka presents a more urgent reason for manufacturing abroad. Once the yen hit the 160-to-$1 line, the Industrial Bank of Japan estimates, Japanese manufacturing wages became the highest in the world: $10.42 an hour on average, vs. $9.52 in the U.S. Southeast Asia, where Japanese companies invested heavily in the 1970s, is more attractive than ever as a place to manufacture. In the last year the ratio between wages in Japan and Taiwan has gone from 5 to 1 to 7 to 1. Some new Japanese investment will go to South Korea, Malaysia, and even Spain, a new low-wage member of the European Community. Deciding what to build where can be a complex exercise. For companies that already have plants outside Japan, it's just a matter of expanding. Matsushita Electric, which markets under the Panasonic, National, Quasar, and Technics brands, makes 14% of its products at plants in 26 countries, including the U.S. and several European countries. It was already expanding under a long- term plan to boost overseas output to 25%. ''We were more ready than others,'' says Kyutaro Isomura, president of Matsushita Electric Trading, the company's trading subsidiary. Matsushita especially wants to increase U.S. and European production. Canon, the camera and copier maker, had planned to start building a plant in Newport News, Virginia, in 1987. After the yen took off, Canon moved the schedule up half a year. The company broke ground in May and expects to start turning out ''Made in USA'' copiers early next spring. Some Japanese managers worry that their Japanese customers back home will question the quality of products manufactured in other Asian countries or the U.S. But the flow of Japanese products into Japan has already begun. Yamaha, the $1.9-billion-a-year musical instruments and sporting goods manufacturer, makes guitars, tennis rackets, and golf clubs in Taiwan for sale in Japan. Matsushita has been manufacturing air conditioners in Malaysia and selling them in Japan for years, and has boosted production since the yen took off. There's a little less hesitation about importing components. Some companies have set up procurement offices to hunt for cheap components and machinery. Earlier this year Sanyo started buying 14-inch color tubes in Korea for its U.S. assembly plants, but the company had reassured domestic distributors that none of those picture tubes would end up in Japan. Komatsu, which has plants in the U.S. and Britain, is buying high-pressure hoses from Korea. Canon says it has saved as much as 30% on a $105,000 die to stamp parts by buying in Korea. Hitachi, the computer and consumer electronics manufacturer, has created a fairly elaborate organization to promote the use of foreign-made products within the company. Its international procurement department sends officials to the U.S. and Southeast Asia to scout out products. In two years Hitachi's purchases from U.S. companies have grown from $260 million to around $450 million. Shinsuke Matsuoka, manager of the department, is particularly proud of a $4.5-million computerized multifunction machine tool the company found in the U.S. this year. He admits that Hitachi executives were pleasantly surprised by the quality of the machine, made by Ingersoll Milling Machine of Rockford, Illinois. Matsushita Electric Trading's Isomura is thinking about importing the large console television sets his company makes in the U.S. Toshiba has just made a deal to market AT&T System 75 PBX telephone switchboards in Japan and has already signed up its first customer. Japanese companies are also fighting the high-yen wars on the domestic front. They long ago embraced ''cost down'' (cost cutting) as avidly as they took to quality control. But the speed and size of the yen's rise make cost cutting a long-term solution, like building plants abroad. To keep making reasonable profits without raising prices, says Komatsu President Nogawa, ''we would need to reduce costs by 50%, which is impossible in the short term no matter what new pioneering technology we employ.'' Suppliers are feeling the pressure too. Manufacturers aren't saying how much of the 36% they can make up by leaning on parts makers. Texas Instruments Japan, the wholly owned subsidiary of the U.S. chipmaker, has felt the heavy boot of cost-conscious customers. ''Customers are asking for 20% to 30% cuts in prices,'' says marketing manager Masataka Hayashida. ''It's more than too much. It's impossible.'' TI, which lost $17.6 million in Japan last year because of the semiconductor slump, reports it is cutting prices by 5% to 10%. Japan's nine automakers compete at least as fiercely at home as they do abroad. Mitsubishi Motors, which ships 450,000 V-6 engines a year to Chrysler in the U.S., just inaugurated a highly automated engine factory, so advanced that the company refuses to let outsiders see or photograph it. Toyota executive vice president Gentaro Tsuji says his company will produce even its new lines of luxury cars in automated plants: ''We are mass-producing what used to be handmade.''

! If highly successful electronics and auto companies were staggered by the high yen, companies in the sunset industries are wondering if they will ever recover. The Japanese steel industry had already done much to stay competitive. Companies closed outdated mills and invested heavily in new technology. But the worldwide steel recession of the past two years, and the emergence of Third World competitors, had left them struggling. The last thing they needed was the high yen. ''Endaka is a body blow,'' says Tatsuhiko Nakamura, a spokesman for Nippon Steel. In the first six months of this year, Japanese steel exports dropped 12% and imports climbed 27%. One sign of the pressures triggered by the high yen is the new hard line some companies are taking against longstanding government protectionism. In May Japanese steelmakers refused to buy domestic coal at a government-set price three times the cost of imports made much cheaper by the high yen. The steel producers declared they would pay Japanese companies what they pay for imported coal. Japan's coal industry is in shock. ''If they go through with it,'' says Kazutoshi Tomikawa, an official of the Japan Coal Association, ''most of the mines will go bankrupt.'' SHIPBUILDING is another Japanese industry with troubles that predate the high yen. Japan is the world's leading shipbuilder, but the global surplus of ships and growing Korean competition have left Japan's shipyards bailing water. New orders fell 18% last year and could drop even more in 1986. The ministry of transport wants Japanese shipbuilders to cut their capacity by 20%. Mitsubishi Heavy Industries, one of the largest shipbuilders, says it will cooperate, but President Yotaro Iida declares he could never abandon shipbuilding. ''We've been in that business 120 years, since our company was born,'' protests Iida, who describes himself as a ''pure engineer -- not an accountant.'' So far, the big cash-rich companies have absorbed the blows of the high yen without laying off workers. Some large firms are offering incentives to older workers to retire early, and others have announced they will hire fewer employees next year. Small companies have sent some workers to suppliers in affiliated firms until times get better. But the country's 2.9% unemployment rate, the envy of the West, will creep up. The most pessimistic economists think it will double in the next several years. Will hard times in Japan mean better times in the U.S.? The new factories on American shores, offering new jobs, are a distinct plus. Many of the parts assembled in the plants will be made abroad -- but so are many of the parts American workers assemble now. Cheap candelabra and peanut dishes from Hong Kong will benefit consumers. U.S. executives have some lead time: They hustled to cope with a strong currency. Now that the Japanese are addressing the same tough problem, their counterparts elsewhere had better keep on hustling. Remember how fast Japan bounced back from