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Parent-subsidiary relationships in Japan: some observations from financial statement data.

Most of the interest in Japanese companies has been on prestigious, large firms such as Toyota Motor, NEC, and Honda Motor. These firms have been widely regarded as very efficient and effective, especially for expanding market share in world markets. A less-known fact, however, is that many subsidiaries or spin-offs have been assisting their parent firms in many ways. It should be noted that subsidiary companies in Japan are legally independent entities that issue their own stock and are listed on the stock exchange. In manufacturing industries, most of these subsidiaries work either as parts suppliers for their parent firms or as manufacturers of products complementary to their parent's. (Nishiguichi, Toshiburo, & Brookfield, 1997). Unlike U.S. firms which tend to treat spin-offs and subsidiaries as somewhat independent companies, Japanese parent companies incorporate their subsidiaries as integral parts of their strategic operations (Dyer, 1994; Rajan & Liker, 1994).

Major manufacturers such as Toyota Motor, Nissan Motor, and Nippon Steel have extensive parts supplier networks, and many suppliers are subsidiaries of these huge manufacturers (Lincoln, Ahmadjian, & Mason, 1998; Woronoff, 1983). These groups of manufacturers and parts suppliers are often called vertical keiretsu. Examples are the Toyota keiretsu and Honda keiretsu. They are referred to as "vertical" because interfirm relationships in these manufacturer groups are hierarchical (Tabeka, 1998; Hugh & Rosovsky, 1976).

There are also horizontal keiretsu groups, e.g., Mitsubishi and Sumitomo, that include vertical keiretsu groups as well as other manufacturers and financial institutions. Horizontal keiretsu groups contain companies of almost equal status, so that the relationships among firms are equal or horizontal. A horizontal keiretsu can have manufacturers that have developed networks of parts suppliers. The parent-subsidiary relationship in vertical keiretsu is often considered to be more hierarchical than that in horizontal keiretsu or non-keiretsu companies (Miyashita & Russell, 1994).

The relationships between Japanese parent and subsidiary firms are widely seen as dependent: subsidiary companies, which tend to be exclusive parts suppliers for parent firms, depend largely on their parents for business and survival. The parent-subsidiary relationships, therefore, tend to be hierarchical. Parent firms usually have overwhelming bargaining powers over their subsidiaries. In fact, it has even been claimed that subsidiaries tend to sacrifice their own profits to help their parent firms become profitable during periods of economic downturns (Sasaki, 1981).

However, few studies have empirically examined the parent-subsidiary relationships. This study investigates these relationships by comparing strategies and performance of parent and subsidiary corporations, using financial statement data. This study also examines the impact of keiretsu relationship on the parent-subsidiary relationship.

Keiretsu and Parent-Subsidiary Relationships in Japan

Keiretsu relationships originated in pre-war zaibatsu or family-owned conglomerates. Before World War II, there were about 10 zaibatsu, which controlled about half of the Japanese economy; these were dissolved under the U.S. Occupation Force. After the Occupation Force left in the 1950s, former zaibatsu firms formed into six groups, called keiretsu.

Today, member companies in these six groups account for about one-third of the Japanese economy; examples are Mitsui, Mitsubishi, and Sumitomo. They are no longer owned by families. Presidents of member companies regularly meet and make major policy decisions. Coordination within an industrial group is also enhanced by cross stockholdings and interlocking directorates. Each keiretsu group includes several large companies. For instance, the Toyota Motor Company belongs to the Mitsui Group and NEC belongs to the Sumitomo Group.

Each industrial group includes almost every industry in Japan. Twenty-three member companies partio<pate in the president club in Mitsui Group, 28 in Mitsubishi, and 21 in Sumitomo (Miyashita). Each member company with its subsidiaries and related companies represents one broadly defined industry. Each keiretsu has only one member company representing each industry to ensure minimum competition and conflict within the industry group.

There are basically two kinds of keiretsu groups. First is a horizontal keiretsu which as explained, are groups of large firms in different industries. The second type is a vertical group, which includes mainly manufacturing companies and their subcontractors in the same industry. According to Toyo-Keizai there are about 40 vertical keiretsu groups. Examples are Hitachi, Toyota, Matsushita, and N.T.T. Each group has a leader firm. For example, Hitachi Electronics Company is the head of the Hitachi group, with a large number of subcontractors. Most vertical keiretsu belong to one of the horizontal keiretsu.

There are also Japanese firms independent of keiretsu groups. They tend to be companies without a long history that operate in new industries. (Some keiretsu firms are 350 years old.)

Research Methodology

Sample firms used in the study were Japanese manufacturers listed in 1993 on the Japanese stock exchange. Financial statement data were taken from the Toyo-Keizai's Kigyou Karute (Financial Statement Analysis of Companies). Financial data were from 1991 through 1993, averaged over the three years. Information used to distinguish between parents and subsidiaries was obtained from Toyo-Keizai's Kigyou Group (Enterprise Groupings). Toyo-Keizai's Keiretsu Soran was used to classify firms into vertical keiretsu, horizontal keiretsu, and independent companies.

A total of 562 firms were identified as parent or subsidiary companies. Of these, 147 were parent firms and 415 were subsidiary corporations. Sample firms averaged about $2.5 billion in sales and $2.6 billion in assets. Since sample firms represented large- to medium-sized companies, the findings of this study may not be applicable to small corporations.

Of the 147 parent firms, 21 belonged to vertical keiretsu, while 69 were in horizontal keiretsu. Thirty-six parent firms were independent. Of the 415 subsidiary companies, 183 belonged to vertical keiretsu and 150 to horizontal keiretsu. Forty-four subsidiary firms were independent. On average, parent firms in vertical keiretsu had about nine subsidiaries, while those in horizontal keiretsu and independent parent firms had only about two subsidiaries.

Four broad types of strategies and performance were compared in analyzing Japanese parent-subsidiary relationships. The first two, i.e., profitability and asset turnover, relate to operating performance. These ratios were compared to discover whether or not subsidiary firms had worse performance than parent companies. Third, employee productivity and pay were compared. Fourth, competitive activities such as advertising intensity and R&D (research and development) intensity were compared. The study used analysis of variance tests to see whether or not the mean parent ratios were significantly different from the mean subsidiary ratios.

Empirical Results

* Profitability

It was interesting to discover that all profitability measures, i.e., profit margin (net profit over net sales), return on assets (net profit over total assets), and return on equity (net profit over equity), did not significantly differ between parent and subsidiary firms or among keiretsu and non-keiretsu affiliated companies (see Table 1). Both parent and subsidiary firms had an average 2% profit margin - somewhat lower than that of U.S. and European companies (Brown, Syobel, & Stickney, 1994). Japanese firms are usually not pressured to report high profit margins, partly due to the crossholdings of stock among keiretsu companies. Notice that independent firms, both parent and subsidiary, had somewhat higher profit margins than keiretsu companies.

Corporate profits in Japan generally declined during 1991, 1992, and 1993. The finding that both parent and subsidiary firms had similar profit margins seems to contradict certain claims that subsidiary firms sacrifice their own profitability to raise their parent firms' profitability (Sasaki). One possible explanation for this similarity is that these subsidiary companies, large enough to be listed on the stock exchange, have such high-level positions in the parts suppliers' hierarchies that they do not have to sacrifice their own profitability to raise their parent firm's profitability. Probably, smaller firms, many of which are privately held and therefore do not disclose their financial statement, do sacrifice for their larger brethren.

Two operating expense-to-sales ratios were examined to further understand profit margin. One was cost-of-goods-sold over sales, and the other was selling and administrative expense over sales. Parent firms tended to have smaller cost-of-goods-sold-to-sales ratios than did subsidiary companies. Notwithstanding, parent corporations tended to have higher selling and administrative expenses-to-sales ratios. Evidently, subsidiary firms may charge low prices to their parent firms and accept lower gross margins. However, parent firms' higher gross margins were somewhat offset by their higher selling and administrative expenses. This finding may indicate higher expenses incurred by parent companies to coordinate subsidiary networks.

For the above two ratios, exceptions were present for firms in horizontal keiretsu. There were no significant differences in cost-of-goods-sold over sales and selling and administrative expense-to-sales ratios between parent and subsidiary companies in horizontal keiretsu. Higher selling and administrative expenses for horizontal keiretsu subsidiary corporations, compared with those in vertical keiretsu and independent subsidiary firms, may indicate that these horizontal keiretsu subsidiary companies have their own networks of subsidiaries. The lower cost-of-goods-sold over sales ratios of horizontal keiretsu companies may indicate that these subsidiary companies charged higher prices to their parent firms than did those in vertical keiretsu. These findings may reveal that parent-subsidiary relationships in horizontal keiretsu tend to be less hierarchical than those in vertical keiretsu.

* Asset Turnover

Parent firms in general have a lower asset turnover ratio (total sales over total assets) than do subsidiary companies. Parent firm assets are not as productive in generating sales as subsidiary company assets. Parent and subsidiary firms not affiliated with any keiretsu groups, however, had similar asset turnover ratios.

To gain insight into asset turnover, individual asset turnovers for receivables, inventories, and fixed assets were examined. Parent and subsidiary firms did not significantly differ in their accounts receivable turnover ratios (total sales over total accounts receivable) except for those in vertical keiretsu. Parent companies in vertical keiretsu exhibited a higher accounts receivable turnover ratio than did their subsidiary firms. This finding indicates a much faster collection of credits (i.e., accounts receivables) by parent companies in vertical keiretsu. One possible explanation may be that these parent companies deal mainly with large subsidiary firms that have enough cash flow, whereas subsidiary companies deal with smaller firms that need longer credits.

Inventory turnover (i.e., sales over inventory) of parent firms was generally similar to that of subsidiary companies. Inventory turnover ratios of parent companies were significantly lower than those of subsidiary firms in horizontal keiretsu. This finding may suggest that these parent companies tend to keep more inventory than do their subsidiary firms. Notice that independent parent firms had much higher inventory turnover than keiretsu-affiliated parent companies, perhaps because of very efficient, "just-in-time" inventory systems.

Accounts receivable turnover (i.e., sales over accounts receivable) of subsidiary companies is generally expected to be lower than that of parent firms. However, significant differences in accounts receivable turnover ratios was found only for parent and subsidiary companies in vertical keiretsu groups.

For fixed asset turnover ratios (sales over fixed assets), subsidiary firms had higher ratios than did parent firms, indicating that the fixed assets of subsidiary companies were more productive than those of parent firms. There may be two reasons. One, subsidiary companies' fixed assets may be less capital intensive than those of parent firms, and two, their fixed assets may be more fully depreciated than those of parent firms.

* Employee Productivity and Compensation Regarding employee productivity (i.e., sales over number of employees), parent firms generally had much higher sales per employee than did subsidiary companies (See Table 1). The difference was large - more than 30% for keiretsu firms. An exception was independent companies. Only parent firms not affiliated with keiretsu groups had employee productivity ratios that were similar to subsidiary companies.

This finding may indicate the following situations. Keiretsu-affiliated parent firms tend to have such huge bargaining positions over subsidiary companies that they can choose to stay in very lucrative business environments. To put it differently, parent firms may create or spin-off subsidiary companies to take over those parts of their business that are not so lucrative.

However, it was surprising to note that employee compensation (i.e., labor costs over number of employees) was almost the same for employees in parent and subsidiary corporations. The only exception was employees in horizontal keiretsu who received slightly higher compensation than those in subsidiary companies in horizontal keiretsu.

* Competitive Advantage

For both ratios relating to competitive activities, i.e., advertising intensity (advertising expenditures over sales), R&D intensity (R&D (research and development) expenditures over sales), parent firms exhibited much higher ratios than did subsidiary companies. The only exception was firms in horizontal keiretsu, where parent and subsidiary firms had similar ' advertising expenditures over sales. These findings may confirm past claims that Japanese subsidiaries, especially captive parts suppliers, depend on their parent firms for such competitive advantages as creative marketing and innovation.


This study identified paternalistic relationships of Japanese parent firms with their subsidiary companies. Although parent firms may have substantial power over subsidiaries, they have exercised their powers on a limited basis.

Both parent and subsidiary firms show similar profitability ratios and employee compensation patterns. Although subsidiary firms seem to have higher production costs they have more productive assets than do parent firms. Also, subsidiary companies appear not to be pressured to maintain higher accounts receivables.

Parent firms seem to be the providers of competitive advantages, i.e., creative marketing and innovation, for their subsidiary companies. In other words, parent firms tend to furnish "core competence" for the entire corporations. This practice would certainly increase the dependency levels of subsidiary companies on parent firms.

It is interesting to find that parent firms in horizontal keiretsu groups do not advertise as much as do those in vertical keiretsu and independent companies. Horizontal keiretsu groups are very well known and prestigious in Japan, which provides a benefit for member companies (Sethi, Nobuaki, & Swanson, 1984). This prestige may reduce the need to advertise heavily in the Japanese marketplace.

In general, parent companies tend to be in businesses with very high employee productivity. Subsidiary firms, on the other hand, tend to operate in labor intensive businesses. The difference in employee productivity is rather large, more than 30%, especially for keiretsu-affiliated companies. The extremely high sales generated by employees in parent firms could provide job security for employees of parent companies. This ability to provide high levels of job security (or lifetime employment) seems to belong to parent firms in keiretsu groups, but not to independent companies.

This study's findings identified one of the major sources of competitive advantage held by large Japanese companies, most of which have a vast network of subsidiaries. Parent companies stay in highly productive environments and focus on creating and maintaining their core competence by spending heavily on creative marketing and R&D while their subsidiaries concentrate on less productive, labor intensive business and produce low-cost, high-quality components for their parent firms.

Also, subsidiary companies that are parts suppliers seem to be flexible enough to adapt to technological and environmental changes. This practice of vertical integration in Japan, i.e., the parent-subsidiary arrangement, is rarely used in the United States, mainly due to the rigidity of parts suppliers. When substantial technological changes occur, it is usually viewed as cheaper to get different suppliers with new technology rather than reequip and remodel existing suppliers with new technologies. However, the American view has been reconsidered by such industries as the U.S. automotive industry. U.S. automobile manufacturers now tend to maintain long-term relationships with parts suppliers, and managers in other U.S. industries could adopt this practice. These managers could gain a great deal by adopting Japanese-style parent-subsidiary relationships.

This study's findings have implications for managers working in Japanese subsidiary firms in the U.S. Many subsidiary firms depend greatly on their parent companies for marketing and R&D functions. They may have only some functions, e.g., production and quality control, that are mainly dedicated to serving their parent firms. Therefore, American employees working in Japanese subsidiaries in the U.S. may not have full career opportunities because their job experiences will encompass only certain functions.


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Dyer, J.H. (1994, Nov.-Dec.). Dedicated assets; Japan's manufacturing edge. Harvard Business Review, 174-178; See also Kamath, R.R. & Liker, J.K. (1994, Nov.-Dec.). A Second look at Japanese product development. Harvard Business Review, 154-170.

Lincoln, J.R., Ahamadjian, C.L., & Mason, E. (1998, Spring). Organizational learning and purchase-supply relations in Japan: Hitachi, Matsushita, and Toyota compared. California Management Review, 241-264; Woronoff, J. (1983). Worm trade war. Tokyo: Lotus Press.

Miyashita, K. & Russell, D.W. (1994). Keiretsu: Inside the hidden Japanese conglomerates. New York: McGraw-Hill; Tokyo Business Today. The wartime state lives on. (1995, Sept. 1).

Miyashita, Keiretsu.

Nishiguchi, T., & Brookfield, H. (1997, Fall). The evolution of Japanese subcontracting. Sloan Management Review, 89-101; Cutts, R.L. (1992, July-August). Capitalism in Japan: Cartels and keiretsu. Harvard Business Review, 48-55.

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Sasaki, N. (1981). Management & Industrial structure in Japan. New York: Pergamon Press.

Sethi, P.S., Namiki, N., & Swanson, C.L. (1984). The false promise of the Japanese miracle. Boston, Mass.: Pitman.

Tabeta, N. (1998, April). The Kigyo keiretsu organization and opportunism in the Japanese automobile manufacturing industry. Asia Pacific Journal of Management, 1-18; Patrick, H. & Rosovsky, H. (1976). Asia's new giant: How the Japanese economy works. Washington, D.C.: Brookings Institutions.

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Toyo-Keizai, Kigyo Keiretsu Soran. Toyko: Toyko-Keizai, (1994).

Dr. Namiki's primary research interests lie in the areas of competitive strategy, export marketing strategy, and Japanese management. He also consults on Japanese-American trade.
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Author:Namiki, Nobuaki
Publication:SAM Advanced Management Journal
Date:Jun 22, 1999
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