THE BIG JAPANESE PUSH INTO EUROPE They're acquiring companies, building plants, and turning up the competitive heat. American multinationals will have to run harder to keep up with them.
By Richard I. Kirkland Jr. REPORTER ASSOCIATE Susan Moffat, Sara Hammes

(FORTUNE Magazine) – SIGNS OF THE TIMES: ''The Japanese miracle can be repeated,'' declare billboards plastered around Budapest by Minolta, the camera maker. Share prices on the Frankfurt stock exchange have been levitated in part by the $1.4 billion invested by Japanese in the first quarter of this year -- up from just $6.8 million a year earlier. In London, now home to some 60 Japanese banks, bond traders unwind with whisky and off-key warbling in one of the new karaoke sing-along bars transplanted from Tokyo's Ginza to the East End. Just down the road at Eton College, tailcoated scions of Britain's elite will soon study Japanese, courtesy of a $1.7 million grant from Sumitomo. After years of treating Europe as a commercial afterthought, Japan has discovered the Old World -- with a vengeance. In the latest fiscal year, which ended March 31, Japanese companies have put an estimated $14.4 billion into direct investments in the European Community. That's a 74% increase from the previous year and a sevenfold rise since the mid-1980s. Almost half that stake was used to buy European companies. Says David Lough, publisher of M&A Japan, a specialist newsletter: ''In 1989, for the first time, Japanese companies began to be taken seriously by European investment bankers.'' And by Japanese financiers as well. In the past 12 months Tokyo's major banks and brokerages either started or expanded mergers and acquisitions operations in Europe. Japan's Europhoria is unlikely to fade soon. Says Kenichi Ohmae, managing director of McKinsey & Co. in Tokyo: ''Japanese investment in Europe is going to grow in quantum leaps. In the past five years Japan has invested heavily in the U.S. That will continue. But for the next five years the focus will shift to Europe.'' As this investment tsunami rolls across the Continent, it will become one of the major forces reshaping Europe's economic landscape in the 1990s. Since the Japanese are determined to increase the technological sophistication as well as the size of their operations in Europe, competition is bound to intensify. That threatens not only national champions in France, Italy, and Britain, but also the outsiders with the biggest stake in Europe -- U.S. multinationals. And since many European companies will emerge from the fray stronger -- and perhaps in partnership with the Japanese -- American companies can expect tougher battles for market share in the U.S. and the Third World. PROTECTIONISM has played a part in drawing Japanese manufacturers into Europe. Whenever the EC has gotten porcupinish about imports, its quills have usually been aimed at Japan. But raw, back-up-the-trucks opportunity is a far more important motive. Says Jack Schmuckli, the Swiss chairman of Sony's European operations: ''We think no other area in the world offers so much potential.'' Western Europe's economy is already larger than America's, and many forecasters think it will grow faster in the decade ahead. Last year, for the first time, Sony sold slightly more electronic gadgetry in Europe than it did in the U.S. Most of Sony's Japanese competitors, though, have a long way to go before their market share in Europe comes anywhere close to what it is in the U.S. or Asia. Still, as Europe dismantles its internal trade barriers as part of Project 1992, the Japanese should have an easier time catching up. The unexpected opening of Eastern Europe is a big bonus. It offers both a potential low-cost manufacturing base and a huge market for Japan's consumer goods. Says Norio Ohga, Sony's chief executive: ''The biggest problem in Eastern Europe isn't the poor state of the physical infrastructure but the need to develop an intellectual infrastructure -- bankruptcy and patent laws, clear property rights, and the basic understanding of international accounting principles.'' With those issues unresolved, Ohga is in no rush to put a plant east of the Elbe. Until recently Japan's investment in Europe was concentrated in Britain, whose language and business customs are comfortingly similar to the American market the Japanese know best. Now the Japanese are starting to spread their money around. Says Robert Hormats, vice chairman of Goldman Sachs International: ''What impresses me is not just the rise in the magnitude of this investment but its growing diversity.'' Among the recent items in Japan's shopping bag: distilleries in Scotland, a French cognac maker, a Parisian shopping mall, a German hair care company, and a fax machine factory near Naples. Many of the Japanese companies now investing in Europe are newcomers to global business. Japan's reputation as an export powerhouse comes from a handful of highly visible industries, like cars and electronics. The Japanese pharmaceutical industry, for example, is stunningly provincial. Sankyo, the second-biggest drugmaker, derives less than 4% of its $2 billion annual revenues from foreign sales, vs. up to 50% for its American and European competitors. To start catching up, Sankyo in January paid $130 million for 74% of Luitpold-Werk, a small, privately held West German drug company with a good distribution network in the U.S. as well as in Europe. Last December, Japan's Leyton House bought 54% of Hugo Boss, the leading West German designer of men's clothing, for about $300 million. Four months later Renown, the biggest Japanese clothing maker, announced plans to acquire Britain's upscale Aquascutum for $125 million. Renown, which had virtually no European sales, will use Aquascutum to move into the prestige market back home as well as to expand in the U.S. and Europe. Also in April, Japan's Seibu Saison and France's Hermes -- in which Nippon Life recently purchased a 1.5% stake -- formed a joint venture to acquire Jean-Louis Scherrer, one of the last remaining independent couture houses in Paris. These ventures are aimed in part at the affluent Japanese, who are traveling to Europe in ever greater numbers. In pricey shops on Paris's Right Bank, signs announcing JAPANESE SPOKEN HERE now hang alongside those offering assistance in English. At London's leading tailors, a customer often has to push through a crowd of eager Japanese. When Japanese carmakers increased their direct investment in the U.S., more than 350 parts suppliers followed. That trend is beginning in Britain, where Japan's Big Three have pledged to spend nearly $3 billion on new assembly plants by the late 1990s. To supply Toyota's factory aborning in the rural Midlands, Nippondenso recently paid $40 million to acquire IMI Radiators in Yorkshire. Says Raymond Douse, head of European M&A for Daiwa Securities: ''For many suppliers a green-field investment takes too long. So acquisitions are an attractive alternative.'' The biggest shift in Japanese investment patterns will be toward Germany and, to a lesser extent, France. Despite its dominance in the European economy, West Germany has so far attracted only about a fifth as much Japanese investment as Britain. The reasons range from language difficulties and high wage costs to Germany's traditional Japanese-like prickliness toward acquisitions -- whether by foreigners or locals. That's changing fast, along with the economic and political geography of Europe. Scan the guest list in any hotel or government ministry in Prague or East Berlin and you see proof of Japan's intense interest in Eastern Europe's potential. Still, with a few exceptions, the cautious Japanese aren't crowding to put their own money into these troubled economies. Of more than 3,000 joint ventures signed by Western companies through March, Japan accounted for fewer than 40. Instead the Japanese are seeking West German partners who know the area (see Europe). Last fall Kao, one of Japan's leading toiletries companies, acquired West Germany's Goldwell for $153 million. Now Goldwell has struck a deal with an East German distributor to market Kao's products there. To help scout other potential acquisitions for its Japanese clients, Nomura recently took a 5% stake in Matuschka Group, West Germany's biggest independent investment bank. West Germany's other main attraction is the technological sophistication of its industries and work force. Matsushita now makes VCRs in partnership with Bosch and electronic components in a joint venture with Siemens. And in a move drawing anxious stares from General Electric, Boeing, and others, Mitsubishi and Daimler-Benz, the Godzilla and King Kong of their respective industries, recently began talks on possible collaboration on products from cars to airplanes. Wherever it flows in Europe, Japan's capital attracts attention. But it doesn't always trigger the negative reaction so prevalent now in the U.S. In Britain particularly, Japan's image is overwhelmingly positive. Because Japanese electronics companies have built plants there, Britain is now an exporter of videotape recorders even though it has no VCR industry of its own. Having resuscitated Britain's dying auto industry, Japanese carmakers plan to export from there too -- a development that disturbs General Motors and Ford no less than Peugeot and Fiat. John Lawson of Nomura Research Institute in London predicts that Britain's current $11 billion trade deficit in cars will be halved by the mid-1990s. So never mind that American-owned companies employ more than 530,000 Britons to Japan Inc.'s 30,000, or that there are more French and German companies than Japanese in the part of southeast Wales now known as Nippon Valley. When polltakers for Market Opinion Research International last summer asked the citizens of Luton, home of a big GM plant, if they'd be better off with a different owner, 60% knew what they'd prefer -- a Japanese company. On the Continent, however, particularly in France and Italy, an undercurrent of anxiety lingers. Last year Asahi Breweries bought the three-star Lucas- Carton restaurant in Paris. Recalls co-owner Eventhia Senderens: ''The French press acted as if people would now eat with chopsticks at Lucas-Carton. In fact, nothing changed except that we took our capital out of the restaurant to expand in other areas of the food business.'' When Japanese Prime Minister Toshiki Kaifu paid a state visit to France last January, European Affairs Minister Edith Cresson described Japan as ''an enemy'' with ''an absolute desire to conquer the world.'' More common, though, was Italy's response to Toyota's announcement in 1989 that it would invest more than $1.2 billion in car assembly and engine plants in Britain -- Japan's biggest green-field investment in Europe. The Italians, who have so far attracted less Japanese investment than has Bermuda, sent a high-level mission to Tokyo to describe their country's charms and do a little polite arm-twisting. At the same time, the Italian government began negotiations to reduce the 41 quotas the country has long imposed on Japanese goods. France, too -- despite Madame Cresson's complaints -- has lately put on a happier face. Admits Industry Minister Roger Faroux: ''It is better to have Japanese factories than unemployment.'' WHAT DESERVES closer scrutiny are the market-distorting national and regional subsidies -- not unlike the tax breaks handed out by state governments in the U.S. -- that are often used to lure job-creating Japanese investors to Europe. By some estimates Britain in the early 1980s spent as much as $85,000 in subsidies for every new job. Complains Philippe Geyres, head of strategic planning for SGS-Thomson, the European semiconductor giant: ''This kind of thing gives our Japanese competitors an unfair advantage and requires much clearer regulation by the EC.'' Rather than limit Japanese investment, the EC will likely try to redirect it -- in effect, to drive it up the value-added chain from so-called screwdriver plants to the most technologically sophisticated manufacturing possible. Says John Stopford, a professor at the London Business School: ''The emphasis will shift from prosecuting antidumping cases to using local-content requirements and rules of origin to get the Japanese to shift their R&D here.'' Typical of the new approach is a 1989 EC ruling that semiconductors must be fabricated in Europe to avoid punitive tariffs. The predictable result has been increased European investment by Japanese semiconductor makers. Among the biggest spenders are Fujitsu, which is building a $650 million chip plant in Britain's Midlands, and Mitsubishi Electric, which is about to break ground on a similar $300 million factory near the West German town of Aachen. Some Japanese managers grumble that EC local-content rules will discourage further investment by making it difficult to maintain production quality. Most, though, seem resigned to living with such rules. A few, notably Sony's Norio Ohga, practically embrace them. Says Ohga: ''For us, the pressure from the EC merely accelerates an evolutionary process that was already under way.'' Ohga, who is fluent in English and passable in German, is especially comfortable in Europe. He studied music in Berlin in the 1950s and later toured Europe as an opera singer. The late conductor Herbert von Karajan was among his close friends. Five years ago less than 20% of Sony's European sales reflected local production. Since then, spurred in part by the sharply stronger yen, Sony has accelerated its drive to shift manufacturing closer to its markets. The company doubled capacity at its TV factory in Wales and added plants for other products in France, West Germany, and northern Italy. Today these eight factories supply 50% of Sony's European sales. In May, Sony announced construction of a new TV factory in Barcelona capable of making 600,000 TV sets a year by 1993. As the next stage in its drive to be what Ohga calls ''a good European corporate citizen'' -- a phrase that falls frequently from the lips of Japanese managers -- Sony is moving to expand its European-based R&D. It recently opened a second R&D center near Stuttgart and moved responsibility for research into digital VCRs from its Tokyo headquarters to its five-year- old European technical center west of London. Most Japanese companies in Europe these days are making similar moves -- or at least similar noises. Yamanouchi, Japan's biggest drugmaker, has built an R&D center at Oxford, as has Sharp, the electronics maker. Hitachi is doing electronics research at Cambridge and developing software at Trinity College in Dublin. Despite their efforts in spreading around the R&D pixie dust, most Japanese companies know they still have a long way to go before they match the status of such U.S. companies as General Motors or IBM. In the ultimate sign of insider status, Big Blue even participates as a European company in EC-backed high-technology projects. But as Takao Negishi, head of the Electronic Industries Association of Japan in Europe, likes to point out, ''IBM has had 70 years to achieve that. We've only had ten.'' One big hurdle for Japanese companies is their tendency to have an almost exclusively imported management team in Europe. Says Sony's Ohga: ''We have to stop sending so many Japanese managers.'' Europeans head all but one of Sony's national subsidiaries and run its European headquarters in Cologne. But Sony, which also boasts two non-Japanese on its board of directors, is ever the maverick. Archrival Matsushita, which employs roughly the same number of people in Europe (10,000) and enjoys slightly higher sales ($4.5 billion), has almost no non-Japanese executives among its top management and financial staff. Less visible but no less important is the development by Japanese companies of more integrated European management structures with at least some independent say over product planning, marketing, and capital spending. Says Gary Hamel, a professor at the London Business School and consultant to many multinationals: ''In the years ahead few companies will succeed in Europe without having a very powerful regional organization.'' Again, only a handful of Japanese companies have taken even their first faltering steps toward this goal. If Japanese companies cope successfully with the awkward transition from pure exporters to true multinationals -- and they probably will -- that should do wonders for reducing Europe's $21 billion trade deficit with Japan. By boosting employment and adding to its technological base, continued Japanese investment should also improve Europe's overall competitiveness. What it won't do is eliminate trade frictions or the pressure for protection from threatened local industries. For some time now the European carmakers most sheltered from Japanese exports -- France's Peugeot and Italy's Fiat -- have been loudly demanding that any lowering of national quotas be accompanied by ''voluntary'' limits on Japan's EC market share. Moreover, they want those restraints to apply both to imports and to cars the Japanese make in their European plants, unlike similar limits in the U.S. Japanese carmakers publicly denounce that proposal as unfair. At the same time they privately promise to be ''prudent'' about using their European production to rapidly increase market share beyond its current 10% level. As old hands at fortress building themselves, the Japanese are worried less about being forced to substitute local production for exports than about being denied reasonable access to a huge, vibrant marketplace. EUROPE'S real challenge is to maintain that dynamism by delivering on its promise to construct the most open market possible. If direct investment is a vote by global capitalists on an economy's attractiveness, then Japan's investors have only recently begun to appreciate the Old World. Now thoughtful analysts, such as Yoshitaka Kitao, head of European M&A for Nomura/Wasserstein Perella in London, no longer dismiss the notion that Europe might someday surpass the U.S. as a magnet for Japanese capital. ''But that depends very much,'' he says, ''on the success of the 1992 project and on economic revival in the East.'' In the years ahead, Europe should be concerned when it starts attracting too little Japanese capital, not too much.

BOX: BUYING IN: SOME RECENT JAPANESE DEALS

COMPANY TARGET VALUE in millions Fuji Photo Film Crosfield Electronics $369 Britain Dai-Ichi Mutual Life Insurance 5% of Cie Financiere $350 du Groupe Victoire France Leyton House 54% of Hugo Boss $300 West Germany Nippon Life Insurance 4% of Banco Bilbao Vizcaya $250 Spain Mitsubishi Buitoni (U.K.) $250 Britain Nippon Seiko United Precision Industries $232 Britain Idemitsu Kosan 9.6% of Statoil $214 Norway Honda 20% of Rover Group $157 Britain Kao 75% of Goldwell $153 West Germany Fujisankei 25% of Virgin Music Group $150 Britain * Estimate. SOURCE: M&A JAPAN

CHART: NOT AVAILABLE CREDIT: SOURCE: MINISTRY OF FINANCE, JAPAN CAPTION: JAPAN'S DIRECT INVESTMENT IN EUROPE