This week I made my annual visit to Tokyo as a Director of JP Morgan Japanese Investment Trust plc to meet with management, analysts, companies and others from whom we can get a view of what is happening in Japan, still the world’s third largest economy and second largest stock market. I also like to take the opportunity of catching up with what is happening at my alma mater, Sony, where I spent ten happy years as Managing Director of Sony UK. Everyone knows that Sony has been struggling of late.

After forecasting operating profit of $2 billion for year ending March 2011, as the earthquake and subsequent tsunami forced it to stop production at ten factories including a Blu-ray disc plant totally overrun by waves, Sony recorded a loss of $3.1 billion, the company’s largest deficit in 16 years.  A few weeks later a massive computer hacking attack compromised 100 million online accounts at the PlayStation Network at a cost of $171 million. In August rioters set fire to a north London warehouse containing CDs and DVDs burning it to the ground.  Then devastating floods in Thailand overwhelmed a digital camera factory and forced a halt in production at a semi-conductor plant because of supply shortages.

The continuing strength of the yen versus all other currencies has cost Sony competitiveness and it has continued to lose market competitiveness to the likes of Apple and Samsung. This year it forecasts a loss of $2.9 billion, the fourth straight year of losses. Sony is now worth $17 billion compared with $100 billion in 2000. By contrast Apple is now worth $500 billion, about 30 times Sony’s value.

On February 1^st Sony announced that Kazuo Hirai, long term PlayStation executive will take over from Sir Howard Stringer as CEO and President on April 1st. Sir Howard will become Chairman of the Board.

Howard Stringer is a Welshman who after graduating from Oxford in 1964 went to work for CBS in New York. However, in 1965 he was called up to fight in Vietnam and realising he would have had to return home if he refused, thus giving up his ambitions in the US, he went to Vietnam for two years winning the US Army Commendation Medal for meritorious service. He returned to take up his career with CBS and became one of its most successful journalists winning 11 Emmy awards including two for lifetime achievement. He served as president of CBS from 1988 to 1995 where he was responsible for all the broadcast activities of its entertainment, news, sport, radio and television stations.

He joined Sony in 1997 where I first met him at conferences in Europe that he was invited to attend. We enjoyed each other’s company and when I left the following year he sent me a very nice note regretting that I had decided to leave. He went on to bring some order to the North American business, first in the software side of music and film for which his TV experience gave him sympathy, and then taking over all operations including electronics and starting to deal with the cost structure in a firm but sympathetic way.

It was this approach which it was thought would help him when he was asked to take the top job. Despite speaking little Japanese and having virtually no experience of electronics and no qualifications as an engineer in 2005 he took over from Nobuyuki Idei as CEO. Over the past few years he has tried to reduce Sony’s sprawling empire and rationalise its product lines but, to be honest, the business still looks to me unnecessarily complicated with excessive fragmentation of line up and too many fingers in too many pies.

Let me give my own analysis of Sony, of which despite leaving nearly 14 years ago I am still extremely fond and want to see it return to its former glory.

·     Business model: For a long time including my time there Sony and indeed, most of its competitors has struggled with its basic business model. In consumer electronics new categories are created from time to time, radio then hifi, TV then video; new formats are created to renew these categories, colour TV then LCD, compact cassette then CD; but in all cases companies first launch products at high prices to attract the early adopter then gradually reduce prices as volume grows and the market achieves higher levels of penetration. The problem is that it is very difficult to stop the music and prices continue to reduce while new features are added. Competitors are swift to copy and in many cases product differentiation is little more than brand name.
 

·         Software: Sony thought that the lesson of the Betamax loss to VHS was that it was necessary to control content to introduce new formats. So it first bought CBS music and then Columbia Pictures renaming them Sony Music Entertainment and Sony Pictures Entertainment respectively. In the case of the former Sony already had a good understanding of this business. It had formed a joint venture with CBS Music in Japan years before which had been run by Norio Ohga, himself a musician and now CEO. But Columbia Pictures was a different kettle of fish. As countless others have found before the movie business is unpredictable and Hollywood is a trap. Huge fees were paid to Hollywood insiders to help integrate the business but they just spent enormous sums on the trappings of Hollywood. At the European Management Conference in 1993 Ken Iwaki, then in charge of finance and strategy and so effectively number three in the Corporation, made some disparaging comments about “this fancy business” and I could see that this had by no means been a diversification to which all top management was committed. Ken was exiled to run the Sony Life Insurance company which he did in a quiet but impressive manner and today that is one of Sony’s most profitable businesses. In 1995 huge write offs were sustained on the movie business but instead of selling it Sony has persevered. To be fair it now contributes quite well but how much capital and management time has been dissipated on a business where no brand loyalty attaches to the studio, only to the stars?
 

·         Synergy: Ever since these acquisitions Sony has sought synergy between them and the core electronics business. This has proved elusive. At the beginning the efforts were sometimes infantile; I recall being asked to use my precious A&P budget to support the marketing of a Sony film, Hook. I, of course declined, thinking, indeed knowing that the consumer had no interest in which company made the film and that there was no good reason why a link with the film would make him buy my TVs.
 

·         PlayStation: the one exception was PlayStation, born out of an internal joint venture between Sony Music and Sony. This ensured it was protected from the rest of the consumer electronics business and that it paid attention to the software side, i.e. the developing and publishing of games. Sony Computer Entertainment as this new division was to be called went on to contribute a significant part of Sony’s profits. Ken Kutaragi, who headed up this business, was often thought of as the natural successor to Nobuyuki Idei but when Stringer got that job Kutaragi left. His deputy Hirai has now been designated as the heir and it will be interesting to see if the lessons he has learnt in this business can be applied to other divisions of Sony. But Apple has achieved its great success without owning content. Instead it charges a commission on the content that is sold to play on its iPods and IPads.
 

·         The Japanese Way: I enjoyed working with the Japanese and learnt a great amount from them.  But I also observed a slowness in decision making, a fragmentation of organisation structure, a complexity in product range, and an excessive cost structure. Early on in my career with Sony I was invited to present on Customer Satisfaction to the General Managers’ Conference in Tokyo. I was the only English speaker in the Hall that day. Over 2,000 General Managers were in the audience and around that time I was given an organisation chart with over 1,200 subsidiaries designated.
 

·         Japan vs. Korea: Much of the difficulties faced by Sony and its traditional Japanese competitors has been the new competition from Korean companies notably Samsung and LG. When I worked for Sony there was little threat from this quarter. Now Samsung is the largest TV manufacturer and Sony has been forced into a humiliating joint venture with them on which it is taking another write off this year. The Korean companies appear more aggressive, more decisive. Their management look more like the Sony management of 40 and 30 years ago so perhaps this is a generational thing with today’s Japanese management less hungry and somewhat soft having grown up in prosperity unlike their fathers who remembered the deprivations of the post war era. But the Koreans have been greatly helped by the currency. Since the global financial crisis in mid-2008, known in Japan as “the Lehman shock”, the won has lost roughly 50% in value against the yen, helping South Korean firms undercut the Japanese on price. The Korean government is committed to helping its exporters, sometimes at the expense of domestic companies and even consumers. The Japanese government shows little such resolution although recently there has been some easing of this.

Looking forward some of Sony’s problems are generic to Japanese companies and some are unique to itself. Most of Japan’s famous electronic companies including Panasonic, Sharp, Hitachi and NEC are in difficulties with a lack of competitiveness through the high value of the yen, a lack of focus with bloated product ranges, excess capacity and manpower. If the forces of creative destruction were allowed to operate in Japan at least some of these companies would disappear.

But Sony in particular still has great innovative capacity, a huge store of intellectual property, and a powerful brand heritage. Kaz Hirai needs to break down the silo mentality and unleash Sony’s creative power through radical reorganisation and a clear focus on value and efficiency in its business model. Quite a few sacred cows need to be put up for sacrifice. I for one hope he succeeds.

Copyright David C Pearson 2012 All rights reserved