Investing for growing income: Pepsi and Cisco
Darius McDermott, discusses the newly launched Evenlode Global Income with co-managers Ben Peters...
Ben Peters and Chris Elliott, co-managers of Evenlode Global Income fund, spent a few weeks in Japan recently, meeting companies and assessing the investment environment.
Here, Ben discusses whether the characterisation of Japan as an ageing population and an inward-facing economy and culture are justified and whether, if Japanese industry does largely serve itself, does it ultimately matter?
Japanese brands have become household names in the West. Super Mario has kept kids in screen time since 1985, and, if you have ever ordered an Uber, you will have almost certainly travelled in a Toyota Prius.
Nonetheless, the world’s third largest economy certainly does look inward. Data from Factset* shows the Japanese equity market derives 58% of its revenues from domestic customers. The next two largest economies, Germany and the UK, generate around 20% of sales from their home turf. So, despite familiarity with tech-driven Japanese names, doing business in the country represents something of a walled garden.
Japan’s unique culture offers an explanation as to why its businesses focus on the archipelago. Its distinctive social hierarchy and communication means it can also be difficult for overseas companies to penetrate the market. As Prime Minister Abe Shinzo (as we have now been asked to refer to him) observed: “The Japanese have a reputation for being taciturn and hard to communicate with”.
In talking to analysts, governance experts and businesses, this tradition appears stubbornly slow to change. It is probably not helped by the intricacies of the language, which is highly contextual and where direct disagreement is frowned upon. There are some 22 ways of saying ‘no’, and even ‘yes’ can mean ‘no’ in the right – or wrong – context.
Thus, the idiosyncrasies of the market allow plenty of space for domestic firms to operate. This is illustrated by IT consultancies like Itochu Techno-Solutions, which executes IT projects in a manner that suits the Japanese way of doing business. Foreign firms, which attempt to deliver projects in a Western way, can often find their services no longer required.
Other cultural factors play into the hands of domestic firms offering up uniquely Japanese business models. Abe is attempting to loosen up the labour market, but a very high degree of job security is still demanded – and engineer outsourcing firms like Meitec and TechnoPro have built businesses taking advantage of this fact.
The Japanese multinational consumer electronics firms and carmakers that have broken through the invisible barriers to the outside world have opened up large addressable markets and diversification. Understandably then, many of the businesses we have spoken to with small or no overseas operations also want to expand internationally. A risk of doing so is that the same cultural effects that benefit businesses in Japan work in reverse, making life difficult for aspiring firms outside their home market.
While not necessarily the primary driver of a merger and acquisition strategy, the difficulties of expanding caused by cultural differences may be reduced by acquiring internationally, rather than attempting to build organically. IT security firm Trend Micro acquired Tipping Point from Hewlett Packard in 2016. This has formed the basis of the next generation of Trend Micro’s products, but a softer benefit can be found in having a non-Japanese division that can naturally develop and sell products in other markets. But expanding abroad should not be done for the sake of doing it. For some businesses, such as Meitec, it simply does not make sense to look outside of Japan.
Good businesses can flourish anywhere. Companies do not need to be huge, but they need to offer high quality, difficult-to-replicate services and products to a stable and preferably growing market.
Given the difficulties Japan has had in the growth part of the equation, domestic firms may not appear to fit the bill. However, firms don’t need to grow very fast in order to be of high quality. Businesses not looking outside the country’s borders may simply be mature companies in terms of their market position and growth profile.
Meanwhile, companies with a proven track record abroad could be faster growers given larger addressable markets. However, we are wary of some that have international ambitions but an unclear value proposition in overseas territories. Competitive positions have been hard won by incumbents in other markets and they are unlikely to give their situations up easily.
The characterisation of Japan as possessing an in inward-looking economy and culture has some truth in it. We believe it is necessary to choose carefully and match a firm’s stated strategy to the reality of competitive global marketplaces. Ultimately, whether a company looks inside or outside Japan’s borders matters less than whether it is doing something good for its customers, no matter where they reside.
*Source: Factset GeoRev figures for MSCI developed market indices