ISSN O075-6407

BUSINESS
41st

ANNUALVOLUME,<iiillilÅël.e/2•

RESEARCH INSTITUTE FOR ECONOMICSAND BUSINESS ADMINISTRATIONKOBE UNIVERSITY
1996

KOBE
ECONOMICBUSINESS&REVIEW
41st

VOLUMEANNUALifsÅëgTE'ltoes,e..JEB../eRESEARCH INSTITUTE FOR ECO.NOMICSAND BUSINESS ADMINISTRATIONKOBE UNIVERSITY
1996

EDITORIAL ANNOUNCEMENTSEIICHI KATAYAMA (Editor--in-chief)

It is a great pleasure and honor to announce that the REVIEW has
been selected as a journal on ECONLIT. On this occasion our editorial

board has decided to change the editorial format. Hereafter
contributors will have to follow standardized manuscript editing.

Our editorial board hopes that much stronger support will beforthcoming to ensure the continued successful publication of the

REVIEW.

CONTENTS

Page
Implications of the Asia-Europe Meeting for the World Trading System:
An Issue-Oriented Review •••'•••••""'••••••••••••'"'••••••••••'•••• Shigeyuki ABE' 1

Michael G. PLUMMER

Reconsideration of Averch-Johnson Argument """"••""' Seiichi KATAYAMA 25

Fumio ABE
Supplier Relations in Japan:
An International Perspective ••••••••••••••-•••""""'•••'•••"""" Kenji KOJIMA 41

Alternative Component Sourcing Strategies

within the Manufacturer-Supplier Network:

Benefits of Quasi-Market Strategy

in the Japanese Automobile Industry ••••••""""""""" Kentaro NOBEOKA 69

Value Networks, Industry Standards, and Firm Performancein the World-Wide Mobile
Communication Industries •••""""""••••"""'"''""""' Jeffrey L. FuNK 101

The Effects of Transport Infrastructure and Urban Development Investment
in London's Docklands with Particular Reference

to Leisure and Tourism 1970-1997 ""''"""'""'""" T. S. Mervyn JONES 133

KOBE ECONOMIC & BUSINESS REVIEW, 41 (1996), 1-23

IMPLICATIONS OF THE ASIA-EUROPE MEETINGFOR THE WORLD T,RADING SYSTEM:AN ISSUE-ORIENTED REVIEWSHIGEYUKI ABE Kobe University
MICHAEL G. PLUMMER Kobe University and Brandeis University

Abstraet
The first Asia-Europe Meeting (ASEM) was convened in March 1996 andreceived strong political support from both Asian and European sides. The creationof ASEM is important in that it attempts to build a "bridge" between Asia andEurope, at the same time that regional economic integration between other major
regional "poles" is taking place. In particular, APEC has emerged as an important

player in defining new boundaries for economic cooperation across the Pacific.
Europe has perceived APEC as a potential threat in this regard, especially since
Asia is the most dynamic region in the world and EU-Asian links remain relatively

weak. Asian countries are interested in strengthening relations with the EU for

economic and strategic reasons. This paper evaluates the political economy of
ASEM in light of the rapidly-changing global trading system. In addition to aclose examination of the economic and policy dime.nsions of ASEM, the paper

considers the future importance of ASEM to Europe and Asia. Analysis
underscores the importance of APEC in driving and, most likely, defining theultimate structure of ASEM, and explores the pivotal link played by ASEAN in
both regional organizations.

JEL classification: F13; F15; 052; 053
Kaywords: ASEM; ASEAN ; Economic integration; APEC; EU-Asian economic relations
Corresponding Address:
Shigeyuki Abe
Research Institute for Economics and Business Administration, Kobe University
2-1 Rokkodai-cho, Nada-ku, Kobe 657, Japan
E-mail: abe@rieb.kobe-u.ac.jp
Fax: (81)-78-803-0397

Micheal G.Plummer
Research Institute for Economics and Business Administration, Kobe University

2-1 Rokkodai-cho, Nada-ku, Kobe 657, Japan
E-mail: plummer@rieb.kobe-u.ac.jp
Fax: (81)-78-803-0413

KOBE ECONOMIC & BUSINESS REVIEW, 41 (1996), 1-23

2

Not only the EAEC but also APEC are simply political shows.
At the first APEC rneeting, they announced the willingness tocornplete a I7TA by the year 2020. I wonder if anyone believes
that this promise will be hept. It is just 20 years frorn now!
Many representatives voted yes, and they might be persuadedby the year 2020. Thebl witnessed the creation of the EU and
NAFTA and other econornic integration areas and they felt
they should do sornething about it. (Lester Thurow)i'
As the 19`h century belonged to Europe, the present belongs
to North America, and the next will belong to East Asia"'.

We tvould fool ourselves if we did not recognize thatimportant parts of East Asia may soon reach and surpass us
in terms of prosperity"'. lf we miss the train, l have no
doubt that Asia `will go it alonel (Harlem Brundtland)2

1. Introduction

The above two quotes contrast starkly regarding their views of the

future of the Asia-Pacific in the world trading system. Thurow
dismisses APEC as a show, with more fJash than substance; one canread from this (aided by a copy of his controversial book, Head toHead) that regional integration is not much of an issue and efforts inthis direction are empty reactions to trade bloc formation elsewhere.
Hence, the promise of free trade in APEC by the year 2020 need not betaken seriously. On the other hand, Brundtland emphasizes theimportance of Asia in the future of the world economy, even going so
far as to predict (as have many before her) the advent of the PacificCentury. Her plea, in contrast to what Thurow might perscribe, is fora strong push toward establishing closer economic cooperation with
Asia. Europe will neglect this region at its own peril.
1 This quote was translated from the Japanese, as found in The Yomiuri, "APEC isJust a Political Show," September 1996. As the original quote was no doubt inEng}ish, there are Iikely to be some discrepancies in the quotation from its
original format.
2 Asahi Evening News, "Europe Revises Its Sense of Asia's Importance," November
6, l995.

3
ABE AIVD PL UMMER: IMPLJCA TIONS O17 THE-ASJA EUR OPE MEETILIVG

These two views probably underscore many of the attitudes that

Europeans had toward the first Asia-Europe Meeting (ASEM) in
March 1996. Asia has elearly not received high priority on the security
or economic fronts since the end of the colonial area. At the regional

level, European economic integration has kept policymakers
preoccupied, and European economic interests are concentrated within
the region or across the Atlantic, not eastwards to Asia. Pressing
security interests go as far as Russia, down to the Middle East, andinto Africa; Asian matters have been left to others. For these reasons,as well as the absence of any specific poliey goal in mind, the ASEM
agenda was kept open and consistent with Asia's own version of NATO("No Action, Talk Only").
Nevertheless, it is difficult for Europe to continue to ignore Asia,

particularly when it is forging closer links with its most important(external) economic partner, the United States, through APEC. The
wide-scale participation of European and Asian countries in ASEM isindicative of this fact.3 Even if APEC were merely a "show," there
would be strong reasons for the EU to be concerned with possible
developments regarding regional cooperation on the other side of theworld. For example, while the Asia-only EAEC has real}y not amounted
to much in terms of concrete initiatives, the fact that it exists in spirit

and principle has been enough to merit close monitoring by the UnitedStates, perhaps even in an overly-ambitious manner.4

Since the late 1980s when the "trade-bloc trend" became anincreasingly vital part of the world trading system, interesting regional

configurations have been developing, especially in the formation ofancillary relationships between major blocs, which we might call"poles." The European pole is ied by the EU; North America is being
led by the United States; and the Asia-Pacific is now being led by
3 ASEAN proposed the ASEM forum, and it ended up being composed of the 15
countries of the EU, the 7 ASEAN countries, Japan, China, and South Korea.
Japan proposed the participation of Australia and New Zealand but failed.

4 The United States reacted quite harshly to the first proposed "East Asian
Economic Grouping" (EAEG), which was tabled by Prime Minister Mahathir of

Malaysia as an Asian-only trade bloc in December 1990. The Bush
Administration--led by Secretary of State Baker--complained that it would impede
the APEC process and was exclusionary. These exchanges }ed to a deteriorationin Malaysian-U.S. relations, even as ASEAN has downgraded the EAEG to amore innocuous "East Asian Economic Caucus" (EAEC). Relations have
improved between t,he Clinton Administration and Mahathir since, but suspicions
continue to be present.

4 KOBE ECONOMIC&BUSIIVESS REVIEVV, 41 (1996), 1-23

APEC. Additional intra-pole and inter-pole relationships have beendeveloping that could be extremely important in forging the nature of

the emerging world trading system. With respect to intra-poledevelopments, the EU has negotiated association agreements with
Central and Eastern European countries and has sought out additional
means of solidifying economic cooperation with Africa and Russia. At
the initiative of the United States, NAFTA is now considering theChilean application of accession (which will probably happen in thenear term, now that the 1996 election year is over) and a "Free Trade
Area of the Americas" (FTAA) is beginning to emerge, in which North,Central, and South America will increasingly form closer cooperative
links, leading to the eventual creation of a free-trade area even as earlyas 2006. Within the Asia-Pacific region, the ASEAN Free-Trade Area
(AFTA) and the Closer Economic Relations between Australia and New
Zealand (CER) already exist; ASEAN has recently enlarged to include
Vietnam, with Laos most likely joining in 1997 (to be followed by
Cambodia and Myanmar), implying expanded subregional integration
at the heart of APEC; special regional cooperation initiatives have beendeveloping, such as "growth triangles" and the Mekong Riverinitiatives; and, of course, the East Asian Economic Caucus (EAEC)
continues to exist.

Inter-pole arrangements have been proceeding more tentatively, but
the trend seems to be clear. The EU and the United States have been
discussing the possibility of forming a "transatlantic free-trade area,"but these negotiations have been set aside for the moment.5 Still, abasis for dialogue exists. The missing link, then, would be the bridge
between Europe and Asia. ASEM is designed to fill this gap.

From the EU perspective, ASEM not only makes sense but may benecessary. The EU's primary economic competitors are the UnitedStates and Japan. The United States is a (leading) member of NAFTA,APEC and the FTAA, i.e., the major non-European poles. In particular,
the United States and Japan are connected within the APEC framework
5 In fact, it is not clear what such a free-trade area would look like. The EU andthe United States will have close to free-trade in most manufactured goods tradedbilaterally by the end of the Uruguay Round cuts. This would leave agriculture
to free up, which is a non-starter (most of the EU-U.S. disputes are directly
related to this sector, and fights regarding the liberalization of agriculture in the

GATT/WTO are legendary, even ieading to two (premature) deaths of Uruguay
Round negotiations in December 1990 and December 1992.)

ABE AND PL UMMER: IMPLICA TJOIVS OF THE-A SIA EUR OPE MEE TIATG 5

and through which each nation implicitly is assured of a strong say inthe other's special groupings, i.e., NAFTA/FTAA and the EAEC,
respectively. Should, for example, the FTAA take a turn for the worst(i.e., through discriminatory arrangements aimed at Northeast Asia),

Japan could exert pressure on the United States against this throughAPEC, thereby containing the United States if it is not to compromise
its goals in APEC. The same would be true should Japan promote suchan arrangement under EAEC (though that is clearly less plausible). But
where will the EU stand in all this? There will be times when the WTO

will not suffice, particularly in the new international economic

environment in which non-traditional trade issues have become

increasingly
paramount. It is the working hypothesis of this paper that the future of theworld trading system will be built around how these poles developinternally and between each other. In particular, it focuses on the"missing" ASEM link. As ASEAN has been a key catalyst in the APEC
pole and instrumental in establishing the Euro-Asian bridge, aconsiderable weight will be placed on the role of ASEAN in this tripolar world. The paper begins with a review of the political backdrop

from which ASEM emerged (Section 2), followed by a review ofEuropean--Asian economic linkages and motivations for establishing
more extensive links between Europe and Asia in Section 3. Section 4
discusses the first ASEM meeting itself and its implicit and explicit
results. In the final section, the paper considers ASEM and APEC inlight of a changing global economic environment in which all parties
appear to be trying to gain open markets, or at least prevent theirpotential exclusion from a major economic "pole".

2. Baekground to ASEM
According to World Bank projections, East Asian countries willgrow at 8 percent or more over the next 10 years, which is consistent
with many other forecasts. This means that Asia will continue to be themost dynamic region in the world. Moreover, this growth rate isexpanding an economic base that has been growing at a similar pace
for a few decades, implying that the addition to world output (and theshare of Asia in world production and consumption) will continue to be

impressive. For example, in 1979 and 1993, Chinese GDP at market

KOBE ECONOMIC & BUSINESS REVIEW, 41 (1996), 1-23

6

prices came to $202 billion and $426 billion, respectively.6 Ten percent

growth using the 1979 base leads to a net addition in world output of$20.2 billion, whereas for 1993, it comes to $42.6 billion. To put this inperspective, this net addition to output is almost half that of Germany
in 1993 (which comes to $96 billion), if the growth rate for 1992-1993

is averaged (using the 1993 growth rate would be deceiving, as theGerman economy contracted by 1.2 percent!). With the growinginternationalization of the world economy, no private sector firm withmultinational operations will be able to ignore Asia in the near future
without deleterious ramifications.

President Clinton initiated the first heads-of-state APEC Summit(on Blake Island, Washington State) in November 1993, which has now
become an annual event. In convening this meeting, which set in motion
discussions regarding an APEC free-trade area, the United Statesclearly had in mind pushing regional liberalization under APEC, rather
than leaving it to, say, an EAEC from which it would be excluded. In
this sense (and in others), it was used as a political vehicle, but one

with substance in mind (rather than "fluff," as Thurow maintains). At
this point, the EU began to take APEC a bit more seriously. And fordomestic political reasons, Clinton did not show up at the Osaka
Summit in 1995--at which the blueprint for economic integration within

APEC was supposed to be created.' Because of this absence, ASEAN
was able to play a stronger role at the Summit; in fact, ASEAN has
always been considered central to APEC, as is evidenced by theagreement to hold APEC summits in ASEAN every other year.S AIso,
6

These figures were taken from World Tables (1995), using its suggested conversion

rate of Chinese Yuan into U.S. dollars. It should be noted that this type oftabulation is trickly (see, for example, Lardy 1994), but we are only using thesefigures for heuristic purposes.
7

The reason for this was not an indication of lack of commitment on the part of
Clinton toward APEC--which, in fact, would have been hurting his own intiative-or a protest to the Japanese, but rather pertained to a highly-politicized fightbetween the Executive and Administrative branches over balancing the national

budget, including much talk about "U.S. government default." In fact, thegovernment was closed down for days during this period. Leaving the UnitedStates at that point would have left him open to considerable political criticism,and just as the 1996 election year was beginning.
8

ASEAN has been sceptical in the past regarding an overly ambitious APEC
agenda, a fact that manifested itself in the Kuching Consensus. Nevertheless, theKuching Consensus has been surpassed by events, and ASEAN is seeking to play

an active part in molding APEC in a way that is advantageous to its own
interests, rather than playing the role of "spoiler". In fact, the agreement tocreate a region of "open trade and investment" came at the Bogor Summit inIndonesia.

ABE AIVD PL UMMER: IMPLJCA TIONS OF THE-A SIA EUR OPE MEE TING 7

economic integration through AFTA has given a boost to ASEAN's
influence, not only because of its reinforcement of overall liberalization

among the member states (thereby givjng it more "prestige") but also

because ASEAN now can (at least potentially) work together more
efficiently. The expansion of ASEAN to include additional members willaJso likely strengthen its role.9 Moreover, there are negative constraints

on other countries and regions; Japan has always had difficulty
assuming the role of leader in Asia, and China is somewhat limited inthat it is not a member of the WTO and is marred by the "Taiwan"
problem, which it calls an internal issue (i.e., not subject to APEC
concerns) but the rest of the organization understands to be of vital
importance. Hence, ASEAN in a literal and figurative sense, is at thecore of APEC and essential to its future.

The EU's dramatic push to create a unified Single Market
commenced in 1986 and was all but completed by the mid-1990s, atwhich time the EU began to focus more intensively on monetary union.
While the Single Market program was designed to lift Europe out of aslow-growth phase (which it did for a few short years), it is, perhaps,ironic that the region is currently trying to emerge from a long, painful

recession since the Single Market was virtually completed in 1993.
Clearly, Europe needs more than mere vertical economic integration asa remedy for success; more important perscriptions relate to domestic
policies and, arguably, constructing closer links with dynamic, newmarkets. This means Asia.

Almost all Asian members of APEC and ASEM have at one time
been a colony of a European power.iO Each of these countries gained
independence in the post-war era; by the late 1970s, all were free in the

Pacific except the very small states of Brunei, Hong Kong, Macao, andsome small South Pacific Islands. European security and, to somedegree, economic interests in Asia largely disappeared with theirempires, a trend that was exacerbated by regiona} developments
9 While Vietnam joined ASEAN in 1995, it is not yet a member of APEC, which has

had a moritorium on new members for the past 3 years. However, when themoritorium is lifted, it will be a prime candidate for accession. Laos will likelyfol}ow, and, possibly, Cambodia. Myanmar is probably a candidate only in themedium- to long-term.
10 Southeast Asian countries receiving independence from colonial powers include:

Myanmar (U.K., 1948); Laos (France, 1954); Vietnam (France, 1954); Cambodia(France, 1954); Malaysia (U.K., 1963); Singapore (U.K., 1965); Philippines (Spain,
1898; U.S., 1946); Brunei Darussalam (U.K., 1984); Indonesia (Netherlands, 1945).

8 KOBE ECONOMIC &BUSINEss REYIELV, 41 (1996), 1-23

elsewhere (e.g., the UK's joining the EU in 1973). For example, direct

foreign investment of the EU in East Asia (excluding Japan) was lessthan 5 percent of total outward position in all major EU countries in
1994, e.g., 1.8 percent for France, 2A percent for Germany, 4.9 percent
for Holland, and O,8 percent for Italy.'i In part because of the European

withdrawal and in part because of structural change in its homemarket, Japan became an increasingly important player in Asia at thistlme.

As a means to address new issues in the post-cold-war era, the EU
published in July 1994 a political statement called, "Toward a New
Asian strategy."i2 In this document, the EU complains about various
economic intrusions and challenges of the United States, but also
underlines the regional security responsibilities of Japan and its
strategies for building well-defined distribution systems--not unlike its

domestic counterparts--in Asian markets, which prevented other foreigncountries from entering the region. The document also considers more

fully the reasons behind the slow outflow of EU investment to Asia,but, perhaps more importantly from an ASEM viewpoint, it stresses
that the Asian development model must embrace democracy and liberty
based essentially on the same philosophy on which EU integration has
been built. This was considered the ideal. In addition, they include
discussion of many of the specific issues that Asian countries tend tofind the most counter-productive in bilateral dialogue (particularly withrespect to economics): political reform, human rights, respect for theenvironment, and the like.i3 But human rights was singled out as the
key issue, and perhaps the most difficult. As the United States haslearned from many bilateral and regional meetings, pushing humanrights comes up against very strong resistance, with Asian countries
noting that: (1) human rights are internal matters and cannot beeffectively discussed in regional fora; and (2) the West continually fails

to understand Asian development in general and "Asian values" inStill, EU countries are working to create the infrastructurenecessary to expand economic interaction, with support coming from11 OECD (1996).
12 Asahi Shinbun, "Europe Revives Its Sense of Asia's Importance," November 6,
1995.

13 Far Eastern Economie Review, February 29, 1996.

9
ABE AND PL UMMER .• IMPLICA TJONS OF TIIE-ASIA EUR OPE MEETING

the highest levels. The Vice President of the EU commission visited
Vietnam in September 1995 and opened a representative office of the

EU commission in Hanoi. The EU's Joint Committee on Human
Resources Development (HRD) and cooperation unveiled a plan to set
up in Europe a seminar on investment in Vietnam. In addition, the EU
has opened a business information center, which collects extensive dataon the actions of European firms in Thailand and Indonesia. The UK
Chamber of Commerce in Thailand brought together support of morethan 100 firms to open a series of study sessions devoted to benefitingfrom Japanese Official Development Assistance (ODA) in the region,and sought funds to undertake various research projects on how to tap
Japanese money in Asia (about 70 percent of Japanese ODA flows to
Asiai`). Germany's industrial trade center opened in 1995 in Singapore
and, since then, has registered more than 100 firms.i5

At the Osaka APEC Summit in November 1995, the EU collected agreat deal of information, particularly because of the "action-agenda"
orientation of the meeting. Much of the information presented, such asthat related to the rapid (unilateral) trade and investment liberalizationin Asia, brought to the fore the riddle as to why the EU had not done
better in the region. They also discovered that the answer certainly

didn't have to do with the exclusion of the EU from economic
integration programs; not only are existing preferential tradingarrangements outward Iooking, only AFTA gives any degree of
discrimination. APEC itself is based on "open regionalism," with very
explicit directions to avoid discrimination against outsiders and remainfaithful to the letter and spirit of the WTO. Hence, while APEC did notachieve a great deal in concrete terms at Osaka and certainly did notintend to go as far as the EU, its developments have thus far been very
positive from the EU point of view, for discriminatory "bad habits"
characteristic of the EU in its early years were not present. Moreover,
if the reason for the poor performance in the past had to do with thesmall nature of the Asian market, the data exchanged at the meeting

clearly showed that this was not the case. As Prime Minister
Brundtland notes, Asia has become a powerhouse and will likely soonbe the largest powerhouse on the planet; Europe must be careful not toenter the "game" too late. The trade and investment programs of
14 Plummer and Abe (l996).
15 Asahi Shinbun, October 23, 1995, p.4.

10 KOBE ECONOMIC &BUSINESS REVIEW, 41 (1996), 1-23

Asian countries by themselves and through regional cooperation
initiatives such as APEC and AFTA should reinforce the motivation fora closer look on the part of the EU.

3. European and Asian Eeonomie Links: A CIoser Look
The extent of change in economic interaction between Europe andAsia might be proxied by changes in trade shares in each other'smarkets. While an imperfect measure, it is, perhaps, better than most.
Another option might be detailed bilateral direct foreign investment
data, but these tend to be riddled with definitional discrepancies (e.g.,
actual versus approval data), missing information, and less up-to-date

information than trade flows. Besides, it has been shown that tradeand investment are closely related, and, hence, analysis of trade flows
should be sufficient.'6

Tables 1 and 2 show aggregate bilateral trade flows between ASEM

members states, as well as other selected countries and country
aggregates, for 1994 and 1986, respectively. The basic conclusion that
one gets from these trade matrices is that the EU essentially tradeswith itself. Intra-regional exports as a percentage of total exports
came to over 60 percent in 1994, whereas the share of ASEM countries

came to only 7 percent. EU exports to and imports from ASEAN as ashare of its total have increased somewhat from 1986-1994, but by O.Ol

percent. Trade with Japan has also stagnated. Hence, one finds fromthe tables that trade shares between regions have stabilized but at avery low level.

Nevertheless, the overall pieture is, perhaps, clouded by the extreme

regionalization of the EU. As the EU is essentially a Single Market anddoes not yet focus exclusively on extra-regional trade flows in its
statistieal outputs, other trade shares--particularly for developing
countries--will inevitably be small. After all, the EU is by far thelargest trading "country" in the world; total EU exports in 1994 cameto over $1.6 trillion, better than 3.4 times that of the United States(the largest single-country exporter). Therefore, it's important to looka bit closer at recent changes in the absolute magnitudes of relevant

16 For a theoretical and quantitative treatment of trade-investment links, see Petri and

Plummer (1996).

IMPLICA TIOAJS OF
ABEiAIVDPLUMMER,•
THLE-ASIAEUR OPE MEETING11

Table la.
Direction of

Asian-EU Exports, 1994
DESTINATION

Tetat

frperts

Us
JPN
HK
SK
Sing.

E [ndo.(1)x Mel.
P PhjLo TheL(2)
R CHN
T FRN
E Ger.

R BeLux
Neth.
ltaly

UK
Den.
lre.

SPN
GCE(2)
Port.(2)SWD
FND
AUS(2)USJPNHKSKrw

Sin. lndo.Mai.PhiL Thai, CHNFRN Ger.Neth,ltalUK
Den.Swlt ASEAN(4](US$BN)
476.00 OOOO.11O.02O.04O.03
O.06
ODI O.02 o.e3 O.04O.03O.OlO.05 O.OOO.Ol
OD2 o.ole.olo.ol
395.oo O,30O.OOO.06O.06O.06O.05 O.02O.03O.Ol O,04 O.05 OOI O.05O,02O.OlO.03 O.OOO.Ol
O,15
O.Ol O.27 O.Ol O.06O.02O.OlO.05 O.OOO.Ol
28.74 O,28O.05O.OOOOIO.03O.06 o.elo.olo.ol
O.10
95.44 O,22O.14O.08O.OOO.03O.04 OD3O.02O.Ol O,02 O.06 O.Ol o.ose.olo.olo.o2
O.13
o.ooo.oo
96.59 O.19O.07O.09O.03O04o,oo OOOO,20O.02O.06 O.02 OOI O.04O.03O.OlO.03 O.OOO.Ol
O.28
3991 O.15O.27O.03O.06O04O.10 ODOO.02O.Ol O.Ol O.03 O.Ol O.03OD3O.02O.03e.ooo.oo
O.14
58.73 O,21O.12O.05O.03O.03 O.21 O.OlO.OOO.Ol O.04 O.03 OOI OD3O.02O.OlO.04o.ooo.oo
O.27
13.09 O.40O.15O,05O.02O.03 O.05 O,OlO.02O.OO O.03 OOI O.OT o.oso.o4o.ole.o4
O.10
o.ooo.oo
37.08 O.22O.17O05O.OlO.02 O.12 e.olo,o3o.ol
o.oo O.Ol O.02 o.o4o.o3o,ole.o3
O.16
O.OOO.Ol
121.00 o.Tge.Tso.27o.o4o,a2
o.ot
O.02 OOrOOIO.OO
o,oo oot o.o4o.o2o,ola.o2
O.06
o.ooo.oo
O.Ol o.ooo.ooo.oo
233.oo o.o7o.o2aolo.olo.ol
o.oo OOI o.oo O.17O.05O.09O.10ODtO.04
e.o2
O.Ol O.Ol O.12 OOOO.07O,OSO.08
423.00 O.08O.03O.OlO.OlOOI O.Ol ODIO.OOOOO
O.03
O,02O.05

O.05ODIO.OlO.OOOOIo.oo o,ooo.ooooo ooo O.Ol O.19 O,21O,13O.05O.08o.oleo2
D.OO o.oo O.1O O.26O,OOO.05O.09O.OlO.02
O.04O.OlO.OlO.OOO.Ol o.oo O.OOD,OOO.OO
O.Ol o.ooo.ooo.oo
o.oso.o2o.o2o.olo.elooo OOI O.t3 O.19OD3ODOO.06
O.OlOD4O.Ol
O,Ol
O.Ol o.to O.13O.07O.05O.OO
200.00 O,13O.02O,02O.OlO.Ol
O.OOO.OlO.OO
O.OlO.02
o.oo oooo,ooo.oo o.oo ooo O.05 O.21O,04O.04O.OSO.OOO.02
39,83 o.oso.o4oolo.oleoo
29.90 O.OBO,03OOOOOOOOOOOI O.OOO.OlO.OOo.oo ooo O.09 o.14oe6o.o4o,27 O.OlO.02
72.87 o.ose.olo,olo.olo,oo
o,oo o.ooo,ooo.oo o.oo eol O.20 O.14O.04OD9O,08O.OlO.Ol
S.78 O.04O.OlO,OOO,OOO.OO
o.oo e.ol
o.oo o.ooo,ooo.oo
O.06 O.24O02O,13O.06O.OlO.Ol
15.42 O,04O.OlOOOO.OOO.OO
o.oe o.ooo.ooo.oo
o,oo o.oo O.15 O.20O.05O,03O.11 O.02O.02
e,ol
61.24 o,oso,o3o,elo,olo.ol
O.OOO.OlO.OOo.el O,02 O.05 O.13O.05O,04O.10 O.07O,02
29.79 O.07O.02O.OlODIO.OOOOI O.OOO.OlO.OOO,Ol O.Ol O.05 e.13o.oso.o3o.lo
O.03O,Olo.oo O.OlODOO.OO
40.14 oo3o.o2o.ole.ooo.oo
ooo O.Ol OD4O.39O.03O.OBO,03O.OlO.06
137.00146.00190.00Addendum/
APEC(3)
165T.r6
1626.97EC15o.2so.ogo.o6o.o4o.o3 O.04 O.OlO.03O.Ot
O.07O.02O.OlODIO.Ol O.Ol oooo.ooo.oo

O.02 O.03 O.02 O.04O.02O.OlO.03 O.OOO.Ol
o.oo O.Ol O.10 o.14o.o6o.o6o.es O.O;O.03

O.Ol
O.Ol

O.02
O.03
O.Ol

O,Ol
O,Ol
O,Ol

ooo
O.03

OD3
O02
O.11

O.02

Netes/")data for East TJmor vves added to Jndonesia(2) 1993 data used fer Thailand, Greece, Portugal, and Austria(3) APEC/ missing Papua New Gulnea, Brunei, and Taiwen(4> A$EAN ineludes lndenesia, Malaysia, Singapore, Theiland, Ph"ippines, and Vietnam
Seuree/ United Nations, Commodity Trade Statistics, Various Years

Table lb.
Direction of

Asian-EU Imports, 1994
$OURCE

Tetu
lmperts

Us
JPN
HK
SK
t

Sing.
lnde.(1)M MaL
P Phil.

o ThaL(2)
R CHN
T FRN
E Ger.

R BeLux
Neth.
ltaly

UK
Den.
lre.

SPN
GCE(2)
Perk.C2)SWD

FND

AUS(2)(USSBN)687.00272.00USJPNHKSKTWSio,lnde.Mal.Ph".Thai,CHNFRNGer.Neth,ltaiUKDen.SvvitA$EAN{4}O,OOO.18O.OlO,03O.04O,02O.OlO.02O.OlO.02O,06O.03O,05O.OlO.02O.04O.ooO.OlO.08
O.23O.OOO.OlO,05O.04O,02O.05O.03O.OlO.03O,10O.02O,04O.OlO.02O.02O.OlO.OlO.T4
o.o7o.16o.ooo.oso.ogo.oso.olo.o2o,ooo.olo,3so.olo,o2o.olo.o2oo2o.oeo.olo.og
O.21O.25O.OlO,OOO.02O.02O.03O.02O.OOO.OlO.05O.02O.05O.OlO.02O,02O.OOO.OlO.07
o.lso.22o.o3o.o4o.o4o.ooo.ooo.16o.elo.eso.o3o.o2o.o3o.olo.olo.o3o.ooo.olo.22
31,98 O.11O.24O.OlO.07O.05O.06O.ooO.02O.ooO.OlO.04O.02O.08O.02O.02O.02O.OOO.OlO09
S8.0S O.17O.27O.02O,03O.05O.14O,02O,OOO.OlO.03O.02OD3O.04O.OlO.OlO,03O.OOO.OlO.19
22,74 o.lso,24o.eso.oso.o6o.o7o,o2o.o2o.ooe.olo.ole.olo.o4o.oto.oTo.o2o.ooo.oro,lt
45.95 o.12o.3oo,olo.o4ooso.o6oole.o4o.oeo.ooo.o2o.o2e.oso.olo,o2o.o2o,olo.olo.12
116.oo O.12O.23O08O.06O.12O.02O.OlO.OlO.OOO.OlOOOO.02O,06O.OlO.03O.02O.OOO.OlO.06
22a.oo o.osoo4e.ooo.olo.olo.olo.ooo.ooo.ooO.olo.o2o.ooo,lso.oso.loo.oso.olo,o3oo2
377.oo o.o7e.o6o.olo.olo.olo.olo.ooo.ole.ooo.olo.o3o.no.ooo.oso.oso.o6o.o2o.o4o,o3
126,OO o.oso'o3o.ooo,eoo.ooo.ooo.ooo.ooo.ooo.olo.olo.16o.2oo.lso.o4oogo.olo,elool
130,OO o.oso.o4o.olo,oooolo.olo.olo.olo.ooo.olo.olo.o7o.22o.ooo.o4o.ogo.ele.oloo3
164.00 o,oso.o2o,ooo.ooo.olo.ooo.ooo,ooo.ooo.ooo.o2o.14o.2oo.o6o.ooe.o6o.olo.o4o.o2
222.00 O.12O.06O.02O.OlO.OlO.OlO,OlO.OTO.OOO.OlO.OlO.10O,15O.07O.05ODOO.OlO.03O.03
33.92 O.05O.03O.OlO.OlO.OlO.OlO.OOO.OOO.OOO,OOO.02O.05O.21O.07O.04O.06O.ooOD2O.02
25.30 o.lse.oso.olo.ooo.olo.Q2o.ooo.olo.ooo.ooo.olo.o4o.o7oo3o.o2o.36o.olo.olo.o4
91.S4 O.07O.04O.OOO.OlO.OlO.OOO.OlO.OOO.OOO.ooO.02O.17O.15O,04O.09O.08O.OtODIO02
22,76 o.o4o.o7o.oooo2o.elo.ooo.ooo.ooo,ooo.ooo.olo.oso.17o.o7o.14o.o6o.olo.o2o.ol
24.12 o.e3o.o3o.ooo.ooo,oeo.ooo.ooooee.ooo.ooo.olo.13o,lso.oso.ogo.o7o,olo.o2o.ol
51.76 o.ogo.oso.olo,olo.olo.ooo.ooo.ooo.ooo.ooo.e2o.o6o,lso.o4o.o4o.loo,o7o.o2o.ol
23.27 o.oso.o7o.olo,olo.olo.olo.ooo.elo.ooo.ooo.o2o,o4o.lsoo3o.o4o.oso.o3oo2o.o2
48,53 e.o4o.o4o.ooo.olo,olo.ooo.ooo.ooo.ooo.ooo.olo.o4o.41oo3o.ogo.o3o.olo.o4o,ol
162.00102.00lo2.oeAddendum/
1901.33
APEC(3}156e.50
EC15

O.17O,15O.02O,03O.05O.03O,02O.03O.OlO.02O.OSO.02O.04O.OlO02OP3O.OOO.OlO.09
o.oso.o4o.olo.olo.olo.olo.ooo.olo.ooo,oloo2o,ogo.14o.o7o.o6o.o7o.olo.o3o,e2Netes/(1) date for East Timor was added to lndonesie(2) 1993 data used fer Thailand, Greece, PertugaL and Austria,(3) APEC/ missing Papua New Guinea, BruneL and Taiwen.
(4) ASEAN includes lndonesia, MaLaysia, Singapore, Thailnnd, Philippines, and Vietnam

Seurce: United Netions, Commodity Trade Statistics, Verious Years

REVIEW,41 (1996),&
KOBEECONOMICBUSIIVESS

12

1-23

Table 2a.

Asian-EU Exports, 1986

Direction of

DESTiNATION

Tetal

hports

us
JPN
HK
SK

JPNHK

Slng

34.70
22.43

lndo.(1)14J9

E Mai.
x Phii.
P Thei,o CHN(2)
R FRN

13.83
4.73

39.44
119.ooT Ger,

261.86E BeLux

68.65
80.55
97.82

R Neth,Å}tatyUKDefi, Swit ASEAN(4)O.04
e.o3e.oso.o4o.o2 O05O.OOODI
O06
O.02D.05O02O.Ol O.03O.OO o,o:
O.Ol
O.04
e.ol
O.02O.07O.02ODIOD6O.OO
ooo
O.04
O,Ol O.Ol ODI O.Ol
O.03O.OO o.oo
e.o2o,o4oole.ol
O.19
O.03O.OO o,oo
o.oo O,15 O.Ol O.04 O,03 e.olo.o3o.o2o.el
O.10
O.OlO.OO o.oe
o.oo ODI D.Ol O.Ol O.Ol oolo.o2o.o3e.ol
O.22
o.oo o,eo O.02 O03 O.Ol O.OlOD4O.03O.Ol O.03O.OO o.oo
O.07
O.Ol o.e2 ooo O.Ol
O.02 o.o2o.oso.esoeo O05O.OOo,oeSK rw Sbng. lndo.
CUS$BN) us
205.00 o,oo O.11O.Ol e.o3 O,02 eo2 o,oo
209.00 O.39 O.OOO.03O.05 O04 O.02 O,Ol
19.73
O.42 O.04O.oo o.oo OOI O.02 o,oo

S.79

O.40
O.23
O.20
O.;7
O,36
O.18
o.os
O.07
O.10
O.05
O.05
O.11

UK

107DO O.14

Den.

20.56

lre.

12.60

SPN
GRE

27,25
5.66
7.16

Port.

O.08
O.09
O.09
O.07
O.07

SWD

37.12

O,11

FND
AUS

16.33

22.52

O,05
O.04

Addendum/
APEC{3)

706,59EU15884.07

O.T6O.05. o.oo O.Ol

O.09OD7O.Ol

Ph",

ODI
ODI
ODI

O.Ol

o.oo

O.Ol

O.Ol

O.09

O.Ol O.04
o.oo OOI
o.oo o.oo e.oo
o.oo o,oo o.oo
o.oo o,oo ooo
o.oo o,oo o.oo
o,oo o.eo e.oo
ODI o.oo o.oo
o.oo o.oo o.oo
o.oo o.oo o.oo
o.oo ooo o.oo
eoo o.oo o.oo
o.oo o.oo o.oo
o.oo ooo o.oo
o.oe o,oo ooo
o.oo o,eo o.oo

o.oo

o.oo

O.03

O.Ol

O.Ol

o,oe

o.oo
o.oo
o.oo

o.oo
o.oo

O.Ol
e,ol

O.08O.02 O.06
O.11OOOO.OSO.08

O.Ol

ooo

O.Ol

O.20O.20O.15O.06O09O.Ol O.02

O.Ol

o.oo

o.oo
o.oo
o,oo
o,oo

e.oo

e.loo.o2
O.11029O.OOO.06

O.Ol

e.o2
o.oo
o.os

O.02
O.45O.02 o.e2 e.o2
O.23O.02 O.05 O.02

O.17

O.18O05 o.e2

O.03

O.03

O.14O.04 O.03 O.02
O.16O.35 o.oo e.oo
O.OlO.OO O.Ol o.oo
O.02D.OOooo o.oo

O.OlOOOo,oo ooe
O.OlO.OO ooo o.oo
o.oto.ot

o.oo
O.02ODI o.oo
O.03ODI o.oo
O.02ODOo.oo
o.olo.oe o.oo
O.OlO.OO o.oo
O.OlO.OO o,oo
O.OlO.OO o.oo
O.02Ooo o.oo
o.oo
O.OTODO

o,oo

ooo
o,oo
o.oo
o.oo
o.oo
o.oo
o.oo
o.oo
o.oo

TheL CHNFRNGer.Neth.Italy

Mal.

O.29 o.ogo.o4 O.03 O02 O.02 O.Ol O.OlOD9 O.OlO.OO o.oo o.oo o.oo o.oo o,oo

ooo
o.oo
o.oo
o,oo
o,oo
o.oo
o.oo
o.oo

O.02
O.05
O,12
o,oo

O.03O.Ol OOIOD3 O.02O.05O.07OD2
O.OlO.04OD2O.Ol O.OlO.OO o.oo

O.14
O.06

O.OOO.16O.05O.12O.09OOI O,05

ODI

O.02
o.es

O.Ol

O.07•O.Ol
O.16O,18OD3OOO

O.Ol

o.oge.12o.o7o.os O.OOO.02 OD2O.11O.OO o.e2
OD5O.16O03O.04
O.34O.Ol O.02
ooo o.oo OD9O.11ODSO.04
O.Ol

O,18O.12O.06O.08O.09O.Ol O.02
O.Ol O.09O.24O.05O.13 O.07O,Ol O.Ol
o,oo O15O.15O.07O.04O.14O.02 OD3OOI O.05O.12O.05OD3
O.10ODSO.02
O.02
o.oo ooo O.Ol O.04O.10O.03O,02 o.loe,o4
O.08
O.Ol
O.04O.Ol
O.04O.34O,03O.09
ooo ooo
o.oo
o.oo
o.oo
o.oo

O.Ol

O.Ol

OD2
o.ol

o,oo
o.oo
o.oo
o.oo
O.Ol

OOI
ODI

OOI

O.Ol

O.03

OD2O.04O.02ODIO.04O.OO O.Ol

O.05

o.oo

o.oo

O.Ol

O.10O.13O.06O.06 O.08O.02 O,04

O.Ol

Notes/{1) data for East Timor was added te lndonesia(2) China 1987 dets used
(3) APEC/ misslng Papua Nevv Guinea. Brvnei. and Teiwen(4) ASEAN mciudes lndenesia. Maleys)a, Singapore, Tha"end, Ph"ippines, end

V;etnem

Source/ United Nations, Oommodity Trade Statistias. Varieus Yesrs

Table 2b.

Direction of Asian-EU

Imports,

1986

SOURCE

Tetal

imperts

ussgNl•Sin. tndo,MaL
JPNHKSKTWOOI O.OlO.Ol

381OO o.oo o.22o.o2o.o4o.e6

SK

31.52
25.46

Sing.
lndo.(1)
:

us

us
JPN
HK

Mal.

M Phll.
P ThaLo CHN(2)R FRN
T Ger.
E BeLux
R Neth.
lteiy

VK
Den.
lre,

SPN
GRE
Port.

SWD
FND
AUS
Addendum/
APEO(3)EC15119,OO

O.22

O,04 O.OlO.Ol
3537 O.08 O.20ODOO,04OD9

43.22 O.11 023O.19OOOODIOOI128DO O07 O04OOOOOIO.Ol
ooo
20966 e,o6 O.05OOIO.OlOOI ooo
68.02
OD5 o.o3o.eoo.ooo.oo o.oo

Den. Swit ASEAN(4i

Thai.

O.Ol

ooo QOI O.03 O.07 O.OlO.03O04 o.oo
OOI O05 O.02 O04 ODOO.OlO.02ODI

O.Ol

O,34OOIODOO.OlODI O.OlO.03 o.oo
O15 O.20OD2O02O.04o.oo OOOO.13ODI
10.72
O,14 O.29O.OlOOIO.04 OD9 oooo.oo ooo
10J3 O,19 O.2TO,02O.02OD3e.15 ODIO.OOOOI
5.39
O,25 o.17o.esoo3o.os e.o2 O.03O.04 ooo
9.12
O.14 o.26o.o2o,o2oe4 O07 O.OlO04 OOI
O.21

CHNFRN Ger, Neth.ltalUK

Phil.

O.OOOOIO.04O.04ODI O.06OD3e.ol

O.Ol

O.30 e.ol

O.03

ODI ooo O.02 O.04
O.03 O.06 O.02 O03
o.o;
O.03 OD3 O.OlOD4 O.03 OD2 O.05
OOI O02 O02 O.04
eoo eo3 O02 O06

O.Ol

O04

O.Ol

O.13

oole.o2o.o3 ooo O.02
O.OlO.OlOOI o.oo OOI

O.07
O.06
O.17

o.oo O.Ol
o.olo.ole.o3
O.02O.OlO.03 o.oo ODI

OOIOOIO.04o.oo

o,elo.oo ODIOOIOOOO02

ooTo.olo.e3

ODI O.02

O.11

O.22
O.10
O.12

O.OTODI o.oo O.Ol ooo e.o2 o.os
o.ooooo o.oo ooo O.Ol o.oo e.2o

O.OlO03O02o.oo
O06O.12O07O.Ol

O.Ol

O.05

o,ooo.oo o,oo o,oo O.Ol O,11 o,oo
o,ooo.oo o,oo ooo o.oo O,16 O.24
75,5a
o.oo
o,ooo.oo
ooo O.Ol o.oe O07 O.27
O08 O.03OOIODIODI
o,oo o.ooo,oo o.oo ooo e.ol
O.15 O.21
99.77 O.06 O,02OOOOOOOOO
126DO O,10 O,06O.02OOIO.Ol o,oo o.ooo,oo o.oo o,oo o.oo O.09 O.17
22.73 O.05 eo6o.olo.olooo
o,oo o.ooo.oo o.oo o,oo O.Ol O.05 e.24
11.56
o.oo oooo.oo oeo o.oo o.oo O.05 O.09
O.16 O.04OOIOOOOOI
3S.41
o.oo o.ooo.oo ooo ooo O,Ol O,12 O.15
O.10 o.oso,ooo.oeo.el
11.24
OOT o.ooo.oo e.oo o.oe o,oe o,os O.22
OD3 OD6ODOO,OOO.OO
9,39 O.07 O04OOOO.OOOOO
ooo o,ooo,oo O.OD O.Ol o,oo O.10 O.14
3249 O.08 O05OOIO.OlO.Ol o.oo o.ooooo o.oo o.oo o,oo O.05 O.21
15.32
O.05 o.o6oooo.oooeo o.oo o,ooooo o,eo ooo o.oo O04 O17
26,79 OD3 O.04O.OOOOOO.Ol
ooo o.ooo,oo o,oo o.oo o,oo OD4 O.45

O.11O.09O.07 O.02

O.02
O.04

O.Ol

O18O,04O08O.Ol

O.02

O.Ol

O.Ol
OOOO,04O.OS

O,Ol

O02

O.Ol OD3
O06O,OOO05

O.02

OOI
ODI
oel

O04O.03O.42 o.ol

O.Ol

O.Ol

o.o3o.e7o.os

O,02

O.Ol

O07O,12OD4OOI O02
oo4eoso,os OOI O.03

o.ot

OD2 O,03
OD8OD5ODO
e.oso.o4o.o7

oo4o.o4e.lo

o.oo
O.Ol

O07 O.02

O.03O.04O.06 O.03

oo3o.ego.o2

O.Ol

O.02
O.05

799.29 O]5 o.lso,e3oo3oo4 O.02 O,02O.02 OOI ODI OD3 O,02 O.06 e.olo.o2oo3 ooo O.Ol
87T9S O,07 O.04OOIODIO,Ol O.OG oooo.oe o,oo eoo ODI OD9 O,16 O,07O.06O.06 O.Ol O.03

Notes/C' O date {or East Timor was added to lmdonesia(2) China 1987 data used

(3) APEC/ missmg Papue New Gu,nea, Brune[. and Tatvvan(4) ASEAN includes +ndonesia. Maieysia, Singapore, Thailand.

PhMppines, and Vietnam

Source/ United Natbons. Cemmodity Trede StatistJcs, Vanous

Years

O,Ol

OOI
O.Ol

ooo
O.Ol

O.06
O.Ol

13
ABE AND PL UMMER: IMPLICA TIONS OF THE-ASIA EUROPE MEETING

variables, in which case the picture looks a bit different. Statistics

compiled by JETRO show that EU direct foreign investment flows to
Asia have doubled from 1990-1994, from $4.4 billion to $8.8 billion,
actually surpassing EU investment in Japan in 1994 ($8.3 billion). The
EU imported $125 billion (excluding Japan) worth of goods from Asia
in 1994, and exported $81 billion (Tabie 1). This compares to about$150 billion and $81 billion in exports to and imports from Japan,
respectively, in 1994, making Japan's trade with Asia only about 12
percent larger than that of the EU ($231 billion compared to $206
billion). Of course, geography plays a major hand in determining EuroAsian interaction at both economic and political levels, a fact that is

becoming increasingly appreciated in the international economic
literature.i7'

After the breath-taking political revolutions of 1989 in Central andEastern Europe and the end of the cold war, economic imperatives rose
to prominence on international diplomatic fronts, and Asia was hurled
into the spotlight. In 1993, the World Bank published an influential
book, East Asian Miracle, which highlighted the successes of the "High-

Performing Asian Economies" (HPAEs) and factors leading to their
explosive growth. In particular, stable macroeconomic policies(including sagacious exchange-rate management), high rates of savings

and investment, reliance on export promotion, a focus on
infrastructural development (especially human capital), market-friendly

microeconomic policies, and strong economic bureaucracies were citedas the most important determinants. 'The World Bank (1993) study was so successful in drawing
attention to the HPAEs effective developments strategies that it
inevitably produced detractors. The most influential has been, perhaps,

Krugman (1994), entitled, "The Myth of the Miracle." Krugman
summarizes a number of recent studies found in the endogenousgrowth literature suggesting that, like flash-in-the-pan growth in theSoviet Union of the 1950s, the lion's share of the growth in some of the

HPAEs tended to be due to increased inputs of labor and capital,
rather than productivity increases. As factor inputs will be accumulated

at an inevitably slower rate in the future, this would suggest that theskyrocketing Asian economies will soon be brought back down to
17 See, for example, Krugman (1993) and related literature.

14 KOBE ECONOMIC &BUSJNESS REVIEW, 41 (1996), 1-23

earth. But while Krugman (1994) has received a good deal of attention
in the literature, it has been criticized from a number of perspectives,

not the least being its focus on sources devoted to the experiences ofSingapore and Hong Kong (two small city-states), whereas booming
large countries such as those in ASEAN and China are excluded, as areother HPAEs.i8 In any event, medium- and long-run forecasts continue

to show Asian countries growing in the 7-8 percent range, at whichrate their economies will (approximately) double every decade. On
balance, academe and the private sector have more faith in the WorldBank (1993) perspective than that of Krugman (1994). The fact that
ASEM has been created suggests that the Europeans are of the samemind-set.

So far, we have focused on an EU-centric approach to ASEM. What
will Asia get out of it? First, the EU is the world's largest market, eventhough it has met with a fairly prolpnged recession. Second, it is amajor supplier of global direct foreign investment, which Asia needs inorder to bring in additional non-debt creating capital flows, provide
ready-made external markets, stimulate trade, and, most importantly,
provide new technologies. Third, Asia has always been nervous about
the potential fortress nature of the economic "deepening" of the EU,
and ASEM could provide a direct forum for Asia to protect itself,
without the over-bearing interaction of other large countries such as
the United States. Fourth, Asia (especially the ASEAN countries) would
like to continually keep a balance of economic power in the region, i.e.,

it would not like to become too dependent on Japan. While the UnitedStates continues to have a large presence in the region, Asia isconcerned that it could in the future be too preoccupied with NAFTA"plus" accords and the FTAA, as well as possible movements in the
direction of a transatlantic free-trade area.

4. The ASEM Meeting: Origin and Results
In sum, a strong dialogue is in the interest of both sides, anecessary condition for any voluntary organization like ASEM (orAPEC for that matter). Two years before, Singapore Prime Minister
Goh Chok Tong approached France, the chair of the EU at the time,
18 For a survey of the critiques of Krugman (1994), see Abe and Plummer (1996).

15
ABE AIVD PL UMMER: IMPLICA TIOIVS OF THE-ASIA EUROPE MEETING

and suggested that there be a bridge between Europe and Asia in thesame way that APEC has created a firm bridge between Asia andNorth America.i9 Thailand was chosen as the cite for the first ASEM
meeting, i.e., an ASEAN country and geographically closest to Europe.
Only Asian countries were included out of respect for Prime Minister
Mahathir's wishes according to the EAEC.
What was accomplished at the March 1996 meetings? It should be
noted from the start that an important emphasis was placed on "equal
partnership" in these discussions, i.e., negotiation and cooperation onequal footing. The main objective was to construct a partnership
between Europe and Asia with a face toward the future, and a focus
on mutually-beneficial trade and investment. The first group of topics
discussed was consistent with direct needs of the ASEAN countries intheir respective economic development drives, e.g., technology transfer,environmental issues (such as transfers of "clean" technologies), andhuman resource development. Also, technical issues such as customs
clearance simplification measures were discussed. Asian participants
stressed open trade and investment and open regionalism issues,

whereas from the more non-economic perspective, Prime Minister
Banharn (obviously after eonsultation with his ASEAN colleagues)
emphasized the following in his opening speech: (1) the goal of ASEM is

no less than to create a new dynamic partnership between Asia andEurope; (2) we should cooperate in non-economic areas such as nuclear
and biochemical weapons; (3) it is hoped that Europe will endorse theinitiatives keeping Southeast Asia a nuclear-free zone; (4) we should

work together in reforming the United Nations; and (5) we should
support human rights and cooperate together in opposing global

terrorism. He also stressed the importance of creating closer
government-private sector links, including a ASEM business forum,

developing the Mekong Region (with Japanese and European
involvement), and in deciding what should be done with Myanmar.20
Europeans focused on the importance of rules-based concerns, e.g.,
global investment rules and intellectual property protection.

Without doubt, there was disagreement regarding a number ofissues, both with respect to approach and suitability for ASEM. For
19 Asahi Evening Netvs, "Asia-Europe Summit to Push Free Trade," February 29,
1996, p.8.

20 Asahi Shinbun, March 2, 1996, p.8.

16 KOBE ECONOMIC &BUSINESS REVJEW, 41 (1996), 1-23

example, the Europeans emphasized the need to abolish child labor,
whereas the Asians noted that this is really a domestic issue. On theenvironment, there was the standard North-South devide, with the
Malaysians leading the criticisms of the European position. Moreover,the more ruies-based approach of the Europeans contrasted with thefamous ASEAN-style of consensus and flexibility, a question of
approach that also comes up in APEC with great frequency.

The meeting was well attended, showing how important it wasdeemed to be even for the smalier countries in Europe and Asia. Out of

the 25 countries invited, 21 sent their heads-of-state and high-level
representatives; only the smaller countries of Spain, Denmark, Sweden,
and Greece did not participate. In 1998, the ASEM will take place in the

United Kingdom, making the possibility that New Zealand andAustralia will be invited that much higher. With respect to results fromthe first ASEM, 19 points were raised, including a strong priority
attached to strengthening opportunities for political dialogue on "equal
footing." Interestingly, trade and investment concerns were placed 10th

on the list, with a special mention of Mekong River development andestablishing the Euro-Asian business forum.2L CIearly, ASEM leaders
are keeping controversial issues off the agenda and, instead, intend tohighlight common (non-controversial) goals before proceeding to moresensltlve lssues.

As the EU has had an important influence on regional cooperation

within ASEAN,22ASEM clearly takes on a special importance for
ASEAN. Without doubt, regional economic integration within the EU
has been highly progressive (at least over the past 10 years), and it isunwise to try to compare it to ASEAN economic integration. After all,ASEAN is a group of developing countries which are far moreheterogeneous than EU countries, in terms of economic structure,political orientation, culture, etc. Still, ASEAN has begun to pick up on

a number of the "deep" integration issues that have been at the core of

the Single Market process, such as some harmonization issues,
21 Asahi Shinbun, March 3, 1996, p.6.
22 It is important to stress that by "influence" we do not mean that ASEAN strove toemulate the EU, but rather that ASEAN was able to monitor EU activities andadopt to its own purposes--or comp!etely reject--certain approaches. The success of
the Single Market program, for example, certainly left a large impression in theminds of ASEAN leaders as they began to explore more extensive regional
cooperatlon.

ABE AND PL UMMER: IMPLICA TIONS OF THE-A SIA EUR OPE MEE TING 17

intellectual property protection, dispute settlement, and customs
harmonization. Hence, an important externality for ASEAN might becloser dialogue with the EU in areas currently driving ASEAN deep
integration. Moreover, the EU has a great deal of experience indeveloping the "infrastrueture of integration," e.g., railway networks,

roads, and telecommunication networks. For example, as is evident
from the above discussion, a theme receiving a great deal of interest is

the Mekong River Initiative, which directly touches 6 countries andfocuses on infrastructure, as well as the plan to develop a railway
between Bangkok and China's Yunnan province.
To conclude, it would appear that strengthening European-Asian
dialogue is in the interest of all parties, not only due to economic but

also political opportunities. But how does the Asian commitment to
ASEM compare with its obligations and stakes in APEC?

5. ASEM and APEC: East Meeting West and West Meeting East
The WTO superseded the GATT shortly after the end of the Cold
War, ushering in a new era of economic cooperation along with acompletely new political environment. Existing regional organizations(such as the EU and ASEAN) were breaking down internal barriers
with new vigor, just as new organizations (such as NAFTA and
MERCOSUR) were seeking the same goal. The simultaneous emergenceof large (and small) regional blocs at the same time that the new
global system was being built was cause for both optimism andconcern on the part of economists and poiicymakers, with somebelieving that the trend was, on the whole, positive for multinational

liberalization and free-markets (and, hence, complementary to the
GATT), while others that they were in competition by definition.

Asian countries tended to view this trend with concern. Economic

integration in the EU--as well as political developments in its
backyard--seemed to be pushing the region to become more inwardlooking or at least self-absorbed. Even if the EU djd not become a"fortress," this trend ostensibly detracted from its commitments under
the GATT/WTO. Evidence of this could be derived from the failure toreach a successful conclusion to the Uruguay Round in December 1990
and December 1992, in which the blame was Iargely piaced on the EU(especially its failure to liberalize agriculture). On the other hand, the18 KOBE ECONOMIC&BUSINESS REVIEVV, 41 (1996), 1-23

United States, by far the most important export market for Asian
manufactures--key to their respective economic development strategies--

for the first time began to embrace regionalism as a commercial policy
strategy, beginning with its free-trade area in manufactures with Israelin 1982, followed by the U.S.-Canada Free-Trade Area (1989) and
NAFTA (1994). The inclusion of Mexico in a U.S. regional cooperative

arrangement was thought to be particularly problematic from the
Asian perspective, as it was the first time that one of its major trading

partners would give preferential treatment to a large developing
COuntry.23

The successful conclusion to the Uruguay Round did much torelieve fears that the multilateral trading system was crumbling under

the weight of regional trading agreements. Still, Asian countries
considered new alliances among themselves and with major trading
partners, both as a means of future defence as well as with a view togaining potential economic benefits associated with region51
integration. It is in this context that APEC was created--in part as ameans to push through the Uruguay Round--and subsequently
expanded to go beyond a discussion forum to become a vehicle to open
regional markets, e.g., through its commitment to "open trade andinvestment in the region" by the year 2010 (for developed countries)
and 2020 (for developing countries). Hence, while ASEM and APEC arevery different organizations in many ways (discussed below), they havethe common feature of exhibiting the Asian desire to liberalizeinternational markets and gain security from possible "fortresses," andfrom the European and U.S. perspectives, the goal of attachingthemselves to the fastest growing region in the world.

Also, APEC and ASEM, rather than being thought of as "trade
blocs" in any real sense, might be included under a "systemization" of

an international-conferences framework, i.e., designed to improvebilateral understanding. Hence, they are out-growths of the regionalism

trend without necessarily being part of it, if regionalism is defined
more traditionally to include discrimination in trade agreements.

APEC was conceived as a forum for discussion in 1989' the first'goals were extremely modest, and the more ambitious of theparticipants hoped that it would eventually turn into a type of "Asia23 For a review of the economic effects of NAFTA on ASEAN countries, see Kreinin
and Plummer (1992).

19
ABEAND PL UMMER.4 IMPLIeA TIONS 0F THE-ASIA EUROPE MEETIIVG

Pacific OECD." The first meetings were only attended by ministers--notheads-of-state--and an enormous amount of effort went into justsettling the membership issue. In fact, this is a major success of APEC;

it has been able to include the "Three China's" under the umbrella ofone organization, though this arrangement continues to have manydifficulties. As noted above, cooperation within APEC gained
considerable momentum at Blake Island, culminating in the Bogor
Declaration to create free trade and investment in the region.

Since then, as APEC countries have tried to put this agenda into
practice, the momentum toward this grandiose vision has, perhaps,
subsided, as the extreme diversity of the Asia-Pacific region makes
realization of the APEC Vision difficult. In fact, pushing too hard
would be counter-productive. It is in this sense that ASEAN has playeda key role in helping to set the APEC agenda. As a voluntaryorganization committed to "open regionalism," all trade and investment
iiberalization is voluntary, consistent with the concept of "concerted

unilateralism," in which peer pressure to liberalize trade andinvestment would play an important role. This has required the offeringof a "down payment" of liberalization at the Osaka meeting (mostly
just speeding up of WTO commitments or reaffirming liberalization andderegulation already promised), and will require a progressive list ofliberalization if the Vision is to be achieved on time. But the important

point is that ASEAN wants to ensure that APEC will follow anapproach that is consistent with its own philosophy of embracing
openness (rather than discrimination) and not forcing any country tomove more quickly than it wishes. In the meantime, the Manila Summit
in November 1996 is moving away from the preoccupation with tradeand investment liberalization and instead is focusing on the "third
pillar of cooperation": development cooperation, again reflecting thecore influence that ASEAN enjoys in hosting the meeting every otheryear.

ASEM, on the other hand, is born in a completely different
environment than APEC, which was, after all, the very first newinternational institution of the post Cold War era. The different goalsof Europeans and Asians in developing ASEM would naturally imply
that its character would differ from APEC. Moreover, the large
influence of the United States in Asia-Pacific economics and security
implies that much of the discussion will be determined with respect to20 KOBE ECOArOMIC &BUSJNESS REVIEVV, 41 (1996), 1-23

this country, whereas in Europe, power is far more diffuse and Asia
does not count on Europe for its security.
It is difficult to extrapolate as to where ASEM will go in the
future--and to what degree it will progress relative to the APEC
experience--but a few salient observations give strong hints. First,
ASEM started off immediately as a heads-of-state meeting, implying
the highest level of commitment from the start. Second, while a few
larger economic projects were discussed, politically-oriented issues
played a prominent role in ASEM, more so than they ever did in APEC
(perhaps a reflection of the limited participation of European countries

in the ASEAN Regional Forum, in which only the EU formallyparticipates rather than member states). Third, major stumbling--blocissues that APEC dealt with from the start---as they were important toU.S. and arguably Asian strategic interests--were ignored, such as the"Three Chinas," making political discussion less polemical at the.
'margm.

These strategies and characteristics of ASEM, along with the open

agenda, political commitment, and informal dialogue, no doubt
contributed significantly to its success. Many Asia-Pacific countries
would like to join ASEM, in addition to Australia and New Zealand.
For example, Prime Minister Bhutto of Pakistan--who has since been
forced to resign--visited Indonesia in March 1996 in order to drum up
support from President Suharto for Pakistan's desire to participate in

the next ASEAN Regional Forum and ASEM meetings. Hong Kong
wanted to join, but as it reverts to China in 1997, this is probably nolonger an important question. The issue of Taiwan, however, still is;
although Taiwan would like to join ASEM, it has little chance of doing
so with China's strong opposition (and Taiwan has less incentive tojoin ASEM than it did in joining APEC).

Moreover, Central and Eastern European countries have been
visiting the region with the goal of strengthening economic ties andsoliciting support to join ASEM. For example, in 1996, high-level

diplomatic missions from Russia, Croatia, Hungary, the Czech
Republic, and others were sent to ASEAN countries with this goal inmind. Interestingly, Russia also asked Thai officials to support its
accession to APEC.
If we tally up all the existing and willing future ASEM members,
we count at least 40. It will be difficult to see how concrete cooperation

ABEAIVDPLUMMER:IMPLICATIONSOFTHE-ASIAEUROPEMEETING 21

could be accomplished within such a large and diverse group ofcountries. At that level, only dialogue would be possible, and, perhaps,
this would not be an ineffective format at this point in time. However,
if closer economic integration issues are to be handled, there will haveto be greater restrictions on membership--as APEC did with its first 3-

year moritorium in 1993. How the membership issue is settled in ASEM,
therefore, will give a strong indication of the envisioned future
directions of the organization.

The EU was created vvith the Treaty of Rome in 1957, in theincarnation of the European Economic Community. Since then, it has
more than doubled in size, progressed beyond a "customs union plus"

format to create a common market coming within a breath ofmonetary union, and has endeavored to forge ever-inereasing politicalcooperation. It has extensive ties through association agreements, theLome accords, and other means of formal cooperation with developing
countries. In sum, it has far more experience than any other grouping

with respect to regional economic cooperation, including thesensitivities of developing (and developed) countries, multi-faceted
cooperative arrangements, political diversity, and, of course, bilateral
friction. Hence, it has greater experience than, say, the United States,

Ja'pan, or Australia, in how to avoid potential pitfalls and achieve
meaningful cooperation within a framework--explicit or implicit--definedby all parties. The agenda of ASEM discussed above was a reflection ofthis experience; it is no accident that it was successful, when, in fact,

the format could have made it a disaster, particularly given the fact
that, relatively speaking, EU and Asian links are less crutial to theirrespective economic development and diplomatic goals. The Philippines,

for example, could walk away from ASEM; it cannot walk away from

APEC.
While the agenda of ASEM has not been well-defined yet--as in thecase of APEC--its meetings will only be every other year at this point.
This gives it plenty of time to discuss formally and informally where it
would like to go in the future, and, in particular, what the likely
membership composition should be. ASEAN will play a pivotal role indefining the ASEM agenda, perhaps even more than it is defining the
APEC agenda. Clearly, ASEAN has in mind using competition between
the EU and the United States in its respective organizations to further

ASEAN goals. In particular, ASEAN will work to ensure open

22

KOBE ECONOMIC & BUSINEss REVIEW, 41 (1996), 1-23

international markets and will use economic and political links
established in both ASEM and APEC toward this goal. On the other
hand, ASEAN is finding that the costs of neglecting closer cooperationin defining joint positions in these organizations are higher; there isstrong incentive for the leadership of ASEAN to define a clear strategy
in these organizations, as part of its global international commercial

strategies. This sort of bargaining and agenda-setting has long beenrecognized as an essential "positive externality" of regional economic
integration. A qtLid pro quo to accomplish this is a unified regional
market; it will be difficult for ASEAN to negotiate as a region if it is
not yet a cohesive regional economic grouping. Having recognized this,ASEAN has moved swiftly to build on AFTA, not only in expanding thefree-trade area itself (and speeding up implementation) but also inestablishing a framework of cooperation on services, intellectual
property rights, a dispute settlement mechanism, and "advanced"
forms of investment cooperation. By the 1998 ASEM meeting, ASEA'N
will be in much better shape in this regard.

Japan plays an important role in this sense. It is the only
developed country that is a member of both groupings. It is the mostimportant economic partner of the Asian countries and a key trading

partner of the Europeans and the Americans. As is the case for
ASEAN, Japan's goal is to maintain an open and non-discriminatoryinternational trading system; in particular, preventing extra-WTO"sanctions" agains.t Japan by the United States and the EU areparamount economic goals. By playing a leadership role in bothorganizations--which it has done increasingly in APEC--Japan will be
best placed to promote these objectives and, if need be, use competition

between APEC and ASEM towards this goal. If Japan--and ASEAN-canensure that discussions and agreements under ASEM and APEC willlead to non-discrimination, support of the WTO system, and freer tradeand investment, it will not only achieve its own objectives but that of
the entire global community.

* Acknowledgment

The authors would like to thank Jason Eis and Shino Kuwahara
for their excellent research assistance in the preparation of this articie.

ABE AIVD PL UM,1{tER .• IMPLJCA TIONS OF THE-A SIA EUR OPE MEE TING 23

Referenees
Abe, Shigeyuki and Michael G.Plummer, "On the Myth of the Miracle," mimeo,
October 1996.
Asahi Shinbun, various issues.
Far Eastern Economie Review, February 29, 1996, pp. 16-17.
Kreinin, Mordechai E., and Michael G. Plummer, "Effects of Economic Integration in

Industrial Countries on ASEAN and the Asian NIEs," World Developrnent,
September 1992.
Krugman, Paul, Geography and Trade (Cambridge: MIT Press, 1993).
Krugman, Paul, "Myth of the Asian Miracle," Foreign Affairs, 73, November/
December 1994, pp. 62-78.
Lardy, Nicholas R., China in the World Econorny (Washington, D.C.: Institute ofInternational Economics, 1994).
OECD, Jnternational Direct Investment Statistics Yearbooh 1996 (Paris: OECD,
1996).

Petri, Peter A. and Michael G. Plummer, "The Determinants of U.S. Direct
Investment Abroad: Evidence of Trade-Investment Links," Brandeis University

Worhing Paper, February 1996).
Plummer, Michael G., and Shigeyuki Abe, "The New Aid Crisis: An Analytical
Assessment," paper presented at the Japanese APEC Consortium Conference,
Nagoya, October 1996.
World Bank, VVorld Tables (Baltimore: Johns Hopkins University Press, 1995).
World Bank, East Asian Miracle (Washington, D.C.: World Bank, 1993).
This is Yomiuri, September, 1996.

KOBE ECONOMIC & BUSINESS REVIEVV, 41 (1996), 25-39

RECONSIDERATION OF AVERCHny-JOHNSON ARGUMENT'SEIICHI KATAYAMA Kobe University
FUMIO ABE Kagawa University

Abstract
The purpose of this paper is to reconsider the essence of Averch-Johnson (A-J)

argument. We show that the critical points in the argument are firstly how tochoose variable adjusting to the regulatory constraint, and how the level ofregulation is assigned. If the so-called A-J effect of overcapitalization is an

essence of the regulatory constraint argument, a simple one factor model isenough to show it in a static model. However in a simple dynamic model,
overcapitalization is not necessarily true with some form of adjustment method.
JEL elassification: D42; L51

Keywords: Rate of return regulation; Averch-Johnson effect; Overcapitalization'

1. Introduction

In general, the imposition of an artificial constraint on an economic

decision process will result in no improvement in outcome andsometimes will induce worse situation. In this respect, Averch andJohnson (A-J) seminal work (1962) explored this issue. A regulatory
constraint on the rate of return for profit maximizing monopolist may
be expected to lead inefficient allocation.

Following the original A-J model, a number of literature explore
the behavior of the firm under the fair rate of return constraint andexamine the results. Among a number of propositions, the main result
is that the profit maximizing fjrm under the rate of return regulation
will tend to use a capital-labor ratio greater than which minimizes cost
Corresponding Address:
Seiichi Katayama
Research Institute for Economics and Business Administration, Kobe University

2-1 Rokkodai-cho, Nada-ku, Kobe 657, Japan
E-mail: katayama@rieb.kobe-u,ac.jp
Fax: (81)-78-803-0402

26 KOBE ECONOMIC &BUSINESS REVIEW, 41 (1996), 25-39'

for its output level.i Specifically if the fair rate of return is greaterthan the cost of capital, a firm will have an incentive to invest as muchas it can be consistent with its production possjbilities. Hence if theessence of A-J argument is understood that an artificial constraint
may reduce efficiency in production, we need not argue a capital-laborratio, and simply be sufficient to show that the firm wM find it
profitable to employ more capital and invest as much as it can beconsistent with its production possibilities. Therefore, a simple one
factor capital model is enough to it. This is the first purpose of thispaper.
As far as we stick to one factor model to argue the essence of A-J

argument, entirely different issue will arise when we turn to the
dynamic case. In a static model, factor choice subject to the regulatory

constraint seems to be made at one stage because the long-run
equilibrium is under consideration. And hereafter, there is no further

adjustment. On the other hand, the regulatory constraint has to besatisfied at every instant of time in the dynamic adjustment process. As

we have already shown (Katayama and Abe 1989, 1992), the choicevariables for the firm to satisfy the regulatory constraint become one
crucial point. In the dynamic setting, the strategic variable is not theamount of capital but the amount of investment to satisfy the rate of
return to capital constraint even in a single factor model. Therefore, weneed some way of adjustment for choice variables to follow theregulatory constrai.nt, especially when it is binding. Even in a simple
form of one factor model, other variable than capital must be chosen
as an instrument. This point is entirely different aspect in a dynamic

model. And even if the adjustment variable is properly chosen,
overcapitalization is not necessarily true in a dynamic model as statedin El-Hodiri and Takayama(1981). We show that the level of the fairrate of return is a significant parameter for the existence ofovercapitalization.

In section 2, A-J argument of the regulatory process in a static
model is explored. Section 3 is devoted to the dynamic model. The
analysis is made in Section 4. The final remarks are in Section 5.

1 See Baumol and Klevorick (1970). They examine carefully other propositions.

KA TA YA MA A IVD A BE: RECONSIDERA TIOrvT OF A VER CH-JOHwsOrv' ARG UMENT 27

2. Simple static Model

Suppose there exists a single product, single factor which isassumed capital, and profit maximizing monopolist subject to the rateof return regulation. The firm's revenue function R(K) is strictly
concave and R(O)==O. The fair rate of return s is taken to be as great
as the cost of capital r (s>r). Then the profit maximizing firm subject
to the constraint become the following.

K

Maximize [R(K) - rK] (1)subieet tosK-R(K)2O. (2)From the necessary condition we getdR A
R'(K)=r- (s-r) (3)dK 1- Z
with the effectivenness of the constraint (2) and the concavity of therevenue function, we get O< Z<1. Consequently R'(K)<r. The marginal

revenue product of capital becomes smaller than the cost of capital.
This shows that the firm uses more capital than the level of efficient
produetion.

3. A Dynamic Model
The optimal investment model with adjustment costs is formulated
as follows:2

Maximize s `,n {R[Q(t)] - c[(t)]}e-'tdt (4)Q(t),ICt)
subject toR[Q(t)]-P[Q(t)]Q(t), (5)K(t) -I(t) - 6K(t), K(O) - K, (> O), (6)Q(t)SF[K(t)], (7)2 For more general model, see EI-Hodiri and Takayama (1981) and Katayama andAbe (1989),

28 KOBE ECONOMIC &BUSINESS REVIEW, 41 (1996), 25-39

sK(t)-R[Q(t)]IO. (8)Here a single input capital K(t)ZO is assumed and F(K) is the
production function where it is assumed that F'(K)>O and F"(K)<O. Q
denotes the amount of output which is a control variable and P(Q) is
the inverse demand function which is assumed P'<Q)<0. I is the level ofgross investment. C(I) denotes the totalAcost of investment including
adjustment costs. It is assumed that C'(I))O, C"(I)>O and C(O)==O.

6 is the rate of depreciation and is assumed positive. Further we
simply assume that the revenue function R[F(K)] is strictly concavewith respect to K when the constraint (7) is binding.3

As we stated at the introduction, we have to notice the regulatory

constraint (8). In the formalized model, control variables are theamount of output and investment. At the time of decision, K is given
and so F(K) is technically feasible. However to satisfy the regulatory
constraint (8), the output level Q is the choice variable. This amount Q

should be understood as amount of sales. Therefore to control
variables so as to satisfy the constraint when binding, the sales amountof output level is only feasible choice variable for adjustment to theconstraint. Thus in this specification, we allow for inefficient
production which is formalized in (7).

Another point to be noticed is the definition of the Averch-Johnson
effect in dynamic model. Following Peterson and vander Weide (1976)

and El-Hodiri and Takayama (1981), among others, the A-J effect isdefined to be the larger optimal capital stock for a regulated firm thanan unregulated one. This definition is the direct extension of that in thestatic setting. There is no literature which discusses the A-cJ effect interms of capital-labor ratio in the dynamic setting.

Next we turn to the analysis of the dynamic model.

4. The Analysis of the Dynamic Model
If there exists an optimal solution in the problem, the necessary
conditions for optimality are derived as follows.4 The Lagrangian W is
3 Nonconcave revenue function caused by the increasing returns to scale
production is assumed and analyzed in Katayama and Abe (1992).

4 It is obvious, for example, by applying Lemma (iv) in Takayama (1985, p.648)
that the constraint qualification in this model is satisfied if R'(Q)IO when theconstraint (8) is binding.

KA TA YA MA AIVD ABE: RECONSJDERA TION OF A VER CH-JOHNSON ARG UMENT 29

defined as

W-= R( Q)-C( I) +q(I- 6K) + e[F(K) -Q] + p[sK-R(Q)]. ( 9 )Assuming an interior solution, there exist functions q(t), e(t) and p(t)which satisfy

K(t)-I(t)-6K(t), K(O)-=Ke (>O), (6)Q(t)-(r+ 6)q(t)-p(t)s- eF'(K), (10)(1-p)R '( Q)- e-O, (11)q=C'(I), (12)e(t)IO, e(t)[F(K)-Q]-O, F(K))Q, (13)"(t))O, pt(t)[sK-R(Q)]-0, sK-R(Q))O. (14)The following transversality condition is assumed:

lim e"`q(t)20, lim e"`q(t)K(t)=O. (T)t.oe t-oe
In the above q(t) is a costate variable, and e(t) and p(t) are themultipliers associated with the inequality constraints (7) and (8)re'spectively. 'The constraints <7) and (8) do not contain a control variable I(t) inthe model. In such case we have to take account of the possibility thatthe costate variable q(t) jumps at the junction points between
unregulated and regulated intervals. However we assume away thepossibility for simplicity.5

Then, from al), (13) and (1aj, there are three possible cases withrespect to the signs of e and pt:(a) e=R'(Q)>0 and "=O,(b) e>O and O<p<1,(c) e=0 and pa ==1.
It is obvious that one of the above three cases is observed at eachpoint of time along an optimal path. Let us examine each case in turn.

Case (a). e>O and u=O.
5 See for detail Katayama and Abe (1989,1992).

30

KOBE ECONOMIC & BUSINESS REVIEW, 41 (J996), 25-39

In this case the regulatory constraint (8) is not binding and theoutput constraint (7) is effective. Therefore the optimal path mustsatisfy the fol}owing equations:6

KO(t)-rv(t)-6Ke(t), KO(O)-KO(>O), (15)ije(t)-(r+ 6)qe(t).R '( QO)F'(Ke), (16)qO-C'(rv),(17)
QO-F(KD). (18)This case is the usual monopoly with no regulation.
Fig.1 depicts the phase diagram in the (K-q) p}ane. It is well known

that the long-run equilibrium EO is a saddle point and the optimal
unregulated path is shown as two stable branches converging to EO inthis infinite horizon case. This will be compared with the optimal
regulated path.

Case (b). e>0 and 0<pt<1.

q

k-o

Ee

R,(ie[o)

r+ 6

:
:
:
:
:

l
:
l

i, q=oI:
1

Ka
Fig. 1 Optimal unregulated path
6

The superscript "(") on variables and functions denote paths where the regulatory
constraint is binding (not binding).

KA TA YA MA A ND ABE: RECONSJDERA TIOiV OF A VER CH-JOHNSON ARG Uil(ENT 31

Two constraints, (7) and (8), are effective in this case. Therefore,
it holds that

Q==F(K) and sK-R(Q)-O. (19)See Fig.2 where average rate of return is depicted. In Fig.2, K

corresponds to the situation satisfying these two equations
simultaneously for the given Ievel of s. For the given level of s, we candefine the set of points:

V-{(K;s): Q-F(K), sK-R(Q)-O}. (20)Thus it holds thats R(K)

r+6=(r+ 6)K. (21)The left hand side of (21) indicates a horizontal line at q==s/(r+6) and the right hand side is obtained by multiplying the average rateof returns on capital by 1/(r+ 6). Here we obtain the switching curve
q=R(K)/(r+ 6)K Notice that the switching curve loeates above the
Q=O locus, i.e., q=R'(Q)F'(K)/(r+ 6), because of the strict concavityof the revenue function.7 (See Fig.3). The range of capital stock, [O, K],is called the regulated region of the capital stock.

Case (c). e=O and "=1.
This is the case where the capital stock is in the regulated region[O, K]. The optimal level of output is not determined by Q=F(K) but

sK-R(Q)=:O. Hence the optimal path is described by the following
equatlons:

K'(t) -I' (t)- 6K' (t), (22)q'(t) -= (r+ 6)q'(t)-s, (23)qt(t) ::= C'(I* ), (24)sK'-R(Q')-O. (25)

7 For more detailed explanation, see Katayama and Abe (1989,1992).

32

41 (1996),
KOBE ECOIVOMIC & BUSINESS REVIEUX,

25-39

R(K)

K

s

o

:
]
:
:
:
:
;
:
:
:
:

K

t

k(s)
'
Fig. 2 Average rate of return

q

k-o

Si

r+6

S2
r+ 6

o

[
l
i
]
:Eo
l
TLL-- -+L="+"'"T"TrLL-ll-r----'
l il

]l
ll
il
:I
II
:l
11
I:
II

:
:
:
:
:
:
:
:
:
:
:

Ki

KO K,

Fig. 3

Switching curve

switching

curve

q=o

K

KA TA YA MA AND A BE: RECONSIDERA TION OF A VER CH-JOHNSOiV ARG UMEiVT 33

This system has a unique steady state of capital ,llr* which is asaddle point. Then if this case occurs throughout the whole planning

period or for the final period, the optimal path goes along thehorizontal line q==s/(r+ 6), since only such paths can satisfy thetransversality condition (T). Furthermore it should be noted that thesteady state of capital R' decreases as the regulated rate of return s
decreases, in other words, regulatory policy turns to stricter. As will

be stated below, this is an important point when considering thepossibility of the A-J effect of overcapitalization.

Next we turn to the analysis of the possible patterns of the optimal
path. We have to notice that there are the following four ranges of s,which enable to clarify the relationship among ,RrO, k' and k:

S,- {s:k*sko<k} ,s,-- {s:kO<k*sk} ,s,=- {s:Ro<k<k'} ,s,- {s:kske<k*} .
'As shown below, the relationship among kO, k' and k is crucial to,determinethe possible patterns of the optimal path and so the A-J
argument. Si'(i=1,"',4) is illustrated on q-axis in Fig.4, where Si'= {s/(r+ 6):s Eil Si}(i=1,"',4). It is noticed that for sESi, sS-RK(kO), i.e., thevalue of s is not larger than the marginal revenue product of capital
evaluated at the unregulated long-run equilibrium point ew. For sESi
(i=2,3,4), s)R.(kO).
Case 1. sES, (k'$ilre<ili )See Fig.5. In this case, the q=O locus is shown as follows.

sq== .+6 for K<kq =,+ 6 [ pt S+(1- pt )R'(Q)F'(K)] O< pt <1 for K-K

41 (1996), 25-39
KOBE ECONOMIC & BUSINESS REVIEVV,

34

q

k==o

i

S'4

:

:
:
"L-U-'---""""+'--t-:
:
l
l
i
l
l
l
i
l
:
:
l
o
R

S'3
S'2

S'i

-----tT-L-J--------T rTul--1 Eo

switching

curve
qo==O

K

Fig. 4 Sets for different rate levels-- >--> optimal unregulated path

- optimal regulated pathq

N. K=O

SNs

AKN

Å~xx
-Lxx
XNXx

Å~.'Å~ EO

RK(ke)

N

r+ 6
..-s.

r+6

s
Ei1 1E XxX.
q==o

dN
:
:
:
:
:
:
:
:
:
:
:

:
:
:
:
:
:
:
:
:
:
:
1

o

R R" ii(
Fig.5 sES, (K'f.Ke<K)

xtw

NN
:
:
:
:
:
:
:
,

q==o

K

KA TA YA MA A ND ABE: RECONSJDERA TJON OF A VER CH-JOHNSON ARG th14ENT 35

R'(Q)F'(K)q== .+6 fork<K

Thus the long-run equilibrium is E' in Fig.5 which is a saddle point. We

now investigate how the optimal path is determined according to thevarious levels of the initial stock of capital Ko. If Ko$K, the optimal
path goes along the horizontal Iine q=s/(r+ 6) throughout the wholeplanning horizon and converges to E". On the other hand, if K<Ko, theoptimal path goes along one of paths satisfying (15)-(18) until it
arrives at K and hereafter goes along the horizontalline q=s/(r+ 6)
and converges to E'. In this case, because k'SRIO, it holds that K"(oo)<KO(oo). Therefore, overcapitalization in the dynamic sense does nothold and under capitalization is realized.

Case 2. sES2 (kO<k'SiZi)
In this case, the long-run equilibrium is E* where it holds that kO<k'. If Ko$]k, the optimal path goes along the horizontal line q ==s/(r+ 6) throughout the whole planning horizon and converges to E'. On
the other hand, if K<Ke, the optimal path goes along one of paths
satisfying (15)-(18) until it arrives at and hereafter goes along the line

q==s/(r+ 6) and converges to E'. As can be seen in Fig.6, this is the
only case that overcapitalization, i.e., Ke(oo)<K'(oo), is realized

because ke<k'. .
case 3. sEs, (iiro<iZr <A *)In this case, the K=:=O locus intersects the q=O locus on thevertical part of it at K=K. Therefore the equilibrium point is E" inFig.7, that is , the steady state of capital is K. The two optimal paths

converging to E' are depicted in Fig.7. Then we have kO<ki. Thus
overcapitalization occurs in this case.

Case 4. sES4 (ilskO<Ar')
See Fig.8. The steady state of capital is RO in this case. If KoSK,
the optimal path goes along one of paths satisfying (22)-(25) until it

arrives at K, and hereafter goes along the optimal unregulated pathand converges to EO. On the other hand, if K <Ko, the optimal pathgoes along the optimal unregulated path during the whole planning
period and converges to Ee. In this case the regulation works neutrally

KOBE ECONOMIC & BUSIIVESS REVIEIV, 41 (1996), 25-39

36-->-- -> optima] unregu}ated path

- optimal regulated path
q

Al x.

k=o

sx
-X-s

s/(r+ 6)

K

Ei

Å~1[
EO1txx/g
1{s
1;1
1:s
ld11
dd
:L
IL
)L
l/
11
/1
1;
11
ld
11
dl
IL
IF
pr
Ll
p/
ld
la
/tRo kt

RK(kO)/(r+ 6)

o

x

N5K-r

x

:
:
:
:
:
:
:
:
:
:

q:=o

K

R

(ke<k'sK)

Fig. 6 sES2

- -F -> optimal unregulated path

- optimal regulated path
q

k-o
Å~

s

r+ 6
R(kn)
r+ 6

Å~
---M--TL-=X':{]?tlllX.
E't:-Å~s.x

Eo

:
:
:
:
:
:
:
:

:
:
l
:

o

:
:
:
:
:
:
:
:
:
:
:
:

Å~

Å~ K-.

Lk"K
1

Fig. 7 sES, (KO<K<K')

Å~

q=o

K

KA TA YA MA A ND ABE: RECONSJDERA TJOiV OF A VER CH-JOewSO,N ARG UMEiVT 37

to the final capital stock.

Looking over the four cases, the overcapitalization
to the case 2 and 3. This shows that the regulated raterole to the overcapitalization argument.

optimal unregulated path
optimal regulated path-- >--->
q

XN

s

ss
XN

r+ 6

case ls limited
plays a crucial

k==o

X-x
x

x

XN

X- x
R.(kn)
r+ 6

NK

Ns
Å~ :
-:-J.-.
:
i
'

I
:
l
i
:
l
l
:
l
l

Eo
:
:
:
,
:
:
:
:
:
:
:
:
:

q =o

O-K
e

K Ko
Fig.s sEs, (ksko<k.)
5. Remarks

As a final remarks, we state a few points on this simple model andthe results.

R-1. We can see that if the A-J effect is simply understood as
unintended policy consequence in the form of overcapitalization, one
factor model is enough to show it. However, in the dynamic analysis,

the regulatory constraint and the choice variables to satisfy theconstraint, when binding, become important. And in the dynamic modelwith adjustment costs attributable to time, the A-J result holds under
special conditions.

R-2. In the static model, it is proved that the closer the "fair rateof return" is to the true cost of capital, the greater the quantity ofKOBE ECONOMIC & BUSINESS REVIEYV, 41 (1996), 25-39

38

capital the firm will want to use. However, this statement need not holdin the dynamic case. We will explain about this in the following. If we
could interpret the marginal revenue product of capital evaluated atunregulated stationary point RK(jiZrO) to be a suitable capital cost in theinfinite horizon model, we have to compare it with the level of regulated
rate. If s$RK(iire), shadow price of capital q(t) become smaller, and as

the result the terminal capital stock becomes less than the unregulatedcase. The result is undercapitalization seen in Case 1. Even in such caseas 2 with overcapitalization, when the regulated rate s is set closer toRK(kO), the terminal quantity of capital stock decreases. This is the

opposite to the static case. This will happen as the result that theregulatory level reduces the implicit price of capital.

R-3. As can be seen in the above analysis, we could avert from thecomplieated indeterminacy in employment probtem in this one factor
model.8* Acknowledgment
The paper was presented at the seminars in Tezukayama University

and Kobe University. We are grateful to the comments by theparticipants, especially S. Ishizawa.

References
Averch, H. and L.L. Johnson, 1962, Behavior of the firm under regulatory constraint,
Arnerican Econornic Review 52, 1052-1069.
Baumol, W.J. and A.K. Klevorick, 1970, Input• choices and rate of return regulation: an overview of discussion, Bell Journal of Economics and Management
Science 1 (2), l82-90.

Dechert, W.D., 1984, Has the Averch-Johnson effect been theoretically justified ?
Journal of Econornic Dynamics and Control 8, 1-17.
El-Hodiri, M. and A. Takayama, 1981, Dynamic behavior of the firm with adjustment
costs under regulatory constraint, Journal of Economic Dynarnics and Control

3, 29-41.
Katayama, S. and F. Abe, 1989, Optimal investment policy of the regulated Firm,
Journal of Economic Dynamics and Control 13, pp 535-552.
Katayama, S. and F. Abe, 1992, Investment and Regulation: Increasing Returns to
Scale and Adjustment Cost Clause , in G.Feichtinger ed. Dynamic Econornics

8 For more detailed discussion, see Katayama and Abe (1989).

KA TA YA MA A IVD A BE: RECOiVSJDERA TJON OF A VER CH-JOHNSON ARG ew14E,VT 39

and Optimal Control, North Holland, pp 125-134.
Peterson, D.W. and J.H. vander Weide, 1976, A note on the optimal investment policyof the regulated firm, Atlantic Economic Journal 4, 51-56.

KOBE ECOIVOMIC & BUSINESS REVIEW, 41 (1996), 41-68

SUPPLIER RELATIONS IN JAPAN:

AN INTERNATIONAL PERSPECTIVE

KENJI KOJIMA' Kobe University

AbstraetThis paper describes major characteristics of Japanese supplier relations in aninternational perspective. The supplier relations in Japan, particularly automobile

industry, is examined in comparison with those in the United States. The primary

purpose of the study is to identify significant features of Japanese supplier
relations and to provide economic rationale for those relationships. In addition,comparing suppliers relations in Japan and the U.S., convergence in the nature ofthose are discussed. Significant features of Japanese supplier relations are

identified: long-term relationships and commitments with effective
communication; forced competition among few suppliers; willingness to maketransaction-specific investments in plant, equipment, and human capital as well as

to share technical information; significant involvement of suppliers in productdevelopment with sharing of information. Suppliers relations in the U.S. arechanging and moving close to the Japanese counterpart. There has been a limited,

yet noticeable, convergence in the nature of the U.S. and Japanese supplier
relations.

<JEL classification: L14; L62

Kaywords: Long-term relationships; Procurement; Supplier relationships;
Transaction relationships; Transaction-specific investments

1. Introduction

Supplier relations are important areas for any firm that
subcontracts portions of components design and production because
Corresponding Address:
Kenji Kojima
Research Institute for Economics and Business Administration, Kobe University
2-1 Rokkodai-cho, Nada-ku, Kobe 657, Japan
E-mail: kojima@rieb.kobe-u.ac.jp
Fax: (81)-78-861-6434

42

KOBE ECONOMIC & BUSINESS REVIEW, 41 (1996), 41-68

this creates the dependence on the technology and operations ofsuppliers. There are significant differences in supplier relations between

Japan and the United States. According to the literature, U.S.
automakers are more vertically integrated than their Japanesecounterparts. Even though U.S. automakers are more verticallyintegrated, they contract directly with more than one thousand
suppliers for the parts they do not make. The Japanese automakers, bycontrast, work with approximately one-tenth that number, buying moreentire subsystems from each supplier. Product development process isheavily influenced by the traditional system in which suppliers produce
parts under short-term, arm's-length contracts and have little role indesign and engineering. In supplier relations in Japan, in contrast,

suppliers are an integral part of the product development andmanufacturing processes: they are heavily involved, assume significant
responsibility, and communicate extensively and directly with productand process engineers. Japanese suppliers frequently play a significant
role in development. 'By vertically integrating, companies get all of the benefits of fewer
direct suppliers and customized investments. But vertical integration
removes the supplier from the discipline of the market and essentiallyeliminates competition because the supplier has a captive customer
base. The autonomy and incentives that keep the company efficient andfocused on continuous improvement are weak. One needs to employ
mechanisms so that suppliers continue to be efficient and innovative.
Supplier relations in Japan can be identified that both buyers andsuppliers have recognized the need to be interdependent and have
responded by developing bonding mechanisms that build trust and goal
congruence between them. The Japanese do not rely on legal contracts
to protect their interests in exchange relationships. The important issue

is understanding why Japanese companies can use such a flexible
arrangement.
Supplier relations in Japan can be identified to have distinctive
characteristics in several aspects compared with the U.S. counterpart.

It is important to understand how efficiently Japanese supplier
relations work, and whether the Japanese practice is unique to thepeculiar circumstances of the Japanese social and cultural system or
1 Cusumano and Takeishi (1995) review the literature in empirical studies on
supplier relations in Japan and the U.S.

KOJJMA .• SUPPLIER RELA TIOIVS IN JAPAN 43

whether it can be applied in other countries. Furthermore, it is also
important to understand the economic rationale of supplier relations inJapan. Yet many aspects are still left unknown about the process that

unfolds between buyers and suppliers in Japan or the U.S. How
prevalent is the Japanese practice of subcontracting across the supply

base in Japan and the U.S.?
This paper describes major characteristics of Japanese supplier
relations in an international perspective. The supplier relations inJapan, particularly automobile industry, is examined in comparison
with those in the U.S. The primary purpose of the study is to identify
significant features of Japanese supplier relations and to provide
economic rationale for those relationships. In addition, comparing
suppliers relations in Japan and the U.S., convergence in the nature ofthose are discussed.
In this paper, significant features of Japanese supplier relations
are identified as follows: long-term relationships and commitments withfrequent planned communication, which reduced transaction costs andeliminated inefficiencies between buyers and suppliers; trust-building

practices like owning stock, transferring employees, having guest
engineers, and using flexible legal contracts that create a high degreeof goal congruence and mutual trust; forced competition among few
suppliers focusing on costs, quality, and technological development;
willingness to make significant transaction-specific investments in plant,

equipment, and human capital as well as to share valuable technicalinformation; significant involvement of suppliers in productdevelopment with intensive and regular sharing of technical and cost
information to improve performance and set prices.
Suppliers relations in the U.S. are changing rapidly and are moving
close to the those in Japan. There has been a limited, yet noticeable,
convergence in the nature of U.S. and Japanese supplier relations. In
the U.S., suppliers are significantly more likely than they were in 1980s

to provide detailed information to their customers, have long-term
contracts, believe that their customers are serious about productquality, and have defect-prevention systems in place. This results
indicate progress toward collaborative relationships, in which suppliers

play an important role in solving problems and developing ideas about
products and processes.

This paper is organized as follows. Major characteristics of44

KOBE ECONOMIC & BUSINESS REVIEW 41, (1996), 41-68

Japanese suppliers relations are discussed in order. The next section
presents transaction relationships with few direct suppliers. Section 3

discusses forced eompetition among limited suppliers. Section 4
describes transaction-specific investments. Section 5 discusses supplierinvolvement in product development. Section 6 discusses the convergencein the nature of supplier relations in Japan and the U.S. Finally,
concluding remarks are presented.
2. Fewer Direet Suppliers

2.1 Long-term Commitments
U.S. automakers are more vertically integrated than their Japanesecounterparts. Even though U.S. automakers are more verticallyintegrated, they contract directly with 1,500 to 3,OOO parts suppliers forthe parts they do not make. Toyota, by contrast, works withapproximately one-tenth that number, buying more entire subsystems
from each supplier. Reducing the total number of direct suppliers canlower costs while increasing quality. Using fewer suppliers can create
value by providing economies of scale and benefits of experience curvethat lower either transaction costs or production costs. Transaction
costs, as defined here, are all the costs associated with effecting an
exchange, that is, information gathering and anaiysis, negotiation,
contacting, physical distribution costs, and so on.

Within most industries, as cumulative production experience inprodueing a product or service increases, quality is improved and costs

are reduced. Japanese automakers have consolidated their businesswith a few highly efficient suppliers and created conditions that permit

the suppliers to make the investments necessary to accelerate down theexperience curve and to share the full advantage of this volume withthe automakers. When a Japanese supplier wins a contract with Toyota
or Nissan, it is essentially guaranteed four years of business or the lifeof the model. Moreover, if the supplier performs up to expectations, it

can usually renew the business for the next model as well. Naturally,
these practices encourage long-term plans and investments. Supplierinvest in developing ideas and plans for the next model well in advance.
Engineers from the limited suppliers have long-term experience working
together, making it easier to rapidly develop designs for the next
model. When the model change occurs, suppliers continue to move down

KOJiMA:SUPPLJER RELATJONS IN JAPAIV 45
the experience curve (Dyer and Ouchi, 1993).

In contrast, U.S. automobile manufacturers have attempted to keep

input prices low by maintaining size and bargaining power oversuppliers. By splitting their business among many suppliers androtating them frequently, U.S. manufactures have repeatedly destroyed
the experience curves of suppliers by ensuring that no one supplier
could accelerate down the experience curve to accumulate decisive costadvantage. Thus, the U.S. suppliers typically do not develop long-term
relationships and experiences with automakers. Moreover, they areunable to effectively plan long-term production and investments, whichis reflected in lower average plant capacity utilization. Without longterm commitments, U.S. suppliers can not have incentives enough tomake long-term investments in capital equipment, Moreover, without
the ability to make long-term forecasts, it is very difficult to makemaximum use of capacity and eapital equipment. For example,
manufacturers may involve suppliers to a greater degree in the productdesign process to utilize fully the value of present tools and equipment.
In this way, the risk of tool obsolescence due to unilateral designchanges is lowered. Naturally, the longer the parties work together
under these circumstances the more likely it is for mutual trust to be
developed. Trust in this case comes from reliability demonstrated overrepeated interactions, as well as the shared knowledge that the parties

need one another.
2.2 Building Trust

The Japanese companies have recognized the need to beinterdependent and have responded by developing bonding mechanismsthat build trust and goal congruence between them. The Japanese do
not rely on legal contracts to protect their interests in exchange
relationships. The key issue is understanding why Japanese companies
can use such a flexible agreement.

The practice of long-term employment within one firm is importantin developing trust among individuals both within the firm as well as
across firms. There is real personal contract between the purchasing

managers of manufactures and the managers or owner of a
subcontracting firm. Because people can develop long-term
reiationships with their counterparts at the supplier or buyer, it is not

surprising that the Japanese have developed significantly greater trust

KOBE ECONOMIC & BUSINESS REVIEW, 41 (1996), 41-68

46

across firms.

The way that Japanese firms build trust is by requiring career

paths in which employees transfer from firm to firm. Employeetransfers, both temporary and permanent, are common among business

partners, particularly between large manufacturers and theirsubcontractors. In addition to permanent and temporary employee
exchanges, suppliers often send guest engineers to work at theircustomer technical centers on an ongoing basis. Supplier andautomaker engineers work jointly designing the components for a new
car model. Not only do these career-path help build trust between
firms, but also transferred and guest employees are better able tounderstand how to enhance the efficiency of the development andproduction processes because they know both buyer and supplier
operations. Direct contact is much more important than other forms ofcontact in developing ways for employees to know and trust eachother. Both of automakers and suppliers encourage a considerable
amount of face-to-face contact between supplier salespeople andengineers and between automaker purchasing agents and supplier.
engmeers.

Companies need credible commitments if they are going to bewilling to make customized investments. Stock ownership in Japanesetrading relationships represents commitments that firms have made toeach other, and in many ways, it is an arrangement that is akin to an
exchange of hostages. Nissan owns significant portions of shares of its

major suppliers. This ownership stake build trust and goal congruence

between Nissan and its suppliers. Interlocking stock ownershiprepresents a commitment to the supplier that needs an ineentive to
make the customized investment Nissan requires.
'
2.3 Supplier-assistanee Management
Toyota and Nissan have large supplier-assistance management
consulting groups with specialized expertise that work full time with
suppliers to help them improve their production techniques and achieve
total quality, cost, and delivery. Providing assistance to suppliers is ahighly effective method for both helping and forcing suppliers tocontinuously innovate and improve to stay ahead of the competition.
Suppliers often feel indebted or obligated to the parent company,
but they also have mixed feelings about the system. On the one hand,KOJIMA:SUPPLIER RELATIONS IN JAPANthey sometimes feel that sharing the business with another supplier isinappropriate when they are clearly ahead in both cost and quality.

Moreover, they have to share not only the business but also
information or technology in order to help their competitor improve.
On the other hand, since they realize that someday they may need suchassistance, they view the system as insurance. Toyota suppliers rarely

go bankrupt because they receive helps from Toyota if they are in
financial distress. Only suppliers that are unwilling or unable toimprove continuously are cut off completely, and suppliers will doalmost anything to avoid such damage to their reputations.
2.4 Suppliers' Mutual Learning
Sako (1995) shows evidence that the suppliers' association continue
to exist in Japan not merely out of inertia but because it is serving a

useful function in delivering benefits to both the automaker andmember supplier. Contrary to the bilateral contracting view, suppliers
value mutual learning from other suppliers just as much as learningfrom their buyers, and that the majority of first-tier suppliers do notconsider suppliers' associations to be of less use now that in the past.
There is a considerable variation from association to association withrespect to the size of membership, the proportion of members in the
total supplier base, and turnover of members over time. However, as acommon characteristic, association membership is much broader thanthe boundary of keiretsu groupings, particularly in recent decades
when independent suppliers which stand outside the keiretsu have been
taking up membership in multiple associations.
Tohai Kyohohai has three sectors grouped according to the type ofparts that members produce. Each group meets once a month, typicallyto visit a member supplier's factory, and to learn from the member's
presentation about problems and achievements at his company in thefollowing month. The automakers except Honda which have anassociation continue to retain much control over the activities of theassociation. Although less common today, many of the associations
required the automaker's recommendation as well as the approval of
the association's administrative board to become members.
Whether leading or advisory, providing support for the suppliers'
association is expensive in managerial time, judging from the frequencyof meetings. Weighed against this cost are the frequently cited benefits

47

48

KOBE ECONOMIC & BUSINESS REVIEVV, 41 (1996), 41-68

of being able to communicate about production plans, and of soliciting

good suggestions for common problems, such as parts standardizationand pollution control. The most popular benefits of belonging to an
association is better informational access to the buyer. Next, learningfrom other members through exchange of technical information isconsidered the second most important benefit, and more important
than the receipt of technical assistance from the buyer. Many members
apparently regard fellow member suppliers as a more important sourceof technical know-how than their buyer. The type of buyer information

which is valued by members appears to be about design anddevelopment for the next model, rather than, for instance, about thecertainty of production scheduling.2
3. Forced Competition
3.1 Multiple Sourcing
Supplier relations require investments in transaction-specific assets.
Even if these investments are entirely contractible, it may be difficult tospecify ex ante precisely how the assets will be employed in production.
One transaction-specific assets are in place, the characteristics of thetransaction and the gain from trade will be determined by ex post
bargaining between the buyer and the supplier. A safeguard for thebuyer is contract with more than one potential supplier to invest in thetransaction-specific assets required for production. Then, after
production requirements become clear, the buyer can arrange acompetition between these suppliers for the right to produce.
The buyer chooses between sole and second sourcing. Under secondsourcing, the buyer contracts for fully redundant capacity, awarding acontract for full production requirements to the more efficient firm.
The choice between sole and second sourcing depends on information
rents, which reflect the costs of inducting supplier's private information

to the buyer under the situation where the supplier has private
information on production. Procurement cost of buyer consists of threecomponents of cost: cost of physical production; the cost of efforts inimproving efficiency; and cost of inducing supplier's private
information on production. The benefit of the second sourcing is that
2 These evidences can be supported by the survey conducted by Fair Trade
Commission in Japan (1993).

KOJIMA: SUPPLIER RELATIONS IIV JAPAN

49

procurement cost are lower when that source is more efficient inproduction. The cost of inducing supplier's private information is lessunder second sourcing, showing a benefit of competition among thetwo. Under asymmetric information, saving in production cost from anadditional supplier is greater than benefit of the economy of scale inproduction of a single supplier, This is because the buyer can harness

greater competition to reduce the information rents paid to suppliers(Riordan, 1996).

Cusmano and Takeishi (1991) survey purchasing agents andproduct planners of the largest Japanese automakers, US automakers,

and the U.S. operations of Japanese automakers. They find solesourcing is not uncommon among the U.S. compan•ies, nor is multiple
sourcing uncommon among Japanese companies, though on average theJapanese use fewer suppliers per part. They also find that suppliers to

U.S. firms play a large role from an apparently early stage indevelopment, though Japanese suppliers still play a greater role indesign.

Japanese firms usually employ a multiple sourcing policy to force
suppliers into intense competition, even though they forgo economies ofscale. Japanese automakers are less likely to rely on one supplier than
U.S. automakers are. They maintain competition so that one supplier's
ability to generate cost or quality improvements provides an incentive
for the other supplier to keep up. The intense competition often begins
at the design stage when the automaker invites guest engineers fromthe two suppliers to work at the automaker's teehnical center as partof the design team. The competitor engineers work in the same room
during the initial design development. The automaker meets with eachseparately to review proprietary ideas and designs and eventually
decides which supplier has a superior product design and cost, thus
becoming the major supplier for the model. The losing supplier may
become a secondary supplier for that model or may simply have an
opportunity to develop a design for a different modeJ.

There is competitive bidding to select the supplier, though it isusually limited to a few qualified suppliers in the existing group of
suppliers. Prices are negotiated prior to production and there isconsiderable rigidity in adjusting for subsequent supplier cost
increases. This commitment to the price also serves to reward the
supplier for investments and innovations that result in eost reduction.

50

KOBE ECONOMIC & BUSINESS REVIEW, 41 (1996), 41-68

3.2 Two Basic Types of Suppliers
A supplier typically has contracts with an automaker both for ivariety of components in a single model and for similar components b

different models. There are usually several companies within th,
automaker's supplier group qualified to manufacture a component. Th,

other qualified suppliers may be currently producing simila]components for other modeis. Within an assembler's hierarchica
structure of suppliers, there are two basic types - design approve((DA) and design supplied (DS). DA suppliers provide both design an(
production services to the automaker's specifications while DS supplierf

produce a component from drawings provided by the automaker. Th(

DA suppliers are usually those with the close and long-terrr
relationships with the automaker. First-tier and the DA suppliers hav(a greater number and more profitable contracts with the automaker
The automaker usually has Iess detailed knowledge of the DA supplier'E

production costs which give the supplier an advantage in pricE
negotiation. There are many thousands of suppliers in the automaker'E
supplier hierarchy and only a few hundred at the first-tier.
The typical production cycle for a car model begins with a length>
design and development stage followed by a 4-year production stage
The automaker usually invites several qualified firms in the supplieigroup to compete for a contract to design and produce a componenl
for a new model cycle. A DA supplier will undertake the design anC
development as well as tooling for production with no guarantee olreimbursement by the automaker. For DS supplier, the automaker wil,guarantee reimbursement for specific investments such as tolling,
Whether DA or DS, the automaker makes a firm commitment to usE
the supplier for the 4-years production life of the model.

3.3 Supplier Competition for Design and Manufacturing

Recent evidence suggests that although the Japanese companies
encourage their suppliers to make customized investments, they usc
forced competition with one or two competitors to make sure that their
suppliers are discipl}ned by the ever-present threat of competition. This

competition often begins at the design stage when the automakerinvites guest engineers from two suppliers to work at the automaker's

technical center as part of the design team. As the design work
proceeds, the automaker meets with each supplier separately to review

KOJIMA:SUPPLIER RELATIONS IN JAPAN

proprietary ideas and eventually decides which supplier has superior
product design. Liker, et al. (1996) shows that Japanese suppliers faceless competition in the design and manufacturing stage than U.S.
suppliers, though Japanese suppliers do face considerable competition -about two competitors for a given design and manufacturing contract3
on average.

The buyer can strengthen the incentives for cost or quality
improvements by making the price paid to each supplier dependent on
relative performance. The second-place supplier loses out on additional
business and the bonus for good performance. However, the buyer does
not abandon a weak supplier, but works with it to help it compete withthe strong suppliers. The forced competition among the limited
suppliers can be explained with the theory of principal-agent. The
theory focuses on how a principal may compensate an agent for works
delegated. The theory deals with the design of optimal compensation
scheme in order to motivate an agent to work efficiently under thesituation where an agent's action is not observed perfectly. According
to the literature in the use of contests to compensate multiple agents,

contests among the suppliers can work as a mean for providing
incentive to suppliers.4 The contest serves to make the supplier's reward

dependent on his rivals' efforts as well as his own, while the reward
are actually independent of the supplier's cost. It can be shown that
contests outperform individual-agent-incentive schemes in solving the
problem in unobservable efforts when suppliers face some degree ofcommon production uncertainty in addition to their own uncertainty.
Thus, the buyer as a principal, can increase incentive of supplier, as anagent for enhancing efficiency of production through multiple suppliers.
4. Transaction-specific Investments

4.1 Dedieated and Asset-speeific Investments
Buyer-supplier relationships in Japan are characterized long-term
3 Liker, et al (1996) examines supplier involvement in design based on a 1993 surveyof approximately 143 Japanese and 189 U.S. automobile components suppliers. The

survey was based on mailed, self-administered questionnaires. Respondents wereasked to identify their Iargest dollar-volume automobile component or component

group. The questions were also to be answered with their largest automobile
customer.
4 The use of contests to compensate multiple agents has been examined by Greenand Stokey (1983); Lazear and Rosen (1981); Nalebuff and Stiglitz (1983).

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KOBE ECONOMIC & BUSJNESS REVIEW, 41 (1996), 41-68

and highly committed, whereas they are more likely to be governed byshort-term, arm's-length relationship in the U.S. One of the major
benefits of the Japanese supplier involvement in design is access tohighly customized design with unique features for a particular buyers'
needs.

Japanese automobile suppliers develop more unique parts for theircustomers and make greater investments in specialized assets than do
U.S. suppliers. A first-tier suppliers does not usually receive a separate

payment for the investment in tools, dies, molds, and jigs that arehighly customized and would need to be scrapped if the automaker cut
off orders to the supplier. The suppliers' specialized capital investments

make them highly dependent on the automakers, with the realpossibility of hold-up problem. However, automakers are alsosignificantly dependent on the suppliers. Most DA suppliers' parts are"black box," meaning that the automaker provides only very general
specifications while the supplier does all of the detailed functional
specifications and blueprints. Consequently, suppliers have significantly

more knowledge about the design and manufacture of the part thandoes the automaker. Because black-box parts are customized to a
specific model, the automaker is highly dependent on the supplier. If
the supplier did not perform as desired, the automaker would havedifficulty simply shifting business to another supplier, given the
product's customized nature. Some DA suppliers claim that they do notprovide the automakers with all of the specific functional details when
they submit their design drawings for approval, but intentionally leaveout certain important details such as tolerances. Because theautomaker does not know the part's exact design specifications, it isdiffieult to change suppliers, resulting in the automaker's dependence
on the supplier.5

Under these conditions, each party makes commitment with
substantial transaction-specificinvestments, which creates quasi rents
only if the both parties continue working together. If the relationship isterminated, each party loses some portion of the rent. Thus these
specialized investments create interdependence, which in turn creates
incentives to cooperate. According to transaction cost economics,
highly transaction-specific investment should be avoided by buying
5 Most automakers in Japan restrict suppliers to sale design specification to othercompanies (Fair Trade Commission in Japan, 1993).

KOJJMA: SUPPLIER RELA TIONS IN JAPAN

commodities in the market and making customized products in-house
where the hierarchy can be used to reduce transaction costs. By
contrast, Japanese automakers increasingly pushed responsibility fordesign and manufacture of more complex subsystems to a close-tiedgroup of suppliers who are willing to make significant transactionspecific investments in developing customized parts for the buyers.
Moreover, Japanese automakers seem willing to allow suppliers todevelopment capabilities to receive the long-term advantages ofcooperation. In fact, relationship-specific investment increase mutual

dependence if they are made equally by both parties. Since these
relationship-specific investments increase the exit costs for a party andreduce the potential for opportunistic behavior, parties are Iikely to be

comforted and thus may increase their commitment to each other. Thisin turn creates incentives to cooperate, and the reduction in cost andimprovements in quality that are gained through the cooperation
outweigh the risks of opportunistic behavior from the parties involved.
Liker et al. (1996) shows that suppliers have a close and long-term

relationship with their largest customer both in Japan and U.S.
automobile industry. They also suggests closer, more long-term
relationships in Japan, though these differences are not as large as

expected. It is observed that Japanese automakers have the mostdedicated relationships with subsystem suppliers and the least
dedicated with lower-tier suppliers. Japanese suppliers are considerably

more dependent on their largest customer. Equity ownership is moreprevalent in Japan. This results suggest U.S. automobile companies are
as likely as Japanese companies to out-source design, given suppliers

early information about product development, and allow them todevelop unique design capabilities the automobile company cannot
replicate.

4.2 Investments in Customized Assets
Japanese suppliers dedicated some of capita investments to theirprimary customer that these customized physical assets that could not
be re-deployed if the customer terminate to purchase from them. Clarkand Fujimoto (1991) suggested that dedicated physical assets play animportant role in the improvement of product integrity and thus in

overall product quality. It generally requires various type ofinvestments in customized assets by one or both firms in order to make

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KOBE ECOIVOMIC & BUSINESS REVIEW, 41 (1996), 41-68

the production and physical distribution more efficient. Dyer and Ouchi(1993) identify three types of customized investments employed insupplier relationship: site-specific investment; physical investments;
human capital investments.6
Site-specific investments: Site specificity refers to the situation

whereby successive production stages that are immobile in nature arelocated in close proximity to one another to improve coordination andeconomize on inventory and transportation costs. Plants are located sothat they are dedicated Iargely to a particular customer in order toimprove coordination and economize on inventory and transportation
costs. Supplier relations in Japan involves building a supplier plantwithin fifteen miles of the customer plant to reduce transportation
costs, improve delivery, and generally improve coordination. It allow
supplier engineers to work daily at customer technical centers withcustomer engineers in designing new products.
Physical investments: Manufacturing equipment such as tools, dies,molds, jigs, machinery, information system and so on is customized.
Physical specificity refers to transaction•-specific capital investments.

Physical asset specialization allows for developing unique feature of
product and may improve quality by increasing product integrity.

Human capital investments: Dedicated design to manufacturing
requires engineers to develop significant customer-specific knowledge.

Human capital specificity refers to transaction-specific know-how
accumulated by trade partners through long-term trading relationship.

Mutual human capital increases as trade partners develop
experiences working together and accumulate specialized information,
language, and know-how that allows them to communicate efficiently
and effectively. It involves transferring the buyer's executives or
employees to the supplier to work on a temporary or permanent basis,and sending consultants to work with the supplier to improve
production methods, implement just-in-time delivery systems, or assist
in solving other problems. For example, Toyota and Nissan have large

supplier-assistance management consulting groups with specialized
expertise that work full time with suppliers to help them improve theirproduction techniques and solve the problems on quality, cost, anddelivery. Providing assistance to suppliers is a highly effective method
6 Asanuma (1989) identified that transaction-specific investments are prevalent insupplier relations in Japan, and developed the notion of "relation-specific skill."KOJIMA:SUPPLIER RELATIONS IN JAPANfor both helping and forcing suppliers to continuously innovate andimprove to stay ahead of the competition. Each type of transactionspecific investment is likely to have differential effects on performance.

For example, site-specific investments economize on inventory andtransportation costs but may have little direct effects on quality, On

the other hand, investments in human capital are not likely toeconomize on inventory or transportation costs, but could have asubstantial impact on increasing quality and reducing new model cyele
time. If transaction-specifjc investments can increase quality, reduce

new model cycle times, and minimize inventory costs, then thesebenefits should translate into higher efficiency.

4.3 Relationship between Transaetion-specific Investments andPerformance
Dyer (1996) examines the relationship between inter-firm asset
speeificity and performance in the automobile industry. The survey
consists of two Japanese automakers and all three U.S. automakers
and a sample of their suppliers. The unit of analysis is the supplierautomaker relationship. Toyota and Nissan's supplier indicated thatapproximately 21 percent of their capital equipment investments were
not re-deployable, compared with 20 percent for Ford suppliers, 14
percent for GM suppliers. On virtually every assets specificity measure,Japanese automakers and their suppliers were more specialized thantheir U.S. counterparts. Moreover, with regard to site and human asset
specificity, Toyota's supplier group was more specialized than Nissan's

supplier group. More specifically, it examines the extent to which
differences in supplier-automaker asset specia}ization may explain
performance differences between Japanese automaker and the U.S. The
findings indicate a positive relationship between supplier-automakerspecialization and performance. In particular, the data suggest apositive relationship between inter-firm human capital specificity andboth quality and new model cycle time. Moreover, site specialization isfound to be positively associated with lower inventory costs. The
findings suggest that in the automobile industry a tightly integrated

production network characterized by proximity and a high level ofmutual human capital specificity will outperform a loosely integrated
production network characterized by low level of inter-firm specificity.
A firm may choose to seek efficiency advantages by creating assets

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KOBE ECONOMIC & BUSINESS REVJEVV, 41 (1996), 41-68

which are specialized in conjunction with the assets of a trading
partner. These relationship-specific assets as the vehicle through which

trading partners are able to generate relational quasi rents. Although
investments in specific assets boost productivity, the incentive to maketransaction-specific investments is tempered by the fact that the more
specialized a resource becomes, the lower its value in alternative uses.

The contingent value of a specific resource exposed its owner to agreater risk of opportunism than the owner of a generalized resources.

According to the transaction cost economics perspective, if trade

partners make transaction-specific investments, then they must
safeguard against the hazards of opportunism. Source of advantage iscontingent on the costs associated with safeguarding those investments.

Transaction-specific investments are more likely to result in highperformance when trade partners have developed safeguards which cancontrol opportunism at relatively low cost and task activities arecharacterized by a highly degree of interdependence.
It would be misleading to suggest that asset specificity is the only,or even the primary, factor that contributes to performance differencesamong automakers. Undoubtedly numerous other factors not captured
in the model contribute to performance differences. The optimal level ofinter-firm asset specificity will depend on the costs of safeguarding
specific investments. If the safeguard costs are particularly high thenthe gains from specialization may be outweighed by the costs. The factthat kanhei gaisha (affiliated suppliers) exhibit greater asset specificity

than U.S. in-house division is intriguing. Trust may be a highly effective

and low-cost means for safeguarding transaction-specific investments.
One can argue that constraints on opportunism within the Japaneseinstitutional environment allow Japanese firms to generate relational
quasi rents more effectively (Dyer, 1996).
The efficient level of specificity between trade partners is likely to

be contingent on the task activities and degree of interdependence.
Generally speaking, the greater the interdependence, the more bothparties will benefit from investments in specialized assets. The findings

suggest that when working activities are highly interdependent as they

are in the automobile industry, the Japanese automakers are more
efficient than the U.S. These transaction-specific investments create
substantial buyer and supplier switching costs and, once sunk, makethe two parties highly interdependence. This interdependent relationshipKOJIMA: SUPPLIER RELATIOIVS IN JAPAAX

can create potential contracting problems if the parties do notcompletely trust each other. Toyota's just-in-time (JIT) system are agood example of how customized investments can create value. Just-in-time system was designed to reduce complexity and costs byeliminating inventories and work in process and to ensure that there
were no redundant buffer stocks, distribution facilities, or quality
inspections. However, to implement JIT efficiently, Toyota and its
suppliers had to make customized investments in information systems,

plants, and flexibJe manufacturing systems that created mutual
dependency.'

5. Supplier Involvement in Product Development

5.1 Supplier-management in Produet Development
One of the key features of Japanese supplier management is thesubstantial involvement of suppliers in product development. Kamath
7

When both parties make transaction-specific investments, the cost to switchingpartners depends on the amount of investment. In this case, MacLead andMalcomson (1993) show that efficiency can be achieved by a contract conditioned
on sufficient external variables to ensure that re-negotiation never occur. It neednot be conditioned on the amount of investment, nor does it require breachpenalties.

Transaction-specific investments create gains from the parÅ}ies continuing totrade with each other rather than trading elsewhere. Once they have been incurred,
any bargaining or contract re-negotiation affect the division of these gains. If asa result one party captures some of the returns on the other's investment, theamount of investment undertaken will be under efficient level. To generate efficientinvestments, a contract must ensure that the investors receives the full marginal

return on investment when account is taken of any subsequent renegotiation.
Renegotiation can be represented by a bargaining with four possible outcomes forthe parties: trade with each other under the terms of the existing contract; notrade at all; commitment to trade with outside parties; or renegotiate of thecontract to trade with each other on different terms.
Specific investment are valuable for trade only with the chosen partner, nor for
trade with third parties. Thus the return on specific investments is not reflected in
the value of outside options. As a result, an investor fails to receive the marginal
return on investment not only when renegotiation results surplus sharing, but also

when it results in the investor's outside-option constraint binding. Wheneverrenegotiation occurs, whether because under the existing contracts one party
would prefer not to trade at all or because one party would prefer to trade witha third party. An investor will not receive the full rnarginal return on investment.
Thus when both parties make specific investments, efficient investment requires acontract conditioned on sufficient external variables to ensure that renegotiation
never occurs, The contract does not, however, need to be conditioned on the levelof investment themselves, nor does it require breach penalty. The escalator clauses

typically work well to condition price on outside variables in such a way thatneither party would do better from an outside option.

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KOBE ECONOMJC & BUSINESS REVIEW, 41 (1996), 41-68

and Liker (1994) studied supplier-management used in productdevelopment practiced by major Japanese automobile manufactures.
They observed closely coordinated buyer-supplier relationships inproduct development. It is widely believed that Japanese manufactures
treat virtually all their primary suppliers who deal directly with theautomobile assembler as close partners. In fact, they typically regard
only a handful as partners and assign more limited roles to the rest.
Nor do buyers and suppliers work together in free-flowing teams todevelop new products. Rather, Japanese automakers structure theirdevelopment programs tightly and use targets and prototypes to keepsuppliers in line. Managed correctly, suppliers can help their buyers
reduced lead times and manufacturing costs, and can aid the design
process as Toyota's and Nissan's suppliers do.
Japanese automakers assign suppliers different roles and give even
first-tier suppliers varying levels of responsibility for the productdevelopment. The Japanese hierarchical structure simplifies
communication between buyers and suppliers: first-tier suppliers
coordinate the activities of the second tier and so on down thehierarchy, allowing customers to focus scarce communication resourceson the top tier. Still, with 100 to 200 first-tier suppliers, an automakercannot easily work with all of them as partners in productdevelopment. Successful partnerships depend on the right balanceamong supplier's technological capabilities, a automaker's willingness

to share informatipn, and both companies' requirements. There is arange of postures that buyers and suppliers can adopt within a longterm cooperative relationship. Suppliers may play different roles fordifferent buyers. Each posture carries fundamentally different
responsibilities during product development, and the buyer-supplier
relationships vary considerably in closeness and intensity.

Partner-suppliers top the hierarchy. These selected first-tiersuppliers can also be thought of as full-service providers. Partnersuppljers are responsible for entire subsystems such as heating,ventilating and air conditioning. They often participate in planning a

new model even before the concept stage. Their understanding of theirproducts and processes are superior to those of their buyers, and theysuggest solutions to meet their buyers' price and performance
objectives. They do their own testing and may even be responsible fortesting other suppliers' parts. One of the major partners is

KOJIMA:SUPPLIER RELATIONS IIV JAPANNippondenso, which has grown to become an independent suppliers ofa broad range of components approaching to Toyota in size.
The distinction between the mature-suppliers and the partner issubtle. Like partners, suppliers in the mature role referred to as full-system suppliers designing and manufacturing complex assemblies.
Because they iack the technological capabilities of partners, they haveless influence on design. The automaker gives mature-suppliers criticalspecifications for performance, interface requirements and spaceconstrajnts. These suppljers then develop the systems on their own.
Moreover, mature-suppliers take on major testing responsibilities: abuyer might not even verify the test data a mature supplier submits
along with its prototype.

Suppliers in the child role have even less influence on design
specifications. They may participate as consultants in meetings with theautomaker during the concept stage, but the buyer determines in
explicit detail •the specifications for the part. The responsibilities ofsuppliers in this role include working out the detailed of the design andbuilding and testing prototypes. But the buyer often conducts criticaltests internally to assess the performance of the supplier's parts.

Communications are not very intensive in the concept stage but
intensify during prototyping, though not to the same degree as withpartners or mature suppliers.
Suppliers in the contractual role simply manufacture parts designedby the automaker, usually standard parts or commodities. This role isappropriate when a customer chooses to supplement its own internalability to design those parts with a contractual supplier's
manufacturing capacity. Contractual-suppliers and their buyers may
communicate frequently during the late-prototype and productionpreparation stages, though communication is less intensive than it is in

the other roles. These suppliers may have long-term relationships with

their customers if the suppliers' unique manufacturing capabilities
make them necessary or if the automakers' just-in-time manufacturingschedules are so tight that they require them. Suppliers and theircustomers become increasingly interdependent as they work together

and their trading relationship grows. The buyer depends on the
supplier's know-how and relies on the supplier to deliver on time andon target. Committed ever more heavily to the customer, the supplierdepends on it for its future business.

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Japanese automakers manage product development tightly. They
set clear, understandable goals and communicate them consistently tosuppliers, and they use targets and prototypes to enforce those goals.
It is a simple, rigid process, much like an assemb}y Iine. Suppliers must

keep the line moving as a highly regimental role. With a highly
structured and routinized product-development process, Japanesesuppliers know exactly where they fit in and when, and thisarrangement allows them to be innovative within clearly determinedboundaries. Japanese automakers give marching orders to suppJjers

through carefully considered targets for price, delivery date,
performance, and space constraints. Then the suppliers go off anddesign to those targets. There is usually little room for missing thembecause a deviation by one supplier will have implications for designers
of mating components systems. Suppliers are expected to work hard tomeet targets on time. Although buyers are generally understanding if
supplier eannot meet a targets, they are unsympathetic if the suppliershows signs that it has not worked very hard. The customer is
responsible for avoiding arbitrary and capricious changes in targets,

because they would reverberate throughout the system and could
disrupt other suppliers' design work.

5.2 Supplier Responsibility for Produet Development

The typical description of Japanese supplier management argues
that suppliers are partners in product development for the early
concept stages of design. By contrast, those of the typical U.S.
automotive makers have been often suggested that most high valueadded component development and production is done by automakers
in-house using large in-house supply capability. Outside suppliers areused predominately as low-cost manufacturing platforms that are
handed blue-prints and build to prints.

A number of generalizations in the literature on supplierinvolvement in design in Japan. Japanese suppliers take on more
responsibilities for designing, prototyping, and testing complex partsand subsystems than U.S. suppliers. Suppliers in Japan are thought tobe given great autonomy in designing, prototyping, and testing theircomponents or subsystems, with little interference on monitoring by thebuyer. The Japanese supplier network is organized into clearly defined,hierarchical tiers with relatively large first-tier suppliers at the top

KOJIMA .• SUPPLIER RELA TIOIVS JN JAPAIV

taking most of the responsibility for design of subsystems anddelegating responsibilities for simple parts to second and lower--tiersuppliers that generally build parts according to blueprints provided tothem.
Liker, et at. (1996) find little support for the expected differences insupplier involvement in the design process. There is a high level ofsupplier involvement in product development in both countries for the

early stages of design, particularly among suppliers of major
subsystems. U.S. companies show levels of supplier involvement inproduct development rivaling Japanese companies. The U.S. automakers
seem to be giving suppliers the responsibility and opportunities to
exploit advantages of asset specificity and customer dependence on the
supplier, without the same level of control as we see in Japan. They do
not hold equity in the supplier, they do not represent as large a volumeof the supplier's sales, they have less internal capability to design theparts themselves, and they are not repeating supplier's tests as
frequently. There is no evidence in these data that Japanese suppliers
are given greater responsibility for prototyping in Japan than in the

U.S. Nor is there evidence that Japanese companies expect more
complete prototypes and trust their suppliers enough not to replicate
their components test. In fact, there is a significantly greater likelihood

in Japan that supplier prototype tests are replicated. Japanese
automakers are closely monitoring their suppliers' designs.

5.3 Early Communication in Produet Development StageThe Japanese supplier management suggests suppliers are trusted
enough to be given model information relatively early in the design
process - often at the concept or pre-concept stage - and suppliers are
expected to participate in the development, beginning at the concept
stage. In the process, Japanese suppliers wield significant influence

over the process of defining customers' requirements so that the

product designs exploit the suppliers' unique manufacturing
capabilities. Liker et al. (1996) indicate that almost all of the subsytem

supplier in Japan receive early vehicle concept information from theircustomers although they do not necessarily have a great deal of
influences over the setting of specifications for their subsystems.
Contrary to the current literature that suggests Japanese companies
provide broader specifications that allow the supplier greater freedom

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41 (1996),
KOBE ECONOMJC & BUSINESS REVIEW,

41-68

to innovate, there were no Japanese-U.S. differences in the degree of
specificity of the customer requirements. Japanese customers were as
likely as their U.S. counterparts to include actual dimensions in therequlrements.
Japanese automakers provide early new model information to first-

tier suppliers as the product concept is forming and issue only theminimum critical product requirements. U.S. companies are thought toprovide much more detailed specifications to their suppliers, allowing
suppliers little latitude on specifying the design. Japanese suppliers
management involve intense and frequent communication during the
product development cycle, particularly in the early stages when the
product is being defined. This includes the intense and regular sharingof technical information to improve performance and reduce cost.
Because these are long-term buyer-supplier relationships, the quality
and efficiency of information exchange is significantly higher than it
would be in new relationships. Thus mutual human capital investment
enhances information sharing and communication between buyer andsupplier.
.
There was considerably more frequent exchange of design
information reported in the U.S. compared to Japan at all tier levels

and all stages of the development process. The frequency ofcommunication does not necessarily reflect the quality ofcommunication. Japanese have a long and continuous history ofworking together with their suppliers on design that they cancommunicate quickly and easily between them. Direct communication
and relationships developed over a long period of time made detailed
and explicit written communications largely unnecessary. The result of

this emphasis on communication is greater efficiency, faster productdevelopment cycles. The greater frequency of information exchange
about product development between buyers and suppliers in the U.S.
may reflect less effective communication and decision making. Japanesesuppliers are given specifications formally, asking to go off and do thedesign and return with a prototype on time. Communication has beenstreamlined so it is less frequent than in the U.S. The Japanese supplier

relation can be thought to involve intense and frequent communication
during the product development cycle, particularly in the early stages
when the product is being defined. This includes the intense and regularsharing of technical information to improve performance and reduceKOJIMA:SUPPLIER RELA TIONS IN JAPANcost. When a supplier gets a notice that the concept session for a
specific vehicle model is being scheduled, there is no ambiguity about

what the supplier must bring to the session; approximately when thefirst, second, and third prototypes will be due; and what the buyer's
expectations at each of those milestone events will be. One can findclear and consistent communication between suppliers and buyers in
the Japanese relationships
5.4 Cost-reducing Efforts

When the Japanese automaker hands design specifications to its
suppliers, these specifications include a target price, whereas U.S.
automobile companies tend to rely more on direct market forces tocontrol costs. Aggressive target prices are a major factor in driving
supplier to use value engineering and reduce cost so they can make aprofit at the price dictated by the customer. In fact, Japanesecompanies also know the cost structure of their suppliers and generally

set the target price very aggressively under the assumption that
suppliers will continually reduce costs over experiences of the previous
model. Supplier which are dependent on a principal customers have no
choice but to reduce cost aggressively or risk losing the affiliation withthat customer which could mean going out of business. For example,
Toyota gives them targets shortly after the 36-month presentation.
Usually, maximum/minimum targets are generally expressed in termsof improvements over an existing product or the prototype in thepresentation: Toyota is likely to want about 4 percent reduction in
cost, or about 5 percent improvement in power output. During themonths that follow, the suppliers diligently strive to meet the targets
through design improvements. If the targets are met or exceeded, thiseventually becomes the specification; if not, in negotiations, the supplierdemonstrates with test data that the target is impossible, and the bothparties compromise on a target. Toyota's engineers typically set
targets on each components higher than really necessary by as muchas 20 percent. They realize that, with production variations, thisensures a comfort zone so parts out of tolerance will actually bequality parts. They also want the suppliers to stretch; if the targets is

too easy, the supplier will relax and not try to continuously pushpossible boundaries. If the supplier cannot achieve the very challenging
goal, there is still room for negotiation (Ward, et al., 1995).

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64 KOBE ECOIVOMIC (Åí} BUSIIY'ESS REVIEW, 41 (1996), 41-68

Liker, et al. (1996) shows the date to support the more widespreaduse of target pricing in Japan and the greater prevalence of competitive
bidding in the U.S. However, there is also considerable evidence that
U.S. companies are using this practice. More than half of both the U.S.
and Japanese suppliers said the use of competitive bids was a major
way to set prices. Value engineering has become an institutionalizedpractice in these companies. The term used for identifying ways toreduce cost in the produet/process development stage is value
engineering. In fact each buyer has a formula for splitting the costsaving suppliers have achieved through value engineering between thecustomer and suppliers.
6. Convergenee
Supplier relations in the U.S. are changing rapidly and are moving
close to the those in Japan. Cusumano and Takeishi (1991) present theresults of a questionnaire survey to a sample of automobile
manufactures in the U.S. and Japan during the spring of 1990. The
survey provides evidence that U.S. automakers and suppliers haveadopted at least some practices traditionally associated with theJapanese, thus indicating a possible convergence toward a Japanesemodel of supplier relations. The evidence shows that U.S. automakers

appeared to move close to the Japanese model during the 1980s inseveral areas, For example, U.S. companies had long, stable histories
of relations with their suppliers; the average contract lengths they gaveout for components after market introduction were dropping while
quality was improving; past relations an financial affiliation, such asuse of internal part divisions, were becoming less important as factors
in choosing suppliers, while pricing accuracy and quality seemed to be

gammg lmportance.
Where once contracts were short-term, arm's-length relationships,
now contracts have increasingly become Iong-term. Helper and Sako
(1995) shows that U.S. suppliers must provide buyers with detailed
information about their processes, and buyers talk of partnerships with

their suppliers. 87 percent of Japanese suppliers, compared with 68
percent of U.S. firms, thought that their customer's commitment would
last more than four years, the typical duration of a model cycle. The
actual record of trading with the same customer was significantly

KO,JJMA.- SUJ)PLIER RELA7'IONS ilV JAPAAX

longer in Japan than in the United States.

In the U.S., between 1984 and 1993, more suppliers provided theircustomers with a detailed breakdown of the steps in their production

process, an increase that is compatible with a trend towardcollaborative relationships.S More and more U.S. suppliers have given
their customers a detailed breakdown of process steps, so that the gap
between U.S. and Japanese companies was eliminated by 1993 in thisrespect. At the same time, buyer commitment, measured by either pastrecord or suppliers' future projections, remains higher in Japan than in
the U.S. In joint problem solving, suppliers' expectations of cooperation

have increased in the U.S. but declined in Japan. Thus there has beena limited, yet noticeable, convergence in the nature of U.S. andJapanese supplier relations. In the U.S., suppliers are significantly

more likely than they were five years ago to provide detailed
information to their customers, have long-term contracts, believe that
their customers are serious about product quality, and have defect-

prevention systems in place. This results indicate progress toward
cooperative relationships, in which suppliers play an important role insolving problems and developing fresh ideas about products andprocesses.

Sako and Helper (1995) also show that there has been a
considerable convergence in the methods of supplier relations towards
those consistent with closer and longer-term relationships in Europe,
the U.S. and Japan. An increasing proportion of European and U.S.
suppliers have provided their customer with a detailed breakdown ofprocess steps, so that the gap between European and the U.S. on the
one hand and Japan on the other in this respect is eliminated by 1994.9
8 Frey and Schlosser (1993) present a case of the Ford-ABB Oakville paint-finishingproject that shows how cooperative and innovative buyer-supplier relationships canbe achieved in the U.S. automobile industry.
9 In the U.K. automobile industry the traditional buyer-supplier relationship was
promised on stable, high volume, low variety production; relationship was one ofclose competition, with any new business secured by one supplier being won at

bidding; price was the primary criterion on which contracts were awarded.
Today, one can notice that several automakers are trying to shift toward reducing

costs, and resolying scheduling problems, technical difficulties and the likethrough a process of cooperation rather than competition. The new relationshipwas characterized by far greater dependeney as it involved suppliers in design,
research and development work, and quality control, and this in turn facilitatedmore commitment from suppliers by a}lowing them to engage in more forward
planning. Reducing the supplier base is one feature of the current transformation,
long-term collaborative contracts awarded to a limited number of suppliers, and

65

66

RE VIE W,4I (1996),
KOBE ECOIVOMICBUSIIVESS
&

41-68

7. Conelusion

Supplier relations are important areas for any firm that
subcontracts portions of components design and production because
this creates the dependence on the technology and operations ofsuppliers. There are significant differences in supplier relations between

Japan and the U.S. Supplier relations in Japan can be identified to havedistinctive characteristics in several aspects compared with the U.S.
counterpart. It is important to understand how efficiently Japanesesupplier relations work, and whether the Japanese practice is unique tothe peculiar circumstances of the Japanese social and cultural systemor whether it can be applied in other countries. Furthermore, it is also
important to understand the economic rationale of supplier relations inJapan.
In this paper, major characteristics of Japanese supplier relations
are described in comparison with the U.S. Economic rationale for thoserelationships are provided. Furthermore, comparing suppliers relationsin Japan and the U.S., convergence in the nature of those are
discussed. Significant features of Japanese supplier relations are
identified as follows: long-term relationships and commitments withfrequent planned communication, which reduced transaction costs andeliminated inefficiencies between buyers and supp}iers; trust-building

practices like owning stock, transferring employees, having guest
engineers, and using flexible legal contracts that create a high degreeof goal congruence and mutual trust; forced competition among few
suppliers focusing on costs, quality, and technological development;
willingness to make signifieant transaction-specific investments in plant,

equipment, and human capital as well as to share valuable technicalinformation; significant involvement of suppliers in productdevelopment with intensive and regular sharing of technical and cost
information to improve performance and set prices.
Supplier relations in the U.S. are changing rapidly and are moving
close to the those in Japan. There has been a limited, yet noticeable,
buying more assembled component systems rather than individual components.
However, the structure of the U.K. vehicle industry presents severe technology
transfer and to the close collaboration between buyers and suppliers. There is alargely independent and common first-tier of suppliers, as we]l as a common sec

ondary/tertiary tier, which are shared by a number of vehicle assemblers(Turnbull, et al., 1992).

KOJIMA .• SUPPLIERRELA TIOIVS JIV' JA PAN

convergence in the nature of U.S. and Japanese supplier relations. In
the U.S., suppliers are becoming significantly more likely to provide

detailed information to their customers, have long-term contracts,
believe that their customers are serious about product quality. This
results indicate progress toward collaborative relationships, in which

suppliers play an important role in solving problems arrd developing
ideas about products and processes technology.

Acknowledgment'Financial supports from Foundation of Sanyo Broadcasting, The Japan
Economic Research Foundation, Ministry of Education in Japan, Murata Foundation,

and Zengin Foundation for Studies on Economics and Finance are gratefully
acknowledged.

Referenees
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of Relation-Specific Skill," Journal of the Japanese and International

Economies, 3, 1-30. .

Clark, K. M. and T. Fujimoto (1991), Product Developrnent Perforinance: Strategy,
Organization, Managerrtent in the ;Vorld Auto Industrov, Harvard Business

School Press.
Cusumano, M. A. and A. Takeishi (1991), "Suppler Relations and Management: A
Suryey of Japanese, Japanese-Transplant, and U.S. Auto Plants," Strategic
Management Journal, 12, 563-588.
Cusumano, M. A. and A. Takeishi (l995), "What We Have Learned and Have Yet toLearn from Manufacturer-Supplier Relations in the Auto Industry," working

paper, MIT.
Dyer, J. H. (1996), "Specialized Supplier Networks as a Source of Competitive
Advantage: Evidence from the Auto Industry," Strategic -IL4anagernent Journal,
17, 271-291.

Dyer, J. J. and W. G. Ouchi (1993), "Japanese-Style Partnerships: Giving Companies
a Competitive Edge," Sloan Management Review, Fall, 51-63.
Fair Trade Commission in Japan (199), Jidosha-buhin no Torihihi ni .kansuru Jittaicyousa, (Survey on Trading of Automobile Parts), The Bureau in Fair Trade

Commission in Japan.
Frey, S. C. and M. M. Schlosser (1993), "ABB and Ford: Creating Value throughCooperation," Sloan Management Review, Fall, 65-72.

Green, J. R. and N. L. Stokey (1983), "A Comparison of Tournaments andContracts," Journal of Political Eeonomy, 91, 349-364.
Helper, S. R. and M. Sako (1995), "Supplier Relations in Japan and the United States:

Are They Converging?" Sloan Management Review, Spring, 77-84.

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Liker, J. K., R. R. Kamath, S, N, Wasti, and M. Nagamachi (1996), "Supplier
Involvement in Automotiye Component Design: Are There Really Large US
Japan Difference?" Research Polic.x', 25, or9-89. ,Kamath, R. R. and J. K. Liker (1994), "A Second Look at Japanese ProductDevelopment," Harvard Business Review, 72, (November-December), 154-170.
MacLead,VLr. B, and J. M. Malcomson (1993), "Investments, Holdup, and the Form ofiMarket Contractc," American Economic Revietv, 83, 811-837.
Nalebuff, B, and J, E, Stiglitz (1983), "Prizes and Incentives: Towards a General
Theory of Compensation and Competition," Bell Journal of Economics, 14, 21-43.
Lazear, E. P, and S. Rosen (1981), "Rank-Order Tournaments as Optimum Labor
Contracts," Journal of Political Economy, 89, 841-864.
Riordan, Mt . H, (1996), "Contracting with Qualified Suppliers" International Economic
Reviett,, 37, 115-128.

Sako, M. (1995), "Suppliers' Associations in the Japanese Automobile Industry:

Collective Action for Technology Diffusion," Cambridge Journal of
Economics, forthcoming.
Sako, M. and S. R. Helper (1995), "Supplier Relations and Performance in the Auto

Industry: European-Japanese-US Comparisons of the Voice/Exit Choice,"
Paper presented in the GERPISA conference.
Turnbull, P., N. OIiver and B. Wilkinson (1992), "Buyer-Supplier Relations in the UK

Automotive Industry: Strategic Implications of the Japanese Manufacturing
Model," Strategic Management Journal, 13, 159-168.
Ward, A., J. K. Liker, J. J. Cristiano, and D. K. Sobek (1995), "The Second Toyota

Paradox: How Delaying Decisions Can Make Better Cars Faster," Sloan
Management Review, (Spring), 43-61.

KOBE ECONOMIC & BUSIIVESS REVJEVV, 41 (1996), 69-99

ALTERNATIVE COMPONENT SOURCING STRATEGIESWITHIN THE MANUFACTURER-SUPPLIER NETWORK:
BENEFITS OF QUASI-MARKET STRATEGY
IN THE JAPANESE AUTOMOBILE INDUSTRY

Kobe University
KENTARO NOBEOKA

Abstract
This study examines the component sourcing strategy of six Japanese
automobile manufacturers. One of the major findings is that firms with a low
sourcing concentration and a high supplier sharing, which are the characteristics ofquasi-market strategy, tend to perform better than the other firms. The Japanesecooperative inter-firm relationship has been considered to be beneficial to bothsuppliers and assemblers. It is commonly considered that a relatively exclusive"keiretsu" system facilitates these close inter-firm ties. However, the results inthis study have implied that a few leading Japanese automobile manufacturers
may have management capabilities in benefiting from both a relatively broad
supplier base and cooperative relationship with individual suppliers.
elEL classification: L14; L62

Kaywords: Supplier relationship; Supplier network; Japanese automobile firms;
Quasi-market strategy

1. Introduction

In many industries, the management of component suppliers is an
important issue. This study analyzes component sourcing strategies ofJapanese automobile manufacturers. Existing literature has mostly
discussed advantages of Japanese keiretsu partnerships, comparing
them with the arms-length relationships in the Western industry. Most
Corresponding Address:

Kentaro Nobeoka
Research Institute for Economics and Business Administration, Kobe University

2-l Rokkodai-cho, Nada-ku, Kobe 657, Japan
E-mail: nobeoka@rieb.kobe-u.ae.jp
Fax: (81)-78-803-0414

70

KOBE ECONOMJC & BUSINESS REVIEVV, 41 (1996), 69-99

studies have focused on the cooperative nature of dyadic inter-firm
relationships between manufacturers and suppliers in Japan. However,few studies have explored the differences among Japanese firms insourcing strategies in the context of the entire manufacturer-supplierindustry network.
As Takeishi and Cusumano (1995) have pointed out, the emphasison cooperative supplier relationships and the notion of the keiretsu

group sometimes leads to a misunderstanding, in which some may
think that there are exclusive one-to-one relationships between
manufacturers and suppliers in Japan. In reality, however, many
suppliers sell a certain type of components to multiple competing

automobile manufacturers, while auto manufacturers buy mostcomponents from multiple suppliers. Therefore, there is a complicatednetwork consisting of multiple automobile competitors and component

suppliers with respect to transactions even on a single type ofcomponent.
This study focuses on the sourcing strategies of Japanese auto
manufacturers, which relate to the manufacturer's positioning in theentire buyer-supplier network. More specifically, there are twointerrelated purposes of this study. First, it develops a framework thatlays out different types of sourcing strategies for individual firms,

considering the entire network of automobile manufacturers andcomponent suppliers, rather than a dyadic inter-firm relationship. This

framework features concepts of the "quasi-market" and the "quasihierarchy" strategies. This study then argues potential relationships
between the sourcing strategy types and automobile manufacturer's

performance. Second, in analyzing the strategy-performance
relationship, it also illustrates differences in the sourcing strategy each

Japanese automobile manufacturer follows, which contrasts with many
existing studies that have emphasized a single "Japanese" supplier
relationship model.

There have been two important areas of study that have exploredsourcing strategy and supplier management. First, the fundamental
issue for manufacturers is related to the make-or-buy decision. Many
studies have provided evidences regarding potential factors that affectthis type of decision making (Monteverde and Teece, 1982; Walker andWeber, 1984; Hart, 1989). In the literature, selecting a "buy" decisionusually means that a manufacturer and a supplier maintain an arms-

71
NOBEOKA : ALTERNA TI VE COMPONEIVT SO UR CING STRA TEGIES

length relationship in the market.

On the other hand, the second body of literature has argued thatthe effective management of the supplier relationship leads to a newmode of inter-organizational relationships, which may necessitatereconsideration regarding a simple distinction between make or buy.

The emerging mode of supplier management is characterized by acooperative long-term relationship with an extensive inter-firm
communication. In particular, many studies have compared suppliermanagement practices between the U.S. and Japanese automobile
industries, emphasizing the advantages of the Japanese style ofmanagement (Abernathy, Clark and Kantrow, 1983; Cole and Yakushiji,
1984; Cusumano, 1985; Asanuma, 1989; McMillan, 1990; Nishiguchi, 1994;
Helper and Sako, 1995). The literature has explained that, in theJapanese automobile industry, a manufacturer and a suppliercoordinate to perform interdependent tasks effectively by sharing more
information, investing in relation-specific assets, and relying on trust to

manage the relationship. These studies and others have also impliedthat this type of supplier relationship is supported by the Japanesekeiretsu system (Lincoln, et. al., 1992; Dyer and Ouchi, 1993).

Even though there has not been a clear definition of the keiretsu
system, many studies seem to have implied that Japanese automobile
firms or at least the leading ones have a keiretsu supplier group andmaintain a relatively exclusive relationship within the group. A typicalexpression explaining the manufacturer-supplier relationship could be "The Japanese also appeared to be organi2ed more in a pyrarnid
structure, with rnany more affiliated suppliers that each had their own
suppliers, creating a high level of `group' integration" (Cusumano andTakeishi, 1991, pp. 564). Despite the notion of the group integration,

there is actually a complicated manufacturer-supplier network acrossthese groups. This study analyzes details of the network structure to
determine the different sourcing strategies each Japanese assembler
follows.

It is important to analyze sourcing strategies as part of a networkof relationships, rather than as relationships on}y at the dyadic level.
This perspective of the sourcing strategy influences the nature of inter-firm transactions (Porter, 1980; Williamson, 1988; Nohria, 1992). This

study tries to conceptualize variations in sourcing strategies in thecontext of the entire network. For example, some firms may buy a

72

KOBE ECOIVOMIC & BUSINESS REVIEW, 41 (1996), 69-99

certain type of components from a single supplier that does not deal
with other automobile manufacturers at all. This type of sourcing
strategy features one-to-one manufacturer-supplier transactions, which
this study considers a typical example of the quasi-hierarchy strategy.

Others may buy the same type of components from several suppliers
that sell the components also to several other manufacturers. This
sourcing strategy features multi-to-multi transactions, which is an
example of a firm that follows the quasi-market strategy.

As in these examples, there are two dimensions with which thesourcing strategy may be determined: the "sourcing concentration"and the "common supplier sharing."i There are some studies that havediscussed the first dimension, explaining that Japanese automobile

manufacturers do not actually rely on a single supplier for eachcomponent (Itami, 1988; Asanuma, 1989; McMillan, 1990). However, inorder to capture the whole picture of the network, it is neeessary toanalyze these two perspectives simultaneously. Different sourcing
strategies within a network with respect to these two variables may
affect the efficiency and the effectiveness of component procurementtransactions. This study particularly explores the following twoquestlons:

1. Are there any differences among Japanese auto manufacturers
regarding sourcing strategies in terms of these two dimensions?
2. If differences exist, how do they affect a firm's performance?
The next section discusses a conceptual framework that contains

the two dimensions of the sourcing strategy, which leads to a
distinction between the quasi-market strategy and the quasi-hierarchy
strategy. Section 3 and 4 analyze data on the sourcing strategy at six

Japanese automobile manufacturers with respect to 95 different
components. In these sections, we provide an evidence that the quasimarket strategy, which features a low sourcing concentration and ahigh supplier sharing, has a positive influence on firm's profit
performance. Section 5 discusses findings from the data analyses. Thissection also considers relationships between findings in thjs study andthose in the existing literature that has focused on dyadic inter-firm
1 These two variables are similar, in concept, to "Sourcing Dispersion per
Automaker," and "Customer Dispersion per Supplier," which Fujjmoto andTakeishi (1994) use to analyze the industry-wide manufacturer-supplier
relationships on different types of components.

73
NOBEOKA : ALTERNA TI VE COMPONENT SO ULR CIIVG STRA TEGIES

relationships.

2. Framework of Soureing Strategy
In order to conceptualize sourcing strategy, this section develops aframework using two strategic dimensions in component sourcing, The
first dimension, the sourcing concentration, determines the degree of
reliance on a small number of suppliers such as on a single supplier.
This dimension is similar in concept to the number of suppliers fromwhich a firm procures a certain type of components, which someexisting studies have treated as one of the important dimensions ofsourcing strategy (Asanuma, 1989; Cusumano a•nd Takeishi, 1991;
Nishiguchi, 1994). The concentration dimension, such as an applicationof the 2-firm concentration ratio or the Herfindahl index, may be more

useful than the simple measurement of the number of suppliers to
capture the degree of a focused reliance. Even when a manufacturer
buys a certain component from many suppliers, it may concentrate on
one or two firms with respect to the values or units of components
purchased. In this case, the degree of reliance on a limited number ofsuppliers is high.

The sourcing concentration, however, does not fully capture afirm's sourcing strategy in the context of the entire assembler-supplier

network. The second dimension in this framework determines thedegree of supplier sharing with competing assemblers. Some assemblers
may buy a certain type of component from a supplier that exclusively
sells it to the manufacturer, while others may rely on a supplier thatsells the same type of component to other manufacturers as well.
Despite the importance of this dimension, few management studies havefully explored it either conceptually or empirically. One specificexample related to this issue in the Japanese automobile industry is thestrategic alternative of whether a firm such as Toyota encourages its
group suppliers to sell a component to Toyota's competitors such as

Nissan and Honda.
These two dimensions lead to a framework that contains four
different sourcing strategies as shown in Figure 1. In order to illustrate

the framework, Figure 1 also shows a simple hypothetical example ofa network that consists of six manufacturers and seven suppliers. In
this model, six manufacturers buy a certain type of component in the41 (1996),
KOBE ECONOMIC & BUSINESS REVIEW,

74

69-99

component market where seven suppliers compete. Ml is an example ofa manufacturer that has a high sourcing concentration and a low
supplier sharing. It buys this component from a single supplier that
does not deal with any of the other automobile assemblers at least on
this particular type of component. On the other hand, M2 buys thecomponent from three suppliers. Therefore, its sourcing concentration

is lower than Ml. M2 does not share these suppliers with othercompetitors either, and the degree of supplier sharing is as low as Ml.

M3, M4, and M5 have a low concentration ratio and high supplier
sharing. M6 concentrates only on one supplier, but the supplier sells
the component to other manufacturers, which position this assembler
as the one following a high concentration ratio and high supplier
sharing.
Figure 1 A Framework and an Example of Different Sourcing Strategies

Automobile Component

Manufacturers supplieTs HighM3M4M5

Ml Sl"e"asi-ilfarK-et"

M2

S2

M3

S3

M4

S4

M5

S5

Supplicr

SharingC2aasi-11ierarchy"

Low

M6

M6

M2

Ml

S6

Low
S7

High

Sourci]lg Concentralion

By using these dimensions, this framework features a distinction
between the quasi-hierarchy
and the quasi-market sourcingstrategles.
forms a sourcing structure featuring oneThe strategy followed by Ml
to-one manufacturer-supplier relationshipwith respect to acertam typehierarchicalof component, which is similar to the notion of a
relationship. However, it iscalled "quasi-hierarchy,"rather than"hierarchy," because thisrelationships withstudy discusses only
outside suppliers, including
only components that no firminternallysources using vertical integration. ' Because there is nota perfect

75
IVOBEOKA : ALTER NA TI VE COMPONENT SO UR CING STLRA TEGIES"market" mechanism anywhere in the Japanese automobile component
market, the opposite extreme of this dimension is called "quasimarket" (Itami, 1988; Asanuma, 1989). Quasi-market nature of thesourcing structure increases when manufacturers lower sourcing
concentration and increase supplier sharing, such as M3, M4, and M5.
Using this framework, the rest of this section attempts to develop
hypotheses regarding advantages of the quasi-market strategy and its
combination of a low sourcing concentration and high supplier sharing.
We do not want to generalize this framework of the sourcing strategy
too much, because we believe that the influence of strategy with respect
to the industrial structure and inter-organizational relationship depends
considerably on the nature of different industries, markets, and social
institutions (Galaskiewicz, 1985). During the following discussions,

therefore, we primarily consider the Japanese automobile andcomponent supplier industry.

For example, first, we assume that in the Japanese automobile

industry there is not a perfect competition or arms-length
manufacturer-supplier relationship in a practical sense (Itami, 1988;

Asanuma, 1989). Automobile manufacturers and component suppliers
usually maintain "cooperative" relationships at least to some extent
regardless of the sourcing strategies that this study discusses (Helper,

1991a; Fujimoto and Takeishi, 1994). Second, Japanese auto
manufacturers, on average, outsource as many as 70%o of components

in values and 90% of the number of components. Therefore,transactions with suppliers tend to have a strong influence on theentire firm performance. Third, in the automobile component industry,
while the speed of product and technology changes is quick, mostchanges are incremental in a pure-technical sense (Fujimoto andTakeishi, 1994).

The following discussions consider potential influences of different
sourcing strategies. With respect to the first dimension, the sourcing
concentration, it is rather clear from the existing literature that too
much concentration on a small number of suppliers such as Ml and M6

may be inappropriate for buyers (Itami, 1988; Asanuma, 1989;
McMillan, 1990; Cusumano and Takeishi, 1991; Richardson, 1993). It
may prevent the suppliers from competing with each other in supplying
high quality components at a low price, and provides suppliers withsome monopolistic power (Porter, 1980). With respect to this argument,

76

KOBE ECOIVOMIC & BUSIIVESS REVIE}V, 41 (1996), 69-99

we emphasize that concentrating on a single supplier in particular may

have a strong negative impact. Japanese automobile manufacturers
seem to be able to maintain competitive behavior among suppliers when
there are multiple suppliers competing with each other (Itami, 1988;
Asanuma, 1989; McMillan, 1990).
A high concentration particularly with one supplier also limits theassembler to accumulate important information. For example, multiple
sources would provide the assembler with a sense of industry standard
for a certain component with respect to quality and production cost
(Riordan and Sappington, 1989; McMillan, 1990; Richardson, 1993). This
type of information is critical for assemblers to monitor suppliers. For

example, a manager at Toyota mentioned that when it cannot avoid
sourcing a certain component from a single supplier, it then sometimes

internally produces some portion to gather information to evaluate
supplier's performance. In this case, sole sourcing may not have anegative influence in this aspect. However, analyses of this particularstudy include only components that assemblers do not internalize at all.

Too much dispersion to a large number of suppliers may also havesome negative impacts. It may deter a manufacturer from closely
monitoring individual suppliers or may increase supplier management
costs. In other words, the number of suppliers may have a curvilinear
relationship with the effectiveness of manufacturer's management of
suppliers. However, Japanese auto manufacturers do not usually havea problem of too many suppliers, because they seldom buy a type ofcomponent from more than five suppliers (Itami, 1988; Cusumano andTakeishi, 1991), which this study also supports in a later section.
Therefore, this framework hypothesizes only the first part of therelationship: too much concentration may have a negative influence on
the supplier management efficiency. In conclusion, the quasi-market
strategy with respect to the sourcing dispersion, then, is hypothesized
as an effective strategy, because it enhances inter-supplier competition,

as well as assembler's monitoring capabilities.

With respect to the second dimension, supplier sharing, there may
be several advantages to buy a component from suppliers that sell thesame type of component to multiple automobile manufacturers. Theseadvantages may be associated with various types of benefits from thepositive network externalities, if the term is interpreted in a broad
sense. Positive network externalities arise when a component is more

NOBEOKA: AL TELR IVA TI VE COMPONENT SO UR CING STRA TEGIES 77

valuable to a user the more other users adopt the same component orcompatible ones (Tirole, 1989). .
First, suppliers could enjoy the economies of scale by selling thesame type of components to multiple customers, which may, in turn,benefit each customer. The more assemblers buy the same components
from the same supplier, the more the price of components decreases.
Second, multiple manufacturers that procure a component from thesame supplier may benefit from quality assurance because of multiple
applications. Suppliers that manufacture auto components are also
usually involved in the design and development stages in Japan (Clarkand Fujimoto, 1991). Product or component development is, in a sense,a collection of iterations of testing, which includes internal testing suchas simulation, prototyping, and general try-and-error in design, andexternal testing such as feedback from users. Suppliers are involved
with testing in multiple stages including engineering development,

manufacturing, and market transactions. The number of testing
iterations for one type of component increases when the supplierdevelops and sells a type of component to a larger number of
automobile manufacturers. The number of iterations usually has apositive influence on the quality of components2. Suppliers may obtain

more information and data regarding technological drawbacks andcustomer needs when they apply a basic component design tocomponents at many different manufacturers. Therefore, manufacturersthat procure a component from multi-user suppliers may have a better
opportunity to buy high-quality components,

Lastly, when there is an extensive "manufacturer - supplier manufacturer" linkage, there may be a positive influence on inter-firm
learning through the network. Suppliers may learn specific capabilities
from transactions with various manufacturers. For example, Toyota's

suppliers learned the Toyota production system and increased
productivity earlier than other suppliers that did not have transactions

with Toyota (Liberman, 1994). Other manufacturers that also bought
components from the same suppliers may also have been able to enjoy
the benefits from the productivity improvement. Toyota may have also
benefited from what suppliers learned from other manufacturers. By
increasing learning opportunities, suppliers that deal with many
2 This hypothesis is drawn from our interview with an engineering manager at amajor bearing supplier, Daido Metal Corp.

78

KOBE ECOIVOMIC & BUSINEss REVIEVV, 41 (1996), 69-99

manufacturers may become more productive suppliers than those thathave transactions only with a single automobile manufacturer.
Therefore, manufacturers that buy components from multi-user
suppliers may procure components at a lower cost.
Moreover, automobile manufacturers that share the same suppliers
may learn technical or management knowhow from each other throughthe learning network in which a supplier is positioned at the eenter.
Suppliers could be one of the most effective tools for inter-competitor
diffusion of intangib]e capabilities.

Although this section has discussed the positive aspects of the
supplier sharing strategy, which is one dimension representing thequasj-market strategy, there might also be some negative influences.
First, by sharing suppliers with competitors, manufaeturers may not beable to protect their proprietary knowledge or information fromspillover. In automobile technology, however, manufacturers primarily
compete over the ways to integrate different components, rather thanstate-of-the-art technologies for each component (Clark and Fujimoto,1991). In addition, key technologies such as engine block and engine

heads are mostly manufactured internally. The styling of theautomobile is also a key competitive factor. Therefore, allmanufacturers also internally press external body panels.
Second, a manufacturer's negotiation power over suppliers may bein jeopardy when the suppliers also sell components to othercompetitors. This may be a problem particularly when the sourcing
concentration is high. However, the combination of high supplier
sharing and the low concentration may ease this threat.
In conclusion, in this study, we hypothesize that the advantages of
the quasi-market strategy, which combines high supplier sharing andlow concentration, may surpass the potential disadvantages. Therefore,

this section hypothesizes that firms that follow the quasi-market
strategy may perform better than those following the quasi-hierarchy
strategy. As mentioned earlier, this hypothesis is based on theassumptions that apply to the industrial conditions in the Japanese
automobile and component industry. Therefore, external validity could
be limited within the assumptions. On the other hand, we believe thatthe single-industry single-nation study is advantageous in testing thespecific hypotheses in this study, because other conditional factors do
not have to be controlled.

NOBEOKA ; AL TERNA TI VE COMPONEIVT SO UR CJIVG STRA TEGIES 79

3. Sample and Data
In order to collect data on the relationship between the sourcing
strategy and performance, this study uses a publicly available database(Sogogiken Corp., 1995), which contains a manufacturer/suppliertransaction matrix for 235 components. The database includes
transactions only for production in Japan. Figure 2 shows an exampleof the matrix on the fuel filter from the database. The data are only inunits not in values. However, we assume that there would not be muchdifferences in results between these two numbers, because the data areon a specific type of component. For example, with respect to the door

lock system, the manual door lock and the power door lock systems
are separately listed.

Sogogiken collected the 1993-1994 data between December 1994 andApril 1995. In order to verify the preciseness of this database, we
compared it with another pubJicly available database developed by IRC
Co., LTD. (1994 & 1995), which some other researchers have used intheir analyses (e.g., Itami, 1988). We did not find major differences

between these two sources of database with respect to the
manufacturer-supplier network, even though the IRC database did nothave data on sourcing amounts.
Figure 2 An Example of Data from the Database

Comonent:FueiFilter
Supplier

ToyotaNipponDenso
KyosanDenki

2258
564

TuchiyaSeisakusho
ToyorokiSeizo

inthousandunits/ear
NissanMazda

Mitsubishi

Suzuki

645

735

194

215
860

184

1350
898
1OO

Tokyoroki
Total

Honda

2822

1350

998

584
919

778

This study focuses on the six major car manufacturers in Japan,
namely Toyota, Nissan, Honda, Mazda, Mitsubishi, Suzuki3. Among 235

components covered in the database, this study uses data on 95
components that satisfy the following two conditions. First, this study
3 Daihatsu and Fuji are exc}uded because they are not independent, being partiallyowned by Toyota and NJ'ssan, respective]y. One of the prjmary concepts of thisstudy is the supplier sharing with competitors. Inclusion of Daihatsu and Fuji
would bias the data.

80

KOBE ECOArOMIC & BUSINESS REVIEW, 41 (1996), 69-99

focuses only on car manufacturers and excludes components used
exclusively for trucks. Industry structure and assembler-supplier
network for car industry and truck industry are relatively separate.
Second, components that at least one manufacturer internally sources
are excluded. As mentioned in the earlier section, influences of sourcing

concentration cannot be fairly compared between a firm that entirely

outsources a component with others that internally source some
portion of the component.
Appendix l lists the 95 components in this study. In addition,

Appendix 2 shows the characteristics of individual components byplotting them on a figure consisting of two dimensions: the average
number of suppliers from which automobile manufactures buy and theaverage number of automobile manufacturers to which suppliers sell.
These appendices indicate that the sample covers a variety ofcomponents in the nature of transactions. At the same time, however,
because the sample does not include components any one manufacturer
internally sources, some major components such as seats and wheels
are not in the list.

In order to interpret the data analyses for the discussion section,in 1994 and 1995, we also interviewed purchasing or product planning

managers at all six manufacturers in this sample. In addition, weinterviewed managers at 19 suppliers during the periodn.
This study measures the first variable, the sourcing concentration,
primarily by applying the idea of the Herfindahl index, which is equal

to the sum of the squares of the sourcing share from each supplier ona certain type of component. For example, if a manufacturer buys acomponent from two suppliers, 30906o from one and 70%o from the other,the Herfindahl index on this component is O.32+O.72=O.58. In order toobtain the sourcing concentration at the manufacturer level, there arethree steps of calculation. First, a Herfindahl index for each of the 95

components at each manufacturer was obtained. Second, in order toadjust for the biased influence of different types of component, theHerfindahl indices of the six firms were standardized at the component

level. In this way, differences in the sourcing strategy among
4 Suppliers we interviewed include Tokairika, Kojima Press, Daido Press, Aishin
Seiki, Araco, TRW Japan, Aichi Kikai, Toyota Shatai, Sumitomo Denso, Zexcel,
Nippon Denso, Diamond Electric, Topy, Kayaba, Nihon Hatsujo, Kansei, Calsonic,
Houwa, and Nichirin.

IVOBEOKA: ALTERIVA TI VE COMPONENT SO UR CJNG STRA TEGIES 81

manufacturers at the component level can be precisely aggregated.
Then, an average of the 95 standardized Herfindahl indices at each firm
was obtained.

We also measured other complementary variables related to theconcentration dimension. First, a simple average of 95 Herfindahl
indices without standardization at the component level was also
obtained for each firm. Another potentially important variable is theone-supplier ratio, which measures the ratio of components that eachfirm buys from a single supplier. For example, if a firm procures 10components from only one supplier, the one-supplier ratio would be
10.5906 (=:10/95). As discussed earlier, procuring a certain type ofcomponent from one supplier may, in particular, have a negative
influence on the firm. We also measured an average number ofsuppliers each manufacturer procures with respect to the 95
components.
In order to obtain data on the seeond variable, the supplier sharing
index, we first counted the number of car manufacturers to which eachcomponent supplier for a certain component sells. If a manufacturer
buys the component from multiple suppliers, we averaged the numbersof manufacturers to which each supplier sells. For example, in Figure

2, Toyota buys fuel filters from Nippon Denso and Kyosan Denki.
Nippon Denso sells the component to four manufacturers, and Kyosan
Denki only one (:= Toyota). The supplier sharing index for thiscomponent at Toyota equals 2.5, an average of the two. Then, sharing
indices for six manufacturers with respect to a certain component werestandardized in order to adjust for different types of components.
Lastly, we averaged the 95 standardized sharing indices for each firm
to obtain a sharing index for each firm. We also measured similarvariables as in the sourcing concentration, which included supplier

indices without standardization at the component level, and one-customer ratios. The one-customer ratio is the percentage ofcomponents for which a manufacturer does not share any supplierswith its competitors.

For the performance measurement of the automobile
manufacturers, this study uses the annual operating profit divided bysales in multiple periods ending in March 1994 and March 1995 to avoid
any single-year data biases (Kaisha Shikiho, Fall 1995). We do not usechanges in performance, because the supplier strategy variables are82 KOBE ECONOMIC & BUSINEss REVIEVV, 41 (1996), 69-99'
also one-time measurements.
4. Results

Table 1 summarizes results from the data analyses. This tableshows that there are two distinct groups of manufacturers with respect

to the sourcing strategy, those that foHow the quasi-market strategy
and those that follow the quasi-hierarchy strategy. One group consistsof Toyota, Mitsubishi, and Suzuki, which all show characteristics of thequasi-market strategy including both a low sourcing concentration anda high supplier sharing. On the other hand, the second group including
Nissan and Honda shows the characteristics of the quasi-hierarchy

strategy including both a high sourcing concentration and a low
supplier sharing. Mazda seems to be positioned between the two. One-supplier ratio of Mazda is low, but its Herfindahl index is not as low
as those of Toyota, Mitsubishi, or Suzuki. The supplier sharing index
also seems to be in between. Therefore, we judge that Mazda is in
between the two groups.

'
Table 1 Summary Table
ToyotaSourcingConcentration
Herfindahllndex(Std,)
Hert'indahttndex(Raw)
One-SupplierRatio(e!o)
SupplierSharing

Sharinglndex(Std,)-'Sharinglndex(Raw)"""
One-CustomerRatio(ele)'-'Avg,NumberofSuppliers"t(MinimumlMaximum)

NissanHonda Mazda Mitsub

LOVV HIGH HIGH
-O.09
OA3 O.14
O.68
25.26

O,72
31,58

O.72
28.42

HIGH LOVV LOVV
-O.16
OA4 -O.44
3.45
7.81

2.87
28.12

O.03
e.72
17.89

Ave.

-O.09

-O.12

O.68

O.66

17.89

2421

o
e.7o
24.21

HIGH HIGH

29.69

O.03
3.35
15.62

3.08

Suzuki

LOVV LOVV

O.05
3.36
9.38

O.39
3.62
9.38

3.29
16.67

2.22

2.22

2.12

2.01

2.38

2.45

2,12

(1/6)

(IX5)

(1/5)

(lt5)

(1/6)

(1/4)

o

Production`93(MillionUnits)

3.56

1.81

IA5

1.03

1.36

O.80

1.62

OperatingProfitiSales(3/94)

o.g4ol,-1.02o!.

O.7501e-2.5ool,

1.63"lo

2.t701e

O.33

OperatingProfitiSales(3f95)

2.5201e-2.20e!e

1.29ele-2.1oo!o2.550fo

2.9401,

O,83

e!o

Ole

S" Difference significant at the O.OOI level (ANOVA).
First, with respect to the sourcing concentration, the Herfindahl
Indices (Std.) of Nissan and Honda are O.13 and O.14, respectively,

which are higher than those of Toyota, Mitsubishi, and Suzuki. Even
though the ANOVA test did not show that the inter-firm differences

83
NOBEOKA: ALTERNA TJ VE COMPONENT SO UR CING STRA TEGIES

were statistically significant, t-tests revealed some significant
differences. For example, the difference between Nissan and Suzuki issignificant at the 5SO)6o level, and the one between Nissan and Toyota at
the 10% level.

The differences in the supplier sharing indices among the six firms

are large and statistically significant. There are also two distinctgroups with respect to this dimension. The standardized sharing indicesof Toyota and Suzuki at O.14 and O.39 are much higher than those of
Nissan and Honda, which are -O.44 and -O.16, respectively. Those of
Mazda and Mitsubishi are in between at O.03 and O.05, respectively.

However, because the one-customer ratio of Mitsubishi is low andsimilar to those of Toyota and Suzuki, we categorized Mitsubishi into
the group with a high supplier sharing index.
Figure 3 plots the six manufacturers on the two dimensions: thesourcing concentration and the supplier sharing. The standardized
Herfindahl index and the standardized supplier sharing index are used

for the measurements. It visually shows that Suzuki, Toyota, andMitsubishi are close to each other and make one group, while Nissan
and Honda make another group.
Figure 3 Soureing Strategy of Six Manufacturers

Suzuki

High

o"so

*
rl'ovota"*Mitsubishi

Mazda

Supplier-O.15

Sharing-

O,15

Ilonda*NissanLow

Low High-O.50*

Sourcing Concentration(Standardized Herfindarl Index)

In Table 1, there seems to be a relationship between a firm's
performance, which is measured by the operating profit / sales ratio,

84

KOBE ECONOMIC & BUSINESS REVIEW, 41 (1996), 69-99

and the sourcing strategy it follows. Manufacturers that follow thequasi-market strategy, Suzuki, Toyota, and Mitsubishi, are the three
best performers with respect to the profit/sales dimension in both

years. Mazda and Nissan are the two worst manufacturers, while
Honda is in between the two groups. There are not much differences indata between 1994 and 1995. Table 2 shows results from the rank-order
Spearman correlation among the sourcing concentration, the supplier

sharing, and operating profit/sales. Even though this is a crude
analysis, there are statistically significant relationships among thesevariables. Firms with a low sourcing concentration and a high supplier
sharing, which are the characteristics of quasi-market strategy, tend to
perform better than the other firms.
Table 2 Results for Rank-Order Spearman Correlation Analyses (n==6)Operating

Herfindahllndex

ProfitlSales(Std.)

SupplierSharing
lndex(Std.)--

1994.3!1995.3

OeratinProfitiSales
HerfindahllndexStd.

SulierSharinlndexStd.

1.00-O.77t/-O.83'O.77de1O,89.t

1.00

-

-O,89tk

1.00

Significant at: S' 5906 level, ' 10% level

Table 1 contains several other interesting data regarding the
manufacturer-supplier structure in the Japanese automobile industry ingeneral. With respect to the degree of sourcing concentration, the data

are compatible with findings in existing studies. For example, theaverage number of suppliers from which each manufacturer procuresfor various types of components ranges between two and three, andthere are, at most, only five or six suppliers (Itami, 1988; Asanuma,1989). By limiting the number of suppliers, Japanese automobile
manufacturers facilitate a close relationship with suppliers, while
encouraging inter-supplier competition. It is also interesting to see noinfluence of the production volume on the number of suppliers. The twolargest firms, Toyota and Nissan, do not necessariiy deal with more
suppliers than other smaller firms.

One of the most interesting data in Table 1, though, is thatJapanese automobile manufacturers, in general, tend to share the same
suppliers. In particular, one-customer ratios for firms in the firstgroup, Toyota, Mitsubishi, and Suzuki, are all less than 10%. With

NOBEOKA: AL TERNA TI VE COMPOIVELIVT SO UR CING STRA TEGIES 85

respect to more than 90%o of the components, these firms share at least

one supplier with competitors. This data indicate that the supplier
relationship in Japan may be characterized, in general, as "quasimarket" transactions, rather than "quasi-hierarchical" transactions.

However, at the same time, this study shows that there areconsiderable differences among Japanese manufacturers regarding thisdimension. For example, Nissan and Honda buy almost 30% of theircomponents from suppliers that do not have interactions with anyother Japanese competitors5.

Data analyses in this section have shown that manufacturers that
follow the quasi-market strategy tend to be more successful withrespect to operating profit. The data analyses are primitive, especiallybecause the sample size is too limited for the findings to be generalized.

In order to supplement the findings, therefore, the next section
discusses these and related issues more extensively primarily based on
findings in our interviews.

5. Discussion

Considering the exploratory nature of the analyses, this section
further develops propositions related to the sourcing strategy in thisstudy. First, in order to understand the findings, we propose ananalytical framework that features both the inter-firm relationshipdimension and the quasi-hierarchy/quasi-market dimension. Second, we
further discuss benefits and negative influences with respect to sharing

common suppliers, which is, this study argues, an important feature of
the quasi-market strategy. Finally, we argue strategic implications of
the sourcing strategy, focusing on ways to consider it as a strategic
optlon.

5.1 Quasi-Hierarehy/Quasi-Market and Inter-Firm Relationship
Many studies on the Japanese supplier relationship have mostly
focused on the nature of the inter-firm relationship (Asanuma, 1989;
Helper, 1991a and 1991b; Nishiguchi, 1994). These studies have argued
5 As discussed earlier, this study does not include Daihatsu and Fuji. Nissan may

share many suppliers with Fuji, which is in the Nissan group. However,
Daihatsu, with which Toyota shares the same suppliers even more extensively, is
not included, either. Therefore, we believe that the exclusion of Daihatsu and Fuji
had a conservative influence on the analyses.

86

KOBE ECONOMIC & BUSINESS REVIEVV, 41 (1996), 69-99

that Japanese system is based on the cooperative relationship, which ismuch different from the U.S. system that is based on the arms-length
relationship. The cooperative relationship is characterized, for example,

by an intensive communication for inter-firm coordination and joint
problem solving. These studies are important to determine the natureof the dyadic manufacturer-supplier relationship. However, the sourcing

strategy cannot be determined solely by the nature of dyadic
relationships. This study has proposed a sourcing structure dimensionthat considers the manufacturer-supplier relationship as part of theentire network of relationships.

Specifically, this study has provided evidence that supports theexistence of a sourcing strategy dimension that ranges from quasihierarchy to quasi-market characteristics (See Figures 1 and 4). The
distinction between the two groups of firms, Group 1: the quasi-market

strategy (Toyota, Mitsubishi, and Suzuki) and Group 2: quasihierarchy strategy (Nissan and Honda), is actually the difference
between firms that benefit from market characteristics and those that
do not. Firms in Group 2 follow the quasi-hierarchy strategy that iscloser to the one-to-one transaction between a manufacturer and a
supplier than those in Group 1. 0n the other hand, firms that follow
the quasi-market strategy may be able to enjoy both the competitive
mechanism of the market by reducing one-supplier concentration andthe benefits of network externalities by sharing common suppliers withcompetitors. This strategy is characterized by a more extensive usageof the market mechanism than the strategy firms in Group 2 follow.
It is important to distinguish this dimension from the inter-firm
relationship dimension. Discussion of cooperative supplier relationshipbased on the keiretsu system sometimes seems to create
misunderstandings. For example, Takeishi and Cusumano (1995) havementioned in their extensive literature-survey paper that "Japanesemanufacturer-supplier relations are sometimes thought to be exclusive,with the assumption that only one supplier ean enter the marhet for
one automaher." In other words, cooperative relationships in theJapanese automobile industry are sometimes directly associated with"quasi-hierarchical" relationships, which, this paper argues, aremisleading.

87
NOBEOKA : ALTERiVA TI VE COMPOIVENT SO UR CIIVG STRA TEGIES

Figure 4 Sourcing Structure and Inter-Firm Relationshipin the Japanese Automobile Industry"Cooperative"
RelationshipNissanHonda

ToyotoMitsubishi

SuzukiInter-Firm Relationship

U.S. Firms in the 80's

"Arms-Length"
Relationship"Quasi- "Quasi-

Hierarchy" Marleet"
Sourcing Structure

The framework in Figure 4 distinguishes the sourcing structure

dimension from the inter-firm relationship to determine the
manufacturer--supplier relationship from both perspectives of these

dimensions. The inter-firm relationship dimension ranges from"cooperative" to "arms-length", while the soureing structure dimension
ranges from quasi-hierarehy to quasi-market. Cooperative relationshipbetween assemblers and suppliers may be enhanced by such factors as
long-term relationship and joint problem-solving behavior. However,these factors do not necessarily determined by the sourcing structuresuch as degrees of supplier concentration and supplier sharing.

One of the empirical supports with respect to the independent
nature between the inter-firm relationship and the sourcing structure
dimensions can be found in Helper (1991a), which has argued that thedegree of cooperation or coordination is not necessarily, high between
an automobile manufacturer and its internal component division that isoften a sole source for certain components to the assembler. Thisfinding indicates that even w'hen manufacturers and suppliers form aquasi-hierarchical relationship, inter-firm relationship could be either

cooperative or arms-length depending on the nature of management.
With respect to the inter-firm relationship, based on the empiricalresults of other studies, this study assumes that most Japanese88 KOBE ECOIVOMIC &BUSJIVESS REVIEW, 41 (1996), 69-99

transactions are through cooperative relationships, compared to thosein the U.S. at least in the 1980's (Helper and Sako, 1995). For example,
Nippon Denso, which is partially owned by Toyota and is considered asa major Toyota keiretsu supplier, shows cooperative joint productdevelopment efforts even with Toyota's competitors such as Mitsubishi,

when it supplies components.

With respect to sourcing concentration, existing studies havealready argued that Japanese automobile firms concentrate on a few
suppliers to maintain a cooperative relationship with them, and yet try

to avoid concentrating on a single supplier. This strategy facilitates
sufficient levels of competition between the multiple suppliers, while thecompetition is carefully monitored by manufacturers (Itami, 1988;
Asanuma, 1989; McMillan, 1990). Among the six manufacturers in thesample, three are firms that are more successful in dispersing relianceinto multiple suppliers than the others, though. These three firms havealso achieved a higher profitability than the others. This finding implies

that as long as there is a cooperative relationship and carefulmonitoring, manufacturers should enhance competitive mechanism
among a limited number of suppliers using the quasi-market strategy.
A unique contribution of this study is that our data have also
supported the theory that there may be another type of benefit of thequasi-market mechanism, which is related to sharing suppliers withother firms, again as long as cooperative relationship is maintained.

The data have shown a positive relationship between the common
supplier sharing and assembler's performance. Firms could enjoy
various types of benefits related to the positive network externalities by

sharing common suppliers.
In conclusion, the data analyses in this study have found that someJapanese firms that extensively use the quasi-market mechanism, while
maintaining cooperative relationships with suppliers, tend to be more
successful than other competitors. We believe that these leading firms
have capabilities in balancing benefits from both the cooperative
supplier relationship and the quasi-market mechanism.
5.2 Benefits of Sharing Common SuppliersWith respect to supplier sharing, we have listed three perspectivesof benefits from a broad sense of positive network externalities in the
hypothesis section. This section further discusses the benefits andIVOBEOKA : ALTERAIA TJ VE COMPONENT SO UR CING STRA TEGIES
89

potential hazards behind the benefits.

First, manufacturers, by buying the same type of component from
common suppliers, can benefit from the scale economies in the supplier.

Even when a supplier manufactures the same type of components withdifferent specifications to different users, it may leverage the same
basic design platform, manufacturing equipments, and test results. In
our interviews, an engineering manager at Suzuki, which is the smallest
firm with respect to production and still has a reputation as a low cost

manufacturer, seems to be most enthusiastic in sharing similar
components with its competitors. He says that Suzuki often tries tofind a component that has already been used by other manufacturers.
This kind of component is less expensive because it does not need muchinvestment on new Suzuki-specific manufacturing equipment.

Suzuki, for example, shares almost the same automatictransmission components with Mitsubishi, Daihatsu, and Fuji for mostof its mini-cars by sharing the same supplier, Aishin Seiki, with thesefirms. Honda, on the other hand, does not share the same automatictransmission design with them for its mini-cars and cannot benefit
from similar scale economies that the other firms are enjoying.
This type of economies of scale may be more important to smallerfirms than to large firms. However, efforts for inter-firm eomponent
sharing are not limited to a small firm such as Suzuki. At Toyota, aproduct planning manager mentioned that it was asking a wire-harness
supplier to increase common components with Toyota's competitorsthat also procure from the same supplier. A large firm such as Toyota
is also fully aware of the importance of this type of scale economies.

Second, each manufacturer can buy a quality component from amulti-user supplier. Even when a supplier sells a similar component
with minor variations to multiple users, it should test different
applications individually in the context of different vehicle models. The

number of testing iterations with respect to the basic design platform

considerably increases. The frequent iterations improve the basic
quality level of a certain type of component. In addition, a manager at

Daido Metal, which sells the engine metal to all six manufacturers inthe sample, mentioned that they have accumulated much more testingdata than its competitors that sell the same type of component tofewer users. The accumulation of the data also contributes to highquality components in the following periods.

90 KOBE ECONOMIC &BUSINESS REVJEW, 41 (1996), 69-99

Related to this perspective, an engineer at Toyota also pointed outthat when Toyota knows that a certain component has already beenused by other car manufacturers, Toyota cou)d sometjmes simplify
internal testing processes. This type of component has already beentested by the supplier and the market, as well as the assembler thathas aJready used it. On the other hand, a component that is completely

new to the firm should be thoroughly tested within the firm fromscratch. Therefore, by sharing a component with a competitor, a firm
could also save some testing cost.

Third, effective usage of common suppliers may enhance intermanufacturer learning. For example, an engineer at Toyota mentionedthat Toyota used to buy clutch unit mostly only from Aishin Seiki, aToyota keiretsu supplier, but it was considering to add a foreign
supplier. One of the reasons for this strategic change was that Toyota
wanted more information about technologies that its competitors andtheir suppliers were developing. The engineer said that it is risky, withrespect to effective information collection, to exclusively rely on a
Toyota keiretsu supplier that deals with only one or a few limited
customers.
If all competitors share the same supplier, learning within the
network may not create much competitive advantage, except for weakfirms that couid learn from competitive ones. However, if only somemanufacturers develop such networks with suppliers positioned in thecenter, that group gf firms may be in a better position to benefit fromthe inter-firm learning than those that do not participate in this type of

network. Even though analyses of a specific network are beyond theinterests in this paper, we have found that Toyota, Mitsubishi, andSuzuki, the three best performers, actually have formed this type of
relatively exclusive network sharing many common suppliers.
In spite of these advantages, there are disadvantages in the

supplier sharing strategy. Sharing common suppliers leads toinformation spillover that some manufacturers may want to avoid.
There are two factors related to influences of the information spillover.

First, when changes in technology are rapid, spillover would be a big
problem for a technically leading firm. Second, spillover is beneficial totechnological followers, while it has a negative impact on leaders.
Regarding the first issue, most technologies in the automobile design
have not changed fundamentally in recent years. With respect to theIVOBEOKA: ALTERIVA TI VE COMPONEIVT SO UR CING STRA TEGIES 91

second issue, there may not be much differences in technicalcompetencies among Japanese automobile firms with respect tocomponents this study used. In addition, generally, they do not compete

against state-of-the-art technologies, but compete more overorganizational capabilities, which cannot be copied easily (Clark andFujimoto, 1991).

Even though most technologies in the automobile are in a mature
stage, there are a few unique technologies belonging to a specific firm.

For example, the super-charger system at Toyota and the automatictransmission at Honda, which is called the Honda-Matic, are unique
technologies to each firm. In these cases, however, Toyota and Honda
entirely internalize development and production of these technologies.

When a firm wants to avoid any spillover, it may think about
internalization. Therefore, spillover problems may be more related tothe make-or-buy decision, which this study does not focus on. The

analyses in this paper concentrate on components that no firminternalizes, although we recognize that the make-or-buy strategy isalso critically important.

Finally, we realize that the strong positive influence of sharing

common suppliers this study found may also be attributed to thetiming of data collection especially with respect to the performancemeasurement. Since the booming economies ended in the early 1990's inJapan, competition among the automobile firms have been based on
product price as opposed to technical features (Fujimoto and Takeishi,
1994). If competition was based more on technical innovations withrespect to the sample components, there would be stronger negative
impacts from the technical spillover that is associated with the supplier
sharing strategy. In that case, the benefits of sharing suppliers in somefirms could be traded off by the technical spillover to competitors.

5.3 Sourcing Strategy as a Strategic Option

One of the critical issues related to sourcing strategy from the
network perspective could be whether supplier sharing is actually astrategic option for manufacturers. For example, manufacturers can
not choose the supplier sharing strategy when only suppliers can decide
the number of customers they want to or can sell to. There are two
approaches to achieve a high supplier sharing. First, a leading firmsuch as Toyota or Nissan that has already developed a keiretsu

92 KOBE ECONOMIC &BUSJNESS REVIEW, 41 (1996), 69-99

supplier group may have a strategic choice whether to actively
encourage these suppliers to sell components to other firms or
discourage it. In our interview with a purchasing staff at Toyota, hesaid that Toyota has been encouraging its keiretsu suppliers to sellcomponents to other automobile manufacturers. Second, a smaller andnewer firm such as Suzuki may have more flexibility in its choice ofstrategy. As discussed above, Suzuki often tries to find a component
that has already used in other firms. A manager at Mitsubishi also
said that it deliberately bought the same door locking system as theone that Toyota had ordered from a supplier that these two firms
shared.

However, in the first case regarding the firms with a strong
keiretsu suppliers, a manufacturer's strategic orientation alone cannot
determine the degree of supplier sharing. A keiretsu supplier should becompetitive enough to sell a component to other users. In the example
shown in Figure 2, Nippon Denso, a keiretsu firm of Toyota, sells fuelfilters also to Mazda, Mitsubishi, and Suzuki. On the other hand,
Tuchiya Seisakusho, a Nissan keiretsu supplier, is not selling it to any

other firms in the sample. There are many examples like this. For
further comparison, strategies for the entire components in the sample
at Toyota and Nissan are shown in Appendix 3. This difference could
be outcomes led by different strategies at Toyota and Nissan. However,it may be attributed to a mere difference in competitiveness of these
two suppliers.

This issue is even more complicated, because, as discussed earlier,suppliers may improve their competitiveness by selling to more users.
Therefore, one hypothesis could be that in the very early period Toyota

may have encouraged Nippon Denso to sell to competitors. Over time,

Nippon Denso may have been accumulating capabilities throughtransactions with many customers, which may have helped it become
more competitive. On the other hand, Nissan may not have encouraged
Tuchiya Seisakusho to supply components to other firms. As a result,in recent years, Tsuchiya Seisakusho may not have the capability tosell the component to other firms, because it is not as competitive as
Nippon Denso. We would like to study details regarding this type ofdynamism in our future research.
Finally, xN'e would like to briefly discuss the strategy at Honda. The

data regarding Honda do not perfectly fit with our conclusions. Honda,

93
IVOBEOKA : ALTER IVA TI VE COMPOIVENT SO UR CIAJG STRA TEGIES

like Nissan, has followed the quasi-hierarchy strategy, which ischaracterized by a high sourcing concentration and low supplier
sharing with competitors, and yet does not perform as poorly as
Nissan. Many auto industry experts share an opinion that Honda is the
manufacturer that has been focusing on its unique technologies in its

competitive strategy. Hirotada Komatsu, a purchasing director at
Honda, acknowledged in an interview that Honda tends to stick to its
proprietary technologies and avoid sharing common suppliers with its
competitors (Japanese Automotive Parts Industry Association, 1995,
pp. 68). Honda's differentiation strategy and its engineering capabilities

to implement it may have fitted with the quasi-hierarchical approach, inwhich Honda avoids teehnology spillover to its competitors.

However, Honda's uniqueness in technologies seems to have beenfading and the competition in the industry also seems to have become
based less on unique technologies. Komatsu at Honda actually adds acomment in the same interview that under the "borderless" age interms of keiretsu system, Honda also needs to change its strategy to

procure more components from other suppliers in order to becompetitive in cost. Therefore, we believe that at least in the Japanese

automobile industry, benefits from the network externalities may
surpass those from procuring from proprietary suppliers for mostcomponents.

6. Conclusion

This study has discussed the sourcing strategy of the Japanese
automobile manufacturers, focusing on the sourcing concentration andthe sharing common suppliers with competitors. We have found thatfirms using the quasi-market mechanism in the context of the
manufacturer-supplier network tend to be more profitable. This result

implies that the leadjng Japanese automobi]e manufacturers havemanagement capabilities in benefiting from both quasi-market
dynamism and integrated cooperative relationship with individual
suppliers.

Even though the data analyses have a clear limitation due to thesample size, we believe that our interviews support our conclusions. In
particular, our conceptual discussions and data with respect to the94 KOBE ECONOMIC & BUSINESS REVIEVV, 41 (1996), 69-99

positive influences of sharing suppliers that form an extensive
manufacturer-supplier-manufacturer network should be relevant atleast to some other industries. The automotive industry may even haveshown rather conservative results, compared to some other industries
where de facto standard is a key competitive factor such as computerand audio-visual industries.

However, this study has proposed many potential research areasthat need to be studied further. First, we would like to analyze data at
the component level, whieh would provide us with sufficient data points,
even though it is difficult to collect performance data at this level. In

addition, further study needs to be done in other industries to modify
and generalize our findings. As discussed earlier, in industries where

technological changes are fast, the quasi-hierarchy strategy at atechnically leading firm may perform better because the strategy isappropriate to limit information spillover. Alternatively, however,benefits of the network externalities such as enhanced standardizationand inter-firm learning could still surpass the benefits regarding thelimited spillover. The personal computer industry seems to besupporting the latter case.

Secondly, in order to analyze the benefits with respect to common
supplier sharing, further studies need to be done to analyze moredetails regarding its positive mechanisms. Specifically, threecompetitors, Toyota, Mitsubishi, and Suzuki, have formed a network
containing common suppliers and seem to benefit from the network. It
is important to analyze firms and relationships as part of the networkof relationships, rather than relationships only at the dyadic level(Granovetter, 1985; Takeishi and Cusumano, 1995). It is also importantto see the mechanism by which Nissan and Honda have been positioned
outside the network. Historical studies may be needed to answer thisquestlon.

Network of firms, rather than a mere inter-firm relationship, havebeen attracting more attention in recent years (Nohria, 1992). We
believe that this study has proposed one useful analytical tool that may
be applicable to studies in other industries. Much more study of the

network using a variety of approaches would be beneficial to our
research community.

NOBEOKA : AL TER NA TI VE COMPOIVIENT SO UR CING STRA TEGIES 95

References
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Asanuma, Banri., 1992. "Japanese manufacturer-supplier relationships ininternational perspective: the automobile case." In International Adiustment
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Clark, Kim and Takahiro Fujimoto, 1991. Produet Developrnent Performance. Harvard

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Cole, Robert and Taizo Yakushiji, 1984. The Arnerican and Japanese Auto Industry inTransition. University of Michigan Press, Ann Arbor,

Cusumano, Michael, 1985. The Japanese Automobile Industry. Harvard University

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Cusumano, Michael and Akira Takeishi, 1991. "Supplier Relations and SupplierManagement: A Survey of Japanese, Japanese-Transplant, and U,S. Auto
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Dyer, Jeffrey, 1995: "From Arms-Length Relationships to Supplier Partnerships: The

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Galaskiewicz, Joseph, 1985. "Interorganizational Relations." Annual Review ofSociology. 11: 281-304.
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the U.S. Automobile Industry," Business History Review, Winter, pp. 781-824.

Helper, Susan, 1991b. "How Much Has Really Changed between U.S. Automakers andTheir Suppliers?" Sloan Management Review, Summer, pp, 15-28.
Helper, Susan and Mari Sako, 1995. "Supplier Relations in Japan and the UnitedStates: Are They Converging ?" Sloan A14anagement Review, Spring, 36, 2, pp.
77-84.
IRC Co., LTD., 1994. Toyota Group no Jittai '94 [Analyses on the Toyota Group '94],
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Mazda and Honda)
Itami, Hiroyuki, 1988. "Visible Hand: t•he Efficiency of Component Supply," inKOBE ECONOMIC & BUSINESS REVIEW, 41 (1996), 69-99

96

Competition and Innovation: Firm Growth in Automobile Industry, ltami etal., Toyo Keizai, Tokyo Japan (in Japanese).
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Kaisha Shikiho, Fall 1995, Toyo Keizai Shinposha, Tokyo.
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Lincoln, J. R. And K. McBride, 1987. "Japanese Industrial Organization in
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Martin, Xavier, Will Mitchell, and Anand Swaminathan, 1995. "Recreating andExtending Japanese Automobile Buyer-Supplier Links in North America,"
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McMillan, J., 1990: "Managing Suppliers: Incentive Systems in Japanese and UnitedStates Industry," California Management Review, 32, pp. 38-55.
Monteverde, Kirk and David J. Teece, 1982, "Supplier Switching Costs and Vertica}
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Nishiguehi, Toshihiro, 1994. Strategic Industrial Sourcing: The Japanese Advantage.

Oxford University Press, New York.

Nohria, Nitin, 1992. "Is a Network Perspective a Useful Way of Studying
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Porter, Michael, 1980: Competitive Advantage, Free Press, New York.
Richardson, James, 1993: Parallel Sourcing and Supplier Performance in the Japanese
Automobile Industry, Strategic Management Journal, 14, pp. 339-350.
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Sogogiken Corp., 1995. Analyses of Supply Matrix on 235 Primary Autornobile
Components in the Domestic Marhet, Sogogiken, Tokyo.
Takeishi, Akira and Michael Cusumano, 1995. "What We have learned and Have Yet
to Learn From Manufacturer-Supplier Relations in the Auto Industry", Paper
presented at the International Motor Vehicle Program Sponsor Meeting inToronto, Canada, June 1995.
Tirole, 'Jean, 1989. The Theory of Industrial Organization, The MIT Press, Cambridge,

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Walker, Gordon and David Weber, 1984, "A Transaction Cost Approach to Make-orBuy Decisions." Administrative Science Quarterly, 29: 373-391.
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Economics and Organization, Spring, 4, pp. 65-94.

97:ALTERNA TIVE COMPONE.VT SO UR CING STRA TEGIESIVOBEOKA

Appendix 1 A

Etmas
1

Engjne Metal

2
3

PistonPiston Ring

4

Cylinder-Head Gasket

5

V-Belt6

Valve Spring

7

Valve Guide

8
9

Timing Belt
Carburetor

10

Elec, Fuel injection Control

11

Pulsation Damper

12
13
14
15
16
17
18
19

Circuit Opening Re]ay

20

Fuel Tube
Charcoal Canister
AirCleaner

2f

22
23
24
25
26
27
28
29
30
31

32
33
34
35
36
37

lnjector

Pressure Reguiator
Throttle Body
ldling Speed Control
Gasoljne Fuel Filter
Electric Fuel Pump

Mechanical Fuel Pump

list of

Components in thisTransmission
38 CIutch Unit
39 CIutch Facjng
40 C[utch Master Cylinder
41 Clutch Release Cylinder
42 C[utch Peda[
43 Change Lever
44 Synchronizer Ring
45 AT Lever

46
47
48
4g
50

ChassisPower Steering Pump
Power Steering Hoses
Steering Wheel
SteeFing Unit

Steering Lock51

Suspension Sprjngs

52
53
54
55
56
57
58
59
60

Stabilizer

Brake Lining Pad

Brake Wheel Cy"nder

61

62
63
64
65
66
67
68
69
70
71

72
73
74
75
76
77
78
79

Study

pmtx/IE t
GlassMirrorSide Molding

Wiper Assembly
Wiper Blade

Wiper Washer System
Door Weather Strip
Wind Regulator
Door Handle
Door Lock
Power Door Lock
Door Hjnge
Headrest
Sun Visor
Seat Belt

Key Sets
Ashtray
Cigarette Lighter

Mark

Break Booster
Electric/EIectronics

Proportioning Valve

Break Hoses

80

Headlamp

Break Pedal

81

Break Tube

Rear Combjnation Lamp
High-mounted Stop Lamp

Battery
Alternator
Starter

82
83
84
85
86
87
88
89
90

Distributor

91

Air-•conditioner

Voltage Regulator

92
93
94
95

HeaterClock
Audio System

Air Control Valve
Anti-vibration Rubber

02 Sensor
Oil Filter

Oil Cooler

Radiator

Thermostat

ignitorlgnition CoilSparkplug

Tyre

Flasher Unit

Combjnation Switch

Horn
Meter Set

Speedometer Cable
Wire Harness
Junction Block

Power Relay

Control Cable(1996),
KOBE ECONOMIC & BUSIIVESS REVIEW,
41 69-99

98

the Sample Components

Appendix 2 Basic Characteristics of
6
37
5

e
ca

o

5

60

3

1

2059

k-

n
sn

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m

30

89

B

"

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5S

29

&

75

ms

61335

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m3

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64653134

662538

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2

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8186
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67

95

925s87g
eei3753,6,2gg'7,g6

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47
84622

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7277
8

o
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94

6290

7478

E

39

19

42

43

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o

1

2

Average Numberof Suppliers

3

4

5

Each Firm Procures from6

99
IVOBEOKA : AL TER NA TI VE COMPONENT SO UR CING STRA TEGIESAppendix 3 Sourcing

Toyota and Nissan

Strategy at't"oyota

754

1.0

143t33 341112 26645 56

2?

72

238

46

gi?g
gs

93

70

4

48

Hcrfindahl

77

Index

17

47

16

299,

43

O.5

B

6g 9

73

28
20

86so

62

21

42
58

19

7

Y8

13

85

6165

1

52

59

8i S95

29

5t

88

89 s7

37
5

75

4

8 s3 3

39 67

4

25

7

71

23

3291
92

9S,46,6374

60

3e

o

5

1

6

Supplier Sharing Indcx

Nissanll12172d

45506974
76788516

Herfindahl

Index
O.5

728

Sesg9 ,71

22 2343 44

1.0

66

36 63

ss

46

82 55

38

15

40
6tO
IB
7758
ai
54
94 4

gg

73 56

39

52

89

86
87

34 25

48

31

68

79
37

9

541
26

95

1

51

32

gg

33
67

81

47

24

62
3

94

90

80

s 29

618B 75
53

20
59

8

30 60

5

o

6

Supp}ier Sharing Index
NTote: 1) Rectangles inare supposed to be atto Appendix 1 for thethe picture mean that all data
the same position at the centercomponent numbers.

pomts inside therectanglesof the2) Refer

rectangle.

KOBE ECOIVOMIC & BUSINEss REVIEVV, 41 (1996), 101-132

VALUE NETWORKS, INDUSTRY STANDARDS,
AND FIRM PERFORMANCE IN THE WORLD-WIDE
MOBILE COMMUNICATION INDUSTRIESJEFFREY L. FUNK Kobe University

Abstract
This paper uses the concepts of enactment and value networks to explain
competition in the mobile communication industries. The most successful suppliersof mobile communication services, equipment and phones for a particulartechnology have been located in countries which have successfully enacted theseeffective value networks. These effective value networks include suppliers ofservices and products where the services and products adhere to a communication

standard that is widely adopted throughout the world. Although incumbents haveby and large been successful in the adoption of competence-destroying innovations,most firms have been trapped by their own value networks and thus have been
unable to be successful in more than one generation of technology. Although thesefirms have and continue to expect technological discontinuities to occur and thus

restart the competitjon between dominant designs, most fjrms have been unable toparticipate in or have ignored the competition between dominant designs which has

occurred outside of their own value network.
JEL cLassification: L14; L62

Kaywords: Mobile; Communication; Standards; Enactment; Phones; Technology;
Management; Innovations; Competencies

Corresponding Address:
Jeffrey L. FunkResearch Institute for Economics and Business Administration, Kobe University
2-1 Rokkodai-cho, Nada-ku, Kobe 657, Japan
E-mail: funk@rieb.kobe-u.ac.jp

Fax: (81)-78-803-0399 '102

KOBE EeONOMIC & BUSIIVESS REVIEW, 41 (1996), 101-732

1. Introduetion

Changes in technology are accelerating particularly in theinformation technology industries. For example, waves of technologicaldiscontinuities are causing major changes in public (e.g., internet) andprivate (intranet) computer networks, public wireline and mobile voicecommunication networks, private wireline and mobile (private branchexchanges) communication networks, and content providers for these
networks. These changes in technology are quite different in several
ways from the technological changes that have been the focus of mostprevious studies on technological change.

First, the pace of technological change has accelerated to such an
extent that many incumbents expect these changes and thus they havebecame much more proficient at adapting to these changes than thefirms who have been the subject of many past studies (Tushman &Anderson, 1986; Anderson & Tushman, 1990; Utterback, 1994). Many
incumbents have been able to adopt both competence-destroying andenhancing innovations (Christensen & Rosenbloom, 1995; Iansiti, 92).
When technological discontinuities are occurring once every few years,
it is difficult for firms not to be aware these changes are occurring
and will continue to occur.
Second, many of the information technology industries that areexperiencing these rapid technologjcal changes are network relatedindustries. Since these industries provide network related products andservices, network externalities have a strong effect on competition inthese industries (Rofles, 1974; Oren & Smith, 1981). The success of
individual firms will therefore depend on their successful establishmentof industry standards and the creation of these standards will require
a subtle combination of collaboration and competition (Asaba, 1995).

Third, these network-related industries are extremely complex. A
single firm cannot supply all of the equipment needed to create such asystem. In addition to the firms that operate the services and provide
content for the services, multiple firms are typically involved withconstructing these networks. Furt,hermore, technological changes are
occurring at multiple levels in these network related industries; at the

network level (both in service and content), the equipment level, thehandset or terminal level, and the component level.
Fourth, the information technology industries are very different

103
FUNK: VALUE iVETWORKS, INDUSTRY STANDARDS, Amo 17IRM PERFORMANCE

from industries that have previously depended on networks such as theutjlity industrjes (e.g., telecommunications, electric power, gas, andwater) where regulated monopolies managed the entire system. The

regulated monopolies determined the system and sub-system's
technological standards, the technologies that would be used in eachsub-system, and the way in which complementary technologies wouldinteract. Since the start of deregulation however, the utility and theinformation technology industries have changed dramatically. New
technologies are not being introduced in a controlled manner by aregulated monopoly. Instead, a combination of competition andcollaboration are determining the technological standards and the
choices of individual technologies in the systems and sub--systems(Asaba, 1995).

Fifth, governments play a much more important role in theinformation technology industries than in the non-information
technology industries and this role is much different from the role they

played in the regulated networks. Part of this required role is related
to standards and their associated network externalities but it is also'
due to the shortages of public resources such as communication
frequencies and the large effect that information technology is expected

to have on many aspects of society.

Sixth and of greatest import, competition between alternative
designs is occurring both at the national and the world-wide level in theinformation teehnology industries. Countries are developing different

information technology networks in response to different needs,
different institutional settings, and different philosophies about
competition and technological change. Therefore, there is competition
occurring simultaneously between designs at both the country and theworld-wide level. Although this competition is first occurring at theindividual country level, as different dominant designs emerge invarious countries, the competition eventually changes to competition
between the dominant designs from a variety of countries.

This study looks at competition in the mobile communicationindustries which display the six attributes mentioned above. There havebeen multiple technologicaJ discontinuities and additional discontinuities

are underway and expected to occur in the future at the network,
equipment, and handset level. Network externalities and governments
have and continue to play a strong role in the competition between

104 KOBE ECONOMIC & BUSIAIEss REVIEW, 41 (1996), 101-132

firms at the country and the world level even with the deregulation ofthese industries. With each technological change, there has been
competition first at the individual country level and then subsequently

between dominant designs from multiple countries at the world-widelevel.

'

Further, the technological discontinuities in the mobile
communication industries are not just effecting mobile communication

networks; they are also effecting public and private computer
networks, public wireline voice and data communication networks,
private branch exchanges, and content providers for these networks.
Since the evolution of the mobile communication networks and theinterplay between the mobile and non-mobile communication networks
are both country dependent, they will cause each country's information
technology networks to evolve in different ways.
Some readers will argue that it is too early to draw conclusions

about competition in the mobile communications industry sincetechnological changes are still underway in this industry. The author
agrees that conclusions about an industry that is undergoing a great

deal of technological change cannot be as robust as those in anindustry which has matured. However, most segments of theinformation technology industries are undergoing similar changes andthus the same argument could be made against trying to explain
competitjon in most segments of the information technology industries.
This would be unwise given the importance of these industries.
There are also multiple benefits to such a preliminary investigation.

First, such an investigation may shed light on future competition inboth the mobile communication and other network-related information
technology industries. Second, there is 20-20 hindsight; it is very easy
to mold theories to fit the past. On the other hand, the limitations oftheories becomes much clearer when they are used to predict a priori
the expected technological changes and their effect on competition in anindustry.

This paper uses the concepts of enactment and value networks to
explain competition in the mobile communication industries. Similar toprevious research on enactment, mobile communication firms and theirgovernments have differed in their capability to enact effective
environments. In the case of mobile communication it is the enactmentof effective communication networks or to use a more general term,

105
FUNK: VALUE NETTVORKS, INDUSTRY STANDARDS, AND FIRMPERFORMANCE

effective value networks that has been central to success in the world-

wide market. A value network represents both the nested architecture

for a system or product and the nested network of producers andcustomers in the system (Christensen & Rosenbloom, 1995).

Each technological discontinuity has required the enactment ofeffective value networks. The most successful suppliers of mobile

communication services, equipment and phones for a particulartechnology have been located in countries or regions which havesuccessfully enacted these effective value networks. These effective value

networks include suppliers of mobile eommunication services, equipment

and phones where the services, equipment, and phones adhere to acommunication standard that is widely adopted throughout the world.
Institutional, philosophica}, and market differences have caused
countries to create different types of value networks.

In the US and Scandinavia, the early choice of analog eellular
standards and the realization of low costs caused the number ofsubscribers to rise in both the US and Scandinavia. With digital eellular

technology, while the US emphasized competition between a variety ofstandards it was Europe that set an early standard (GSM) which has

subsequently been adopted by most of the world. With personalcommunication services, Japan's early choice of a standard (PHS) andthe creation of a system that is much cheaper albeit somewhat
functionally inferior to digital cellular has opened up an entirely newmarket for mobile communication services. It appears that the PHS
standard will be adopted by a large number of Asian and SouthAmerican countries. Further, the emergence of new technologies has
already started a new round of competition between dominant designs
in both the cellular and personal communication services markets. In
particular, the merging of mobile phones, pagers, laptops and personal
digital assistants is expected to cause changes in both the mobile andwireline, both public and private, and both voice and multimedia
communication networks.
Although incumbents have by and large been successful in the
adoption of competence-destroying innovations, most firms have been
trapped by their own value networks and thus have been unable to be
successful in more than one generation of technology. Although thesefirms have and continue to expect technological discontinuities to occur
and thus restart the competition between dominant designs, most firms

106KOBE ECONOMIC & BUSIIVESS REVIEW, 41 (1996), 101-132

have to some extent ignored the competition between dominant designs
which has occurred outside of thelr own value networks and thus foundit difficult to partieipate in the creation of these dominant designs.

Therefore, while US and Scandinavia firms dominated the analog
cellular market, it was difficult for US firms to participate in thecreation of Europe's GSM standard and the result is that European
firms are the leading suppliers of digital cellular technology. Most
recently, Japan's Personal Handyphone System (PHS), which has been
ignored by non-Japanese firms, appears as if it will enable Japanesefirms to become for the first time significant exporters of
telecommunications infrastructure equipment and services.

This paper first discusses previous research on technologicaldiscontinuities and dominant designs including value networks, network
externalities, and enactment. Second, it describes the methodology usedin the study. Third, it uses a modified form of Christensen and
Rosenbloom's (1995) concept of the value network to explain the
success of ineumbents or new entrants in the three major (North
America, Europe, and Japan) regional markets of the world. Fourth,the paper argues that the most successful firms for a specifictechnology are from countries that have enacted an effective value
network. However, most firms have been trapped by these va}ue

networks and have been unable to succeed in the subsequent
technology. Fifth, the paper uses the results from competition in analog
and digital cellular and personal communication services to predict how

competition will evolve in future generations of mobile communication
technologies and how this competition will effect public and private
wireline networks.
2. Previous Research
There are three lines of academic research which are central to thearguments made in this paper concerning technological change andcompetition in the information technology industries: 1) technologicaldiscontinuities and dominant designs; 2) network externalities; and 3)

enactment. The concepts of technological discontinuities and dominant
designs were first proposed by Abernathy and Utterback (1978) in thelate 1970s. These technological diseontinuities have either overturned theconcepts that underlay the product (Utterback, 1994) or the product's

107
FUIVK: VALUE NETW'ORKS, JIVDUSTRY STAswARDS, AND FIRM PERFORMAIVCE

architecture (Henderson & Clark, 1990). In several industries, multiple
generations of these technological discontinuities have been identified(Utterback, 1994; Anderson & Tushman, 1990; Tushman & Anderson,1986).

The success of incumbents vs. new entrants has been an importantresearch question within the area of technological discontinuities anddominant designs. Incumbents have usually been the successful
adopters when the innovation enhances the incumbent's competencies
whereas new entrants have usually been the successful adopters when
the innovation destroys the incumbent's competeneies (Utterback, 1994;

Anderson & Tushman, 1990; Tushman & Anderson, 1986; Henderson &Clark, 1990).

However, studies of recent technologies have found that incumbents
have also been successful with the adoption of competence-destroying

technologies (Iansiti, 1992; Christensen & Rosenbloom,1995).
Christensen and Rosenbloom argue that value networks are a better
explanation for the success of either incumbents or new entrants in the
adoption of new innovations in the disk drive industry. Their concept ofa value network builds off of Henderson and Clark's (1990)
differentiation between system-wide and component-based innovations.
They extend this concept by demonstrating that many products involve

multiple layers of systems and components which they call value
networks. These va}ue networks not only describe the nested physicalarchitecture of a product system, they also represent a nested networkof producers and markets through which the tradable components are
made and sold to integrators at the next higher level in the system. A
firm's competitive strategy, in particular, the markets that it haschosen to serve are reflected in the value network that the firm
operates within and the firm's position in that network.
It is difficult for a firm to adopt an innovation that best meets theneeds of customers that are not within a firm's value network. The
formal and informal establishment of a firm's organizational routines
tend to focus the firm's attention on existing customers. On the other
hand, when an innovation is particularly suited to the needs of existingcustomers, it is more likely that firms will adopt the innovation, even if

the innovation may destroy some of the firm's competencies. This wasfound to be the case in the disk drive industry. The incumbents
developed competence-enhancing and destroying innovations which

108 KOBE ECOIVOMIC & BUSINESS REVIEVV, 41 (1996), 101-132

helped them better meet the needs of firms above them in their value
network (i.e., existing customers) and they did not develop thoseinnovations which would have helped them better meet the needs of new
customers (i.e., firms in a different value network). The incumbent's
linkages with existing customers and their lack of linkages with newcustomers caused them to focus on those innovations which helped
them meet the needs of existing customers. New entrants developed theinnovations that were of interest to new customers (Christensen &Rosenbloom, 1995).

Network externalities have direct and indirect effects ontechnological innovation and competition in network-related industries(Rofles,1974; Oren & Smith,1981). The direct effect of network
externalities is that the value-to cost ratio of a product is a function of

the number of users. In the telecommunication industries, the value ofa product is related to the number of people with which a person cancommunicate. For example, although ATT originally had higher
charges for calls than the competition in the early 1900s, the ability tomake long-distance and overseas calls increased the number of people
with whom a user could communicate and thus increased the value ofa subscription to ATT (Asaba, 1995)
The indirect effects of network externalities are when the numberof users has an impact on complementary products (Katz & Shapiro,
1985; Hayashi, 1992). For example, as the amount of hardware (e.g.,
MS-DOS computers) available to a particular software type (e.g.,
Microsoft's operating system) increases (or visa versa), the value ofthe software increases. In particular, if there are economies of scale as

there are with software, the price reductions of software provide
substantial positive feedback. Therefore, software producers produce
software for the most popular computers and visa versa (Conner &Rumelt, 1991)

The strong effect of network externalities on competition in
network-related industries such as the information technology
industries increases the importance of creating industry standards
which primarily occurs by increasing the number of users. However,the competition between VHS and Beta and between NEC's Series 98
and other personal computers suggest that price and features are notthe only factors that increase the number of users and thus drive thecreation of industry standards (Asaba, 1995).

FUNK: VALUE iVETWORKS, JIVDUSTRYSTANDAR,DS, AND FIRMPELRFORMAIVCE 109

Asaba (1995) argues that a subtle combination of cooperation andcompetition is needed to succeed in both the creation of industry
standards and the subsequent competition once a standard has been
determined. Firms share information in order to create a standard
while they simultaneously create a competitive advantage in order toprofit from the fixed standard. For example, in the video disk market,
the most profitable firms participated in the creation of a hardware
standard and then made their profits through the sale of software.

However, it is still unclear how this subtle combination ofcooperation and competition should be carried out. It is particularly
unclear how it should be carried out in the information technology

industries which are more comp}ex than the cases which have been
considered in previous research on network externalities. The networks
in the information technology industries are more complex in terms ofthe number of components, the interplay between service, component,
and content providers, and the degree of technological change in boththe system network and its components than the cases considered in
the previous research. Further, competition at both the national andworld-wide level and the role of national governments has not been
considered in the previous research.

This paper uses the concept of value networks and enactment to
explain competition in the mobile communication industries. Firms
enact their environments and these environments include customers andsuppliers (i.e., value network), government regulations, labor markets,and sources of technology. However, firms often do not recognize thatthey are enacting their environments.
In particular, decisions made during a technological discontinuity
concerning choice of customers often have a large impact on the firm's
subsequent ability to compete.

3. Researeh Methodology
This research on the mobile communication industries grew out ofa study on the management of product development in the cellu}arphone industry where about 20 interviews where conducted withengineering and marketing personnel in five producers of cellular
phones between 1993 and 1995. Questions were asked about project
selection, management of project portfolios, management of individual

110

KOBE ECONOMIC & BUSINESS REVIEW, 41 (1996), 101-132

projects, measures of product performance, methods of redueing cye}etime, and market share (Funk, in press). Through these interviews, it

became clear that the generational changes in technology and therelationships between cellular phone, base station, and service
providers, retail outlets, and the final users are critical issues in themobile communication industries.

Therefore, a broader set of interviews along with a broader
literature search was conducted to understand the key technologicalinnovations in the industry, the effect of these innovations on theincumbent's competencies, the relationships between cellular phone,base station, and service providers, retail outlets, and the final users,
and the reasons for success in these industries. These interviews havebeen carried out during the fall of 1995 and the spring, summer, andfall of 1996. More than 30 interviews have been conducted withengineering, research, marketing, and director level personnel in not
only cellular phone companies but also in service providers, basestation providers, mobile communication consulting organizations,
government agencies concerned with the communication industries, andin universities (communication engineers).

4. The Value Network and the Suecess of Incumbents or New Entrants
in North Ameriea, Europe, and Japan
Table 1 summarizes the major technological innovations in mobile
communication, the effeet of these innovations on the incumbent's
competencies, the changes in the value network, and the success of

incumbents or new entrants. Although there were mobile
communication system predecessors to analog cellular in many
countries, analog cellular was the first mobile voice communication
system that was available to a large percentage of the public. Digitalcellular is now available in most industrialized countries while analog
cellular is being phased out in most countries albeit slowly in the US.

Personal communication services are being installed in most countries
but only Japan has a significant number of subscribers.
In the case of analog cellular, the change in competencies is inreference to wireline technology while for digital cellular and personalcommunication services, the change in competencies is in reference toanalog cellular and digital cellular respectively. As shown in Table 1,

111
FUNK: VALUE rv'ETiVORKS, INDUSTRYSTAswARDS, AND FIRMPERFORMANCE

Table 1. Changes in Competencies, the Value Network, and the Successof Ineumbents vs. New Entrants in Major Regions (US,Japan,and,Europe)

Ness, Product Change in Change in Top Market

Tuaeehl -TLyllg SC2Q!ppg!gn!iet ValueNetwork ShareFirms
Ana)ogService

destroying

CeHularBase Stations

destroying

Phonesdestroying

none
none
Deregulation

Incumbents

Incumbents
New Firms Ent,er

Digital Sersice destroying none Incumbents

Cellular BaseStation destroying none Incumbents

Phones destroying Deregrilarion NewFirmsStrengthen

PCS Service enhancing none Incumbents
BaseStation enhancing none Incumbents

Phones enhancing Deregulation New Firms Strengthen
Dere.frulationJ Relationship bets-'een service provider and handset producer weakens.

analog and digital cellular technology are characterized as competence-

destroying innovations. Different models of propagation andattenuation are used in wireless systems (through air) than in wireline(through copper wire or fiber) systems. There are well-developed mod
els/rules of thumb that are used to estimate attenuation of signals

through copper wires and fiber that do not account for the different
types of attenuation that exist in wireless systems (e.g., attenuation inwooded vs. urban areas
Digital cellular technology is also characterized as a competencedestroying innovation. However, according to engineering and researchpersonnel who were interviewed, digital cellular technology requires lessnew competencies than analog cellular technology. It requires adifferent set of design skills than those found in analog technology andfor this reason it is often characterized as a competence-destroying
innovation (Utterback, 1994; Anderson & Tushman, 1990; Tushman &Anderson, 1986; Christensen & Rosenbloom; 1995). Although it has
several advantages over analog technology, it has been primarily
implemented because it uses the frequency spectrum about twice as

efficiently as analog cellular technology. 'Personal communication services is characterized as a competence-enhancing technology. According to the engineering and researchpersonnel who were interviewed, most of the technology used in112

KOBE ECOATOMIC & BUSINESS REVIEve', 41 (1996), 101-132

personnel communication services are not new. The samecommunication protocols are used in both digital cellular and personalcommunication services. The major difference is in the size of the cells.
While digital cellular systems have cell radii on the order of 1-3 miles,

some personal communication service systems have cell radii that areas small as 100 yards. Since the allocated portion of the frequency

spectrum can be reused in multiple cells, personal communication
service systems use the frequency spectrum much more efficiently thandigital cellular systems; potentially as much as 100 times as efficiently.

In addition, the small cell sizes enable low power base stations and low

power phones to be used that are much less expensive than digitalcellular base stations and phones and in the case of phones, have much
longer battery lives.

Standards are now being developed for the Future Land Mobile
Telephone System (FLMTS). This system is expected to have highspeed data communication capability including the capability totransmit moving pictures. It is also expected to integrate existing
mobile phone systems by being accessible by phones that are based onmost existing analog and digital standards. CDMA is the major
candidate for the FLMTS standard.
Multimedia communication is expected to represent a significant
percentage of the calling volume in mobile phone services in the future.

Although data communication services and terminals already exist(e.g., alphanumeric paging), it appears that mobile phone service
providers will begin to take pver this market due to the limitations ofpagers, the advantages of mobile phones, and the desire not to carry
multiple handsets. Pagers have limited data communication and display

capability and most mobile communication users also want thecapability to communicate with voice. Laptops and personal digitalassistants that can be connected to mobile phones via a modem haveexisted for several years and devices that contain mobile phones havebegun to appear. The market for these devices is expected to grow as
their prices drop and additional services become available that areaccessible by these devices.

5. Suceess of Incumbents and New Entrants
As shown in Table 1 there is no relation between the effect of the'113
FUNK: VALUE NETLVORKS, INDUSTR Y STANDARDS, AND FIRtXf PERFORMANCE

innovation on competencies and the success of incumbents or new
entrants. Success is measured in terms of market share and this isdiscussed in more detail below. In all cases, the incumbents are
assumed to be the providers of wireline service, equipment, and phones

before deregulation was introduced in the communications industries.
Incumbents have been successful in providing service and base stations
while new entrants have been successful in phones.

In mobile communication services, although there have been anumber of new entrants due to the ending of national telephonemonopolies, wireline service providers have been able to maintain alarge share of the mobile service market and their market shares haveactually increased following the emergence of digita•1 technology. In the

US many of the new small cellular service providers have since beenacquired by incumbents such as AT&T, Sprint, GTE, and the Bell
Regional Holding Companies (RHCs) who now have more than a 75%
market share in cellular services. In Japan, all of the long-distancewireline service companies also provide cellular and personalcommunications service through a variety of majority owned
subsidiaries (Kojima, 1996). In Europe, the national telephonecompanies still provide most of the cellular service and the recent
newcomers are consortiums that include wireline service providers frommultiple countries.

Most of the mobile communication equipment makers were and still
are the major producers of wireline equipment. Of the top 15 wireline
and mobile communication equipment providers, only Ascom, a Swiss
provider of small central office switches and Bosch do not produce
mobile communication equipment while Motorola is the only mobile
communication equipment producer that is not a supplier of wireline
equipment or telephones. Motorola made the transition from supplying
mobile radios, pagers, and the initial wireless equipment for thepredecessor to analog cellular to become the number two supplier ofmobile communications equipment in the world (Morone, 1993).
However, new entrants, particularly firms with experience in the
consumer electronics industries have been much more successful in thephone market. Motorola and Nokia, neither of whom produce wireline
handsets are the two largest producers of cellular phones in the world.

Nokia is a producer of consumer electronics products such as
televisions and monitors and Motorola is a producer of pagers and it

114 KOBE ECONOMIC & BUSINESS REVIEVIi, 41 (1996), 10J-132

was a producer of consumer electronics products such as televisions
and radios until the late 1970s. In the US, Motorola and Nokia have40906o and 20% of the market respectively. In Europe, Nokia is number

one and Motorola is number 2. The remaining firms are primarily
Japanese. As is described below, although in the 1980s the strongest
Japanese firms were once wireline phone producers, their shares havesteadily decreased in the US, Europe and in Japan while the shares of
new Japanese entrants has increased.

The Value Network and the Success of Incumbents and New Entrants
The success of incumbents in the service and base station markets
and the success of new entrants in the phone market can be explainedin terms of the value network. Figure 1 shows an example of a value

network for the mobile communication and wireline communicationindustries. Individual businesses or consumers create their own
communication systems. They purchase a variety of devices such as
phones, facsimiles, and computers along with a wireline or mobile
communication service. The wireline service providers construct a
communication system with switching and transmission equipment
while the mobile communication service providers use switchingequipment and base stations.

One important difference between the value network shown in
Figure 1 and the value network used by Christensen and Rosenbloom intheir study of the disk drive industry is the role of the government andgovernment-industry organizations, All of the devices shown in Figure
1 interact through standards that are created by government agencies
and government-industry organizations. Firms attempt to develop andsell products that support adopted standards while also lobbying
governments to adopt certain standards that are supported by theirdesigns. In addition, since spectrum space is the limited resource inmobile communication, governments or government-industry
organizations allocate spectrum space to various companies which also
results in determining the amount of competition in the market.
In the case of service providers there has not been a major change
in their value networks at the regional level and thus the wireline
service providers have been able to make the transition to analog
cellular, digital cellular, and personal communication services. The

users of wireline' service and their particular needs have not

115
FUNK: VALUE NETiVORKS, ImoUSTR Y STAIVDARDS, AND lillRM PERFORMIANCE

Figure 1. Value Network for Wireline and Wireless Communication!/ud!yidua[LCg!pE!nu!ggagg!L$ys!ndividualCommcatioSt

PBXs

Wireless andWireline Service

Mobie
Fax

SwitchingPh
ones

Equipment'

Wireline
Base Station

Equipment
WirelineandTransmission

Wireless
ServiceEquipmentA.
nswerlng

Machineeregulati

PhonesCordlePhonesComputers

significantly changed. More importantly, the wireline service providers
have used their connections with government agencies to acquire thenecessary spectrum space for analog and digital cellular and personalcommunication services. In the case of digital cellular and personalcommunication services, since these technologies use spectrum space
more efficiently than their predecessors, government agencies havebasically forced companies to adopt these new technologies by only

on

116

KOBE ECOIVOMIC & BUSINEss REVIELV, 41 (1996), 101-132

allocating new spectrum space for the new technologies.

There has also not been a change in the value network for basestation providers and thus most of the wireline equipment makers havealso been able become the dominant suppliers of base stations foranalog cellular, digital cellular, and personal communication service.

Since most national telephone companies were awarded the initial
contracts for mobile communication service, the wireline equipment
makers have used their connections with the national telephonecompanies to understand mobile communication equipment needs andtechnology and to obtain the mobile communication equipment
contracts. More than 70% of the mobile communication equipment
orders that have been received by traditional wireline equipment
makers have been from the telecommunication authorities. Motorola,which does not produce wireline equipment and thus did not originallyhave connections with the national telephone companies, has only
received 30% of its orders from the national telephone companies. It

has been the most suceessful supplier of equipment to mobile
communication service providers who are either new to a particularregion (e.g., US service providers who have started services in othercountries) or new entrants to the business (USITC, 1993).

In the phone market, there has been a change in the value networkand this has enabled new entrants to succeed. However, the way inwhich changes in the value network have caused new entrants tosucceed is different from Christensen's and Rosenbloom's study of thedisk drive industry. In the case of disk drive industry, since the newtechnology was more appropriate for new customers as opposed toexisting customers, the incumbents ignored the new technology because
they were too focused on their existing customers. Therefore, newentrants become the suppliers of the new technology for the newcustomers. In the mobile communication industries when new entrants'
succeeded in the phone market, it was not because the technology was
more appropriate for new customers. Instead, deregulation of thetelecommunication market has caused changes to occur in therelationship between phone producers, service providers, and the final

users. These changes have enabled new firms, particularly firms which
experience in the consumer electronics industries to become the mostsuccessful providers of mobile phones.

As shown in Figure 1, these changes were concerned with the

17UIVK: VALUE NET"t'ORKS, IswUSTRYSTANDARDS, AND 171RMPEJRFORjlttANCE 117

relationship between the handset producers, the service providers andthe final customer. The relationship between the service providers andproducers has weakened thus enabling new entrants to enter themarket. In particular, as deregulation has proceeded, phones havebecome more like consumer electronics products that are sold directly

to consumers for use in their individual communication systems(outside box) without any interaction with the service providers (insidebox). This has enabled firms with consumer electronics experience tosucceed. For traditional wireline and analog cordless phones, thischange has already occurred; consumer electronics firms now dominate

these markets in most countries. 'For mobile phones, however, the pace at which this has occurredhas varied by country depending on the openness of the standards andthe tightness of the relationships between service providers and phone
producers. Open standards were adopted the fastest in the US where
new entrants such as Motorola have replaced the incumbents (e.g.,

GTE and ATT) as the major suppliers of mobile phones. Japanesefirms (e.g., Matsushita, NEC, Mitsubishi, Fujitsu, and Oki Electric) who

were also once the main providers of wireline phones in Japan provided
the majority of mobile phones in the US in the mid- and late 1980s.

However, their shares have subsequently dropped for the reasonsdescribed below while a new entrant Nokia has become number 2 in the
US market and Motorola's market share has continued to increase.
In Europe, although open standards were not adopted as quickly asin the US, by the late 1980s most countries had adopted an open analog

standard such as AMPS, TACS (similar to AMPS) or NMT. New
entrants such as Motorola, Nokia, Technophone (subsequent}ypurchased by Nokia) and the Japanese firms mentioned above quickly
became the dominant firms. Similar, to the US, the Japanese firms havesubsequently seen their shares steadily decrease in Europe during the
1990s for the reasons described below.

In Japan, these same firms who originally provided NTT withwireline phones have also seen their shares of the mobile phone market
decrease. However, these changes have taken longer than in the US andEurope because long-term relationships are more important in Japan
than in other countries, until recently the standards were not open, andthere was little competition between service providers in Japan. Until

recently, one firm (NTT) provided most of the mobile communication

118 KOBE ECOIVOMIC &BUSINESS REVIEW, 41 (1996), 101-132

services, it controlled the specifications for the system, and it would

only work with a certain set of phone suppliers. These suppliers had
worked with NTT almost since its inception more than 100 years ago
and they held the largest share of the Japanese cellular phone market

in the following order (1 Matsushita; 2 NEC; 3 Mitsubishi; and 4
Fujitsu) until the early 1990s.

It was only as other service providers (non-NTT firms) entered thecellular market in the late 1980s and standards were made open in theearly 1990s that new entrants have succeeded. As non-NTT service
providers have increased their share of service subscribers, theircellular phone suppliers have also increased their share of the cellular

phone market. These firms had not worked with NTT on cellular phonedevelopment nor did NTT's phone partners work with non-NTT service
providers. By early to mid-1990s, new firms such as Kyocera, Toshiba,
Motorola, and Sony had become leading producers of mobile phones inJapan.
New entrants with consumer electronics experience have become
even stronger in the PHS phone market. The market share rankings forfiscal 1995 (through March, 1996) were: 1) Matsushita; 2) Sharp; 3)
Kyocera; 4) NEC; 5) Kyushu Matsushita; 6.)Toshiba; 7) Sanyo; and 8)
Casio. Of these firms, four of them are not in the top eight producers
for digital cellular handsets and only two firms, Matsuhita and NEC,
were providers of wireline phones before deregulation of the phonemarket occurred. The primary reason for the change in market sharesis that PHS communication standards were made open from the
beginning and non-NTT service providers have more than 70906o of theservice subscribers. Both of these factors have enabled new firms toenter and succeed in the market. In particu}ar, the two PHS service

providers who together have more than 709(of of the subscribers
primarily work with non-NTT phone suppliers most of whom areconsumer electronics firms.

6. The Enactment and Entrapment by Effective Value Networks
Success at the regional level does not necessarily translate into
success in the world market, again measured in terms of market share.
Each technological discontinuity has required the enactment of effective
value networks. The most successful suppliers of mobile communicationFUNK: VALUE NETTVORKS, INDUSTRYSTANDARDS, AND FIRMPERFORil4AIVCE 119

services, equipment and phones for a particular technology have been
located in countries which have successfully enacted these effective
value networks. These effective value networks include suppliers ofmobile communication services, equipment and phones where theservices, equipment, and phones adhere to a communication standard
that is widely adopted throughout the world.
The adoption of a communication standard that is wide}y adopted
throughout the world is important since the direct and indirect effects

of network externalities are very important to mobile communication
products. First, the value of a mobile phone is strongly related to thenumber of people which can be contacted with the phone. For the initial
applications of mobile phones, this was not a major issue since mostphones were used in a local area and most calls were connected withwireline users. However, as the number of mobile phones has increased,
the demand for using the same mobile phone in multiple areas including
multiple countries has increased and the demand for calls to othermobile phone users has increased. Both of these trends increase theimportance of interconnnectivity between phones.
Second, there are significant economies of scale associated withmobile communication. AIthough for service providers these economies
of scale are also extremely important, this is a different issue than theissue concerned with creating a communication standard that is
adopted by a large number of countries.
Countries and service providers choose standards partly based on theirforecast of which standard will be most widely used and thus will havethe lowest cost phones and equipment in the future. Further, as non-voice mobile communication becomes more important, countries andservice providers will choose standards partly based on their forecastof which standard will be used for these applications and thus have thelowest cost complementary products.
Institutional, philosophical, and market differences have caused
countries or regions to value the importance of interconnectivity andeconomies of scale and thus enact different types of value networks
including different types of communication standards. The creation ofthese value networks and the choices of these standards has largely
determined the level of success for a firm and a particular technology.
However, few firms have succeeded in more than one generation oftechnology. Most firms have been trapped by their own value networks

120 KOBE ECONOMIC & BUSIIVESS REVIEW, 41 (1996), 101-132

and thus have found it difficult or in some cases ignored thecompetition between dominant designs which has occurred outside of
their own region. Similar to Christensen & Rosenbloom's findings that
it is difficult for a firm to adopt an innovation that best meets theneeds of customers that are not within its own value network, it is alsodifficult for a firm to consider dominant designs that are developed

outside of the firm's value network. The formal and informal
establishment of a firm's organizational routines tend to focus thefirm's attention on exjsting customers and the dominant designs they
are considering.

Table 2 summarizes the most successful firms for each technology,
the firm's geographical regions, and the standards that underlay the

successful value networks. North America (AMPS) and Scandinavia(NMT) each adopted a single analog communication standard and thenumber of users increased rapidly primarily due to falling prices. Bothcountries believed that a single standard was necessary in order forconnectivity; for example, in order to reduce the risk of obsolescence toearly users in the US, the US government required that all subsequently

made phones be made compatible with the AMPS standard. The US
experienced falling prices through the introduction of competition (aduopoly was introduced in each region) while Scandinavian countries
realized falling prices through government oversight. The result of thesingle standards and the growth in subscribers is that most of the restof the world has adopted either the US or Scandinavian analog
standards and US and Scandinavian firms provide most of the analog
service, equipment, and phones in the world.
However, with digital technology, the US used its success in the
personal computer industry as a model for setting standards in digitalcellular technology. It approved a number of communication standards
and encouraged competition between them in the expectation that thebest "defacto" standard would emerge. Further, since the needs for
digital technology are much lower in the US than jn Japan or Europe,
the US have been very slow in the adoption of digital technology. The
major benefit of digital technology is its greater efficiency in terms offrequency spectrum. However, due to the differences in population
density, the US has sufficient frequency space even with analog
technology.

Europe on the other hand, had multiple analog standards and17UNK: VALUE IVETWORKS, INDUSTRY STANDARDS,
AND FIRM PERFORMANCE
121

Table 2. Most.Suecessful Firms m the Worldwide WirelessCommunication Industries
New
LTLggnpg!Qgyh1.dnalog
Cellular

Product
Most Communication.TLyRe pSggggssuuflFirms
SC2guu!ry Standa!Ld
Service'

AT&T, Baby Bells NorthAmerica AMPS

Scandinavian Sca'ndinavian NMT

Base Stations Motorola, Northern Telecorn, AT&T North America ALMPS

Ericsson, Nokia Scandinavian NMT

Phones Motorola North Arnerica AMPS
Nokia Scandinavian NMT
Digital

CellularService
European European GSM
AT&T,BabyBells NorthAmerica TDMA

Base Stations Ericsson, Nokia, Siemens, Alcatel European GSM

Motorola,NT,AT&T NorthAmerica TDMA

Phones Nokia.Ericsson European GSM
Motorola NorthAmerica TDrm

PCS

Service Japanese firms? Japan? PHS?
Phones Jap anese firms? Jap an? PHS?

Base Stations Japanese firms? Japan? PHS?

wanted to adopt a single digital standard (GSM) in a effort to promote
Europeanintegration; it was hoped that the same phone could be usedin different countries. Discussions concerning a digital standard began
in the early 1980s between European service providers, equipment

makers and ministries of telecommunications and they occurred
simultaneouslywith discussions to create a single European common
market. Withexpectations for and the subsequent realization of pricereductions in equipment and phones using the GSM standard, the restof the world, including many parts of the US have adopted GSM as the' standard for mobile communication. The result is that
communlcatlon
firms
have seen their shares of the mobile communication
Europeanservice, basestation, and phone markets increase dramatically.
With personal communication services, it appears as if Japan's
standard (PHS) has the greatest chance of becoming a world-widestandard. Japan has adopted a significantly different philosophy thanthe US andEurope. Through a desire to create a mobile communication
system for the masses, Japan has created a system that is muchcheaper, albeitsomewhat functionally inferior to digital cellular which

has openedup an entirely new market for mobile communication.
takes full advantage of the low cost potential of theJapan's systemsmall base station approach whereas the Europe and the US
have decidedto create personal communication systems that are almost
small cell,122 KOBE ECONOMIC &BUSINESS REVIEW, 41 (1996), 101-132

identical to digital cellular. Because both US and Europe have decided
that communication in a fast moving vehicle is a necessary capability ina mobile communication system, their personal communication systems
do not utilize as small of cells as the Japanese system and they include

complex switching equipment which also raises the costs of the system.

The Japanese Ministry of Posts and Telecommunications would
only approve a system that was 1/4 as expensive as cellular technology

in order to bring mobile communication to a large number of people.
This directive caused Japanese firms to design a very inexpensive
system in which calls cannot be made when users are travelling morethan 20 miles per hour. However, due to its low cost, there is almost 4

million subscribers and they are increasing at more than 10%o eachmonth. Further, more than ten countries have adopted the standard
and many people are predicting that PHS will become the standard for
personal communication services in much of Asia (Economist, 6/22/96).
'
Services

The adoption of the US analog standard, Advanced Mobile Phone

System (AMPS), by most of the world has enabled US firms todominate the market for analog services. As of July, 1995, 65SO)6o of theawarded analog service and equipment contracts were for AMPS. The
result of this large-scale adoption of AMPS by the rest-of the world isthat 48906o of the cellular service licenses that had been awarded toforeign firms by 1993 had been awarded to US firms while 38% of thecellular services subscribers in the world were provided service by US

firms as of 1993 (USITC,1993). GTE, AT&T and the Bell Regional
Holding Companies participate as a sole provider or as a partner in
30%o of the contracts that offer AMPS-based service (51 out of 177
contracts). On the other hand, they have only participated in 15SO)6o of

the contracts that offer NMT-based service (12 out of 81 contracts)
and 90/o of the contracts that offer TACS-based service (5 out of 57
contracts) (USDOC, 1995b).

Similar to the US, the adoption of the Scandinavian analog
standard, NMT, by a number of countries has enabled Scandinavian
firms to be awarded the second highest number of analog licenses toforeign firms (23906o) (USITC, 1993). As of July, 95, 23%o of the awarded

service and equipment contracts were for NMT (USDOC, 1995b). In
particular, most Eastern European countries including Russia andI7UNK: VALUENETVVORKS, IIVDUSTRYSTANDARDS, AND FIRMPERFORMAIVCE 123

other countries from the former Soviet Union have adopted NMT and
Scandinavian service providers participate in half of the awarded
contracts in these countries (Zehle, 1994).

Japanese and other European countries have been much slower tointroduce competition and some of them have adopted somewhat uniquestandards. For example, Germany, Japan, France and Italy were slow
to introduce competition into mobile communication services and as aresult the growth in subscribers has been very slow. Germany(CNETZ), France (RC2000), Italy (RTMS-450), and Japan (NTT HCS)
also initially adopted standards which have not been used much outsideof these eountries (USITC,1993).

With increased competition in most European countries and theadoption of GSM as a digital standard by Europe and many Asian
countries, non-Scandinavian European countries have seen their shareof the market increase. As opposed to the case of analog standards
where most European countries either adopted a unique standard or

borrowed NMT from Scandinavia, Europe as a whole has chosen GSM
thus providing European cellular providers with a greater opportunity
to provide this service in foreign countries (USITC, 1993).

Equipment Market
Similar to the market for mobile communication services, the mostsuccessful equipment producers are from countries which havesuccessfully enacted and exported their value networks. As shown in
Table 3, North American and Scandinavian (Ericsson, Nokia) firms
have participated in the most analog equipment orders. Further, mostof the participation in equipment orders has been when the requested
standards are used in the equipment provider's value network (i.e.,
domestic standards). Ericsson is the lone exception. As the largest
telecommunications equipment firm in the world in both the wireline, it
has the broadest value network (i.e., largest number and customers)
and the most resources. It was able to make a strategic decision todevelop expertise in a US standard and subsequently participate in a
number of equipment orders that were based on the US standard.
A similar story can be told with the digital equipment orders. Mostof the participants in the equipment orders supplied equipment thatwas used in the equipment provider's value network (i.e., domestic
standards). Here, Motorola and Ericsson are the exceptions. Motorola124 KOBE ECONOMJC &BUSINESS REVIEW, 41 (1996), 101-132

Table 3. Percent Participation in Non-US Equipment Orders

for Both Domestic and Non-Domestic StandardsAna]ov
Di"iTalBoth Domestic and Non=#uaxp=L;=L=!

Domestic l on-Domestic Demestic NQn-Domestic Domestic Standards

Firm Standards Standards Standards Standards tA!n!!a!s}g] pat tl

Motorola 260!o 20•'o 29io 320/o 280/o 34%
Northern Telecom ]2e/o <leie' 10f6 30/o 130/e 50f6

AT&T l2• Ofo <l ef6 12• Ofh 30/o 120/o l60/e

Plexsvs 89t'o 09.o 09.'b OOf6 80ib OO/oTotal North America 559,'o 430x o'
Ericssen ]30,o 2]O•o 390,e' 5ei'e' 350/o 440/oNokia 7efo <19.'o 229,o OOri 80,o' 220/o
Siemens 19•o Og,o 299•o OOfo ]Olo 29eie
Alcatel 20io Ogo ]50•o 09o 20/o 150,'o'Other 7% ],exo geyo oO,6 loOf6 gO/o

Total Europe 44e/o 820fo
Japan 60io '20•D 09•'o ]Of'b 80/e Oe/orecognized early that GSM would become the world-wide standard andit made a strategic decision to invest in both the US and European
standards. Ericsson also made a strategic decision to invest in both the

US and European standards. Since the data in Table 3 is only for nonUS equipment orders, the data in Table 3 does not show the extent towhich Ericsson has succeeded in the US market. It is the number two
supplier after AT&T in the US market.

The adoption of the European standard, GSM, by most of theworld has enabled European firms to become the leading suppliers ofbase station equipment. European firms were able to increase their
participation from 44%o to 82%o of equipment orders. In particular,
Siemens and Alcatel increased their participation dramatically in thebase station market. Unlike with analog cellular, they were able toparticipate in the enactment and export of the GSM based value
network. Because of the inability of US firms to enact an effective
digital value network, their participation dropped significantly (from55%o to 43SO)6o) and it would have dropped even more had not Motorola(see below) also participated in the enactment of the GSM value
network.

125
FUNK: VALUE NET;VORKS, JNDUSTRY STANDARDS, AND FIRMPELRFORMANCE

Mobile Phones
Similar to what has occurred in the mobile communication services

and equipment markets, Motorola's and Nokia's mobile phonebusinesses have benefited from their location in countries that havesuccessfully enacted an effective analog value network. As the AMPS

and NMT standards were adopted by the rest of the world, Motorola
and Nokia became the leading suppliers of mobile phones in the world.
In digital phones, European firms have benefited from Europe's
creation of the GSM standard. Motorola's share in the digital phonemarket is lower than its share of the analog phone market while
Ericsson and to some extent Siemens have seen their shares increase

dramatically. Ericsson is now the third largest producer of GSM
phones after Nokia and Motorola (total for three firms is about 80906o).

Japanese firms occupy many of the other top ten positions interms of world market share for analog and digital cellular phones. As

discussed above, the market share of new Japanese entrants has
gradually increased at the expense of the Japanese incumbents as thevalue network has changed. In addition, Japanese firms have seen theiroverall market share drop over the last ten years. In the mid-to late1980s Japanese firms appeared as if they would dominate the world
market for cellular phones in much the same way they have dominatedother products that require similar miniaturization and manufacturing
skills.

However, Japanese firms suffered from both the inability of Japanto successfully enact an effective value network in either analog ordigital technology and their lack of consumer electronic experience.
Japan enacted analog and digital value networks that revolved aroundunique standards. These unique standards required Japanese firms touse valuable resources to develop phones and base stations for thesmall Japanese market. Further, the lack of growth in subscribers (dueto lack of competition) coupled with Japan's unique standards andtheir domestic purchasing and production practices resulted in the useof high-priced domestic components. Although Japanese firms wereable to obtain more than 600/o of the US market in the late 1980s by
selling below cost in the US, a dumping conviction resulted in tariffs ashigh as 1009(of which lead to a rapid decrease in Japan's market share.

Japanese firms were much slower than Motorola and Nokia todevelop world-wide purchasing and production capability which is126 KOBE ECONOMIC &BUSINESS REVIEW, 41 (1996), 101-132

extremely necessary in the consumer electronics industry where razor

thin margins are the rule. Unlike the major Japanese consumer
electronics firms such as Sanyo, Sony, and Panasonic who began todevelop world-wide production and purchasing capabilities in the late1970s, the Japanese mobile phone producers did not begin to developthese capabilities until the early 1990s after their market shares had
declined precipitously in the US. The shares of the Japanese firms haveincreased slightly since their development of local production andpurchasing capability in the US.

With the adoption of GSM as a digital standard by most of theworld, Japanese firms have seen their shares also drop dramaticallyoutside the US particularly in Europe. For example, NEC, Matsushita,
and Mitsubishi were once the third through fifth largest producers ofanaiog phones in Japan but their shares have dropped dramaticallywith the adoption of GSM by Europe.
According to representatives of these companies, they were unable
to either effectively participate in the standard setting process andeffectively obtain patents for the GSM standard. Participation in thestandard setting process was necessary in order to simultaneously
develop the phones as the standards were finalized. Critical details
concerning the standards were not fully available without sufficientparticipation in the standard-setting process.

Patents were even a larger problem. Foreign firms are required to
pay a licensing fee .for each patent concerning the GSM standard. For
some firms, the licensing fees for all of the necessary patents are morethan 10%o of the sales of the GSM-related products. Further, thenegotiations for these patents was extremely time-consuming anddelayed the development efforts by Japanese firms. The increased
complexity of the air interface for digital GSM as opposed to analog
cellular has increased the effect of this delay.

Although Motorola has also seen its shares in the European mobile

phone market decline with the change to the GSM standard, it has
succeeded far better than the Japanese firms. Motorola recognized in
the early 1980s the importance of GSM and of obtaining patents on
GSM. The early acquisition of these patents enabled Motorola to playa larger role than the Japanese firms in the GSM standard-setting
process and to obtain other GSM patents through cross-licensing.

127
FUNK: VALUE NETWORKS, INDUSTRYSTANDARDS, AND FIRMPERFORMAIVCE

7. Future Competition in the Mobile Communication Industries and Its
Effect on Other Information Technology Industries
As discussed above, new generations of technology continue to be
introduced in the mobile communication industry. AIthough it appears
that Japanese firms have enacted an effective value network in personalcommunication services technology through their PHS standard, due toa number of emerging technologies, there may be only a 3-5 year
window for PHS. CDMA is expected to narrow the cost gap between
cellular and PHS since it is about twice as effective as cellular in termsof both the use of the frequency spectrum and the base station cost
per potential conversation. It is being introduced in the US, it is being

considered by Japan's Ministry of Posts and Telecommunications as
the next generation of digital cellular technology in Japan, and it is aleading contender for the standard in the Future Land Mobile
Telephone System (FLMTS). The standard for FLMTS will be chosen
by the year 2000.

In order for CDMA to become an world-wide standard, however,there needs to be a large number of initial users somewhere in theworld in order to convince the rest of the world that CDMA basestation and phone costs will decline. Given the slow growth insubscribers and the capacity of existing analog systems in the US, it

seems unlikely that the US will be a major consumer of CDMAtechnology unless virtually all providers of personal communication
services adopt CDMA (which is not occurring). Europe will not be amajor user of CDMA since Europe is pushing for the adoption of GSM
as the standard for FLMTS. Japan has the highest growth in mobile

communication users and it has a large shortage of frequency
spectrum due to its high population density. However, it seems unlikelythat the Japanese Ministry of Posts and Telecommunications and theJapanese service providers will adopt a foreign technology unless theyreceive a very large benefit from the developers of CDMA technology
such as inexpensive licenses to use and subsequently sell CDMA-based
products and services.

A potentially much larger trend in mobile communication is themove towards multimedia communication and the competition between
mobile communication and wireline communication. The move towards

multimedia communication represents a large technological128 KOBE ECOIVOMIC & BUSINESS REVIEVV, 41 (1996), 101-132

discontinuity in mobile communication. New services and handsets foraccessing these services have started to appear, particularly in Europe
and Japan where personal digital assistants are very popular. These
new handsets reflect a merging of PHS phones, cellular phones, pagers,
laptops, and personal digital assistants. A variety of combinations now
exist and it is expected that costs will drop and new features willcontinually be added to these new handsets.

As shown in Figure 2, there is already competition between
wireline, PHS, and cellular systems not only in the public systems but

also in private and home networks. This competition is causing
information networks in Japan, the US, and Europe to evolve in very
different ways. PHS and DECT (a European technology that is similar
to PHS in the office) -based private branch exehanges allow muchgreater user mobility in the office for only a slightly higher cost. They

are now major competitors to wireline-based PBX systems. PHS homeantennas also increase user mobility and they have lower initial costs

than Japan's wireline system. Therefore, some Japanese people aresubscribing to PHS in lieu of subscribing to NTT's wireline system andthis trend is expected to accelerate as the cost of home antennas
decrease. Further, in developing countries where wireline phones arestill rather rare, wireless local loop is much cheaper and faster toinstall than wireline phone systems. Six countries have already decided
to install PHS-based wireless local loop systems.

As multimedia information becomes available to users of mobile

communication, there will be new forms of competition between
wireline, PHS and cellular and this competition will most likely cause

information networks to evolve differently in Japan, the US, andEurope. For example, if commuters on a train in Japan or Europe wereasked about the type of electronic information they would like to haveaccess to while commuting, few would mention access to the internet.
They would most likely mention the types of information they alreadyaccess to on the train in traditional mediums: newspapers, magazines,

train schedules, maps, product and service information, andentertainment information on restaurants, bars, and events. Similarly,

if people who commute by or work out of their car where asked thesame question, they would probably respond in a very similar way
except that the information would have to be available in a voice
medium for drivers.

129
FUNK: VALUE IVETWORKS, IiVDUSTRYSTAIVDARDS, AND FIRMPERFORMANCE

Figure 2. Competition between Wireline,

Public, Private, and Home

PHS, and Cellular in
Networks

Type of
Network

Horne
Network
PrivateNetwork
Pub]icW'ire]ine

Te[ephone
Network

PnvateBranehExchange

PHS Home
Antenna andWireless Local

Wtreless Local Loop

Loop

PHSIDECT-Based
PTIvate Branch

Exchangenone

Pub[icWireiine

Public PHS

PublicCellular,PCS

Network

Telephone

Network and SAv'irelessl etrvork and Yt'irelessN, etN-'ork

Local Loop

Locai Loop

Voice

WirelinePHSC.e"uiariPCS

User Mobilitv

Text
PicturesVideo

T.v Pe lnternel
Of and inrranet
Informationmobi]eeomputing
data accessmobilecomputing
data accessinformation does not require access to the internet.
Much of this in formation already exists in an electronic format andservices and handsets for accessing these services are beginning toelsewhere. As these services and handsets become
emerge in Japan andAccess to thiswidely available and accessed, different dominant designs for
information
networks in Japan, Europe, and the US will emerge.
Eventually, these designs will compete at the worldwide level in muchthe same way thatregional dominant designs have competed in theanalog cellular, digital cellular, and personal communication services
markets.
8. Conelusions

This paper uses the concepts of enactment and value networks to
explain competition in the mobile communication industries. Eachtechnologicaldiscontinuity has required the enactment of effective value

networks. The mostsuccessful suppliers of mobile communication
servlces, equlpmentand phones for a particular technology have been
located in countries or regions which have successfully enacted these130

41 (1996),
KOBE ECONOMIC & BUSINESS REVIE;V,

101-132

effective value networks.

However, most firms have been trapped by their own value
networks and thus have been unable to be successful in more than one

generation of technology. While US and Scandinavia firms are themajor suppliers of analog-based products and services, the adoption ofEurope's standard by much of the world has enabled European firms
to become the major suppliers of digital-based products and services.
In personal communication services, it appears that the PHS standard

will be adopted by a large number of Asian and South Americancountries. This will most likely enable Japanese firms to become major
suppliers of these services and products.

Further, the emergence of new technologies, in particular themerging of mobile phones, pagers, laptops and personal digitalassistants is beginning to cause changes in both the mobile andwireline, both public and private, and both voice and data
communication networks. Since countries have different informationneeds, different institutional settings, and different philosophies about

competition and technological change, their information networks will
evolve in different ways and different dominant designs for these
networks will emerge in Japan, Europe, the US, and the rest of theworld. Eventually, these designs will compete at the worldwide level inmuch the same way that regional dominant designs have competed in
the analog cellular, digital cellular, and personal communication
services markets.

Firms need to be cognizant of how these country-dependent
differences in information networks will'effect competition in the world-

wide markets. Firms are easily trapped by their own value networks inthat firms tend to focus on existing customers and ignore changes
outside of their own value networks. This is particularly a problem forfirms with regional-based value networks.
In the mobile communication industries, firms with the broadest
value networks such as Ericsson, Motorola, and Nokia have been themost successful. In particular, Ericsson has used its large customer
based in wireline equipment to understand the evolution of dominant
designs in a multitude of countries. This has enabled it to be the mostsuccessful firm in both the analog and digital technologies. However, itappears that even Ericsson (along with other non-Japanese firms) haveoverlooked the importance of Japan's PHS technology which is most131
FUNK:VALUE iVETW'ORKS, IiVD USTR Y STANDARDS, AND 17IRi)f PERFORMAIVTCE

appropriate in countries with high-population densities. Since mobile
communication will also effect other communication networks and theseeffects will be different in high-population and low-popu]ation density

countries, information technology firms need value networks that
extend into countries with both high-and low popu}ation densities.

References
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Abernathy, W. and Clark, K., "Innovation: Mapping the Winds of Creative
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Anderson, P. & M. Tushman, "Technological Discontinuities and Dominant Designs:
A Cyclical Model of Technological Change," Administrative Science Quarterly,
vol. 35, no. 4 (December, 1990), 604-633.

Asaba, Shigeru, Kyoso to Kyoryohu no Senryahu: Gyohai HyoJ'un wo Meguru Kigyo

Kodo (A Strategy of Cornpetition and Cooperation: Firm Actions in the
Search for an Industry Standard), 1995.

Clark, K., The Interaction of Design Hierarchies and Market Concepts inTechnological Evolution, Research Policy 14 (1985) 235-251.
Christensen, C. & R. Rosenbloom, Explaining the Attackers advantage: technologicalparadigms, organizational dynamics, and the value network," Research Policy.
vol. 24 (1995) 233-257
Gregory, G., Japanese Electronics Technology: Enterprise and Innovation, Tokyo: The

Japan Times, 1986.
Hayashi, K., 1992, "From Network Externalities to Interconnection: The Changing

Nature of Networks and Economy." In C. Antonelli, ed., The Economics ofInformation Networks, Elsevier Science Publishers B.V.

Henderson, R. & K. Clark, "Architectural Innovationi The Reconfiguration of
Existing Systems and the Failure of Established Firms," Administrative
Science Quarterly, 35 (1990) 9-30.

M. Iansiti, "Science-Based Product Development: An Empirical Study of theMainframe Computer Industry," Harvard Business School Working Paper #92083.

Katz, M. and Shapiro, C., 1985, "Network ExternaHties, Competition, andCompatibility," American Economic Revieu), 75 (3),Morone, Winning in High-Tech Marhets: The Rote of General Managernent, Boston:
Harvard Business School Press, 1993.
Oren, S. and Smith, S., 1981, "Critical Mass and Tariff Structure in Eiectronic
Communications Markets," Bell Journal of Economics, 2 (2).

Rofles, J., 1974, "A Theory of Interdependent Demand for a Communications
Service," Bell Journal of Economics and Management Science, 5 (1).

Tushman, M. & P. Anderson, "Technological Discontinuities and Organizational
Environment," Administrative Science Quarterly, vol. 31 (1986), 439-456.

United States International Trade Commission, Global Competitiveness of US

132 KOBE ECONOMIC & BUSINESS REVIEW, 41 (1996), 101-132

Advaneed-Technologbl Industries: Cellular Commuieations, Publication 2646,
Washington, DC, June, 1993.
US Department of Commerce, Office of Telecommunications, ;Vorld Cellular Marhet,
August, 1995.
Utterback, J.M., Mastering the Dynamics of Innovation: How Companies Can Sei2e
Opportunities in the Face of Technological Change, Boston: Harvard Business
School Press, l994.

KOBE ECONOMIC & BUSINESS REVJEW, 41 (1996), 133-156

THE EFFECTS OF TRANSPORT INFRASTRUCTURE
AND URBAN DEVELOPMENT INVESTMENT
IN LONDON'S DOCKLANDSWITH PARTICULAR REFERENCE
TO LEISURE AND TOURISM 1970 - 1997

T S MERVYN JONESBrookes University (Oxford)
Abstract
The Docklands redevelopment area is the largest urban renewal programme inEurope. It covers an area of eight square miles (2,226 hectares) and extends fornearly twelve kilometres following the River Thames. This paper traces andanalyses chronologically the land use and transport background, the changing
planning, technical and social objectives during this period, and the reasons behindthe selection of the new transport infrastructure. It further analyses the role andpower of the newly created London Docklands Development Corporation (LDDC).
The `Learning Curve' associated with this urban development investment is also
considered, with particular reference to (i) the spectacular growth of leisure andtourism redevelopment area, ( li ) the incremental nature of the redevelopment;(hi) the major players involved in the success of this redevelopment and (ir) thewinners and losers of the changes.
JEL classification: L83

Kaywords: Redevelopment; Land uses; Transport planning/Investment;
Measurable effects; Accessibility; Tourism/Leisure growth; Learning curve;

Entreprenuership; Winners/Losers

Corresponding Address:
T S Mervyn Jones
School of Town Planning, Brookes University, Oxford OX3 OBP U.K.
Fax: (44)-181-997-5264

134

KOBE ECOIVOMIC & BUSINESS REVIELV, 41 (1996), 133-156

1. Introduction

This paper introduces the unique location of London Docklands.
The role that the London Docklands Development Corporation (LDDC)

has played in securing the regeneration in this once run down
Metropolitan area. The effects and repercussions of change represented
together with the importance of enhanced aceessibility. The effects fortourism and leisure are particularly highlighted. The causation factors

and the `learning curve' associated with this particular creation ofcentral Government and the implications for private and public sector
structural co-operation are also considered. Finally some conclusions
are presented.
The paper is presented in six sections.

1. London Docklands Redevelopment - the Location
2. Land Use and Transport Planning - the Historic Background
3. The Observable/Measurable Effects and Repercussions of Docklands

Redevelopment
4. The Tourism and Leisure Dimension and Accessibility
5. The Causation factors and the `learning curve'
6. Conclusions and Open Questions

2. The London Docklands Redevelopment - The Location"This is one of the largest single urban opportunities in thiscountry up to the present time and to implement redevelopment by 1991
would involve a programme of considerably greater speed than so far
achieved in any new town."]"There is no uniquely correct plan for the redevelopment ofDocklands. Some sections of community will want one emphasis, others
will want another conflicting emphasis. No plan can please all, and inselecting a particular plan the community as a whole will be choosing
to meet the demands of some and to turn down, in part or completely,
the claims of others."2 The significance of these perceptive statements
made over twenty-four years ago will become apparent later.
1 These two quotations are taken from the London Docklands Study Team report,
Volume 1, published in 1973.
2 As a point of accuracy very small parts of Greenwich (279 ha) and Lewisham (69ha) were in the 1970s part of the present Docklands area.

JONES: THE EFFECTS OF TRANSLPORTINFRASTRUCTURE 135

The London redevelopment area stretches for nearly twelve
kilometres. Its widest portion from north to south is approximately fivekilometres. It has a total area of approximately 2,200 hectares (22square kilometres) of which ten per cent (220 hectares) represents thewater area of the enclosed former dock system (Figure 1 Appendix 1).
The most crucial characteristics, however, of the whole area is theRiver Thames which varies in width from 200 metres. Due to its
meandering nature it conveniently divides the Docklands Redevelopment
area into five land sub divisions: Wapping, Rotherhithe, Poplar, the Isleof Dogs and the Greenwich Peninsular Silvertown to Barking Creek(including Beckton).

Administratively the redevelopment area was within the confines of

the Greater London Council (abolished 1986). It now incorporates

former parts of three[2j London Boroughs: Newham (1,126 ha),Southwark (214 ha) and Tower Hamlets (562 ha). Theseadministrations are the statutory plan making authorities. (They will

resume their role, when the LDDC leaves the area at the end of March
1998).

London has been a port since Roman times due to the fact that
direct access to the sea was afforded by the River Thames. As early as
the 16th century both sides of he River Thames in the vicinity of theTower of London were extensively developed with wharves andwarehouses. These docks and facilities became considerably overloadedby the end of the 18th century. This congestion of sea traffic resulted in

the building of numerous enclosed docks, between 1902 and 1921 when
the final extension to the London dock system was opened (all within
the present redevelopment area).

The Docklands suffered very badly during World War ll, losing
much of its traffic and sustaining extensive bomb damage. After the
war mechanisation became widespread, resulting in a reduction in thelabour force required. The older docks were not suited to modern
vessels and mechanised cargo handling and closures followed.
The first to close was the East India dock in 1967, followed in
1968/9 by the London and St.Katherine Docks. The last ship left theSurrey Commercial system in 1970 and during the following ten years

the remainder of the docks were gradually run down. Commercial
freight activity of any significance ceased in the late 1970s in all ofthem.

136 KOBE ECONOMIC & BUSIIYTESS REVIEW, 4J (1996), 133-156'
Complementing the development and the demise of London's docks
were population and employment changes (Table 1).

Table 1
Changes In The Docklands Populations (By Boroughs) l901 and 1951
Population(thousands)
1901
1951

BermondseyMB

131

61

Deptford

110

MB
MB
MB
MB

o/o

ChangeBorough1901!1951
-54
-32

96

75
90

169

73

99

-67

121

.

WestHam CBC

299
96
267

171

"

TOT.AL

1l68

690

-

Greenwich
PoplarStepney

EastHam

UDC

-

6

. 56

26
36
11

Source: 1901 and 1951 censuses

During the mid and late sixties the characteristics of London
Docklands would have been accurately described as follows:(i) A run down inner city area
( ti ) Very poor public transport(di) A predominant proportion of unskilled workers( iv) General lack of social and cultural facilities(v) No new business willing to come to the area(vi)A waste waterscape of abandoned docks and its adjacentlandscape3. Land use and Transport Planning - the Historie Background

Against this economic history and consequent social decline, anumber of planning reports and proposals were undertaken for thearea in the late sixties and seventies. In 1973 Travers Morgan &Associates produced a most thoughtful and technically future looking
report. In their volume one, the implicit overriding aim was to produce
a plan for the area which would satisfy physical and social objectives
for the area, in particular to create an environment which would utilise

the area two most outstanding features, namely, (1) its location

JONES: THE EFFECTS OF TRANSPORTI]VFRASTLRUCTURE 137

relative to the rest of London, and (2) its immediate proximity to theRiver Thames. The provision of social amenities and light industry were
the key ingredients of the preferred strategy of that tjme.

In 1974, a Docklands Joint Committee (DJC) was created3 which
was made up of representatives from five London boroughs. This bodywas entrusted wjth the task of promotjng a development plan for thearea.

In 1976, the DJC published the `London Docklands Strategic Plan'
for a target population of 55,OOO people. It dealt with such social issues

as employment, health, education and recreation as well as its overall

land use proposals for redeveloping the whole area was an explicit
proposals for redeveloping the whole area. The importance of transport
was critical to the plan. Other key requirements for success included:

1. A commitment by central government to invest public money in thisarea over a planned period.

2. The release of fand at an early stage by large landowners in thearea. It was the public utilities, namely the Port of London
Authority (PLA), gas, water, electricity and railway undertakings
which were the large owners of land.
It is important to note that these public undertakings, together
with the local authorities, accounted for as much as 80 percent of landownership within the plan boundaries. Therefore, although the DJC

may be credited with identifying the main social and economic
problems and the necessity to control and own land in the docklands,
however, it was unable to acquire this land. In 1979 DJC was abolishedby the newly elected conservative Government, for by 1980, the Local

Government Planing and Land Act was enacted and an Urban
Development Corporation (on the British new towns model) wasestablished by the Secretary of State. The London Docklands
Development Corporation (LDDC) had a financier (Sir Nigel Broackes,

Head of Trafalgar House Group) as similar to that of a privatecompany, but was funded with an initial grant of around Åí250 million
up to 1985, (this figure has risen to around Åí2,OOO million of public
3 This committee was a result of the Local Government Act 1972 (Labour)

138 KOBE ECONOMIC & BUSINESS REVIEW, 41 (1996), 133-156'

money by 1996)". The internal structure, however, is now very similar

to that of a traditional local authority, or any other new town
corporation, with the usual range of chief officers.

The LDDC is divided into four organisational parts: Wapping and
Limehouse, Isle of Dogs, Leamouth and Poplar, Surrey Docks and theRoyal Docks, but at its core it had very much a centralised function.
The individual directors of each sub area could have the task in theoryof virtually competing with each other to initiate and market
development5 /LDDC as a whoJe uses a criterion of `leverage' in order
to assess the performance between areas.
It is important to note that there is no overall strategic land use
plan for Docklands as a whole, in fact LDDC is not empowered to doso6. in contrast the LDDC prepares a financial and corporate plan for
its future strategy for the area, and after this stage relates theobjectives to a physical plan of implementation.
The LDDC is able to do this due to the fact it was provided withconsiderable executive power by central government, which enables it toperform at least six most powerful identifiable functions:'
1. To acquire and purchase land (compulsorily if necessary)
2. To hold land as necessary for a prescribed future use as decided by

LDDC.
3. To dispose of land as and when it wishes.
4. To plan and build infrastructure as considered appropriate (e.g. thelaying of fibre optic cables.)5. To provide infrastructure services where and when required, e.g. gas,drainage, etc.

6. To plan and promote land for industrial, commercial, housing or tourism/leisure type developments for sale or lease to the private andpublic sectors.
4 This figure has been more than compensated by private investment and the highprofits occuring to LDDC through land sales especially during its early years dueto the sale of }and.

5 In practice this was not strictly the case and the markets for which they arecompeting are often different. In fact the dynamism of the first chief executive
together with a corporate strategy tended to dominate decisions,
6 This procedure is completely different from all local authorities in England andWales, who have to provide a statutory local Iand use plan for their areas. It

should be remembered that there was a weak economic climate at this time in
Britain post 1973 oil price crisis.

139
JOIVES: 7'HE EFLFECTS OF TRANSPORT INFRASTR UCTURE

In addition, since 1984, the LDDC has had the powerful andimportant option to reinvest any revenues it earns from its activities,
e.g. from land sales.

The special powers conferred by a Conservative Government of theera certainly enabled the LDDC to overcome the difficulties DJC had
experienced with the former land owners, the utilities and the local
authorities. The importance of being able to acquire land quickly and in

key locations cannot be emphasised too much.

The three key methods which have been employed for landacquisition in Docklands by the LDDC are:
1. Compulsory purchase at market rate.
2. Acquisition by mutual agreement.
3. Vesting, i.e. transfer of land from one state organisation to another,e.g. from the utilities and from the local authorities to the LDDC.
(This power again being conferred by central government).

This last method, although sparingly used, was most important in
the early stages of the LDDC programme. It was this fact, together
with high guaranteed government funding initially that was a major
reason for the new LDDC to take its opportunities and to succeed. The
financial acumen of all the subsequent LDDC chairmen, the vision of its
first Chief Executive' together with the professionalism of appointed
staff have all been ingredients in the LDDC achievement since that time.

Turning to the transport planning background, during the post war
years public transport provision, comprising bus service to the Isle ofDogs area and rail and bus service to the other parts of the area had
decreased both in actual numbers and in efficiency. Throughout thesixties it was hoped to solved the problem with the building of the Fleet

Line (later renamed the Jubilee Line) whlch was to have served thearea and increased mobility opportunities for the local communities inDocklands, providing direct access to the whole London subway
network. However, it was not built on economic grounds at that timeand its rejection to the docklands was followed up by a study of low

7 Undoubtedly, Mr. Reg
contributed significantly

Ward with his entrepreneurship and marketing abilities
at this crucial period.

140 KOBE ECOIVOMIC & BUSINESS REVIEW, 41 (1996), 133-156

cost alternatives in 1980'. The passenger traffic forecasts provided atthat time ranged from only 2,900 - 3,800 persons per hour in eachdirection (pphed), travelling to and from central London in themorning peak in 1990, for the proposed bus way and street tram
options while 3,400 - 4,300 pphed were predicted for a new light railsystem. The variations reflecting the different postulated catchment
areas to be served by the different options.
This 1980 study did attempt to highlight the fact that on the basisof its evaluation (although admittedly limited) that `the transport
benefits of the options do not increase in proportion to the investment.
A decision on which options to pursue, therefore needed to reflect theimportance attached to the social planing and economic benefits andthe actual funds available'. The options put forward during this period

for further investigation included both a light rail and bus way
solution.

A further study in 1982 `Public Transport Provision for Docklands'

eventually decided upon an east/west and north/south light rail
network system with an estimated capital cost of Åí65 million. Thisparticular decision being influenced by an earlier independent London
Transport report which stated:"In the Docklands situation a light rail system would have thefollowing objectives;a) To link together the main development areas of Docklands without
incurring the high costs of river crossings in deep tunnel and toprovide a link to central London.

b) To provide an high quality public transport service in terms offrequency, journey time and day to day reliability.

c) To provide an intermediate capacity public transport systemappropriate for a forecast demand level of up to some 4,500
passengers in one direction during the maximum peak hour over theheaviest section.

* Report no. 376/4244/BB/AR 'A Study of Lower Cost Alternatives to the Jubilee
Line in Docklands' provides a detailed account of recommendations and theoptions suggested.

JONES: THE EFFECTS OF TRANSPORTINFRASTR UCTURE 141

Formal Government endorsement of the scheme came quickly in theautumn of 1982 and was based on a strict cash limit of Åí67 million forthe combined east/west and north/south schemes (later increased tolight rail project that further design work determined and suggested
that the new system should be an automatic one).
4. The Observable/Measurable Effects and Repercussions ofDoeklands Redevelopment 1980-1996 ''The physical transformation on the ground of a large part of the
22 square kilometres (8.5 square miles) of once derelict and enclosed
land into a high technology, accessible, vibrant, modern area has beenquite dramatic to witness. To date the record stands as follows:4.1 Transport Infrastructure
The Docklands Light Railway (DLR) initially consisted of a 12.1

km line with a carrying capacity of only around a maximum of 4000
persons per hour in each direction (pphed).

It started operation in August 1987 and immediately added a
dramatic commercial visual impact, especially to the Isle of Dogs. Thisline was built largely on old rail alignments and infrastructure and it
cost only Åí77 million at that time of Government funding. During thesame year the highly speculative London City Airport was built andsubsequently owned (until very recently) by Mowlem Construction Plc8

on the site of the Royal Docks, Beckton. .
In 1992 the `catalytic' DLR one kilometre Bank extension was
opened. It cost Åí130 million and was funded by private capital. This

event marked the real signal of Docklands existence to the rest of
London, via the extensive Underground of the metropolis, (and to therest of the world!). The much criticised Limehouse dual carriageway
road tunnel link was opened in 1993. It is 1.8 kms. Iong and costaround Åí450 million. .
In 1994 the Åí280 million DLR Beckton extension became
operational. The DLR now operates seven days a week (in line with theLondon Underground schedule) on all routes - the City, Isle of Dogs,

Island Gardens, Stratford and Beckton. More than 300,OOO passenger
8 London City Airport has recently been acquired by an Irish Consortium

142

41 (1996),
KOBE ECONOMIC & BUSIIVESS REVIEVV,

133-156

journeys are completed each week and peak capacity to Canary Wharf
has been boosted from 15,OOO to 24,OOO pphed9 (a dramatic rise fromthe low capacity railway of nearly a decade ago!).

In summary, London Docklands is now accessible by an extensive
new integrated transport network which is to be further enhanced by
the opening of the Jubilee line in 1998, and the important extension(especialiy for tourists) of the DLR to the Cutty Sark, Greenwich andeventually to Lewisham (excepted to be completed by 2000AD). Major
road improvements (Canning Town flyover) are also scheduled forcompletion by 1999. The accessibility section discusses the implication
for the tourism and leisure trip later.

Investment in transport infrastructure by LDDC and private capitalis summarised in Table 2.

Table 2
Transport And Infrastructure

Investment 1981 - 1996

O/o ofTctal LDDC
Åí million

Roads and Transport
Docklands Li t R.ailwa

ex enditure

638
310

Note: Total cash expenditure 1981-1996 up to 31

Transport took nearly half the budget
Elource: LDDC Finance Department

320/o
160/o

March 1995 was Åí1,966

million. i.e.

4.2 Housing Infrastructure

Approaching 19,OOO new houses/flats have been built in the fourareas by the LDCC. The scale and quality of housing, particularly in
the Surrey Docks area has been dramatic. Complete and imaginativerefurbishment of `old warehouses' in Wapping and Limehouse also has
been spectacular. The building of social housing however would seemvery limited (a point that is discussed later). Table 3 summarises
LDDC's housing effects.

9

DLR since its inception

has been continually upgraded inoperation signalling track,

computer software, etc.

every

facet

of its143
JONES: THE EFFECTS OF TRANSPORT JNFRASTR UCTURE

Table 3
Housing Built For LDDC 1981 - 1996

By Area And Ownership
Private

HousingLocal

AssociationAuthority

Wapping&Limehouse
RoyalDocks

2,856
2,861

625O
1,794114
376184

TOTAL

13,270(710/,)

4,541(24SOb6o)874(50/o)

IsleofDogs
SurreyDocks

2,680
4,873

1,746576

Total
3,305
6,781

3,416
5,183

18,685

Source: LDDC executive office Housing Database

4.3 Commercial And Industrial Infrastructure
The most observable building in London's Docklands is the Canary
Wharf Tower (800 feet/244 metres high). It has fifty f}oors and is thetallest building in Britain'.

Canary Wharf' however at this stage of its development (end ofphase one) comprises approximately 4.5 million net square feet of
office space, together with approximately a further 210,OOO net square

feet of retail space. In fact Canary Wharf extends over 80 acres,containing Canary Wharf (71 acres) and Heron Quays (15 acres) andcomprises of some 10 office buildings - a retail cectre, confrence andbanqueting centre, DLR station, 4 car park and landscaped grounds.
Over 80 percent of the space is currently leased (September 1996) andthere are nearly 14,OOO people now working at Canary Wharf area.
According to LDDC London Docklands has potential for a further
4 million square metres of commercial and industrial infrastructure. Up

to the present time only 2i/4 million square metres (36%) has been
built.

The commercial and industrial infrastructural development inDocklands 1981 - 1995 may be summarised in Tables 4 and 5 below.

*

Unt.il recently, it was the tallest building in Europe but Frankfurt now boosts this*Canarv VL•rharf is so named due to the fact that it was the major duck for produce

honour!
from the Canarv Islands.

KOBE ECONOMIC & BUSINESS REVIEW, 41 (1996), 133-156

144

Table 4 The Total Commercial And Industrial Infrastructure Built

By LDDC Between 1981 -k 1995 In Docklands
StatusTotalGross

Total Gross

FloorArea

Floor Area(mi}lionsq.ft)(million

yo6o

sq.m)

Completed
UnderConstruction

24.3

2.26

34

O,2

O.02

*

PlannedDevelopment

3.5

O.31

5

Potential

42.9

3.99

61

TOTAL

70.9

6.58

100

Note: 'Less than O.50/o Source:LDDC hebl facts and figures (1996)

Table 5 The Location Of The New Commercial
And Industrial Infrastructure Built
By LDDC Between 1981 - 1995 In Docklands
Gross Floor Area (thousand sq. metres)
StatusCompleted
UnderConstruction

IsleofSurrey

Wapping/
Limehouse

Royal
Docks

Total

1,380.4368.1

303.2

297.1

2258.8'15.5

DogsDocks

5.41.345.9138.7

PlannedDevelopment
Potential

TOTAL

2,378.5222.4
3810.2730.5'

O.2

8.0

34.0

95.7

314.3

184.3

1,205.0

3,990.2

522.3

1515.8'

6,578.8

Eiburce: LDDC hey facts and figures (1996)

4.4 The Tourism/Leisure And Indoor/Outdoor Space Faeilities
Infrastructure
The newly created tourism/leisure and open space facilities include

numerous parks and signed tourist walks especially around Marina
developments, e.g. St.Katherine's Docks (now an established London
tourist destination).

4.5 Indoor Sports Infrastructure

An all purpose large indoor arena, known as the London Arena,
was opened on the Isle of Dogs in 1989. This is one of London's largest

single indoor spaces and has been used for various events: pop
concerts, exhibitions, sporting events, boxing, etc. It can accommodate
up to 15,OOO persons.

4.6 Outdoor Sports Infrastrueture
A purpose built athletic track and football stadium are now in use.
Also a mountain top ski village at Beckton Alps - it is one of the

JONES: THE EFFECTS OF TRANSPORTINFRASTR UCTURE 145

highest profile outdoor sports facilities in Docklands.

Sailing, board sailing, wet biking, jet skiing and wind surfing,
canopying, sub aqua, rowing, as weH as fishing are all increasing in
intensity, directly as a result of such newly built centres as the Surrey

Docks Water Sports Centre. The Shadwell Basin and Canada Water
also now offer attractive venue for water sports.

4.7 Some Repercussions

It is claimed by both central Government and the LDDC that
London Docklands has been a success story for attracting venture
capital - a major repercussion. This is quite true when the accounts are
scrutinised. Up to 31 March 1995 the LDDC had invested Åí1,966 millionof public money via central Government Funds (see appendix 1), while
the private sector had invested Åí6,100 million up to this date (i.e. overa fourteen year period) giving a ratio of around 3.2 to 1 (a figure
incidentally which is much lower than earlier years when a ratio of 6
to 1 was the norm!).
The inflated increases in the value of land in Docklands, particularon the Isle of Dogs may be analysed as the second major repercussion
attributable to the LDDC and its redevelopment policies. When LDDC
came to dockland housing land could have been bought for Åí33,OOO an

acre. Nearly ten years later, 1990 waterfront land for officedevelopment had risen to around the astonishing amount of up to wellover Åí3 million an acre (although this was its zenith'). Housing landvaried from Åí1.2 to Åí1.5 million per acre in 1995. The current land
prices are comparable to the 1990 figures.

It should be noted however the rest of office space per square
metre in the `Square Mile' in the City is still (1996) almost 80% moreon average than compareble office space in Docklands.

Certainly all this entrepreneurial activity and the resultant
investment especially during the period 1981 to 1990 has some six years
later (1996) given Docklands a momentum of its own and financiers are
now postulating that critical mass' and has been achieved. A viewpoint

to whichlwould subscribe. '* Following the `boom' of the Thatcher years 1981 - 1989 the first half of the 90s

saw economic recession in the UK, which in 1996 is beginning again to show
upward trends.
* The term is applied by financiers to mean that there is enough infrastructure inplace and personnel to generate further investment opportunity.

146 KOBE ECONOMIC & BUSIIVESS REVIEW, 41 (1996), 133-156

A third major positive repercussion of Docklands redevelopment isdirectly attributable to the DLR or more particularly the City extension
at Bank. This direct linkage to the Isle of Dogs enterprise zone was theraison d'etre of the Canary Wharf project. Situated in the heart ofDocklands and strategically placed between the City (London'sestablished financial centre) and the London City Airport.
Originally it was proposed that the office element would largely be

accommodated in three 600 to 800 foot high skyscraper blocks. A
number of large public concourses, smaller tower blocks and shopping

malls were also incorporated in the plan. However the scheme
eventually built, comprises a single massive structure and is integrated

with the DLR rail station and soon with the Jubilee extension.

The initial idea and commitment for the project came from a

consortium of American and European banking and financialorganisations (including Credit Suisse, First Boston and Morgan
Stanley). However in 1987 the entire scheme was taken over by the

Canadian Development Conglomerate Olympia and York. In 1992
unfortunately this particular organisation went into liquidation andCanary Wharf went into `administration'under LDDC. However in 1995
a consortium of the North American and Far Eastern investors agreed
to buy Canary Wharf.
The scheme was almost entirely within the enterprise zone whichmeant that the occupiers did not have to pay local authority rates until

April 1992, a considerable saving compared to other areas in London.
This particular concession however did not represent the major raisond'etre for the consortium. More fundamental, theoretical and pragmatic

reasons may be suggested in terms of geography, history and timing.

The man-made peninsular of Canary Wharf (just under 3 kilometrelong) is located exactly on the OO Greenwich meridian of longitude.
This tends to reinforce Britain's artificially created location as centreof the world, particularly in respect of the important time zones

between New York 740 W and Tokyo 140e E. The then Chairman andChief Executive of Credit Sussie, First Boston (Mr. J M Hennessy)
clearly recognised its importance when he stated in as early as 1968
that `for historical reasons, for cultual reasons, London really is thecentre of today's global market place' and it is an important andaccepted fact that financial markets operate over a twenty-four hour
time cycle.

JONES: THE EFFECTS OJ7 TRANSPORTIIVFRASTRUCTURE 147

The timing of this project in relation to the `Big Bang' may beconsidered important and cannot be over emphasised too strongly. In

December 1986 the New York Chairman of Merrill Lynch CapitalMarkets (Dr. Michael von Chemn) summed up the situation quite
succinctly: `One has to create a new kind of working space for firms
which are trading in securities and money and exchange on a global
basis. These very large financial trading firms are soffering in terms ofcosts and efficiencies and management control because their operations
are scattered in different locations in the existing Square Mile ... theCity of London is not able to provide this kind of space ... that is why
Canary Wharf is so exciting, it is an unbelievable historical coincidenceof an overriding need being met by an extraordinary urban
development in just the right location.

The fact also that LDDC had thoughtfully laid out much of
Docklands with a fibre optic cable network meant that good
telecommunications was assured - a most important factor for modern
business.

Certainly the existing 90 million square feet of office space locatedwithin the Square Mile can only be increased gradually in the shortterm. Even allowing for some relaxation in planning controls whichcame about in early 1986 and which did allow for the creation ofsubstantial floor space. Initially City of London local government
planners were understandably, unofficially, against the Canary Wharf
project, They realised (almost certainly correctly) that the City's
dominant role as a provider of very lucrative office space would bepartially undermined by the consortium's development. In September
1996 however both locations would appear to be benefiting from eachother, and the 21St century is likely to witness a twin financial roie ona world scale for the two centres! (see Conclusions and Open Questions
Section).

Two negative and disturbing repercussions of the Docklands
redevelopment are already identifiable. The indigenous local residents(largely unskilled and predominantly council house tenants) for whom

the numerous plans produced by the consultants and the local
authorities in the early seventies were really intended, are becoming
completely overwhelmed by the scale, type and pace of development.
CIealy of the new private housing the majority developments are
predominantly targeted at the very wealthy. The price of a number of148 KOBE ECONOMIC &BUSINESS REVIEW, 41 (1996), 133-156

units being within ÅíO.25 milion category, thus this area is becoming

one of the most expensive in London. A memorandum prepared by theex Greater London council and the local neighbouring Tower Hamlets
Council recognised in the mid 80s that one of the most controversial
issues in Docklands is the question of how much and (and money) is

allocated for public housing by LDDC. The surrounding boroughs
however are short of land for public housing but now cannot afford to
buy in Docklands. This repercussion is still a major concern for the
50,OOO `non rich' population. Written abuse in the form of graffiti withthe slogan `People before Profits' may still be seen in some parts of
the area, as a direct and honest response to what has happened. The
relative housing stock created by LDDC 1981 - 1995 (Table 3) showsthat only a ratio of 5 to 7 percent private housing.

According to Phillips, R, Chairman 94/95 Docklands Forum (asocial pressure group) "The LDDC is set to finally exit in March 1998.

From the lead up to that date, it is pursuing land sale programmeswith added vigour leading to even more houses for sale and little social

housing for the communities."
Axiomatic to the highland values being paid for office, leisure/

shopping, leisure and housing developments, this policy has had theeffect to `squeeze out' existing local industries (employing
predominantly local labour) with little or no chance of them being able
to afford to return even to an enterprise zone (when it existed 1982 1992) presumably created originally on their behalf. Again the vast
majority of long term jobs being created are in the tertiary sector andnot suitable in the short term at all for the traditional `blue collar'

worker from the east of London. However this particular problem istends to resolve itself.

It will be interesting for new owners and the multi international

tenants and others to witness Canary Wharf's future in the next
century. Will it become a ture satellite of the City or vice versa? They

could be destined to become the major geographically twin financial
centres of the world which long term should benefit Britain's economy
and position in the world! A discussion of these ideas is given later.

5. The Tourism/Leisure Dimension and Aeeessibility
Post LDDC during the 80s and especially.the early 90s, accessibility

149
JONES: THE EFFECTS O17 TRANSPORT INFRASTR UCTURE

to London's Docklands has undergone a revolution by rail and air.
Apart from the pragmatic need of good accessibility for the people who

now work and whose numbers are likely to continually increase inDocklands, tourism and leisure activities have gained enormously fromthe enhanced accessibility. In certain cases the Water Sport Centre at
Surrey Docks would argue that good accessibility is its raison d'etre.
Looking at each new accessibility mode in turn, the following features

emerge:- RailThe Jubilee Line extension will provide the necessary accessibility

for many passengers using the line for leisure-and tourism. The
benefits of this accessibility have not been included in an analysis,
because their diverse nature makes quantification difficult, but arelikely to be significant particularly to occasional users. A large umberof existing (already described) and planned leisure facilities will beserved by the extension. Also access from south east London to theWest End and Wembley Stadium and from the whole of London to theSouth Bank will be greatly increased once the Jubilee Line is completed
by the year 2000 AD.
Other main line (ex British Rail) routes do and will make a major

contribution to bringing visitors and workers to and from the area,

especially when certain rail infrastructure developments become
operational in the next millennium.

- RoadThe Department of Transport's A B trunk road, together with theDocklands Highway and its infamous Limehouse link provide good roadaccessibility to the area when some other major junctions arecompleted accessibility will be even further enhanced. The proposed

East London river erossing again (by road tunnel) again willconsolidate Docklands as a major focus North and South of the River
Thames by car or coach for would be tourists!.
In 1996 approximate and average driving time from the City (Bank)
to the Canary Wharf is around 15 minutes. The City Airport from theCanary Wharf is also around 15 minutes while Canary Wharf to the
Mll/M25 is around 30 minutes. All these times are subject to thecongestion conditions.

150

KOBE ECONOMIC & BUSINESS REVIEW, 41 (J996), 133-156- Air

Doeklands can boast its own airport, London City Airport (LCY)

opened in the Royal Docks, the runway actually being built on aformer Wharf. It has an expanding network of direct routes to Europe
and other major business centres. Almost 650,OOO passengers used LCY
in 1996 - a 25% increase since 1994.

Destinations include Antwerp (YLM); Augsburg / Cologne(Augsburg Airlines); Berne (Air Engiadina); Brussels (Sabena); Dublin(Virgin Atlantic Cityjet); Frankfurt (Lufthansa), Geneva (Crossair);
Lugano (Crossair), Paris (Air France Express and Airject);Rotterdam(KLM); Zurich (Crossair); Dusseldorf (KLM); Amsterdam (World
Airlines); Milan (Alitalia). Low noise jet aircraft mainly serve these.
servlces.

London City Airport was bought in October 1995 by Irish
businessman Dermot Desmond from the construction group, John
Mowlem & Co. Plc for the sum of Åí23.5 million. (Dermot Desmond is
Chairman of International & Underwriting Limited based at Dublin's
International Financial Services Centre).

Since the early 1990s LDDC have undertaken visitor surveys. Tables
6 and 7 summarise the main attractions visited and the reasons forvisiting Docklands. Enhanced accessibility (although at high publiccost) has certainly been the major factor in making Docklands animportant tourist attraction for visitors to London. An average of 1.5
million visitors were recorded of the years 1995 and 1996 .

6. The `Causation' Factors and the `Learning Curve'
In essence the Docklands regeneration to date represents a classic
case history of generally uncoordinated, fortuitous and incremental

decision making. Certainly LDDC's mdrket led approach, has beenhighly successful in encouraging the developers to take advantage ofthe land availability. Not that the developers needed much wooing withthe accelerating high demand for offices for the financial and ancillary

sector, by domestic and international companies (post 1979) new
Exchange Control Regulations), also the guaranteed accessibility
provided by the new light rail system (although its needed capacity wascompletely misjudged at the time).
This accessibility faetor was particularly enhanced by the decision

JOIVES: TffE EFFECTS OF TRANSLPORT INI7TRASTR UCTURE 151

Table 6 Major Attractions

Intending

Visited By Leisure Vistors/Tourists
To Visit(1994)*

Canary Wl]arf

299!oDocklands Light Railway

280/o

St Kathenne's Docks2•6e/,

Is]and Gardens

24 0/oHays Ga]Iena

22• 9•6

Butlers "liarf

21 0/o*Respondents could choose more than one option
Source: London Dochlands Visitors Survey's 1991, 1992, 1993, and 1994.

Table 7 Reasons For Visting Docklands'(1994)
Just to look around

410/o

See the architecture

l3 0/oGreenwich 1 Cutty Sark

120/oTower Bridgeloo/,

Design Museumloo/,

Tower of London

90/oCanary NVIiarf

70/o*Leisure visitors only

Source: London Doeklands Visitors Survey's 1991,

1992, 1993, and ?994.

(rather late in the day) to build automatic light rail system, which

provided the forward looking and high technology image' forDocklands, which was exactly what was needed in the early 80s period.
Two other critical factors may also be postulated for the regeneration
the strong powers which were given to LDDC by central government,
enabled the `vesting' procedure to overcome the hitherto stubbornnessof the utilities releasing strategically placed land. This being placed
subsequently on the open market by LDDC. An injection of government
funding at this critical period was also fundamental importance.
The last but undoubtedly the major significant factor is Dockland's
Iocation, close to the major established financial centre of the world -the City of London. The fact also that part of Docklands Iies
symbolically exactly aside the O' meridian gives it a perceptive edge inKOBE ECOIVOMIC & BUSINESS REVIEVV, 41 (1996), 133-156

152

the `global' world of revolving finance.

It is highly probable tat if there had been an absence of any ofthese factors/cornerstones present especially during the period 1980 1990 (together with the `developer'), it is most unlikely that London'sDocklands would have been regenerated in such a rapid andspectacular way (figure 4).

Certainly the `learrung curve' has shown the power of the LDDC
and the strength of this type of quasi governmental strucure to `getthings done'.' However, the character of Docklands' regeneration 1980

- 1996 would indicate that the LDDC has not been orientated or
motivated directly towards the local and social needs of the former
population and employers of the ares, which was clearly the main
objective of the regeneration plans produced in the 70s. The `on the
ground' evidence reveals that the needs of the developer and morelately the demands of new high income residents have received mostattentlon.

Although the LDDC Is responsible to the Department of
Figure 4 The Major Causal Factors In Docklands' Regeneration

1980 - 1996
Posvers 1 Acuman

Automatic Light Rail S>'stemof LDDC(controD(accessibi/itv?

Reaeneration svcccss

Docklands location

Opcning up of financiai(O' nieridian)markels(demand?

(sttpp(y?
Land spcculation by dcN'clopcrs(high profus lo clate)(eiitt'e/)t'etieitrshi/);,)* It is doubtful however if any future urban development corporation in Britain even

if given powers to LDDC will be bale to achieve so much so quickly due to theunique location of Docklands.

153
JONES: THE EFFECTS OF TRAIVSPOR T IIVFRASTR UCTURE

Environment there would appear to have been few checks and balances
exercised throughout the period (especially during the Thatcher era).
7. Conclusions and Open Questions
An overwhelming conclusion of Dockland Redevelopment 1981 - 1997
must be the incremental (sometimes dramatic) sequence of change.
These changes have illustrated ( i) definite `laissez faire' market led

approach by a powerful LDDC, (li) the increasing importance of the
Canary Wharf location. The bias has been (at least post '85) towards

offices, high income housing and leisure and tourism generation
facilities. The 90s undoubtedly was and is characterised by highinvestment in transport infrastructure to enhance accessibility to thearea especially the Canary Wharf development. For example, the very
expensive 1.8 kilometre Limehouse road link (which incidentally has
been criticised by the Government's spending watchdog!).The main
beneficiaries besides the office commuters of this increased accessibility

to the area and its attractions old and new will be the tourist andleisure traveller (as indicated in an earlier section). It is highly
Docklands.
It is highly likely over 2 million tourists a year will be visiting thearea by the turn of the century, with the consequent economic andsocial effects positive and negative. The losers in part have been thelocal population especially those blue coller workers which have lived in

the area for generations. It will be interesting to see whether
Southwark, Tower Hamlets and Newham, i, e. the boroughs that will be
responsible for planning and policy of the area post March 1998 will beable to redress this imbalance of social provision via their urban
development plans (especially in the Isle of Dogs and Surrey Docks
areas). Clearly the past discussions of the LDDC will determine thedestiny of the area for decades to come and certain trends will be
unavoidable, for example, a steady rising resident population andaccelerated number of employees working in Docklands. Threeinteresting questions may therefore be posed:(1) What type of place is Docklands really destined to become in thetwenty-first century? A vibrant 24 hour inner city activity
generator or more sterile and grandiose office complex? Given the154 KOBE ECOIVOMIC & BUSINESS REVIEYV, 41 (1996), I33-156

mixture of expensive private and social housing-will demarcationlines be firmly drawn? Will security against rising crime in certain

affluent residential sector result in a bleak environment whereguard dogs and electronic surveillanee become the norm?

(2) Was a truly unique opportunity lost to create a `Venice' typeenvironment for local people, employed in local type manufacturing

or service trades as was envisaged by Travers Morgan and
Associates in the early 70s, that would have certainly satisfied thesustainability arguments of the present time? Maybe physicalplanning is too difficult and `no unique correct plan for
redevelopment' is ever possible in the changing and continuing`urban dynamic' of human existence?
(3) Are the Royal Docks and Beckton development destined always to
be a very poor second compared to the quality scale of the Isle ofDogs and the Surrey Docks area.
References
Bonnet, C (1987) On Track with a New Transport Artery Transport Vol. 2, No 2, June

editionClay, I.M. (1994) Transforming a Budget Automatic Railway into world class
Culen, G (1982) Isle of Dogs. A guide to design and development opportunities -London Docklands Development Corporation
Docklands Joint Board London Docklands - A strategic plan report published by

Docklands Development TeamDoe er al (1981) A study of Lower cost Alternatives, published as a special report,

1981
Euromoney (1986) Canary Wharf - A special supplement - special edition, December

Goldsack, P.J.(1987) LRT gives London Docklands a chance - Mass Transit, Vol.
XIV, No. 6, June
Greater London Council & Docklands Boroughs (1985) Memorandum on the London
Docklands Development Corporation - GLC Supplise DeptInternational Railway Journal (1986) Editorial Docklands leads British LRT revival

Vol. XXIV, No.4, March
Jolly, S and Bayman, B (1967) Docklands Light Railway Official Handbook Capital
Transport Publications
Jones, T,S.M. (1986) Riverside Urban Redevelopments - The Way Ahead Public SpaceTokyo(published in Japanese) Vol.2, No.8
Jones, T.S.M. (1987) Tokyo and London Urban Development Situation Public SpaceTokyo (published in Japanese) Vol.3, No.9
Jones, T,S.M. (1990) Transport Infrastructure and Docklands Redevelopment Working

155
JONES: THE EFI7ECTS OF TRANSPORT INFLRASTR UCTURE

Paper,No.1 City University Transport Studies Group London Docklands
Development Corporation (LDDC) 1984 - 1995 The Corporate Plans &Financial Accounts, London
LDDC (1994) The Isle of Dogs Development Framework - Press Office, London
LDDC (1995) LDDC and its Responsibilities (Briefing Series) - Press Office, London
LDDC (1996) Facts and Figures - Press OffiÅëe, London
London Transport (1980) The possible future role of intermediate capacity
guided transport system in London. A special report prepared by Railway

Development Group
London Transport (1981) Docklands Rail Study
Phillips, R (1995) Docklands Forum Annual Report
Shepherd, J. (1985) Land, landholders and the regeneration of London Docklands.
Occasional lecture

Smith, A. (1987) Housing in Docklands - A report prepared and published by

Docklands Forum
Travers Morgan and Associates (1973) London Docklands, Vols.1&2. A consultant
reportWyse, W.J.(1986) Docklands update. Modern Tramways. Vol.49, No.585, September
editionN"il "of 'sto"timgt

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REVIEW
KOBEECONOMIC & BUSINESSCONTENTS
NO. 34 (1989)
Recent Inflation of Land Prices in Metropolitan

Areas of Japan-A Case Study of Regional Accounting- '"'"•••••''""""'••••' Nobuho Nosse
Little Basics and Emloyeeism

Japanese Management inInternational Perspetive "'"•••'"""""""""''"""•""•'""""' Hldehi Yoshihara
Bank's Loans to Developing Countries:
A Normative Approach """"'"""""'-'"""""""••"•••"'"•""' Kazuhiro Igaiva
Japan's Trade Diplomacy:
Yesterday, Today, Tomorrow ""'"""'""'""'''""'"'''"""""•••' Peter Drysdale
A Labour Union in Every Country-A Game-Theoretic Approach- "''"""""'''""'•••••••••""' Kazuo Shirnomura
The Costs and Benefits for Firms of
Accounting Information Disclosure """""""'"'•••••""""" Hidetoshi Yamoji
Increasing Returns to Scale and Optimal

Investment Policy of the Regulated Firm """"'•""""""" Seiichi Katayama

Fumio Abe
Problems and Method of Economics"""""""""""""•""'"`"""•••• Nobuo Oktshio
Industrial Organization and International Trade-Textile Industries in theWestern Pacific Region- "••"""'""'""""''"""""""""""••' Katuhiho Ikeda

NO. 35 (1990)
Some Implieations of the PresenVValueBased Depreciation Within the
Historical Cost Framework '""""""''••""'"""""'"'""'"'•••'•" Isao Nakano
Foreign Subsidiaries as Contributors

to Parent Companies-A New Paradigm of Multinational
Enterprises-""""'"""""'"""'""""""""""'""""""""""' Hidehi Yoshihara
The Gains from Free Trade for a Monetary
Economy '""'""'"""`'"'"'""'"""""""""'""'''""'"''''""' Murray C. Kemp
On the Optimal Timing of Foreign Aid""""""''"''"'•"'""'''"'' Murray C. Kernp
Ngo Van Long
Kazuo Shimomura
A Simple Union-Ridden General
Equilibrium Model '""'"""'"'"'""''""""''"'""'•""'"""" Kazuo Shimomura
Industrial Policy under International

Oligopoly "'H""""'''H"'H"''"'"''""'""'""'"'"'"•"H"'"""'•••••• Kenji Kojima
Realtime Distributed Control of World Link Models

in the International Computer Networks """""'••••"""'"""•"" Ko Mlya2ahi

NO. 36 (1990)
Outward Direct Foreign Investment
and Structural Adjustment in a
Small Open Economy ''""""'""''"""""'"'''"'''""'""''''""••"' Chung H. Lee

An Approach to Transaction
Contracts with Asymmetric
Information •"''"'-•••••''••-"'""'--•-•-•••"''"'""•"'"""'"'' Ka2uhiro Igawa
A Mathematical Note on the
Impossibility of Global Absolute Advantage '"'"""'"""' Ka2uo Shimomura
On Reform of the International
Monetary System: A Survey '""""•••••••••••••"""'"'•'"••••"""''"' Hidehi Izawa

NO. 37 (1992)
Corporate Behaviors on Disclosure of Social Responsibility
Information and Distrust Dissolution Accounting-A Survey of Researches Not Based on Rigorous Models """"' Isao IVakano
Local Entrepreneuership and Reverse

Technology Transfer-Messages
from Foreign Companies in Japan- -•••••-••""'"""'••'••••••••• Hiclehi Yoshihara

The Forms of Enterprises and Transactionin General Equilibrium:A Note on
Analytical Framework ••••••••'•••"-'•••••••••••••••••••""••••••••"•"" Kazuhiro Igawa

A Note on the Flatness of theTransformation Surface ""''••••'•••••••••••••••••••••""'•••••••••" Kazuo Shimomura

The Long.Term Relationship in theJapanese Distribution System:
Game-Theoretic Viempoints •"•'t""•••••••t••••••••••""'•••••••"""""' Ken]'i Kojiina

Recent Developments in the Theoryof Trade with ImperfectCompetition """""••••••••••••'•""'"''•••••••••••••••••••""•••••••••' VVinston VV. Chang

Seiichi Katayama
Long-term Expectations and Economic

Growth-A Post Keynesian Theoryof Long-term Growth- •""'""""•••••••••••••"""""••••••••••••" HiclayuleiAdachi

NO. 38 (1993)
Generalized Lower-of-Cost-or-Market Rule for Inventory
Valuation for Qua.si-rational Managers •••••""""""••••••••••'•"""' Isao Nahano
Effects of Financial Deregulation on Australian Financial
System """"""""••••••"••""'""""••••••••••••••••••""'-••••••••••••••• Kenichi Isigahi

NAFTA and Asia-Pacific Economic Relations """""""•••••"""""""'" Seij'i Naya
The Asian Development Experience and Its Relavance toAfrican Development Problems """""•"'""""""'"""""'"""""'" Seil'i Naya

Robert KMcCleery
A Qualitative Assessment of the Effects of NAFTA on Japan'sForeign Investment and Trade with East Asia and Mexico:
Opportunity or Diversion? '""'""'••••••••••••••••'"""••••••••••' VVilliam E. James

Dynamic Effects of Tax Policies in A q
Model of Investment ••'••"'•'''"''"••••••••••••••-"•"'''••••••••••'••"' Tahao Ohhawa

Kazuo Shimomara
Corporate Governance in Germany, Japan, and theUnited States : A Comparative Study •••••••••••••""'••••••••••••••••" Kenji Kojima

Economic Issues in International Debt:A Survey '"'""••••••••""""'" Hideki I2awa
A Note on the Estimation of Scale Economies and their
Use in Modeling Free Trade Agreements ••••••••""'••••••" Robert K MeCleeryNO. 39 (1994)
Labour Unions and Nominal Prices '""""""""''''""''"""""" Kazuo Shimomura
An International Perspective on Japanese Corporate Finance "'•••••• Kenji Kojima
Measuring Natural Resource Rents and their
Macroeeonomic Significance for Developing Countries,
with Reference to Latin American Suger Producers "''""' Robert K.McCleery
The Influence of Product Development Strategy on
Inter-Project Learning """"•'''"•""''"'••••••'•'""''•'""""''"' Kentaro Nobeoka

A Comparison of Japanese and UK Welfare """""''"""''"""' Stephen J Davies

NO. 40 (1995)
Financial Relationships in Japan:

An International Perspective """""""''"""""""""""""""" Kenji Koioina
Structual Adjustment and Economic Growth in Mexico:With Comparisons to Indonesia """'"""""'''""""''""" Robert K McCleerrv
Reorganizing for Multi-Project Management:
Toyota's New Structure of ProductDevelopment Centers """""'""""""`""""'"""'""""'""' Kentaro Nobeoha
Production Subsidies, Local Content Requirements
and Foreign Direct Investment:

A Theoretical Analysis """""""""'"""""""""'""'"""" Roger N. Strange

KOBE UNIVERSITY ECONOMIC REVIEW 42, 1996
Edited by Faculty of Economics,
Kobe University, Kobe, JapanCONTENTS
North-South Interdependence,

Growth and the Terms of Trade ""'"""'""""'"'"""""'"" Hideyuhi Adachi
A Study of the Awa Indigo Industry
in the Middle of the Meiji Period-With Special References to theIndigo Business of the Takahashi

Family in Tokushima Prefecture- "'""""""'""""""'"" Masatoshi Amano
A Linear Dynamic Model of Ecological Succession """""'"""' Toyoahi Washida
An Analytical Framework for a Yen Area ''"""""""'"'"""'""'"" Seiichi Fujita
Small Sample Properties of the Generalized

Method of Moments Estimators:Application
to the ARCH-Model ""'•'••••"'"'""'""'""•'"""""""""'" Shigeyuhi Hamori
The Privatization of British Rail-An Economic Analysis - '"""''""'"'""'•"""'""""""'" Robert H. N. Parry
Nrf,LrKrfsLrf,.lfLrfiL)JNL)fLrf•Lrf,LrfLrSLrSLr!-LrfL)"NLrS-kLtfxL)fsLrf!L)tNL)-LrfLrf!Lrf!LrtsLr-LrfL)-iLrr-•LrfLrfLrfxLrfsLrf!LrlHL)rALrfsLrfLrrFL)f!LY

THE ANNALS OF THE SCHOOL OF BUSINESS ADMINISTRATION,
KOBE UNIVERSITY No. 41, 1997
Edited by the School of Business Administration,
Kobe University, Kobe, JapanCONTENTS
Industrial Technological Trajectories and Corporate Technology

Traditions:The Development of Antibacterial Drugs in Japan "' Takoji Hara
New Roles of Middle Managers under the Influenceof Information Technology:

A New Paradigm of Personnel Management '"''''"''''"''" Norio Kambayashi
Good and Bad Scenarios for Japanese HRM Systems:
Short-and Long-Term Adaptability of Individuals
in an Organization with Special Reference toEntry Management and the Plightof Middle Managers in Jalpan ''''""'''""""""'"""''`'"'""""Toshihiro Kanai
Grundzuge der Jahresabsch}usse Japanischer Aktiengesellschaften-Grundlagen fUr einen Vergleich mit den Jahresabschlissn

Deutscher Kapita]gesellschaften- '"'"""""""'""''"'""''" Masatoshi Kuroda
Sales Process Innovation in Japan '"''••'••''"'""'"""'""" Katsuyoshi Tahashima.YtiCh-tlh"t"it'h,Ft'S-.lkiSThSL'"}NSL'.Sl""1.St'".W'".Xi.Sl-.Ki."LV-rh(LWSrli,FL'hStihtFL""M.7L,S..XMXWwolt"-S'-KOBE UNIVERSITY LAW REVIEWInternational Edition No. 30, 1996
Edited by Faculty of Law, Kobe University, Kobe, JapanCONTENTS
Security in the Context of our Everyday Lives:

Lessons from the Great Hanshin Awaji Earthquake '''""'"" Ronni Alexander
Restructuring of Enterprises and Protection of Working

Conditions of Middle-aged andElderly Employees in Japan •••••"••"''•••••••••••••"'•"""'""'""''"' Shinya Ouehi

The Road to Exclusion: The 1920 California Alien Land
Law and U.S.-Japan Relations """"''•••••••""""'•••••-•""""•••• Tosh Minohara

RESEARCH INSTITUTE FORECONOMICS AND
BUSINESS ADMINISTRATION,
KOBE UNIVERSITYHISTORICAL SKETCH
In 1919, a research organization named the Institute for Commerce

was founded in Kobe Higher Commercial School, one of the chief
predecessors of Kobe University, with a gift made by F. Kanematsu &Company, a leading mercantile firm in Kobe. The organization was
designed to carry on and facilitate integrated research on business andcommerce and to formulate and publish the results of these studies andinvestigations in such form as to make them available to the business.
communlty.

With the founding of Kobe University of Commerce, successor of
Kobe Higher Commercial School, in 1929, the Institute extended its
research activities by adding several divisions. One was the famous
Latin-American Library, which soon became the center of research inthis field in Japan. A room for statistics equipped with various
computing machines was established and began publication of Jtiyo
Keizai T6kei and Sekai B6eki T6kei annually. A filing room was
prepared to deposit press clipping files systematically arranged by
topics and dates. Another room was designed to become the center ofall possible original records and data having to do with the beginningand progress of Japanese business.

On the campus of Kobe University of Commerce, anotherorganization named the Institute for Business Mechanization was
founded in 1941 utilizing business machines donated by the IBM
Corporation and others. With Professor Yasutaro Hirai as its head abroad and forward-looking plan for business mechanization in Japanwas developed.
In 1944, Kobe University of Commerce changed its name to Kobe
University of Economics. After the War, however, the University was
consolidated with three other colleges in Hyogo Prefecture to become
Kobe University. With this development, the two Institutes were also
amalgamated into the Research Institute for FJconomics and Business
Administration, Kobe University. At present, the Institute, with its
twenty-four full-time professional staff members, carries on studies

and investigations in international economics, international
environment, international comparative economics, international
business, management information systems and international
cooperatlon.

ORGANIZATIONThe Institute consists of six sections. Each section and its researchsubjects are as follows:

1. International Economic Studies
International Economics, International Monetary Economics,
Maritime Economics, International Labor Relations
2. International Environmental Studies
Resource Development, International Organizations,International Industrial Adjustment
3. International Comparative Eeonomie Studies

Pacific Basin I (Oceanian Economy)
Pacific Basin ff (Latin American Economy)
Pacific Basin M (North American Economy)
4. International Business Studies

Comparative Business, Multinational Enterprise,International Business Finance

5. Management Information Systems
Business and Accounting Information, Information Processing
System, International Comparative Statistics

6. International Cooperation
In addition to the ordinary work of each section, several

research Groups, whose members are not limited to theInstitute staffs, are regularly held to carry on joint studies. At

present, there are nine standing research groups, as follows:

Group of International Trade, Maritime Economics, Dynamic
International Economic Analysis, International Economic

Environment, International Economic Comparison,International Comparative Financial Studies, Institutional

Accounting and International Comparative Accounting
Research, International Comparative Statistics andInformation Strategy for Regional Development.
For convenience and greater efficiency in carrying out its
research-activities, the Institute has a general office which is

responsible for 1) the collection and preservation of acomprehensive collection of books, periodicals, pamphlets, andoriginal records and data of finance, trade, commerce,industry and business generally: 2) the classification,
cataloguing, indexing arranging, annotation and compilation ofthese research materials: and 3) the formulation andpublication of the results of the investigations and studies

accomplished by the professional staff members of theInstitute.

As an affiliated institute, the Documentation Center for
Business Analysis has been established in 1964. It is the firstsystematic information facilities in the field of businessadministration in Japan that has been recognized andauthorized by the Ministry of Education. The purpose is tocollect and to make intensive control of all kinds of materials

on business administration and to make them available toscholars, universities, governments, and business world withthe aid of modern documentation techniques.

RESEARCH INSTITUTE FORECONOMICS & BUSINESS ADMINISTRATIONKOBE UNIVERSITY
Director: Kenichi
Secretary: Koji

IsHIGAKIUNNOINTERNATIONAL ECONOMIC STUDIESInternational Economics
International Economics, Asian Development,

Prof. Kazuhiro IGAwA

Economic Integration
International Monetary Economics

Assoc, Prof. Robert Kenneth MccLEERy

Maritime Economics

Assoc. Prof. Hideki IzAwA
Assoc. Prof. Masahiro ToMiTA

Trade Theory, Microeconomics, Macroeconomics

Prof. Kazuo SHiMoMuRA

Public Economics

Prof. Tetsuya KisHrMcrro

INTERNATIONAL ENVIRONMENTAL STUDIES

Resource Development Prof. Shigeyuki ABEInternational Organizations Prof. Junichi GcrTo

Commercial Law Prof. Masao KisHiDA

Economic Integration, International Tradeand lnvestment, Economic Development Assoc. Prof. Michael George PLuMMER

INTERNATIONAL COMPARATIVE ECONOMIC STUDIES
Pacific Basm I(Oceanian Economy)Prof. Kenichi IsmGAKi

Pacific Basin ll

Prof. Shoji NisHiJiMA

Assoc. Prof. Ryuzo MiyAo(Latin American Economy)Prof. Seiichi KATAyAMA

Pacific Basin M(North American Economy)

INTERNATIONAL BUSINESS
Comparative Business

Multinational Enterprise

Assoc. Prof. Kenji KonMA
Prof. Hideki YosHIHARAManagement of Technology, Corporate
Strategy, Organization Theory

Assoc. Prof. Kentaro NoBEoKA

International Business Finance and Accounting

Prof. Hidetoshi YAMAJt

Human Resource Management in Japan,
U.S.A. U.K. and China'
Managementof Technology

Prof. Koji OKuBAyASHI
Assoc. Prof. Jeffrey Lee FuNK

Organizational Capability Development

and Change; Management of Technology

Research. Assoc. Richard Steven W}{iTE

MANAGEMENT INFORMATION SYSTEMSBusiness and Accounting Information
Information Processing Systerns
International Comparative Statistics
Information Processing System

INTERNATIONAL COOPERATION

Prof. Isao NAKANo
Prof. Komayuki ITow
Prof. Yasuo KoNism
Research. Assoc. Yutaka

YASLTDA

Prof. Robert William BixBy
Prof. Mervyn Tomas Stanley

JoNEs

DOCUMENTATION CENTER FOR BUSINESSANALYSIS
Accounting

Business Administration Docurnentation

Assoc. Prof. Akira KAtJiwARA
Research. Assoc. Hideko Sh]KiGuorii

FOR ECONOMICS & BUSINESS
Office:RESEARCH INSTITUTEADMINISTRATION( The
KaKn \;ktsuuNIYGI}flgilaTIyHai] >oe

ROKKO, KOBE, JAPAN /Published on February 1997

by
The Research Institute for Economics &Administration(RIEB)
Kobe University

Business

2-1 Rokkodai-cho, Nada-ku Kobe, Japan 657
Phone: 81-78-803-0383

Fa x: 81-78-861-MM 'Home page at http:/1 www.rieb.kobe-u.ac.jp/
I'rinted inJapan