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Is Digital Transformation (DX) Necessary for Industrial Complex?
-Comparing Japanese petrochemical and chemical companies withglobal ones in TFP (Total Factor Productivity)Kazuya Inaba
Graduate School of Innovation & Technology Management, Yamaguchi University

1 Issues and Structure
Japanese industrial complexes have developed from their formative period in the 1950s
to the present day when RING1 projects and other projects have been implemented. The
business model of industrial complexes is a unique business model that has historicallydeveloped in Japan2. One research question of this paper is whether this business model
can be competitive internationally. In order to confirm this, it is necessary to compare
Japanese and global petrochemical and chemical companies by some kind of index.
I have explained the development of Japanese industrial complexes from their
historical background. From the aspect of economic rationality that make them possible
to pursue cost leadership strategies and product differentiation strategies simultaneously,
I have analyzed the economics of industrial complex theoretically, naming it the"economy of combination." But, without comparing competitiveness of Japanesecomplexes with that of others around the world in petrochemical and chemical industry
by any index, it is difficult to determine whether it is or not an economically superior inbusiness model. Therefore, I assume Total Factor Productivity (TFP), considering
indicators that can be compared quantitatively3. I adopted TFP instead of financial oraccounting analysis such as sales and other scale or profit margins. And I verify whether
this model has the efficiency of production and manufacturing processes as well as capitaland labor, and confirm whether there is the presence or absence of innovation(technological innovation). In this paper, I calculate TFP of Japanese companies inindustrial complexes (mainly members of the Japan Petrochemical Industry Association)and that of petrochemical and chemical ones in other countries, and compare their
1

RING (Research Association of Refinery Integration for Group-Operation) got support of theMinistry of Economy, Trade and Industry and was established in 2000. It has acted group-operation
programs in Japanese industrial complexes.
2I have described them in these books: Kazuya Inaba, Kikkawa Takeo, and Sou Hirano (2013)"Industrial Complex Integration: The Revival of Japan's Petroleum and Petrochemical Industry,"
Chemical Daily; (2018) "New Era of Industrial Complexes: IoT, Hydrogen, and Business
Cooperation," Chemical Daily.
3This study relies on M. E. Porter's arguments that "productivity" is important when determining
international competitiveness, and that productivity focuses on "each industries and segments withinindustries" (Porter, M. E. (1990) “The Competitive Advantage of nations: with a new introduction”,
New York: Free Press pp. 6-11).
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international competitiveness in terms of TFP. Furthermore I propose to examine the needfor DX.
2 Calculation of TFP (Total Factor Productivity) by Cobb-Douglas typed
production function
In analyzing productivity, I assume a production function of Cobb-Douglas’s type. Thisfunction considers capital and labor as factors of production. And TFP is a measure ofproductivity. It is a factor of variation in output that cannot be explained by inputs ofcapital and labor alone, and is often viewed as innovation in the broadest sense.
Y = A × K(1-α) × Lα
Y is value added, A is TFP, K is assets, L is labor, and α is the labor share. α and 1-αmean the elasticity of output with respect to labor and capital inputs. A is a concept that
expresses the efficiency of capital and labor and is called TFP.
The Cobb-Douglas typed production function is a production function commonly usedin macroeconomics4, but I applied it to individual firms in this case. There are the same
examples applied to individual firms for the study of profitability and productivity ofsmall and medium enterprises5. However, it is necessary to make some modifications toapply this production function to individual firms in the petrochemical and chemicalindustries, which are defined as follows.
Value added (Y) = Operating income + Labor costs + Income taxes
Labor force (L) = Number of employees (consolidated)
Assets (K) = Property, plant and equipment (gross) or property, plant and equipment(net)
Labor distribution ratio (α) = Labor cost/Value added
Capital distribution ratio (1-α) = 1 - Labor cost/Value added
We should generally compute by using a tangible fixed assets on a "gross" basis6. ThisA historical analysis of productivity transitions from macroeconomics is Gordon, R. J. (2016)“The Rise and Fall of American Growth”, Princeton University Press.
5Kenji Akamatsu (2013) "Trends in the Profitability and Productivity of Small and Medium
Enterprises," Shoko Kinyu, October 2013, pp. 22-63.
6
To be precise, it should not be presented as "gross value" but rather as "replacement cost”,
which is "market value”. Whether gross or net book value should be adopted technically whenreplacement cost data is not available.
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is why it needs to include costs of land and machinery and equipment. However, I adopt
both "gross" and "net". In many cases, firms announce either "gross" or "net" in theirbalance sheets. If we could compare their data, using both is the only choice to avoid
reducing the number of firms. Therefore, in calculating TFP, I determine to describe twofigures: TFP (1) (calculated by using gross tangible fixed assets) and TFP (2) (calculatedby using net tangible fixed assets).
Data were gathered mainly from Refinitiv Eikon, a financial analysis data platform
provided by Refinitiv, which is a subsidiary of the London Stock Exchange Group.
However, in cases where the data were clearly erroneous (e.g., confusion of consolidated
for non-consolidated figures), I corrected errors by checking their securities reports ofrelevant companies. The covered period is almost from 1994 to 2022, and years for which
no data existed were left blank. The year-by-year data is presented as the end of the fiscal
year (end of March) for Japanese firms, while as their annual results (end of December)for foreign firms. There are two main reasons for setting this period. I wanted to examine
whether the development of ICT had an impact on TFP since the release of Windows 95
in 1995, and whether the RING project had an impact since the launch of the RING in
2000. I also tried to understand how the historical development of industrial complexes
has affected the current TFP of their companies.
In comparing with many companies participating in complexes, I utilized the categories
in the book of Takeo Kikkawa and So Hirano(2011) "The Age of Chemical Industry:
Why can Japan overtake the world?", Chemical Daily. Based on their research findings,
I used their classifications for petrochemical and chemical companies. The study divided
styles of production into "specific" and "comprehensive" categories and productcharacteristics into "function-oriented" and "general-purpose product-oriented"
categories. There are two axes and they classified the four categories. As a result, the fourclassifications for Japanese chemical industry are "Specific Functional Chemistry"("specific" and "function-oriented"), "Global Commodity Chemistry" ("specific" and"general-purpose product"), "Comprehensive Functional Chemistry" ("comprehensive"and "function"), and "Global Comprehensive Chemistry" ("comprehensive" and "general-purpose product"). In addition to these four categories, global petrochemical andchemical companies were classified by region into three categories: "Europe and North
America," "Korea and China," and "Others." 7 Here I compare the TFP of the fourTFP estimation is usually done by each industry. Firms are categorized by production functions
and classified the sample into groups. Each group must be classified because they have different
production functions or because they have the same production function and different TFP. The
treatment of diversified firms is controversial because it may conflict with assumption of similarity73

categories of Japanese companies with that of three categories of global companies inpetrochemical and chemical industry.
In calculating TFP for each company, I widely checked their profit and loss statements
and balance sheets in Japanese and foreign ones, citing "Refinitiv Eikon." But in manycases, it was difficult to take data of the figures to calculate a Cobb-Douglas typeproduction function, and it was impossible to calculate many foreign petrochemical andchemical companies, whose TFP was necessary for comparison in this study. In addition,
among the Japanese companies that are members of JPCA (Japan Petrochemical IndustryAssociation), there were many companies for which TFP could not be calculated due toa lack of data or because the data was not publicly available. Unfortunately, TFP for mostU.S. companies could not be calculated. Because many U.S. companies included laborcosts among "selling, general and administrative expenses" in their profit and loss
statements, it is impossible to extract only labor costs. Their foreign companies for which
TFP could not be calculated due to lack of data, considering it necessary for comparison,
were Sinopec (China), Ineos (U.K.), Taiwan Plastic Group (Taiwan), Exxon Mobil (U.S.),
Lyondell Basell Industries (The Netherlands), Braskem (Brazil), PPG Industries (U.S.),
Solvay (Belgium), Praxair (U.S.), Arkema (France), Chevron Phillips Chemical (U.S.),
Borealis (Austria), Huntsman (U.S.), Air Products & Chemicals (U.S.), Ecolab Inc. (U.S.),
Ecolab (U.S.), Westlake Chemical (U.S.), Mosaic (U.S.), The Dow Chemical Company(U.S.), E.I. du Pont de Nemous and Company (U.S.) and others.
In cases where the calculated value clearly showed an abnormal number, thesenumerical figures were left blank. I regularly applied this rule to the year (degree) inwhich operating profit is negative. Each company sometimes has negative operating
profit due to economic fluctuations or management failure (labor costs are often kept
unchanged from the previous year), in which case the TFP value becomes extremely large,
so it was treated as an error value8.
The results of my calculations based on the above definitions and methods arepresented in the graphs below (See from Figure 1 to Figure 28). I made two types ofgraphs for TFP (the whole) and TFP (individual firms) for each year (degree), andseparated TFP (1) and TFP (2) (I drew four ones in total). In TFP (the whole) I showedof production function. In relation to this, it is inherently better to describe the statistics bycomparing capital share with labor share.
8In addition to these cases, shocks of investment and restructuring also have a significant impact
on the TFP value. It is an appropriate evaluation to exclude these firms from the sample only whenconditions are bad, because this case probably result in overestimates in general. On the other hand,
if we use single-year data for individual firms, the estimates will be highly volatile, so it is better toshow a moving average over a period of about three years.
4the average value (ave), median (median), and added standard deviation values to these
average value up and down. You can understand the degree of variation by the length ofthe line segment of the standard deviation9.
3 Conclusion
Comparing TFP (1) and (2) among the four categories of Japanese petrochemical andchemical companies, the graphs show that the "Global Integrated Chemicals" and "GlobalGeneral-Purpose Chemicals" groups have relatively high TFP values. The "GlobalGeneral Chemicals" group averaged 0.79 in TFP (1) and 1.27 in TFP (2) for each year,
while the "Global General-Purpose Chemicals" group averaged 1.08 in TFP (1) and 1.30
in TFP (2) for each year. On the other hand, the "Specialty Chemicals" group averaged
0.56 in TFP (1) and 1.02 in TFP (2) for each year, and the TFP value was slightly lower
than that of two groups of companies focusing on commodity products. The average TFPvalues for the "General Functional Chemicals" group are unreliable figures and uselessbecause of the wide variation in TFP among the companies. Tosoh Corporation, inparticular, has been benefited from recent market conditions and has achieved extremely
high TFP values. I failed to analyze the "General Functional Chemicals" group and did
not provide a clear picture of characteristics of the group as a whole, and it will benecessary to research each individual company separately.
After that, “the European and U.S.” petrochemical and chemical companies averaged
0.16 in TFP (1) and 0.26 in TFP (2) for each year, which are considerably lower than thefigures of Japanese ones. On the contrary, the average annual TFP (1) and TFP (2) valueof “the South Korean and Chinese” groups are 0.73 and 0.85, and indicates relatively highfigures. These values of TFP are comparable to those of Japanese companies. “The Other”
petrochemical and chemical companies group shows similar trends to those in Europe
and the U.S., although their average annual TFP (1) is 0.27 and TFP (2) is 0.33, slightly
higher than that of the European and U.S. group. However, the large variation between
years suggests the need for analysis of individual companies.
The TFP values of (1) and (2) in Japanese petrochemical and chemical companies arehigher as a whole than those of their foreign ones. However, there are several problems
in concluding that the business model of industrial complexes in Japan is superior. To
begin with, there is a question of whether TFP can be used to explain the superiority of
the industry's international competitiveness. It is only the fact that Japanese petrochemical
In case of analyzing changes, it would be better to show the annual changes in histograms (bygroup, country, period, etc.) in usual TFP research papers rather than figures of TFP in individualfirms.
95and chemical companies have relatively high TFP values. An accurate judgment must be
made by adding many other indicators of performance, including other theories andmodels, as well as financial, accounting, and patent information.
On the other hand, the analysis of TFP changes from 1994 to 2022 proves that theimpact of the RING project, which started in 2000, is not clear, and that both Japaneseand global firms show little significant change in TFP values, which remain flat in theirline graphs. This suggests that the petrochemical and chemical industries in Japan andglobal are technologically mature and stagnant, with little innovation taking place over along period of these years.
As a result, this industry is expected to continue to promote DX in order to increase
profit margins by improving the efficiency of manufacturing processes. In addition, theindustry is under pressure of greenhouse-gas reduction and must advance carbon neutral.
So, it will be interesting to see how the impact of decarbonization’s efforts will bereflected on TFP in the future.
In order to achieve sustainable development, industrial complexes must make strategic
arrangements for the future. Business cooperation must be further promoted in order toincrease the international competitiveness of industrial complexes. In order to further
advance the sophistication of production, it is necessary to establish a businesscollaboration system using information and communication technology. Therefore,
digital transformation is required for development of the industrial complex.
The complex is an industrial area where facilities for the petroleum, petrochemical, andchemical industries are concentrated from upstream to downstream. There are mainequipments of naphtha crackers that produce basic raw materials such as ethylene andpropylene, as well as plants of various sizes that manufacture a variety of products. As
the word "Комбинат" implies combination, plants of different firms are connected to eachother by piping, and they exchange raw materials, steam, and other resources. And inorder to develop their integration further from now on, it is necessary to establish theorganization to cope with changes of international competence and to design not only thecombination of materials but also the system of information network.
The RING project has been playing a central role in the development of industrial
complexes since the beginning of 2000, under the slogan called industrial complex’srenaissance, overcoming barriers of capital, people, and geography. In order to develop
and advance their collaboration further, the industrial complexes must be digitaltransformed to improve productivity and efficiency. Japanese petroleum, petrochemical,and chemical companies depend on the assumption of importing raw materials and having
disadvantages of small and medium-sized plants and dispersed domestic manufacturing
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factories, digital transformation will be the key to future development and innovation in
the petroleum, petrochemical, and chemical industries.

Figure21: Korea and China's Petro Chemical and5
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Chemical TFP① (the whole)

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medianFigure23: Korea and China's Petro Chemical and65.5
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medianReferences[1]Kikkawa, Takeo and So Hirano (2011) "The Age of Chemical Industry: Why Japan is
Overtaking the World," Chemical Daily.
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[2]Koji Nakamura, Sohei Kaihatsu, and Tomoyuki Yagi (2017) "Livelihood
Improvement and Economic Growth," Bank of Japan Working Paper, No. 17-J-7, Bankof Japan.
[3]Kenji Akamatsu (2013) "Trends in the Profitability and Productivity of Small andMedium Enterprises," Shoko Kinyu, October 2013, pp. 22-63.
[4]Gordon, R. J. (2016) “The Rise and Fall of American Growth”, Princeton UniversityPress.
[5]Lewis, W. W. (2004) “The Power of Productivity: Wealth, Poverty, and the Threat to
Global Stability”, University of Chicago Press.
[6]Porter, M. E. (1980) “Competitive Strategy”, New York: Free Press.
[7]Porter, M. E. (1990) “The Competitive Advantage of Nations”, New York: Free Press.
[8]Chandler, Jr., Alfred D. (1990) "Scale and Scope: The Dynamics of Industrial
Capitalism", THE BELKNAP PRESS OF HARVARD UNIVERSITY Press.
[9]Barney, Jay B. (2002) “Gaining and sustaining competitive advantage” 2nd ed.,Pearson Education, Inc..
[10]Kazuya Inaba, Kikkawa Takeo, and So Hirano (2013) "Industrial Complex
Integration: The Revival of Japan's Oil and Petrochemical Industry", Chemical Daily.
[11]Kazuya Inaba, So Hirano, and Kikkawa Takeo (2018) "The New Era of Industrial
Complexes: IoT, Hydrogen, and Interregional Collaboration," Chemical Daily.
*This chapter benefited from the generous advice of Professor Yoshiyuki Matsuura,Associate Professor Masakazu Takahashi, and Professor Kazuhiro Fukuyo (Graduate
School of Technology Management, Yamaguchi University). I would like to express oursincere appreciation.

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