Business Group

Management in Japan
 Monden Institute of Management: Japanese Management and
International Studies (ISSN: 1793-2874)

Editor-in-Chief: Yasuhiro Monden (Mejiro University, Japan)

Published
Vol. 1 Value-Based Management of the Rising Sun
edited by Yasuhiro Monden, Kanji Miyamoto, Kazuki Hamada,
Gunyung Lee & Takayuki Asada

Vol. 2 Japanese Management Accounting Today

edited by Yasuhiro Monden, Masanobu Kosuga,
Yoshiyuki Nagasaka, Shufuku Hiraoka & Noriko Hoshi

Vol. 3 Japanese Project Management:

KPM — Innovation, Development and Improvement
edited by Shigenobu Ohara & Takayuki Asada

Vol. 4 International Management Accounting in Japan:

Current Status of Electronics Companies
edited by Kanji Miyamoto

Vol. 5 Business Process Management of Japanese and Korean Companies

edited by Gunyung Lee, Masanobu Kosuga, Yoshiyuki Nagasaka &
Byungkyu Sohn

Vol. 6 M&A for Value Creation in Japan

edited by Yasuyoshi Kurokawa

Vol. 7 Business Group Management in Japan

edited by Kazuki Hamada

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 Monden Institute of Management
Japanese Management and International Studies – Vol. 7

Business Group
Management in Japan

editor

Kazuki Hamada
Kwansei Gakuin University, Japan

World Scientific
NEW JERSEY • LONDON • SINGAPORE • BEIJING • SHANGHAI • HONG KONG • TA I P E I • CHENNAI
 Published by
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UK office: 57 Shelton Street, Covent Garden, London WC2H 9HE

British Library Cataloguing-in-Publication Data

A catalogue record for this book is available from the British Library.

BUSINESS GROUP MANAGEMENT IN JAPAN

Monden Institute of Management: Japanese Management and International Studies — Vol. 7
Copyright © 2010 by World Scientific Publishing Co. Pte. Ltd.
All rights reserved. This book, or parts thereof, may not be reproduced in any form or by any means,
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For photocopying of material in this volume, please pay a copying fee through the Copyright
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photocopy is not required from the publisher.

ISBN-13 978-981-4289-50-4

Printed in Singapore.

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Japan Society of Organization and

Accounting
President
Kazuki Hamada, Kwansei Gakuin University, Japan

Vice Presidents
Gunyung Lee, Niigata University, Japan
Kanji Miyamoto, Osaka Gakuin University, Japan

Directors
Henry Aigbedo, Oakland University, USA
Shufuku Hiraoka, Soka University; Japan
Mahfuzul Hoque, University of Dhaka, Bangladesh
Noriko Hoshi, Hakuoh University, Japan
Tomonori Inooka, Kokushikan University, Japan
Chao Hsiung Lee, National Chung Hsing University, Taiwan
Yoshiyuki Nagasaka, Konan University, Japan

Founder & Editor-in-Chief

Japanese Management and International Studies
Yasuhiro Monden, Mejiro University, Japan

Mission of JSOA and Editorial Information

For the purpose of making a contribution to the business and academic
communities, the Japan Society of Organization and Accounting (JSOA),
a reformed and expanded organization from the Monden Institute of
Management, is committed to publishing the book series, entitled
Japanese Management and International Studies, with a refereed system.
Focusing on Japan and Japan-related issues, the series is designed to
inform the world about research outcomes of the new ‘‘Japanese style
management system’’ developed in Japan. It includes the Japanese version
of management systems developed abroad. In addition, it publishes
research by foreign scholars and concerning foreign systems that constitute
significant points of comparison with the Japanese system.

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vi Japan Society of Organization and Accounting

Research topics included in this series are management of organizations

in a broad sense (including the business group) and the accounting that
supports the organization. More specifically, topics include business strat-
egy, organizational restructuring, corporate finance, M&A, environmental
management, business models, operations management, managerial
accounting, financial accounting for organizational restructuring, manager
performance evaluation, remuneration systems, and management of rev-
enues and costs. The research approach is interdisciplinary, which includes
case studies, theoretical studies, normative studies and empirical studies,
but emphasizes real world business.
Each volume contains the series title and a book title which reflects the
volume’s special theme.
Our JSOA’s board of directors has established an editorial board of
international standing, which is served by the Monden Institute of
Management. In each volume, guest editors who are experts on the vol-
ume’s special theme serve as the volume editors.
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Editorial Board
MONDEN INSTITUTE OF MANAGEMENT
Japanese Management and International Studies

Editor-in-Chief
Yasuhiro Monden, Mejiro University, Japan

Managing Editors
Henry Aigbedo, Oakland University, USA
Kazuki Hamada, Kwansei Gakuin University, Japan
Shufuku Hiraoka, Soka University; Japan
Mahfuzul Hoque, University of Dhaka, Bangladesh
Noriko Hoshi, Hakuoh University, Japan
Tomonori Inooka, Kokushikan University, Japan
Chao Hsiung Lee, National Chung Hsing University, Taiwan
Gunyung Lee, Niigata University, Japan
Yoshiyuki Nagasaka, Konan University, Japan

Editorial Advisory Board

Mohammad Aghdassi, Tarbiat Modarres University, Iran
Mahmuda Akter, University of Dhaka, Bangladesh
Takayuki Asada, Osaka University, Japan
Takahiro Fujimoto, University of Tokyo, Japan
Péter Horváth, University Stuttgart, Germany
Arnd Huchzermeier, WHU Koblenz, Germany
Christer Karlsson, Copenhagen Business School, Denmark
Masanobu Kosuga, Kwansei Gakuin University, Japan
Bruce Henry Lambert, Stockholm School of Entrepreneurship, Sweden
Rolf G Larsson, Lund University, Sweden
John Y. Lee, Pace University, USA
Jose Antonio Dominguez Machuca, University of Sevilla, Spain
Kenneth A. Merchant, University of Southern California, USA
Yoshiteru Minagawa, Nagoya Gakuin University, Japan
Kanji Miyamoto, Osaka Gakuin University, Japan

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viii Editorial Board

Tengku Akbar Tengku Abdullah, Universiti Kebangsaan Malaysia,

Malaysia
Jimmy Y.T. Tsay, National Taiwan University, Taiwan
Susumu Ueno, Konan University, Japan
Eri Yokota, Keio University, Japan
Walid Zaramdini, Al Akhawayn University, Morocco
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Contents

Preface xiii
About the Volume Editor xix
List of Contributors xxi

Part 1: Accounting Information for Group Management

and Management Control System

Management Accounting Information for Consolidated 3

Group Management
Kazuki Hamada

Management Control Systems of Japanese Pure 17

Holding Companies
Makoto Tomo, Makoto Yori and Takayuki Asada

Part 2: M&A Including MBO and Outsourcing

for Group Reformation

Influence of M&A on Financial Performance: Measuring 39

the Performance of M&A from Sustainability of Utility
Kozo Suzuki

Management Buyout of a Japanese Business Group 51

Naoyuki Kaneda
Managerial Significance of Strategic Outsourcing 63
Shunzo Matsuoka

Acquisition Price as an Incentive Price of M&A 73

Yasuhiro Monden

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x Contents

Part 3: Analysis of Accounting Information for Consolidated and

Business Group and Segmental Business Units

Consolidated Accounting Information for Business Group 95

Management
Manabu Takano

Business Evaluation of a Company Group in Japan: 105

A Case Study of Segment Reporting by Panasonic
Electric Works
Shufuku Hiraoka

Part 4: Management of Inter-Firm Relations

How Can Management Accounting Achieve Goal Congruence 121

Among Supply Chain Partners?
Yoshiteru Minagawa

How to Maintain the Bargaining Position Defined 137

in Toyota’s Dealership Control
Hiroshi Ozawa

Royalties and Profit Sharing: Focusing on Seven-Eleven 151

Japan Co., Ltd.
Noriko Hoshi

Factors Influencing Control Mechanisms in Joint Ventures: 163

Evidence from Japanese
Manufacturing Industries
Yuichi Kubota

Does Inter-Firm Cooperation Contribute to the Performance 183

of Japanese Firms?
Junya Sakaguchi

Concept of Incentive Price for Motivating Inter-Firm 193

Cooperation
Yasuhiro Monden
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Contents xi

Part 5: Inter-Organizational Learning and Autonomous

Organizations

Management of Population-level Learning and Inter- 211

Organizational Relations in Japan
Hiroki Kondo

Management Control System in an Empowered Organization 227

Katsuhiro Ito

Index 239
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Preface

Currently, Japanese companies are positively promoting the “integration

and/or separation of businesses” with the aim of gaining a competitive
advantage. Although various individual and combined business models
exist, the common goal is to enhance the value of the business.
Nowadays, the competition that exists among business groups is more
important than that among individual firms. Therefore, the strategies for
managing numerous individual firms have become important from the
viewpoint of the business group as a whole.
In Japan, there are many core companies that engage in unique inter-
firm relationships, called “Keiretsu”, which confer substantial influence
upon the members of the group through continuous transactions, even in
the absence of capital-alliances. Therefore, our research also considers
these uniquely Japanese attributes. The management methods employed
in Japanese companies include the following: (1) application of evaluation
systems; (2) execution of mergers and acquisitions (M&A); (3) utilization
of segment information; (4) management of inter-firm relations; and
(5) adoption of organizational learning.
In this book, we explore and elucidate business group management
(BGM) and inter-firm management in Japanese companies, both theoret-
ically and practically through case studies, survey research, and other
methodologies. The analyses, hypotheses, and conclusions presented in
this book will be useful for business practitioners and for academic
researchers.
This book consists of the following five parts.

Part 1: Accounting Information for Group Management

and Management Control Systems
The first paper by Hamada examines the managerial accounting methods
used in business group management by analyzing the role played by the

xiii
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xiv Preface

group headquarters. In particular, it is examined how the managerial

accounting system and consolidated performance evaluation system are
designed and utilized in Japanese companies.
The second paper by Tomo, Yori, and Asada investigates the current
situation and problems associated with the application of management
control systems in companies that are falling under the control of hold-
ing company. The meaning of business reformation, the extent of
authority delegation, and the roles of the holding company are examined.

Part 2: M&A, Including MBO, and Outsourcing

for Group Reformation
The first paper by Suzuki investigates the effects of M&A on financial
performance. This paper regards M&A as a means to transfer business
resources from one company to another, whereby a firm or business is
itself a type of resource. From this standpoint, the effects of M&A on
business sustainability performance are evaluated.
The second paper by Kaneda examines management buyouts (MBOs)
of Japanese companies. In MBOs, corporations tend to retain the original
management and employees, generally avoiding massive layoffs. Thus,
some large corporations prefer to use MBOs to spin off subsidiaries. As an
example, the spinning off of subsidiaries from Nissan Motor Company,
during which the management changed its style of corporate management,
is presented.
The third paper by Matsuoka discusses outsourcing. The purpose
of outsourcing has evolved, and strategic outsourcing or value-creation
outsourcing has emerged in recent years. This paper describes the
historical transitions undergone by outsourcing and looks in particular at
the current managerial meaning of strategic outsourcing.
The fourth paper by Monden explains the acquisition price of M&A as
a practical example of the incentive price, using the case study of the
merger between City group and Nikko. The estimated synergy of M&A
will be allocated to both the acquiring firm and the acquired firm. The
central problem in this allocation is how to determine the acquisition pre-
mium for the stockholders of the acquired firm considering the interest of
stockholders of the acquiring firm.
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Preface xv

Part 3: Analyses of Accounting Information

for Consolidated Business Groups
and Segmental Business Units
The first paper by Takano discusses how management accounting infor-
mation is used for BGM through the analysis of consolidated accounting
information. The associated analyses with case studies are provided in this
paper.
The second chapter by Hiraoka investigates segment reporting for busi-
ness evaluation using a case study. Starting in April 2010, Japanese
companies will be obliged to introduce a “management approach” to
segment reporting. However, Panasonic Electric Works is already applying
this approach to arrangement. Through a case study of segment reporting
at Panasonic Electric Works, this paper shows how an analysis of
“business evaluation” can be made.

Part 4: Management of Inter-Firm Relations

The first paper by Minagawa discusses how management accounting can
achieve the goal congruence among supply chain partners. Among the crit-
ical issues to be resolved for efficient supply chain management is how to
reduce the risks that associate with opportunistic behaviors by partners.
The second paper by Ozawa demonstrates the hypothesis that for
Toyota to maintain its strong negotiating position, it is necessary to have
a system in place that rewards dealerships based on their sales perform-
ances, rather than one that increases sales by reducing invoice prices in
the low-demand season.
The third paper by Hoshi discusses the royalties of franchise contracts
and profit allocation. The basis for assessing royalties in a franchise
contract in a convenience store business is usually the gross profit or the
gross profit plus the “loss amount,” which corresponds to the cost of
purchased merchandise that was subsequently discarded because it was
past its consumption-date. This paper examines the effect of loss inclu-
sion in the royalty base, so that the profit allocation issues that arise in
a convenience store business can be clarified.
The fourth paper by Kubota investigates the factors that influence
the control mechanisms of joint ventures. The success of inter-company
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xvi Preface

alliances or joint ventures is dependent upon the management control sys-

tems for inter-firm relations. In general, compared to the situation in
Western companies, the managers of Japanese companies are inclined
to get involved in on-site, shop-floor-level manufacturing, and to con-
duct informal controls. This paper clarifies the Japanese inter-firm
control mechanism through the research survey of the top management of
manufacturing companies in Japan.
The fifth paper by Sakaguchi explores the question as to whether or
not inter-firm cooperation contributes to the performance level of
Japanese firms, based on a survey of 97 Japanese manufacturing
companies. Inter-firm cooperation, the relationship between cooperation
and performance, and the emerging problems in Japanese inter-firm
cooperation are examined.
The sixth paper by Monden discusses incentive price used as a trans-
action price for allocating the joint profits to the member firms of the
network organization. The criterion to determine such an incentive price
is the contribution grade of how each party has contributed to gain the
joint profit, and it will be measured based on the tangible and/or intangible
assets or the expenses paid to develop such assets.

Part 5: Inter-Organizational Learning and

Autonomous Organizations
The first paper by Kondo discusses the management of population-level
learning and inter-organizational relations in Japan. In this paper, the
differences in the various learning patterns of various inter-firm relations
are summarized. In addition, appropriate organizational learning strate-
gies to be adopted by each organization to adapt flexibly to changes in the
management environments, while controlling dysfunctional results, are
discussed.
The second paper by Ito investigates management control systems for
empowered organizations. The concepts and principles of empowered
organizations contrast with those of centralized organizations, which are
designed and managed using a “command-and-control” logic. The rela-
tionship between the organization principle and management accounting
is analyzed in detail. Tentative conclusions are reached based on case stud-
ies of high-achieving Japanese companies, such as Toyota, Kyocera, Kao,
and 7-Eleven.
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Preface xvii

I am very grateful to Ms. Juliet Lee Ley Chin, the Social Sciences
commissioning editor of World Scientific Publishing Company, for her invalu-
able efforts in making this book a reality. Furthermore, Ms. Kim Tan, the
book editor, is acknowledged for her handling of the manuscripts. Lastly,
I would like to express my special thanks to Prof. Yasuhiro Monden, founder
of the Monden Institute of Management, who made it possible for me to
publish this book as a book series (Vol. 7) of the Institute.

Kazuki Hamada
25 April 2009
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About the Volume Editor

Kazuki Hamada
Professor of Institute of Business and Accounting,
Kwansei Gakuin University
1-155 Uegahara-1bancho, Nishinomiya, Hyogo 662-8501, Japan
President, Japan Society of Organization and Accounting
Majoring in Management Accounting
BA and MBA from Kwansei Gakuin University,
Ph.D. from Tsukuba University
[email protected]

Main publications
“Total Productivity Management and the Theory of Constraints: An
Integrated Application of Supply Chain Management Methods,” in
Monden, Y. et al., eds., Japanese Management Accounting Today, World
Scientific, 2007.
“Managerial Roles of Financial and Non-Financial Measures in Supply
Chain and Engineering Chain Management,” in Monden, Y. et al., eds.,
Value-Based Management of the Rising Sun, World Scientific, 2006,
Chapter 23.
“A Method for Simultaneously Achieving Cost Reduction and Quality
Improvement,” “A Management System for the Simultaneous Attainment
of Customer Satisfaction and Employee Satisfaction,” in Monden, Y., ed.,
Japanese Cost Management, Imperial College Press, 2000, Chapter 7 and
Chapter 19.
Evolution of Management Accounting Method, Chuoukeizai-sha, 1998 (in
Japanese).
“Target Costing and Kaizen Costing in the Japanese Automobile
Companies,” Journal of Management Accounting Research, Vol. 3, 1992
(co-authored with Monden, Y.).

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List of Contributors

Takayuki Asada
Professor, Graduate School of Economics, Osaka University
1-7 Machikaneyama, Toyonaka, Osaka 560-0043, Japan
Ph.D. from Kobe University
[email protected]

Shufuku Hiraoka
Professor, Faculty of Business Administration, Soka University
1-236 Tangi-cho, Hachioji, Tokyo 192-0087, Japan
Ph.D. from Meiji University
[email protected]

Noriko Hoshi
Professor, Faculty of Business Adminstration, Hakuoh University
1117 Daigyoji, Oyama, Tochigi 323-8588, Japan
Ph.D. from Tsukuba University

Katsuhiro Ito
Professor, Faculty of Economics, Seikei University
3-3-1 Kichijyoji-kitamachi, Musashino, Tokyo 180-8633, Japan
MBA from Hitotsubashi University
[email protected]

Naoyuki Kaneda
Professor, Faculty of Economics, Gakushuin University
1-5-1 Mejiro, Toshima-ku, Tokyo 171-8588, Japan
Ph.D. from Carnegie Melon University

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xxii List of Contributors

Hiroki Kondo
Lecturer, Faculty of Business Administration, Mejiro University
4-31-1 Nakaochiai, Shinjyuku-ku, Tokyo 161-8539, Japan
Ph.D. from Kyushu University
[email protected]

Yuichi Kubota
Associate Professor, School of Economics, Osaka Prefecture University
1-1 Gakuen-cho, Naka-ku, Sakai, Osaka 599-8531, Japan
Ph.D. from Kobe University

Syunzo Matuoka
Professor, Faculty of Business, Hannan University
5-4-33 Amamihigashi, Matubara, Osaka 580-8502, Japan
MBA from Osaka Prefecture University

Yoshiteru Minagawa
Professor, Faculty of Commerce, Nagoya Gakuin University
1-25 Atsuta, Nishimachi, Atsuta, Nagoya, Aichi 456-8612, Japan
Ph.D. from Nagoya University

Yasuhiro Monden
Professor, Faculty of Business Administration, Mejiro University
4-31-1 Nakaochiai, Shinjyuku-ku, Tokyo 161-8539, Japan
Professor-Emeritus of Tsukuba University
Ph.D. from Tsukuba University
[email protected]

Hiroshi Ozawa
Associate Professor, Graduate School of Economics, Nagoya University
Furocho, Chikusa-ku, Nagoya, Aichi 464-8601, Japan
Ph.D. from Nagoya University

Junya Sakaguchi
Associate Professor, School of Accountancy, Kansai University
3-3-35 Yamate-cho, Suita, Osaka 564-8680, Japan
Ph.D. from Kobe University
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List of Contributors xxiii

Kozo Suzuki
Director of Management Section
Tama Waterworks Reform Promotion Center
Tokyo Metropolitan Government
6-7 Midorimati, Tachikawa, Tokyo 190-0014, Japan
Ph.D. from Tsukuba University

Manabu Takano
Associate Professor, Department of Commerce
Seinan Gakuin University
6-2-92 Nishijin, Sawara-ku, Fukuoka 814-8511, Japan
Ph.D. from Meiji University

Makoto Tomo
Associate Professor, Faculty of Economics, Seijo University
6-1-20 Seijo, Setagaya-ku, Tokyo 157-8511, Japan
Ph.D. from Osaka University
[email protected]

Makoto Yori
Professor, Graduate School of Accountancy, University of Hyogo
8-2-1 Gakuennishi, Nishi-ku, Kobe, Hyogo 651-2197, Japan
Ph.D. from Kobe University
[email protected]
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Part 1

Accounting Information for

Group Management and
Management Control System
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1
Management Accounting Information
for Consolidated Group Management
Kazuki Hamada
Institute of Business and Accounting,
Kwansei Gakuin University

1. Introduction
Japanese companies can be roughly divided into two types: (1) corporate
groups that were formed before World War II, such as Mitsui, Mitsubishi,
Sumitomo; and (2) corporate groups that are affiliated with city banks,
such as former Daiichi Kangyo Bank, Fuyo (former Fuji Bank, former
Yasuda Bank) and the former Sanwa Bank. The business relationships
among the large companies in these groups are only fair and not direct in
many cases. However, for business groups that place large companies in
the center, the business relationships between the large companies and
their associated small/medium companies are close. The other type of cor-
porate group is the vertical group, in which the parent company is at the
top, as is the case at Toyota, Hitachi, Panasonic, Canon, and so forth.
These groups are based on business operating relationships and close con-
nections between the constituent companies.
In recent years, in both types of corporate groups, many companies
have been split to delegate the authority for speedy decision making, to
ensure complete responsibility for own profit/loss, and to reduce the frag-
mentation of effort required for the launching on new business ventures
and the development of new products. When a company is broken, the bad
assets are often retained at its headquarters. Therefore, the delegation of
authority and company fragmentation may produce some good results but
may also weaken the headquarters of the company. In addition, the com-
pany may encounter problems with the pursuit of local optimization at
each company, synergy creation in subdivisions, waste of resources, and
increase of adjustment costs.
3
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4 Kazuki Hamada

The group headquarters has to optimize its functions and manage from
the view of the whole group rather than that of the parent company. For
some companies, the effects of decentralization can be detrimental, forcing
revision of management methods and even reconsideration of the decision
to decentralize. In this paper, the group headquarters is in charge of the
management of the entire group.
The purpose of this paper is to examine the methods that can be used
for group management from the standpoint of management accounting, with
a consideration of the role of the group headquarters. In particular,
the characteristics of management accounting information that facilitate
group management and the design and use of consolidated performance
evaluation system are discussed. In Japan, the ban on pure holding com-
panies was lifted in principle in 1997, and some companies subsequently
adopted this system. For a company that seeks to change to this type of
company structure, it is usual to start as an operating and holding com-
pany that runs its own business and is managed like a pure holding
company. In any case, many companies currently execute such group
management now. Therefore, I consider this paper taking this type into
consideration.

2. The Role of Group Headquarters and Three Types

of Group Management
2.1. The importance of “management of dispersion
and unification”
The group headquarters functions to

(1) Adjust and unify the component businesses from the view of the whole
group, while promoting the self-management of group companies.
(2) Develop the new businesses and to abolish defunct businesses.
(3) Cooperate and conduct the joint development projects with companies
outside the groups.
(4) Support the companies in the group.

The philosophy underlying these roles of the group headquarters relate to

balanced “management of dispersion and unification.”
For the management to promote self-management, management meth-
ods such as clarification of the individual missions of each company,
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Management Accounting Information 5

delegation of authority, clarification of the ranges of responsibility and

authority, introduction of market mechanism, and clarification of
performance evaluation standards must be implemented. For reinforce-
ment of group centripetal force, management methods such as the
clarification of missions and the unification strategies across the entire
group, information sharing, joint responsibility for ethics, personal
exchange, common training programs, and consolidated performance
evaluation are required.
For management of dispersion and unification, it is necessary to combine
both management methods in a satisfactory manner. From the standpoint
of management accounting, I think it is important to consider carefully the
formulation of group missions and unification strategies, the establishment
of individual missions and strategic goals in each company, the design of
appropriate performance evaluation systems in which the ranges of
authority and responsibility are considered, and the procedures for
accounting information sharing and mutual communication.

2.2. The three types of group management

and the roles of the group headquarters
Group management can be roughly divided into three types. The
management of dispersion and unification is necessary for all the types listed
below, and even within a single type of group management, the emphasis
placed on dispersion and unification may be quite different.
The first type of group management is that led by a group headquar-
ters (Type I), which not only formulates and transmits group missions and
group strategies, but also decides on the missions and concrete targets for
the headquarters business divisions and group companies. The concrete
measures applied by the business divisions and group companies are
decided by themselves. The group headquarters allocates a role to each
company, to achieve synergy among the companies in the group, and to
attain global optimum. Both periodic performance evaluations and intra-
period controls are performed, and management is executed based on
detailed information. From the evaluation results, essential businesses are
established and superfluous businesses are abolished. Information sharing
is promoted between the headquarters and group companies, and the
group headquarters decides the necessary technology and support in terms
of funding, tie-ups, and so forth.
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6 Kazuki Hamada

The second form of group management is led by business divisions and

related companies (Type II). In this organization, the group headquarters
not only formulates and transmits group missions and group strategies,
but also defines the individual missions for the business divisions and
related companies. However, the group headquarters does not decide
on concrete strategy targets, and the business divisions and related
companies manage independently. In addition, the group headquarters
introduces a market mechanism, manages the overall group, and executes
performance evaluations regularly. The de novo establishment and aboli-
tion of businesses are performed based on the evaluation results.
Information sharing and cross-sectional evaluations are carried out as
much as possible to maintain the centripetal force of the group. When
requested by a business division or a related company, the group head-
quarters may support a new technology, a fund scheme, or a plan to
strengthen the business.
The third form of group management is financial management (Type III).
The group headquarters transmits group missions and group strategies to
maintain centripetal force. As the relationships between the individual
business divisions and related companies may be poor and they may lack
common strategies, there may be little synergy between them. The group
headquarters executes only a periodical performance evaluation and
decides on the direction of the business. Upon receipt of a request from a
business division or a related company, the group headquarters may
support a new technology, a fund scheme, or a plan to strengthen the
business.
Hitachi is divided into the M (management) consolidated company,
V (vision) consolidated company, and F (financial) consolidated company.
The M consolidated company performs strategic management within
Hitachi with regard to pursuit synergy. The V consolidated company leads
businesses that share a management vision and brand and that are mem-
bers of the Hitachi group. The F consolidated company executes only
financial consolidation.

2.3. Functions of the group headquarters

The functions of headquarters can be divided into functions related to the
management of the overall group and functions that support the group
businesses and related companies. Moreover, the former can be divided
into activities of strategic formulation and adjustment, resource alloca-
tion, and strategic control. The operational details of these three
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Management Accounting Information 7

activities depend on the type of the group management used, as described

below.
Strategic formulation and adjustment:
(1) Strategic formulation and communication of the vision, missions, and
strategies of the whole group; for all types of group management.
(2) Formulation and communication of the business divisions and related
companies; for Type I and Type II.
(3) Establishment and indication of the individual goals of the business
divisions and related companies; for Type I.

Resource allocation:
Investigation of an optimal group management system and formulation of
a resource allocation plan; these activities should always be executed for
Type I group management, and should be performed as the circumstances
demand in Type II and Type III.

Strategic control:
(1) Decisions as to performance evaluation indicators; for all types of
group management, with detailed decisions for Type I.
(2) Monitoring accomplishment of overall goals and each divisional goal
in the intra-period; for Type I.
(3) Interpretation of enforcement results and performance evaluation and
decisions as to rewards; for all types, although the grasping detailed
results and evaluation is needed for Type I.

Support functions, which are implemented to support the businesses in the

group and the related companies, include personnel affairs, accounting,
legal affairs, personnel training, technologic support, intellectual assets
strategies, and research and development particularly basic research and
high-risk, high-return studies. These operations are necessary for all the
group management types.

3. Group Management and Management Accounting

Information
3.1. Group performance accounting
The objectives of accounting for group decision making are outlined in
points (1) and (2) of Strategic formulation and adjustment (Section 2.3),
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8 Kazuki Hamada

and in Resource allocation (Section 2.3), if group support functions are

excluded. In contrast, the objectives of group performance accounting are
covered by point (3) of Strategic formulation and adjustment (Section 2.3),
and in Strategic control (Section 2.3). In this paper, I focus on group per-
formance accounting.
In performance accounting, the establishment of goals, the performance
evaluations, and performance control over a short period are the most
important issues. Of course, the short-term goals must be consistent with
the declared strategies, individual plans, and long-term goals. However, in
recent years, the importance of an emergent strategy has been emphasized,
and the domain of performance accounting is no longer considered to be
narrow but is expected to expand in accordance with the business strategy.
As indicated in Fig. 1, performance evaluation for a short period is designed
to take into account the strategies, and the performance evaluation results
are considered to influence strategy formulation. In other words, the group
evaluation system has handled relations of (a) in Fig. 1 traditionally, but to
consider the relations of (b) in Fig. 1 is important.

(Strategies)

(b) (Short-term goals) (b)

(a) (a)
(Periodical performance evaluation system)

Fig. 1. The relationship between strategies and the periodical performance

evaluation system.

3.2. Characteristics of performance accounting

information that are useful for group management
In this section, I will comment on the usefulness and characteristics of
management accounting information based on the characteristics of group
performance accounting described in the previous section.
The group headquarters not only informs about the financial goals
(group goals) in the short term. However, it is also important to clarify
the relationships between the group missions and group strategies, so that
the division managers and company managers understand their individual
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Management Accounting Information 9

missions. Thus, they understand the roles of their own division and com-
pany by understanding the direction of the whole group and their own
stand-point, which allows them to evaluate the current situation and
results in an autonomous manner.
In the group headquarters-led model, the headquarters informs the
business divisions and related companies of their goals and their perform-
ance evaluation indicators, and allows them to report in detail regularly
(every month), while at the same time permitting them to report neces-
sary information on a weekly, daily or real-time basis. In the business
divisions/related companies-led model, the headquarters informs these
units only regarding performance evaluation indicators, and allowing
them to report results regularly (every month), while proving the oppor-
tunity to report weekly or daily if necessary. In the financial management
model, the headquarters allows the companies to report results regularly
(every month).
For group headquarters-led management and business divisions/related
companies-led management, it is necessary to clarify the issues of author-
ity and responsibility, since this dictates the positioning within the overall
group and increased autonomy. Moreover, since various forms of businesses
are carried out in the group, it is important to define unambiguously using
a matrix the relationships between the functions of the headquarters/
related companies and the various businesses, and to manage regarding a
factor of the matrix as a business unit (responsibility center). In addition,
authority and responsibility are decided by considering the relationships
between the functions and businesses. When a bundle of business units is
small, it is good to be able to consider plans and measures concretely, but
it is not possible to consider from a general point of view and to consider
synergy in a wide range. On the contrary, when a bundle of business unit
is large, it is possible to consider goals and synergy from a general view,
but it is difficult to consider concrete measures.
It is necessary to determine in advance transfer prices, internal inter-
est rates for fund raising from headquarters, the calculation method for
internal dividends on adopting an internal capital system, and the alloca-
tion methods for corporation expenses occurred in the business divisions
and related companies, to compute the profit/loss for the headquarters,
each functional division at the headquarters, and each related company, as
well as the profit/loss for each business division and business. It appears
that clear definition of these parameters make it easier for the constituent
units to act autonomously. Of course, these performance calculation methods
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10 Kazuki Hamada

need to be consistent with not only the short-term goals, but also the
strategies of the whole group.
Accounting procedures for performance evaluation should be con-
ducted fairly. Cost burden rules often tend to be different. For example,
internal business divisions bear the common costs of the headquarters,
while related companies do not. Internal business divisions also often have
courtesies which are mutually beneficial but unofficial arrangements, while
related companies do not. It is important to standardize these accounting
procedures.
It is necessary to expedite reporting by standardizing accounting
procedures. For the purposes of managing, complete information is not
essential, as estimated values or predicted values can be used.

4. Example of Using a Performance Evaluation System

for Group Management
An appropriate performance evaluation system is essential for the pro-
curement of useful performance accounting information. In recent years,
the numbers of overseas subsidiaries in global companies, such as electric
companies and office machine companies, which deal with many products,
have increased, such that integral information on the businesses at home
and abroad has become crucial. When the horizontal and vertical divisions
of labor systems are taken, not only the evaluation of each company and
each function, but also the evaluation of each business is necessary, as
I mentioned in the previous section. One example of a matrix evaluation
system is provided by Canon.
At Canon, most of the sales and production activities are carried out by
subsidiaries. The business divisions do not have their own production and
sales companies. Essentially, a single production company produces the prod-
ucts of some of the business divisions and all the sales companies sell the
products of all the businesses. In light of this corporate structure, the matrix
performance evaluation system was introduced for the following reasons.

(1) When the independent management system of each business division

becomes too strong, some production companies and sales companies
are built by business division in the same area, with the potential for
increased wastage of resources.
(2) Business divisions need to run businesses not only from the view of
their own business, but also from the overall view.
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Management Accounting Information 11

(3) As production companies are in charge of some businesses and sales

companies execute management by channel, a unified management is
necessary.

The profit/loss made by each company and each business division are
computed in this evaluation system, and management aimed at maximiz-
ing both of these parameters is enabled. Since close communication is
important in matrix management, the directors of the business divisions
regularly visit the sales companies and production companies, to exchange
information and to share group accounting information.
At Murata Manufacturing, the profit/loss levels of each department
and each product (consolidated profit/loss for each product) are calcu-
lated, and two-dimensional matrix management based on these parameters
is executed. The department profit/loss in the company is the starting
point for profit/loss management and is a generic term for profit/loss by
process, by place, and by corporation. Murata Manufacturing differs from
Canon in that its matrix evaluation is enforced in detail within the
company. Research and development, business planning, and general man-
agement are conducted intensively in the headquarters. If these activities
are added, the management becomes three-dimensional.
During the calculation of department profit/loss, cases may arise in
which a general administration/sales department and a research and
development department at the parent company and some of the sub-
sidiaries conduct their activities at a location other than their usual place
of business. In such cases, the costs are assigned directly or allocated
adequately among the divisions and corporations. In the calculation of
consolidated profit/loss for each type of product, general administration/
sales costs and research and development costs are assigned directly or
allocated by received benefit beyond the position. The budgets and actual
profit/loss results are controlled monthly.
The main rules for profit/loss management are established unambigu-
ously. These rules include transfer prices, which are decided using an
addition method. However, a special price is set when a product cannot
be sold at the transfer price. This method has been adopted because it
guarantees the gross margin for the headquarters, and limits losses for the
subsidiaries. In addition, transfer prices are determined in yen, to make
overseas companies susceptible to exchange rate fluctuation. Moreover, an
interest rate system is introduced, which means that funds for equipments/
inventories and all the working capital are supposedly borrowed from the
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12 Kazuki Hamada

headquarters, so that interest can be charged. However, the internal

capital system is not adopted. This system is peculiar to Japan and its
purpose is to assign intra-divisional capital and to allow the divisions to
act autonomously as independent companies. When the internal capital
system is adopted, it will let you misjudge because the past profit is
reserved as surplus funds. Furthermore, standard costs are calculated and
used to set the sales prices and intra-transfer prices, as well as for cost
management, budgeting, and inventory evaluations.
The knowledge gains and the points to be considered from these exam-
ples are as follows:

(1) The consolidated performance evaluation system is useful in generat-

ing a unified consciousness across the group, and it should be devised
as strategic executive means, as well as evaluation of the achievements
in the short term.
(2) For the matrix organization to be the premise underlying matrix per-
formance evaluation, the issues of authority and responsibility need
to be clarified, to facilitate autonomous management.
(3) For autonomous management, transfer prices to evaluate performance
and allocation rules for common costs and corporate costs must be
established.
(4) Consolidated monthly closing procedures must be adopted, and an
information system should be devised to disseminate important infor-
mation as soon as possible, weekly and daily.
(5) Information sharing is necessary for matrix management. Therefore,
it is important to establish a location for communication.

5. Using Management Accounting Information

to Generate Synergies
It is necessary for the group headquarters to generate value that is greater
than the sum of the values of the parts, so that group management is effec-
tive. Therefore, it is important to generate synergies. Group missions and
visions give definitive guidelines for the value to be created by synergy. In
addition, it is important to monitor continuously the situation of each
business, so that synergy is created. Group synergy comprises planned
synergy and emergent synergy. Planned synergy is expected at the time of
planning, whereas emergent synergy emerges during the enforcement
process and cannot be anticipated at the time of planning. Synergy arises
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Management Accounting Information 13

from joint ownership of know-how, strategic adjustment, joint ownership

of tangible assets, and concentration of negotiating power.
When synergy effects are estimated, the effects and feasibilities tend to
be overestimated and the costs tend to be underestimated. Therefore,
managers need to analyze more carefully the synergy effects and the asso-
ciated financial costs, and to evaluate these items using a consolidated
performance evaluation system, as mentioned above. The evaluation does
not have to be strictly accurate. The effects of synergy are linked to
increased profit and reduced costs.
In this section, I will consider the relationships between emergent
synergy and performance accounting information. The places in which
creativity is stimulated and promoted are indispensable for the genera-
tion of emergent synergy. It is extremely important that information and
knowledge are allowed to flow within the group and are used diversely,
and that devices and places are established in which information and
knowledge are considered and linked freely. Therefore, it is important to
build networks of human information and knowledge and to use person-
nel system.
Professor Yoshiya Teramoto mentions that the following items are
necessary for the organization of learning, presupposing autonomous
diversity of the organization members.

(1) Knowledge sharing, which is the sharing of explicit knowledge, tacit

knowledge and sense of value;
(2) Holistic viewing;
(3) Flexible networking, which the flexible linkage and combination of
people and organization; and
(4) Hypothetical experimenting, which involves the proposing of hypotheses
regarding countermeasures and verification through experimentation.

Considering the generation of synergy from the stand-point of perform-

ance accounting using this way of thinking, it is necessary to establish the
places that are used to accumulate performance accounting information
and that facilitate knowledge sharing. To produce emergent synergy,
reporting and communication only in the top and bottom directions, but
also in the right-and-left directions are important. In addition, it is impor-
tant to collect management accounting information in all locations at all
times, and to educate users. Moreover, it is necessary to generate not only
management accounting information, but also qualitative information.
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14 Kazuki Hamada

From a holistic view, it is necessary that the goals of the overall group,
those of each division, and the personal goals are consistent, and that
achievements can be evaluated as needed. It is important that manage-
ment accounting information is provided in a timely fashion. For flexible
networking, the measurement of effects through the connection of persons
and the organization is needed. For hypothetical experimentation, it is
necessary that the influences of the measures that correspond to the
various situations regarding profits and costs can be measured using
simulations.

6. Summary and Conclusions

Group headquarters plays various roles. I believe that it is essential for
group companies to be integrated while acting autonomously, and it is
essential that they are managed from the overall view. I have discussed
how valuable balanced “management of dispersion and unification” is
for the field of management accounting, as well as the features and effec-
tive uses of useful management accounting information. In addition, I
have considered how best to design and use a group consolidated per-
formance evaluation system, so as to promote the management from the
overall view.
I have emphasized the importance of defining clearly the group visions
and the visions of each business division/related company, so as to encour-
age these units to act autonomously while maintaining a sense of unity.
The authority and responsibility within each business unit, as defined by
two axes, i.e., company (function of the company) and business, as well as
the evaluation standard of the unit, should be clarified. In addition, it is
indispensable to clarify the transfer prices and allocation rules for common
costs and corporate costs.
I consider the matrix evaluation system to be effective, since various
forms of business are executed in group companies and not only the
performance of each company, but also that of each business beyond the
company is needed. Establishing an appropriate performance evaluation
system facilitates the maintenance of the centripetal force and
autonomous management. As examples, I have mentioned Canon and
Murata Manufacturing.
The evaluation system should be used not only to evaluate consolidated
performance, but also to generate group synergies, i.e., planned synergy
and emergent synergy.
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Management Accounting Information 15

Regarding further group management, conflicts, such as those related

to transfer prices, will occur if an individual business division and each
related company is overemphasized in performance evaluation, since sub-
sidiaries and related companies are linked by the flow of trade. Therefore,
relative importance attached to consolidated performance evaluation or
performance evaluation of each business division/related company is cru-
cial. Although I also considered the focusing of intra-group companies,
consideration of the relationships with the companies outside the group is
also necessary.

References
Asada, T. (2005). Characteristics of the holding company in the Japanese company,
in Organization Design for Increase of Corporate Value and Management
Accounting, edited by Monden, Y., published by Zeimu Keiri Kyokai, Chapter 14
(in Japanese).
Hamada, K. (2006). Performance Accounting Information for Consolidated Group
Management, Kaikei, 170(4) (in Japanese).
Ishigaki, H. and Nagasawa, I. (2004). From management accounting to manage-
ment oriented accounting, Chiteki Shisan Sozo, September (in Japanese).
Izumitani, H. (2001). The company can be examined if its “profit” can be examined:
all of Murata style “matrix management”, Nihon Keizai Shinbunsha
(in Japanese).
Onuma, Y. and Kawano, T. (2005). Construction of next generation group
management model, Chiteki Shisan Sozo, January (in Japanese).
Sawai, R. (1998). A elaborate plan to realize global excellent company group and its
promotion measures for consolidated management innovation, in A Practical
Casebook for Management of Group Innovation and Related Companies, edited
by Nihon Noritu Kyokai (in Japanese).
Tanahashi, K. (2006). Promotion and management system of global/group consoli-
date management in Canon, in From “Choice/Concentration” to “Realization of
Next Growth Strategy: A Practical Casebook for the Promotion of Management
Innovation, edited by Kigyo Kenkyukai (in Japanese).
Tani, T. (1990). Corporate strategy and performance accounting, Kaikei, 137(5)
(in Japanese).
Teramoto, Y. (2005). Management of contexts conversion: study about “synthe-
sizing fusion” and “co-evolution” by organizational networking, Hakuto Shobo
(in Japanese).
Tuda, N. (2003). Group management and a holding company system, in An Ideal
Type of the Global & Group Management in 21st Century: Strategy of Group
b853_Chapter-01.qxd 4/21/2010 2:43 PM Page 16
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16 Kazuki Hamada

Corporate Value Maximization and Management System, edited by Kigyo

Kenkyukai (in Japanese).
Yamamoto, N. (2006). Global group management by new governance, in From
“Choice/Concentration” to “Realization of Next Growth Strategy: A Practical
Casebook for the Promotion of Management Innovation, edited by Kigyo
Kenkyukai (in Japanese).
Yokota, E. (2005). A consideration about management control for autonomous
organization and its unification, Kaikei, 168(6) (in Japanese).
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2
Management Control System
of Japanese Pure Holding Companies
Makoto Tomo
Faculty of Economics, Seijo University
Makoto Yori
Graduate School of Accounting, University of Hyogo
Takayuki Asada
Graduate School of Economics, Osaka University

1. Introduction
It became possible for Japanese companies to establish a pure holding
company (HD) through the revision of the Japanese Antitrust Law in
1997. After 1999, more than a hundred of listed companies have estab-
lished pure HD. Those companies might have various motives to keep
pace with changes of the equity market environment, the globalization of
M&A, the revision of the Anti-monopoly Law, and so on. We studied the
present conditions and the issue of a management control system (MCS)
for pure HD through an interview and literature study. Especially, we
focused on the business reorganization, empowerment, and role of the
headquarters. In this paper, we will propose our hypothesis concerning
the MCS for HD.

2. Significance and the Purpose of the Study

The earlier studies about the pure HD did not distinguish between
Japanese HD systems and Western HD systems. They classified them by
HD’s functions. We found some different HD’s cases from the prototype of
earlier studies — Japanese holding companies manage the diversified
subsidiaries under different circumstances. We will describe the robustness

17
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18 Makoto Tomo et al.

and innovativeness of Japanese HD’s MCS, and the ways in which they
are different from Western models of HD. In addition, this paper
is based on the case method by interview, literature study, and financial
data analysis. Thus, this study is at the stage of hypothesis formation
(Tables 1 and 2).

3. The Meaning and the Purpose of a Pure HD System

A pure HD owns other companies and does no business itself. The HD
delegates authority business functions to subsidiaries and controls them.

Table 1. The company for a hearing.

Establishment
Corporate name year of HD Sales Core business

JS Group 2001 1,124 Housing-related business,

commercial-building-related
business
Nippon Mining HD 2002 3,802 Petroleum, metals
JFE HD 2002 3,260 Steel, engineering,
shipbuilding
Fuji Electric HD 2003 908 Power, control devices,
semiconductor devices,
vending machines
Sojitz 2003 5,218 Machinery & aerospace,
energy & mineral
resources, chemicals &
plastics
Konica Minolta 2003 1,028 Multi-function peripherals,
HD optics, medical and graphic
imaging
Asahi Chemical 2003 1,624 Fibers, chemicals, electronics,
health care
Mitsubishi 2005 2,623 Petrochemicals, synthetic
Chemical HD plastic products,
pharmaceuticals
Dowa HD 2006 459 Nonferrous metals,
environmental
management & recycling

Data: 2007.3 consolidated accounting, sales amount: 1 billion yen, HD: holdings.
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MCS of Japanese Pure Holding Companies 19

Table 2. Main questionnaire entries.

• The purpose of establishing pure HD and organizational restructuring,

and the current state of such restructuring.
• The basic policy to restructure the product department and sales department.
• The corporate governance system and the structure of organizational
integration.
• The extent of involvement in subsidiary’s management decision: subsidiary’s
strategy, goal setting, and so on. What kinds of support function for
subsidiary do headquarters have?
• Where does HD obtain the income? Where does the HD reserve the enterprise
group profit?
• What are the performance evaluation measures of the subsidiary?
• What kinds of demands do the subsidiaries have? Do headquarters have the
official system to deal with them?
• What kinds of transfer price rule are in enterprise group? Can the subsidiaries
purchase goods from outside vendor, even though another subsidiary in the
group makes them?
• What kind of organizational structure do you have about the shared service:
disperse to the subsidiaries or concentrate on HD? What is the purpose?

The purpose of the pure HD organization was as follows:

(1) The restructuring, which aimed at the profitability improvement.

(2) The delegation of business decision authority and encouraging the
manager of subsidiary.
(3) The integration of the enterprises which have different corporate
cultures.
(4) Placing the companies which have different business models under the
same umbrella.
(5) The adaptation to the structural changes of the customer market.
(6) Protecting business rights from hostile takeover. (Modified by Asada,
2007, p. 4.)

It is difficult to determine what purpose each HD had. Most of the HD

might have the purpose to achieve the economies of scale by M&A and
diversification of risks by company split-up. However, in general, HD
might have more purpose.
Moreover, the purposes after several years since HD was established
might be different from those purposes when HD was originally established.
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20 Makoto Tomo et al.

However, we thought the main purpose was aforementioned. The rea-

son is the poor business performance company tends to adopt pure HD
organization as follows.

4. Organizational Restructuring
4.1. The pattern of organizational restructuring
The organizational restructuring can be divided roughly into two
patterns — mergers and corporate spin-offs. Of course, there might be the
case that they adopt corporate spin-off and mergers at the same time. We
typified the surveyed enterprises as follows:

(1) Integration type (substitute of mergers): To reduce the conflict by

mergers by taking the form that two companies operate as subsidiary
under headquarters instead of mergers.

Case example: Konica Minolta Holdings, Inc. (Konica and Minolta),

JFE Holdings, Inc. (Kawasaki Steel and NKK), JS Group Corporation
(TOSTEM and INAX), Sojitz Corporation (Nichimen and Nissho
Iwai): Headquarters and subsidiaries were merged a year later. The
pure HD was used during a preparation period until they merged.
(2) Group restructuring type: The reorganization in a corporate group.
(i) Spin-off type: Shifting from “company system: pseudo intra-
corporation system, investment center system” to HD system.

Case example: Asahi Kasei Corporation (To closure of the unre-

lated diversification with poor profitability), Fuji Electric
Holdings Co., Ltd. (To increase the independency and profitabil-
ity of investment centers), DOWA Holdings Co., Ltd. (To increase
the unifying force by assembling the young human resources
under 45 years to headquarters.)
(ii) Shifting from operating HD to pure HD type: To equate with
subsidiaries and department in the operating HD.

Case example: Mitsubishi Chemical Holdings Corporation. (The

chemistry department was spun off as subsidiary to equate with
pharmaceutical subsidiary.)
(iii) Corporate parallel type: Case example: Nippon Mining Holdings,
Inc. (The mining corporation and the oil corporation were
located under the newly established pure HD as subsidiaries.)
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MCS of Japanese Pure Holding Companies 21

4.2. The purpose of organizational restructuring

According to Table 3, most of the surveyed companies’ sales were less
than No. 2, except for the sash business in JS Group Corporation. These
companies might exploit organizational restructuring, selection and
concentration, for competitive advantage.
Table 4 shows the degree of diversification of the surveyed corpora-
tions compared with their competitors in their industry by entropy

Table 3. Position in the industry of the surveyed corporations.

Domestic
Company name Field Sales competitor Sales Ratio

(a) (b) (a)/(b)

JS Group Sash 543 Nippon Light 173 3.14

Metal
Housing 270 TOTO 512 0.53
Equipment
Nippon Oil 677 Nippon Oil 5,964 0.11
Mining HD Corporation
Nonferrous 279 Mitsubishi 1,452 0.19
Metal Materials
Mitsubishi Chemistry 1,246 Sumitomo 1,790 0.70
Chemical HD Chemical
Pharmaceutical 305 Takeda 1,305 0.23
Pharmaceutical
JFE HD Steel 2,754 Nippon Steel 4,302 0.64
Engineering 306 Chiyoda Kakoh 485 0.63
Co. Ltd.
Fuji Electric HD Electrical 908 Toshiba 7,116 0.13
Machinery
Konica Office 1,028 Canon 4,156 0.25
Minolta HD Machine
Dowa HD Nonferrous 459 Mitsubishi 1,452 0.32
Metals Materials
Asahi Kasei Chemistry 677 Sumitomo 1,790 0.38
Chemical
Housing 405 Sekisui House 1,596 0.25

Sales: The sales (a consolidated accounting classified by segment) of 2007.3 terms, unit:
1 billion yen.
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22 Makoto Tomo et al.

Table 4. Domestic competitor comparison of the diversification degree.

Entropy Domestic Entropy

Company name index competitor index Ratio

(a) (b) (a)/(b)

JS Group 88 Nippon Light Metal 187 0.5

TOTO 14 6.2
Nippon 111 Nippon Oil 60 1.8
Mining HD Corporation
Mitsubishi 231 0.5
Materials
Mitsubishi 199 Sumitomo 262 0.8
Chemical HD Chemical
Takeda 40 5.0
Pharmaceutical
JFE HD 60 Nippon Steel 115 0.5
Chiyoda Kakoh 148 0.4
Co. Ltd.
Fuji 212 Toshiba 207 1.0
Electric HD
Konica 158 Canon 124 1.3
Minolta HD
Dowa HD 198 Mitsubishi 231 0.9
Materials
Asahi Kasei 220 Sumitomo 262 0.8
Chemical
Sekisui House 179 1.2
n
Entropy index Â
Pi ¥ log2 1/ Pi , Pi: composition ratio of business DI.
i =1

index. The entropy index was measured with the data in Kaisha shikiho,
summer 2007 edition: quarterly corporate report (Toyo Keizai Shinpo-
Sha). It shows that the larger an entropy index is, the higher a
diversified level is.
The diversification degree of surveyed corporation was higher than the
competitor. It is thought to be the cause that the scale of sales of
surveyed operations are smaller than the competitor, in addition, they
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MCS of Japanese Pure Holding Companies 23

sell or withdraw the poor performance business when they adopt the pure
holding company system.
For example, Nippon Mining Holdings, Inc. handed over a part of
pharmaceutical business to Sumitomo pharmaceuticals. It also transferred
shares of Convenience store chain, “AM/PM”, to Reins International Inc.
Asahi Chemical also got out of business, such as acrylics, food, alco-
hol, and housing timber material, at the time it adopted a pure HD
organization. It also handed over white-distilled-liquor business to Asahi
Breweries, food business to JT, and so forth.
Thus, it is thought that pure HD’s diversified level was low because the
poor performance businesses was sold out.

5. The Result of Field Study of Pure HD System

By our survey of actual conditions, we made several findings contrary
to common knowledge about pure HD systems. They are indicated
below.

• The purpose is the succession of family business.

• There is a case which has utilized the company system simultaneously
to utilizing a HD system.
• There is a case that the listed pure HD has listed subsidiaries.
• Establishing the pure HD does not always aim to maximize a share-
holder value.
• There is weak pure HD, which cannot collect the funds from the
subsidiaries and which cannot intervene in subsidiaries’ business.
• There is pure HD, which does not have a strategic function.
• There is a case to encourage the loyalty by using the HD. This is an
application of the “Ba” theory. Ba means a place for knowledge
creation.

These might suggest the existence of singular pure HD system in Japan,

where three types (financial strategy type, strategic planning type, a
strategy management type) of HD do not suit. The three types are
the classifications according to the headquarters’ span of management to
the subsidiaries. We call this a static classification in this paper.

(1) In the financial strategy type, the headquarters lay weight on the
achievement of financial target, although it does not intervene in the
b853_Chapter-02.qxd 4/21/2010 2:48 PM Page 24
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24 Makoto Tomo et al.

planning and the operation process of the subsidiary. It tends to have

the small headquarters and the shared service subsidiaries.
(2) In the strategic planning type, the headquarters take part in the
strategy formulation of subsidiaries. It does not lay weight on the
achievement of financial targets.
(3) In the strategy management type, the headquarters formulate inter-
active systems, from strategic decision, monitoring, to performance
evaluation, with headquarters and subsidiaries. A Balanced Score
Card (BSC) and a project budget, and so forth were used in the inter-
active systems, for example (Asada, 2005a, p. 146).

We will set up some hypotheses mainly based on the following two

questions.
The first question concerns the function of pure HD. The second ques-
tion concerns the purpose, the manner, and the methods of establishing
the pure HD organization.
We cannot describe the MCS of HD by the static classification,
which is the relationship between headquarters and subsidiaries at some
point.
Therefore, we show diagrammatically a “dynamic classification” in
Fig. 1. The “dynamic” means that we described the restructuring process
being used by pure HD. Thus, each company’s position in this figure will
change continually.

Portfolio type Restructuring Type

INAX Kawasak
i KONICA
g Tostem i steel JFE
n JS Group MINOLTA
r NKK HD Nisyo iwai KONICA
t
o Tomen MINOLTA HD
e
u Mitsubishi
r Sojitz
p Pharmacy
- Mitsubishi
Tanabe Seiyaku
Chemical HD
Hybrid Type
i Japan
g
n Energy Fuji
r
t Nippon Electric Asahi DOWA
o
r Nippon HD KASEI HD
u
a Mining HD
p
-

Layered organizational structure Flat organizational structure

Fig. 1. A dynamic classification of surveyed companies.

b853_Chapter-02.qxd 4/21/2010 2:48 PM Page 25
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MCS of Japanese Pure Holding Companies 25

The vertical axis shows the type of restructuring target — whether

they are only group companies or not. The horizontal axis shows the
subsidiaries’ organization restructuring type — whether they are merged
with other divisions or not. The portfolio type organization has the
independent subsidiaries, which did not merge completely. The restruc-
turing type organization has the restructured subsidiaries: spin off or
merger.
There are two types of MCS such as flat and layered. The layered type
has intermediate headquarters: such as regional headquarters or business
domain headquarters. In addition, the intermediate headquarters practi-
cally formulate strategy and do decision making for its subsidiaries.
The surveyed companies were plotted on Fig. 1 by foregoing criterion.
The ellipse of solid line show the present pure HD. The main companies
before becoming a pure HD are shown in the box of dotted line box about
on the ellipse. The box of solid line shows the number of the main sub-
sidiaries along with the restructuring process.
Mitsubishi Chemical Holdings has been positioned on each four quad-
rants. This is because the restructured core business subsidiaries were both
inner and outside group companies. Moreover, the purpose of reorganiza-
tion by pure HD was portfolio type and a restructuring type.

5.1. Portfolio type

There were two portfolio type companies (JS Group and Nippon Mining
Holdings Inc.). INAX and Tostem established JS GROUP as a joint HD.
INAX and Tostem are keeping the prior organization and corporate
name, though they are jointly conducting the development of some prod-
ucts. Before establishing Nippon Mining Holdings Inc., both Japan
Energy Corporation (oil industry) and Nippon Mining & Metals Co., Ltd.
(metal industry) were listed companies. After establishing the pure HD,
it keeps the two corporations, though they were delisted.
Nippon Mining & Metals Co., Ltd. sold the 80% share of am/pm
Japan Co., Ltd. to Rex Holdings Co., Ltd. in the process of establishing
the pure holding company in August 2004.
The number of core business companies of the portfolio type is fewer
than that of the restructuring type. Both JS Group and Nippon Mining
Holdings Inc. only have two core business companies. Mitsubishi Chemical
Holdings also has only three core business companies. On the other hand,
the restructuring type holdings have from 4 to 7 core business companies.
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26 Makoto Tomo et al.

In the portfolio type, it thought that the core business company has a
high degree of autonomy. In addition, the headquarters are seldom
involved in the management decision process of the core business compa-
nies. Therefore, the performance evaluation indicator for them tends to be
the investment efficiency from the financial view. The earnings of the core
business subsidiary are paid to HD as a dividend at a rate proportional to
the external dividend. And the rest of the earnings are retained in the core
business companies. In this case, the main function of the HD is to create
the missions of the group, control by rule, and audit on operation.

5.2. Restructuring type

There are two patterns in the type of restructuring. First, there is the
method of integrating the similar functions of the two enterprises, and
doing the spin off. JFE Holdings, Inc. and Konica Minolta Holdings cor-
respond to this type. JFE Holdings, Inc. was established by merging
Kawasaki Steel and NKK. JFE Holdings did not place Kawasaki Steel and
NKK under the HD, but integrated the steel manufacture business and the
engineering business, and so forth, of the two companies, and placed each
business under the HD as a subsidiary. Furthermore, in the restructuring
process, JFE Holdings transferred the subsidiaries of resin business to GE
plastics. Konica Minolta HD reorganized each business field into five busi-
ness subsidiaries and put them under the HD. Konica Minolta HD closed
the camera and photo business that were the initial business in March
2006 after about three years of the pure HD establishment. It was a part
of the “selection and concentration” strategy.
The second pattern is to spin off divisions into separate companies.
This is an advanced type of an in-house company system. Asahi Chemical,
Fuji Electric HD, and DOWA HD correspond to this type. Asahi Chemical
spun off divisions into seven subsidiaries, such as fiber, chemistry, and so
forth, under the HD. Fuji Electric HD and DOWA HD are similar to Asahi
Chemical.

5.3. Hybrid type

Mitsubishi Chemical HD consists of two-domain identity as shown in
Fig. 2. In the chemistry DI, Mitsubishi Chemical merged the subsidiary
(Mitsubishi Plastics Inc.) on October 2007. In the pharmaceutical
DI, Mitsubishi Pharmacy merged with Tanabe Seiyaku Co., Ltd. on
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MCS of Japanese Pure Holding Companies 27

Mitsubishi Chemical HD

Portfolio type
Mitsubishi Chemical Mitsubishi Pharma

Restructuring Type
Mitsubishi Plastics Tanabe Seiyaku
(Oct.2007) (Oct.2007)

intragroup merger intergroup merger

Fig. 2. Mergers and restructuring of Mitsubishi Chemical HD.

October 2007, and Tanabe Mitsubishi Pharmaceuticals was established.

In this case, the reorganization took place with outside group and in-
house corporation concurrently.
This case was the hybrid type. The HD is a portfolio type that has two
core subsidiaries (chemical and pharmacy). The core subsidiary level is a
restructuring type. The chemical subsidiary and pharmacy subsidiary have
adopted different restructuring manner. The chemical subsidiary reorgan-
ized with in-house corporation, on the other hand, the pharmacy
subsidiary reorganized with outside group.

6. Organizational Structure of Pure HD,

and Relation of Authority
6.1. The layered organizational structure
The pure HD system is compared with the in-house company system.
There is the view that the pure HD system is the advanced type of the
in-house company system. However, there was the case that was using
both the pure HD system and the in-house company system by our
research.
For example, the in-house company system was adopted in Nippon
Mining & Metals Co., Ltd., which is the core business company of
Nippon Mining Holdings, Inc., and in the JFE engineering, which is a
core business company of JFE HD. Moreover, the segment system was
adopted in each core business company of Mitsubishi Chemical and Fuji
Electric. The segment system is a kind of advanced in-house company
system.
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28 Makoto Tomo et al.

Furthermore, some enterprises had the intermediate HD system that

the core business subsidiary was a HD.
For example, Nippon Mining Holdings, Inc. corresponds to this case.
It has only two core business companies, Japan Energy (oil business) and
Nippon Mining & Metals Co., Ltd. (metal business). On the oil business,
Japan Energy has the following subsidiaries: Japan Energy development
Co. Ltd. (petroleum development), Kashima Oil Co., Ltd. (petroleum
refining and chemistry), JOMO-NET Co., Ltd. (management of gas
station).
On the metal business, Nippon Mining & Metals adopts the in-house
company system. It has the following in-house companies: a resource and
a metal company, an electronic materials company, a metal processing
company, and so forth. Furthermore, each in-house company has a sub-
sidiary. The metal business has layered headquarters’ structure.
Thus, it cannot necessarily be said that the pure HD system is an
advanced type of the in-house company system. When the independence
between the core business companies is high, and those scales are large,
the in-house company system and so forth is often used together.
The purpose of not dividing the core business company in detail is
to maintain the independence of the business and the advantage of
specialization. Besides, it is to exclude the possibility of the business rep-
etition in the future, and to leave room for the organization restructuring.
There is a possibility that the overlapping business is caused in the
future by change of technology and market if the core business company
is divided in detail. In addition, even when a layered headquarters struc-
ture is adopted, the pure holding company specializes in the strategic
function.
It should be concluded that the combination of the company split-up
by the pure HD system and the in-house company system in the core
business company level is one of the features of the Japanese pure HD
system.

6.2. Going public of a core business subsidiary,

and the conglomerate discount
It is said that there is a possibility that the conglomerate discount is gen-
erated in stock prices of the pure HD. The conglomerate discounts are that
valuation of the diversified company relatively lower than single business
company in the stock market is.
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MCS of Japanese Pure Holding Companies 29

Table 5. The PER comparison with a competitor.

Company name PER Competitor PER Ratio Competitor PER Ratio

JS Group 21.4 Nippon Light 14.2 1.5 TOTO 30.2 0.7

Metal
Nippon 8.6 Nippon Oil 19.9 0.4 Mitsubishi 9.3 0.9
Mining HD Corporation Materials
Mitsubishi 13.6 Sumitomo 15.7 0.9 Takeda 20 0.7
Chemical HD Chemical Pharma-
ceutical
JFE HD 13.6 Nippon 15.3 0.9 Chiyoda 21.1 0.6
Steel Kakoh
Konica 11.3 Canon 19.6 0.6
Minolta HD
Fuji 16.9 Toshiba 18.4 0.9
Electric HD
Dowa HD 13.6 Mitsubishi 9.3 1.5
Materials
Asahi KASEI 17.5 Sumitomo 15.7 1.1 Sekisui 19 0.9
Chemical House

Table 5 shows the PER (per-share earning ratio) of the surveyed com-
pany and competitor. The ratio in the table was calculated as below: the
numerator is the PER of the surveyed company and the denominator is
the PER of the competitor.
Only the PER of DOWA HD was higher than the PER of competitor.
As for JS Group and Asahi Chemical, the PER was higher than the com-
petitor only in some business fields. The PER of other companies was
lower than competitor.
The PER was relatively lower than competitor. This is the reason why
most companies were not top-sales company in their fields. However, the
possibility that the conglomerate discount had been generated cannot be
denied. (The type-of-industry classification was based on the quarterly
corporate report of Toyo Keizai, Inc.)
Going public of the core business company becomes one of the choices,
when there is a possibility that the conglomerate discount is generated.
There is the case of Mitsubishi Tanabe Pharma Corporation that
Mitsubishi Pharma Corporation (pharmaceutical subsidiary of Mitsubishi
Chemical HD) merged with Tanabe Seiyaku in October 2007. Tanabe
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30 Makoto Tomo et al.

Seiyaku was a listed company; on the other hand, Mitsubishi Pharma

Corporation was unlisted company (a 100% subsidiary of Mitsubishi
Chemical HD). Mitsubishi Tanabe Pharma Corporation is subsidiary of
Mitsubishi Chemical HD, though the share holding ratio of Mitsubishi
Chemical HD fell to 56.34% by the merger. The subsidiary (Mitsubishi
Tanabe Pharma Corporation), and the parent company (Mitsubishi Chemical
HD) keep listed company. In October 2005, Mitsubishi Pharma
Corporation, that had become an unlisted company, continued IR by itself
as if it was a listed company. The briefing of settlement of accounts had
been held alone. Moreover, the Annual Report, the business report, the
environmental report, and the brief announcement of the most recent
financial statement following the end of the fiscal year, and so forth were
published by itself. It seems that this intended the re-listing in the future.
This is a special case, in general, in the process of establishing
pure HD, the listed subsidiary tends to be converted into a totally held
subsidiary. For instance, Nippon Mining Holdings, Inc. delisted Nippon
Mining & Metals Co., Ltd. (subsidiary of Japan Energy Corporation).
In the pure HD system, it seems that the higher independence of the
subsidiary company is, the harder allocation of strategic resources is.
In such a case, listing of the subsidiary is one of the options. This is
because each subsidiary can get the discipline by the market valuation for
the appropriately funding. Listing of the subsidiary existed before the pure
HD system adoption. It is the characteristic of Japanese pure HD, which
might have the listed subsidiary.

6.3. Dividend policies to holding company

and subsidiary’s earning retention place
The power relationship between the pure HD and the core business
company is reflected on the dividend policy to the headquarters by the
core business subsidiary and earning retention place. The HD normally has
the authority to decide the dividend policy of core business subsidiary.
If so, it must be indifferent wherever the HD reserves the earnings in
the group. However, many companies think that the autonomy of a core
business company is influenced by the dividend policy of a subsidiary and
the place of the retention of earnings.
Therefore, in the enterprise that values independence of the core busi-
ness company, the dividend payout ratio of the core business subsidiary to
the headquarters tends to be the same as the dividend payout ratio for
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MCS of Japanese Pure Holding Companies 31

Table 6. The dividend policy of core business subsidiary and earning retention
place.

Type Company Retained profit place Policy of dividend to HQ

P JS Group Subsidiary Under an external dividend

ratio
P Nippon Subsidiary Equal to external dividend
Mining HD
H Mitsubishi HQ + subsidiary 50% of profits (2007.3)
Chemical HD
R Fuji Electric HD Subsidiary Equal to external dividend
R JFE HD HQ + subsidiary 97% of profits (2007.3)
R Konica HQ + subsidiary 20% of profits (2007.3)
Minolta HD
R Asahi Kasei HQ + subsidiary 50% of profits

P: portfolio type, H: hybrid type, R: restructuring type.

Source: Compute by the term financial report ended March 2007 of each company.

external stockholder. In this case, it can be said that the core business
company keep the earning retention. On the other hand, when the head-
quarters reallocate the capital strategically, all the profits of the core
business subsidiary might be collected by dividend.
Table 6 shows the dividend rate of the core business subsidiary in the
surveyed company. In JS Group, Nippon Mining Holdings, and Fuji
Electric, the distribution ratio to headquarters by the core business sub-
sidiary was lower than the external distribution ratio. These kept the
earning retention in themselves. In Konica Minolta HD, the subsidiary was
dividing 20% into the headquarters. In Mitsubishi Chemical HD and Asahi
Chemical Industrial Co., Ltd., the subsidiary was dividing 50% into the
headquarters.
In JFE HD, the subsidiary was dividing 97% into the headquarters for
the period on March 2007. JFE have been investing strategically such as
M&A by the headquarters lead against the worldwide reorganization of
the iron and steel industry.
Thus, the dividend policy of core business subsidiary and the earning
retention place depend on the business environment and the financial
autonomy of core business subsidiary.
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32 Makoto Tomo et al.

6.4. Division of profits into stakeholders

One of the functions of the pure HD is to balance the conflicting interests
of stakeholders and to manage the distribution of profit to them.
Table 7 shows the reward system for stockholders, managers, and
employees. Three companies (JSG, JFE HD, and Konica Minolta HD)
committed the target of dividend payout ratio. Four companies had the
stock option program for the manager. In JS Group, the stock option
was applied even to the employees besides managers. In addition, the
performance linkage remuneration was applied to the manager.
It is one of the purposes of the pure HD system to introduce a
different personnel system and a reward system of each subsidiary char-
acteristic. Six companies had the personnel system of each subsidiary
characteristic. The performance-based evaluation reward to the employee
had been introduced into seven companies.
It seems that the fewer adoption of personnel system of each subsidiary
characteristic shows the independency of the core business subsidiary is
not so high.

7. Summary and Future Tasks

It should be concluded, from what has been mentioned above, that several
Japanese pure HDs have some purposes different from those of Western
holdings. The pure HD has a wide variety of backgrounds and actual
conditions.
We showed diagrammatically a “dynamic classification” regarding the
restructuring process and the MCS in pure HD. In addition, we tried to
describe the variety of purposes and MCS which Japanese enterprise adopt
with respect to the pure holding company.
The following hypotheses we are able to propose at the present stage,
although we will describe the detail in another paper.

1. The pure HD is not an advanced type of the in-house company system.

2. The in-house company system might be used together under the core
business subsidiary.
3. There is the issue concerning the evasion of the conglomerate discount
in the pure HD system. Listing of the core business subsidiary is one
of the options.
 b853_Chapter-02.qxd
4/21/2010
Table 7. Division of profits for stakeholders.

MCS of Japanese Pure Holding Companies

Stockholder Manager Employee

2:48 PM
Commitment Different type Pay-per-
of dividend Performance- of personnel performance
Company name payout ratio Stock option based system system system Stock option

Page 33
JS Group 30% or more





Nippon Mining HD ×
×

×
Mitsubishi Chemical HD ×
×

×
JFE HD About 25% × ×

×
Konica Minolta HD 15% or more
× ×
×
Fuji Electric HD × × ×

×
Dowa HD × × × × × ×
Asahi Kasei × × ×

×

FA
33
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34 Makoto Tomo et al.

4. The power relationship of the pure HD and the core business

company is reflected in the dividend policy to the headquarters by
the core business subsidiary and earning retention place. The
dividend policy of core business subsidiary and the earning retention
place depend on the financial autonomy of core business subsidiary.
The less autonomy of core business subsidiary has, the more author-
ity headquarters appropriation of subsidiaries’ earnings has.
5. One of the functions of the pure HD is to balance the conflicting inter-
ests of stakeholders and how to distribute the profit to them.

In this paper, we addressed a part of question mentioned at the beginning.

The remaining questions are left as a future task.

References
Asada, T. (2005a). The strategy and management of a holding company, in The
Organization Design and Management Accounting in Order to Improve
Corporate Value, edited by Monden, Y., Zeimukeiri Kyokai (in Japanese).
Asada, T. (2005b). The feature of the holding company system in Japanese com-
panies, in The Organization Design and Management Accounting in Order to
Improve Corporate Value, edited by Monden, Y., Zeimukeiri Kyokai (in
Japanese).
Asada, T. (2007). Management accounting subject of a pure holding company,
Kigyou Kaikei, 59(8) (in Japanese).
Business Research Institute, The Construction of a group management organiza-
tion and management innovation towards the consolidated management age,
Business Research Institute (in Japanese).
Diamond Harvard Business Editorial Department (1996). The Principle and
Management Strategy of a Holding Company, Diamond Co. (in Japanese).
Hamada, K. (2006). Performance management accounting information for consol-
idated group management, Kaikei, 170(4) (in Japanese).
Hattori, N. (2005). The Strongest Selection About M&A, Nikkei BP (in Japanese).
Hiki, F. (2000). Group management and management accounting: On the cases of
Western companies, The Journal of Management Accounting, Japan, 8(1,2)
(in Japanese).
Makoto, Y. (1997). The significance and subjects of a in-house company system,
Research Annual Report, Vol. 4, Department of Economics, Shiga University
(in Japanese).
Makoto, Y. (2001). ‘Doppo’ management and strategy of Mycom, Group
Management Strategy; Theory and Practice, The Tokyo Keizai Jyouho
Shuppan, edited by Hayashi, S. and Asada, T. (in Japanese).
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Makoto, Y. (2006). The present condition and subject of a holding company: The
case study of a trading company, The Hikone Ronso, Shiga University,
Vol. 362 (in Japanese).
Mutoh, Y. (1996). The merits and subjects of a holding company, DHB,
April–May (in Japanese).
Mutoh, Y. (2003). An Actual Condition of Holding Company Organization, Nihon
Keizai Shinbunsha (in Japanese).
Sakurai, M. (2004). The significance of corporate restructuring and decentraliza-
tion in management accounting, Kigyou Kaikei, 56(5) (in Japanese).
Sonoda, T. (2006). Performance management of a pure holding company, An
Innovation and Enterprise Reconstruction, Keio University Press (in Japanese).
Tamamura, H. (2006). A Holding Company and a Modern Enterprise, Koyoshobo
(in Japanese).
Tanaka, T. (1999). Management and accounting of a holding company, Kigyo
Kaikei, 51(9) (in Japanese).
Tsuda, N. (2003). Mitsubishi Chemical: Group management and a holding
company system, The Strategy and Management System in Order to Maximize
the Value of a Group Company, Kigyo Kenkyukai, Kenkyu Sousyo, No. 119
(in Japanese).
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Part 2

M&A Including MBO and Outsourcing

for Group Reformation
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3
Influence of M&A on Financial
Performance: Measuring the Performance
of M&A from Sustainability of Utility
Kozo Suzuki
Tama Waterworks Reform Promotion Center,
Tokyo Metropolitan Government

1. Introduction
In recent years, the potential resale profitability of corporations has been
considered important in the purposes of “merger and acquisition” (hence-
forth, M&A). There have been many cases of the acquisition, restructure
and resale of companies that were under-performing or undervalued in
stock-price. Furthermore, very often sales occurred to save the time and
effort of restructuring. And, of course, it can be an end in itself to gain
huge profit through resale. The latter, though, has been less successful or
attractive since autumn 2008.
On the other hand, it is argued that the reconstruction and restruc-
turing of companies or enterprises contribute to human society and
sustainable development. If the society or markets need the goods or the
services supplied by a mismanaged business, it may encourage successful
companies to try through M&A. In this context, M&A is useful since the
necessity of continuing the activities of production has not changed.
Therefore, M&A as the transfer of external management resources is an
essential requirement in a capitalist society.
In this paper (based on Suzuki and Ogura (2007, pp. 77–91)), the
important elements of M&A will be examined. Especially, it will stress
cost reduction and “research and development” (henceforth, R&D) as a
part of M&A, since they are processes to attract external resources, and
in many cases, they are required for the continuation of business.

39
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40 Kozo Suzuki

The Japanese manufacturing industry in 1990s will be used as a focus

because business viability and the contribution to society of business
enterprises, such as drug companies for example, had been thought of as
important in M&A activities in that period. The acquisition of external
management resources was also another main purpose. Looking back upon
M&A at that time may yield useful suggestions toward future sustainable
development.

2. The Effects of M&A

In this paper, M&A is positioned as an introductory means of attracting
external management resources (Das and Teng, 2000, p. 31). And the
effectiveness of that is shown by positive analysis. The conditions in which
M&A for cost reduction realizes the purpose are also shown. Furthermore,
the performance of financial or other effects and relations with M&A are
examined.
The first reason for considering cost reduction as being important is
that M&A for cost reduction actually exists (Suzuki, 1999, pp. 75–78).
The second reason is for the evaluation of M&A.
The following positive outcomes will be realized if M&A for cost reduc-
tion is set as the object of the research. This is because the effects of the
introduction of external resources through M&A can be easily grasped
numerically. So, as a result, M&A can be evaluated economically.
Generally, M&A has many goals, with R&D, expansion of the market
share, reduction of risks, and cost reduction being some. But when reflect-
ing on the pattern of accounting income, M&A for cost reduction differs
from the other purposes.
For R&D, expansion and risk reduction, there is a high possibility of
them being connected with a reduction in earning statements. In other
words, they may, initially, cost money. But in the case of cost reduction,
complicated processes are followed. That is, the accounting income is
improved after the additional injection of management resources brings
about an increase of cost, i.e., there will be a reduction of profits. In other
words, the aim is to, eventually, save money.
There is a likelihood of an improvement in the accounting income by
the introduction of external management resources. However, there is also
a high possibility of accounting income being diluted by the result of the
administrative behavior of others, both inside the company and outside
the company, such as outsourcing companies. This is more and more likely
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Influence of M&A on Financial Performance 41

over time. As stated previously, cost reduction is one of the various pur-
poses of M&A; however, there is a question over the effect of M&A on
corporate management.
To further illustrate these points, M&A for R&D is contrasted with
the cost reduction by M&A in this paper. The relation between
the evaluation of M&A by business administrators and the financial
effects of that M&A is analyzed through this comparison. The financial
effect means the improvement effect on financial statements. This
is an improvement phenomenon of many indices that appear on finan-
cial statements after carrying out M&A. The method of this research
does not merely evaluate the effect of M&A from numerical changes in
financial indicators. It acknowledges the evaluation of business admin-
istrators involved in the process and also the differences appearing in
financial indicators that relate to the effects on the nonfinancial sides of
management.

3. The Outline of the Verification Method

and Questionnaire
From the above viewpoint, a model based on the following rough hypoth-
esis is made.

H0: Many activities involved in the M&A process influence the perform-
ance of management and bring about and improvement in financial
achievements.

In this hypothetical verification, two kinds of data are analyzed through a

covariance structure analysis. One is the data collected by questionnaire
(Appendix 1). This is a subjective self-evaluation undertaken by the busi-
ness administrators, who carried out M&A. The other objective data are
the financial statistics in the financial report of the company that partic-
ipated in the questionnaire. This analysis is adjustable based on the
consideration of whether the objective performance (e.g., financial state-
ments) is in reasonable agreement with or largely incompatible with the
subjective performance (e.g., administrative questionnaires).
The characteristic feature this method of analysis is having added the
subjective evaluation of the managers via questionnaire to the more tra-
ditional method of evaluating the effectiveness of M&A based on financial
indicators.
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42 Kozo Suzuki

With the aim to survey the general conditions of M&A in Japanese

manufacturing industry, this questionnaire was distributed to the
management-planning departments of 1,714 listed companies belonging to
the manufacturing industry in Japan in the Year 2000. Effective responses
were received from 102 companies and, of these, 95 responses were used in
this paper.
In this investigation, respondents were asked to focus on a single M&A
case that they judged to be the most important among any M&A carried
out in the past 10 years by the company. In the questionnaire, the
observed variables of cost reduction (Question 9) and R&D (Question 10)
were selected as focus elements of M&A.
Furthermore, the effects of the participant’s M&A was measured from
six main viewpoints (Question 12):

1. General economic well-being

2. Cost reduction
3. Profit
4. Speed of management
5. Market share
6. R&D

Cost reduction was further classified into eight cost-related activities

that follow the value chain based on the cost for reduction that the M&A
manager regarded as important (Question 9):

1. Control of plant-and-equipment investment

2. R&D costs
3. Raw material & parts costs
4. Physical distribution costs for supplying
5. Manufacturing costs
6. Sales costs
7. General & administrative costs
8. Physical distribution and delivery costs

R&D activities were also classified into six items based on the contents of
the R&D that the managers thought of as important (Question 10):

1. Gathering information
2. Contribution of technology
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Influence of M&A on Financial Performance 43

3. Synergistic effect
4. Reduction of R&D cost
5. Shortening of period for R&D
6. Introduction of patent.

Question 12 asked respondents to indicate the existence and degree of cer-

tain possible effects. Question items 9 and 10 were measured on a scale of
1–5 in order of the perceived importance of each item, 5 being of most
importance and 1 being of least importance.

4. Creation of Analytic Models

Next, the models for covariance structure analysis are constructed. In
these models, the following three qualitatively different constructs or
latent variables are specified.

1. The activities (divided into cost reduction and R&D) carried out by
the M&A.
2. The performance of management.
3. The improvement effects on financial indicators.

The causal relationship between the three constructs is also verified and
examples of many management activities that affect those relationships are
also investigated. In addition, before conducting the covariance structure
analysis, the measurement models of three latent variables were prepared.
Based on the above procedure, latent variables are defined as follows:

m1:
m2:
Cost reduction (activity via M&A)
R&D (activity via M&A) } (Latent variable 1).

P: Performance of management (Latent variable 2).

X: The improvement effect on financial indicators (Latent variable 3).

Latent variables m1, m2, and P have been explained above. The financial
statistics used to make the measurement model of the latent variable X
represent the difference between three annual averages of accounting data
from before M&A and three annual averages of accounting data from after
the company undertook it’s M&A. Twenty-five kinds of statistical data on
financial indicators were drawn from the 95 companies that responded to
the questionnaire.
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44 Kozo Suzuki

Table 1. Latent variables and observed variables.

Latent variables Observed variables

1 m1 md: physical distribution cost of supplying

mg: general & administrative cost
mh: physical distribution cost of delivery
m2 ra: reduction of R&D cost
rb: shortening for period of R&D
rc: synergistic effect
2 P pa: general economic well-being
pb: cost reduction
pc: R&D
3 X xa: current profit ratio
xb: turnover-of-total-capital-employed operating income to sale
xc: margin of profit

In regards to latent variable X (in Table 1), a principal component

analysis by correlation-matrix method is applied to this data. This analy-
sis highlighted factors showing the change in the financial conditions of the
sample companies.
Furthermore, for each latent variable, the three top items from the var-
ious data possible were determined as representative. In the case of X, this
was three out of 25 possible items. As a result, the observed variables of
m1, m2, P, and X are as above-mentioned (Table 1).

5. Characteristics of the Relationship Between

Cost Reduction, Performance, and Financial
Indicators in M&A
First, the relationship between the latent variables of m1, P, and X are
examined. Therefore, the Model 1 (Fig. 1) is made and the Hypothesis 1 is
verified.

H1: In M&A, cost reduction promotes the improvement of financial

indicators.

As a result of testing Model 1 for goodness of fit (the number of samples: 95),
the significant probability of the suitability of the model is set to 0.124,
exceeding 0.05. The comparative fit index (CFI), that is a measurement
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Influence of M&A on Financial Performance 45

e1 md 1
mh 0.238∗ 0.804∗∗ pa e11
e2
0.994∗∗
m1
1
e3 mg 0.921∗∗ P pb e12

−1.597 e13
xa 2.472∗∗ 1.133∗∗ pc
e21 1
d1
xb
e22
0.596∗∗ X d2
e23 xc 0.596∗∗

Significance of probability (Model 1) = 0.124 Note

CFI = 0.994 (1) Numerical value with paths means
AIC = 92.112 (Model 1) correlation coefficient.
(2) Significance level of Wald Statistic Test
= 108.000 (Saturated model) ∗∗:5%,∗:10%.
= 1,518.923 (Independence model)

Fig. 1. Model 1.

of the goodness of fit, is 0.994. And since Akaike information criterion

(AIC) of this model is within the minimum standard, so Model 1 can be
said to be acceptable.
The Wald Statistic Test, which, based on the “null measurement” of
hypotheses, assesses the levels whereby, “There is no influence from m1 to
P.”, and “There is no influence from P to X.”, measures 1.819 and 2.474,
respectively. Therefore, the former hypothesis is rejected by a significance
level of roughly 10%. The latter is also rejected by roughly 5%. But since the
Wald Statistic Test on the direct causal relationship from m1 to X is −1.549,
the null hypothesis, “There is no influence from m1 to X.”, is not rejected.

6. Amended Model
In Model 1, the direct influence on X from m1 becomes negative (−1.597),
though this is not significant. Therefore, this path (from m1 to X) is
deleted from the Model 1 based on the Simon and Blalock method. Thus
an amended model (Model 2) and the Hypothesis 2 are verified (Fig. 2).

H2: In M&A, the cost reduction that raises the performance of manage-
ment promotes the improvement of financial indicators.

On the significant probability and the goodness of fit, this Model 2 has no
problems. On the Wald Statistic Test, the null hypothesis of “There is
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46 Kozo Suzuki

e1 md
1
mh m1 0.805** pa e11
e2 0.988** 0.236*
mg 0.956** 1
e3 P pb e12
xa 1
e21 2.142** pc e13
1.143**
e22 xb 0.594** X d1
d2
e23 xc 0.746**

Significance of probability (Model 2) = 0.119 Note

CFI = 0.994 (1) Numerical value with paths means
AIC = 91.513 (Model 2) correlation coefficient.
(2) Significance level of Wald Statistic Test
= 108.000 (Saturated model)
**:5%,*:10%.
= 1,518.923 (Independence model)

Fig. 2. Model 2.

Standardized total effect Standardized direct effect Standardized indirect effect

m1 P X m1 P X m1 P X
P 0.283 0.000 0.000 P 0.283 0.000 0.000 P 0.000 0.000 0.000
X 0.072 0.253 0.000 X 0.000 0.252 0.000 X 0.072 0.000 0.000

Fig. 3. Effects between latent variables in Model 2.

no influence from m1 to P.” is 1.765, and the null hypothesis of “There is

no influence from P to X.” is 2.102. Therefore, the former is rejected by a
significance level of 10% and the latter is also rejected with the level 5%
(Fig. 3).
Next, the direct influences from m1 to P and P to X are positive. The
comprehensive influence from m1 to X is similarly positive.
Therefore, in M&A, cost reduction and the improvement effective on
financial indicators have positive correlations (Fig. 3). Thus, it is observed
that the cost reduction that raises the performance of management acts
on the improvement of financial indicators.
Therefore, Hypothesis 2 is accepted and it is suggested that cost reduc-
tion influences the improvement effective on financial indicators indirectly.
Next, to make a comparison with R&D to cost reduction, Model 3,
which transposes m1 to m2, is created (Fig. 4). The influence from m2 to
P is rejected as a result of the same calculation method. Similarly, the influ-
ence from m2 to X is also rejected.
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Influence of M&A on Financial Performance 47

e31 ra 1.242**

e32 rb m2 0.718** pa e11

1 −0.029
e33 rc P 1.133** pb e12
0.507**
−0.844
1 pc e13
e21 xa 1.906**
1 d1
e22 xb X
0.593**
0.745** d2
e23 xc

Significance of probability (Model 3) = 0.043 Note

CFI = 0.991 (1) Numerical value with paths means
AIC = 97.066 (Model 3) correlation coefficient.
= 108.000 (Saturated model) (2) Significance level of Wald Statistic
= 1,592.687 (Independence model) Test **:5%,*:10%.

Fig. 4. Model 3.

7. The Result of Verification

The latent variable, m1, has the highest goodness of fit when the follow-
ing three costs, physical distribution cost of supply, general and
administrative costs, and the physical distribution costs for delivery, are
applied as observed variables. That is, such costs have the tendency to act
favorably as activities of cost reduction in M&A.
General and administrative costs contain the portion equivalent to a
fixed cost, such as personnel expenses and administrative expenses. In those
cost reductions, the single, top-down integration of the value chain or cost
structure is needed. Since M&A integrates all partner companies, strong
centralized control is realized. That is, that reduction of general and admin-
istrative costs in the observed variables indicates that a strong controlling
power is important to influence the cost structure of any partner company.
On the other hand, costs for incoming physical distribution cost of sup-
ply or outgoing deliveries are costs in peripheral parts of production. With
the integration of those as items of expenditure, there is a high possibility
to directly affect cost reduction.
Next, P is explained from three observed variables of general economic
well-being, cost reduction, and R&D. They are evaluation indices related
to profit-and-loss account. Moreover, X is close to profitability as men-
tioned above. So, the tendency is observed that the performance of M&A
is recognized on the profit-and-loss basis.
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48 Kozo Suzuki

About latent variables, cost reduction (m1) carried by M&A may be

connected with the improvement effects on financial indicators (X) via the
performance of management (P). Thus, in M&A, there is a tendency for
cost reduction to be clearly reflected in financial indicators. However, it
is restrictive to only measure improvement in the performance of manage-
ment and an improvement effective on financial indicators. Even if cost
reduction is considered as important, neither the performance of manage-
ment nor the upward trend of financial conditions is necessarily
automatically or unconditionally realized. Consideration of it is required.
Characteristically, the financial numerical value of an accounting report
measures the surface achievements of a company. If that is right, the cost
reduction in M&A will clearly appear as an improvement result of the sur-
face portion of corporate management.

8. Conclusion
Considering all of the above, the following four problems with the decision-
making on M&A can be highlighted.

1. In M&A, cost reduction produces the improvement of financial indi-

cators. But R&D influences neither performance of management nor
the improvement of financial indicators.
2. A tendency is found that managers of companies attach importance
to financial indicators by M&A.
3. A tendency is found that the motive to M&A and financial motiva-
tion are coincident because cost reduction is evaluated as a
performance of management and financial effectives can be considered
as measurable.
4. The M&A that is recognized as effective on management and that
brings an improvement of financial indicators in profit-and-loss
account corresponds to following conditions.

(1) It realizes the integration of the value chain and the decision-
making processes of both companies.
(2) It integrates overlapping activities in both companies, such as
physical distribution and delivery costs.
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Influence of M&A on Financial Performance 49

That is, when introducing the management resources of other companies via
M&A with the aim to improve the management effectiveness or financial
indicators, M&A must be considered according to management purposes
rather than purely those of finance, i.e., profit. M&A involves the intro-
duction of external management resources to a new environment, resulting
in new viewpoints for practical use of M&A toward continuation of
business or sustainable development.

References
Das, T. K. and Teng, B. T. (2000). A resource-based theory of strategic alliances,
Journal of Management, 26–31, 31–61.
Suzuki, K. (1999). Strategic cost reduction by making relationships between com-
panies in Japanese manufacturing industries, The Journal of Management
Accounting, 7–1(2), 65–89 (in Japanese).
Suzuki, K. and Ogura, N. (2007). The influence of M&A and alliance on the finan-
cial performance: Measuring the performance of M&A and alliance from cost
reduction, The Journal of Management Accounting, 15–2, 77–91 (in Japanese).

Appendix 1
Questions 1–8 concerned general backgrounds and other information not
immediately relevant to this paper.
(Question 9) M&A and cost reduction

Activities of cost reduction Degree of importance 1: No importance

1. Control of plant-and- 1 2 3 4 5
equipment investment 2: Little
2. R&D costs 1 2 3 4 5 importance
3. Raw material & parts costs 1 2 3 4 5
4. Physical distribution costs 1 2 3 4 5 3: Average
of supply importance
5. Manufacturing costs 1 2 3 4 5
6. Sales costs 1 2 3 4 5
4: Important
7. General & administrative 1 2 3 4 5
costs
8. Physical distribution and 1 2 3 4 5 5: Great
delivery costs importance
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50 Kozo Suzuki

(Question 10) M&A and R&D

Activities of R&A Degree of importance 1: No importance

2: Little
1. Gathering information 1 2 3 4 5 importance
2. Contributing of technology 1 2 3 4 5 3: Average
3. Synergistic effect 1 2 3 4 5 importance
4. Reduction of R&D cost 1 2 3 4 5 4: Important
5. Shortening of period for R&D 1 2 3 4 5 5: Great
6. Introduction of patent 1 2 3 4 5 importance

(Question 12) Effects of M&A

Effects of M&A Degree of effect 1: Not effective

1. General economic well-being 1 2 3 4 5 2: Not so effective

2. Cost reduction 1 2 3 4 5
3: Average effective
3. Profit 1 2 3 4 5
4. Speed of management 1 2 3 4 5 4: Effective
5. Market share 1 2 3 4 5
6. R&D 1 2 3 4 5 5: Very effective

Note: Question 11 was not used in this analysis.

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4
Management Buyout of a Japanese
Business Group
Naoyuki Kaneda
Faculty of Economics, Gakushuin University

1. Introduction
During the late 1980s, high prices for stocks and real estate were features
of the asset price bubble in Japan. In this booming economy, large corpo-
rations, engaged in equity financing, increased their debt obligations to
increase production capacity, and made investments in financial securities
and real estate, to generate profits for their portfolio. With the collapse of
the asset bubble, many Japanese corporations suffered from high fixed
costs, together with overcapacity and the burden of unrealized losses for
their financial assets and real estate investments.
Furthermore, some large corporations engaged in expanding their
businesses into diverse areas in the late 1980s. After the collapse of
the “bubble economy,” these corporations restructured their business
groups to concentrate their business resources in the areas of their
core competencies.
With the introduction of the financial “Big Bang” in Japan, new
accounting rules were introduced that emphasized consolidated financial
statements rather than nonconsolidated ones. Traditionally, investors
scrutinized the financial statements of the parent company to evaluate
the corporations and the investment opportunities. As a result, the per-
formance of subsidiaries was not highly regarded among the management
tiers of many Japanese corporations. Thus, after the introduction of
the new accounting rules, listed companies had to improve the per-
formance of their subsidiaries, to survive in the deflationary economic
environment. Poorly performing subsidiaries needed to be closed or sold
to other business groups.

51
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52 Naoyuki Kaneda

Management buyout (MBO) involves the buying out of firms by their

management and a private equity fund. As mentioned above, during the
late 1990s, many Japanese corporations created spin-off companies and
acquired subsidiaries to strengthen their strategic position. In an ordinary
merger and acquisition, subsidiaries are acquired by strategic buyers and
ex-subsidiaries are under the complete control of the acquirer. In this type
of situation, the existing management and employees may be dismissed or
laid off. In a management buyout, subsidiaries are acquired by financial
buyers, such as private equity funds. In many cases, the existing manage-
ment teams of the ex-subsidiaries continue to manage the companies
post-MBO. Many companies retain their employees rather than laying
them off after the buyout. These characteristics of MBOs are considered
to be more acceptable to the Japanese business community, in which it has
been the common practice, at least since World War II, not to lay off
employees.
Financial buyers are usually private equity funds that aim to earn
significant returns from their leveraged investment. Their targets are
mature companies, which bring stable cash-flows from their business,
rather than new ventures. The managers of these funds usually plan to
exit from the investments in an initial public offering or in a subsequent
MBO several years later.
In current Japanese business practice, there are three types of MBO.
In the first type, the management teams of listed firms buy out the
company’s shares to privatize the company. In the second type of MBO,
the management teams of the subsidiaries of one business group acquire
the shares of the subsidiary and become independent after the buyout.
In the third category of MBO, managers acquire the shares of the spin-
out division and become independent after the buyout (Kaneda and
Sonoda, 2009).
In the following sections, we present examples of MBOs that appeared
during the restructuring of Nissan Motor Company. The companies in
question are Zero and Vantec, which became independent after the
buyouts that occurred as part of the Nissan Revival Plan. These MBOs
are in the second category, in which the management of the subsidiary
acquires the corporate shares.
In this paper, we deal with two issues in relation to each MBO. First,
we examine the changes in management and operations. In the case of the
two Nissan MBOs, their shares were sold in a time of financial difficulties.
The performance of the subsidiaries was poor and was expected to
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Management Buyout of a Japanese Business Group 53

improve under the new scheme. It is very important to recognize the

impact of the change in management style and the reason for improve-
ments in management and operations, if any (Kaneda and Sonoda, 2009).
Second, we examine the change in corporate governance as a result of
each buyout. Traditionally, the cornerstone of corporate governance in
large Japanese corporations has been the main bank. Main banks are
typically those banks that provide a large proportion of the capital loaned
to the corporation. These banks closely monitor the financial status of the
corporation and provide liquidity to support the corporation during
periods of financial difficulty.
In the late 1980s, many large corporations gained access to direct
financing and relied to a lesser extent on financial intermediaries, such as
banks and various credit companies. In the late 1990s, the Japanese
banking system suffered its worst financial crisis ever. Corporate gover-
nance through the main banks had been significantly weakened and was
not functioning very well. It is significant to examine how private equity
funds monitor acquired companies and strengthen their corporate gover-
nance to improve the value of the corporation.

2. Financial Difficulties and Restructuring

at Nissan Motor Company
Nissan Motor Company is one of the automobile manufacturers of Japan.
The company was established in 1933 and used to be the second largest
automobile manufacturer. After the collapse of the asset bubble in the
early 1990s, sales of automobiles stagnated. The financial crisis in the late
1990s resulted in a further decline in automobile sales in Japan. In 1999,
Nissan Motor Company found itself in severe financial difficulties with
stagnant revenues and a debt of two trillion yen.
In March 1999, Renault acquired 36.8% of Nissan Motor Company’s
shares and entered an alliance with Nissan. This alliance gave Nissan
precious time in which to restructure. Carlos Ghosn, then Executive Vice
President of Renault, was appointed as Chief Operating Officer of Nissan
Motor in June 1999.
Under Ghosn’s leadership, the Nissan Revival Plan (NRP) was intro-
duced in October 1999. NRP basically consisted of (1) cost reductions in
marketing and production; (2) cost reductions in financial management;
and (3) making investment from improved cash flow streams to increase
corporate value (Okuno, 2004). Cost reductions in marketing and production
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54 Naoyuki Kaneda

were achieved by closing factories and reducing the number of suppliers.

Cost reductions in financial management were achieved by reducing inven-
tory and selling noncore assets. A large Japanese corporation traditionally
holds group companies’ shares to maintain strong business relationships.
NRP terminated this practice for the Nissan Group and most of the shares
in noncore group companies were sold. NRP considered only four
group firms to be core assets among its existing shareholdings in group
companies. Aside those four subsidiaries, stockholdings in most of the
subsidiaries were planned to be sold off during the restructuring.
With respect to the spinning off of noncore companies in the NRP,
Nissan Motor would be reluctant to sell these shares to competing auto-
mobile manufacturers and financial buyers as part of ordinary acquisition
deals, since these subsidiaries would still have close ties to the major
business of Nissan Motor. If these deals went through, the long-term
effects on Nissan’s business operations might be detrimental. In this
sense, an MBO might be a convenient tool for the stakeholders in these
subsidiaries.

3. Corporate Governance and MBOs

The existing literature provides useful insights into the issue of corporate
governance with respect to MBOs.
Jensen (1986) proposed the “control hypothesis” for debt creation.
Managers of the corporations are the agents of corporate shareholders. In
this scenario, managers and shareholders have conflicting interests with
regard to the management of the corporation. Managers have incentives
to grow their corporations beyond the optimal size for shareholders, as
corporate growth increases the resources that are under the control of the
management. Conflicts of interest between shareholders and managers are
severe when the firms generate a substantial free cash flow.
Managers with substantial free cash flow may promise to increase
dividends or to repurchase stocks, to avoid low-return projects or “empire-
building.” However, these promises are dubious, since they are not binding
contracts. In contrast, debt creation forces managers to pay out future
cash flows as part of a binding contract. Consistent with this theory, the
stock price rises with unexpected increases in payouts to shareholders,
unless firms have ample profitable projects in their business plan.
Conversely, the stock price falls with reduction in payments or seasonal
equity issuance.
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Management Buyout of a Japanese Business Group 55

In the case of MBOs, the “control hypothesis” for debt creation

provides useful perspectives on the issue of monitoring. The major targets
of MBOs are firms that operate in an established business and generate
substantial free cash flow. In this situation, conflicts of interest over
payout policies can be serious. Managers may undertake low-return
projects to create a corporate empire. However, in the process of a typical
MBO, firms usually have large debts in addition to the equity investments
of management and private equity funds. Management has strong
incentives to service the debt after the leveraged buyout. Otherwise, they
may face dismissal from the corporate seat.
Kester (1991) pointed out the importance of corporate governance
for corporate diversification. In the late 1980s, some large Japanese cor-
porations diversified their business in the absence of synergies. Managers
in mature industries have sufficient cash that can be used for corporate
growth rather than value creation. When management invests the free
cash flow in a low-return project, there is little monitoring by the banks,
whereas in the cases of bond issuance and bank loans, management has
to adhere to strict monitoring by the markets and banks. Thus, diversifi-
cation into mature industries is more likely to result in less successful
value creation.
Jensen (1993) indicated that firms may improve efficiency and increase
value with higher leverage and smaller boards, even with low-growth firms
in which agency costs to free cash flow are high.
Based on case studies of leveraged buyouts and venture capital funds,
Jensen (1993) listed the principles underlying a well-performing company
board. First, successful associations are organized as limited partnerships,
which prohibit the cross-subsidization of one division with cash from
another division. From the viewpoint of management control, this implies
that each division should be evaluated based on its own performance.
Second, successful boards tend to have high levels of equity ownership by
the managers and board members. This strengthens the commitment of
management and board members to the company’s management. Third,
board members represent the larger shareholders of each company.
If board members represent numerous small shareholders, their moni-
toring becomes ineffective. Fourth, successful boards are small boards,
consisting of no more than eight persons. In the early 1990s, many
Japanese corporations had large boards and were criticized for the inef-
fectiveness. Fifth, in successful boards, CEOs are the only insiders on the
board. Sixth, the CEO is not the chairman of a well-performing board.
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56 Naoyuki Kaneda

If private equity funds acquire the shares of subsidiaries, the manage-

ment makes business decisions in the new corporate governance structure.
It is very important for the management to interact with the private
equity funds in terms of the daily business decisions and to understand the
strategy of the funds.
In the following sections, we examine how each subsidiary was spun
off from the Nissan Group and review the changes in operations and
corporate governance that occurred post-buyout.

4. Vantec, a Logistics Company

Yokohama Yuso, latterly Vantec Corporation, was established as a wholly-
owned subsidiary of Nissan Motors in 1954. It was the first division to be
split off from Nissan Motors. Their major business was originally auto-
motive logistics. They renamed as Vantec Corporation in 1997, merged
with Overseas Air Cargo, and became independent through MBO in the
process of the Nissan Revival Plan in 2001. They expanded their business
operations further into global logistics, merged with Tokyu Air Cargo.
They continuously endeavor to upgrade the corporate values through
M&A from different industries.
We interviewed one of the board members who was responsible for
the first MBO.1 In the first buyout, the shares were acquired by its board
members and 3i-Kogin Buyouts, which was a joint venture launched
by 3i Group Plc, one of the Europe’s leading venture capitals and
private equity firms, and Industrial Bank of Japan, which subsequently
merged with two other city-center banks and became Mizuho Financial
Group, Inc.
After the buyout, some more Japanese directors and a couple of British
directors were appointed as the board of directors. The company’s man-
agement had the full confidence of the equity fund. 3i-Kogin joined the
process of making Vantec’s business plan, which helped strengthen
the partnership between them. According to the original business plan,
the management had some flexibility in terms of their decision making.
However, the decisions by Vantec with respect to mergers and acqui-
sitions were delayed, as they had to ask for official approval from the
headquarters in Europe (Okuno, 2004). In addition, it took time to
explain Japanese business customs and details of the business plan in
English.
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Management Buyout of a Japanese Business Group 57

After the first MBO, the company divided the roles between directors
and executive officers, since directors were also regarded as executive
officers, followed by the traditional governance system. A Compensation
Committee and a Nomination Committee were also established without
corresponding to the Japanese Corporation Law. The management under-
stood that the fund did not require the binding committee system, since
they trusted the management style of Mr. Okuno, the President.
In the first buyout, all executive officers were requested to hold
company shares (Okuno, 2004). It encouraged them to strengthen their
commitment. Directors and executive officers used to recognize themselves
simply as employees of the parent company, whereas after the buyout they
became shareholders as well as executive officers, who could lose their
investment if the company did not perform well. This is an example of the
second principle of Jensen (1993). Vantec Group Holdings has 7 members
of board of directors, which is within the range proposed in the fourth
principle of Jensen (1993).
Vantec closed a deal with 3i-Kogin for their second MBO in 2003, and
Mizuho Capital Partners became their major shareholder. We will explain
Vantec’s operations after MBO, referring to Kaneda and Sonoda (2009).
After the MBO, more executive officers and managers from outside the
company were hired. They developed an internal management system,
including a personnel system that would be a model for other companies.
This new personnel system enables employees to be evaluated by their
immediate bosses. Their evaluation had to be fair and accurate, or they
could be demoted. Under the previous system, individual performance
never effected their position and salary in a negative way. On the contrary,
the new system allows employees to get incentives, depending on their
performance to the company. Vantec’s management reformation seems to
be undertaken by simple principles that are leading to improve employees’
mind-set.
At the time of the MBO, cost reduction was the top priority for them
to survive in response to Nissan’s requests of cut-back, followed by the
Nissan Revival Plan. Wage cut was the answer for that since it was higher
than the industry average. As salary cut might not be the good solution to
motivate employees, they introduced a results-based remuneration system
to encourage well-performers. They set individual target for managers and
executive officers for their contributions to annual profit of the company.
Their salaries were set based on achievement upon their targets.
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58 Naoyuki Kaneda

They endeavored to reduce costs by finding suppliers offering cheaper

products. They also enhanced to improve turnover of trucks and loading
efficiency. In addition, they returned the loaned personnel to Nissan
Motors. These measures improved the morale of the nonloaned personnel
in the company and revitalized the firm.
They endeavored to increase their sales through non-Nissan or nonauto
industries to expand their customer base. Logistics services for conven-
ience stores and restaurants were increased and office relocation services
and international freight services were developed as their new businesses.
This is how they enlarged their business and developed business strategies
for their future growth. Their objectives also include offering services
to corporate clients that would like to outsource their logistics operations
to them.
They also expanded their business through mergers and acquisitions to
increase the corporate values. Merger with Overseas Air Cargo and Tokyu
Air Cargo, acquisition of Ikeda Unyu were typical example of their
strategic M&A. Tokyu Air Cargo is currently known as Vantec World
Transport and it is a key company in the Vantec group, providing air
cargo services. The acquisition shows the fact that a company post-MBO
would be a leading company in consolidating industries under support of
private equity funds. Unifying all systems of the companies involved is also
a key to increase corporate values. Enterprise Resource Planning system
is currently under the preparation to launch, as it merges Vantec and
Vantec World Transport in April, 2009.

5. Zero, An Automobile Carrier2

The predecessor of Zero is Nissan Rikusou, which was established as a hun-
dred-percent subsidiary of Nissan Motor in 1961 and transports new cars
from the Nissan factory to domestic car dealers. Overall, seventy-five percent
of its sales are from automobile transportation and automobile-related activ-
ities, such as automobile body maintenance. Although the business of Nissan
Rikusou was listed as noncore in the NRP, their operations are invaluable for
the automobile manufacturer. Some of the directors of Nissan Motor opposed
the sale of Nissan Rikusou shares based on the indispensible nature of the
subsidiary’s business. Other automobile manufacturers have their own carrier
subsidiaries within their business groups. Car carriers require large motor
pools and expensive specialized equipment for their activities. It is difficult
for a new entrant to penetrate this segment of the industry.
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Management Buyout of a Japanese Business Group 59

In certain instances, management and employees might prefer not to

be acquired by competitors, as the takeover might entail drastic restruc-
turing and redundancies. In the case of Nissan Motor, the MBO has
proven to be beneficial, both for the Nissan Rikusou management and
employees. The buyout was carried out in May 2001, and the company was
renamed Zero, which symbolizes the starting from zero as a new company.
Nissan Rikusou management sought a private equity fund for the
buyout of their company. In the end, most of the investment came from
Tokio Marine Capital, with AIG Japan Capital Investment assuming a
smaller share of the investment. The two funds acquired eighty-five percent
of the shares of Nissan Rikusou and the management and business partners
acquired fifteen percent of the shares.
Zero went public in August, 2005. Before pursuing an initial public
offering (IPO), Zero asked their large shareholders to sell their shares, to
mitigate the selling pressure at the time of the IPO. The shareholders
agreed to sell their shares exceptionally as private equity funds. Even after
the company went public, Zero’s shares have been held by Zenith
Logistics, SBS Holdings, and Mitsuike Corporation as stable stockholders.
The President of the company, Mr. Iwashita, has made significant
advances in terms of investor relations through his personal network. In
the following few paragraphs, we describe the changes in the operations of
Zero, referring to Kaneda and Sonoda (2009).
As mentioned above, the shares of Nissan Rikusou were sold off
according to the NRP. The management started to plan the buyouts even
before the official company decision. They took advantage of this head start
in preparation for the MBO. They achieved the MBO in six months, whereas
this process usually takes one year. This was basically a “management”
buyout, with the management assuming the leadership of the process. The -
employees had concerns about the buyout itself because they felt that they
were losing the economic protection afforded by the once-mighty Nissan
Motor. In the NRP, Nissan Rikusou was asked to cut price by thirty percent,
and it was emphasized that the company could not survive without this dras-
tic cost reduction.
After the buyout, the management established an in-house manage-
ment system. As a first step, the management changed the remuneration
system, to enhance the employees’ business mindset. The salaries were set
higher than the industry average and had to be cut to meet the NRP-
required cost reductions. The company did not reduce the number of
employees to lower the fixed costs. As a subsidiary of Nissan Motor,
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60 Naoyuki Kaneda

Nissan Rikusou relied on the parent company for most of its business. The
employees did not promote their services to their customers and they are
not proactive in improving their operations.
A pay structure system was not really established before the buyout.
The previous system for paying drivers was not incentive-based. If they
worked overtime, their wages were higher even if they worked inefficiently.
In the new system, the company started to evaluate and pay drivers
through a partially result-oriented remuneration system. Thus, the new
system provides incentives to work effectively with adequate safety
precautions. Before the MBO, the work force included persons who were
originally hired by Nissan Rikusou immediately after graduation from
college, as well as staff loaned from Nissan Motor. Since the buyout, the
company also hires experienced workers from other companies and
industries. The IPO provided a tremendous opportunity to increase the
value of the company name, and the company has taken advantage of its
status as a listed company to incorporate highly skilled labor into its
workforce.
The second issue related to management reform is promotion of sales
to take advantage of the independent status of the firm. As a Nissan
subsidiary, the business connection between Zero with Nissan Motor
presented some obstacles to extending the business relationship to com-
peting automobile manufacturers. As mentioned above, most car carriers
are subsidiaries of car makers. Zero exploits its unique position as an inde-
pendent operator in the industry to promote sales with non-Nissan
manufacturers. Thus, the company has increased sales to both Nissan and
non-Nissan automakers. Before the buyout, the drivers were not very
enthusiastic to pick up loads to fill the vacant spaces in returning trucks.
Once the management emphasized the importance for sales of maximizing
carrying capacity, the drivers’ mentality changed. The next task is to
change the remuneration system to create “sales drivers,” who will sell
more eagerly their carrying capacity. Similar to the case of Vantec, Zero
may acquire firms in other sectors, since the market for car carriers is
stagnant and it is difficult to grow in this business sector. After an acqui-
sition, it may be advantageous to slash indirect costs by sharing services.
The third issue in management reform is the emphasis that must be
placed on the cost of a service. Before the buyouts, the managers and
employees were not very cost-conscious. The sales representatives would
offer a price that was not based on cost accounting. As part of the
management reform post-MBO, the management monitors and improves
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Management Buyout of a Japanese Business Group 61

operational efficiency using performance measures. With respect to human

resources, the company has returned loaned personnel to Nissan Motor, as
did Vantec, to improve management flexibility. Zero and Vantec are excep-
tional in stopping the loaning of personnel from the previous parent
company. In these aspects, Zero has become an independent trans-
portation operator that is not under the direct control of the automaker.
Nevertheless, Zero continues to cooperate with Nissan Motor in some
operations, e.g., in the sharing of trucks to deliver different products to the
same destinations, thereby reducing waste and environmental impact.
Zero also has extended overseas operations in China as a partner of
Nissan Motor.
As mentioned above, an MBO generates a firm that is severed from the
parent company. It also enables the firm to penetrate new markets as an
independent operator. The MBO provides opportunities to reform the
management, operations, and employee mindset, leading to dramatic
changes in the way the business of the company is conducted.

Endnotes
1. We interviewed Mr. Yasuaki Suzuki, Director and Senior Executive Officer of
Vantec Group Holdings Corporation, and Mr. Yoshio Sato, Public Relations
Manager of Vantec Group Holdings Corporation, in February 2007.
2. We interviewed Mr. Yasuhiro Ogawa, Manager of Corporate Planning
Department of Zero Co., Ltd. in April 2006.

References
Jensen, M. C. (1986). The agency costs of free cash flow: Corporate finance and
free cash flow, American Economic Review, 76(2), May.
Jensen, M. (1993). The modern industrial revolution, exit, and the failure of inter-
nal control systems, Journal of Finance, 48(2), July.
Kaneda, N. and Sonoda, T. (2009). Spin-off through MBO and management issues,
Kigyou-kaikei, 61(7), July (in Japanese).
Kester, W. (1991). The hidden costs of Japanese success, in Chew, D. H. (1997),
Studies in International Corporate Finance and Governance Systems: A
Comparison of the US, Japan and Europe, Oxford Univ. Press.
Okuno, S. (2004). Survival Plan, Kindai Shuppansha (in Japanese).
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5
Managerial Significance of Strategic
Outsourcing
Shunzo Matsuoka
Faculty of Business, Hannan University

1. Introduction
In times of continued economic growth, a product was sold if produced.
However, the cessation of economic growth is accompanied by a sharp
downturn in the sales growth, and companies seek to reduce the more obvi-
ous costs such as personnel expenses and enlarged assets. Interest determines
how efficiently a company performs its administrative and stockholder
duties. Outsourcing has traditionally been utilized as a measure of reduction
in cost and to enhance efficiency by management; however, it has become the
strategic means of companies to maintain competition predominance.
It is important in outsourcing and group management that a company
shares information with an associated company and other companies through
management; therefore, a business process is administered smoothly through
the information sharing within the company as well as with the outside
company. When the competition intensifies, it is natural to use external
resources such as outsourcing, or sharing a service. The promotion of group
management and the outsourcing between different organizations can be a
necessity. Following the collapse of the bubble boom, companies suffered
from a rise in the fixed cost ratio due to surplus staff — an overinvestment.
Group management is natural under these conditions. A company increases
its efficiency through the indirect performance of duties by outsourcing — a
measure utilized to reduce the costs. With the resulting surplus resources
these measures can produce, management has clearly realized its importance.
Independent, plural companies become the group for group manage-
ment, and this group management system is in place to plan business
expansions and value-added improvements. Outsourcing is more attractive

63
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64 Shunzo Matsuoka

to companies without major capital assets. In group management, problems

owing to the management of the individual company occur but can be
reconciled. In group management and outsourcing, the optimization of the
whole is provided by the optimization of the individual.
In the following text, outsourcer means a consignment company while
outsourcee means a trustee company.

2. A Change in the Purpose of Outsourcing

2.1. Outsourcing for speed and value added
An outsourcee increases the value added of the business process re-
engineering (BPR) process and performance, improving cost, service, and
speed. The success of outsourcing lies in its ability to improve upon a
company’s existing duties. Currently, long-term outsourcing contracts of
more than five years are common. The contracted outsourcee, in turn,
improves the ability of the company to reduce the annual costs and
enhance the service quality as well as the business and duties processes; in
addition, the outsourcee must provide the technological improvements
required of their specialization. The outsourcer utilizes the original know-
how of the outsourcee and plans the reinforcement of the non-core aspects
of the business after which the outsourcer reviews the operations of
the company and advances the business development area that is more
dominant than a competitor’s.

2.2. Introduction of new services through outsourcing

Traditionally, companies have entrusted their work to outsourcing, which
improved and added value to these duties. However, an outsourcee can
provide new services to the outsourcer and absorb the latter’s consignment
of internal work. Indeed, it appears that new services are being introduced
by the outsourcees to the outsourcers simultaneously with the transfer of
services from the outsourcers to the outsourcees.
The built-operation-transfer (BOT) model is one example of an out-
sourcing activity that is introduced by the external company to the
outsourcer. The outsourcee replaces the model with the new activity and
when the activity becomes familiar to the company, the outsourcee moves
it to the outsourcer. A BOT model is a transformation model of the third
type of so-called outsourcing.
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Managerial Significance of Strategic Outsourcing 65

In light of the spread of business process outsourcing (BPO) in Japan,

the BOT scheme may acquire an increasingly subtle importance. The
BOT process involves the following: A private enterprise establishes an
institution and administers it for a certain period. The outsourcee then
transfers it to the outsourcer, a self-governing body, and the country after-
wards. Security operations occur in the user company of the business
model such as the BOT.
The third passenger terminal at Ninoy Aquino International Airport of
the Manila metropolitan area in the Philippines employs this scheme. This
investment was made by the private operators of the Philippine
International Air Terminals Corporation (PIATCO). The terminal is
administered for a certain period by PIATCO and the investment is
collected in the process. This BOT method was transferred to the country
that subsequently managed the international airport.

3. The Organization and Risk Reduction

3.1. Source of the competition’s predominance turns
from tangible assets to knowledge assets
Tangible assets were the growth factors of a company in the industrial-
ization era. However, these came to be associated with the risks involved
in large assets. In fact, as with real estate in good condition, the rise in
price can become remarkable. However, it is always accompanied by the
risk of price depreciation. Movable property, unlike real estate, always
involves the risk of reduction in price. These risks are curbed when a
company maximizes outsourcing and a lease.
Outsourcing can prevent the risks associated with idle assets. It is
important to eliminate the risk of price depreciation and increase the price
expectations of a company’s fixed assets. The ability to achieve the latter
has been an increasingly serious demand. As for holding fixed assets, it
should be recognized that the expectations and risks are real.
The intangible assets of a company include high quality products and
services; motivated, expert employees; and speed and an operating process
that adequately supports customer satisfaction. In the age of information
technology, intangible assets became more important than tangible assets
to management. Value creation shifted from the management of tangible
assets to the strategic management of the knowledge base for the prac-
tical use of the intangible assets. Intangible assets also include customer
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66 Shunzo Matsuoka

relations, innovative products and services, high quality, a business process

that is responsive, IT and database processes, employee skill, motivation,
and organizational ability. The strategy of value creation is required to
positively utilize not only tangible assets, but also intangible assets, espe-
cially since intangible assets became the main source of the competition’s
predominance.

3.2. Reduction in capital investments

Outsourcing contributes to a reduction of the investment or holding of
assets. When a company is founded, it controls the means to investment
in outsourcing a part of its duties. Instead of creating a section if a
new function is needed in a company, as with the development of a new
product, the outsourcing of the function controls investments such as those
required to build new facilities. The assets and financial risks of the
company are, therefore, reduced.
In addition, a technical job can be performed by an outsourcee for the
outsourcer. By utilizing the support of an outsourcee, the outsourcer was
able to find the means of supplying the continuous production of their
product without incurring significant investment costs. The outsourcer can
provide the outsourcee the inside resources newly added into the develop-
ment and innovation process of a new product, advanced technical
production intensively here. These actions are more strategic.

3.3. Streamlining the administrative body

The assembly and the subassembly line of many outsourcers have begun
to be transferred from outsourcer to the subsystem maker, an associated
company and outsourcee. This occurred in the 1960s. Japanese companies
have since begun to outsource the assembling of the parts and the finished
product itself. These are the characteristic strategies of this type of
outsourcing. During the periods of sharp increases in product types and
the reduction of the product life cycle, outsourcers concentrated on a few
primary outsourcees to fulfill their production needs. The outsourcee, as
the system component maker, was in charge of organizing the scope of
jurisdiction. The outsourcee was, therefore, relegated the task of cluster
management.
This administrative task became complicated with rapid economic
growth and significant increases in product types. The outsourcer was
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Managerial Significance of Strategic Outsourcing 67

freed to a considerable extent from this necessary activity of its opera-

tional management by the process of outsourcing. The organizational
structure, which became complicated, was streamlined by this flexible
outsourcing of various types of production activities and some develop-
ment duties. In general, the lead time and the life cycle of the product
were shortened. The product type was extended beyond that which was
previously merely maintained.

4. Essentials of Strategic Outsourcing

4.1. Construction of the core competence
It became extremely important that the modern company built a core
competence that it could develop. Everything but the core competence is
outsourced thereby increasing the tendency to streamline production. The
core competence is the by-product of the integrated powers of the com-
panies. It can be superior in comparison with that of other companies,
which has become a unique competitive power; however, in the future,
entry into the new product market will become simpler to sustain com-
petition predominance. For example, the finished product maker uses the
part manufactured by the maker and can demand a profit that is higher
than other manufacturers when the part maker produces a superior part,
which is the element of superiority in that it is not possible for the other
part makers to replicate the item.
Sony owns the synthetic technology to miniaturize a product and pro-
duces new products such as the world’s smallest Walkman and the digital
video camera with passport size technology. Fuji film acquired the painting
technology of the multilayer film and developed film production technology
from cameras to audio tape systems to the production of videotapes.

4.2. Value creation outsourcing

Outsourcing is a process utilized by an organization to reduce costs by
relegating duties to outsourcees. As of late, companies outsource a signif-
icant amount of work involving a wide range of functions to specialized
agencies. The objectives of outsourcing lay primarily in production,
personnel affairs, accounting, distribution, research and development, and
sales. This strategic judgment produces high value added that can be
enjoyed by the outsourcing company and plays a cost reduction role.
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68 Shunzo Matsuoka

The essence of strategic outsourcing is different from the outsourcing

used solely to reduce costs. The outside specialty organization’s skill,
knowledge, and know-how are utilized; therefore, strategic outsourcing can
be defined as specific duties being maximized through a series of processes
to add new value to the company. Strategic outsourcing is distinguishable
from the conventional subcontracting method that aims to reduce costs,
insofar as it is a value creation type of outsourcing. The outsourcer
allocates financial resources in the field of its strength. The outsourcer
thereby relegates the duties associated with its fringe areas to the
outsourcee, and manages the know-how of the outside organization.
The value creation business model in which a user company cannot act
alone is further developed when technology development is consigned to
the outsourcee who then controls the fate of the business. The source
of the competition predominance of a company is shifting from facilities
or a fund to knowledge and wisdom.
Outsourcing that leads to value creation collects all knowledge from
the concept stage to the design stage. If there is a design idea that
promotes a product as more compact, easy to assemble and repair, then
it is respected by the designer, the production and manufacturing staff,
and all those participating from the concept stage.

4.3. Source of the competition’s predominance:

from a thing to a person
Outsourcees are analyzed in the same manner as a company’s materials,
costs, and property. Management methods differ in their view. With out-
sourcing methods, a person is compared to and must be able to provide a
service at a low variable cost. On the other hand, that person is also
compared to property and must provide a high fixed cost value. In the
end, however, the decision to outsource or not depends on the talent of the
individual to raise the quality of the software, even with an excellent man-
agement performance and process. The outsourcer must occasionally
provide personnel training to the outsourcee — as in the cases of Eastman
Kodak and Seven-Eleven — namely in the absence of a crucial employee.
The ratio of knowledge to labor rises and the value of the means of
production declines when the knowledge of the outsourcee becomes more
significant in the promotion of efficiency of resources in management than
the practical abilities of the external source. In other words, managing
those who can bring about knowledge and wisdom becomes increasingly
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Managerial Significance of Strategic Outsourcing 69

important to building and maintaining competition predominance. It is

necessary to nurture talented individuals for the growth of the BPO
industry and that this future BPO industry growth is publicized. BPO
involves the sale of specialized work, and, thereby, it should be regarded
as a specialized service.
Outsourcing a function of a particular section of a company cannot
ignore the talented person supporting this section and function. Though a
company is an organic body of its sections, it integrates a section into an
external organization to achieve lower costs and high quality. Therefore,
the company’s conventional ability, knowledge, and the resources such as
skill are invalidated.

5. Issues of Quality in Outsourcing

5.1. Quality becomes the black box
With the division of labor in a company, each sphere of business becomes
too narrow and it is difficult to understand what a neighboring section
does and the influence of one’s work on an end product. This may nega-
tively effect the associated sense of accomplishment and royalties. As for
the division of labor and specialized progress, the level of efficiency may
rise. However, technical engineers do not understand others or experience
failure in the same manner either. Outsourcing is identical in this respect.
The aggravation of the division of labor is still only beneficial in one’s own
company. Furthermore, if the division of labor of the company is
outsourced, the know-how is not left with the outsourcee. If outsourcing
progresses, a certain part becomes the so-called black box. It becomes
difficult to discern how a product is made and how its quality is guar-
anteed. It becomes key to ascertain and manage the quality of the
outsourcing. In the field of software, the establishment of a quality brand
made in Japan is a rushed process. As for the future of manufacturing, a
guarantee of quality in the outsourcing will become important.

5.2. Customer satisfaction shifts from cost to quality

Many companies must determine how they will quickly manufacture a
product and provide the end-consumer needs of its associated services in
a precise and quick Manner. These are the most important problems; for
example, the part maker must satisfy the consumer of the finished product,
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70 Shunzo Matsuoka

which a division of the outsourcing company is used for. Cooperation

between business partners is important in resolving this problem. In the
future, this will intensify the competition among the supply chain
providers. In the case of Dell, competition superiority for a reduction in
costs was fulfilled by the promotion of efficiency of the supply chain; for
example, the price of a Dell computer was around 60% of the competing
model — thus overwhelming cost competitive in the Japanese PC market
in 2000. However, in 2005, Dell was not a price leader in their market
entry of E machines. At the time, the purchasing action of the consumer
shifted to a focus on design — a serious break from price consideration.
The American computer manufacturers Dell and HP are very good at
outsourcing. They do not manufacture parts but relegate this task to
outsourcing — a business model in which a company entirely purchases
what it needs. Quality is guaranteed through a very severe set of standards
whereby several hundred items are examined for this purpose. A product
that does not meet the required standards is not received. Currently,
Japanese quality standards are vaguely observed. The United States
differs from this. Specifications contracts and a standard of 100% are made
clear to the outsourcee from the beginning.

6. Outsourcing is Not a Panacea

Outsourcing has its merits and demerits. For companies without pro-
duction factories, outsourcing can provide speed in correspondence and a
possible reduction in cost. However, in terms of technical maintenance, the
technical succession and the progress of the technology may decline. If a
reduction in the appointed date of delivery and costs are achieved by
insourcing rather than outsourcing, the decision to insource should be
made. Insourcing is different from the world of outsourcing. The decision
to outsource the production of a product should be made while the future
of the product is considered. Insourcing is new speech, but, there reflection
for the excessive outsourcing is read. Insourcing prevents an outflow of the
know-how that is found in excessive outsourcing, and these companies
prefer to accumulate this internally.

7. Total Optimization Rather Than Partial Optimization

is Important
The decision making to insourcing or outsource is required in cost argu-
ments. Although there are factories that are self-owned and related
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Managerial Significance of Strategic Outsourcing 71

production subsidiaries, some operations must still be outsourced to

reduce the cost. If all factories and subsidiaries have a rate of operation
of 100%, it is still optimal. However, it may be profitable to outsource a
business unit even if there is an idle part in the operation. However, this
may provide a deficit for the whole group. Hence, the reason for out-
sourcing is argued.
At the planning stage, the head of the unit and the planners only have
information. However, at the design and quality stages, the production
engineer and a design engineer participate jointly. At this stage, there may
be concerns that technological outsourcing might result in leaks.
Therefore, insourcing will be forced.
In addition, due to the lack of coordination between sections and the
opposition from higher-ranking officials, it is possible that interest adjust-
ments for these companies will be difficult; for example, the production
section might insist on insourcing to maintain the rate of operation of the
plant. Moreover, outsource might have an advantage in that correspon-
dence regarding design changes will lead to the rapid development of new
development parts.
In such situations, the decision making at the presidential level is
required. One argument states that businesses must be conducted in a
group to reduce the fixed cost ratio overall. Total optimization must be
maintained in the place of individual optimization.

8. Summaries
Corporate management was brought into the fore to bring attention to the
importance of utilizing internal resources as well as outsourcing; however,
both group management and outsourcing have similar backgrounds. There
are two approaches: dealing with the entire company or only sections.
Outsourcing now demands investing important resources in the core of the
company to secure competition predominance. Strategic outsourcing
demands value added and cost reduction. Group management can easily
lead to high value added as compared to individual management.
Knowledge increased through group management, and the source of the
profit changed. However, the management of talented individuals to secure
competition predominance cannot be ignored. Outsourcing leads to the
quality “black box” issue of quality. Customer satisfaction has shifted from
cost to quality. Outsourcing is not a panacea for ensuring the appointed
date of delivery, cost reduction, and speed for competition predominance.
Some believe that insourcing enhances management efficiency.
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72 Shunzo Matsuoka

Further Readings
Greaver, M. F. (1999). Strategic Outsourcing, AMACOM.
Hanada, M. (2008). Credit by the human resources development is the source of
the guarantee of quality, Quality Management, 59(8), 10–17 (in Japanese).
Japan Association of Management Accounting (ed.) (2000). Dictionary of
Management Accounting, Chyuou-keizaisya (in Japanese).
Kato, T. (1996). A risk and cost-effectiveness analysis in the strategic out-
sourcing, Kigyou-kaikei, 48(7), 40–44 (in Japanese).
Kawamoto, S. (2008). Outsource which can embody thought of Bandai, Quality
Management, 59(8), 26–30 (in Japanese).
Kurata, K. (2008). It is a key to ascertain a quality control point during
outsourcing. To the establishment of a brand made in Japan of the software
quality, Quality Management, 59(8), 18–25 (in Japanese).
Minagawa, Y. (2008). Management Accounting of the Supply Chain, Koyoshobou
(in Japanese).
Monden, Y. et al. (2005). Management Accounting Text. 3rd edn., Zeimukeiri-
Kyoukai (in Japanese).
Okamoto, K. et al. (2008). Management Accounting, Tyuou Keizaisya (in Japanese).
Sakurai, M. (2000). Management Accounting Dictionary. Doubunkan publication
(in Japanese).
Takeishi, A. (2003). Divisions of Labor and Competition. Yuhikaku (in Japanese).
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6
Acquisition Price as an Incentive
Price of M&A
Yasuhiro Monden
Professor-Emeritus, Tsukuba University

1. Research Purpose: How Can the Purchase

Price of M&A Function as Incentive to Merger?
Decision making on mergers and acquisitions is dependent on consensual
agreement between the firms concerned. Where managers of both firms, as
representatives of their shareholders, are satisfied with the incentive return
for their shareholders, mutual agreement is obtained; in other words, they
will decide to merge the two firms.
Economically, the most important incentive is the expected “shared
profit”, which is distributed to both firms from a joint profit that is the
incremental profit the firms would gain after merger by the synergy effect.
Only where both firms are satisfied with that shared profit, will they
decide to merge.
Therefore, the decision to merge is based on a “satisfying principle” of
“Total amount of shared profit for each firm”, which is the incentive for
the merger. The “satisfaction” in of M&A means “mutual satisfaction” of
both parties concerned with fair allocation” of joint profits.
The reason why the M&A decision is dependent on a “satisfying solu-
tion”, not on an “optimal solution” is that all M&A-related firms need to
“decide whether they should participate” in one coalition or not, and this
is different from the other case of expanding the scale of the firm when
one firm makes a decision on capital investment to expand its own pro-
duction capacity. The decision to merge is made on mutual-agreement on
final negotiations between both firms, and their decision criteria are mutu-
ally satisfactory for the benefit of each firm.

73
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74 Yasuhiro Monden

However, the leader firm of the coalition has influence when each of
several firms decides autonomously whether they will participate in the
new coalition or not. The leader of the “core firm” of the coalition or busi-
ness group will decide, in advance, which company can be a candidate of
a new participating firm who can maximize their “joint profit” and the
leader also presents the incentive distribution plan to member firms to
attract them in participating in the coalition.1
As above, M&A is based on decision making supported by mutual-
agreement over the incentive of an incremental distribution amount
generated by the synergy effect between several people, not on decision
making of one single person. Therefore, M&A is substantially decided
upon mutual satisfaction of several people, who are affected by the agree-
ment. This can be expressed in the model of a corporative game.
The purpose of this paper is to demonstrate that the decision of pur-
chase price under M&A, and the decision of the control-premium included
in it, will follow the profit-sharing mechanism among the participating
firms concerned, and will clarify its mechanism. The author named such
price as “Incentive Price” that is the price that motivates and induces
firms to participate in a network organization based on incentive by shar-
ing profit. The purchase price or acquisition price for merger is functioning
as Incentive Price.

2. Sources and Result of Synergy Effect: Innovation

for Supply and Demand Balancing by M&A
For the synergy effect mentioned above to become a reality, it is necessary
that participating firms improve and reform the balance of supply and
demand after the merger, as shown below. The synergy effect will present
as increased sales and reduced costs to equilibrate sales revenues and pro-
duction costs as an intra-corporate total sum in the after-merger company.
Therefore, integrating corporations by M&A has a function of balancing
revenue and expenses in a microfinancial aspect. (Refer to Fig. 1).2

3. Control-Premium
Under M&A, the top management of the acquirer firm or the new top
management dispatched by the acquirer to the acquired firm reforms a
system of the acquired business by introducing some new business projects
after M&A to add new value to the existing enterprise value realized under
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Acquisition Price as an Incentive Price of M&A 75

Innovations and improvements

in the after-merger company

Sales Opening new distribution

department channel
Sales Entry into new market by new
department business (diversification)

Increase in Marketing
Improvement of brand power
sales revenue department
Improvement of R&D to produce
R&D new product
department (including diversification)
Incremental
operating
profit Merger and abolition of
(Synergy Sales distributors to reduce promotion
effect) department costs
Decrease in Merger and abolition of
Production manufacturing plants to reduce
costs department processing costs
Purchasing Reduced the number of
department suppliers to reduce parts costs

Merger and abolition of

Administrative
duplicated functions to reduce
department labor cost in administration dep.

Fig. 1. Supply and demand equilibrium from M&A synergy effect. (Adapted from
Maekawa et al. (2005) with modification.)

the previous top management. Such a new business project has an poten-
tial to increase the sales through new products developed by combined
technologies of both firms, and the merger of marketing channels. This is
called the “Synergy Effect” (merger effect) and the benefit of “Economies
of Scale” provided by increase in the scale of the enterprise will enable the
reduction of costs, and various restructuring may be carried out.
What is called the “Income Approach” is the method used to measure
the synergy effect (accretion), which will be provided by new business
projects after M&A, in assessing the target company. However, to actual-
ize the synergy effect, it is necessary for (shareholders of) the acquiring
firm or merging firm to hold enough share capital to have “Corporate
Control Rights”, which is a majority of voting rights. Because, having
Corporate Control Rights over the after-merger company in M&A enables
(shareholders of) the acquirer firm to make a decision of implementing
new business practices and projects, at the General Meeting of
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76 Yasuhiro Monden

Shareholders. According to MacKinsey & Co. et al., (2000), the value of

that is called the “Control Premium” or “Acquisition Premium” is
expressed as: (Refer to Fig. 2).

Control Premium
= [The value of the target company after control by M&A]
− [The value of the target company under the top management
before the merger] (1)

4. Allocation of Synergy Effect Based on the Purchase

Price and Acquisition Premium
The substance of Control Premium (or “acquisition premium”) is, as
clarified in the foregoing section, an allocation of synergy effect provided
by M&A to the target company. In foregoing paragraph, it was expressed
as equation (1).
The first term of the right side of above equation [the value of the
target company after control by M&A] is “Purchase Value of Target
Company”, which could become Purchase Price.
The second term of the right side of above equation [The value of the
target company under the top management before the merger] is “the
stand-alone value of the target company as an independent firm” before
acquisition. This stand-alone value is the value of the firm of the inde-
pendent target company before the merger, and measured by the book
value of Net Asset plus the “sum of the present values of future income
flows” of the target company before merger. (Apply “DCF formula for
residual profits” of Income Approach.) Therefore,

Control Premium = [Purchase value of target company]

– [Stand-alone value of target company] (2)

Further the relationship between the Control Premium and the Synergy
Effect which both companies would gain after M&A can be shown as
Fig. 2.
In Fig. 2, the synergy effect is divided into the “gain of the acquirer
company” and the “control premium of the target company”. This is the
expected synergy effect allocated to both firms. Speaking precisely, the
gain of the acquiring firm means the expected profit for shareholders of
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Acquisition Price as an Incentive Price of M&A 77

Purchase price

Gain of Standalone
Standalone value Control
acquirer value of
of acquirer firm premium
firm target firm

Synergy effect
gained by M&A

Value of the after-M&A company

Fig. 2. The relationship between synergy effect and control premium.

acquiring firm, and the control premium means the realized profit for
shareholders of target company though the latter actually realizes when
the shareholders sell the rendered stocks to the stock market immediately.
The agreement on M&A will be concluded upon whether or not managers
of both firms, as representatives of shareholders of each firm, are satisfied
with their benefits, through negotiation.
The problem here is that the gain for acquiring firm is only the
expected value as contrary to the premium for target company that can
be realized immediately because the premium for target company is
included in the purchase price offered at the time of merger. Because of
this problem, sometimes it is regretted after merger that synergy effect did
not work as expected, and the premium amount was considered an “Over-
paid” premium.
Since the purchase price is the price which induces shareholders of the
acquired firm to merger with the acquiring firm or to participate in a net-
work organization of acquiring firm, this is nothing but a kind of the
“Incentive Price” that motivates parties to participate in a coalition.

5. Calculation Method of Merger Ratio

5.1. Process of acquisition
Firstly, refer to Fig. 3 for time-flow diagram of “Acquisition Process”. In
the Acquisition Process, the acquiring firm and the target firm will first
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78 Yasuhiro Monden

Stock price

Synergy effect

Final Time flow

Conclusion
Conclusion due negotiation Payment date
date of final
date of basic diligence of merger (share issuing
procedures ratio and contract of
agreement date)
acquisition merger
price Press release
Press release of final merger
of merger ratio and
purchase price
Press release Press release
of provisional of the number
merger ratio of new-shares

Fig. 3. Share price change during the acquisition process.

(1) conclude the “Basic Agreement” and carry out acquisition research of
due-diligences procedures, (2) decide the final “Merger Ratio” and
“Purchase Price”, and (3) hand over the business (assets and liabilities of
target firm) and pay the price in a form of acquirer’s stocks for it. This
process takes several months.
In this figure, both of the companies will announce their intention of
merger to the public on the conclusion date of Basic Agreement. Thus, from
this date, the share prices of both companies will usually begin to rise in
anticipation of synergy effect gained by merger. On the conclusion date of
the final contract of merger, they publish the final merger ratio payment
and the number of new issued shares. Often, the share price falls in antic-
ipation of decrease of the dividend amount per share because of increase of
share supply in the market (i.e., dilution effect). Finally, the difference
between the stock price average (dotted line) before the press release of
merger on the conclusion date of Basic Agreement and the share price on
the last date which is the new-share issuing date (merger date) becomes
the total synergy effect reflected on the share price of acquiring firm.

5.2. Calculation method of merger ratio

As shown in Fig. 3, strictly speaking, the final determination date of
Merger ratio is just prior to the actual merger date. Therefore, there could
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Acquisition Price as an Incentive Price of M&A 79

be a difference in share prices between Merger Ratio determination date

and merger date (i.e., new-share issuing date or final conclusion date of
contract of Merger). However, it is simplified here to call both days as
“merger date” considering them as the same day.
Also, strictly speaking, the share price immediately after the merger
could be different from the share price on the very merger date. However,
in the following, we simplify to call the share price immediately after the
merger, the “share price on the merger date”. Furthermore, we assume
that the share price on either date is adjusted to the fluctuations in the
general market price such as TOPICS.
Now the “Merger Ratio” in a merger stands for how many stocks of
the surviving firm per share of the nonsurviving firm shall be offered to
the shareholders of the latter.
For example, in the triangular merger among the Citigroup in America
and the Nikko Cordial Group in Japan, they decided the Merger Ratio
based on the share price on the merger date (actually a day before merger)
by the following calculation formula:

Merger ratio = (Nikko share price) ÷ (Citigroup share price)

= 1,700 JPY ÷ (27 dollars × 110 JPY per dollar) ⱌ 0.6.

It followed that 0.6 Citigroup shares were allotted per one Nikko share.
(However, Nikko share was set 1,700 JPY, which is equivalent to the price
of TOB offered by Citigroup before the press release of merger.) This
application of TOB price is according to the “principle of equal treatment
of all shareholders”. Therefore, in the above case of the merger ratio, the
Nokko shareholder who held say 5,000 Nikko shares would receive 3,000
Citigroup shares (being 5,000 shares × merger ratio 0.6).
To calculate merger ratio, it is necessary to calculate the “Stockholders’
Value” of each of nonsurviving firm and surviving firm. Stockholders’
Value is calculated using the valuation methods of the firm value stated
as follows:

(1) Income Approach (DCF method on Free Cash Flow, DCF method on
Residual Profits).
(2) Market Approach (Published Market Price method, Similar Listed
Company method).
(3) Cost Approach (Book-value Net Asset method, Replacement Value
Net Asset method).
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80 Yasuhiro Monden

The following formulas are used to calculate merger ratio:

[Shareholders, value of nonsurviving firm at merger date

∏ the number of issued shares of nonsurviving firm]
Merger ratio =
[Shareholders, value of surviving firm at merger datee
∏ the number of issued share of surviving firm]
(3)

= [Shareholders, value per share of nonsurviving firm]

∏ [Shareholders, value per share of surviving firm]
(4)

Using this merger ratio, the number of newly offered shares of the surviv-
ing firm will be calculated applied by the following formula:

The total number of offered shares

= [Total number of issued shares of nonsurviving firm]
× [merger ratio]. (5)

6. Role of Stock Price in Calculating the Merger Ratio

Merger Ratio is calculated based on Shareholder Value of each firm as
stated above. However, shareholder value is sometimes calculated by
Published Market Price method of “Market Approach”. On the assump-
tion that the stock market is efficient, the share price must actually reflect
various factors that have impacts on the fundamental earning capability
of the firm, and the following should be correct:

Shareholders’ value per share

= [Market price of the stock of the firm in question] (6)

Therefore, from equation (4), the following formula can be derived:

Merger ratio
= [The stock price of nonsurviving firm on merger date]
÷ [the stock price of surviving firm on merger date] (7)
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Acquisition Price as an Incentive Price of M&A 81

From equation (7), the following will be derived:

The stock price of the nonsurviving firm on merger date

= Merger ratio
× [the stock price of the surviving firm on merger date] (8)

Therefore, from the equations (5) through (8), the following formula can
be derived3:

Total market value of the number of newly offered shares

of the surviving firm on merger date
= Total market value of the nonsurviving firm on merger date. (9)

Therefore, the total market value of the nonsurviving firm on merger date
is completely compensated by the number of new offered stocks of the
surviving firm. And such total market value includes synergy effect allot-
ment, which the shareholder of nonsurviving firm will obtain. Therefore,
the allotment of the synergy effect is calculated by merger ratio as well.
This will be explained in the next paragraph.
However, the actual share market is not always efficient in a short
period; therefore, the investment bankers are reluctant to determine
Merger Ratio only by comparing the share prices of both companies. For
that reason, Merger Ratio is often determined by applying the three
approaches (mentioned in the Section 2) to calculate the Shareholder
Value. Notwithstanding that, the share price has in fact the biggest weight
on determination of the Merger Ratio.

7. Formula for Synergy Effect Allocation

and Determination of Acquisition Price
Synergy effects which could be obtained by the newly formed firm of
merger are described below as mentioned in the Section 2:

(1) Incremental sales revenue after merger.

(2) Cost-reduction by reorganizing system after merger.

The various plans of (1) and (2) above will be realized since the surviving firm
has control over the nonsurviving firm from the capital ownership viewpoint.
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82 Yasuhiro Monden

How much of those synergy effects the shareholders of each merger-

related company will get must reflect on the Shareholder Value of each
company on merger date. Therefore, if the stock market is efficient, the
following relationship would hold.4 (The equation (10) is corresponding
to Fig. 2.)

Total market value of firm the newly formed firm on merger date
= {(Synergy effect allotment for shareholders of surviving firm)
+ (Stand-alone market value of surviving firm before the
press release of Merger)}
+ (Synergy effect allotment for shareholders of nonsurviving firm)
+ (Stand-alone market value of nonsurviving firm before the
press release of merger)} (10)

In the following, total annual synergy effect for both shareholders will be
calculated as potential annual incremental operating profits by a detailed
survey of incremental cost-reduction and incremental sales revenues, which
the newly formed firm will gain. That is

Annual incremental operating profits of the newly formed firm after merger
= [Annual incremental sales profits]
+ [annual incremental cost-reduction] (11)

Thus,

Total market value of newly formed firm after the merger on merger date
= [Total present value of annual incremental operating profits
of the combined firm after merger]
+ (Stand-alone total market value of the surviving firm before
the press release of merger)
+ (Stand-alone total market value of the non-surviving firm
before the press release of merger) (12)

It can be said that the equation (12) is equivalent to the formula of the
“DCF method on Residual Profits”5 of the Income Approach that calcu-
lates Enterprise Value.6
Total present value of synergy effect should be allocated to the share-
holders of surviving firm and nonsurviving firm, respectively, based on
their degree of contribution, with which each ex-firm will contribute to
generating the synergy effect in the newly formed firm.
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Acquisition Price as an Incentive Price of M&A 83

To my opinion, such degree of contribution should be determined on

the basis of the amount of the comprehensive investment contained in
their tangible and intangible assets, because the tangible and intangible
assets of each firm would generate the synergy effect when they are
merged. So the amount of the comprehensive investment should be used
as an allocation base. The stand-alone market value of each firm before
press release of merger can be used as such comprehensive investment
amount before merger, because it is the market value of the fund that the
shareholders of each firm have invested before the merger.
However, people cannot know before merger what the share price of
both firms will be at the merger date. Then how could we determine the
merger ratio before merger? And also how should the synergy effect be
allocated?
Again, “the amount of the comprehensive investment contained in
their tangible and intangible assets,” that is, “stand-alone market value of
each firm before press release of merger” can be used as the degree of con-
tribution to the synergy effect or the synergy allocation criterion, and thus
the synergy effect can be allotted in advance before knowing the share
price on merger date. This is how they can determine the provisional
merger ratio and the acquisition price on the date of initial press release.
Let us see the formula of this logic.

Denote:

Shareholder value of the nonsurviving firm on merger date = X

Shareholder value of the surviving firm on merger date = Y
Stand-alone market value of nonsurviving firm before the press release of
Merger = A
Stand-alone market value of surviving firm before the press release of
Merger = B
Present value of synergy effect7 = C.

Then,
the formula for allocating the synergy effect is as follows:

X = {A/(A + B)} C + A (13)

= Synergy effect allotment to shareholders of non-surviving firm
+ Stand-alone market value of nonsurviving firm before
press release of merger.
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84 Yasuhiro Monden

Y = {A/(A + B)} C + B (14)

= Synergy effect allotment to shareholders of surviving firm
+ Stand-alone market value of surviving firm before press
release of merger.

Summing up both equations (13) and (14),

Theoretical shareholders value (or theoretical market value) of the newly

formed firm after merger = X + Y = C + (A + B).

Therefore, from the equation (3), the following formula will be derived:

Merger ratio
(X ∏ number of issued shares of nonsurviving firm)
=
(Y ∏ number of issued share of surviving firm before merger)8

8. Market Transaction and Intra-Organizational

Transaction for M&A
8.1. M&A through market transaction
As the cases of M&A are processed, there are Market Transaction cases
or Intra-Organizational Transaction cases. However, generally, M&A is
processed through market transaction in most cases.
In the case of “market transaction”, a buyer and a seller trade the
business itself as a kind of merchandise in the capital market. (Even
though a seller firm is nonlisted firm, they still negotiate face to face.)
Because of market transaction, the merchandise (a business in this case)
has a “purchase price” as an asset transfer price. However, even in the case
of market transaction, the purchase price still has the feature of an
“Incentive Price” that has been described above.
Where lots of bidders are after one seller firm, a seller business is put
up for bidding. Even if a seller were not put up for auction, they would go
through negotiation for purchase price under price adjustment mechanism,
and then the trade would be finally completed. Such a process is just a
market transaction. In this case, shareholders of seller firm make compar-
ative examination to find out which bidder they shall merge with to get
the largest potential profits.
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Acquisition Price as an Incentive Price of M&A 85

On the contrary, where there are lots of sellers and one bidder firm, the
market will be a “buyer’s market”.
In the case of Separation of business where a firm is selling a certain
section of the business, the process of transferring that business will be
through market transaction.

8.2. M&A through intra-organizational transaction

This is merger or acquisition between member firms within the network
organization. For example, there is a situation where the operational-
allied firms become capital-allied firms within the network, and another
situation where the capital-allied firms become parent and subsidiary
companies.
As another angle, for example, the consolidated company group of
Panasonic (ex-Matsushita Electric Industrial Co. Ltd.) carried out reorga-
nization within group as follows in recent past years.

(1) Merger between subsidiaries within group, and between subsidiary and
parent companies.
(2) Converting the subsidiary company into wholly-owned subsidiary
through stock exchange.
(3) Converting the equity method affiliate into the subsidiary company
through TOB.
(4) “Re-shuffle” that combines businesses by “business split-off” between
subsidiaries or between subsidiary company and internal division of
the parent firm.

Those transactions are essentially Intra-Organizational Transactions, but

not Market Transactions. Such reorganization within a consolidated
company group is also a sort of reformation within network organization.

9. Condition for Realizing M&A Agreement

Under the Theory of Cooperative Game
Applying the principle of participation decision in M&A to the theory of
cooperative game, it can be expressed in simple formula as follows.
However, only gains of shareholders are mainly considered here, although
all the interested parties will get gains (benefits) from merger.
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86 Yasuhiro Monden

Combined company’s profits after M&A

> sum of individual company’s profits before M&A (15)

Above equation is prerequisite for M&A, and

Allocated profit for each company i after M&A

> individual profit of each company i before M&A (16)

must hold for all participating companies as a required condition. The

formula (16) is called the “individual rationality” in the theory of co-
operative game.
Furthermore, where there are more than 2 firms participating in M&A,
if the “Partial Coalition” could happen between certain firms, and the fol-
lowing equation come into effect, then, the member firm will withdraw
from the Partial Coalition, so that a Merger of the “grand coalition” will
occur (the grand coalition means the biggest coalition that all member
firms will merge in M&A).

Combined Profits from “Partial Coalition”

< [Sum of the allocated profit from “Grand Coalition”
to each member firm of “Partial Coalition”]. (17)

The Formula (17) is called “Rationality of partial coalition” or “Core

condition” in the Theory of cooperative game.
In the above equation (15), “the left side figure minus the right side
figure” leaves the “Synergy Effect” (also called the “operational synergy”)
of M&A, and it is also the source of the above “Rationality of partial
coalition” and “Core condition”.
Therefore, at least, it is a necessary condition of a Merger decision that
the Synergy effect of equation (15) is realized. (However, strictly speaking,
if the conditions of equations (16) and (17) do not hold, it cannot be said
that necessary and efficient conditions for M&A have been fulfilled, and
thus the allocation of synergy will not be stable.)
Further, the existing member firms within the consolidated business
group cannot freely make a “partial coalition” with other companies,
because of control power of the parent company through their capital own-
ership and on sending the directors, etc. As a result the rationality of
partial condition (17) can be neglected. Therefore the consolidated business
group can only consider the “individual rationality” (16), which will be
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Acquisition Price as an Incentive Price of M&A 87

satisfied by equations (13) and (14). In other words, for the consolidated
business group if the condition (16) is satisfied the synergy allocation
will be stable.

10. Conclusion: Other Factors in the Real World

In this paper, the author asserted that the determination of the acquisi-
tion price under M&A or the control-premium included in it will follow
the profit allocation mechanism among the combining firms concerned.
On the other hand, M&A practitioners may be influenced by the var-
ious following factors in determination of purchase price in reality
(Okumura, 2007a, b).

(1) Bargaining Power for M&A: Acquisition price will depend on bargain-
ing power of each seller and bidder during negotiation. For example, in
case of the rescue of the company, the seller’s bargaining power would
become weaker, and in case where target shares are mainly held by spe-
cific institutional investors or Funds, the seller’s bargaining power will
become stronger. Furthermore, there are also many price-settings, which
appear to have resulted from “bargaining tactics”. Many practitioners
also point out that because of the seller’s strong bargaining power, the
shareholders of the seller firm will often get most of the synergy value
in advance, which should be generated by both of the merger-related
companies after merger. This is also called “Winner’s curse”.
(2) Time Passage: If it passes too long time after the M&A press release,
until final decisions of merger ratio, purchase price and the business
plans to be taken after merger, some speculative price movement may
happen, and the “excessively higher valuation” of the target may be
carried out and result in the “over-paid” phenomenon.
(3) Personal Satisfaction of CEO: There is a tendency that the bigger the
scale of the enterprise gets, the more compensation President gets.
Many cases of M&A failed because M&A was carried out for appar-
ent psychological (behavioral finance) factors such as “prestige for the
President”, rather than for the purpose of truly creating value. Or
else, M&A are often just the results of personal motivation such as
“Empire Building”.
(4) Recent Trend of M&A Popularity: When a premium begins to rise
under the tendency of a recent popularity of M&A market, such as
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88 Yasuhiro Monden

the popular cases of TOB price offered with 30% premium, the
purchase price may be affected.
(5) Lack in Ability of Valuation of the Firm: Because the synergy effect
only appears after merger, it is very difficult to forecast that before
merger. Its value is only “God knows” or “anyone’s guess” before the
merger. This applies to investment bankers who support this forecast,
or for the acquirer concerned.

Certainly, the purchase price and the control premium could be affected
to some extent or largely by the above factors. However, as I see it, these
factors are not substantial for the agreement of purchase price. The author
is of strong opinion that a substantial underlying factor behind M&A deci-
sion lies in the mutual satisfaction with the incentive of allocated synergy
effect. Based on this idea, a mechanism of deciding the control premium
was explained in Section 5.
Finally, referring to the valuation of synergy effect which the author
described as “God knows” in (5) above, it is of course impossible to
forecast exactly how much annual incremental profit a target firm will
bring in the after-merger company. However, to my opinion, if the
“Principle of Conservatism” conventionally used in financial accounting is
applied, it is fairly easy to forecast the restructuring effect which will be
definitely generated in the next few years, and only that can be practically
measured as synergy effect.

Endnotes
1. Incentive Price issue can be viewed in the framework of Agency Theory, where
a Core Company in the network organization is considered as principal and a
Member Company in network as agency. This can be considered as the issue
that the principal gives an incentive to the multiple agents. (It is also
explained by the expectancy theory as well.) However, for example, two allied
firms within the network organization could be merged without instruction of
any core company. In that case, it cannot be analyzed by the framework of
agency theory.
2. Merger generates not only sales revenue increase and cost-reduction, but also
temporary integration costs. For example, the information system department
will suffer from additional costs of system-integration. Sales department and
production department also suffer from additional costs for merger and abo-
lition of shops.
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Acquisition Price as an Incentive Price of M&A 89

3. [The number of new offered stocks] × [the stock price of surviving firm on
merger date]
= [(Total number of issued stocks of the nonsurviving firm on merger date)
× (merger ratio)]
× [the stock price of the surviving firm on merger date]
(due to the equation (5))
= [The number of issued stocks of the nonsurviving firm on merger date]
× [the stock price of the nonsurviving firm on merger date]
(due to the equation (8))
= [Total market value of the nonsurviving firm on merger date] (9)
4. Total market value of the newly formed firm after the merger
= [(Number of issued shares of surviving firm just prior to merger date)
+ number of new offering shares] × [the share price of newly formed firm
after merger]
= [(Number of issued shares of surviving firm just prior to merger date)
× the share price of newly formed firm after merger]
+ [Number of new offering share × the share price of newly formed firm
after merger]
= [Shareholder value that shareholders of the surviving firm have on merger
date]
+ [Shareholder value that shareholders of the nonsurviving firm have on
merger date]
= {(Synergy effect allotment for shareholders of surviving firm)
+ (Stand-alone market value of surviving firm before the press release of
Merger)}
+ {(Synergy effect allotment for shareholders of nonsurviving firm)
+ (Stand-alone market value of nonsurviving firm before the press release
of Merger)}
5. Basic equation of accounting profit method (JICPA (2007); this method is
equivalent to the Ohlson Model.)

RI 1 RI 2 RI 3 RI •
VE1 = NA1 + + + +L+
(1 + ke ) (1 + ke )2
(1 + ke )3
(1 + ke )•

RI 1 RI 2 RI 3 RI n RCVn
VE1 = NA1 + + + +L+ +
(1 + ke ) (1 + ke )2
(1 + ke )3
(1 + ke )n
(1 + ke )n

where

VE1 = stock value at appraisal (at the beginning of the first period)
NE1 = net asset book value at the beginning of the first period
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90 Yasuhiro Monden

RIt = expected value of “residual profit”, which belongs to the ordinary

shareholders at period t
RIt = NPt − NAt+1 × ke
NPt = expected value of net profit after tax at period t. (This is the net
profit of current period under financial accounting)
RCVn = the value of the accounting profit after period n + 1, which was
discounted at the end of period n
ke = owner’s capital cost
NAt+1 = net asset book value at the end of period t

The reason why ke is owner’s capital cost is that the borrowed capital cost has
been deducted from the operating profit already because NPt is the net profit
of current period under financial accounting.
6. The reason is that the following will hold where “DCF method on Residual
Profits” is applied to each firm before merger.

Stand-alone stock value of each firm before press release of merger

= [Net asset book value of each firm at that time]
+ [Total present value of potential annual residual profits of
the same firm]

Likewise, when the “DCF method on residual profits” is applied to newly

formed firm after merger,

The following will hold:

The shareholders value of the newly formed firm after merger date
= The total of [the stand-alone shareholders value of each firm
before press release of merger]
+ [Total present value of annual residual profits for the newly formed
firm after merger].

7. The present value of synergy effect (= C ) is the sum of the present values of
RIt that is the expected value of “Residual Profit” at period t, denoted in the
end note (6) above.
8. The following is a supplementary explanation.
From the first equation in the end note (4), the following can be derived:

Since

Total market value of newly formed firm after the merger = X + Y,

Merger ratio
= {X/number of issued shares of nonsurviving firm}
÷ {(X + Y )/(number of issued shares of surviving firm prior to Merger
+ number of new offering shares on merger date)}.
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Acquisition Price as an Incentive Price of M&A 91

So Merger Ratio can be calculated as above, too. However, since “X + Y = Total

market value of newly formed firm after Merger”, the denominator on the
right side = the share price of newly formed firm after Merger.
And this can be rearranged as:

“Merger ratio = the stock price of nonsurviving firm on merger date

÷ the stock price of surviving firm on merger date”

This equation is the exactly same as the formula (7).

References
Japan Institute of Certified Public Accountants, Professional Group of Corporation
Valuation (2007). Valuation approaches and methods of corporation value, as
the material 1 of Guideline for Corporation Value, Research material (in
Japanese).
MacKinsey & Co., Inc. Copeland, T., Koller, T., and Murrain, J. (2000).
Valuation: Measuring and Managing The Value of Companies, 3rd edn. John
Wiley & Sons.
Maekawa, N., Nodera, D. and Matsushita, M. (2005). Basics of M&A, Nikkei Inc.
(in Japanese).
Miller, M. and Modigliani, F. (1961). Dividend policy, growth, and the valuation
of shares, Journal of Business, XXXIV(4) (October 1961), 411–433.
Monden, Y. (1989). Foundation of Transfer Price and Profit Sharing, Dobunkan
Pub. Co. (in Japanese).
Monden, Y. (1991). Development of Transfer Price and Profit Sharing, Dobunkan
Pub. Co. (in Japanese).
Okumura, M. (2007a). Analysis and investigation of acquisition premium, in
Proceedings of Conference 2007 of Japan Association of Management
Accounting (in Japanese).
Okumura, M. (2007b). Analysis and investigation of acquisition premium,
in Handout Resume in the Conference of Japan Association of Management
Accounting, September 8th (in Japanese).
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Part 3

Analysis of Accounting Information

for Consolidated and Business Group
and Segmental Business Units
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7
Consolidated Accounting Information
for Business Group Management
Manabu Takano
Department of Commerce, Seinan Gakuin University

1. Introduction
Although in business group management the final consolidated results
are reflected in the consolidated financial statements, the institutional
consolidated accounting information is not always useful for bringing
about improvements in the performance of business group management.
The overall financial situation and the strengths and weaknesses of the
respective business groups can be deduced from the consolidated financial
statements. Nevertheless, it is difficult to introduce business management
practices that would improve the consolidated results using only the
collated financial information for the entire business group. To improve
business group management, in addition to the institutional consolidated
accounting information, it is necessary to have the consolidated accounts
of the divisions of a parent company, the divisions’ affiliated companies,
and associated companies.
This paper deals with consolidated accounting information for business
group management, and examines the consolidated financial statements
prepared by businesses and the nature of performance evaluation. In par-
ticular, we look at Canon, which manages its business group using business
consolidation. Since only 10% of the listed companies in Japan have shifted
to the holding company system (December 10, 2008; Nihon Keizai
Shimbun), this paper concentrates on the “operating holding company”
system.

95
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96 Manabu Takano

2. Differences between Institutional Consolidated

Accounting Information and Consolidated
Accounting Information for Business
Group Management
We propose that the institutional consolidated accounting information
and consolidated accounting information necessary for business group
management differ in the following two respects.

2.1. Scope of consolidation

The scope of consolidation is different between institutional consolidated
accounting and consolidated accounting for business group management.
In the institutional accounting system, the criteria by a rate of equity stake
apply to the disclosure of consolidated financial statements. In contrast, in
business group management, the scopes of the affiliated companies and
associated companies in the consolidated accounts do not correspond to
the overall scope of the business group management. As shown in Fig. 1,
the scope of consolidation in consolidated accounting consists of Part A and
Part B, whereas the scope of consolidation required for business group
management consists of Part A and Part C. Part B represents the affiliated
companies and associated companies that are not part of the strategy for
improving the consolidated business results, although as a matter of form
Part B is included in the scope of consolidation as an institutional object
of consolidation. Part C represents the companies that constitute a supply
chain and execute business processes, such as manufacturing and sales,
although they are not included in the scope of institutional consolidation.
That is, in business group management, those companies that are linked to

Scope of consolidation in Scope of consolidation in

consolidated accounting business group management

B A C

Fig. 1. Differences in the scope of consolidation between consolidated account-

ing and business group management. Adapted from Muto (2002, p. 14).
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Consolidated Accounting Information 97

the business executive functions of the business groups and assume the
strategies of business group management are included in the scope of
consolidation, even though these companies are not the objects of institu-
tional consolidation (Kimura, 1999).

2.2. Types of consolidated accounting information

The management of the business group analyzes the business group using
the consolidated financial statements as part of the evaluation of the
performance of the entire group. However, certain limitations and caveats
are attached to the analysis of consolidated financial statements.
It is necessary to be careful about return on equity (ROE), which in
recent years has been referred to as the index for the management target
of Japanese companies, since ROE is high when the debt is large and equity
capital is very low. The ROE increases if the equity capital is low and
financial leverage is strong, even if the ratio of profit to net sales is low.
Although the analysis of consolidated financial statements has the
aforementioned limitations, it provides outside interested parties with
financial information on the entire business group, and it provides the
management of the business group with valuable information on the finan-
cial situation of the entire business group, particularly with respect to the
strengths and weaknesses of the business group and potential strategies for
improving performance. However, the management of the business group
cannot obtain concrete information that can be used to improve the
consolidated results, even if it grasps the overall financial situation of the
business group from analyzing the consolidated financial statements. Since
the consolidated financial statements represent financial information on
the entire group as a unit, they are insufficient for the needs of business
management (Kimura, 2005). To obtain information that is useful for the
management of a business group, it is necessary to break down the
consolidated accounting information for the entire business group.

3. Information on Consolidated Accounting

that is Indispensable for Business Group Management
3.1. Consolidated financial statements by business
There are various forms of business group management. If the business
group is assumed to be an operating holding company, the parent company
comprises more than one division, and under the control of the parent
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98 Manabu Takano

company the affiliated and associated companies assume the processes of

manufacturing and sales. The formulation and implementation of strategy
for each consolidated business are essential to improving the performance of
the business group management, and the accounting information for each
consolidated business becomes useful for the business group management.
Since the self-contained activities of consolidated businesses are carried
out by affiliated and associated companies, which assume responsibility for
development, production, and sales under the control of individual divi-
sions of the parent company, each consolidated business has independent
management responsibility for both income and expenses, i.e., profit
responsibility. Accordingly, each consolidated business prepares a consoli-
dated profit-and-loss statement, which makes it possible to grasp the level
of profitability and to analyze growth potential in terms of the rate of
increase in sales and the rate of new products that account for of the sales
amount.
Furthermore, in consolidated businesses, consolidated balance sheets
and consolidated profit-and-loss statement are prepared. These documents
are helpful for decision making, as each division of the parent company
can extract information on the accumulated profit or loss of the consoli-
dated business, the debts payable, and the consolidated ROE (Hiki, 1998).
Indeed, from 1997 through 2001. Mitsubishi Corporation adopted the
consolidated in-house capital stock system, and consolidated balance sheet
for each sales department was prepared (May 25, 1997 and March 23,
2001; Nihon Keizai Shimbun). At Mitsubishi, the consolidated in-house
capital stock was determined by aggregating the balances of the surpluses
of the group companies and adding the in-house capital stock, which was
based on the results of the sales divisions and took into account foreign
exchange losses. At Mitsubishi, the person in charge of each sales division
took into consideration the balance sheet of the entire group by preparing
a consolidated balance sheet for the sales division, and the business group
was managed by setting a target value for the consolidated ROE (May 25,
1997; Nihon Keizai Shimbun).
Furthermore, in a consolidated business, a consolidated cash-flow
statement is prepared. The consolidated cash-flow statement prepared by
the business reveals various indices that can be used in analyses of the
cash flow and cash-flow cycle of each consolidated business, thereby
providing information that is helpful implementing improvements in the
cash flow for each consolidated business. In addition, decision-making
information for fund raising and information useful for developing the
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Consolidated Accounting Information 99

business strategy can be obtained by determining the free cash flow after
subtracting the investment cash flow from the operating cash flow for each
consolidated business (Fushimi, 1998).

3.2. Performance evaluation index

In business group management, as mentioned above, the consolidated
financial statements are prepared by the business. Previously, the budget
was drafted by the consolidated business, and performance was evaluated
by comparing the budget against the results.
The indices for performance evaluation are roughly classified into
financial and nonfinancial. For the financial indices, return-on-capital
indices, such as ROI and ROE, are used in addition to income determi-
nation indices, such as sales amount and profits, which have been used
traditionally. Since achievements related to cash flow and the parent
company’s dividend are required of each consolidated business (Asada,
1999), the cash flow and free cash flow are also used as indices for
performance evaluation. Thus, for performance evaluation using financial
indices, a well-balanced management uses various indices, such as income
determination, return-on-capital, and cash-flow indices, instead of a single
index (Asada, 1999).
With regard to nonfinancial indices, to evaluate qualitative factors,
indices associated with the future growth potential of each business and
indices associated with the degree of attainment of business plans are
used. Future growth potential encompasses quality, productivity, market
share, customer satisfaction, the results of new product development,
and safety factors (Hoshino, 1999). The degree of attainment of a business
plan means the extent to which a business strategy is executed
(Moriyama, 2003).
These performance evaluation indices should be created based on the
objectives, vision, and strategy of the entire group rather than on those
of the individual divisions of the parent company. Each company in the
business group must match its own performance evaluation criteria to
those of the divisions of the parent company, to ensure consistency across
the consolidated businesses (Terasawa, 2000). In addition, the establish-
ment of performance evaluation indices motivates each employee within
the group to attain the goals of the entire group (Hamada, 2007).
The above-mentioned performance evaluation is used in decision making
by business group executives, who evaluate the performance of each
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100 Manabu Takano

consolidated business and make decisions as to resource allocation, such

as the types of business investment that should be made or whether or not
investment should be withdrawn. In general, the management of each
consolidated business uses the performance evaluation index for the sub-
sequent formulation and implementation of business strategies.

4. Case Study: Canon Inc.

4.1. Adoption of the consolidated divisional organization
Canon Inc. (hereinafter referred to as ‘Canon’) was founded in 1937 as a
company that was engaged in the manufacturing and sales of cameras.
Today, Canon is a global business group based in Japan and overseas that
is engaged in development, production, marketing, and customer service
in the areas of business machines, cameras, and optical equipment. The
consolidated sales of Canon group in 2007 were 39.3 billion dollars, and
the consolidated current net profit is about 4.3 billion dollars (U.S.
accounting standards). The group consists of 239 consolidated subsidiaries
and 131,352 employees.
In 1996, Canon worked out the “concept of global quality company
group.” This concept was incorporated into a matrix management system,
and the consolidated divisional organization was adopted as the core
mechanism to support this system. The matrix management adopted by
the Canon group is a group-management technique (Fig. 2), in which the
main bodies of Canon, the manufacturing company and sales company, are
deployed longitudinally. In addition, the six operational headquarters,
which include the imaging business machine headquarters, peripheral
equipment headquarters, and ink-jet printer headquarters, are deployed
transversely. This matrix management requires the maximization of
individual company profits by creating a physical relationship between the
individual companies (vertical axis) and operational headquarters
(horizontal axis), and requires the maximization of the consolidated
operational headquarter profits (Sawago, 1998). Through matrix manage-
ment, Canon has come to place greater emphasis on the performance
management of the operational headquarters and the company.

4.2. Performance determination system for each

consolidated operational headquarters
Canon started to implement the performance determination system
for each consolidated operational headquarters to put the consolidated
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Consolidated Accounting Information 101

Operational Operational Headquarters

headquarters headquarters of each

Pursuit of maximum profit by each company

A B company

Canon Inc.

Manufacturing
company

Sales company

Maximization of profit for each consolidated operational headquarters

Fig. 2. Conceptual drawing of the matrix management at Canon. From Sawago

(1998, p. 113, partly modified).

operational headquarters system into practice. This is a system of monthly

performance management in which the budget by company and by oper-
ational headquarters is prepared and compared with past results.
A comprehensive and multifaceted performance evaluation of each
operating headquarters, manufacturing company, and sales company is
made semiannually based on a long-term perspective, in terms of man-
agement indices such as profitability, growth potential and safety, as well
as indices other than management indices such as the technology, devel-
opment capability, proprietary technology, and market share. Table 1
shows an example of the items and indices for the performance evaluation.
At Canon, these evaluation items are rated and each business performance
is ranked with overall points. However, such rankings are not directly asso-
ciated with personnel evaluation or remuneration by the heads of the
operational headquarters. Instead, the purpose of such rankings is to grasp
the strong and weak points of one’s own department or company with the
aim of future improvement.
As just described, Canon aims at utilizing its management resources
to the utmost extent on a global basis through matrix management by
adopting the consolidated operational headquarters system and through
the performance determination system for each consolidated operational
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102 Manabu Takano

Table 1. An example of the items and indices for the consolidated performance
evaluation at Canon. Adapted from Yanagihashi (2002, p. 8).

Evaluation item Evaluation index

Management indices
Profitability Return on total assets (ROA),
pretax profit ratio on sales
Growth potential Sales growth ratio, profit growth
ratio
Safety Degree of dependence on loan,
ratio of investment in plant, and
equipment/cash flow

Indices other than management indices

Technology development capability Qualitative evaluation of
technological potential
Proprietary technology Number proposed per employee,
income from license
Market share Market shares of main products

headquarters to support matrix management in terms of accounting. At

Canon, it has become easier to build up close communication between the
operational headquarters and the manufacturing/sales companies through
performance management and performance evaluation on a consolidated
basis (Sawago, 1998).

5. Conclusion
In this paper, the consolidated accounting information by business is
examined, as the consolidated accounting information is indispensable
to business group management. Although the results of business group
management will eventually be reflected in the consolidated financial
statements, the institutional consolidated accounting information alone,
in which the entire business group is treated as a unit, cannot provide
information useful to the performance improvement of business group
management. In business group management, it becomes necessary to
break down the consolidated accounting information for the entire
business group and extract the accounting information therefrom.
Accordingly, the author feels that, in business group management, it
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Consolidated Accounting Information 103

becomes necessary to conduct business management through a consoli-

dated business consisting of each division of the parent company as a core,
and affiliated companies and associated companies under the control
thereof. In a consolidated business, the consolidated financial statements
by business are prepared, and performance is evaluated using multifaceted
evaluation items. In fact, at Canon, the consolidated operational head-
quarters system that grasps the divisions of the parent company on a
consolidated basis is adopted, and performance is managed monthly and
evaluated semiannually by preparing the consolidated financial statements
for each operational headquarters for the purpose of the business man-
agement of the business group.
In this paper, the consolidated accounting information for business
group management is examined based on the structure of the operating
holding company, but what kind of accounting information should be used
in the case of business group management that adopts the structure of the
holding company? Is there any essential difference from the structure of the
operating holding company? Also, in the performance evaluation of a con-
solidated business, when the items requiring evaluation are too diversified,
the target of the entire business group may be inconsistent with that of the
consolidated business. In that case, would the management of the consoli-
dated business, which is the object of the performance evaluation, not have
difficulty in finding what should be targeted and what should be improved?
These questions are left as future tasks to be resolved.

References
Asada, T. (1999). Issues of diversification and globalization in performance meas-
urement, Kigyou-kaikei, 51(4), 18–23 (in Japanese).
Fushimi, T. (1998). Cash flow information to support management strategy,
Kigyou-kaikei, 50(8), 42–53 (in Japanese).
Hamada, K. (2007). The role of group headquarters, and evaluation system of
group performance: Matrix evaluation system, The Commercial Review of
Seinan Gakuin University, 53(3–4), 1–24 (in Japanese).
Hiki, F. (1998). Consolidated information as management accounting information,
Sangyou-keiri, 58(1), 88–97 (in Japanese).
Hoshino, Y. (1999). Incentives and diversity in the performance evaluation of
Japanese companies, Kigyou-kaikei, 51(4), 24–31 (in Japanese).
Kimura, I. (1999). Management accounting information of group company organ-
izations: From divisional companies to group companies, The Journal of
Management Accounting, Japan, 7(1–2), 137–157 (in Japanese).
b853_Chapter-07.qxd 4/21/2010 3:01 PM Page 104
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104 Manabu Takano

Kimura, I. (2005). Management Accounting for Business Groups, Zeimukeiri-kyokai

(in Japanese).
Moriyama, C. (ed.) (2003). Strategy for the Maximization of Company Values in
a Business Group, and Management System, Business Research Institute
(in Japanese).
Mutou, Y. (2002). Seven New Common Senses for the Business Group Manage-
ment — From Investors’ Viewpoint to Companies’ Viewpoint, Chuokeizaisha
(in Japanese).
Sawago, R. (1998). Canon — The Concept of Global Quality Company Group and
Measures for Facilitating Consolidated Management Innovation, in The
Research Project for Consolidated Management Innovation (ed.). Information
Packet for Business Group Innovation and the Management of Associated
Companies, Japan Management Association, pp. 101–119 (in Japanese).
Terasawa, N. (2000). True Picture of Business Group Management, Nihon Keizai
Shimbunsha (in Japanese).
Yanagihashi, K. (2002). Business group management and business group perform-
ance management at Canon, Keiei Jitsumu, 06, 4–9 (in Japanese).
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8
Business Evaluation of a Company
Group in Japan: A Case Study
of Segment Reporting by
Panasonic Electric Works
Shufuku Hiraoka
Faculty of Business Administration, Soka University

1. Introduction
The so-called “management approach” in segment reporting is based on
the organization of segments internally for the purpose of making operat-
ing decisions and assessing performance (Epstein et al., 2007; Huefner
et al., 2007). Japanese companies will be obligated to introduce this
approach from March 2011 (Hiraoka, 2007); however, Panasonic Electric
Works has been applying this approach in advance (Hiraoka, 2007). Using
a case study of segment reporting by Panasonic Electric Works, this paper
will show an analysis of business evaluation based on economic profit.

2. Organizational Innovation and the Management

Approach
The Panasonic Electric Works Group introduced the intra-company
system in November 1998. An intra-company is not a corporation but a
kind of imitative company. In Japan, it is an investment center which has
more authority than an operating division. Panasonic Electric Works
organized five intra-companies, Electrical Construction Materials, Home
Appliances, Building Products, Electronic and Plastic Materials, and
Automation Control. However, each intra-company consolidated func-
tional overseas subsidiaries, and each became a subgroup in accordance
with the purpose of management. At the same time, economic profit was

105
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106 Shufuku Hiraoka

adopted as the basis for business evaluation. When Panasonic Electric

Works became a subsidiary of Panasonic Electric Industrial in April 2004,
the Panasonic group’s brands were unified (Hiraoka, 2006).
Thereafter, Panasonic Electric Works introduced the marketing head-
quarter system to develop marketing strategies for every area and category.
Therefore, Panasonic Electric Works took over some parts of the business
belonging to Electrical Construction Materials, Home Appliances and
Building Products from Panasonic Electric Industrial. On the other
hand, it transferred some parts of Home Appliances to Panasonic Electric
Industrial. In this way, business restructuring was performed between the
parent company and its subsidiaries.
Having introduced the intra-company system, Panasonic Electric
Works has been disclosing the segment reporting based on the manage-
ment approach since November 1999. The originality of Panasonic Electric
Works in segment reporting has been maintained even after becoming the
subsidiary of Panasonic Electric Industrial. This remarkable tendency
continues to manifest in the annual report. The segment’s income state-
ments, balance sheets, and cash flow statements have been disclosed since
2000. Such detailed contents cannot be seen in the other companies’
reports. Of course, segment reporting must be derived from the manage-
ment accounting information. The chief operating decision makers are able
to not only arrive at better decisions, but also more accurately evaluate
performance for the given business segment when using these reports
together with other internal information; these data are collectively more
detailed and more helpful than they would otherwise be for measuring and
improving the corporate value.

3. Measuring the Entire WACC

In the case of Panasonic Electric Works, the economic profit of every
segment can be measured using the information obtained based on the
management approach. But before we can measure the economic profit of
the business segment, we must calculate the cost of capital.
First, the entire cost rate of equity capital must be calculated. We can
use the capital asset pricing model (CAPM) to perform the calculation.
The β-value can be estimated as the regression coefficient between the
variance rate of TOPIX (Tokyo Stock Exchange 1st Section Price Index)
and that of the stock price of Panasonic Electric Works from April 2002
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Business Evaluation of a Company Group in Japan 107

to March 2008 using the least squares method. The risk-free rate (Rf ) is
estimated as the average of rate of government bonds from April 2002 to
March 2008. Rm is the expected return on the stock market. We assume
it to be 8% here. The entire cost rate of equity capital (Re) can then be
calculated as follows:

The entire cost rate of equity capital on March 31, 2007:

Re = Rf + β * (Rm − Rf) = 1.39% + 0.91 * (8% − 1.39%) = 7.4%.
The entire cost rate of equity capital on March 31, 2008:
Re = Rf + β * (Rm − Rf) = 1.49% + 0.85 * (8% − 1.49%) = 7.0%.
Next, we must calculate the average of the ending and beginning
liabilities with interest:

The average of the liabilities with interest as of March 31, 2007

= (51,049 + 51,678 + 36,552 + 51,889)/2 = 95,584 Yen (millions).

The average of the liabilities with interest as of March 31, 2008

= (36,552 + 51,889 + 54,998 + 21,726)/2 = 82,582.5 Yen (millions).
The tax rates are calculated in the same way as the segment’s taxes
rate, as follows:

The tax rate

= income taxes/income before income taxes and minority interests.
The tax rate as of March 31, 2007
= 30,935/79,945 = 0.387.
The tax rate as of March 31, 2008
= 32,226/82,665 = 0.390.
We must also calculate the average of the market capitalization:
Market capitalization
= stock price * the number of issued and outstanding.
Market capitalization on March 31, 2006
= 1,413 Yen * 733.21 millions = 1,036,026 Yen (millions).
Market capitalization on March 31, 2007
= 1,351 Yen * 733.21 millions = 990,567 Yen (millions).
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108 Shufuku Hiraoka

Market capitalization on March 31, 2008

= 1,025 Yen * 751.07 millions = 769,847 Yen (millions).
The average of the market capitalization as of March 31, 2007
= (1,036,026 + 990,567)/2 = 1,013,296.5 Yen (millions).
The average of the market capitalization as of March 31, 2008
= (990,567 + 769,847)/2 = 880,207 Yen (millions).

The interest as of March 31, 2007 is 3,647 Yen (millions), and that as of
March 31, 2008 is 3,699 Yen (millions). Therefore, we can calculate the
entire weighted-average cost of capital (WACC) as follows:

WACC as of March 31, 2007 (%)

= {3,647 * (1 − 0.387) + 0.074 * 1,013,296.5}/(95,584 + 1,013.296.5) * 100
= 7%

WACC as of March 31, 2008 (%)

= {3,699 * (1 − 0.390) + 0.070 * 880,207}/(82,582.5 + 880,207) * 100 = 7%
In this connection, the entire rate of liabilities with interest before taxes
is calculated as follows:

The interest rate as of March 31, 2007 (%)

= 3,647 * 100/95,584 = 3.8 %.
The interest rate as of March 31, 2008 (%)
= 3,699 * 100/82.582.5 = 4.5%.

4. Measuring the WACC of Each Business Segment

We need to know the WACC of each business segment when we want
to calculate the segment’s economic profit. We apportion the market cap-
italization to the business segment on a distribution basis with the total
equity (net assets) of the segment. In the annual reports of Panasonic
Electric Works, the total equity of every segment on the consolidated
balance sheets is listed by business segment. The total of the segment’s
total equities is as follows:

March 31, 2006: 439,675 Yen (millions)

March 31, 2007: 517,129 Yen (millions)
March 31, 2008: 538,461 Yen (millions)
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Business Evaluation of a Company Group in Japan 109

The distribution amount of the market capitalization of each segment

is calculated as follows:
As of March 31, 2007: Yen (millions)
Market capitalization distributed to Electrical Construction Materials
= 1,013,296.5 * (159,300 + 192,145)/(439,675 + 517,129) = 372,195.
Market capitalization distributed to Home Appliances
= 1,013,296.5 * (54,920 + 58,490)/(439,675 + 517,129) = 120,106.
Market capitalization distributed to Building Products
= 1,013,296.5 * (98,232 + 100,284)/(439,675 + 517,129) = 210,237.
Market capitalization distributed to Electronic and Plastic Materials
= 1,013,296.5 * (40,014 + 48,603)/(439,675 + 517,129) = 93,849.
Market capitalization distributed to Automation Control
= 1,013,296.5 * (58,161 + 78,215)/(439,675 + 517,129) = 144,428.
Market capitalization distributed to others
= 1,013,296.5 * (29,048 + 39,392)/(439,675 + 517,129) = 72,481.

As of March 31, 2008: Yen (millions)

Market capitalization distributed to Electrical Construction Materials
= 880,207 * (192,145 + 211,873)/(517,129 + 538,461) = 336,892.
Market capitalization distributed to Home Appliances
= 880,207 * (58,490 + 57,545)/(517,129 + 538,461) = 96,756.
Market capitalization distributed to Building Products
= 880,207 * (100,284 + 92,224)/(517,129 + 538,461) = 160,523.
Market capitalization distributed to Electronic and Plastic Materials
= 880,207 * (48,603 + 50,613)/(517,129 + 538,461) = 82,732.
Market capitalization distributed to Automation Control
= 880,207 * (78,215 + 81,367)/(517,129 + 538,461) = 133,068.
Market capitalization distributed to others
= 880,207 * (39,392 + 44,839)/(517,129 + 538,461) = 70,236.
Since the liabilities with interest of every segment are disclosed, the aver-
age of the beginning and ending is calculated for every segment as follows:
The average as of March 31, 2007: Yen (millions)
The liabilities with interest of Electrical Construction Materials (ECM)
= (61,419 + 1,610 + 51,129 + 1,788)/2 = 57,973.
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110 Shufuku Hiraoka

The liabilities with interest of Home Appliances (HA)

= (620 + 25 + 1,151 + 25)/2 = 910.5.
The liabilities with interest of Building Products (BP)
= (23,941 + 2,030 + 17,789 + 3,264)/2 = 23,512.
The liabilities with interest of Electronic and Plastic Materials (EPM)
= (18,925 + 2,354 + 10,001 + 111)/2 = 15,695.5.
The liabilities with interest of Automation Control (AC)
= (13,136 + 14,194 + 14,062 + 16,484)/2 = 28,928.
The liabilities with interest of others
= (6,730 + 30,392 + 6,321 + 30,573)/2 = 37,008.
The average as of March 31, 2008: Yen (millions)
The liabilities with interest of ECM
= (51,129 + 1,788 + 47,143 + 45,229)/2 = 72,644.5.
The liabilities with interest of HA
= (1,151 + 25 + 555 + 0)/2 = 865.5.
The liabilities with interest of BP
= (17,789 + 3,264 + 26,104 + 3,588)/2 = 25,372.5.
The liabilities with interest of EPM
= (10,001 + 111 + 3,256 + 682)/2 = 7,025.
The liabilities with interest of AC
= (14,062 + 16,484 + 14,755 + 15,000)/2 = 30,150.5.
The liabilities with interest of others
= (6,321 + 30,573 + 8 + 27,422)/2 = 32,162.

Not only the income taxes, but also the income before taxes and minority
interests are disclosed. Therefore, we can calculate the tax rate for each seg-
ment except Building Products, which has a deficit (Solomons, 1965, 1968).
Let us suppose that Building Products’ tax rate is equal to the total one.

As of March 31, 2007:

The taxes rate for ECM = 16,045/39,157 = 0.410

The taxes rate for HA = 1,976/7,169 = 0.2756
The taxes rate for BP = 0.387
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Business Evaluation of a Company Group in Japan 111

The taxes rate for EPM = 1,907/7,479 = 0.255

The taxes rate for AC = 5,793/13,698 = 0.423
The taxes rate for others = 2,919/7,415 = 0.3937.

As of March 31, 2008:

The taxes rate for ECM = 18,391/43,541 = 0.422

The taxes rate for HA = 2,012/6,556 = 0.307
The taxes rate for BP = 0.390
The taxes rate for EPM = 2,145/7,729 = 0.2775
The taxes rate for AC = 5,633/14,693 = 0.383
The taxes rate for others = 5,363/13,157 = 0.4076.

Finally, the WACC of each business segment is calculated as follows:

As of March 31, 2007:

WACC of ECM
= {57,973 * (1 −0.410) * 3.8% + 372,195 * 7%}/(57,973 + 372,195) = 6.36%
WACC of HA
= {910.5 * (1 − 0.2756) * 3.8% + 120,106 * 7%}/(910.5 + 120,106) = 6.96%
WACC of BP
= {23,512 * (1 −0.387) * 3.8% + 210,237 * 7%}/(23,512 + 210,237) = 6.53%
WACC of EPM
= {15,695.5 * (1−0.255) * 3.8% + 93,849 * 7%}/(15,695.5+93,849) = 6.40%
WACC of AC
= {28,928 * (1 −0.423) * 3.8% + 144,428 * 7%}/(28,928 + 144,428) = 6.20%
WACC of others
= {37,008 * (1 −0.3937) * 3.8% + 72,481 * 7%}/(37,008 + 72,481) = 5.41%

As of March 31, 2008:

WACC of ECM
= {72,644.5 * (1 −0.422) * 4.5% + 336,892 * 7%}/(72,644.5 + 336,892)
= 6.22%
WACC of HA
= {865.5 * (1 − 0.307) * 4.5% + 96,756 * 7%}/(865.5 + 96,756) = 6.97%
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112 Shufuku Hiraoka

WACC of BP
= {25,372.5 * (1−0.390) * 4.5% + 160,523 * 7%}/(25,372.5 + 160,523) = 6.42%
WACC of EPM
= {7,025 * (1 −0.2775) * 4.5% + 82,732 * 7%}/(7,025 + 82,732) = 6.71%
WACC of AC
= {30,150.5 * (1−0.383) * 4.5% + 133,068 * 7%}/(30,150.5 + 133,068) = 6.22%
WACC of others
= {32,162 * (1 −0.4076) * 4.5% + 70,236 * 7%}/(32,162 + 70,236) = 5.64%

5. The First Method of Measuring Each

Segment’s Economic Profit
In addition to the above calculated results, we must measure the net oper-
ating profit after taxes (NOPAT) and the economic capital before we
calculate the economic profit of each segment. We define NOPAT as follows:

NOPAT = Operating income * (1 −taxes rate)

− amortization of the capitalized restructuring charge.

We can recognize the impairment loss of the segment as one of the restruc-
turing charges (Stewart, 1991). According to Young and O’Byrne (2001), a
good case can be made for the subsequent amortization of the capitalized
restructuring charge. We depreciate the capitalized impairment loss over
five years equally. The impairment loss of the segment has been disclosed
since 2007. Therefore, NOPAT as of March 31, 2008 (NOPAT08) is defined
as follows:

NOPAT08
= (Operating income08 − impairment loss08/5) * (1−taxes rate08)
− impairment loss07 * (1−taxes rate07)/5

The NOPAT08 of each segment is calculated as follows:

NOPAT08 of ECM = (44,706 −46/5) * (1 − 0.422)−446 * (1 − 0.410)/5

= 25,782 Yen (millions)

NOPAT08 of HA = (7,974 − 49/5) * (1 − 0.307)−0 * (1 − 0.2756)/5

= 5,519 Yen (millions)
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Business Evaluation of a Company Group in Japan 113

NOPAT08 of BP = (505 − 388/5) * (1 − 0.390)−5,429 * (1 − 0.387)/5

= ∆405 Yen (millions)
NOPAT08 of EPM = (7,404 −256/5) * (1 − 0.2775)−1,074 * (1 − 0.255)/5
= 5,152 Yen (millions)
NOPAT08 of AC = (15,379 − 0) * (1 − 0.383)−1,191 * (1 − 0.423)/5
= 9,351 Yen (millions)
NOPAT08 of others = (8,657−0) * (1 − 0.4076)−1,194 * (1−0.3937)/5
= 4,984 Yen (millions).

Next, the beginning of the economic capital as of March 31, 2008 (EC)
is defined as follows:

EC = Liabilities with interest07

+ noncurrent liabilities without interest07 + Total equity07
+ impairment loss07 * (1 − taxes rate07) * 4/5

The EC of each segment is calculated as follows:

EC of ECM = 51,129 + 1,788 + 50,670 + 192,145 + 446 * (1−0.410)*4/5

= 295,943 Yen (millions)
EC of HA = 1,151 + 25 + 790 + 58,490 + 0 * (1−0.2756) * 4/5
= 60,456 Yen (millions)
EC of BP = 17,789 + 3,264 + 28,274 + 100,284 + 5,429 * (1 −0.387) * 4/5
= 152,273 Yen (millions)
EC of EPM = 10,001 + 111 + 3,079 + 48,603 + 1,074 * (1−0.255) * 4/5
= 62,434 Yen (millions)
EC of AC = 14,062 + 16,484 + 7,386 + 78,215 + 1,191 * (1 −0.423) * 4/5
= 116,697 Yen (millions)
EC of others = 6,321 + 30,573 + 2,480 + 39,392 + 1,194 * (1−0.3937) * 4/5
= 79,345 Yen (millions)
The economic profit (EP) of each segment as of March 31, 2008 is calcu-
lated as follows:
EP = NOPAT−EC * WACC
EP of ECM = 25,782−295,943 * 6.22% = 7,374 Yen (millions)
EP of HA = 5,519 −60,456 * 6.97% = 1,305 Yen (millions)
EP of BP = ∆405−152,273 * 6.42% = ∆9,371 Yen (millions)
EP of EPM = 5,152−62,434*6.71% = 963 Yen (millions)
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114 Shufuku Hiraoka

EP of AC = 9,351−116,697 * 6.22% = 2,092 Yen (millions)

EP of Others = 4,984−79,345 * 5.64% = 509 Yen (millions).

From the calculations above, we can see that the economic profit of
Building Products is only deficit. The total of the economic profits of all
the segments is as follows:
Total of the economic profits
= 7,374 + 1,305 + ∆9,371 + 963 + 2,092 + 509
= 2,872 Yen (millions).

In the same way, the entire economic profit in the consolidated financial
statement is as follows:

EP = (83,923−1,052/5)*(1−0.390)
−(36,552 + 51,889 + 111,918 + 723,755
+ 9,387 * [1−0.387] * 4/5) * 7.0%
= ∆13,945 Yen (millions).

Thus, the entire economic profit is not equal to the total profit of the
segments because of the internal transactions between the segments and
the head office.

6. The Second Method for Measuring Each

Segment’s Economic Profit
As calculated above, the entire cost of capital is larger than the total cost
of the segments when we use the first method. The first reason for this is
that the total of liabilities with interest for the segments is larger than the
consolidated liabilities with interest due to the internal transactions within
the Panasonic Electric Works Group. In other words, the cost rate of the
liabilities with interest is smaller than the cost of equity capital. Therefore,
the WACC calculated by the first method is smaller. The second reason is
that the entire capital is larger than the total capital of the segments.
In such cases, if we look in Table 1, we can use the rates of revision. The
liabilities of each segment, WACC and economic capital are adjusted
(Adj.) as follows:
The average as of March 31, 2008: Yen (millions)
Adj. liabilities with interest of ECM
= [(51,129 + 1,788) * (1−0.4028) + (47,143 + 45,229) * (1−0.5824)]/2 = 34,612
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Business Evaluation of a Company Group in Japan 115

Table 1. Adjustment of the variance of the liabilities and equity:

Yen (millions).

The amount on March 31 2007 2008

Liabilities with interest

Consolidated
1 88,441 76,724
The total for the segments
2 152,698 183,742
Variance =
−
=

1 2 3 −64,257 −107,018
Rate of revision =
4 =
3 /

2 −0.4208 −0.5824
Non-current liabilities without interest
Consolidated
5 111,918 90,695
The total for the segments
6 92,679 73,694
Variance =
5 −
6 =
7 19,239 17,001
Total equity
Consolidated
8 723,755 734,710
The total for the segments
9 517,129 538,461
Variance =
8 −
9 =
10 206,626 151,249
The total of variance =
3 +
7 +

10 =

11 161,608 61,237
The total capital for the segments 762,506 795,897
=
2 +
6 +
9 =

12

Rate of revision =
13 =

11 /

12 0.2119 0.0770

Adj. liabilities with interest of HA

= [(1,151 + 25) * (1−0.4208) + (555 + 0) * (1−0.5824)]/2 = 456

Adj. liabilities with interest of BP

= [(17,789 + 3,264) * (1−0.4208) + (26,104 + 3,588) * (1−0.5824)]/2
= 12,297

Adj. liabilities with interest of EPM

= [(10,001 + 111) * (1 −0.4208) + (14,755 + 15,000) * (1 −0.5824)]/2
= 3,751

Adj. liabilities with interest of AC

= [(14,062 + 16,484) * (1−0.4208) + (14,755 + 15,000) * (1−0.5824)]/2
= 15,059

Adj. liabilities with interest of others

= [(6,321 + 30,573) * (1−0.4208) + (8 + 27,422) * (1−0.5824)]/2
= 16,412
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116 Shufuku Hiraoka

Therefore, the adjusted (Adj.) WACC of each segment is calculated

follows:

As of March 31, 2008:

Adj. WACC of ECM

= {34,612 * (1 −0.422) * 4.5% + 336,892 * 7%}/(34,612 + 336,892) = 6.59%

Adj. WACC of HA
= {456 * (1 −0.307) * 4.5% + 96,756 * 7%}/(456 + 96,756) = 6.98%

Adj. WACC of BP
= {12,297 * (1 −0.390) * 4.5% + 160,523 * 7%}/(12,297 + 160,523) = 6.70%

Adj. WACC of EPM

= {3,751 * (1 −0.2775)*4.5% + 82,732 * 7%}/(3,751 + 82,732) = 6.84%

Adj. WACC of AC
= {15,059*(1 −0.383)*4.5% + 133,068 * 7%}/(15,059 + 133,068) = 6.57%

Adj. WACC of others

= {16,412 * (1 −0.4076) * 4.5% + 70,236 * 7%}/(16,412 + 70,236) = 6.18%.

By using the rate of revision the capital in Table 1, we can calculate the
adjusted economic profit (Adj. EC) of each segment, as follows:

Adj. EC of ECM
= (51,129 + 1,788 + 50,670 + 192,145) * (1 + 0.2119) + 446 * (1−0.410) * 4/5
= 358,608 Yen (millions)

Adj. EC of HA
= (1,151 + 25 + 790 + 58,490)*(1 + 0.2119) + 0 * (1−0.2756)*4/5
= 73,267 Yen (millions)

Adj. EC of BP
= (17,789 + 3,264 + 28,274 + 100,284) * (1 + 0.2119) + 5,429*(1−0.387) * 4/5
= 183,976 Yen (millions)

Adj. EC of EPM
= (10,001 + 111 + 3,079 + 48,603) * (1 + 0.2119) + 1,074 * (1−0.255) * 4/5
= 75,511 Yen (millions)

Adj. EC of AC
= (14,062 + 16,484 + 7,386 + 78,215) * (1 + 0.2119) + 1,191 * (1−0.423) * 4/5
= 141,308 Yen (millions)
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Business Evaluation of a Company Group in Japan 117

Adj. EC of others
= (6,321 + 30,573 + 2,480 + 39,392) * (1 + 0.2119) + 1,194 * (1−0.3937) * 4/5
= 96,034 Yen (millions).

Finally, the adjusted economic profit (Adj. EP) of each segment is calcu-
lated as follows:

As of March 31, 2008:

Adj. EP of ECM = 25,782−358,608 * 6.59% = 2,150 Yen (millions)

Adj. EP of HA = 5,519 −73,267 * 6.98% = 455 Yen (millions)
Adj. EP of BP = ∆405−183,976 * 6.70% = ∆12,731 Yen (millions)
Adj. EP of EPM = 5,152 −75,511 * 6.84% = ∆13 Yen (millions)
Adj. EP of AC = 9,351 −141,308*6.57% = 67 Yen (millions)
Adj. EP of others = 4,984 −96,034* 6.18% = ∆951 Yen (millions).

Thus, the calculated results using the second method are different from
the results using the first method, in that three segments are in the red
with the second method.

7. Conclusion
Panasonic Electric Works has been applying the management approach
well in advance of the required deadline. It must be possible for us to ana-
lyze in detail the direction of decision making and performance of each
business segment if we can study cases analogous to this company’s case.
Unfortunately, we cannot find similar cases in other companies’ reports. In
this paper, we were able to measure the economic profit especially based
on detailed information regarding income and capital of each business seg-
ment. There is a capital information system called the “internal capital
system” in Japanese management accounting practice. Therefore, in line
with the original purpose of the management approach, Japanese compa-
nies would do best to disclose the capital information on each of their
segments. In this regard, Japanese segment reporting is potentially more
advanced.

References
Epstein, B. J. and Jermakowicz, E. K. (2007). Willey IFPS 2007: International
and Application of International Financial Reporting Standards, John
Willey & Sons.
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118 Shufuku Hiraoka

Hiraoka, S. (2005). Valuation and goal growth rate of business segments:

The case study of Matsushita Electric Works, Ltd. in Organization Design
and Management Accounting for Corporate Value, edited by Monden, Y.,
Zeim-keiri-kyokai, pp. 89–99 (in Japanese).
Hiraoka, S. (2006). Valuation of business based on EVA-type metrics in Japanese
companies, in Value-Based Management of the Rising Sun, edited by
Monden, Y., Miyamoto, K., Hamada, K., Lee, G. and Asada, T, World
Scientific, pp. 75–87.
Hiraoka, S. (2007). Changes in the concept of capital and their effects on economic
profit in Japan, in Japanese Management Accounting Today, edited by
Monden, Y., Kosuga, M., Nagasaka, Y., Hiraoka, S. and Hoshi, N., pp. 23–34.
Huefner, R. J., Largay, III., J. A. and Hamlen, S. S. (2007). Advanced Financial
Accounting, 10th edn., Thompson.
Stewart, III. G. B. (1991). The Quest for Value: The EVATM Management Guide,
Harper Business.
Solomons, D. (1965). Divisional Performance: Measurement and Control, Financial
Executive Research Foundation, New York.
Solomons, D. (1968). Accounting and some proposed solutions, in Public Reporting
by Conglomerates: The Issues, the Problems, and Some Possible Solutions,
edited by Rappaport, A., Peter, A. F. and Stephen, A. Z., pp. 91–104.
Young, S. D. and O’Byrne, S. F. (2001). EVA® and Value-Based Management: A
Practical Guide to Implementation, McGraw-Hill.
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Part 4

Management of Inter-firm Relations

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9
How Can Management Accounting
Achieve Goal Congruence Among Supply
Chain Partners?
Yoshiteru Minagawa
Faculty of Commerce, Nagoya Gakuin University

1. Introduction
One of the most consequential changes now rapidly occurring in many
markets is the trend toward shorter product life cycles. To overcome this
market challenge, it is particularly important that each company, as a
partner of a supply chain to which it belongs, creates more effective and
efficient information exchange and movement of goods processes within
the supply chain. This increases the importance of decision making
that involves the selection of a supply chain that companies may wish to
join to increase their profits. Thus, competition among supply chains is
becoming increasingly fierce in the current business environment.
Companies are motivated to become part of a supply chain to increase
their profits by enhancing the performance of the supply chain as a whole
(Schary and Skjøtt-Larsen, 2001, p. 29). However, reducing the risks of
opportunistic behavior by partners is one of the most critical issues that
must be dealt with in establishing an efficient supply chain management
system. According to Williamson, opportunistic action is defined as self-
interest seeking with guile (Williamson, 1996, p. 6). Guile includes
calculated efforts to mislead, distort, disguise, obfuscate or otherwise
confuse (Williamson, 1996, p. 378).
Opportunism manifests itself in the form of distortion information or
agreement violation in supply chains. Self-interest seeking actions with
guile allow partners to receive the benefits from without helping to pay for
the cost of performing the business. However, opportunistic behavior by
partners results in the failure to enhance the supply chain partnership and

121
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122 Yoshiteru Minagawa

its integration. Partners who initially carry out their business prioritizing
the increased performance of the supply chain as a whole can subsequently
come to behave in an opportunistic manner and create an adverse impact
(Jap and Anderson, 2003, p. 1685).
One of the most effective methods for managing opportunism is the
promotion of goal congruence. This study will develop an integrated man-
agement accounting system (MAS) that can be used to achieve the goal
congruence in supply chains and thereby discouraging the opportunistic
behavior by partners.

2. Literature Review
2.1. The SCOR-model
The Supply-Chain Operations Reference-model (SCOR) was developed in
1996 and upgraded repeatedly for a decade by the Supply-Chain Council,
with the aim of achieving a more efficient supply chain collaboration
(Supply-Chain Council, 2008).
The SCOR-model is beneficial when standardizing the processes of
supply chains (Meyr et al., 2000, p. 38). The SCOR-model is based on the
following five core management processes: (1) Plan. Processes for demand
and supply balancing to establish the operational activities which best
meet sourcing, production, and deliver requirements. (2) Source. Processes
associated with procuring goods and services to meet planned or actual
demand. (3) Make. Processes that transform raw materials and interme-
diates to finished products. (4) Deliver. Processes that provide finished
goods and services. (5) Return. Processes that return or receive returned
products (Supply-Chain Council, 2008). The framework of these five types
of management processes has commonality with that of Porter’s value
chain (Porter, 1985).
The SCOR-model provides some insights into the key success factors
of business performance among supply chain partners. That is, the effec-
tiveness and efficiency of a value chain’s operational execution with
individual partners in a supply chain depends substantially on the level of
integration of the supply chain as a whole. Furthermore, the important
determinants of an individual partner’s profits include increasing the effec-
tiveness and efficiency of each operational function (i.e., sourcing,
production, delivery, and return) and enhancing the integration of
the value chains comprised of these functions. Moreover, the business
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Goal Congruence among Supply Chain Partners 123

performance of a partner within a supply chain is influenced by the degree

of effectiveness and efficiency of the other partners’ value chains.

2.2. Inter-firm cost management

Surviving the competition among supply chains depends on the ability of
a supply chain to effectively and efficiently satisfy its own final customers
by quickly responding to the changing market. According to Porter (1996),
the achievement of sustainable growth by companies necessitates the
creation of innovative and low-cost business activities. He adds that the
heart of a company’s success is the creation and execution of innovative
activities required to generate customer value (Porter, 1996).
Activities consume resources (Kaplan and Cooper, 1998). Activity-
based costing (ABC) provides managers with an economic map, based on
activity-based cost, which illustrates the type and amount of resources
consumed by each activity conducted in defined sections of the company.
Additionally, under ABC, resource and activity drivers are helpful in
establishing more effective and efficient activities and to implementing
these activities successfully (Kaplan and Cooper, 1998).
As stated above, the amount of a resource consumed by the activities
of an individual partner in a supply chain is determined by how efficiently
the activities of the other partners in the supply chain are performed.
Therefore, using ABC throughout the entire supply chain is conducive to
increasing the performance level of the supply chain as a whole (Kaplan
and Anderson, 2007; Cokins, 2001; Dekker and Goor, 2000).
The following section will explain the positive impacts of applying
ABC across a supply chain based on Kaplan and Anderson (2007) and
Dekker and Goor (2000). Consider a supply chain consisting of two part-
ners: a producer and a retailer. The shipping and receiving activities of the
producer and retailer, respectively, form boundary-spanning responsibilities
assumed by each of the two companies. This leads to the interactive influ-
ence of both the shipping and receiving costs incurred by the producer and
retailer. Shifting a method of procurement in a supply chain changes the
amount of resources consumed by the producer in shipping as well as that
for receiving and stocking by the retailer. In this case, “the method for
ordering and receiving” is found to be a common cost driver of shipping
and receiving activities for the producer and retailer, respectively.
Based on Kaplan and Anderson (2007, pp. 122–144) and Dekker
and Goor (2000), let us suppose that the procurement method in the
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124 Yoshiteru Minagawa

above-mentioned supply chain is shifted from delivering large quantities of

goods at one time to shipping small quantities of goods frequently.
Consider in this case how much such a change in the procurement method
affects the costs incurred by the producer in shipping the goods and the
retailer’s receiving activities associated with them. The shifting of the pro-
curement method from shipping large quantities collectively to delivering
small quantities frequently results in the increased complexity of shipping
in the producer as well as receiving in the retailer, hereby bringing about
an increase in the amounts of resources consumed by both activities.
Consequently, the total amount of the costs incurred by both the producer
and the retailer under the frequent small quantities delivery method
exceeds the total of the two companies’ incurring costs under the infre-
quent large quantities shipping. However, when focusing on the retailer’s
costs of stocking goods, a shift in the procurement method to the frequent
small quantities delivery method is helpful to reduce the number of days
for stock-keeping, thereby decreasing the retailer’s stock-keeping costs.1

2.3. Time-driven activity-based costing

What motivates companies to be part of a certain supply chain is its
potential to effectively and efficiently function the customer-value-creation
chains consisting of the activities performed by its partners. To achieve the
sustainable growth of supply chains requires, above all, the highly
enhanced relevance of their value systems to satisfy their end customers.
In tackling this requirement, supply chain partners need information on
the time per activity and their costs. This intelligence or information
demand made by managers can be well met by time-driven activity-based
costing (Kaplan and Anderson, 2007). Therefore, time-driven activity-
based costing can contribute to more efficient and effective supply chain
management (Kaplan and Anderson, 2007, pp. 133–148).

3. Managing Supply Chain Opportunism

3.1. Opportunism in supply chains
Opportunism is divided into two forms: ex ante and ex post opportunism
(Williamson, 1985; Wathne and Heide, 2000). Among the former is a delib-
erate misrepresentation of information during the initiation phase of a new
transaction. The latter involves refraining from honoring agreements in
the ongoing transactions (Wathne and Heide, 2000).
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Goal Congruence among Supply Chain Partners 125

According to Wathne and Heide (2000), the causes for the emergence
of opportunistic behavior by partners include information asymmetry and
switching costs. Information asymmetry occurs when sellers possess no
information on buyers: sellers are therefore unable to detect buyers’
opportunistic behavior. Switching cost-driven opportunism arises in situ-
ation in which sellers are economically locked into their relationships with
buyers: sellers indulge in tolerating the buyers’ opportunistic behavior as
long as the losses incurred because of this behavior remain affordable to
the sellers (Jap and Anderson, 2003, pp. 42, 43).
Opportunism significantly challenges partners as it can take place
under any set of circumstances (e.g., Wathne and Heide, 2000). A point
for consideration on the causes of opportunism in supply chains is that
business exchanges in a supply chain often generate characteristics that
endanger the partnership with the passage of time (Jap and Anderson,
2003, p. 1685). This means that each supply chain is always facing the risk
of opportunism.

3.2. Controlling supply chain opportunism

This section will conduct a review of the relevant literature wherein the
control of opportunism is considered.
Wathne and Heide (2000) represent four different ways to control
opportunism. First, more effective monitoring of a partner’s behavior and
its outcomes contributes to managing opportunism. It is only if informa-
tion asymmetry exists in a supply chain that partners can continue to act
opportunistically without being detected. From this perspective, closer
monitoring can increase the ability to detect opportunistic behavior,
thereby reducing opportunism (Wathne and Heide, 2000, pp. 43–44).
Second, the incorporation of incentive systems into supply chain man-
agement is important in reducing the payoff from opportunism. At the
heart of the incentive systems is the building management mechanism,
wherein exerting efforts in collaboration with partners to increase the
overall performance of supply chains becomes more beneficial to the
sustainable growth of individual partners than acting opportunistically.
The introduction of the incentive systems to reduce opportunism requires
overcoming information asymmetry, and its rationale resides in the
following: when information about partners remains unknown due to the
existence of information asymmetry, it becomes more difficult to set up
an effective reward and penalty system for partners (Wathne and Heide,
2000, pp. 44–45).
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126 Yoshiteru Minagawa

Third, according to Wathne and Heide (2000, pp. 45–46), the priori
selection of partners who are inherently inclined not to act opportunisti-
cally before supply chains commence business is beneficial to managing
opportunism. A key to success in the selection strategy is establishing goal
congruence, which is the central theme of this study.
Fourth, opportunism in supply chains can be significantly reduced
whenever the goal of supply chains as a whole can be well aligned with
partners’ goals (Wathne and Heide, 2000, pp. 47–48).
Jap and Anderson (2003) propose three ways to reduce opportunistic
behavior by partners. First, the promotion of relationship-specific invest-
ments by supply chain partners is important to management opportunism
(Jap and Anderson, 2003, p. 1687). That is, as partners of a supply chain
increase their investments that are specific to other partners of the
supply chain, the partnership is solidified. In addition, aligning the goals
of the supply chain and the partners can keep the partners from acting
opportunistically (Jap and Anderson, 2003, p. 1688). Furthermore, consol-
idating trust and commitment in supply chains is crucial to increasing
the performance of the supply chains as a whole (Jap and Anderson,
2003, p. 1688).

4. Effects of Management Accounting on Goal

Congruence in Supply Chains
According to Wathne and Heide (2000), information asymmetry is a cause
of opportunistic behavior by exchange partners. As mentioned above, over-
coming opportunism involves methods such as monitoring, incentives,
selection, and goal congruence (Wathne and Heide, 2000). There are
important factors associated with information asymmetry and its influence
on opportunism: goal alignment is capable of reducing information asym-
metry and information sharing among supply chain partners should,
therefore, be encouraged. The theoretical rationale lies in aligning goals in
supply chains to increase partner awareness of the effects of the overall
supply chain performance on their own profits, which leads partners to
willingly commit themselves to sharing information among themselves.
Of the measures to reduce opportunism under information asymmetry
as proposed by Wathne and Heide (2000), goal congruence is the most
resilient (Wathne and Heide, 2000, p. 47). That is, to the extent that
partners’ profits become significantly affected by the overall performance
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Goal Congruence among Supply Chain Partners 127

of the supply chain and the alignment of individual partners’ with the
overall supply chain’s goals, partners can gain increased pay-offs by
engaging in cooperative partnership-based behavior even when they remain
unknowledgeable about partners’ private information. On the other hand,
monitoring and incentives as measures for managing opportunism require
private information about partners. Additionally, since supply chain man-
agement is directed at encouraging partners to behave in a manner that is
consistent with the overall goal of the supply chains, the essential aim of
the incentive strategy is to control opportunism by effectively aligning the
partners’ with the supply chains’ goals. Moreover, the important criterion
of selecting the partners is based on the ability to collaborate with other
partners to maximize the overall profits of the supply chain.
Based on an examination of the capabilities of the above-mentioned
measures for managing opportunism, it can be said that goal congruence
is the most effective way to overcome information asymmetry. In other
words, aligning the goals of a supply chain and its partners promotes infor-
mation sharing within the supply chain. Information sharing can enhance
the functions of monitoring, incentives, and selection.
This study sheds light on the impacts of three management accounting
systems — ABC (Kaplan and Cooper, 1998), balanced scorecard (BSC)
(Kaplan and Norton, 1996, 2001) and revenue sharing — on goal congru-
ence in supply chains. Prior to the detailed examination on the capabilities
of these management accounting approaches to achieve goal congruence, a
description of each follows.
First, to develop supply chain focused on customer value creation, it
is especially important to effectively manage the boundary-spanning
activities of partners. ABC is one of the most important managerial
systems for achieving customer-value creation. The introduction of ABC
across supply chain partners allows them to learn that an individual
partner’s activities influence the overall performances of the supply chain
as well as the other partners.
Second, a key driver for attaining sustainable growth in supply chains
is the use of the BSC for the inter-partner performance management. BSC
is effective in the creation and implementation of customer-value focused
strategies. Supply chain BSC is instrumental in the creation of a causal
relationship between the strategic goals of the supply chain as a whole and
the strategic planning by its partners. Consequently, supply chain BSC is
substantially helpful for partners to acknowledge that their own profits are
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128 Yoshiteru Minagawa

affected by the performance of the supply chain as a whole. This means

that supply chain BSC encourages the promotion of goal congruence.2
Third, sharing the overall financial output profits of supply chains
among its partners successfully promotes goal congruence within supply
chains.

5. Effects of ABC on Supply Chain Integration

A key success factor in surviving the competition among supply chains is
to meet consumer demands quickly and at a low cost. ABC is an effective
instrument to achieve quick and efficient consumer satisfaction. To
increase overall supply chain profits, it is important to manage the activ-
ities and concurrently reassign responsibilities for supply chain functions
across partner boundaries. To successfully achieve these, it is critical to
calculate activity-based costs. An ABC examination of both boundary-
spanning activities and functional shifts within supply chains results in the
enhanced combined effects of boundary-spanning activities as well as
lessened overall costs.
Furthermore, introducing ABC throughout a supply chain enables
its partners to become more aware of the following two requirements to
establish excellent supply chain strategies. First, an individual partner’s
profits are affected by the activities of the other partners. Second, the
overall performance of a supply chain is influenced by the activities
performed by all of the partners.
Let us suppose a supply chain comprising of a part producer and a
finished product producer. Moreover, assume that the part producer has
completed the shift from a batch to a one-piece flow production method.
This shift in the manufacturing method of the part producer results in
changes in the production of the finished product for the end producer.
For example, preceding the shift in the production method of the part
producer, the activity-based costs of manufacturing for the two partners
of the supply chain were commonly affected by batch-level cost drivers.
By contrast, the manufacturing costs of both partners are determined
by unit-level cost drivers subsequent to the part production method
shift.3
With ABC data, supply chain managers can evaluate alternatives to
the boundary-spanning activities of partners and the supply chain config-
uration. This means that inter-firm ABC within a supply chain can give
rise to enhanced goal congruence.4
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Goal Congruence among Supply Chain Partners 129

6. Using the BSC System to Promote Goal Congruence

One of the most significant benefits in participating in a supply chain is
its capability to achieve quick customer satisfaction at low cost. Looking
at the formulation of an individual firm’s strategy, its sustainable growth
is determined by the capability of satisfying the final consumer, even
though it is engaged in upstream functions far removed from the final
consumers. Consequently, the strategy of the entire supply chain is of
great importance for the competitive advantage of all the firms, regardless
of their role in the supply chain.
To effectively and efficiently achieve customer satisfaction, which is a
potential capability of supply chains, it is necessary to establish collabo-
ration and cooperation among the partners. This study focuses on
the “alignment of goals between a supply chain and the partner” to
encourage the partners to behave in a manner conducive to creating
customer value through the supply chain.
As mentioned above, using ABC throughout a supply chain is effective
in giving its partners a better understanding of the individual partner’s
own profits as determined by the other partners’ activities and the over-
all supply chain’s performance.
ABC data demonstrates how the partners’ profits and the performance
of supply chains as a whole are mutually influenced. Moreover, through the
participation of supply chain BSC, the partners can better understand that
the manner in which they run their own business affects the overall per-
formance of the supply chains. This results in enhanced goal congruence.
The literature review identifies two types of or approaches to supply
chain BSC. First, individual partners of a supply chain develop their
own BSC, into which the perspectives relating to supply chain strategies
and supply chain management are incorporated (e.g., Park et al., 2005).
Second, supply chain partners collaborate to establish an integrated
BSC for the performance of the supply chain as a whole (e.g.,
Zimmermann, 2002).
Supply chain management associated with BSC is instrumental in
creating a supply chain focused on customer value creation through a
collaborative partnership. In supply chain BSC, all partners jointly estab-
lish the key success factors toward creating customer value, followed by
setting up performance indicators as well as their targeted values for these
factors. What should not be overlooked is that the establishment of strate-
gies is identical to developing adaptive business measures that forecast a
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130 Yoshiteru Minagawa

transformation in a business environment: therefore, it is likely that strate-

gies will need to be amended to counteract unforeseen transformations in
a business environment.
Supply chain BSC thrives on the creation of new strategies to success-
fully adapt to changes in business environments through the evaluation of
performance by means of variances between actual and targeted values for
strategic goals. Analyses of variances on strategic goals in BSC enable the
rise of two types of signals. First, BSC generates signals indicating that
the previously determined key performance in achieving the strategic goals
is no longer effective in the successful execution of existing strategies.
With these signals, supply chain managers can effectively amend both
their tactics and key performance indicators. Second, BSC signals warn of
existing strategies that have failed in continuing to enjoy competitive
advantages because of drastic changes in the business environment. In this
case, managers are required to create and deploy strategies that can lead
to increased performance even in the face of a market shift.
Financial goals require the specific monitoring of “strategy malfunctions”
to enable targeted strategic executions over a period, which are divided by
the estimated overall periods for the execution of strategies. Its positive
effects reside in its ability to implement phased monitoring on the deploy-
ment of strategies using analyses of variances on strategic goals over a
period. A financial goal that can satisfy the requirement is a targeted cash
flow of the supply chains as a whole throughout the duration of a targeted
strategic execution (see Fig. 1).5

7. Revenue Sharing in Supply Chains

7.1. Precedence in studies
Sharing the overall revenue of a supply chain as a whole among its part-
ners is conducive to the promotion of aligning individual partners’ goals
with the overall supply chain’s goals. To actually obtain the positive
effects of revenue sharing in a supply chain on goal congruence, it is essen-
tial to determine a way of accurately capturing how much effort individual
partners have exerted toward enhancing value for the customers targeted
by the supply chain. Thus, one of the most rational methods of deciding
how to allocate the overall revenue of a supply chain to its partners is rev-
enue sharing based on each partner’s weighted overall consumed resource
costs or invested capital in relation to the individual partners’ investment
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Goal Congruence among Supply Chain Partners 131

Cash flow
Actual cash flow

+
Cash flow target

Time

Now is the time to create

new strategies
− Execution of the analysis of
variances on tactics for
existing strategies aiming
at creating new tactics that are
more relevant to the strategies

Fig. 1. Variation analysis for creating new strategies.

contributions toward the total supply chain profit (e.g., Jap, 2001;
Coughlan et al., 2001).
Coughlan et al. (2001) propose a promising method for allocating
the overall profits of a marketing channel to its members. The key
components of the method are outlined as follows. First, the costs of per-
forming individual activities in the entire marketing channel as a
proportion of total channel cost are calculated. Second, the customer
value generated through the performance of each marketing activity is
determined. Third, each marketing activity’s weighted proportional cost
with its value added is measured as “cost-value weight.” Fourth, each
channel member’s weighted average cost-value as summing up the cost-
value weight of activities performed by individual members is determined.
Last, based on the weighted average cost-value, the allocation of the
entire marketing channel profit — as calculated from the total revenue
minus all costs of running the channels — to members is executed
(Coughlan et al., 2001).
There have been improvements on the above-mentioned allocation of
total profit of a marketing channel as expounded by Coughlan et al.
(2001). First, according to Coughlan et al. (2001), ABC must be used in
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132 Yoshiteru Minagawa

calculating the costs of partners’ activities as a component of the alloca-

tion of the entire profits of a supply chain.6 Using ABC throughout the
entire supply chain can generate the costs of all activities performed by
the partners. Such ABC data within the supply chain enable the supply
chain managers to correctly decide which partners to engage for certain
activities as well as how to perform certain activities to increase the prof-
its of the entire supply chain. This activity map is a good tool for
estimating ABC. The estimated ABC refers to standard ABC. It is impor-
tant to use the standard ABC when allocating the overall performance of
the supply chain.
Second, it is not the total profit of a supply chain that is the financial
output to be distributed to the partners. Rather, the entire revenue of a
supply chain ought to be shared among its partners. Consider a supply
chain that adopts profit sharing. Let us also assume that a partner of the
supply chain succeeded in reducing the costs and increasing the profits
accordingly. However, profit sharing leads the partner to receive only a
fraction of the increased profit, thereby generating disincentives to invest
in further cost reduction efforts. In contrast, revenue sharing does not
diminish the motivation for partners to decrease their costs.7

7.2. Revenue sharing based on ABC

This section explains the means to allocate revenue using ABC data in
supply chains — a method based partly on Coughlan et al. (2001).
The issue of what part of the overall revenue or profit of a supply chain
ought to be shared among the partners is not considered. First, inter-
partner ABC in supply chains generates standard ABC for all the
activities performed by the partners as a whole. In addition, all the part-
ners in the supply chain cooperate to decide the amount of the
incremental final sales to be obtained by incurring a unit standard activ-
ity-based cost. The degree of the unit activity-based cost’s contribution
to the increase in final sales in supply chains needs to be measured for all
activities. Second, the weighted standard ABC along with the contribu-
tion rate of the unit standard ABC to final sales in supply chains is
calculated. Third, individual partners calculate their total value of the
weighted standard ABC. Last, individual partners obtain their own
shares of the overall supply chain revenue in proportion to their total
value of the weighted standard ABC.
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Goal Congruence among Supply Chain Partners 133

There is an alternative method to the above-mentioned revenue shar-

ing of the ABC method. Activity analysis is a process of ABC systems
that can identify customer value-adding and non-value-adding activities.
It is conceivable to share the entire revenue of a supply chain among its
partners exclusively based on the overall cost of value-adding activities in
participating firms while discarding the non-value-adding activities’ costs.
This revenue sharing method first measures the standard activity-based
cost for supply chain activities including value-adding and non-value-
adding ones, and then focuses on specific value-adding activities to
establish the total standard activity-based costs of value-adding activities
for individual partners. Last, each partner earns its share of the entire sup-
ply chain revenue based on its total standard activity-based costs of
value-adding activities.

8. Concluding Remarks
Reducing the risks associated with opportunistic behavior of partners is
one of the critical issues to be solved to achieve efficient supply chain
management. One of the most important means of managing opportunism
is the promotion of goal congruence. This study developed an integrated
Management Accounting (MA) system that can be used to achieve the
goal congruence in supply chains and thereby discourage the opportunis-
tic behavior by partners. The integrated MA system which the study
explained comprises of ABC, BSC, and revenue sharing.

Endnotes
1. The discussion on the impacts of the change of order system on activity based
costs of shipping, receiving, and stocking here is based on Kaplan and
Anderson (2007) and Dekker and Goor (2000).
2. The discussion on BSC here is based on Kaplan and Norton (1996) and
Kaplan and Norton (2001).
3. As for batch-level and unit-level cost drivers, see Kaplan and Cooper (1998).
4. The discussion on ABC here is based on Kaplan and Cooper (1998).
5. The discussion on BSC here is based on Kaplan and Norton (1996) and
Kaplan and Norton (2001).
6. Coughlan et al. (2001) stress the importance of using ABC.
7. As for the adverse effects of profit sharing on cost reduction, see Sappington
and Weisman (1996, pp. 232–233).
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134 Yoshiteru Minagawa

References
Cokins, G. (2001). Measuring costs across the supply chain, Cost Engineering,
43(10), 25–31.
Coughlan, A. T., Stern, L. W., Anderson, E. and El-Ansary, A. I. (2001) Marketing
Channels, 6th edn., Prentice Hall.
Dekker, H. C. and Goor, A. R. V. (2000). Supply chain management and man-
agement accounting: A case study of activity-based costing, International
Journal of Logistics: Research and Applications, 3(1), 41–52.
Jap, S. D. (2001). “Pie sharing” in complex collaboration contexts, Journal of
Marketing Research, 38, 86–99.
Jap, S. D. and Anderson, E. (2003). Safeguarding interorganizational performance
and continuity under ex post opportunism, Management Science, 49(12),
1684–1701.
Kaplan, R. S. and Anderson, S. R. (2007). Time-Driven Activity-Based Costing:
A Simple and More Powerful Path to Higher Profits, Harvard Business School
Press.
Kaplan, R. S. and Cooper, R. (1998). Cost & Effect: Using Integrated Cost Systems
to Drive Profitability and Performance, Harvard Business School Press.
Kaplan, R. S. and Norton, D. P. (1996). The Balanced Scorecard: Translating
Strategy into Action, Harvard Business School Press.
Kaplan, R. S. and Norton, D. P. (2001). The Strategy-Focused Organization: How
Balanced Scorecard Companies Thrive in the New Business Environment,
Harvard Business School Press.
Meyr, H., Rohde, J., Stadtler, H. and Surie, C. (2000). Supply chain analysis, in
Supply Chain Management and Advanced Planning, edited by Stadtler, H. and
Kilger, C., Springer, pp. 29–56.
Park, J. H., Lee, J. K. and Yoo, J. S. (2005). A framework for designing the
balanced supply chain scorecard, European Journal of Information Systems,
14, 335–346.
Porter, M. E. (1985). Competitive Advantage: Creating and Sustaining Superior
Performance, The Free Press, New York.
Porter, M. E. (1996). What is a strategy?, Harvard Business Review,
November–December, pp. 61–78.
Sappington, D. E. M. and Weisman, D. L. (1996). Revenue sharing in incentive
regulation plans, Information Economics & Policy, 8(3), 229–248.
Schary, P. B. and Skjøtt-Larsen, T. (2001). Managing the Global Supply Chain,
Copenhagen Business School Press.
Supply-Chain Council (2008). Homepage, URL:http://www.supply-chain.org,
2008, August.
Wathne, K. H. and Heide, J. B. (2000). Opportunism in interfirm relationships:
Forms, outcomes, and solutions, Journal of Marketing, 64, 36–51.
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Williamson, O. E. (1985). The Economic Institutions of Capitalism, Free Press.

Williamson, O. E. (1996). The Mechanisms of Governance, Oxford University
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10
How to Maintain the Bargaining Position
Defined in Toyota’s Dealership Control?
Hiroshi Ozawa
Graduate School of Economics, Nagoya University

1. Introduction
Toyota Motor Corporation’s Just-In-Time (JIT) production system with
its catchphrase “producing what is needed, when it is needed, and in the
quantity needed” as introduced as a production system that does
not retain inventory and reduce costs. When implementing JIT, it is
commonly understood that constructing a flexible production system that
can respond to demand uncertainties and changes is essential.1
Alternatively, by turning our attention to the Keiretsu that are unique to
Japanese companies, the common explanation is that JIT is but an
expression of the same thing that is implemented at the expense of
affiliated parts manufacturers, and that it cannot be implemented without
the existence of superior affiliated parts manufacturers.2
These explanations are not wrong but they only explain a part of JIT
and are incomplete. This is because these explanations do not take into
consideration important constraints that are inherently found in almost all
production systems. Production systems require large sums of investment
and are made up of many workers. So once money is invested, it is not
possible to change the production volume freely. At the very least, it is
impossible to completely cater to the large fluctuations in demand every
season. If we wish to do so, we have to build up the production capacity
in line with the estimated maximum demand volume. As a result, during
periods of off-peak demand, most of the production capacity is left idle
and this increases costs substantially. Affiliated parts manufacturers are in
the same situation because they belong to the same industry. So if costs
of parts increase, product costs will also have to increase. Assume that

137
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138 Hiroshi Ozawa

despite the increase in the cost of the parts, if the parts manufacturers
were to sacrifice themselves and supply the parts at low costs, it would not
be possible to maintain long-term affiliated business relationships within
the Keiretsu.
Hence, because of demand uncertainties and fluctuations, we cannot
have both zero inventory and reduced costs. The only exception, where we
are able to have both zero inventory and cost reduction, is when the
demand is certain and does not fluctuate. As a matter of fact, Toyota is
able to implement JIT production because it has a system that stabilizes
demand through its distributors. This is the point this thesis is advocating
here. However, many theses have thus far focused only on upstream parts
manufacturers, and almost none have paid attention to the presence
and roles of distributors that exist between Toyota and the market. In this
thesis, we shall focus on the relationship between Toyota and its distrib-
utors and explain the JIT system.

2. Framework: Production Quantity Budget and

Sales Quantity Budget in Toyota
To understand the actual situation of JIT in Toyota, we have to first
understand the production plan as well as the sales plan and demand fore-
cast which it is based on. For this purpose, it is necessary to explain the
method of preparing the budget, which is seldom explained in manage-
ment accounting textbooks. This budget preparation method is the
framework behind understanding the role of distributors and the distrib-
utor management method in Toyota.
With regard to preparing the budget, in general management account-
ing textbooks, the number of units that should be produced is calculated by
adding the target ending finished goods inventory (units) to budget sales
(units) which is the base, and then subtracting the beginning finished goods
inventory (units) from it.3 This explanation is based on the assumption that
sales are exogenous variables that cannot be controlled by companies.
Hence, as this budget will eventually be used to calculate the production
unit, it is referred to as the production quantity budget in this thesis.

Target ending Beginning

Budget Budgeted
+ finished goods − finished goods =
sales production
inventory inventory
(units) (units)
(units) (units)
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Bargaining Position Defined in Toyota’s Dealership Control 139

In contrast, there is another budget that is not explained in general text-

books. This is the budget that calculates the target sales (units) by adding
beginning order backlog (units) to and subtracting the target ending order
backlog (units) from the expected order (units) based on demand forecast as
displayed in the following equation.

Expected Beginning Target ending Budgeted

order + order backlog − order backlog = sales
(units) (units) (units) (units)

The budgeted sales unit is known as the “actual demand” and refers
to the demands that have to be met in this period out of the total demand.
In addition, as this budget will eventually be used to calculate the sales
quantity, it is referred to as the sales quantity budget in this thesis. Due
to the time difference that exists between occurrence of car demand and
car sales, the sales quantity budget can be used in industries where com-
panies have the room to control sales by making use of this time difference.
The above equation expresses the time difference between the order
(demand) and the sales as order backlogs.
Also, the sales quantity budget and production quantity budget are
combined via the budgeted sales (units).

Expected order


+ Beginning orderbacklog

Sales quantity budget
−) Target ending order backlog
Budgeted sales
+ Target ending finished goods inventory Production quantity
budget
−) Beginning finished goods inventory
Budgeted production

Next, to realize JIT, the management process consists of two phases.

The first phase is the order backlog control phase, where the sales quan-
tity budget is used (Fig. 1a). In this phase, the aim of the management
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140 Hiroshi Ozawa

(a) Order backlog control phase (b) Inventory control phase

Factor to disturb demand Factor to disturb demand

Expected demand Actual demand Expected demand Actual demand

Budgeted sales Actual sales Budgeted sales Actual sales

Order backlog control

Budgeted production Actual production Budgeted production Actual production

Inventory control

Fig. 1. Order backlog control and inventory control.

process is to make use of order backlogs to cope with demand uncer-

tainty and achieve budgeted sales (units) = actual sales (units). If the
budgeted sales units can be correctly achieved, there is no need to
change the production plan midway and the production plan can be
expected to progress only according to the budget. In other words, the
production quantity budget and the flexible budget based on it, both of
which are explained in management accounting textbooks, are unneces-
sary. In addition, in this phase, the budgeted sales unit will not be
based on demand forecast but on production capacity, and will be
decided at a level where production capacity can be most efficiently
deployed.
Another thing to mention is the case whereby it is not possible to execute
order backlogs control due to insufficient orders. The production quantity
budget will be used in the inventory control phase. (Fig. 1b). In the case
whereby the budgeted sales (units) ≠ actual sales (units), the aim is to adjust
the inventory and production unit to maximize the profits. Therefore in this
case, production capacity does not always have to operate efficiently.
In this way, if order (demand) is made an exogenetic variable and pro-
duction capacity an endogenous variable, then it is clear that there is no
room for control except to increase or decrease the order backlog and
inventory. Given this, order backlog and inventory, which are important
elements that stabilize production, will not be controlled by Toyota itself
but by its distributors. If this is the case, then Toyota’s management of
distributors is an important element that supports JIT, and we will not
be able to understand JIT by ignoring it.
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Bargaining Position Defined in Toyota’s Dealership Control 141

3. Example Relating to Production Quantity Budget

and Order Quantity Budget4
Figure 2 shows Toyota’s sales quantity budget and the actual results in a
given year.5 As the actual units cannot be released, the budget values in
the first month of Term 1 are relatively taken to be 100%. This will apply
to all graphs henceforth. As there are times whereby the data cannot be
obtained, the graph is divided into two terms (Term 1 and Term 2).
Although it is a pity that the data set is incomplete, these two terms clearly
show the above-mentioned two phases, which stabilize the production.
From the graph, we see that the budgeted units and actual units are
almost the same in Term 1. In contrast, in Term 2, the budgeted units and
actual units are wide apart. If we apply the above-mentioned two phases,
order backlog control and inventory control, then Term 1 will belong to
the order backlog control phase, and Term 2 will belong to the inventory
control phrase.
To confirm this, let’s look at the changes in order backlog and inven-
tory. The change in order backlog is shown in Fig. 3. In Term 1, there is
much order backlog but it is slowly declining. In Term 2, it is clear
that the order backlog is near zero. The change in inventory is shown in
Fig. 4. In Term 1, there is low inventory volume while in Term 2 the inven-
tory is on the increase. This is because Term 1 is in the order backlog
control phase while Term 2 is in the inventory control phase.

120%

100%

80%

Budgeted units
60%
Actual units

40%

20%

0%
1st 2nd 3rd 1st 2nd 3rd 4th 5th 6th Month
Term 1 Term 2

Fig. 2. Budgeted and actual units sales.

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142 Hiroshi Ozawa

120%

100%

80%

Budgeted units
60%
Actual units

40%

20%

0%
1st 2nd 3rd 1st 2nd 3rd 4th 5th 6th Month
Term 1 Term 2

Fig. 3. Budgeted and actual units of order backlogs.

1,800%

1,600%

1,400%

1,200%

1,000% Budgeted units

800% Actual units

600%

400%

200%

0%
1st 2nd 3rd 1st 2nd 3rd 4th 5th 6th Month
Term 1 Term 2

Fig. 4. Budgeted and actual units of inventories.

On top of that, Fig. 5 shows the budgeted units of sales and produc-
tion. In Term 1, the budgeted sales units = budgeted production units.
This shows that there is almost no adjustment of the inventory, which
means that the production quantity budget was not used. In Term 2, there
is a gap between the budgeted sales units and budgeted production units.
Looking at Figs. 2 and 3 as a whole, it is clear that the difference is due to
inventory adjustment. This is also because Term 1 is in the order backlog
control phase and Term 2 is in the inventory control phase.
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Bargaining Position Defined in Toyota’s Dealership Control 143

140%

120%

100%

80%
Sales units
Production units
60%

40%

20%

0%
1st 2nd 3rd 1st 2nd 3rd 4th 5th 6th Month
Term 1 Term 2

Fig. 5. Budgeted units of sales and production.6

4. Management of Toyota’s Distributors in Japan

Toyota’s production system is a mass production system. It is an order
placement production that is unlike the production system of consumer
electronics products. Distributors will place orders with Toyota and
Toyota, upon receiving the orders, will start production. Normally, about
30–60 days are needed between order placement and completion of
production. During this period, it will have to keep the customers waiting.
To shorten the waiting time for customers, distributors will have to first
place orders with Toyota based on forecast before receiving the orders
from customers. It is the responsibility of distributors to judge whether to
make the customers wait and then sell the cars or take on the risks and
place orders based on the forecast.7
In other words, the responsibility of forecasting demand, and con-
trolling order placement and inventory levels, does not rest on Toyota
but on its affiliated distributors. The distributors have direct contact
with its users, so they understand the market well and can quickly
detect market changes. This makes them well suited to proactively
respond to the market conditions when needed. However, what Toyota
wishes of its distributors is not for them to report the evolving market
trends to its production side, but to alleviate seasonal demand fluctua-
tions and demand forecast uncertainties so that it can maintain a stable
production.
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144 Hiroshi Ozawa

Thus, Toyota established the distributor management system so that its

distributors can achieve this. This system is based on two principles. The
first principle is to limit, as far as possible, the range of actions distributors
can take. If there are multiple options which distributors can choose from
and take action, then what the distributors want will not match what
Toyota wants. Hence, to ensure that distributors do not take actions that
will harm Toyota, it is necessary that Toyota set limitations in the first
place. The second principle of distributor management is to regulate the
weakness and strengths of the actions of distributors within the limited
range of available options. For this purpose, Toyota has set up different
kinds of incentive systems. In the following, we shall introduce Toyota’s dis-
tributor management system with reference to these two principles.

4.1. Business structure that enables tight control

To restrict the operations of distributors, Toyota established the monopoly
system, franchise system and one region, one distributor system.

4.1.1. Monopoly system

Toyota’s distributors only handle Toyota’s products and no other compa-
nies’ products. In Japan, besides Toyota, Nissan and Honda also have their
own sales routes and this is considered normal. Contrast this sales method
with, for example, the sales of consumer electronics products whereby prod-
ucts from different manufacturers are sold under the same shop.
If distributors also sell other companies’ products besides that of
Toyota, then they will actively sell products that bring them the greatest
profits.8 In this case, Toyota will need to approach distributors to sell its
own products aggressively by acceding to their demands for an increase in
sales commission, and a shorter delivery period. When this happens,
distributors will no longer contribute to the stable production of Toyota.
Rather they will make demands of Toyota, and disturb Toyota. This is
why Toyota prohibits its distributors to sell other companies’ cars and
wants them to sell only its own Toyota cars.

4.1.2. Franchise system

Toyota builds its sales network based on the franchise system. This means
that by establishing distributors in corporate entities that do not have
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Bargaining Position Defined in Toyota’s Dealership Control 145

capital ties with Toyota and separating their management from Toyota’s
business, it ensures that the performance of the distributors do not affect
the performance of Toyota. In contrast, Nissan builds its sales network
focusing on direct distributors. In the case of direct sales, the merit is that
the policies of the top management are directly passed down to the sales
department and executed. However, on the flip side, because the perform-
ance of the production department and the results of the sales department
will ultimately make up the total sales performance of the company, the
sales department has the opportunity to state their views and possesses
negotiation power. As a result, it is difficult to follow the production logic
alone to carry out efficient production.
In addition, in many cases, distributors of Toyota that are part of the
franchise system, such as influential oil companies and transportation
companies in different regions, manage the sales of the car as part of their
business. Thus, they have more financial power. In contrast, in Honda’s
case, despite adopting a franchise system, the distributors in the franchise
system are mostly former bicycle shops and car repair workshops that do
not have much financial muscle. As a result, Honda’s distributors do not
have the ability to take on anything but their own risks, and therefore
function only as “agents”.

4.1.3. One region, one distributor system

Toyota Motor’s distribution channels in Japan can be divided into five
groups according to car types. In principle, in each of the groups, only one
distributor is established in each region. In other words, company X is the
only company that sells type A cars in a certain region. If there are several
distributors (for example, companies X and Y) that sell the same type of car
in the same region, companies X and Y will compete over the same customer.
Competition among the distributors may make the customers happy but it
only impoverishes the companies and does not bring any benefits to Toyota.
In addition, competing distributors may feel reluctant to provide accu-
rate sales and inventory information to Toyota, being wary of the other
distributors obtaining such information. It is also highly probable that
such distributors negotiate with Toyota with the intention of obtaining a
better contract with Toyota than those of other distributors in the same
region.9 In actual fact, by implementing the one region, one sales system,
Toyota has succeeded in correctly grasping the orders and sales trends of
the distributors.
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146 Hiroshi Ozawa

In addition, because orders that are not confirmed are included in the
order demand forecasts, the accuracy of the forecast is irrevocably
reduced. Even though the existence of uncertainties arising from compe-
tition with other manufacturers cannot be avoided, the accuracy of the
forecast is improved through the one region, one distributor system.

4.2. Control of distributors through incentives

Even though Toyota can avoid risks of demand uncertainties by having its
distributors bear the risks, nevertheless, by doing so, it is not fully suffi-
cient for stable production. As demand fluctuates according to seasons, it
is necessary to alleviate and average out the fluctuations. Hence, despite
the use of order backlog and inventory, Toyota also uses sales incentives
and adopts the product allocation policy as incentives to spur distributors
to get orders and retain inventory.
In addition, the source of Toyota’s negotiation power with its distribu-
tors is built on a relationship whereby Toyota is in a position to provide the
products that the distributors hope to sell. In other words, if distributors
have the inventory and do not wish for Toyota to supply any more prod-
ucts, Toyota will not have any influence over them and cannot control them.
The structure of the incentive is designed in full consideration of this point.

4.2.1. Sales incentive

The most typical incentive is the sales incentive. Toyota gives incentives
to its distributors for product sales during times of weak demand or even
during times booming demand when they should compete with other
companies for customers, and increases order backlog.10 The distributors
can use the incentives to offer price discounts or launch advertisements.
The important point to understanding the relationship between Toyota
and distributors here is that Toyota does not reduce the invoice price but
rewards the distributors for actual sales. If Toyota did not provide any
form of encouragement to its distributors, the unit of orders the distributors
placed with Toyota would always be similar to the unit of orders users
placed with distributors. However, if Toyota reduces the invoice price, it
will be possible for distributors to place a higher unit of orders with
Toyota as compared to the orders received from users. This is because
distributors know that demand fluctuation is seasonal and they believe in
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Bargaining Position Defined in Toyota’s Dealership Control 147

placing orders in large volumes in times when products can be cheaply

purchased. By keeping the goods in inventory and selling them off during
times of high demand, distributors can earn higher profits.
Next, we shall talk about negotiation power which can be explained as
follows. If distributors wish to have negotiation power with Toyota, it is
always better that they place orders that are slightly below the supply capac-
ity of Toyota. When sales are low, they should place orders that are less than
the units supplied by Toyota and retain them as inventory. And when sales
are high, distributors can liquidate inventories and channel them to sales,
and also place orders that are below the units supplied by Toyota. So if dis-
tributors possess negotiation power in this manner, the order units placed by
distributors will be decided without any relation to the user demand trends,
and requests for a decrease in invoice price will occur. Thus, from Toyota’s
standpoint, having its distributors leave order backlog and supplying fewer
units that distributors desire is needed to maintain its negotiation power.
Therefore, sales incentive is used as a reward for the number of units
purchased by users, and this drives the demand of the users not the
distributors. As a result, the number of orders placed by distributors with
Toyota is similar to the orders placed by users with distributors. This will
enable Toyota to maintain its negotiation power while ensuring that the
distributors take up the products in a stable manner.

4.2.2. Product allocation policy

As mentioned, the type of products that distributors handle is decided by
Toyota. Distributors have to increase the sales and profits within a limited
range of products and, therefore, they wish to actively sell products with
large profit margins, and products that are popular and easy to sell.
Offering those products that are highly demanded by distributors is how
Toyota controls the distributors.
For example, even for popular products, there are seasonal fluctuations
in demand. In addition, even for unpopular products, to maintain stable
production, there are situations whereby Toyota has to produce more
products than distributors wish to have. In this case, Toyota will allocate
popular products first, even in times of brisk demand, to distributors that
ordered a lot during times of weak demand. Or Toyota will adopt the
method of allocating more of the popular products to distributors that
took up the unpopular products. In this way, Toyota can enjoy stable
order placements from its distributors.
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148 Hiroshi Ozawa

5. Summary
This thesis explains the essential role distributors play in alleviating
demand uncertainties and fluctuations in order for Toyota to implement
JIT, and the methods of control used by Toyota on its distributors.
If Toyota’s management of its distributors in Japan is an important
element that supports JIT, this would mean that other automobile man-
ufacturers and manufacturing firms, which hope to learn from Toyota,
have to face the difficult problem of maintaining a distribution system for
the realization of JIT. For example, it may be difficult to realize JIT in
the market where customers demand prompt delivery of products.
Nevertheless, we have pointed out in this thesis that the key to realiz-
ing JIT lies not in relying on the flexibility of the production system or on
the parts manufacturer, but in a stable production backed by the allevia-
tion of demand uncertainties and fluctuations. We believe that this will,
at the very least, direct companies’ efforts in the correct direction.

Acknowledgments
This work was supported by MEXT. Grant-in-Aid for Young Scientists (B)
21730297.

Endnotes
1. In this thesis, “uncertainty” refers to grasping the phenomenon only proba-
bilistically due to a lack of information. “Change” is where the phenomenon
which one wishes to grasp is a dynamic phenomenon. Even for a dynamic
phenomenon, if we can predict the shifts in the phenomenon completely, then
the phenomenon will not be uncertain.
2. Asanuma (1997) refers to this as Risk Shifting Hypothesis (RSH).
3. For example, Horngren et al. (2008).
4. In this section, information from Ozawa (2002a, b) is reorganized according
to the framework of this thesis.
5. Created from sales data related to car model X sold and manufactured only
in Japan, and production data relating to production line which manufactures
only car model X.
6. Although we see that there are major fluctuations in production units every
month, this is a result of the differences in monthly operational days. The
monthly operational rate is approximately 80–85% in Term 1, 90–96% in
Term 2. In addition, between Term 1 and Term 2, large-scale adjustment
which halved the production capacity was carried out.
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Bargaining Position Defined in Toyota’s Dealership Control 149

7. To reduce the risk of such distributors, the “season order” and “daily order”
methods of ordering is adopted. This is an order method that will decide
on the specification details in stages. For example, the car model is decided
30–60 days beforehand, and the engine is decided 30 days beforehand. This is
followed in sequential order, starting from color, seats, and grade, which are
decided 10 days beforehand. Five days beforehand, the order will be placed
(Ozawa, 2002b).
8. This behavioral principle is known as equal compensation principle (Milgrom
and Roberts, 1992).
9. This kind of negotiation between consumer electronics retailers and manufac-
turer is introduced in NIKKEI Business (2000).
10. There are various ways to design incentives including incentive per sales unit
and incentive per market share within region.

References
Asanuma, B. (1997). Mechanism of Reformative Adaptation Defined in Japanese
Corporate Organization, Toyo Keizai (in Japanese).
Horngren, C. T., Dater, S. M., Foster, G., Rajan, M., and Ittner, C. (2008). Cost
Accounting: A Managerial Emphasis, 13th edn., Pearson Education.
Milgrom, R. and Roberts, J. (1992). Economics, Organization & Management,
Prentice-Hall.
NIKKEI BUSINESS (ed). (2000). Nobody Needs These Management Methods,
NIKKEI BP (in Japanese).
Ozawa, H. (2002a). Stable production and dealer management in just-in-time,
Collected Papers of AAAA in Nagoya.
Ozawa, H. (2002b). Roles of Toyota dealerships in JIT, The Journal of Cost
Accounting Research, 26(2) (in Japanese).
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11
Royalties and Profit Sharing: Focusing
on Seven-Eleven Japan Co., Ltd.
Noriko Hoshi
Faculty of Business Administration, Hakuoh University

1. Introduction
Regarding the basis of the royalty calculation used for franchise agreements
in the convenience-store business, the largest number of companies uses
gross profit or gross profit on sales. According to “Franchise Chains in
Japan 2006” (Shogyokai, 2006), as the basis of the royalty calculation, the
above gross profit or gross profit on sales is being used by 16 retailers
(13.1%) out of 122 convenience-store chains, supermarket chains and other
food retailers, and among those 16 retailers, most (13 retailers) are
convenience-store chains. Of the 13 convenience-store chains, 10 chains
use gross profit and 3 chains use gross profit on sales as the basis of royalty
calculations.
In general, gross profit and gross profit on sales are taken as having
the same meaning. However, when these two terms are used as the bases
of royalty calculations in the convenience-store business, “gross profit
on sales” means gross profit + amount of loss. At convenience stores,
daily dishes, including packed lunches, are discarded after the expira-
tion dates. In general, the prime costs for the discarded goods, called
the “ loss”, are entirely borne by the franchise store, although at some
franchise chains the franchiser bears a part thereof. What would be
the reason for the inclusion of the amount of loss in the data used to
calculate the royalty? This paper examines this issue and the ideal basis
of royalty calculations.

151
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152 Noriko Hoshi

2. Convenience-Store Royalties
2.1. Mechanism of the franchise system
The Japan Franchise Association defines a franchise as follows: “a con-
tinuing relationship between one entity (called the ‘franchiser’) and
another entity (called the ‘franchisee’), where a franchiser and a franchisee
enter into an agreement, the franchiser granting the franchisee the right to
use the signs representing the franchiser’s business, which signs include
the franchiser’s logo, service mark, trade name and others as well as
the franchiser’s management know-how, and to conduct product sales
and other businesses which bear the same image as the franchiser’s, the
franchisee paying a consideration therefor to the franchiser in return,
providing the funds required for the business, and operating the business
under the franchiser’s guidance and assistance”.
According to the JFA definition, a franchiser grants a franchisee the
rights listed below:

(1) The right to use the franchiser’s logo, service mark, and trade name;
(2) The right to use the franchiser’s management know-how, including
the products, services, and proprietary information developed by the
franchiser; and
(3) The right to obtain continuous guidance and assistance provided by
the franchiser.

These concessions are collectively called a “package”; the franchisee uses

the package and pays a fee in consideration thereof. This consideration is
called a “royalty”.
A franchisee appears to be a branch of the franchiser, since both use
the same logo and trade name, but in fact the two are independent
entities. They are a “joint venture,” in which each party fulfills each task
imposed on it to share the profit from the venture.

2.2. The bases of the royalty calculation

In general, there are three bases of calculation of the royalty paid by the
franchisee to the franchiser: (1) the sales amount, (2) the gross profit, and
(3) the flat-rate system. A method of royalty calculation frequently used
by the convenience-store business is that in which the gross profit is
multiplied by a certain rate. The meaning of “gross profit” used in the
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Royalties and Profit Sharing 153

convenience-store business differs slightly from that used generally. “Gross

profit” in general means the sales amount after the deduction of the cost
of goods sold, that is, the gross profit on sales as shown in the following
expression:

Gross profit = gross profit on sales

= sales amount − cost of goods sold. (1)

However, “gross profit” in the convenience-store business is understood

as the gross profit on sales after the addition of both the prime cost for
the food products discarded after expiry and the amount of loss from
inventory, as shown in the following expression:

Gross profit = gross profit on sales + amount of loss

= sales amount − cost of goods sold + amount of loss
= sales amount − (cost of goods sold − amount of loss). (2)

In many convenience stores, the amount of royalty is determined by the

gross profit multiplied by a certain rate.

3. Sales Cost and Amount of Loss

3.1. Relationship between the cost of goods sold
and the amount of loss
The cost of goods sold is the cost of the goods purchased corresponding
to the amount of sales, as shown in the following expression:
Cost of goods sold = opening inventory of goods
+ current-term amount of goods purchased
− closing inventory of goods. (3)
Furthermore, the cost of goods sold may include the appraisal loss of
goods that occurs when the market value of the goods conspicuously and
irreparably falls when the cost-or-market-whichever-is-lower basis is
adopted, or when the inventory shrinks in ordinary activity.
The amount of loss applied to the convenience-store business con-
sists of the cost of goods discarded after expiry and inventory shrinkage.
In accounting, this amount of loss is generally considered to be the cost
of goods sold, and is included in the cost of goods sold and deducted
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154 Noriko Hoshi

from the amount of sales when the gross profit on sales is calculated.
That is, the cost of goods sold shown in Expression (1) includes the
amount of loss.
However, business accounting allows the amount of loss to be treated
as a business expense, instead of its inclusion in the cost of goods sold.

3.2 Dissatisfaction of franchisees with the accounting

treatment of the amount of loss
As mentioned above, the cost of goods sold applied to the convenience-
store business excludes the amount of loss, and the gross profit is
calculated as shown in Expression (2). The amount of loss excluded from
the cost of goods sold is treated as a business expense. Since this method
of accounting greatly differs from the generally adopted method shown in
Expression (1), it is frequently raised as a point of contention in lawsuits
concerning franchise agreements. In concrete terms, if the royalty is deter-
mined by the gross profit in Equation (2) multiplied by a certain rate,
it means that the royalty is also imposed on the amount of loss, and
franchisees consequently incur great costs. Franchisees maintain that it is
unreasonable to impose a royalty on the cost of goods after expiry and
inventory shrinkage.
However, in spite of the lawsuits filed by franchisees in regard to the
amount of loss, the courts have never accepted the franchisees’ arguments.
Any franchise agreement in the convenience-store business provides that
the amount of loss shall be included in the business expenses and that the
franchisee shall incur any business expenses. Accordingly, the above
provision can be interpreted to mean that the amount of loss is included
in the gross profit; thus, the franchisees’ arguments have never been
accepted (Kondo, 2008).
In other words, since the above is stipulated in the agreement, even if
the franchisees are dissatisfied with the fact that the amount of loss is
included in the gross profit on sales instead of the cost of goods sold and
consequently file lawsuits, the franchise agreement for convenience stores
is interpreted as legal.

4. Gross-Profit Sharing System for Convenience Stores

The first Japanese convenience store that adopted the gross profit as the
basis of royalty calculations was York Seven (currently, Seven-Eleven
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Royalties and Profit Sharing 155

Japan Co., Ltd.). When York Seven entered into a license agreement with
the Southland Corp., USA, in 1973, the gross profit was used as the basis
of royalty calculations in the United States.
Then, what would be the reason for using the gross profit as the basis
of royalty calculations?

4.1. Interpretation of the gross-profit sharing system

The JFA defines royalty as referring to the consideration of the use of the
package provided by a franchiser. However, regarding royalty determined
based on the gross profit, i.e., royalty that is calculated by deducting the
cost of goods sold, excluding the amount of loss, from the amount of sales,
after multiplying by a certain rate, Seven-Eleven Japan expresses an
opinion different from the usual definition and uses the term “charge”
instead of royalty.
In an ordinary franchise system, the royalty is interpreted to be the
price for the use by franchisee of the package provided by franchiser. The
franchiser provides the franchisee with its own logo and management know-
how in the form of management guidance, and in return the franchisee pays
the franchiser the price therefore. However, in the philosophy of Seven-
Eleven Japan, the mode of thinking centered on “price” is rejected
(Kawagoe, 2001). The philosophy of Seven-Eleven Japan is as follows: while
both the franchiser and the franchisee are independent entities, they are
engaged in a joint venture, assuming their respective roles for the sake of
prosperous coexistence. The gross profit is the outcome of the cooperation
between the two independent entities. The gross profit is allotted to each
party, and the rightful share of the franchiser is the “charge”.
In profit sharing at an ordinary company, the management decides
the method of allocation of current-term unappropriated profits to dis-
tribution, such as dividends and board members’ bonuses, and to
retention, such as profit reserves and voluntary reserves. Regarding the
profit, the current-term profit that is the final profit is used instead of
the gross profit (Table 1).
The gross-profit sharing system can be understood as a profit-oriented
method in which the amount of sales and the cost of goods sold are
considered important; the profit obtained as a result of active participa-
tion in the franchisee’s management by the franchiser as a cooperative
entity is shared, instead of the receipt of a royalty by the franchiser in
consideration of the rights granted to the franchisee.
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156 Noriko Hoshi

Table 1. Gross margin and net income.

Income statement

Sale revenue 36,080

Cost of sale 30,300
Gross margin 5,780
Operating expenses 3,190
Income before taxes 2,590
Provision fro income taxes 1,200
Net income 1,390

4.2. Role of the franchisee

Those who play an important role in the management guidance of the
Seven-Eleven franchisees are the operation field counselors (OFCs). The
management advice offered by the OFC consists of the concept of order
placement, proposals on selling and display techniques, in-house system
architecture, analysis of business data, method of trade-area measurement,
utilization of information, and so forth. These pieces of advice allow each
franchisee to place orders based on his or her own judgment, with local
information and weather conditions in mind.
The component ratios in terms of the amount of sales at Seven-Eleven
Japan in fiscal 2007 were as follows: processed foods such as soft drinks
and sweets: 29.8%; nonfood items such as cosmetics: 28.7%; fast foods
such as packed lunches, rice balls and daily dishes: 28.6%; chilled groceries
such as milk and desserts: 12.9% (source: Seven-Eleven Homepage). Of
these items, disposal loss is the greatest in fast foods with short best-
before periods. Disposal loss also occurs in processed foods and chilled
groceries. The disposal loss is one of the three main business expenses that
put pressure on the profit of a franchisee, the other two being inventory
loss and personnel expenses (Kondo, 2008).
Since each franchisee that has received management guidance takes
charge of product management (ordering and sales promotion) as one of
the tasks allotted, each franchisee is responsible for finding the best way
of reducing the disposal loss (Table 2).
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Royalties and Profit Sharing 157

Table 2. Tasks allotted to the franchisee and the franchiser.

Tasks of the franchisee

— Personnel management (employment, education, training, etc.)
— Product management (ordering, sales promotion, etc.)
— Business data management (sales amount, business management)

Tasks of the franchiser

— Business consultation
— Product development and product information service
— Development of the physical distribution system
— Information system service
— Advertising and promotional activities
— Lending of sales equipment
— Accounting and book-keeping service
— Development and maintenance of a system of work without anxiety

Source: http://www.sej.co.jp/corp/aboutsej/franchise.html.

To minimize the disposal loss, the order for each item should be placed
based on the minimum demand therefore, to make sure that it goes out of
stock. However, if the item remains out of stock, consumers gradually
come to visit the store less frequently. An important task of the franchisee
is to control the order quantity for each item so that the item goes out of
stock less frequently and the disposal loss becomes minimal. It appears
that the disposal loss is excluded from the cost of goods sold to place the
responsibility for this task on the franchisee.

5. Disposal Loss and Risk Sharing

5.1. Optimum sharing of disposal loss
The study of Kim and Senbongi (1999) theoretically examined the opti-
mum sharing of disposal loss using mathematical models. In their study,
the cost burden on the franchiser due to the disposal loss was analyzed for
three possibilities: no burden, partial burden, and total burden. In each
case, the mathematical models of the amount of disposal loss, franchisee
profit, cost burden on the franchiser due to disposal loss and profit for the
entire franchise chain were formulated to determine the optimal solution
for the profit for the entire chain. Furthermore, the analysis results were
explained by classifying them into two cases.
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158 Noriko Hoshi

Case 1: The disposal loss is entirely borne by the franchiser. In this case,
since the franchisee does not take purchase risks, the incentive for lean and
effective purchases is lost, and the purchase for each item is made based
on the maximum demand therefore. This leads to greater disposal loss.
Therefore, it is not desirable that the disposal loss be entirely borne by
the franchiser.
Case 2: The disposal loss is partially borne by the franchiser or no disposal
loss is borne by the franchiser. This case is classified into two subcases:
(2.1) the franchisee considers the lack of stock undesirable and (2.2) the
franchiser considers it desirable that a part of the disposal loss be borne
by the franchiser, which means that the franchiser considers the lack of
stock acceptable. In this case, it is preferable to minimize the disposal loss
by minimizing the amount of disposal loss borne by the franchiser.
The above results would apply to those franchisees with some years’
experience in convenience-store management. An inexperienced franchisee
who opens a convenience store for the first time tends to purchase the
minimum amount of stock for fear of risk. In such a case, the alternative
is to adopt Case 1 (the disposal loss is entirely borne by the franchiser)
for a limited period, to give the franchisee enough time to gain an under-
standing of the optimum purchase method without fear of risk. Also, there
may be cases where a lack of stock may cause little inconvenience, whereas
there may be cases where a lack of stock should be avoided by all means.
Case 2.1 or 2.2 may be adopted depending on the product.

5.2. Risk sharing of disposal loss

If it is assumed that the purchase quantity of a product is based on the
sales quantity expected by the franchisee, the disposal loss depends on the
difference between the expected sales quantity or purchase quantity and
the actual sales quantity:
Disposal loss = {expected sales quantity (or purchase quantity)
− actual sales quantity} × purchase unit price
= operation variance. (4)
The disposal risk refers to the possibility that the actual sales quantity
may be less than the expected sales quantity. Also, the actual sales quan-
tity must not be greater than the expected sales quantity (purchase
quantity). If purchasing is performed only once a day, and the expected
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Royalties and Profit Sharing 159

Cost

Purchase
amount
Disposal loss
(short fall
recovered)

Purchase unit price

Operation
Actual sales Expected sales Actual sales
quantity a quantity quantity b
(purchase
quantity)

Fig. 1. Occurrence of disposal loss due to operational variance.

sales quantity (purchase quantity) is less than the actual sales quantity,
and the unsold goods must be disposed of, a lack of stock occurs.
Since fast foods, and so forth, cannot be returned once they are pur-
chased and cannot be held in stock beyond their expiry dates, the amount
of purchase should be borne as a cost (Fig. 1). And since this is a cost
borne regardless of whether the items are sold or unsold, this cost is sim-
ilar to a fixed cost. The unrecovered portion of the fixed cost is operational
variance, that is, disposal loss.
In the manufacturing industry, the operational variance is shared
among the manufacturers. In the auto industry, the difference between the
production volume and the actual sales quantity at a parts manufacturer
is shared between the manufacturer of finished cars, such as Toyota, and
the parts manufacturer. If operational variance occurs in a case where the
production volume is determined using the unit price as determined by full
cost accounting, the fixed cost for the parts manufacturer constitutes the
risk of the cost remaining unrecoverable. As for the production volume,
each parts manufacturer receives orders placed by the manufacturer of
finished cars as to the delivery amount of parts based on the sales
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160 Noriko Hoshi

expected by the manufacturer of finished cars. Accordingly, if at a point

during, for example, a two-year period of agreement the actual sales
volume exceeds the initially expected sales volume, the unit part price
thereafter is discounted. On the other hand, if at the time of the expira-
tion of the two-year agreement the actual sales volume has not reached the
initially expected sales volume, the manufacturer of finished cars gives a
subsidy equal to the unrecovered amount of the fixed cost of the equip-
ment investment in a specific part (for example, a metal mold). Thus, the
risk is shared between the two companies.
Regarding convenience stores, is the purchase quantity ordered by the
franchisee determined by the franchisee alone? Are the purchase quanti-
ties of private brand goods, and so forth, not pushed by the franchiser?
Also, in convenience stores, the risk caused by the operational variance
may be shared between the franchiser and the franchisee.
It appears that the method of handling the amount of loss in the
franchise business is unique, in that it gives the franchisee a responsi-
bility. Although this method of placing responsibility on the franchisee,
as stipulated by the standard franchise agreement, has been deemed legal
by the courts, many franchisees are unsatisfied with it. Improvements of
the standard agreement would be necessary to reach a compromise
between the two parties. Such improvements would optimize the profit for
the entire chain and ensure prosperous coexistence, which is the original
aim of the franchise business.

6. Conclusion
In the convenience-store franchise system, great importance is placed on
profit, and the franchiser and franchisee assume their respective allotted
roles and work together. There is a system of minimum gross profit guar-
anty by the franchiser. The franchiser assumes the responsibility for both
the sales amount and the cost of goods sold, and supports the manage-
ment of each franchise store.
It may be necessary for a franchisee to bear the entire loss amount to
fulfill the obligations allocated to him/her. However, the franchisees are
increasingly unsatisfied with the cost burden, in which the entire loss
amount, which is said to be one of the three main business expenses, is
borne by the franchisee alone, and many lawsuits have been and are being
filed because of this problem. In the franchise agreement, it is stipulated
that the loss amount is borne by the franchisee. However, as in profit
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Royalties and Profit Sharing 161

sharing, the risk of disposal and inventory shrinkage should also be shared
between the joint venture partners.
While the standard franchise agreement has been deemed legal by the
courts in lawsuits filed by franchisees pertaining to disposal loss, the Japan
Fair Trade Commission has conducted an on-the-spot inspection based on
the consideration that the act of obliging the franchisees to dispose of close-
to-expiry-date goods is an abuse of the dominant bargaining position by
the franchiser (The Nikkei, 21 February 2009, p. 9). As a rule, Seven-Eleven
Japan does not discount the prices of unsold goods. If the prices of close-
to-expiry-date goods can be discounted, the costs of goods sold can be
recovered, even if only to a small extent, thus leading to the mitigation of
the royalty burden. From now on, it may become necessary to modify the
relationship between the franchiser and the franchisees.

References
Kawagoe, K. (2001). The Low of Franchising, Shojihomu (in Japanese).
Kim, H. and Senbongi, S. (1999). The optimum distribution of abandonment loss
in convenience-store business. The Journal of Marketing and Distribution,
364, 4–14 (in Japanese).
Kondo, K. (2008). The interpretation of case of sales cost in franchise contract, The
Journal of Administrative and Social Sciences, 20(3), 88–119 (in Japanese).
Seven-Eleven Japan (2004). Seven-Eleven Japan Sustainability Report 2004.
Seven-Eleven Japan Co., Ltd web site, http://www.sej.co.jp/corp/company/pdf/
yokogao/2008/711.pdf. (in Japanese).
Shogyokai (ed.). 2006 Franchise Chain in Japan, Shogyokai (in Japanese).
The Nikkei. Japan Fair Trade Commission Launched an Investigation of Seven-
Eleven Japan Co. Ltd., 21 February 2009, p. 9 (in Japanese).
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12
Factors Influencing Control Mechanisms
in Joint Ventures: Evidence from
Japanese Manufacturing Industries
Yuichi Kubota
School of Economics, Osaka Prefecture University

1. Introduction
The management of interorganizational relationships (IORs) such as joint
ventures (JVs) and strategic alliances has become important in a net-
worked age. Many companies have created values in collaboration with
various partners. Interorganizational controls in hybrid organizational
forms that lie between market and hierarchy are needed for collaborations
(Otley, 1994; Hopwood, 1996). In Japan, the number of strategic alliances
and JVs seems to be increasing, and collaborations are an important fac-
tor for the acquisition of a competitive advantage. However, prior research
has found that many strategic alliances and JVs encounter problems and
fail. Interorganizational control problems are the primary causes of these
failures (Chua and Mahama, 2007; Groot and Merchant, 2000; Kamminga
and Van der Meer-Kooistra, 2007).
The terms “alliance” and “JV” are often used ambiguously and syn-
onymously. In fact, the structure of a JV is very similar to that of an
alliance. Dekker (2004, p. 42) describes the practices common to the
two IORs as follows: “joint financial investments are made, a separate
organizational structure with a joint board and joint task groups is
installed, specific tasks and resources are dedicated to it, and separate
rules, regulations and costing and nonmarket pricing are used”.
Additionally, Groot and Merchant (2000) explain that JVs are of two
types: equity and nonequity. Equity JVs owned by two or more partners

163
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164 Yuichi Kubota

are a prominent form of cooperative agreement. Nonequity JVs promote

cooperation between partners in accordance with contractual arrange-
ments, that is, without the creation of a new company.
The Japan Fair Trade Commission (2002) investigated the collabora-
tions and competition among companies. The report states that nonequity
JVs have become more popular than equity JVs. However, according to
the results of this empirical survey, Japanese managers seem to believe
that a nonequity JV partnership is easier to dissolve than an equity JV.
If managers want to reduce financial investments and risks of uncertainty
and share secrets and information with partners, equity JVs are preferred
to nonequity ones.
Dekker (2004) classifies the control mechanisms of IORs as ex-ante
mechanisms (goal setting, incentive systems, structural specifications,
organizational structuring, partner selection, reputation, and trust) and
ex-post mechanisms (performance and behavior monitoring, shared deci-
sion making, and goal setting). Accounting researchers have also discussed
control mechanisms in JVs (Chalos and O’Connor, 2004; Groot and
Merchant, 2000; Kamminga and Van der Meer-Kooistra, 2007). However,
the problems related to factors influencing control mechanisms in JVs
remain unsolved.
This study focused on the control problems of equity JVs in Japanese
manufacturing industries. Equity JVs need to be examined as they are
assumed to be managed through interdependent partnerships and to
involve a longer relation than nonequity JVs. The present study aims to
explore the main factors influencing ex-post JV controls and to analyze the
determinants of JV control mechanisms. The next section develops
the extended research model that builds on Kamminga and Van der Meer-
Kooistra (2007). Section 3 explains the empirical design and variable
measurement. Section 4 discusses the results of multiple regression analysis.
The final section presents the conclusion and directions for future research.

2. Conceptual Framework and Literature Review

The model of Kamminga and Van der Meer-Kooistra (2007) provided four
characteristics of JV control patterns: transaction, relational, control, and
institutional characteristics. This study focuses on the first three charac-
teristics and does not deal with institutional characteristics.
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Factors Influencing Control Mechanisms in Joint Ventures 165

2.1. Transaction characteristics

Concepts based on transaction cost economics (TCE) have been applied
in most studies of IORs. Studies on TCE have discussed organizational
boundaries and the minimization of transaction costs; they also point out
the risks of opportunistic behavior (ex. Gietzmann, 1996).
In particular, asset specificity has been widely drawn on in empirical
research. TCE suggests that high asset specificity can lead to opportunis-
tic behaviors, hold-up problems, and incomplete contracts (Gietzmann,
1996; Williamson, 1975, 1997). Chalos and O’Connor (2004) examined the
effects of relative partner knowledge and specific asset investments on the
usage of various types of control mechanisms in US-Chinese JVs. They
found that partner knowledge and specific asset investments influenced a
broad set of controls. Further, Kamminga and Van der Meer-Kooistra
(2007) introduced and confirmed that it is not only the level of asset
specificity, but also its types (physical, human, and procedural asset speci-
ficity) that matter. As they suggest, “human, procedural, and marketing
asset specificity may be more difficult to settle by contract due to the tacit
character of the information”.
Employees of JV partners may be working for the JV firm on a
contractual basis. Human asset specificity, therefore, occurs in the case of
JVs. Procedural asset specificity can occur when ordering and production,
techniques or tools of cost and production management, procedures of
financial planning, reporting and budgeting, and internal terminology
need to be standardized or unified in a JV. As a manufacturing JV
operates with limited resources, in general, business processes such as
cost accounting, procurement, sales, and production maintenance will be
outsourced to one or some of the JV partners.
Further, TCE has certain important attributes or characteristics.
Williamson (1975, 1997) shows uncertainty and frequency. However,
Kamminga and Van der Meer-Kooistra (2007) assert that frequency
does not play a role in the JV governance structure because the
frequency of transactions is always assumed to be high. They suggest
that there are two other transaction characteristics in JVs: knowledge
of the transformation process and ability to measure outputs. Milgrom
and Roberts (1992) point out complexity as another transaction
characteristic.
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166 Yuichi Kubota

2.2. Relational characteristics

Kamminga and Van der Meer-Kooistra (2007, p. 133) state that “in the
joint venture literature, four important relational characteristics are
discussed: (1) parental differences, (2) information asymmetry, (3) trust,
and (4) bargaining power”.
Parental differences include differences in partners’ objectives, strategic
interests, motivation for the JV, and cultures. For example, Groot and
Merchant (2000) suggest that partners’ objectives with regard to the JVs
in which they become engaged differ significantly; these objectives are
important to a given partner and affect choices regarding the control focus.
Second, in JVs, there is information asymmetry between parent com-
panies and between a parent and its JV. Information asymmetry can
result in problems such as hidden actions and hidden information. Sharing
of information has been discussed as one of the solutions to these prob-
lems (Roberts, 2004). Tomkins (2001) analyzes the relationship between
trust and information and proposes two types of information needs: the
information needed to assess willingness to trust and information needed
to attempt a collaborative mastery of events. He assumes that the two
types of information needs are relevant to JVs as well as other IORs.
The third relational characteristic is trust. Recent investigations have
demonstrated that trust is important in the governance of IORs (Dekker,
2003, 2004; Langfield-Smith and Smith, 2003; Mouritsen et al., 2001; Van
der Meer-Kooistra and Vosselman, 2000). For example, Dekker (2003,
2004) suggests that trust in the other’s goodwill is an important informal
or social control mechanism. In addition, Emsley and Kidon (2007) dif-
ferentiated trust from control, and examined the relationship between the
two characteristics in a JV between two international airlines.
Bargaining power is the last relational characteristic. Kamminga and
Van der Meer-Kooistra (2007) argue that the extent to which parents can
exercise control over a JV is regarded as the outcome of a bargaining
process. They, however, note that the mere possession of power by a
parent does not imply that this power will actually be exercised.

2.3. Control characteristics

Geringer and Hebert (1989) believe that control is a critical concept for
the successful management and performance of JVs, and present a
conceptualization of JV control. The dimensions of JV control are as
follows: (1) mechanisms by which parents exercise control; (2) extent of
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Factors Influencing Control Mechanisms in Joint Ventures 167

control exercised over a JV, namely, dependence on centralization or the

locus of the decision-making process; and (3) scope of the JV activities
(relatively wide or narrow) that parents focus on when they choose to
exercise control. In addition, Geringer and Herbert suggest three compo-
nents of control mechanisms: context-oriented mechanisms (encompassing
a wide variety of informal and culture-based mechanisms), content-
oriented mechanisms (formal and bureaucratic), and process-oriented
mechanisms (exercising control through reporting relationships or influ-
ence on JV planning and decisions). Some previous studies used this
conceptualization of JV controls (Groot and Merchant, 2000; Kamminga
and Van der Meer-Kooistra, 2007).
Groot and Merchant (2000) identify three distinct types of control
mechanisms: action controls, results controls, and personnel/cultural con-
trols. Action controls involve steps taken by parents to ensure that certain
desirable actions are implemented. Results controls are used to determine
performance, to monitor performance reports, and to provide rewards.
Third, personnel/cultural controls are those that make personnel willing
and able to perform well; alternatively, they could refer to the JV culture
and its role in motivating the employees to perform well. Further, Groot
and Merchant (2000) explain the concepts related to the extent of control
(control tightness) in Merchant (1998) — namely, tighter and looser con-
trol. For example, they suggest that action controls are tight from the
partner perspective in cases where approval reviews are frequent, detailed,
and performed by a knowledgeable person.
Kamminga and Van der Meer-Kooistra (2007) also distinguish three
control patterns on the basis of control characteristics: content-based con-
trol pattern, consultation-based control pattern, and context-based control
pattern. The control characteristics they discuss include focus, tightness,
JV types (shared/dominant/split/independent), control mechanisms, and
contract type. Borrowing Geringer and Hebert’s terminology, they break
the control mechanism down into two components: content-based and
context-based. Moreover, they suggest that the consultation-based control
pattern serves as the medium between the content-based and context-
based components, depending on the relative control complexity.

2.4. Research model and expectations

The literature on control in IORs has demonstrated the choice of gover-
nance structures (Dekker, 2004; Langfield-Smith and Smith, 2003; Van der
Meer-Kooistra and Vosselman, 2000). Governance structures are related to
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168 Yuichi Kubota

Transaction Relational Other control

characteristics characteristics characteristics

Control
mechanisms

Fig. 1. Research model.

the control mechanisms of IORs. Further, measures and causal factors

explaining differences in JV control systems, such as transaction, rela-
tional, and control characteristics, have been explored and founded.
However, little is known about the factors influencing (ex-post) control
mechanisms in Japanese JV practices and their determinants. Therefore,
a research model is provided and examined (see Fig. 1). The research
expectation is that the control mechanisms are affected to some extent by
the transaction, relational, and other control characteristics.

3. Research Method
3.1. Sample
Survey data were collected through questionnaires administered to
Japanese JV managers. A total of 275 JVs were selected from The Group
Companies in Japan (2006) database. Since 1990, JVs have begun to be
formed in Japan for development and production; typically, the parents
in these JVs are one or more of the listed Japanese manufacturing
companies. Moreover, some of the JVs seem to be strategically important
to one or some of the parents. The questionnaire for the study was sent
in March 2007 and responses were received from 58 JVs (valid responses:
55, valid response rate: 20.0%). The respondents were asked to answer
some of the questions from the viewpoint of the largest shareholder (one
parent) of the JV.

3.2. Variable measurement

This study conducted exploratory factor analysis to examine a priori types
of measures. The questionnaire contained questions for measuring trans-
action, relational, and control characteristics, followed by the research
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Factors Influencing Control Mechanisms in Joint Ventures 169

expectation. Each item was rated on a seven-point Likert-type scale (7 =

high, 4 = medium, 1 = low). Table 1 provides an overview of the survey
items in the factor analysis.
First, the transaction characteristics were measured to examine the
constructs about environmental uncertainty (4 items) and complexity
(3 items), measurability of performance and efficiency (3 items), parent’s
knowledge (4 items), and asset specificity (10 items). With regard to the
relation between transaction uncertainty and environmental uncertainty,
Kamminga and Van der Meer-Kooistra (2007) explained that both
increased and decreased environmental uncertainty may lead to uncertainty
regarding the activities of transacting parties. Langfield-Smith (2008,
p. 346) state that “environmental uncertainty arises from conditions that
are outside of the control of an alliance, but which may affect the execution
of agreements and the outcomes of cooperation”. This study applied
environmental uncertainty (instead of transaction uncertainty) and envi-
ronmental complexity for a similar reason. As a result of the principal factor
analysis of uncertainty, complexity, measurability, and knowledge, one fac-
tor was retained for each construct. For asset specificity, three factors whose
eigenvalues were greater than 1 were identified: (1) asset specificity of plan-
ning and reporting processes (planning), that is, the extent to which the
JV’s planning and reporting processes are consistent in the parent’s work-
flows, (2) asset specificity of the processes of specified tasks (operation), and
(3) physical and human asset specificity. The first and second factors can be
interpreted as process and procedural asset specificity.
Second, the relational characteristics comprised parental similarity
(2 items), information sharing between partners (16 items), trust (4 items),
and bargaining power (1 item). The items under similarity are concerned
with the parental “objectives” and “cultures”. As information sharing is
closely linked to information asymmetry and the management of Japanese
companies is, in general, characterized by tendencies toward a high level
of sharing, several items were set in this construct. The items of similar-
ity and bargaining power were directly utilized. The analysis of information
sharing revealed two factors: (1) maintaining current relationships and
(2) building long-term relationships. Although these factors have been
interpreted as types of information needs (Tomkins, 2001), they do not
coincide with each other. Moreover, through the factor analysis, one com-
ponent was identified for the items measuring trust between JV partners.
Third, the control characteristics were divided into control mechanisms
and other control characteristics. The 18 items of control mechanisms
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170 Yuichi Kubota

Table 1. Results of factor analysis for JV management control (n = 55).

Factor loadings

Factors and Cronbach alphas I II III IV

A. Uncertainty (α = 0.719) (Eigenvalue =

2.18, % of variance = 40.53)
Frequency of new product development 0.81
Competitiveness of product market 0.62
Difficulty of demand forecasting 0.54
Pace of technology obsolescence 0.54
B. Complexity (α = 0.570) (Eigenvalue =
1.65, % of variance = 36.31)
Diversity of product market 0.43
Similarity/commonality in 0.49
technology (reverse)
Diversity of sales promotion 0.82
C. Measurability (α = 0.750) (Eigenvalue =
2.00, % of variance = 51.36)
Measurability of JV performance 0.82
Identification of performance drivers 0.72
and measurement
Visibility of JV operation (stipulating 0.59
operation task)
D. Knowledge (α = 0.814) (Eigenvalue =
2.60, % of variance = 54.98)
Knowledge and information about 0.90
development/production for JV
Knowledge and information about 0.76
technology for JV
Knowledge and information about 0.73
management techniques for JV
Knowledge and information about 0.53
sales and marketing for JV
E. Asset specificity (α = 0.842)
I. Planning (Eigenvalue = 4.24,
% of variance = 24.41)
Business planning process 0.96 0.08 0.22

(Continued )
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Factors Influencing Control Mechanisms in Joint Ventures 171

Table 1. (Continued )

Factor loadings

Factors and Cronbach alphas I II III IV

Budgeting process 0.83 0.17 0.15

Financial reporting process 0.66 0.27 0.32
II. Operation (Eigenvalue = 1.41,
% of variance = 17.56)
Ordering process 0.17 0.87 0.04
Engineering design and production 0.32 0.79 0.26
process
Procuring/purchasing parts or 0.01 0.44 0.33
materials
III. Physical/human (Eigenvalue = 1.25,
% of variance = 16.66)
Sending JV employees to parents 0.30 0.03 0.79
for training
Sending parent’s employees (engineers) 0.19 0.14 0.56
to JV
Renting equipment, machines, facilities, 0.08 0.17 0.51
and land from JV partners
Technical support to JV 0.34 0.17 0.36
F. Information sharing between partners
(α = 0.961)
I. Maintaining (Eigenvalue = 10.17,
% of variance = 34.47)
Assessment of JV’s competitive position 0.79 0.31
Strategic analysis for JV 0.78 0.33
Potential risks for JV 0.73 0.48
Information on plans (goals for profits, 0.73 0.42
costs, and quality, etc.)
Progress of goals/targets 0.72 0.47
Values and ethics for JV 0.64 0.48
Detailed financial positioning and 0.63 0.33
structure of JV
Satisfactory JV financial results 0.57 0.55
Detailed investment appraisal 0.57 0.49

(Continued )
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172 Yuichi Kubota

Table 1. (Continued )

Factor loadings

Factors and Cronbach alphas I II III IV

II. Building (Eigenvalue = 1.02,

% of variance = 31.36)
New business development possibilities 0.35 0.83
Partners’ contribution to JV operations 0.35 0.77
Openness in reporting of information 0.41 0.69
on all operations of JV to parent
organization
Concrete suggestions from partner to JV 0.49 0.67
and reaction to the same
Detailed cost data of JV 0.31 0.64
Detailed information of partners’ 0.50 0.64
request to JV
Providing more reliable open data 0.51 0.54
G. Trust (α = 0.930) (Eigenvalue = 3.31,
% of variance = 77.28)
Competence trust 0.96
Goodwill trust 0.89
Reciprocal trust and willingness to 0.85
contribute
Contractual trust 0.81
H. Autonomy of JV (α = 0.862)
I. Profit center level (Eigenvalue = 4.30,
% of variance = 44.63)
Authority to develop and enter a 0.91 0.08
new market
Authority to select buyers 0.90 0.13
Authority to change product design or 0.84 0.02
technical specification
Authority to decide the plan with regard 0.79 0.26
to production and sales volume
Authority to select suppliers 0.67 0.36

(Continued )
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Factors Influencing Control Mechanisms in Joint Ventures 173

Table 1. (Continued )

Factor loadings

Factors and Cronbach alphas I II III IV

II. Investment center level (Eigenvalue =

1.66, % of variance = 21.70)
Authority to employ and dismiss the 0.13 0.85
members of JV
Authority to promote and demote 0.36 0.71
managers within JV
Authority to purchase an asset and to 0.00 0.53
transfer or dispose one
I. Tightness of NFT (α = 0.804)
(Eigenvalue = 2.15, % of variance = 57.92)
Tightness of cost reduction targets 0.79
Tightness of quality targets 0.78
Tightness of nonfinancial and 0.70
operational targets
J. Control mechanisms (α = 0.929)
I. Participation (Eigenvalue = 9.20,
% of variance = 23.76)
Participation in setting quality targets 0.87 0.28 0.08 –0.07
Participation in setting cost reduction 0.78 0.18 0.24 0.06
targets
Involvement in cost management 0.77 0.27 0.19 –0.21
activities
Involvement in Kaizen activities 0.76 0.22 0.08 –0.13
Participation in setting nonfinancial 0.75 0.17 0.14 –0.06
targets
Involvement in quality management 0.72 0.38 0.02 –0.15
activities
Participation in setting financial targets 0.61 0.12 0.47 –0.05
II. Monitoring of nonfinancial measures
(Eigenvalue = 2.88, % of
variance = 22.06)
Frequency in monitoring lead-time 0.22 0.91 0.12 0.07
variability

(Continued )
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174 Yuichi Kubota

Table 1. (Continued )

Factor loadings

Factors and Cronbach alphas I II III IV

Frequency in monitoring product design 0.22 0.89 0.20 –0.04

and specification compliance
Frequency in monitoring customer 0.22 0.81 0.14 0.13
satisfaction
Frequency in monitoring product quality 0.29 0.81 0.21 –0.03
Frequency in monitoring operational 0.40 0.70 0.20 0.05
activities
Frequency in monitoring 0.29 0.66 0.49 –0.04
manufacturing costs
III. Monitoring of financial measures
(Eigenvalue = 1.94, % of
variance = 14.40)
Frequency in monitoring financial 0.18 0.06 0.93 0.00
performance
Frequency in monitoring sales volume 0.02 0.37 0.76 0.15
Involvement in JV administrative 0.52 0.11 0.58 –0.16
support activities and tasks
Frequency in monitoring investment 0.15 0.31 0.57 –0.10
and its result
Frequency in monitoring market share 0.38 0.30 0.40 0.12
IV. Cooperative coordination (Eigenvalue =
1.80, % of variance = 9.71)
Collaboration and cooperative –0.19 –0.02 –0.09 0.85
coordination among JV employees
Mutual reliance between employees –0.02 0.03 –0.03 0.76
Communication among JV employees –0.08 0.08 0.10 0.73

Loadings are based on principal factor analysis with varimax rotation. One or more factors
are retained for each construct. The constructs all have eigenvalues greater than 1.

were developed in relation to participation in setting targets, involvement

in JV activities, monitoring of financial and nonfinancial measures, and
cooperative coordination. Four factors emerged from the items of con-
trol mechanisms: participation, monitoring of nonfinancial measures,
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Factors Influencing Control Mechanisms in Joint Ventures 175

monitoring of financial measures, and cooperative coordination in JV

operation. The first factor seems to be an ex-post mechanism wherein a
parent participates in setting the JV’s targets and directly supports the
JV for operational management activities (ex. cost management, quality
management, and Kaizen activities). In particular, this mechanism may
involve the exercise of control over processes “for mastery of events by
the relationship as an entity itself ” (as pointed out by Tomkins (2001))
and contain both outcome and behavior controls. The second factor can
be related to behavior monitoring based on nonfinancial measures, and
the third factor can be interpreted as an ex-post outcome control mech-
anism related to financial performance monitoring. The fourth factor
seems to be an ex-post social control mechanism.
Other control characteristics included the constructs of autonomy
(8 items), tightness (4 items), comprehensive contracts (1 item), and
detailed agreements (1 item) and prior consultation (1 item) between par-
ents to avoid conflicts. The items of contract, agreement, and prior
consultation were directly used. The construct of autonomy was set
because it seemed be relevant for controlling focus and empowerment
(Simons, 2005). As a result of the analysis, two factors were retained
because both had eigenvalues above 1; these factors were characterized by
the authority of (1) profit center level and (2) investment center level. In
addition, from the factor analysis of tightness, the item of “tightness of
financial targets” was removed owing to its low communality. As a result,
one factor was identified within three items: “tightness of nonfinancial
targets (NFT)”.

4. Results and Discussion

Using each factor score of the above analysis, multiple stepwise regression
analysis was performed to examine the relationships between control
mechanisms as the dependent variables and the independent variables
measuring transaction, relational, and other control characteristics. The
results of the regression analysis are presented in Table 2.
First, “monitoring of financial measures” would be positively associ-
ated with “planning”, “maintaining”, “comprehensive contracts”, “profit
center level”, and “detailed agreements”; on the other hand, it would be
negatively associated with “complexity”. The most important variable
explaining the extent of the monitoring of financial measures was
 b853_Chapter-12.qxd
176

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Table 2. Multiple regression analysis of control mechanisms (n = 55).

4/21/2010
Monitoring of Monitoring of
financial nonfinancial Cooperative
measures measures Participation coordination

3:32 PM
β t β t β t β t

Transaction characteristics

Yuichi Kubota
Complexity –0.217* –2.382 0.322* 2.670

Page 176
Knowledge 0.206+ 1.742
Asset specificity
Planning 0.562*** 6.283
Operation 0.233+ 1.974 0.339** 2.876
Physical/Human 0.317* 2.659
Relational characteristics
Bargaining power –0.315* –2.390
Trust 0.278* 2.110

(Continued )
 b853_Chapter-12.qxd
Table 2. (Continued )

Factors Influencing Control Mechanisms in Joint Ventures

Monitoring of Monitoring of

4/21/2010
financial nonfinancial Cooperative
measures measures Participation coordination

β t β t β t β t

3:32 PM
Information sharing
Maintaining 0.155+ 1.712 –0.208+ –1.721
Other control characteristics

Page 177
Comprehensive contract 0.186+ 1.951
Autonomy
Profit center level 0.275** 3.112 –0.419** –3.455
Tightness of NFT 0.187 1.623
Detailed agreements 0.215* 2.259
F 16.562*** 6.788*** 5.796*** 4.204*
Adjusted R 2 0.634 0.300 0.262 0.106

Significance levels: ***p < 0.001, **p < 0.01, *p < 0.05, +p < 0.1 (two-tailed). The beta values are standardized coefficients from the final regres-
sion equation. The stepwise method was applied to select the best set of predictor variables for the regression equation (F-value to enter = 2,
F-value to remove = 1.96). Each model with the highest adjusted R-square was chosen. Tests of multicollinearity: no variance inflation factor
(VIF) scores were greater than 2.00, indicating that multicollinearity is not a problem.

FA
177
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178 Yuichi Kubota

“planning” (β = 0.562), which means that the asset specificity of planning

and reporting processes increases the frequency of the monitoring of the
JV’s financial measures by a parent. Moreover, if a parent at least gives
the JV managers authority of the profit center level, it can control the JV
by monitoring the financial measures. The lower the level of a JV’s envi-
ronmental complexity and the more detailed agreements between partners,
the greater is the monitoring of financial measures that the parent will
undertake.
Second, “complexity” and “operation” have significantly positive effects
on “monitoring of nonfinancial measures” while “profit center level” has a
negative effect. It seems that a parent could exercise control through the
monitoring of nonfinancial measures, which is the exact opposite of moni-
toring financial measures, in cases involving a low level of authority as a
profit center and a high level of environmental complexity. Although the
effect of “operation” is statistically insignificant at 10%, it seems that the
monitoring of nonfinancial measures entails the matching of the JV’s
processes for specified tasks to the parent’s workflows.
Third, “knowledge”, “operation”, and “physical/human” have posi-
tive effects on “participation” while “maintaining” has a negative effect.
If a parent participates in the setting of the JV’s targets and directly
supports the JV, it is accordingly required to have a higher level of knowl-
edge. In addition, in this case, it is necessary to match the JV’s processes
for specified tasks to the parent’s workflows and to contain a greater level
of physical and human asset specificity. This result implies that the type
of JV (shared/dominant/split/independent) could affect the extent of
participation.
Finally, “trust” has a positive effect and “bargaining power” has a neg-
ative effect on “cooperative coordination”. When one of the JV partners
has more power than the others and the power linearly translates into the
parent’s control, cooperative coordination may not be achievable or desir-
able. In a case where cooperative coordination is necessary, the bargaining
power must be exercised very carefully. In addition, the greater the level
of trust between JV partners, the more cooperative coordination can be
improved.

5. Concluding Remarks
This study has explored transaction, relational, and control characteristics
and analyzed the determinants of ex-post control mechanisms.
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Factors Influencing Control Mechanisms in Joint Ventures 179

The results may be summarized as follows. In the exploratory factor

analysis, four factors in the construct of control mechanisms were clarified:
participation consisting of outcome and behavior controls, monitoring of
financial measures mainly as outcome control, monitoring of nonfinancial
measures as behavior control, and cooperative coordination related to
social control. In particular, it seems to be necessary to examine the
parents’ participation in setting targets and directly supporting the JV’s
operational activities under various conditions. Moreover, some determi-
nants of each mechanism were found. This research revealed that the two
types of monitoring were positively or negatively associated with the levels
of environmental complexity and autonomy as a profit center. Specifically,
for the monitoring of financial measures, it may be necessary to match the
JV’s planning and reporting processes to the parent’s workflows.
Furthermore, it was estimated that participation can differ according to
the type of JV. As a matter of course, trust and bargaining power have an
effect on cooperative coordination. These results seem to be relevant to
the detail-oriented management style of Japanese JVs. However, the style
has yet to be adequately examined — a task that can be undertaken by
future multilateral studies.
Another suggestion for future research is an integrated study of these
controls. These control mechanisms are never exercised in isolation (Malmi
and Brown, 2008). Moreover, their operation may differ across the
stages/phases of the JV’s growth. Although this research dealt with JVs
in the start-up phase, there may be individual variations in the way JVs
develop. The pace of growth of JVs is one of the control issues that remain
to be examined.

Acknowledgement
This research was partially supported by a Grant-in-Aid for Young
Scientists (B) No. 20730306 from the Ministry of Education, Culture,
Sports, Science & Technology, Japan.

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13
Does Inter-Firm Cooperation Contribute
to the Performance of Japanese Firms?
Junya Sakaguchi
Graduate School of Accountancy, Kansai University

1. Introduction
From the 1980s to the beginning of the 1990s, Japanese manufacturing
companies demonstrated overwhelming competitiveness in the world mar-
kets by producing multifunctional and high-quality products at low costs
and providing such products at low prices. With this as a background,
studies on the management of Japanese manufacturing companies have
been actively pursued around the world, and a number of unique activi-
ties and programs undertaken by Japanese manufacturing companies
have been introduced (Clark and Fujimoto, 1991). Similarly, in the field of
management accounting, target cost management (cost management
activities in the product development phase), the Just-in-Time (JIT)
production system (which aims to reduce inventories on the basis of pro-
duction instruction sheets called “kanban”) and the inter-organizational
cost management system (cost reduction activities involving parts
suppliers) have been widely introduced as techniques incorporated into
“Japanese Management Accounting” (Hiromoto, 1988; Monden and
Sakurai, 1989; Cooper, 1995, 1996).
In particular, regarding inter-firm cooperation in cost reduction between
manufacturers and parts suppliers, some previous studies have pointed
out, based on an analysis of some cases of Japanese manufacturers,
(1) that manufacturers set the target prices for parts they purchase from
suppliers and continuously evaluate individual suppliers’ target achieve-
ment levels, (2) that manufacturers and suppliers share various information

183
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184 Junya Sakaguchi

about products and parts, and cooperatively generate new ideas for cost
reduction, and (3) that these inter-company efforts have yielded dramatic
improvements in cost reduction (Cooper, 1995, 1996; Cooper and
Slagmulder, 1999, 2004; Cooper and Yoshikawa, 1994). These studies com-
monly describe inter-firm cooperation, i.e., cost reduction activities
involving parts suppliers, as an important system that contributes to
strengthening the competitiveness of Japanese manufacturers.
As stated above, inter-firm cooperation among Japanese manufactur-
ers has been widely introduced as an excellent system that enables them
to produce multifunctional and high-quality yet low-priced products at
low costs. However, looking at the present condition of Japanese manu-
facturers, it appears that some have lost their competitiveness. This study
considers the question of “whether inter-firm cooperation contributes,
even today, to the performance of Japanese companies”, on the basis of
the results of a questionnaire survey targeting Japanese manufacturers.
The purpose of this study is to clarify, through consideration of the above
question, the present status of inter-firm cooperation among Japanese
manufacturers. Section 2 discusses the actual state of inter-firm coopera-
tion among Japanese manufacturers; Section 3 examines the relationship
between inter-firm cooperation and performance. Based on these, this
paper concludes with a description of the limitations of this study and
directions for future research.

2. Actual State of Inter-Firm Cooperation

A questionnaire survey used in this study was conducted between
January 29, 2008 and February 23, 2008, targeting 376 companies in the
processing and assembly industry (general machinery, electrical machin-
ery, transportation machinery, and precision machinery), all listed on the
first section of the Tokyo Stock Exchange. The number of survey respon-
dents by the type of industry is as follows: 30 companies in the general
machinery industry (out of a total of 122 companies), 49 companies in
the electrical machinery industry (out of a total of 165 companies),
15 companies in the transportation machinery industry (out of a total
of 63 companies) and 6 companies in the precision machinery industry
(out of a total of 26 companies). The overall response rate was 26.6%
(100/376), which is relatively high compared with other questionnaire
surveys. The results of the survey used in this study are therefore
considered to accurately represent the actual condition of Japanese
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Does Inter-Firm Cooperation Contribute to Performance 185

manufacturing companies today. This study analyzed the responses of

97 companies (25.8%) that answered all the questions relevant to this
study.
Before discussing the actual state of inter-firm cooperation today
among Japanese manufacturers, let us look at the trends in Japanese man-
ufacturers’ attitude toward parts suppliers. First, let us consider
manufacturers’ attitude toward a continuous long-term business relation-
ship with their parts suppliers. In the questionnaire, the respondents were
asked to select one of the three choices (1 = positive, 2 = neutral, and 3 =
negative) in response to the statement: “Our company and suppliers have
maintained a long-term business relationship. Therefore, we wish to main-
tain a long-term business relationship with the suppliers in the future”.
Secondly, let us consider manufacturers’ attitude toward cost reduction
benefit sharing with their parts suppliers. In the questionnaire, the respon-
dents were asked to select one of the three choices (1 = positive, 2 =
neutral, and 3 = negative) in response to the statement: “Our company
successfully achieved cost reduction targets by cooperatively working with
our suppliers before and after mass production. Therefore, we believe that
we should share the profits derived from cost reduction efforts, according
to the degree of efforts”. Table 1 shows the Japanese manufacturers’ atti-
tude toward long-term business relationship and cost reduction benefit
sharing with their parts suppliers.
As shown in Table 1, it can be concluded that many Japanese manu-
facturers are trying to sustain a cooperative relationship with their parts
suppliers. These results also suggest that inter-firm cooperation, beyond
the boundaries of individual companies, has been still important.
Based on these results, the following part in this section examines
the actual state of inter-firm cooperation today among Japanese
manufacturers. As mentioned in the previous section, some previous
studies regarding inter-firm cooperation have pointed out: (1) the con-
trol aspects of inter-firm cooperation, i.e., the facts that manufacturers
set targets for price/cost, delivery and quality of purchased parts and

Table 1. Manufacturers’ attitude toward parts suppliers (created by author).

Positive Neutral Negative

Long-term business relationship 45/97 (46.4%) 40/97 (41.2%) 12/97 (12.4%)

Cost reduction benefit sharing 56/97 (57.7%) 40/97 (41.2%) 1/97 (1.0%)
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186 Junya Sakaguchi

continuously evaluate individual suppliers’ target achievement levels;

(2) the interactive aspects of inter-firm cooperation, i.e., the fact
that manufacturers and suppliers share various information about
products and parts, and cooperatively generate new ideas for cost
reduction; and (3) effects of inter-firm cooperation, i.e., the fact that
inter-organizational efforts bring great benefits in terms of reduced
costs and improved quality to manufacturers who purchase parts from
suppliers. To examine these three points, survey questions were devel-
oped for this study, using previous studies as a reference (Kato, 1993;
Nishiguchi, 1994; Asanuma, 1997). In the survey, respondents were
asked to rate each question using a five-point Likert scale (1 = strongly
disagree and 5 = strongly agree). Taking into account characteristics
of parts and materials that manufacturers procure from suppliers,
questions were asked separately for “custom parts and materials”
(which are tailored to a particular manufacturer (purchaser)’s specifi-
cations and products) and for “standard parts and materials” (which
are not tailored to a particular manufacturer (purchaser)’s specifica-
tions and products) (Nobeoka, 1999).
First, (1) the survey results regarding the control aspects of inter-firm
cooperation are presented. In this study, to investigate manufacturers’
practice of evaluating suppliers’ performance, four questions were asked
about “target price/cost setting,” “evaluation of target price/cost
achievement”, “evaluation of on-time delivery,” and “quality level
evaluation”. Table 2 shows the responses to each of the questions regarding
control aspects.
Regarding control aspects, as can be seen in Table 2, “evaluation of on-
time delivery” and “quality level evaluation” were widely performed. These

Table 2. Control aspects of inter-firm cooperation (created by author).

Custom parts/ Standard parts/

materials materials

n Mean S.D. n Mean S.D.

Target price/cost setting 97 3.70 1.072 97 3.35 1.137

Evaluation of target price/ 97 4.14 0.854 97 3.95 0.940
cost achievement
Evaluation of on-time delivery 97 4.61 0.531 97 4.56 0.629
Quality level evaluation 97 4.67 0.515 97 4.45 0.842
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Does Inter-Firm Cooperation Contribute to Performance 187

results indicate that in inter-firm cooperation, the level of achievement of

the delivery and quality targets is evaluated on a continuous basis. Looking
at the results by the type of parts/materials, “target price/cost setting
(t-value = 4.040, p < 0.01)” and “quality level evaluation (t-value = 3.065,
p < 0.01)” are more widely practiced in the case of custom parts/materials.
These results suggest that control based on accounting and quality data is
prevalent particularly in the case of custom parts/materials.
Next, (2) the survey results regarding the interactive aspects of inter-
firm cooperation are presented. In this study, four questions were asked
about “sharing of various types of information”, “sharing of various
events”, “sharing of various problems”, and “joint problem solving”.
Table 3 shows the responses to each of the questions regarding interac-
tive aspects.
Regarding interactive aspects, as can be seen in Table 3, “sharing of
various types of information (t-value = 6.217, p < 0.01)”, “sharing of var-
ious events (t-value = 5.872, p < 0.01)”, “sharing of various problems
(t-value = 6.462, p < 0.01)”, and “joint problem solving (t-value = 6.319,
p < 0.01)” are more actively conducted in the case of custom parts/
materials. From these results, it can be said that information sharing and
joint problem solving, which are the interactive aspects of inter-firm coop-
eration, are common practices, particularly in the case of custom parts/
materials. It can also be assumed that information sharing and joint
problem-solving activities provide manufacturers and their parts suppliers
with plenty of opportunities to cooperatively generate new cost reduction
ideas and to share those ideas.
Lastly, (3) the survey results regarding the effects of inter-firm coop-
eration on manufacturers’ performance are presented. In this study, to

Table 3. Interactive aspects of inter-firm cooperation (created by author).

Custom parts/ Standard parts/

materials materials

n Mean S.D. n Mean S.D.

Sharing of various types 97 4.09 0.693 97 3.62 0.883

of information
Sharing of various events 97 4.26 0.650 97 3.79 0.877
Sharing of various problems 97 4.39 0.605 97 3.96 0.853
Joint problem solving 97 4.41 0.625 97 3.99 0.823
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188 Junya Sakaguchi

Table 4. Effects on performance (created by author).

Custom parts/ Standard parts/

materials materials

n Mean S.D. n Mean S.D.

Quality improvement 97 4.06 0.788 97 3.86 0.854

Cost reduction 97 4.18 0.707 97 4.04 0.763
Lead-time reduction 97 4.04 0.828 97 3.87 0.874

determine the effects of inter-firm cooperation on manufacturers’ per-

formance, three questions were asked about “quality improvement”, “cost
reduction”, and “lead-time reduction”. Table 4 shows the responses to
each of the questions regarding performance.
As can be seen in Table 4, most manufacturers reported positive effects
in terms of “cost reduction”. This supports the findings of previous
researchers who argued that inter-firm cooperation contributed to improve
cost reduction performance of Japanese manufacturers. Looking at the
results by the type of parts/materials, improvement in “quality improve-
ment (t-value = 3.911, p < 0.01)” and “lead-time reduction (t-value =
3.087, p < 0.01)” is more pronounced in the case of custom parts/materials.
This suggests that particularly in the case of custom parts/materials,
inter-firm cooperation with parts suppliers is widely recognized as an
important activity that contributes not only to reducing cost, but also to
improving the quality level and lead-time performance.
This section discussed the present state of inter-firm cooperation
among Japanese manufacturers, based on the results of a questionnaire
survey. The discussion of this section is summarized as follows.

1. Control aspects of inter-firm cooperation: Continuous evaluations of

parts suppliers’ performance in terms of delivery and product quality
are widely performed by manufacturers. Accounting control (target
price/cost setting) and quality control are actively exercised particu-
larly in the case of custom parts/materials.
2. Interactive aspects of inter-firm cooperation: Particularly in the
case of custom parts/materials, manufacturers and parts suppliers
actively share various types of information and solve problems
cooperatively, leading to increased opportunities to generate and
share new ideas for cost reduction.
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Does Inter-Firm Cooperation Contribute to Performance 189

3. Effects of inter-firm cooperation on performance: Positive effects in

cost reduction are widely recognized by manufacturers. It is also
widely recognized that inter-firm cooperation greatly contributes to
improving product quality and shortening lead-time, particularly in
the case of custom parts/materials.

As stated above, inter-firm cooperation actively takes place among

Japanese manufacturers today, and it is widely recognized that inter-firm
cooperation contributes to improved performance of manufacturers. This
tendency seems particularly strong in the case of custom parts/materials.
Then, how do the control and interactive aspects of inter-firm cooperation
relate to manufacturers’ performance? The next section discusses this
point further.

3. Relationship between Inter-Firm Cooperation

and Performance
The fundamental question of this study is “whether inter-firm
cooperation contributes, even today, to the performance of Japanese
companies”. This section examines how (1) control aspects and (2) inter-
active aspects of inter-firm cooperation relate to (3) the performance of
manufacturers.
In this study, with respect to the control aspects of inter-firm cooper-
ation, the following one composite variable was used as an independent
variable: “control aspects” (an average of “target price/cost setting”,
“evaluation of target price/cost achievement”, “evaluation of on-time
delivery”, and “quality level evaluation”). With respect to the interactive
aspects of inter-firm cooperation, one composite variable was used as an
independent variable: “interactive aspects” (an average of “sharing of var-
ious types of information”, “sharing of various events”, “sharing of various
problems”, and “joint problem solving”). With respect to the performance
of manufacturers, “performance”, one composite variable obtained as an
average of the following three: “quality improvement”, “cost reduction”,
and “lead-time reduction”, was used as a dependent variable. Table 5
shows the descriptive statistics regarding “control aspects”, “interactive
aspects”, and “performance”. Table 6 shows the results of multiple regres-
sion analysis of the impact of the control and interactive aspects of
inter-firm cooperation on manufacturers’ performance.
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190 Junya Sakaguchi

Table 5. Control aspects, interactive aspects, and performance (created by author).

Custom parts/ Standard parts/

materials materials

n Mean S.D. n Mean S.D.

Control aspects 97 4.2809 0.56511 97 4.0773 0.66081

Interactive aspects 97 4.2887 0.51329 97 3.8402 0.72814
Performance 97 4.0928 0.66795 97 3.9210 0.70181

Table 6. Relationship between control/interaction and performance (created by

author).

Custom parts/materials Standard parts/materials

Performance Performance

Control aspects 0.366 (2.799)** 0.321 (2.839)**

Interactive aspects 0.219 (1.524) 0.224 (2.182)*
Constant 1.588 (2.771)** 1.750 (4.078)**
F-value 10.300** 13.155**
Adjusted R-square 0.162 0.202

* Indicates statistically significant at 5% level.

** Indicates statistically significant at 1% level.

As shown in Table 6, the “control aspects” of inter-firm cooperation

has a noticeable positive impact on “performance”. This indicates that the
accounting-based control, such as target price/cost setting and achieve-
ment evaluation, and the continuous evaluations of quality and delivery
time have a strong impact on the improvement of performance by manu-
facturers (purchasers) in terms of cost reduction, quality improvement,
and lead-time reduction. However, the “interactive aspects” of inter-firm
cooperation does not have a significant impact on the improvement of
manufacturers’ performance in the case of custom parts/materials. This
result can be interpreted as indicating that inter-organizational informa-
tion sharing and joint problem-solving activities, as well as the generation
and sharing of new ideas for cost reduction, do not contribute noticeably
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Does Inter-Firm Cooperation Contribute to Performance 191

to the improvement in manufacturers’ performance, regarding inter-

firm cooperation between manufacturers and custom parts/materials
suppliers.
This section discussed the relationship between inter-firm cooperation
among Japanese manufacturers and their performance, on the basis of the
results of a questionnaire survey. Below is a brief summary of the discus-
sion of this section.

1. Relationship between the control and interactive aspects of inter-

firm cooperation and performance: The “control aspects” have a
significant positive impact on the improvement of overall manufac-
turers’ performance.
2. However, from the fact that the “interactive aspects” do not have a
significant impact on manufacturers’ performance in the case of
custom parts/materials, it is thought that the generation and sharing
of cost reduction ideas do not contribute significantly to the improve-
ment in manufacturers’ performance, regarding inter-firm cooperation
between manufacturers and custom parts/materials suppliers.

4. Conclusion
This study addressed the question of “whether inter-firm cooperation
contributes, even today, to the performance of Japanese companies”. On
the basis of the results of a questionnaire survey of 97 Japanese manufac-
turing companies, this paper discussed the actual state of inter-firm
cooperation among Japanese manufacturers and the relationship between
inter-firm cooperation and performance.
As a result, it was found that continuous evaluations of parts suppliers’
performance on delivery and quality are widely conducted by manufacturers;
and that information sharing and joint problem-solving activities actively
take place, particularly in the case of custom parts/materials. Furthermore,
it was also found that the control aspects of inter-firm cooperation had a
noticeable positive impact on the performance of manufacturers. These
results support the findings of previous studies. However, it was found that
the interactive aspects did not have a noticeable impact on manufacturers’
performance in the case of custom parts/materials.
However, since the analysis results of this study were largely descrip-
tive, it is necessary to conduct further analysis. To understand the actual
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192 Junya Sakaguchi

status of Japanese manufacturing companies in more detail, interview

surveys should be conducted in future.
Additionally, with respect to activities related to inter-firm coopera-
tion and their usefulness, there are only a limited number of studies from
the parts supplier’s perspective; studies are largely from the perspective of
manufacturers (purchasers). Therefore, in future, it is necessary to con-
sider what kind of activities exist, when seen from the parts supplier’s
perspective, and what impact these activities have on the usefulness of
inter-firm cooperation. By considering these, the actual situation of inter-
firm cooperation among Japanese companies, which is stereotypically
considered “excellent” in the field of management accounting, will become
clearer.

References
Asanuma, B. (1997). The Organizations in Japanese Companies, Toyo-keizai
(in Japanese).
Clark, K. and Fujimoto, T. (1991). Product Development Performance: Strategy,
Organization and Management in the World Auto Industry, Boston, Harvard
Business School Press.
Cooper, R. (1995). When Lean Enterprises Collide: Competing through
Confrontation, Boston, Harvard Business School Press.
Cooper, R. (1996). Costing techniques to support corporate strategy: Evidence
from Japan, Management Accounting Research, 7(2), 219–246.
Cooper, R. and Slagmulder, R. (1999). Supply Chain Development for the Lean
Enterprise: Interorganizational Cost Management, Portland, Productivity Press.
Cooper, R. and Slagmulder, R. (2004). Interorganizational cost management and
relational context, Accounting, Organizations and Society, 29(1), 1–26.
Cooper, R. and Yoshikawa, T. (1994). Inter-organizational cost management
systems: The case of the Tokyo-Yokohama-Kamakura supplier chain,
International Journal of Production Economics, 37, 51–62.
Hiromoto, T. (1988). Another hidden edge: Japanese management accounting,
Harvard Business Review, July/August, 22–26.
Kato, Y. (1993). Target Costing: Strategic Cost Management, Nihon-keizai-
sinbunshya (in Japanese).
Monden, Y. and Sakurai, M. (1989). Japanese Management Accounting,
Cambridge, Productivity Press.
Nishiguchi, T. (1994). Strategic Industrial Sourcing: The Japanese Advantage,
New York, Oxford University Press.
Nobeoka, K. (1999). Changes in component procurement network in the Japanese
automobile industry, Kokumin-keizai Zassi, 180(2), 57–69 (in Japanese).
b853_Chapter-14.qxd 4/21/2010 3:38 PM Page 193
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14
Concept of Incentive Price for
Motivating Inter-Firm Cooperation
Yasuhiro Monden
Professor-Emeritus, Tsukuba University

1. The Purpose of This Paper

The function of price mechanism in the traditional economics is supposed
to be only the one for balancing the supply and demand in the market.
Since such price as a “supply–demand equilibrium price” has a goal of
socially optimal allocation of resources, it could be called as a “global opti-
mal price”. The papers applied to the corporate divisional transfer pricing
are all based on such a “supply-demand equilibrium price.” (See Hirshleifer
(1956); (1957), Cook (1955); (1957) and Gould (1964).)
On the contrary to such price, the author will propose a new concept
of the price called an “incentive price”. This is the price that will be
attached to the good or service transferred between the seller and buyer,
to allocate the joint profit earned through their cooperation. (The earlier
papers of such concept of incentive price are Shubik (1962), Schneider
(1966) and Ronen & McKinney (1970), but they are not explicitly coined
it as an incentive price and show the accounting way of its measurement
from the viewpoint of intangible assests.)
The incentive price has a purpose for the seller or buyer of the resource
to decide if they should participate in the network organization as its
member or not, considering the amount of such allocated profit. The
“participation” in this context implies that (1) an independent company
will get into the network organization as its member company, and/or
(2) an existing participated member company will enhance their self-
efforts in the network.

193
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194 Yasuhiro Monden

Therefore, the incentive price has no goal of determining the quan-

tity of supply and demand or the global optimal allocation of resources,
unlike the supply–demand equilibrium price. The determination of quan-
tity is made by the central authority of the core company in the network
organization.
Moreover, the monetary equivalence between the supply–demand equi-
librium price and the incentive price could not be necessarily assured. The
amount of price will be usually different between two of them.
This paper will clarify the difference between these two prices and con-
tend the raison d’être for the new concept of incentive price. For this
purpose, we will use some numerical examples.

2. Comparison of the Incentive Price and the Price

for Supply and Demand Equilibrium:
Numerical Examples
2.1. Problem setting
A certain consolidated business group has two subsidiary companies. The
first one is the zinc buyer company X purchasing from a zinc mining and
refining company, and the second one is the zinc-vessel manufacturing and
selling company Y. The group central company calls each of these two
companies as two divisions.
This zinc-vessel manufacturing and selling company Y makes three
kinds of zinc vessels. But, there is a limit to the zinc quantity that the zinc
buyer company X can purchase, and since this quantity limit is a bottle-
neck for the manufacturing company, it makes a product-mix decision
based on the contribution margin (i.e., gross profit) of each product per
1 kg of zinc. The author quoted this example from famous German
Schmalenbach (1947) (pp. 66–) and arranged it to clarify the points.
The accounting information for each of the zinc products A, B, and C
are as follows and shown in Table 1.

Unit contribution margin = sales price – variable outlay-cost

where the variable outlay cost = zinc purchasing cost per unit of product +
variable processing cost.
Also since both the zinc market and the zinc vessels market are imper-
fect competition markets, there exists the acquisition constraint for zinc
and the sales constraints for each products.
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Table 1. Data for the product-mix decision.

Contribution Necessary Contribution Net marginal

3:38 PM
margin quantity margin Purchase cost revenue Maximum

Concept of Incentive Price

per unit of zinc per 1 kg per 1 kg per 1 kg sales
Product variety product per unit of zinc of zinc (MC) of zinc (NMR) capacity

Page 195
(1) (2) (3) = (1)/(2) (4) (5) = (3) + (4) (6)

Product A 400 Yen 2.0 kg 200 Yen 200 Yen 400 Yen 1,000 units
(all-zinc vessel)
Product B (tin 300 Yen 0.4 kg 750 Yen 200 Yen 950 Yen 2,500 units
galvanized vessel)
Product C (electric 200 Yen 0.2 kg 1,000 Yen 200 Yen 1,200 Yen 10,000 units
zinc vessel)

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196 Yasuhiro Monden

Table 2. Optimal allocation of resource under the constraints of resource and

sales capacities.

Necessary
Maximum quantity Maximum Optimal
Selction rank sales of zinc per demand allocation
of products capacity unit product for zinc of zinc

(6)′ (2)′ (7) = (6)′ × (2)′ (8)

C (1st rank) 10,000 units 0.2 kg 2,000 kg 2,000 kg

B (2nd rank) 2,500 units 0.4 kg 1,000 kg 800 kg (accumulated
quantity 2,800 kg)
C (3rd rank) 1,000 units 2 kg 2,000 kg 0 kg

Seeing from the column (1) the rank of the contribution margin per unit
of product is A → B → C, whereas seeing from the column (3) the contri-
bution margin of each product per 1 kg of zinc has the order of C → B → A
because the zinc supply constraint is 2,800 kg. Therefore, the zinc should
be allocated according to the order of C → B → A, but the sales constraints
for each product in column (6) should also be considered to determine the
amount of allocation quantity itself.
Now take a look at column (7) of Table 2. Because the allocation
order of zinc is C → B → A, the product C will be given 2,000 kg at first
and the remaining 800 kg will be given to the product B of the second
order. Product B will have a shortage of 200 kg, while the product A will
not be given any amount of zinc. Then, the quantities produced will be
10,000 units of C, 2,000 units of B and 0 unit of A.

2.2. “Supply and demand equilibrium price”

when the resource demand exceeds
its supply
In the following Fig. 1, the horizontal axis shows the quantity; the supply
quantity of the supplying company X of zinc and the demand quantity of
the demanding company Y of zinc, who makes and sells final products.
Although the former is the quantity of zinc supply and the latter is the
sales quantity of zinc-made vessels, the sales quantity of final products
are also measured by the contained zinc quantity (i.e., weight of kg).
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Concept of Incentive Price 197

Net marginal revenue per 1 kg of zinc (NMR)

Purchasing cost per 1 kg of zinc (MC)

MC
Zinc demand by product C
1,200 Yen
Zinc demand by product B
950 Yen
x y

shadow Zinc demand by product A

price
400 Yen

200 Yen v z NMR

0 w
2,000 kg 3,000 kg 5,000 kg Zinc supply quantiy
Zinc demand quantity
2,800 kg
Zinc constraint

Fig. 1. Case of the resource demand that exceeds the resource supply.

In Figure 1, it will be defined that

MC = marginal cost
= acquisition cost of 200 yen per 1 kg of zinc
= variable outlay-cost 200 yen per 1 kg of zinc

NMR = net marginal revenue

冢 required quantity of zinc per unit of product 冣

contribution margin per unit of product
=

   + acquisition cost of zinc per 1 kg.

NMR of product C = (200 yen/0.2 kg) + 200 yen = 1,000 yen

+ 200 yen = 1,200 yen/1 kg

In Fig. 1, the point where MC is equivalent to NMR is the quantity of

the point where MC curve will merge NMR curve that is 2,800 kg of zinc
constraint.
At this point the transfer price of zinc is the line yw, which is 950 yen.
This price is the supply and, demand equilibrium price. (The readers should
note that Fig. 1 does not deal with a final consumer good, but it deals with
the supply and demand equilibrium price of raw-material good of zinc.)
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198 Yasuhiro Monden

This transfer price is composed of

Transfer price = (variable outlay-cost of 1 kg zinc; 200 yen)

+ (contribution margin per 1 kg zinc; 750 yen) = 950 yen.

In other words, the transfer price has exceeded the variable outlay-cost
(i.e., acquisition cost) and got the premium of 750 yen. This is due to the
fact that demand for zinc exceeded its supply of 2,800 kg and the zinc
became a scarce resource within this business group.
This premium is the one that will be attached to zinc when three
product segments had an auction for buying the zinc within this business
group.
As a result of applying this transfer price of 950 yen, the premium of
750 yen per 1 kg was attached to the zinc supplying company X in this
group, and the zinc receiving company Y lost their profit by this premium
amount per 1 kg zinc. This will be numerically shown in the income state-
ments of both companies X and Y by Table 3.

2.3. “Incentive price” when the resource demand

exceeds the resource supply
Now, according to the supply–demand balancing price as a transfer price,
the profit of the supplying company became 2,100,000 yen that is equiva-
lent to the shadowed rectangular xyzv, whereas the profit of the zinc
receiving company is only 500,000 yen. The manager of product company
Y, however, will not approve such an allocation of profits.
Certainly under the supply and demand relations of Fig. 1, the bot-
tleneck of this business group lies in the zinc supply company X. Thus, it
may be reasonable to allocate much profit to this company X, to motivate
the supplying company X expand its capacity.
However, such allocation scheme will attribute all of the shadowed
profit in Fig. 1 to the supplying company and the efforts of the product
manufacturing and sales company Y who contributed to achievement of
the joint profit 2,600,000 yen (= 2,100,000 + 500,000) was neglected at all.
(Note that there exists also another joint profit in Fig. 1 that belonged to
Product C, which is the white colored space above the shaded one.)
Zinc-vessels manufacturing company also has been developing the
profitable products, expanding the sales-network under the market sales
constraints and making efforts to increase the sales. In other words, they
have generated the intangible assets such as the product development
technology and sales-network. Such contribution made by the final product
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Table 3. Income statements of both companies X and Y, based on the supply–demand balancing price.

3:38 PM
Income statement of zinc supply company Income statement of zinc demand company

Concept of Incentive Price

Expense 560,000 yen Sales 2,660,000 yen ⇒ Expense 2,660,000 yen Net sales 3,160,000 yen
(= variable outlay cost (= transfer price (= transfer price (= Σ (marginal revenue per 1 kg

Page 199
of zinc × zinc supply × zinc supply quantity × zinc supply quantity zinc × zinc used quantity)
quantity
= 200 × 2,800) = 950 × 2,800) = 950 × 2,800) = 1,200 yen × 2,000 kg
+ 950 yen × (2,800 – 2,000 kg)
Profit 2,100,000 yen Profit 500,000 yen

2,660,000 yen 2,660,000 yen 3,160,000 yen 3,160,000 yen

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200 Yasuhiro Monden

company Y for a long time must be awarded. Without such remuneration

or reward, the managers of the product company Y will lose their morale
and as a result, their self-help efforts for the company will be badly affected.
Here is the reason why the incentive price has to appear on stage.
An incentive price stands for the transfer price of goods that has the
purpose of allocating the joint profit to each division appropriately corre-
sponding to their respective contribution and thus motivates the managers
of all divisions to make their participation and self-help.
Therefore, the profit attributed to the zinc supplying company should
be allocated to the product sales company, too.
The profit attributed to the zinc supplying company X

= (zinc transfer price − variable outlay cost per 1 kg of zinc)

× total quantity of zinc supplied
= (950 yen – 200 yen) × 2,800 kg = 2,100,000 yen.

Now let us measure the contribution level of each company to realization

of the joint profit by use of the investment amount of each company. This
investment amount can be measured by the book value applying the “cost
approach” of business valuation. Also, it can be measured by the stand-
alone market value of the firm (= book value amount of investment +
estimated value-created; or the market value of tangible assets & identifi-
able intangible assets + good will), which is a stand-alone business value
by the “market approach”.

Suppose that

Investment amount to the zinc supply company

= 1,080,000 yen
investment amount to the zinc-vessel manufacturing company
= 1,620,000 yen.

Then, the following formula will be applied

Allocated profit to the zinc supply company

= Joint profit
Investment amount to the zinc supply company
¥
Investment amoounts to the zinc supply and the zinc demand companies
+ stand-alone profit of zinc supply company
= {2,600,000 yen × [1,080,000 yen/1,080,000 + 1,620,000) yen]} + 0 yen
= 1,040,000 yen.
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Table 4. Income statements of zinc company X and product company Y, based on incentive price.

3:38 PM
Concept of Incentive Price
Income statement of zinc supply company Income statement of zinc demand company

Expense 560,000 yen Sales 1,601,600 yen ⇒ Expense 1,601,600 yen Net sales 3,160,000 yen
(= variable outlay (= transfer price (= transfer price (= Σ(marginal revenue per 1 kg zinc

Page 201
cost of zinc × zinc supply quantity × zinc supply quantity × zinc used quantity) = 1,200 yen
× zinc supply quantity = 572 × 2,800) = 572 × 2,800) × 2,000kg + 950 yen × (2,800–2,000 kg)
= 200 × 2,800)
Profit 1,041,600 yen Profit 1,558,400 yen

1,601,600 yen 1,601,600 yen 3,160,000 yen 3,160,000 yen

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202 Yasuhiro Monden

Therefore the transfer price per 1 kg of zinc

= (allocated profit to the zinc supply company
÷ total quantity of zinc supplied)
+ acquisition cost per 1 kg of zinc
= 1,040,000 yen ÷ 2,800kg + 200yen = 372 + 200 = 572 yen.

Thus while the profits of each company were 2,100,000 yen vs. 500,000 yen
respectively under the supply–demand equilibrium price, the allocated
profits changed to 1,041,600 yen vs. 1,558,400 yen under the incentive
price. The figures of the transfer prices themselves were different between
two prices; the supply-demand equilibrium price = 950 yen, while the
incentive price = 572 yen (see Table 4).

2.4. “Supply and demand equilibrium price” when

the resource supply exceeds its demand
Regarding the case of the supply–demand equilibrium price when the
zinc supply exceeds its demand, Schmalenbach (1947) did not treat
it all.
In this case because the zinc supply has enough amount so that some
remaining amount will appear in the auction for zinc in the inner-business
group, the premium will not be attached to the zinc, unlike the case of
over-demand.
Therefore the transfer price will be

Transfer price = variable outlay cost per 1 kg of zinc = 200 yen.

Under this situation, the zinc supply company X has to supply the zinc to
the product company Y with the price of 200 yen that is equivalent to
the acquisition price of zinc from the zinc mining company, the company
X will not be given any amount of profit at all and all amount of joint
profit will be attributed to the zinc vessels producing company.

2.5. “Incentive price” when the resource

supply exceeds the resource demand
Now according to the supply–demand equilibrium price, total amount of
joint profit was allocated to the zinc receiving company Y and none of
profit was attributed to the zinc supply company X. Is such allocation
approved by the zinc supply company? No!
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Concept of Incentive Price 203

Suppose, for instance, that the zinc supply company has expanded their
capacity of buying the zinc through their enormous efforts during this
period because their acquisition capacity was small in the preceding period.
Then, the top management of this business group should compensate for
their contribution. Again here comes the reason why the incentive price has
to appear on stage.
Thus, the profit exclusively allocated to the product sales company
should be partially allocated to the zinc supply company, too. Therefore,
again as like as the previous case in Section 2.3 the level of the contribu-
tion of each company to realization of the joint profit will be measured by
the investment amount of each company.

3. Problem of the Supply–Demand Equilibrium Price:

Redundant Decentralized Decisions
3.1. Opportunity cost of the constrained
resource and the transfer price
In the above case of zinc transfer price in the Section 2.2, the premium
amount of 750 yen per 1 kg of zinc that will be gained by the final use of
zinc under the zinc constraint of 2,800 kg has the meaning of opportunity
cost. The reason is as follows:
When we see this zinc-vessels manufacturing company as an inde-
pendent firm, the premium amount of profit 750 yen will be lost if the final
unit of zinc was lost or wastefully used or kept unused. Therefore each
product manager who wishes to utilize 1 kg of zinc must earn at least
750 yen when they use it for product A or B or C.
Thus the premium amount of 750 yen is the opportunity cost in
the meaning of the “minimum necessary profit” to be attained per 1 kg
zinc use.
Then the product manager of product A cannot bear the opportunity
cost of 750 yen per 1 kg of zinc. The product B is a barely permissible
product because its profit will be zero under this opportunity cost, while
only the product manager of C can earn the positive profit of 250 yen per
1 kg of zinc.
If such opportunity cost of 750 yen plus the acquisition cost of 200 yen
are used as a transfer price, then managers of each product can make a
decentralized decision about whether or not their use of zinc resource is
profitable.
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204 Yasuhiro Monden

In other words, the decentralized decision making will be possible by

the transfer price based on opportunity cost. (In the situation where the
sales revenue is a function of the sales price under a certain “elasticity of
price”, any products will not break-even unlike the product B in the
above Fig. 1 example. Thus the decentralized decision can be made
clearly.)1
However, the transfer price based on the opportunity cost itself must
be calculated centrally by the central headquarters that collected the date
of all divisions, which are Tables 1 and 2 or Fig. 1. Also at the same time
when the transfer price is calculated the globally optimal production plan
(i.e., zinc allocation plan and the production plan of each product) will be
centrally determined. Therefore, the decentralized decision by use of a
supply–demand equilibrium price will be redundant.2
Therefore, it follows that the supply–demand equilibrium price will be
unnecessary to the network organization, where the core company can
make a centralized “quantity decisions”.3

3.2. “Shadow price” as the opportunity cost

The numerical example in Section 3 had only one capacity constraint of
zinc supply that commonly had dealt with multiple products. That was
why the problem of determining the optimal product-mix was easily
solved by the accounting method. On the other hand, in the general
situations there are more than two constraints such as various machines
that will be used to manufacture the multiple products. In such general
case, the mathematical programming method must be applied.
The zinc allocation problem of Schmalenbach also can be formulated
as a linear programming (LP) model (see Opfermann und Reinerman,
1965). The opportunity cost or premium 750 yen per 1 kg of zinc will be
calculated as the “shadow price” of zinc constraint equation by the LP
model.
For the case of Section 2.4 when the resource supply exceeds the
resource demand, the LP model will solve the problem. And the zinc
resource will be found as “excessive” and its shadow price will be zero,
which is corresponding to the zero amount of zinc opportunity cost.
In general the shadow price will take zero value when the resource
in question is excessive (i.e., the profit will not be attached to such
resource supply in our example). On the other hand, the shadow price
will be nonnegative (i.e., positive or zero) when the resource in question
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Concept of Incentive Price 205

is scarce (i.e., the profit will be attached to such resource supply in our
example).4

4. Conclusion: Long-Term Contribution to Realize

the Synergy Effect
Kaplan (1982) posed a negative opinion for the use of shadow prices as
supply–demand equilibrium price, from the viewpoint of incentives to the
divisional managers. Under the shadow price method if each manager of
individual division has known that only the bottleneck division can be
given profit allocation, they would not tell the candid information about
their sales or production capacity to the central headquarters. In other
words, the shadow price method may induce a dysfunctional behavior of
each divisional manager or strategic manipulation of their information.
That is the so-called “incentive comparability” that induces truthful infor-
mation will not be assured.

4.1. Merits of incentive pricing

Instead of the incentive comparability problem as Kaplan noted, the
author will contend from the motivation theory such as “expectancy the-
ory” that the shadow price method or the supply–demand equilibrium
pricing cannot motivate the manager of affluent resource capacity to make
their self-help efforts after the next period, because he will not be given
any profit allocation in this period and thus his reward based on the meas-
ured profit performance will be smaller.
According to the mathematical programming algorism (complementary
slackness theorem), only the relationship of resource supply and demand
in the business group will affect the joint profit allocation as stated above.
However, since the relationship of resource supply and demand in the
business group will be determined by the short-run conditions such as
seasonal fluctuation during a year, the shadow price also varies depend-
ing on the monthly conditions. Then do people trust such a variable
evaluation criteria?
On the other hand, according to the incentive pricing method, the joint
profit will be allocated by the long-term accumulated efforts of divisional
manager and employees, which will make the intelligent assets or intangi-
ble assets. Such a long term allocation measure will earn more acceptance
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206 Yasuhiro Monden

by the divisional managers and employees as much fair, than the short run
measure.
As such long-term contribution factors, there are tangible and intangi-
ble assets, and the division that has much amount of such resources can
contribute more to achieving the joint profits than others. The examples
of such intangible assets are the sales network in the sales division and the
know-how of production management such as JIT or TQM in the manu-
facturing division, and also the engineering know-how of R&D in the
development or production divisions. Tangible assets are also another con-
tributor to the joint profit. Thus, the amount of investments to the tangible
and intangible assets or the cost outlay to the human resources (i.e.,
amount of labor costs) is contributing to the realization of joint profits.
Thus, the participants of network organization will better satisfy to the
allocation of joint profit based on such long-term contribution measure.5
The shadow price method reflects the short-run scale of holding
resources, while the incentive price method reflects the long-run scale of
holding resources.
Finally, let us confirm the purpose of the incentive price again. The
incentive price is the transfer price of resource that has the purpose of
motivating all divisional managers to do their participating or self-help
efforts by allocating the joint profit according to the long-term profit con-
tribution. Since the decisions of participation or self-help efforts are the
long-term commitment of each member to the network organization, the
long-term contribution measure should be utilized for the allocation of
synergy effect.

4.2. Forming the socially optimal organizational

structure through the incentive price
Although the incentive price differs from the supply–demand equilibrium
price that was supposed by Adam Smith as an “invisible hand”, it has
some automatic adjusting function for the allocation of business resources
in a society as a whole.
The network organization is an open system where any firm can depart
from or enter in the network in question. Thus any member-candidate firm
will naturally get into the network that they select as the best for them
based on the amount of incentive price.
If a certain member candidate did not participate in the network as
its central headquarters expected, it means that the member candidate
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Concept of Incentive Price 207

could not be satisfied with the amount of profit allocated by the center.
Then the separated candidate in question will go independently or may
participate in another network that can satisfy this member candidate
through their suggested profit allocation.

Endnotes
1. In this case, the problem formulated as a mathematical programming model
has a nonlinear objective function. And if each division solved its own local
optimization problem by using the shadow price of global model, then each
manager can get a globally optimum solution.
2. Similar criticism was made long before by Hax (1965a,b) S.208f in German
literature.
3. When a manager faced the decision problems such as the “make or buy” and
the “sell outside or transfer to inside”, and so forth, the problems can be
solved by applying the “incremental cost” analysis or by the “differential cost”
analysis as so-called “special cost studies”. Because, if the resource has a con-
straint, then the opportunity cost will be included in the incremental cost or
differential cost. The function of the transfer price should be confined to the
profit allocation goal to motivate managers under inter-firm relations or inter-
divisional relations.
4. This theorem is called the “complementary slackness theorem” in the
mathematical programming. There are many kinds of decomposition solution
methods in mathematical programming models that resemble decentralized
managerial decisions (see Dantzig and Wolf (1960), Kornai and Liptak (1965),
Adam and Röhrs (1967), Adam (1970), Ruefli (1971), Kornbluth (1974), etc.).
5. In the well-known “prisoner’s dilemma” of game theory all players will not
betray any others in the long-term repetitive games. This result suggests that
long-term contribution measure will be the incentive system that induces the
“truthful information” transmission.

References
Adam, D. and Röhrs, W. (1967). Ein Algorithmus zur Dekomposition linearer
planungsprobleme, Zeitschrift für Betriebswirtschaft, June, 395–417.
Adam, D. (1970). Entscheidungsorientierte Kostenbewertung, Betriebswirtschftlicher
Verlag.
Cook Jr., P. W. (1955). Decentralization and transfer pricing, Journal of Business,
1153 (April) 87–94.
Cook Jr., P. W. (1957). New technique for intracompany pricing, Harvard Business
Review, 35(4), July–August. 74–80. (reprinted in: Decentralized Management
Series. HBR Supplement).
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Dantzig, G. B. and Wolf, P. (1960). Decomposition principle for linear programs,

Operations Research, 8(January–February), 101–111.
Gould, J. R. (1964). Internal pricing in firms when there are costs of using an
outside market, Journal of Business, XXXVII(January), 61–67.
Hax, H. (1965a). Kostenbewertung mit Hilfe der mathematischen Programmierung,
Zeitschrift fur Betriebswirtshaft, April SS, 197–210.
Hax, H. (1965b). Die Koordination von Entscheidungenn: Ein beitrag zur
Betriebswirtschaftlichen Organizationslehre, Carl Heymanns Verlag.
Hirshleifer, J. (1956). On the economics of transfer pricing, Journal of Business,
XXIX(July), 172–184.
Hirshleifer, J. (1957). Economics of the divisionalized firm, Journal of Business,
XXX(April), 96–100.
Kaplan, A. (1982). Advances in Management Accounting, Prentice-Hall.
Kornai, J. and Liptak, T. (1965). Two level planning, Econometrica, 33(1), 141–169.
Kornbluth, J. S. H. (1974). Accounting in multiple objective linear programming,
The Accounting Review, April 284–295.
Milgrom, P. and Roberts, J. (1992). Economics, Organization & Management,
Prentice Hall.
Opfermann, K. and Reinerman, H. (1965). Opportunitatskosten, Shattenpreis und
Optimale Geltungszahl, ZFB, (4, SS). 233–234.
Ronen, J. and McKinney, G. III. (1970). Transfer pricing for divisional autonomy,
Journal of Accounting Research, 8(1), (Spring), 99–112.
Ruefli, T. W. (1971). A Generalized goal decomposition model, Management
Science, 9–6 (June), B649–B518.
Schmalenbach, E. (1947). Pretiale Wirtschaftslenkung, Band 1, Die optimale
Geltungszahl, Industrie-u. Handelsverlag Walter Dorn Gmbh.
Schneider, D. (1966). Zielvorstellung und innerbetriebliche Leistungspreise in
privaten und öffentlichen Unternehmen, ZfbF, 3.
Shubik, M. (1962). Incentives, Decentralized control, the assignment of joint costs
and internal pricing, Management Science, (April), 325–342.
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Part 5

Inter-Organizational Learning
and Autonomous Organizations
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15
Management of Population-Level
Learning and Inter-Organizational
Relations in Japan
Hiroki Kondo
Faculty of Business Administration, Mejiro University

1. Introduction
The role of long-term transaction practices that characterize Japanese
corporate groups and keiretsu relationships is not only a coordination
mechanism of strategic behavior among group organizations, but also a
channel of learning that transfers new practices and allows for the sharing
of knowledge among group organizations. Moreover, through these inter-
organizational learning processes, trust among keiretsu group companies is
encouraged, again accelerating the sharing of more knowledge about each
other (Manabe and Nobeoka, 2002). In addition, in some local industrial
accumulations or clusters, knowledge sharing and imitating each other
among geographically approximate firms provide regions with the poten-
tial to develop as learning regions.
However, according to behavioral organizational learning theorists
(Levitt and March, 1988; Levinthal and March, 1993), learning does not
necessarily improve corporate efficiency, and thus dysfunction often
occurs. In fact, a level of performance is widely dispersed among each com-
pany group and each keiretsu group in Japan. A long-term relationship is
not a sufficient condition for learning. Furthermore, some industrial accu-
mulations fall into disuse with their core technology or products that is
obsolete, such as the traditional local industry.
Therefore, the problem is how to control the inter-organizational
learning that easily deteriorates into dysfunction. There should be good
management practices to promote effective learning. Therefore, this
paper aims to propose a framework for controlling inter-organizational

211
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212 Hiroki Kondo

learning using collective strategy as a channel of learning. For this purpose,

routine-based (Levitt and March, 1988) and population-level learning
(Miner and Haunschild, 1995) are examined as an analytical framework for
the dysfunction of inter-organizational learning. In addition, a collective
strategy framework (Astley and Fombrun, 1983) is introduced to classify
the channel of population-level learning.

2. Brief Overview of Population-Level Learning

2.1. Routine-based learning theory
From the standpoint that considers organizational learning not only as the
development of knowledge but also a change in the knowledge system and
the action pattern, organizational learning is not necessarily useful for the
survival of an organization. Levitt and March (1988), the representative
advocates of behavioral organizational learning theory, proposed some
constraints on organizational learning and its dysfunctional outcomes.
Considering learning as a “process” rather than “outcome” and illustrat-
ing the dysfunctional aspects of learning, they ask how organizational
learning can be effective.
Within their framework, “organizations are seen as learning by
encoding inferences from history into routines that guide behavior”
(p. 320). Their framework is based on the characteristics of behavioral
organization theory — “routine-based”, “history-dependent”, and “target
orientation” — characteristic of organizational action. Given these char-
acteristics, the legitimacy and plausibility of selected routines are more
important than the calculated choices or logical sequence with regard to
the circumstances or intention. Moreover, the frame of interpretation of
historical experiences makes a large difference on the selection of routines
and, consequently, the entire organizational action.
The term “routines” include “the forms, rules procedures, conventions,
strategies, and technologies around which organizations are constructed
and through which they operate. It also includes the structure of
beliefs, frameworks, paradigms, codes, cultures, and knowledge that but-
tress, elaborate, and contradict the formal routines” (p. 320). Beliefs,
frames, and paradigms are the foundation for interpreting the past
experiences. Therefore, learning new frames for interpretation and
unlearning the old actualize radical learning such as double-loop learning
(p. 324).
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Population-Level Learning and Inter-Organizational Relations 213

2.2. Competency traps and the exploration–exploitation

problem
Such transformation in behavioral patterns through organizational learn-
ing does not necessarily contribute to the effectiveness of organizations.
March’s theory indicates the possibility of organizational dysfunction.
Competency trap involves the inability of organizations to shift to new
routines of potentially higher performance when old routines based on
sufficient experiences guarantee organizations the satisfaction with their
present performance. March (1991) classified two modes of learning:
exploitation and exploration. Exploration leads to competency traps, so an
organization must adopt exploration to an extent in which it will not fall
into failure traps.
However, Levinthal and March (1993) argue that organizations that
learn from their own experiences are likely to fall into competency traps
due to their myopic tendency. To promote effective learning, organizations
gravitate to making the environment simple and comprehensive, and spe-
cialized organizational divisions deal with each aspect of the environment
separately. This tendency makes learning myopic. The authors also clas-
sify three types of myopia. Temporal myopia refers to the tendency to put
greater emphasis on short-term rather than long-term performance.
Spatial myopia refers to the tendency in failing to see the entire system in
terms of local experiences. Failure myopia refers to the tendency to stick
to successful experiences and forget failures. Thus, it becomes easy to fall
into competency traps, as organizations try to learn effectively from their
own experiences.
Competency traps are the outcomes that result from incremental learn-
ing on the basis of one’s own experience. As a solution to avoid falling into
competency traps, organizations can draw on other companies’ experi-
ences. But in such a vicarious learning process, an interpretation of the
relationship between routine and performance is more ambiguous than
that in the case of own experience. Thus, vicarious learning tends to lead
organizations to superstitious learning by mistaking the relationships
between routine and performance and adopting irrelevant routines. In this
way, a clue to resolve the antinomy between exploitation and exploration
would exist in inter-organizational learning or vicarious learning about
another organization’s experience. However, to avoid superstitious learn-
ing, the evaluation or interpretation of routines must be discussed among
peer organizations.
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214 Hiroki Kondo

2.3. Framework of population-level learning

Miner and Haunschild (1995) applied routine-based learning theory to
population-level analysis. Population-level learning is defined as a
“Systematic change in the nature and mix of organizational action routines
in a population of organizations, arising from experience” (p. 115). A pop-
ulation is defined as “a set of organizations that share at least one major
semistable trait, activity or resource utilization pattern” (Miner and
Anderson, 1999, p. 6). Researchers can consider various collectives of
organizations as a unit of analysis in light of the broad definition of pop-
ulation. They consider an industry as a type of population, and “a regional
collection of organizations might also represent a local organizational
population” (p. 6). Once an organization introduces a new routine, it is
imitated and diffused to other organizations by vicarious learning. It can
be said that population-level learning seems to be generated when a rou-
tine is diffused to an entire population, and thus the mix of organizational
routines is changed.
As with March’s theory, learning does not necessarily bring adaptation
at the population level. The outcome of population-level learning appears
as a change in the distribution of routines in a population. Competency or
failure traps occur in an entire population causing a decline of industry or
local industrial districts. The subject of inter-organizational learning
research is the practices that an organization attempts to obtain new
routines through interaction with other organizations and its research
interest is in the survival of individual organizations. On the other hand,
the primary focus of population-level learning is the survival and growth
of the entire population and an individual organization is merely a vehi-
cle of organizational routines.
Populations in which the same routines have been diffused through
population-level learning come to competitive relationships with other
populations that have substitutive routines. In such cases, the timing of
learning affects the survival of populations (Miner and Haunschild, 1995).
In the event that the timing of learning is too early, the diffusion of an
underdeveloped routine begins before alternatives are fully explored. The
second-best routine, which would be inferior to the optimum state, is
selected and introduced to the population. On the other hand, in the
event that the timing of learning is too late, it is possible that a com-
peting population would invent a routine superior to that of the focal
population. The timing of diffusion is important to the survival of an
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Population-Level Learning and Inter-Organizational Relations 215

individual organization in each population in terms of making a forking

point of competitive advantage for the entire population.

2.4. Research implication of population-level learning

The survival of populations is a central concern in population-level learn-
ing, but it is also quite important to individual organizations. In
particular, it has already seen that individual organizations will try to
avoid competency traps through vicarious learning that seeks a source of
exploration in other organizations. Individual organizations in that popu-
lation would fall into competency or failure traps unless the mix of
exploration and exploitation could be balanced.
Miner and Haunschild (1995, p. 116) illustrate such balancing of
exploitation and exploration in two examples. A major pharmaceutical
manufacturer in the United States has been carefully studying the behav-
ior of newly founded biotech firms. Once it becomes clear which venture
firm would be successful, major firms cautiously imitate that routine
through head hunting, licensing, or investing in patents that are periph-
eral to seemingly valuable technology. Early period in which biotech
venture firms were established worked as a period of exploration learning
for major firms. On the other hand, the semiconductor industry in the
United States established corporative R&D institutions called the
Microelectronics and Computer Consortium (MCC) and Semiconductor
Manufacturing Technology (SEMATECH) on the basis of the successful
experience of Japanese companies (Aldrich and Fiol, 1994).
In this paper, following Miner and Haunschild (1995), the diffusion of
routines among a population is classified in three patterns. First, contact
transmission refers to a direct transfer of routines from one organization to
another. It includes technology transfer from other firms, inferential imita-
tion by observing seemingly successful competitors, acquisition of routines
through formal and informal personal networks, interlock of directors,
mergers and acquisitions, and so on. Second, broadcast transmission refers
to the diffusion from an authoritative source to other organizations in the
entire populations. It is carried out through promulgation by professionals
such as certified accountants and lawyers, regulation by nation states,
establishment of educational systems, transfer of technology transfer from
research institutions such as universities, and so on. Third, a population-
level routine includes a foundation of trading associations and R&D
consortiums, standard lobbying or implicit price-fixing cartels, and so on.
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216 Hiroki Kondo

These are routines for collective strategy and cannot be adopted by any
one or a few organizations.

3. Collective Strategy and Population-Level Learning

Population-level learning is based on the diffusion of routines through
interaction among inter-organizational networks and coordinated activity
among organizations. Individual organizations within a population are
embedded in multiple relationships that include networks or hierarchical
coordination among independent organizations. Astley and Fombrun
(1983) classified these relationships into four types and conceived strate-
gies to control each relationship. We can see these collective strategies as
a channel for the diffusion of routines. Moreover, individual organizations
may use collective strategy to control the dynamics of population-level
learning and avoid the dysfunctional effects of learning.

3.1. Brief overview of collective strategy

Collective strategies were originally conceived as strategies to deal with
a turbulent environment (Astley and Fombrun, 1983). Because turbulence
of environment arises from complex interactions on the part of organiza-
tions acting independently, a collective strategy aims to reduce
environmental uncertainty by making the behaviors of each other pre-
dictable. Organizational theories that emphasize environmental selection,
such as population ecology, depreciate the strategic choices made by
individual organizations, considering that the environment rigorously
restricts the autonomy of organizations. Astley and Fombrun (1983)
argued that strategic choices can be possible at the collective level if the
competitive relationships among organizations can be overcome using col-
lective strategies. Collective strategy has been presented as a theoretical
and practical solution to the selection–adaptation debate in organization
theory.
Astley and Fombrun (1983) classified the relationship between organ-
izations and the four types using two axes. One axis denotes whether the
relationship is competitive or corporative (commensalism or symbiosis)
and another axis denotes whether the resource transfer among organiza-
tions is direct or indirect. Commensalism refers to the relationship in
which organizations compete over the same resources and share the
same selection pressure from the environment. Symbiosis refers to the
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Population-Level Learning and Inter-Organizational Relations 217

relationship in which organizations do not compete over any resources and

exchange resources reciprocally. A collective strategy can be conceived for
each relationship, as seen in Table 1.
Agglomerative collectives consist of organizations of the same species
that compete over the same limited resources. In such associations, inter-
organizational relationships would be coordinated by information flow,
especially price information. A competitive relationship is restricted by a
centralized coordinative mechanism such as lobbying by industry organi-
zations and price agreements by cartels.
Confederate collectives occur in an oligopolistic industry. In such rela-
tionships, price information would not be important; rather, personnel
transfer is more important in inter-organizational coordination. Collusion
enhanced by informal contacts is a coordinative mechanism.
Conjugate collectives occur in interdependent relationships among
relative industries. In such a relationship, stabilization of workflow by
the prolongation of transactions is important in reducing the turbulence.
A collective strategy is the improvement of a relationship by the coopta-
tion of partner organizations through joint ventures and interlocking
directors.
Organic collectives consist of independent organizations that belong to
unrelated industries having no direct transaction with each other. An
increase in the interrelations among organizations in such associations
accelerates environmental turbulence and gives organizations an unin-
tended outcome. Therefore, control of the network is attempted through
restrictions by political influence.

3.2. Control of population-level learning

In each type of collective, collective strategies work as a channel through
which organizational routines are diffused by the vicarious learning of
organizations. We can classify the modes of population-level learning pro-
posed in Miner and Haunschild (1995) into four organizational collectives.
Population-level learning can be controlled to enhance organizational
learning or to avoid dysfunctional learning by influencing the flow of the
diffusion of routines through collective strategies. However, if a collective
strategy operates incorrectly, population-level learning would result in
dysfunctional effects.
In agglomerative collectives, population-level learning is promoted
by diffusion of routines through imitation between organizations in
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4/21/2010
Table 1. Framework of collective strategy (Astley and Fombrun, 1983, Table 2).

Agglomerative Confederate Conjugate Organic

collectives collectives collectives collectives

3:39 PM
Sub-structural relationships
Forms of internal interdependence Indirect Direct Direct symbiosis Indirect symbiosis
commensalisms commensalism

Hiroki Kondo

Page 218
Resource flow through network Information flows Personnel flows Work flows Influence flows
Super-structural relationships
Form of control Economic sanction Social sanction Regal sanction Political sanction
Emergent structures of Cartel, trade, and Collusion Informal Agreement/ Network
coordination professional leadership contract organizations’
associations Interlocking institutionalized
directorates rule structures
Joint ventures
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Population-Level Learning and Inter-Organizational Relations 219

competitive relationships. Because imitation by vicarious learning is

performed by inference about the experiences of other organizations,
processes of inferences or results from mis-inferences invent rich blind
variations. This process can affect the growth of the entire population by
enhancing the knowledge base of the population and the entry of new
firms (Aldrich and Fiol, 1994). At the same time, trade associations
acquire population-level routines.
In confederate collectives, imitation among large organizations in oli-
gopolistic competition would promote population-level learning, similar to
agglomerative collectives. In addition, personnel transfer among competi-
tors may also facilitate the diffusion of routines, though this has not
occurred to a great extent in Japan thus far. An R&D consortium would
be founded to coordinate the development of technology and set industrial
standards among competitors.
In conjugate collectives, routines are diffused through the interaction
between organizations that make transactions with each other. Similar
to contact transmissions, broadband transmissions that take the shape
of guidance of the coordinative organizations promote population-level
learning. For example, large distributors or assemblers who control
their districts or groups instruct their subcontractors to adopt certain
routines.
In organic collectives, there is less coercive force to restrict the strate-
gic behavior of organizations than in other collectives; therefore,
organizations can establish inter-organizational relationships more
autonomously. Cross-industrial association between various industries
becomes the route for the transmission of knowledge between organiza-
tions. The failure of the interpretation that arises from vicarious learning
is reduced by the sharing of knowledge in the association.

4. A Case of Population-Level Learning in Japan

Individual organizations are usually involved simultaneously in four types
of collectives. They use different strategies in each collective to try to
restrict the turbulence caused by a complex interaction of organizations.
Moreover, collective strategies work as a coordinative channel that affects
the outcome of population-level learning. In particular, in Japan, these
collective strategies have been used not only to restrict turbulence, but
also to share knowledge.
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220 Hiroki Kondo

4.1. Flexibility of fixed transaction relationships

Numagami (1995) argues about the cause of the differences between Japan
and the United States in the choice of technology for the display of an
electronic watch in the 1970s. At that time, the following two technologi-
cal alternatives were available for an electric watch display: Light Emitting
Diode (LED) and Liquid Crystal Diode (LCD). The LED consumed con-
siderable power, so the user would have to light the display every time to
confirm time. On the other hand, the LCD consumed less power and could
produce a continuous display, but its production cost was expensive.
However, the second generation (TN-LCD) had the potential to clear up
the problem of the production cost as compared to the first generation
(DSM-LCD). Nevertheless, watchmakers in the United States did not
decrease their supply of LED watches until 1977, though it was clear that
the second generation had been launched, and that the LCD had exceeded
the LED in 1975. In the United States, the volume of consumption of the
LCD and the LED was reversed in 1978. On the other hand, no Japanese
firms selected the LED from the outset.
Numagami (1995) contends that the differences in the transaction
system between the Japanese and US industry affected the choice of
technology. The industrial system of the United States is a flexible one
that consists of market transactions, and it is possible to procure both the
LED and the LCD relatively freely from an outside company. On the other
hand, the industrial system of Japan is a fixed one, and Japanese firms
customarily procure parts from suppliers in a long-term relationship. If
Japanese companies want to use the LCD in future, they must select a
fixed transaction with a certain parts supplier or an in-house production
from the outset. Thus, due to the lack of flexibility with parts suppliers,
a large number of companies had to choose the LCD from the outset.
Therefore, investment and technological progress occurred in the LCD and
the peripheral technology.
Numagami (1995) concludes that if endogenous technological progress
is great, consensus among industrial systems about technology in the next
generation is more important than flexible transactional relationships. If
the possibility of technological change in the future is relatively clear and
endogenous technology development is important, a technological conver-
sion will be delayed in a flexible rather than in a fixed industrial system.
Due to the lack of flexibility, technological choice has to be undertaken
carefully in a fixed industrial system. The fixed relationship between the
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Population-Level Learning and Inter-Organizational Relations 221

organizations automatically forms the selection criterion of right technol-

ogy. Even when the future technology is uncertain, this selection
mechanism can be supplemented by sharing knowledge about technology
at the industry level and prompting an appropriate interpretation of the
situation that influences the industry.

4.2. Collective strategies related to growth

of local industry
In the Okawa region of Fukuoka Prefecture in the northern part of
Kyushu, Japan, 838 companies related to woodwork gathered in a small
town comprising 40,000 people in 2007. In addition, in the same year, in
the Fuchu region of Hiroshima Prefecture in the western part of main-
land Japan, 262 companies related to woodwork gathered in a small
town comprising 45,000 people. These two towns came to compete with
each other intensely after high-consuming regions, including Osaka and
Tokyo, became important markets with the development of transporta-
tion routes such as railways and tracks beginning with the period of
rapid economic growth in Japan. In both regions, under the instruction
of industrial associations and traditional craft institutes, almost all com-
panies learned and adopted production techniques from Germany (flash
structure, Dübel construction method, and so forth) in 1950s and shifted
from the craftsman’s process to the assembly line operation. Both
regions acquired a large market share through low-cost strategy using
cheap local manpower.
At that time, the painting process was the greatest bottleneck in whole
manufacturing process. However, companies in the Hiroshima region intro-
duced the curtain flow coater from Germany, which was the most
up-to-date process at that time, in 1959, and was able to apply uniform,
beautiful painting at a high speed. By introducing this expensive machine,
companies in the Hiroshima region shifted from a system of specialization
involving manufacturing processes coordinated by large producers or dis-
tributors to an integrated system of production from raw material to the
finished product. Therefore, the Hiroshima region achieved four times
more productivity than in the Okawa region and was able to overwhelm
in both the price and quality of its product during the 1960s. Thus, dur-
ing the 1950 and the 1960s, population-level learning was promoted and
routines in entire regions were changed through broadband transmission
by trade associations in agglomerative collectives.
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222 Hiroki Kondo

In the Okawa region, which had been left behind by the Hiroshima
region, the first company that adopted the Numerical Control machine
appeared in 1967. With this event, many operators of the NC router
became independent, which resulted in an increase in the trade of decora-
tion of furniture parts. In addition, as the coating technology advanced
and the painting processes became more important, this aspect of the
operations often came to be subcontracted out to independent specialists.
The lease contracts of the NC router made the entry barrier very low for
the subcontractor. Moreover, because the Okawa region consisted of innu-
merable small firms that did not have sufficient facilities and manpower
to implement these processes, large numbers of orders piled up from these
firms. Thus, the specialization of manufacturing processes was restruc-
tured. This specialization led to the coexistence of economy of scale and
rapid technological change in the NC decorating process and the coating
process. In the Okawa region during the 1970s and the 1980s, adaptation
was achieved by decoupling exploitation in the assembling routine that
was developed in the 1950s and exploration of rapid technological changes
in the coating and decorating processes.
Japan has been in a long economic depression since the 1990s.
Moreover, due to the high valuation of the yen, extraordinarily low-priced
wooden furniture has been imported from China into the Japanese mar-
ket. In such poor economic conditions, the Karimoku group in Aichi
Prefecture is the only Japanese manufacturer that has been expanding its
market share in Japan. Karimoku adopts a management style that exerts
consistent control from manufacturing to retailing. A brand management
system develops brand product lines targeted to every lifestyle and age
group, and the marketing center makes a request for implementation of
details of planned products to manufacturing division. In the factory, man-
agers of manufacturing divisions set up engineering activity to respond to
the demands of the marketing center. Through this engineering activity,
they offer kaizen in the procurement, draft, manufacturing operation,
inventory control, and so forth, to the marketing center. In 2008, Karimoku
surpassed the entire Okawa region that consisted of over 800 companies by
sales of wooden furniture.
Karimoku introduced a market-directed management style by using a
top–down approach, while the small manufacturers in the Okawa region
have tried various projects by forming inter-firm groups cooperatively. The
three groups presented below tried to introduce themselves by building
their own brands of products at the outset. They assumed that the only
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Population-Level Learning and Inter-Organizational Relations 223

recourse the Japanese manufacturers could take against Chinese products

was to produce a complete set of interior furnishings for Japanese con-
sumers, which consisted of a set of special furniture produced by each
company in the group. They assumed that a Chinese manufacturer that is
geographically distant from the Japanese market could not produce a set
of furniture for a complete interior style. However, based on consumers’
responses directly to large retailers in Tokyo, it appeared that their own
brand products made with a product-oriented approach did not appeal to
customers.
Two of these groups therefore abandoned their own brand products
and the product-oriented approach that they had at first. The first group,
Order Seven, assumed that small retailers exist everywhere in Japan as
customers, and started to create a merchandising plan with such retailers
cooperatively, proposing planning and designing of store space that is cus-
tomized for each location and customer traffic. The second group,
Collabostyle, started OEM manufacturing for various retailers and house
builders, introducing the JIT manufacturing system and making the best
use of the flexibility of SMCs. In contrast, the third group, MOST, did not
follow any transformation of style from product-oriented to market-in.
Organizations outside the groups, such as large retailers or trade asso-
ciations, are influenced by the strategic changes of each group. For the
first and second groups, the large retailers in Tokyo, Tokyo-Marui, and
Otsuka Furniture are joining temporarily as referent organizations that
redefine the problematique faced by the population (Trist, 1983). However,
for the third group, which was formed under the mentorship of a trade
association, the authoritative consensus about the goal setting and the
understanding of business environment worked as regulative pressure.
Therefore, the failure experienced in transactions with outside retailers
was also interpreted in light of that consensus and a product-oriented con-
cept was repeated in the changing membership of the group.

5. Discussion
In the first case of the watch industry, we see population-level learning
restricted by inter-organizational relationships in conjugate collectives.
Correcting the relationships between contracting firms would have
worked as a motive to communicate with each other to invest in new
technology, and thereby avoid the second-best choice of technology.
Moreover, as Numagami (1995) argued, a collective understanding about
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224 Hiroki Kondo

future technology can complement the flexibility of the fixed industry sys-
tem when the future technology is uncertain. This could be understood
as a case in which the appropriate usage of the collective strategy can
restrict the dysfunctional aspect of population-level learning.
In the second case of the traditional local industry of wooden furniture,
we see that the effect of population-level learning changes along with the
local industry’s stage of development. In the first stage of development,
broadband transmission by a trade association in the agglomerative
collective worked to establish the modernization of the furniture assembly
process. In the second stage, contract transmission between woodwork
manufacturers and independent subcontractors of the NC router and the
coating processes enhanced the flexibility of the entire region by decou-
pling exploitation in the assembly process and exploring the complex NC
router and coating technology. During this period, contact transmission in
conjugate collectives worked to balance the exploitation and exploration
processes in the entire region. In the third stage, broadband transmission
in conjugate collectives worked as a redefinition of problematique, or
double-loop learning, by learning a routine in the shape of the frame of
the interpretation of past experiences.
In this paper, I have offered some tentative assumptions that collective
strategy should be considered as a vehicle to control population-level
learning. In population-level learning, the balance between exploitation
and exploration would be a core issue to be discussed in terms of an
evolutionary perspective. Partly, it was seen in these cases that learning
through collective strategies may be attempted to study about exploration
by other organization to imitate from geographically approximate organi-
zations to another segment or industry. How the balance between
exploitation and exploration is resolved collectively at the population level
of analysis would be a future research topic.

References
Aldrich, H. E. and Fiol, M. C. (1994). Fools rush in? The institutional context of
industry creation, Academy of Management Review, 19, 645–670.
Astley, W. G. and Fombrun, C. J. (1983). Collective strategy: Social ecology of
organizational environments, Academy of Management Review, 8(4).
Levitt, B. and March, J. G. (1988). Organizational learning, Annual Review of
Sociology, 14, 319–340.
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Population-Level Learning and Inter-Organizational Relations 225

Levinthal, D. A. and March, J. G. (1993). The myopia of learning, Strategic

Management Journal. 14, 95–112.
Manabe, S. and Nobeoka, K. (2002). Constructing trust in network: Inter-
organizational learning system of Toyota, Hitotsubashi Business Review, 50(3)
(in Japanese).
March, J. G. (1991). Exploration and exploitation in organizational learning,
Organization Science, 2, 71–87.
Miner, A. S. and Anderson, P. (1999) Industry and population level learning:
Organizational, interorganizational, and collective learning processes,
Advances in Strategic Management, 16, 1–30.
Miner, A. S. and Haunschild, P. R. (1995). Population-level learning, Research in
Organizational Behavior, 17, 115–166.
Numagami, T. (1995). Adaptive capacity of fixed industrial system to the tech-
nological change. Research group of corporate behavior (eds.), Adaptive
Capacity of Japanese Company, Ch. 8, Nihon keizai shinbun sha (in Japanese).
Trist, E. (1983). Referent organizations and the development of interorganizational
domains, Human Relations, 36, 269–284.
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16
Management Control System
in an Empowered Organization
Katsuhiro Ito
Department of Economics, Seikei University

1. Characteristics of Empowered Organizations

Observed in Japanese Companies
Among Japanese companies, there are some that have been designed and
managed based on a logic different from that of traditional centralized
organizations on which management accounting theory was originally
premised. The JAA Special Committee (2006) has conceptualized those
organizations represented by such Japanese companies with organizational
principles different from those of centralized organizations as empowered
organizations. Today, even in Europe and the United States, an organiza-
tional design (empowered organization, individualized corporation)
different from that of organizations (centralized organizations) assumed by
management accounting theory at its birth is attracting attention as an
alternative. The change in organizational context (movement to empow-
ered organization) is discussed in some documents (Hamel and Breen,
2007; Ghoshal and Bartlett, 1997). The empowered organization therein is
contradistinguished from the centralized organization, which is under
“command and control” through official positions and hierarchy. As char-
acteristics of empowered organizations, the following three can be listed:
(1) emergence of strategy, (2) distributed execution of field operational
decision making (autonomous judgment by each organizational unit), and
(3) renewal of organizational routines by front-line personnel. This paper
discusses mainly (3).

227
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228 Katsuhiro Ito

2. Importance of Organizational Learning

in Empowered Organizations
Organizational learning is one of the means by which an empowered
organization accommodates itself to its surroundings. In the midst of
ever-increasing environmental changes, the promotion of organizational
learning has become an important management task. Then, what role can
the management control system play in this task?

2.1. Significance of organizational learning

Learning, unlike problem solving, means that changes in potential imple-
menting abilities continue and establish themselves. For example, there is
a clear difference between the success of a company in the development of
a product and the improvement in the company’s product development
capability itself. The former is a problem-solving task within the frame-
work of the existing product development capability, whereas the latter is
a learning process for the acquisition of greater product development
capability. Organizational learning results in organizational routine.
Therefore, organizational learning can be defined as a change in organiza-
tional routine (Cyert and March, 1963; Hedberg, 1981). Organizational
routine refers to a program that gives continuity or consistency to organi-
zational behaviors. Organizational routines are present as formulated/
documented regulations, standard business procedures, manuals and job
description forms, and take the form of customs, beliefs, knowledge, tech-
nologies, strategies, cultures, and so forth, shared among organizational
members (Levitt and March, 1988).
Individual learning is the fundamental element of organizational learn-
ing. However, the sum total of individual learning does not amount to
organizational learning. Organizational learning is the sharing of the
results of individual learning among the organizational members, and the
acceptance of a common interpretation thereto; thus, a new organizational
routine is formed or an existing organizational routine is modified (Huber,
1991; March, 1991). The accumulated organizational routines remain in
the organizational memory irrespective of the time lapse or the changes in
the member roster, and serve as guides for future organizational behav-
iors. That is, organizational routines are the “memory” which allows the
preservation of the continuity or consistency of organizational behaviors
(Levitt and March, 1988), and are “genes” that are inherited over gener-
ations (Nelson and Winter, 1982).
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Management Control System in an Empowered Organization 229

2.2. Change in the process of organizational

routine formation
In the preceding Section, organizational learning was defined as a change
in organizational routine. An important fact to note here is that, nowa-
days, certain changes are observed in the process of organizational routine
formation. That is, in the past, organizational routines used to be formed
by specific organizational members such as top executives, their staff or
engineers, and were not modified in the absence of substantial changes in
the conditions. However, today, more diversified organizational members
(from top executives to frontline workers) have come to participate in the
formation of organizational routines, and frequent updates thereof are
being widely observed especially in Japanese leading companies such as
Toyota, Seven Eleven Japan and Kao. The continuous improvement activ-
ities in the manufacturing operations of Japanese companies are a typical
example of organizational learning by all employees. The design of the
operation process was once the task of engineers. However, nowadays,
those actually engaged in the production process have come to suggest or
propose a wide range of ideas as well, and such suggestions or propositions
have contributed to the day-to-day evolution of the production methods
(Fujimoto, 1997; Satake, 1998).
The change in the process of strategy formation as well as the frequent
modification of organizational routines is an important point in charac-
terizing the empowered organizations. Although emergent strategy has
recently come to attract attention, it was once considered that manage-
ment strategy should be formulated by top executives and their staff
members, and that field personnel should only carry out the strategy
given by their superiors (Mintzberg, 1987, 1994). Nowadays, it has come
to be understood that the actual strategies are realized through slow
changes in the initially intended strategies brought about by the removal
of inappropriate parts and the addition of new ideas, as they are being
implemented on-site (Simons, 1987, 1995, 2000).

2.3. Two-step model for organizational learning

If the formation of frontline-entry-type organizational routines in empow-
ered organizations is assumed, it is natural for organizational learning to
consist of the two steps shown in Fig. 1. The two stages refer to the mem-
ories of individual organizational members and the organizational memory
as a whole, that is, organizational routines.
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230 Katsuhiro Ito

Guidelines for investigation

Memories of individual
Organizational routines
employee

Acquisition of knowledge Interpretation and Enforcement of

Sharing of knowledge organizational routines

Fig. 1. Two-step model for organizational learning.

New information or knowledge is initially acquired by individual orga-

nizational members. Of various types of information or knowledge,
knowledge useful for the attainment of organizational goals is shared
among the members and is given a common interpretation for the whole
organization; thus, such knowledge is committed to corporate memory in
the form of organizational routines. The memorized organizational rou-
tines are imposed on the members by some method, and the members are
required to follow them. This two-step model for organizational learning
can be well applicable to Japanese business practice such as TQC/TQM,
TPM, and Kaizen Costing.
If the formation of organizational routines in an empowered organiza-
tion is assumed, those organizational members who take part in the first
step of organizational learning are not limited to certain organizational
members such as top executives and their staff. Instead, employees and
managers who are engaged in various sectors, including manufacturing and
sales, of value chains are expected to take part therein. If this is the case,
to achieve more efficient and effective organizational learning, some sort
of management would be required to direct this process. That is, the for-
mation of organizational routines in an empowered organization also
affects the role of the management control system. However, before dis-
cussing this issue, let us briefly examine a few cases in the next section.

3. Cases of Empowered Organization

The Toyota production system of Toyota and the on-premise ordering sys-
tem of Seven-Eleven Japan Co., Ltd. are discussed below as examples of
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Management Control System in an Empowered Organization 231

the formation of organizational routines in empowered organizations. The

mechanisms of both systems are familiar, but the most important point to
be noted here is that both systems have been gradually formed over many
years through the participation of many organizational members.

3.1. The Toyota production system of Toyota

The Toyota production system is a production system with the ultimate
aim of cost reduction by productivity improvement. It is a complex system
consisting of various elements, but the two main pillars of the system are
just-in-time (JIT) and JIDOKA (autonomation). Autonomation can be
described as “intelligent automation” or “automation with a human
knowledge”.
Initial studies of the Toyota production system elucidated its structure
and mechanism, and analyzed and proved why it is more effective than
other systems (for instance, Clark and Fujimoto, 1991; Monden, 1991;
Ohno, 1978). The results of those studies are summarized as follows: the
Toyota production system has established and maintained its superiority
over other production systems by overcoming trade-offs in terms of qual-
ity, costs and delivery time, realizing flexibility in manufacturing activities
and incorporating the mechanism of incessant improvements into the
system (Fujimoto, 1997).
Meanwhile, recent studies have focused on the development/formation
process, such as how the Toyota production system was formed or why
only Toyota has been able to create such a system (Fujimoto, 1997;
Satake, 1998). These questions are far more difficult to answer than those
addressed in the initial studies, and, to date, no clear explanations have
been given. However, one certain thing is that the Toyota production sys-
tem is the result of historical evolution. That is, “the Toyota system was
not established at a certain point in time by a certain person or persons,
but was gradually formed as a result of the merging of various elements
at different times before and after World War II (Fujimoto, 1997).” In
fact, an examination of the formation process of the Toyota production
system shows this clearly. For example, multiprocess handling (TAK-
OUTEI-MOCHI), which is the main element of Toyota Production
System, was already adopted in 1947. Also, regarding the JIT inventory
management, which is the main element of JIT, the pull system had
already been worked out in 1948. Thus, it was as late as 1970 that, as a
result of the accumulation of various ideas, the Toyota production method
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232 Katsuhiro Ito

was organized into a system, albeit imperfect; that is, some 20 years
passed after the initial spark. Thereafter, experiments and examinations
have been accumulating over a period of nearly 40 years (Toyota Motor
Corp., 1987; Ogawa, 1994).
Regarding those who worked out the Toyota production system, some
engineers, including Taiichi Ohno, are named from time to time as the
inventors of the system. However, considering the length of time it took
for the creation of the system and its utter complexity, it is quite natural
to assume that numerous engineers and front line workers took part
therein. Also, it has been pointed out that, besides these individuals,
numerous on-site employees and managers contributed thereto as well.
As described above, the Toyota production system focuses on the
formation of organizational routines in an empowered organization.
The contents of the organizational routines have been and will be
improved through organizational learning.

3.2. The on-premise ordering system

of Seven-Eleven Japan
Let us now discuss the on-premise ordering system of Seven-Eleven Japan.
The “ordering” refers to the decision of each store on the daily purchase of
specific products, including the number of units to be bought. Seven-Eleven
places the ordering affairs into the hands of each affiliated store, consider-
ing that the owner (store manager) and store personnel who attend to their
customers in their daily business grasp the customer needs best (Yahagi,
1994). Yet, it is not easy for the owner and a few part-timers to determine
the daily orders for as many as 3,000 items. They may be susceptible to
the temptation to place the same orders as those on the previous day, even
though they know very well that the ordering is an important matter.
Therefore, Seven-Eleven has systemized the policy and procedure
of the ordering operation, and called the ordering system “hypothesis
verification-type ordering”. The basic concept of this system is that each
order should be placed based on a clear hypothesis regarding the expected
sales quantity of each specific product the next day and the reason there-
fore, and that the sales results based on such hypothesis should be verified
utilizing the point-of-sale (POS) system data, so that such results may be
reflected in the next order. In the practice of “hypothesis verification-type
ordering”, the on-premise ordering system is very helpful.
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Management Control System in an Empowered Organization 233

The on-premise ordering system provides a wide range of detailed

information, and information of special importance is displayed in such
a manner that the person in charge of ordering can notice it very easily.
So, the person in charge of ordering figures out the order quantity for
each item based on the hypothesis, while verifying the information on
the terminal dangling from his or her neck with the stock status on
the shelf.
It is said that, at Seven-Eleven, the above-mentioned on-premise order-
ing system has enhanced the ordering accuracy, thus contributing to the
increase of the average daily sales and stock reduction for each store, and
consequently to the consistently good business results of Seven-Eleven
Japan. However, the on-premise ordering system of Seven-Eleven was not
created all at once, just as in the case of the Toyota production system.
In fact, the concept of “hypothesis verification-type ordering” did not exist
at the time of its foundation.
It was in 1978, immediately after the foundation of Seven-Eleven, that
the company started the development of the on-premise ordering system.
The initial purpose of the first system of 1978 was merely to save labor
for ordering by printing bar codes on products, and the order quantity was
decided based on the principle of replenishment; that is, sold items were
reordered.
Since then, Seven-Eleven Japan has sustained its efforts to improve the
on-premise ordering operation and the information system supporting it.
The main arena for such improvements was the management conferences
held every week, in which supervisors and managers gathered from all over
the country discussed various issues with the top management. At these
management conferences, the problem of inaccuracy in the orders placed
by stores was repeatedly raised, and possible solutions were discussed. As
a result, in 1982, the POS system was adopted to have a firm grasp on the
sales for each product. And in 1985, the function of graphing and analyz-
ing the sales data was added to the system. Through this process, the
mechanism of hypothesis verification-type ordering, in which orders are
placed based on hypotheses and the results are verified by the sales data,
was created (Kawabe, 1994; Ogawa, 2000).
The hypothesis verification-type ordering operation of Seven-Eleven is
unimaginable without the on-premise ordering system that supports the
ordering operation. In fact, the personnel in charge of system planning and
development have examined the details of the improvements to be made
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234 Katsuhiro Ito

by frequently visiting the stores, and so forth, to support the improvements

in the ordering operation in terms of the ordering system. Also, they were
always present at the above-said management conferences held every week,
to gain a proper understanding of and share on-site operational problems,
as well as cope with and solve each problem if it was relevant to the infor-
mation system. Thus, the cycle of problem occurrence and troubleshooting
was completed (Ogawa, 2000).
As just described, it is clear that both the hypothesis verification-type
ordering operation of Seven-Eleven and the on-premise ordering system
supporting this operation are also an example of the formation of organi-
zational routines in an empowered organization.

4. Change in the Role of the Management Control System

In the preceding sections, the significance and process of organizational
learning were elucidated, and the concept and cases of the organizational
routine formation process in an empowered organization were discussed.
In this section, the change in the role of the management control system
due to the change in the formation process of organizational routines is
examined.

4.1. Traditional role of MCS

In view of the aforesaid two-step model of organizational learning, the tra-
ditional management accounting technique was helpful for forcing
organizational members to comply with the routines. Also, in the forma-
tion of organizational routines, the participation of those who carry out
the routines, such as on-site employees and managers, was not expected.
Instead, top executives and engineers prepared the routines before the
implementation of the operation.
For example, in standard cost accounting, cost standards are given as
targets to the manufacturing premise upon the decision on the product
specifications. Since the cost standards are determined based on the stan-
dard operation procedure for the production of the relevant product, it is
possible to monitor whether or not the standard operation procedure is
followed through an analysis of the differences from the actual costs.
Budget management is basically the same. That is, since a budget assumes
the standard operation procedure and detailed work planning, we can
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Management Control System in an Empowered Organization 235

learn whether or not these are accomplished through an analysis of the

differences from the results.

4.2. Roles of MCS in an empowered organization

In an empowered organization, MCS should enforce the efficient imple-
mentation of organizational routines and contribute to the modifications
(improvements) thereof. MCS was forced to play a new role, that is, to
facilitate organizational learning.
As a result, the traditional view of MCS has changed. The concept
of management control assumed by Anthony (1965) focused on formal
financial information. With the 1980s as a momentum, the concept of
management control expanded, covering organizational culture, manage-
ment creed, and so forth.
According to Machin and Lowe (1983), one of the most potent myths
in the field of the study of the management control system is that man-
agement control is the synonym of management accounting, and they
pointed out, management control can no longer be said to be near equal
to management accounting. In Collier (2005), the management control sys-
tem includes the management accounting system and other control means,
that is, he clearly expressed the idea that management accounting is a
subset of the management control system. Similarly, Chenhall (2007) indi-
cated, the management control system is a wide concept covering other
controls such as clan control, in addition to the management accounting
system.
As just described, the concept of management control gradually
changed from that defined by Anthony to a wider concept covering con-
trol means other than management accounting. Merchant (1985) and
Merchant and Van Der Stede (2007) defined management control more
widely. In that context, management control refers to all the means or sys-
tems used by managers for the purpose of mating the behaviors and
decision making of employees with the objectives and strategy of an organ-
ization. An important fact to be noted here is that a wide variety of the
means of control, such as direct supervision, employee recruitment criteria
and norms of conduct, as well as measured financial results that are uti-
lized for control by output, came to be covered. Otley (1999) also defined
it relatively widely.
The idea of control mix came to be adopted because the concept of
management control spread and various means of control were brought
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236 Katsuhiro Ito

into view at the same time. Control mix (or control package) refers to a
selection of the means of control (control mechanisms) from among a
wide range of possible means of control, integrated into one system for the
purpose of attaining one goal (Abernethy and Chua, 1996). As examples
of control means that are included in the control mix, Abernethy and
Chua (1996) listed the standard operation procedure, office regulations,
supervision and guidance by superiors, budget management system,
achievement measurement, remuneration system, internal control, alloca-
tion of official authority, personnel affairs/selection, education and
training, and so forth.
Because an empowered organization was assumed, the frequent and
effective updating as well as efficient implementation of organizational
routines became the roles of MCS. This mechanism is inherent in those
Japanese companies that consistently achieve the solid results.

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Index

β-value 106 built-operation-transfer (BOT) 64

business administrators 41
accounting for group decision making business segment 108
7
acquisition premium 76 calculation method of merger ratio
acquisition process 77 77, 78
action controls 167 Canon Inc 100
activity-based costing (ABC) 123, capital asset pricing model (CAPM)
128 106
adjusted economic profit 117 centralized organizations 227
akaike information criterion (AIC) cluster management 66
45 collective strategy 212, 215
amortization of the capitalized command and control 227
restructuring charge 112 comparative fit index (CFI) 44
asset bubble 51 competency trap 213
asset specificity 165, 169 competition predominance 67
autonomous management 12 competition superiority 70
autonomy 175 complementary slackness theorem
207
balanced scorecard 127 conglomerate discount 28
bargaining power 166, 169 consolidated balance sheets 98
behavior control 175, 179 consolidated business 98
Big Bang 51 consolidated cash-flow statement
boundary-spanning activities 128 98
BPO 69 consolidated divisional organization
BPR 64 100
broadcast transmission 214 consolidated performance evaluation
budget 138 system 12

239
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240 Index

consolidated profit/loss for each dividend policy 30

product 11 dividend rate 31
consolidated profit-and-loss statement division of labor 69
98 dynamic classification 24
contact transmission 214
continuation of business 39, 49 economic capital 112
continuous improvement 229 economic profit 105
control hypothesis 54 economies of scale 19
control mechanisms 164 emergent synergy 12
control mix 236 empowered organizations 227
control package 236 entropy index 22
control premium 74, 76, 77 environmental complexity 169
convenience-store business 151 equity JVs 164
cooperative coordination 174 establishment of goals 8
core condition 86 executive officers 57
corporate control rights 75 exploitation 213
corporate governance 53 external management resources 39,
corporate groups that are affiliated 40, 49
with city banks 3 external stockholder 31
correlation-matrix method 44
cost approach 79, 200 F (financial) consolidated company
cost of capital 106 6
cost of equity capital 114 failure traps 213
cost of goods sold 153 financial buyers 54
cost rate of equity capital 107 financial crisis 53
cost rate of the liabilities with interest financial indicators 41, 43–45, 48
114 flexible networking 13
cost reduction 39–45, 47, 48 franchise system 144
cost reduction benefit sharing 185 functions of the group headquarters
cost structure 47 6
covariance structure analysis 41, 43
custom parts and materials 186 goal congruence 126, 127
customer satisfaction 69, 71 governance structures 167
grand coalition 86
DCF method on residual profits 82 gross profit 151, 153
degree of contribution 83 group management 5, 63
detail-oriented management style group performance accounting 8
179 group restructuring 20
distributor management system group synergy 12
144
diversification 21, 22 holistic viewing 13
diversification of risks 19 Honda 144, 145
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Index 241

hybrid type 26 JIDOKA (autonomation) 231

hypothesis verification-type ordering joint ventures (JVs) 163
232 Just-In-Time (JIT) 137, 183, 231
hypothetical experimenting 13 JV control 166

imitative company 105 Kaizen Costing 230

impairment loss 112 Kao 229
incentive comparability 205 knowledge 169
incentive price 74, 193, 200 knowledge sharing 13
incentives 126
income approach 79 latent variable 43, 44, 47, 48
income before taxes and minority liabilities with interest 107, 109
interests 110 listing of the subsidiary 30
income taxes 110 long-term business relationship 185
individual optimization 71 long-term contribution factors 206
individual rationality 86
individualized corporation 227 M (management) consolidated
information asymmetry 166 company 6
information sharing 127, 169 M&A 39, 40, 43–45, 47–49, 56
in-house company system 27 M&A through intra-organizational
initial public offering (IPO) 59 transaction 85
insourcing 70, 71 M&A through market transaction 84
intangible assets 65, 198, 206 management approach 105
integration 20 management buyout (MBO) 52
intermediate HD system 28 management control system 228
internal capital system 9, 117 management of dispersion and
internal dividends 9 unification 4
internal interest rates 9 management of distributors 140
internal transactions 114 management to promote
interorganizational controls 163 self-management 4
inter-organizational cost management manufacturing industry 40, 42
system 183 market approach 79, 80, 200
intra-company system 105 market capitalization 107
inventory control 140 matrix evaluation system 10
investment contained in their tangible matrix management system 100
and intangible assets 83 measurability 169
invoice price 146 merger ratio 80
involvement in JV activities 174 minimum necessary profit 203
Mitsubishi Corporation 98
Japanese Management Accounting monitoring 126, 174
183 monopoly system 144
Japanese segment reporting 117 movable property 65
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242 Index

multiprocess handling performance control 8

(TAKOUTEI-MOCHI) 231 performance evaluation 8, 99
myopia 213 performance of management 41, 43,
45, 48
negotiation power 147 personnel system 32
net operating profit after taxes personnel/cultural controls 167
(NOPAT) 112 PIATCO 65
Nissan 144, 145 planned synergy 12
Nissan Motor 52 population 214
Nissan Revival Plan (NRP) 53 population-level learning 214
noncurrent liabilities without interest populationlevel routine 214
113 portfolio type 25
nonequity JVs 164 present value of synergy effect 83, 90
nonfinancial sides of management 41 principle of conservatism 88
prisoner’s dilemma 207
objective data 41 product allocation policy 147
objective performance 41 production quantity budget 138
observed variables 44, 47 production system 183
Ohlson model 89 profit-and-loss account 47, 48
one region, one distributor system purchase value 76
145 pure holding company 17
on-premise ordering system 232
operating income 112 R&D 39–42, 46–48
operation variance 158 rate of liabilities with interest 108
opportunism 121, 124, 125 rationality of partial coalition 86
opportunity cost 203 referent organizations 223
order backlog control 139, 140 reinforcement of group centripetal
order placement production 143 force 5
organizational learning 228 remuneration system 59
organizational restructuring 20 resource allocation 7
organizational routine 228 responsibility center 9
outcome control 175, 179 restructuring type 26
outsourcing 63 results controls 167
over-paid phenomenon 87 reward system 32
overpaid premium 77 roles of the group headquarters 4
routines 212
Panasonic Electric Industrial 106 royalty 151
Panasonic Electric Works 105
parental differences 166 sales incentives 146
partial coalition 86 sales quantity budget 139
participation 174 Schmalenbach 194
PER 29 scope of consolidation 96
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Index 243

second MBO 57 the third form of group management

segment reporting 105 6
segment’s economic profit 112 theory of cooperative game 85
selection 126 three types of MBO 52
Seven Eleven Japan 229, 230 tightness 175
shadow price 204 time-driven activity-based costing
social control 175, 179 124
stable production 143 TOPIX (Tokyo Stock Exchange 1st
stand-alone value 76 Section Price Index) 106
standard parts and materials 186 total optimization 70
strategic alliances 163 Toyota 137, 223, 230
strategic control 7 TPM 230
strategic formulation and adjustment transaction cost economics 165
7 transfer prices 9
strategic outsourcing 68, 71 trust 166, 169
subjective performance 41 two-dimensional matrix management
superstitious learning 213 11
supply chain BSC 129, 130 two-step model for organizational
supply–demand equilibrium price 193 learning 230
sustainable development 39, 49
synergy effect 13, 75, 77 V (vision) consolidated company 6
synthetic technology 67 value chain 42, 47, 48
value creation 67
tangible assets 65 variables of cost reduction 42
target cost management 183 vertical group 3
the core competence 67 vicarious learning 213
the first type of group management 5
the objectives of outsourcing 67 Wald statistic test, 45
the SCOR-model 122 weighted-average cost of capital
the second form of group (WACC) 108
management 6 Winner’s curse 87