Our studies thus conclude that the government model played little if any role in the successful industries, with scarcely any intervention, few cartels, and scant cooperative R&D. Among the failures, the government model prevailed, with numerous cartels, widespread cooperation, and rampant intervention in competition. If anything, the Japanesegovernment model is a cause of failure, not of success.

THE CORPORATE MODEL

The model of Japanese corporate success centers on the notion that a company can achieve both high quality and low cost by employing-and continuously improving- fundamentally better managerial practices. The idea is that companies compete by relentlessly staying at thefrontier of best practice. This model is not an abstract theory but stems fromextraordinary advances mode by Japanese companies after the introduction of nowwell-known managerial practices, such as total quality management (TQM), leanproduction, and close supplier relationships. The model clearly worked throughthe 1980�fs, producing results so stunning that at first many Western companiesbelieved that the Japanese were competing unfairly by pricing blow cost. Infact, Japanese companies were just incredibly productive. Exports grew rapidlyas Japanese companies seized world market share in many industries. And sinceproductivity was rising so dramatically, Japanese wages and per capita incomegrew rapidly as well.

Even before the real-estate and stock-market bubble burst, however, sings of weakness had emerged. First, a large number of Japanese industries were simply not competitive; many were downright unproductive and a drag on the economy�fs overall productivity. One result was an extraordinarily high cost of living. The Japanese paid (and still pay) too much for almosteverything, forcing their standard of living far lower than their per capitaincome suggests. Second, the array of significant export industries wasremarkably small for a large economy. Japan�es top 50 industries�f export valueaccounted for 59 percent of Japanese exports in 1993, compared to 46 percent inSweden, 43 percent in the United States, and 38 percent in Germany. Japan iscomparable to Canada and Korea in export concentration, with exports dominatedby a relatively small number of industries in automotives, consumerelectronics, office machines, and production machinery. In huge areas of theeconomy there are few if any successful exporters, including chemicals,packaged goods, services, and health care. Third, Japanese corporate profitrates were chronically low by international standards (even in the successfulindustries before the bubble burst). Fourth, by the rate 1980s grows had slowedand export share peaked. In some industries it was actually declining. Finally,the Japanese corporate model did not give rise to a next generation of dynamicexport industries, a striking sign that something was fundamentally amiss.

 How can Japan�fs apparent competitive success be reconciledwith its low profitability, limited array of competitive industries, andinability to sustain competitiveness? The answer rests on two distinctapproaches to competition: operational effectiveness and strategy. The Japaneseset the world standard in the 1970s and 1980s for the former-that is, forimproving quality and lowering cost. Japanese companies literally taught theworld many management approaches that are enormously useful to nearly anycompany in any industry. They were so far ahead in this dimension that theydefined the frontier of productivity. Much more operationally effective thanWestern companies, they could beat them on both cost and differentiation. Inthe successful industries, Japanese companies also competed fiercely with eachother, rapidly matching each other�fs moves and driving operational improvementeven faster. It also meant that even in industries where rivals started ourwith distinct competitive positions-as was the case in fax machines-theyeventually converged.

 Initially there was room for everybody to grow. Although oneJapanese company could rarely stay ahead of the others, as a group they gainedinternational market share. But today, the rest of the world has caught up andsome are leapfrogging ahead, particularly American companies that have beenmore aggressive about restructuring and using information technology. Japan�fsrelative weakness are especially evident in activities outside of production,such a planning and control, finance, logistics, distribution, orderprocessing, customer information, and after-sale service. The problem is thatif all companies offer more or less the same value, customers must choosebetween them solely based on cost, inevitably undermining prices andprofitability. The many Japanese companies that compete on operationaleffectiveness alone have thus been caught in a trap of their own making. Havinglost their decisive lead in operational effectiveness, these companies foundthat competitive convergence and slower growth have made the 1990sextraordinarily painful.

There are some notable exceptions. A handful of the mostcelebrated and successful companies in Japan do have clear strategies, but thisis not widely appreciated as what sets them apart. Honda did not win becauseits distinctive strategy produced it was better at kanban or TQM or because itcopied Toyota. It won because its distinctive strategy produced unique vehiclesand unique marketing. The same is true for Sony in consumer electronics and forNintendo and Sega in video games. But it is telling that these immenselysuccessful companies are seen in Japan as mavericks.

COMPETITION IS CRUCIAL

The government policies that are widely believed to explainJapan�fs success-practices that limit competition in myriad ways-turn out tohave inflicted a profound cost on the Japanese economy. Those industries thatprospered did so in spite of these policies, not because of them. This findingis consistent with hat is known about the competitiveness of othercountries-vigorous rivalry is the only path to economic vitality. Ultimately, acountry�fs productivity is the sum of its corporate productivity. As a measurethat includes both the prices that products and services can command and theefficiency with which they are produced, productivity reflects thesophistication with which companies compete.

It is here that public policy and private business practiceintersect. Macroeconomic policy set the broad context but does not itselfcreate wealth. It is the macroeconomic environment, also shaped by publicpolicy, that strongly influences competitive sophistication, efficiency, andthe types of feasible strategies. Companies will have a hard time competing onthe basis of differentiated products and superior service if they cannot findwell-educated staff, if marketing channels are poorly developed, or if localcustomers are unsophisticated. In every one of our case studies, microeconomicenvironment and company performance were inextricably interlined. Japanesecompanies were only competitive to the extent that their business environmentswere dynamic, stimulating, and intensely competitive. And in industry afterindustry, the business environment was shaped by four interrelated influences.

 The first is the cost, quality, and specialization offundamental inputs, such as skilled employees or basic raw materials. Companiesmust be able to acquire at a competitive price and quality. Although the mostbasic factor inputs rarely constitute a competitive advantage-because manylocations have them or they can be accessed in global markets-they cancontribute to competitive disadvantage. Japan�fs failure industries weretypically plagued by such handicaps. Consider chocolates, where governmenttrade barriers meant that Japanese companies paid excessive prices for importedsugar and cocoa. In contrast, the internationally competitive soy sauceindustry had no import restraints. Competitive advantages normally arise frompools of specialized inputs. Japan�fs supply of highly trained electrical andmechanical engineers, for example, has clearly given it an edge in faxmachines, robotics, and consumer electronics. Conversely, Japan�fs weak chemicalsector has long suffered from a shortage of chemists and chemical engineers, aproblem related weaknesses in research and in the university system.

 The second influence on business environments is especiallycritical in advanced competition: efficient local access to the most advancedand specialized suppliers and partners. When interconnected companies andinstitutions cluster in one location-Silicon Valley, for example-all companiesgain from the proximity of specialized components, services, and know-how,which enables them to improve productivity and pursue more sophisticatedstrategies. Japan�fs successful industries almost always could be found to havebenefited from such a cluster. Consider robotics: it is no accident that Japanhas also been a world leader in a host of related and supportingindustries-numerical controls, machine tools, optical sensors, and motors. Inhome air conditioners, Japan leads the way in components such as converters,compressors, small motors, and radiators. Similarly, Japan�fs fax industry grewout of a powerful cluster in cameras, optics, and electronics.

 The third influence is the sophistication of local customers.When consumers are knowledgeable and demanding, companies must work harder toprovide satisfaction. Strong quality, safety, health, and environmentalstandards often enhance customer sophistication and push companies to use moreadvanced technologies. In robotics, for example, Japanese manufacturers movedto large-scale robot use much faster than companies in other countries becauseof their sophisticated manufacturing practice, shortage of skilled workers, andcaution in hiring due to life time employment. In the fax machine market, theproblems posed by the Japanese language for typewriters and telex machines,office space constrains, major time differences with large foreign markets, andexpensive telephone charges all meant producers had to meet stringent localneeds.

 The contrast between air conditioners and detergents is alsoinstructive. Japan is a nation of small, closely packed houses and hot, muggysummers-hence a strong local demand for compact, quiet air conditioners. Overtime, knowledgeable consumers have pushed manufacturers to upgrade. Theirproducts�f performance and add features. Following the oil crisis of the 1970s,the government set stringent energy standards that triggered additionalinnovation. In detergents, on the other hand, the Japanese market is sodifferent from the rest of the world that home demand distracts Japanesecompanies from becoming globally competitive. The same energy and spaceconstraints that led to successful air conditioners resulted in small washingmachines and frequent loads. This coupled with softer water, produceddetergents of lower quality than those required by foreign customers.

 The most powerful of the four influences shaping a businessenvironment, however, is intense local rivalry. It drives innovation andcontinued improvement in productivity. The nature of such rivalry is governedby policies, incentives, and norms that directly affect competition (such astrade, foreign investment, and antitrust policy) or that affect the climate forinvestment and competition (such as the tax system, the corporate governancesystem, labor market policies, and intellectual property rights).

 In virtually all the Japanese failure cases, rivalry wasconstrained in some way, often by government-imposed impediments. In chemicals,for example, the government controlled production levels. In securities,overregulation by the government and fixed commissions created a comfortableoligopoly of just four (now three) players. In detergents, the governmentprotected the home industry from foreign competition, effectively leaving twocompanies in control of the market. In contrast, vigorous local competitionoccurred in all of Japan�fs internationally successful industries. In airconditioners, more than a dozen rivals competed aggressively with each other,while there were well over 100 robotics companies and more than 15 fax machineproducers. These findings were confirmed statistically. In a broad sample ofJapanese industries, the intensity of local rivalry as measured by market-sharefluctuation was by far the dominant factor explaining international success.This link was one of the most striking research findings. Although someJapanese say this rivalry is excessive, that is only because of flaws in theJapanese approach to competition, such as luck of focus on profitability andpervasive imitation.

Piecemeal solutions and quick fixes bailing out financialinstitutions, lowering consumption taxes, issuing merchandise vouchers-will notsolve Japan�fs economic ills because of these deeper, underlying problems. Japanmust speed up the pace of regulatory reform and increase the transparency ofthe regulatory process. But it is overly simplistic to label all regulations badthose that stimulate early demand for new products foster competitiveness, andhigh standards in energy usage, safety, quality, and noise encourageinnovation. Instead, the single biggest lesson from Japan�fs failure is that thegovernment should abandon its anti competitive policies. Japanese policy makersneed to rethink lax antitrust policy, rampant cartels and consortia, governmentguidance, and regulatory barriers to competition. Enhancing competition, notjust deregulation per se, must be the goal of regulatory reform. The same holdstrue for trade. It is time for Japan to confidently embrace free trade, whichwill reduce input costs and increase competitiveness across all industries.Restraining imports actually crippled many of the industries it was designed toprotect and dragged down others.

 Responsibility for many of Japan�fs uncompetitive industriescan be traced back to the universities. University and graduate training isuneven in quality. Japanese universities fail to produce enough students inimportant disciplines like computer software and biotechnology, and also failin their research. Hampered by scare funds and antiquated facilities, theseschools lack strong research programs in many important fields and focus onapplied work rather than original science. With promotion based on seniority,the incentive to conduct innovative work in new fields is minimal. The core of Japaneseresearch resides in companies and to far lesser extent government laboratories.But unfettered university-based research is critical to competition. It is moreopen than private or government research, training advanced scientists andengineers and providing a fertile breeding ground for new companies. Lackingthis component, Japan has compensated with distorting subsidies to individualcompanies and cumbersome government-sponsored cooperative R&D.

 Many of Japan�fs failures can also be traced to fragmented,inefficient, and anachronistic domestic sectors such as retailing, wholesaling,logistics, financial, services, health care, energy, trucking,telecommunications, housing, and agriculture. By design, government policieshave created two Japans: one composed of highly productive export industries,the other containing domestic sectors. Inefficiency in the letter set was allbut guaranteed by a huge array of rules and policies that raised costs, barredcompetition, and limited consolidation. The government hoped hat while thatefficient Japan would carry the economy, the inefficient Japan would providestability, jobs, self-sufficiency, and an implicit retirement system of smallfamily business. The obvious price of this solution was borne by Japaneseconsumers. Policy makers, however, failed to anticipate two devastatingconsequences of this approach. First, the inefficient Japan drives up businesscosts across he board, weakening the competitiveness of the export industries.Second, it inhibits the formation of internationally competitive industries inhuge pats of the economy. Japanese domestic industries are so idiosyncraticthat their operating practices do not work in foreign markets. Japan�fsdistorted service sector, in a world where services are increasingly traded,precludes competitiveness in those areas in which an advanced country should begrowing. The net result is an almost total absence of new Japanese exportindustries.

A new corporate governance system-one less beholden to banksand bureaucrats-is needed to enhance accountability. Without pressure to usecapital efficiently and earn decent profits, Japanese companies will notaddress their fundamental competitiveness problems. Shareholders need moreinfluence, boards, of directors more independence, and corporate decisions andfinancial results mast be made more transparent. Japan must also move from afinancing system based on collateralized loans and guarantees toward one thatencourages risk. In the process, though, Japan should preserve its longerinvestment horizons and not adopt the frenzied trading of the Anglo-Saxonsystem.

Lastly, the Japanese government tends to centralize economicactivity around Tokyo and Osaka, a practice that not only creates congestionand high costs but also impedes the formation of healthy business clusters. InCalifornia, for example, which is approximately the size of Japan, vibrantclusters of microelectronics and biotechnology flourish in Silicon Valley;multimedia in San Francisco; and entertainment, defense, and aerospace in LosAngels. By promoting decentralization and specialization, the Japanesegovernment will fuel productivity and innovation.

Despite the persistent problems of the 1990s, Japanesebusiness executives have yet to fundamentally question how they compete. Inresponse to poor profitability, Japanese companies have migrated offshore insearch of cheap labor and other inexpensive inputs-a continuation ofoperational thinking-rather than change heir way of competing. In response toslow growth, companies have diversified into unrelated business instead offixing the problems in their core. Improvements in operational effectivenessmust continue but must widen to encompass office productivity, information technology,the Internet, marketing, and other traditionally weak areas. Japan must catchup in computer technology and information networking in schools, homes, andoffices.

 Japanese companies must embrace strategy that forsakesimitation and distinguishes them from rivals. Strategy depends on tradeoffs,but the Japanese have gotten so used to competing by extending the productivityfrontier-pursuing both cost and quality advantages equally-that they fail todecide where on the frontier to compete. The importance of consensus indecision-making and the deeply ingrained tradition of customer serviceexacerbate this tendency. Japanese executives treat every customer need asequally valid-trying to be all things to all people. They rarely choose whichcustomers to serve and which to leave to competitors. Companies must understandhat the essence of strategy is choosing what not to do.

 These companies need not look for far to discover thatcompanies with distinctive strategies are winning in the global market. In videogames, Nintendo, Sega, and Sony have chosen to do different things and achievedsuccess as a result. Nintendo emphasized speed and play ability, Sega offeredenhanced graphics, and Sony focused on low cost.

 A pervasive weakness in the Japanese approach to competitionis the tendency to ignore industry structure-such as the power of customers andthe availability of substitute products-in deciding both where and how tocompete. Profitability depends not only on a-company�fs own position but on thestructure of the industry itself. Japanese companies enter �ghigh-tech�h orgrowing industries assuming they will be attractive-but without studyingindustry economies. Thus they end up crowding into unprofitable industries orundermining industry structure (such as by transferring power to customers),and then wondering why the profits are poor or nonexistent.

 Japanese companies should abandon the outmoded dream ofbecoming diversified giants like Toshiba, Hitachi, or Mitsubishi Electric, whomake everything from microchips and batteries to power plants and automatedassembly plants. Contrast these companies, now facing their worst crisis inhistory, with high performers, all of whom had focused strategies. They includeAdvantest, one of the world�fs top manufacturers of chip-testing equipment;Futaba Corporation, with 80 percent of the world market in fluorescentindicator tubes; and Nidec Corporation, which dominates specialized motors.

 Profitability is the only reliable measure of sound strategy.Lifetime employment and lack of shareholder pressure have led Japanesecompanies to put growth ahead of profitability, but they are starting torealize that this drives imitation, competitive convergence, unrelateddiversification, and massive excess capacity. Shifting their goal now willrequire some fundamental changes in Japanese business, but concern with profitsis growing, partly due to pressure from non-Japanese investors. Embracing strategywill inevitably challenge the dominant Japanese model of leadership andorganization. Leaders in Japan most often see their role as building consensus,ensuring continuity, and providing for orderly succession. But what Japan needstoday are leaders like Sony�fs Nobuyuki Idei, Orix�fs Yoshihiko Miyauchi, andSoftbank�fs Masayoshi Son. Seen as mavericks in Japan, they are not afraid torock the boat and make bold moves. They exemplify the new type of innovativethinkers and risk-takers who are emerging in Japan.

 Finally, Japanese companies will continue to suffer fromimitation and indistinct strategies until internal incentives are modified.Currently they encourage imitation, which is taken as demonstrating that amanager is careful and has diligently studied competitors. The Japanese systempenalizes mistakes but does not reward successes, creating strong pressures tofollow competitors. Companies must move from an exclusively egalitarian,seniority-driven model to one where doing things differently is rewarded incompensation, advancement, and opportunities for entrepreneurship.

 CAN JAPAN CHANGE?

 Japan�fs leaders are proud of their hard-won economic growthand remain wary of Anglo-Saxon capitalism. But many have drawn the wronglessons from their success-a lack of objectivity that has been reinforced byinternational opinion. Although Japan is a nation that reveres its traditions,it is also a country that has demonstrated an extraordinary capacity to transformitself when the common well-being is at stake. Today�fs Japan was invented by acollective act of will following the devastation of World War 2. It wassuccessful because it had the flexibility to apply its unique strengths to thebest ideas then available-regardless of where those ideas came from. It is timefor Japan to reinvent itself once more, based on a deeper understanding of thestrengths and limitations of its approach and a new, more sophisticated way ofcompeting.