MMRCDISCUSSION PAPER SERIES
No. 230

Business practices of purchasers in Japanese industrial districts:
An integrated model for economies of agglomeration
Nobuyuki Inamizu
Graduate School of Economics, University of Tokyo
Takahisa Wakabayashi
Graduate School of Economics, University of Tokyo
April 2008

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Manufacturing Management Research Center (MMRC)
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Business practices of purchasers in Japanese industrial districts: An integrated model for economies
of agglomeration

Nobuyuki Inamizu
Graduate school of Economics, University of Tokyo
Takahisa Wakabayashi
Graduate school of Economics, University of Tokyo

This paper aims to reveal the conditions for economies of agglomeration in Japanese industrial
districts. The existing Japanese industrial district theory has focused only on supplier-side

logic and ignored the purchaser-side logic. In light of the purchaser-side logic, weinterviewed large retail firms serving as purchasers for industrial districts and 21 small-scale
firms located in Tokyo's Ota Ward and Joto area, serving as suppliers. These interviews showedbusiness practices called “Kouza” and “Chouai”: Large enterprises deal only withkouza-holding firms. Assuming these business practices, we will complete the mechanism
behind economies of agglomeration in industrial districts for the first time. (100 words)

industrial district, agglomeration, localized labor market, kouza, business practices

Japanese industrial district theory andbusiness practices of purchasers
Graduate school of Economics, University of Tokyo
Nobuyuki Inamizu
Graduate school of Economics, University of Tokyo
Takahisa Wakabayashi
April 2008

1. Introduction
In the past two decades, there have been intensive debates on spatial issues, such as industrial
district or industrial cluster. Several crucial studies, such as Piore & Sable (1984), Krugman (1991),
Porter (1990, 1998), and Saxenian (1994), have been carried out, and their important contributions
advanced the analysis of territorial agglomeration of firms and economic activities enormously. At
the same time, individual case studies on industrial districts have been conducted, for example
industrial district in Italy (Lombardi, 2003; Russo, 1983) or US high-tech industry (Dorfman, 1983;
Saxenian, 1991, 1994).
In Japan, interest in industrial districts has also increased rapidly since the latter half of the
1990s. Amid a lengthy economic downturn, there were lively movements attempting to revitalize
regional economies by creating industrial districts across Japan (e.g., Matsushima, 1998; Ogawa,
1998; Ohashi, 2000) and lively discussion on connecting technology transfers from universities toregional industrial clusters (e.g., Ishikura et al., 2003). Several policies have launched at local level tonational level: For example, Industrial Cluster Project has implemented since 2001 by Ministry of
Economy, Trade and Industry.
Originally, Japanese industrial districts have closely linked with large firms’ productdevelopment. Because, Japanese large manufacturers and distributors use industrial districts in order1

to make prototypes or order custom goods. Some studies pointed out that Japanese economies andlarge manufacturers have benefited enormously from small and medium-sized enterprises inindustrial districts (Seki, 2003; Seki and Kato, 1990; Watanabe, 1997).
To begin with, there are two strains of industrial district theory: the Weber strain explaining themechanisms behind formation of industrial districts based on location theory and the Marshall strain
explaining the mechanisms behind the functioning and continued existence of industrial districts
based on small-business theory (Matsubara, 1999; Sumiya, 1971; Yamamoto, 2005). Weber
explained the formation of industrial districts by clearly differentiating simple geographicaleconomies in terms of factors such as transportation costs and labor costs and advantages arisingfrom the agglomeration of companies itself. Marshall was highly interested in the surprisingcontinuity of industrial districts over long periods of time even after the loss of geographicaladvantages. In other words, it can be said that a disputed point in industrial district research is
elucidation of the mechanisms of economies of agglomeration, as distinct from geographicaleconomies.
At the same time, Japanese industrial district theory, which has flourished since the latter half ofthe 1990s, has described merely the history of local industries. For this reason, it has argued theoriesof the formation and continued existence of industrial districts leaving the distinction between
geographical economies and economies of agglomeration unclear. In addition, much research covers
individual cases, with insufficient discussion of the degree to which such cases can be applied
generally.
In this paper, we first summarize the mechanism behind economies of agglomeration, cited mostcommonly in Japanese industrial district theory. We point out that Japanese industrial district theory
has repeatedly insisted that a condition required for small-scale manufacturers (suppliers) to enjoy
economies of agglomeration is the existence within the industrial district of local markets for special
skills. This shows clearly how Japanese industrial district theory has been unconcerned not only withgeneralization and theoretical development from individual cases but also with purchasers' logic.
In light of this state of affairs, in this study we interviewed large retail firms serving aspurchasers for industrial districts and 21 small-scale firms located in Tokyo's Ota Ward and Joto area,
serving as suppliers. These interviews clearly showed that the business practice of large
manufacturers and distributors was to deal only with suppliers and subcontractors having supplierkouza or numbers, and that the presence of such kouza has come to signify the supplier's credit. As aresult, such firms place strict demands on suppliers and subcontractors, such as (a) examining thelatter firms when opening kouza, and (b) terminating kouza when problems arise with delivery times
or failure rates. Furthermore, these results also show the clear presence of the business practiceknown as chouai, in which one of these firms holding kouza is designated the chouai-saki, charged
with coordinating and serving as a liaison with other small-scale suppliers and managing production
and delivery times, in return for commissions of several percentage points. Assuming this businesspractice as a precondition, for purchasers the presence within the industrial district of firms holding
kouza becomes a necessary condition of enjoying economies of agglomeration.
Moreover, the following mutually reinforcing relationship exists between the two requiredconditions applying to the supplier and the purchaser above: (a) Since the presence of local markets
2

for special skills in the vicinity makes it possible for kouza-holding firms to accept orders frompurchasers and maintain their kouza even for relatively large orders in comparison with their own
capabilities such firms tend to locate in areas with local markets for special skills; and, (b) local
markets for special skills tend to form in the vicinity of kouza-holding firms since outside suppliers
accepting orders from kouza-holding firms can secure stable—if small—volumes of business. By
looking on purchaser-side logic instead of only the supplier side as in past Japanese industrial district
theory, we will complete the mechanism behind economies of agglomeration in industrial districts forthe first time.
Furthermore, due to the facts that (i) purchasers and kouza-holding firms are separateorganizations and (ii) moreover, kouza-holding firms are chosen individually by each purchaser (i.e.,such firms differ by purchaser), this model can explain important the following characteristics andphenomena related to industrial districts that have been pointed out in Japanese industrial district
theory: confrere trading, structures of social division of labor like mountain chains, and location ofpurchasers outside industrial districts. These points will be discussed as topics for future research at
the end of this paper.

2. Disputed points in industrial district research: classical industrial district
theoryNow, we revisit the two strains of industrial district theory. In particular, we clarify the disputed
points in industrial district research by revisiting the classic works of each strain: Weber (1909) andMarshall (1920).
In his Theory of the Location of Industries, Weber analyzes agglomeration (concentration of
economic activities or organizations involved in such activities in certain geographical areas).
Considering firms' locations to be decided based first of all on minimization of transportation costs,
Weber proposed economies in expenses as well as economies in labor costs as factors contributing todeviations from the points of minimized transportation costs. Then, he developed and studied models
of how industrial agglomeration developed as a result of these factors.
Weber's contribution is in his differentiation between agglomeration resulting fromminimization of transportation and labor costs (incidental agglomeration) and agglomeration
resulting from economies in expenses (economies of agglomeration) arising from agglomeration
itself (pure agglomeration). While the former economies originally are specific to certain
geographical areas, the latter economies of agglomeration are not, because they can arise anywhere
agglomeration takes place (Aoki, 1960). In other words, these can be considered economies that canbe enjoyed only after agglomeration has taken place.
In Chapter 10 ("Industrial Organization, Continued. The Concentration of Specialized Industries
in Particular Localities") of Book IV of Principles of Economics, Marshall discussed localized
industries. First, regarding why localization (agglomeration of a number of small firms of the same
industry in a specific geographical area) occurs, he enumerated a wide range of geographical factors
and proposed that numerous fortuities could affect such localization. Rather, what Marshall focusedon was the surprising persistence in industries in which localization already had taken place. Notingthat "When an industry has thus chosen a locality for itself, it is likely to stay there long" (Marshall,
3

1920, p. 271), he proposed the following as primary factors: 1) growth of subsidiaries, 2) formationof local markets for special skills, and 3) adoption and spillover of new technologies. In particular, inIndustry and Trade (Marshall, 1923), he called the adoption of new technologies based on local
markets for special skills a "special industrial atmosphere" and proposed that this atmosphere itself
was a primary factor behind the maintenance of localized industries over long periods of time. In
other words, like Weber Marshall clearly differentiates simple geographical economies from
economies of agglomeration.
Unlike Weber, Marshall differentiates internal economies (economies gained from growth in thesize of a single company) from external economies, naming industrial districts as classic examples ofexternal economies. Since Weber's agglomeration theory covered both growth in business size andagglomeration of multiple businesses together (Aoki, 1960; Fujikawa, 1999; Hoover, 1937; Itoh,1970), it included advantages from internal economies such as adoption of more efficient machineryand production organizations resulting from expansion of a firm's size within the scope of economies
of agglomeration. However, differentiation of internal and external economies is very important.
Since only the affected firm can enjoy the benefits of internal economies, such economies cannot
attract other firms to the vicinity. This is because it is thought that external economies, which otherfirms can enjoy, are the economies capable of attracting other firms to the vicinity. (Aoki, 1960)
This differentiation between geographical economies and economies of agglomeration meansthat the economies of agglomeration (external economies) proposed by Marshall will not necessarily
be enjoyed by firms as a result of their agglomeration due to geographical advantages. In fact,according to Saxenian (1994), whose research compared Silicon Valley with Route 128, the Silicon
Valley is a regional industrial structure based on the local community and on professional andinformation networks, in which were built human networks surpassing the boundaries of company
and function, forming a culture that attempts to create new things. On the other hand, Route 128 has
the regional industrial structure of a collection of vertically integrated firms, with almost no relationsof mutual dependency apparent either socially or in work-related areas. As a result, although firms
located in Route 128 enjoyed internal economies, the district did not advance to the formation of
local markets for special skills or a culture of technological innovation as seen in Silicon Valley.
Although Route 128 did see the formation of an industrial district, local markets for special skills did
not form, and a culture of technological innovation did not develop there.
In light of the above discussion, we should be able to summarize points of dispute in industrial
district research using the following three points:(1) There is a need to analyze economies of agglomeration as distinct from geographical economies.
(2) In addition, since internal economies cannot attract other firms to the vicinity, focus should beplaced on external economies, which can.
(3) Moreover, since industrial districts that have formed will not necessarily generate and sustain
external economies automatically, there is a need to seek out the conditions for generating andsustaining external economies.
Although in speaking of external economies there is a tendency to bring up only economies from
infrastructure improvements, such as railroads and roads (Hoover, 1937; Isard, 1956), external
4

economies also include those gained by multiple firms through direct interaction with each other.
This paper focuses on third point of dispute, what are the conditions for generating andsustaining economies of agglomeration in Japanese industrial district.

3. Reconsidering Japanese industrial district theory
3.1. Rarity of generalization and theoretical development
Since the 1990s, industrial districts have attracted attention for their possible contributions toincreasing the competitive advantages of firms located in them (e.g., Porter, 1990, 1998). In Japan inparticular, as shown in Fig. 1 even when accounting for biases of search systems 1 it is a fact thatliterature on industrial districts has increased rapidly since the latter half of the 1990s. Amid alengthy economic downturn, there were lively movements attempting to revitalize regional
economies by creating industrial districts across Japan (e.g., Matsushima, 1998; Ogawa, 1998;
Ohashi, 2000) and lively discussion on connecting technology transfers from universities to regional
industrial clusters (e.g., Ishikura et al., 2003).
Perhaps due to this timing, research in Japanese industrial district theory has studied the Jonanarea in Tokyo (Seki and Kato, 1990; Watanabe, 1998; Whittaker, 1997) and the Higashi Osaka area
(Ueda, 2000; 2004a; 2004b), which can be seen as leading examples of urban industrial districts inJapan, Okaya in Nagano Prefecture, which features an agglomeration of the precision machineryindustry (Seki and Tsujita, 2001), and Tsubame in Niigata Prefecture, a leading example of a ruralindustrial district (Iga, 2000; Seki and Fukuda, 1998), with such research frequently covering thehistory and current circumstances of such districts in detail from the perspective of small andmedium-sized enterprises. For this reason, the research tends to fall into the pattern of specificanalysis of individual case studies, without sufficient generalization or theoretical development inaccordance with the three points of dispute summarized in the preceding section. Although simple
comparison is difficult due to substantial changes in the numbers of journals indexed, literature on
local industry seems to have peaked in the 1980s. Since it places such old wine (research on local
industry) in new bottles (research on industrial districts), Japanese industrial district theory seems tohave a strong tendency toward consisting only of coverage of localities.

1

Total numbers of hits per year when conducing a general bibliographic search in the National Diet Library

Online Public Access Catalog User Guide (NDL-OPAC) and searches of indices of journal articles, using the
keyword sangyo shuseki ("industrial district"). The search was conducted April 21, 2007. Care is required
concerning the general bibliographic search because the number of journals indexed has undergone substantialchanges. While 3 100 journals were indexed in June 1996, today the number has risen to 9 891. Also, the termsangyo shuseki was almost never used until the 1970s.
5Results for searching “sangyo shuseki”

Book
hits

20

80

15

Journal60 hits

10

40

5

20

0

0

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

Year
Books

Journals

Figure 1: Results for searching “sangyo shuseki” (industrial district)
However, it is not the case that all preceding research merely begins and ends with the history
and current circumstances of industrial districts. For example, in examining the cases of five local
industries, Yamazaki (1977) showed that while the origins of the social division of labor apparent
throughout local industry are fairly old and that the background behind the formation of suchindustries differs fairly considerably by locality, the following seven characteristics serve asfunctional and fundamental reasons for sustaining local industries over a long period of time: 1) lackof economies of scale, 2) technical divisibility of production processes, 3) availability of low-costlabor, 4) a social division of labor is a system that makes new entry easy with small amounts ofcapital, 5) a social division of labor that functions to diversify risks and keep them to minimal levels,
6) benefits of locating in a locality that increase massively as the external economy advantages
increase in the process of development of local industry, and 7) adaptability and elasticity of thesocial division of labor that play a role in the formation of product structures suited to the times. In
particular, he cited Marshall in explaining the external economy as described under characteristic "6."
Accordingly, in this paper we will identify and classify matters pointed out by the consensus in
Japanese industrial district theory, conscious of Marshall's industrial district theory. Before doing so,
we will first define key concepts. In this study, we define industrial districts according to Marshall(1920), as the location of a number of small and medium-sized enterprises of the same industry in acertain geographical area. In addition, we define economies of agglomeration according to Weber(1909), as cost savings enjoyed from use of an industrial district greater than those that could beenjoyed without using the industrial district. Since we are defining industrial districts according toMarshall (1920), these economies of agglomeration do not include internal economies. Below, weclassify the claims of Japanese industrial district theory from the perspective of external economies— in particular, economies arising from the presence of local markets for special skills.
63.2. Consensus opinions of Japanese industrial district theory: supplier-side logic
Relatively low levels of unstable demand (i.e., volume of orders received that fluctuates
constantly with factors such as economic and seasonal variations) has been pointed out as the
background for firms located within industrial districts enjoying economies of agglomeration(Watanabe, 1997). When demand fluctuates quantitatively and qualitatively, production equipment
must be rearranged to suit such changes with flexibility, but from a cost perspective the scope towhich a single firm can respond to such changes is naturally limited. However, it is thought that afirm located inside an industrial district can secure subcontractors and organize, manage productionof, and manage processes of such subcontractors with a consciousness of fluctuations in demand.
As pointed out by Marshall, a precondition for the above responses to be possible is thepresence within the industrial district of local markets for special skills. When this precondition ismet, even in response to large or high-level orders that it cannot handle on its own a company canprocure the skilled labor it needs from local markets for special skills, enabling it to accept orders
with an idea of the delivery times and quality levels it can achieve. However, it must be noted thatskilled labor can be absorbed by firms not just through employment relationships but also throughsubcontracting relationships. In fact, in order to meet delivery time firms sometimes hire skilledlaborers from outside as immediate reinforcements or subcontract work to small firms (Watanabe,1997). In Ota Ward, thanks to the large numbers of confreres located nearby, firms can accept orders
despite their own capabilities are weak or they would not be able to accept alone due to delivery-timeor quantity considerations (Watanabe, 1997). In this way, firms in Ota Ward are able to focus on theirown areas of specialization, while responding with flexibility to qualitative and quantitative
fluctuations in demand.
Incidentally, that fact that local markets for special skills are maintained without vertical
integration into a single firm means that the ranks of skilled laborers and small firms are undergoing
constant renewal. A number of studies point out this mechanism—a mechanism that promotes
independence and entrepreneurship.
For example, it is said that in Tokyo's Jonan area the route toward independence was observedby which skilled machinists with nearly 10 years' experience as factory employees shift frommonthly salaried work to a subcontractor system in which they receive a fixed percentage of laborcharges for orders received, starting by renting some of the space in new factories as self-employedpersons, then renting semidetached or detached factory space and finally moving into plants ownedby their own companies. It was fairly easy to go into business for oneself because rental factories andinstallment purchases of machinery were available on the funding side and subcontracting work fromone's former employer as well as orders obtained through one's network of associates were available
on the order side (Watanabe, 1979, 1997).
Alternatively, in the tool and die industry in the Higashi Osaka area, since demand for dies isconcentrated on the times when user firms develop and introduce new products and most tool and die
firms are positioned upstream in the supply chain, demand fluctuations are sizable. As a result, it issaid that (i) when economic conditions were poor, the parent company would encourage employees
to go independent and start their own firms by presenting them with used machine tools lieu of7

severance pay in order to eliminate or reduce fixed costs and then assist these former employees bymeans such as sending some of their work to them or introducing customers, and (ii) when economic
conditions improved, the parent company would outsource subcontracting work to these newly
independent firms (Kato, 2006).
In this way, the presence within industrial districts of local markets for special skills can be said
to be the consensus opinion of Japanese industrial district theory. To small and medium-sized
manufacturers in industrial districts, this is a required condition for economies of agglomeration.

4. Overlooked purchaser-side logic: business practices in Japan
4.1. Awareness of the issues involved
In the preceding section, we pointed out that the ability to receive orders for work that fluctuates
quantitatively and qualitatively, by using local markets for special skills, has been surveyed andresearched in Japanese industrial district theory. However, there is a substantial difference in meaning
between the ability to receive orders and actually receiving such orders. This is because in orderactually to receive an order, the purchaser must actually place an order. Since its surveys and research
have targeted the small and medium-sized enterprises in industrial districts—that is, the supplierside—very little research in Japanese industrial district theory has discussed the other side of theequation: logic and economies on the purchaser side. To begin with, the kinds of conditions underwhich local markets for special skills are maintained also have not been elucidated 2.
An exception is the research by Yoshida (2002) looking at kouza, which express therelationships between purchasers and suppliers in industrial districts. Holding a kouza means that afirm has formally registered with and been approved by a large enterprise as a supplier and tradeswith the large enterprise directly. Seeing kouza-holding firms as the organizations that organize andcoordinate division of labor in the relatively horizontal division of labor in Ota Ward, Yoshida (2002)
focused on the concept of kouza as a means of clarifying the divisions of labor within industrial
districts 3. For this reason, although he focused on the concept of kouza, it can be said that Yoshida
did not address the logic of purchasers, who open these kouza.
4.2. Research settings
Accordingly, in this survey we conducted interviews as outlined below, to fill in these blanks in

2

Theoretical research is more advanced outside Japan. For example, Krugman (1991) attempts to clarify themechanisms for maintaining local markets for special skills by modeling interdependence between laborers andfirms.
3
Originally, with the exception of Yoshida (2002) research did not attempt to confirm whether companies holdkouza. Within the scope of our study, as a business practice in Japan large manufacturers and large distributors
do not designate companies other than kouza-holding firms as chouai-saki, and as such the holding of kouza
may be considered a tacit requirement. In fact, similar concepts have been asserted repeatedly in Japaneseindustrial district theory since Sumiya (1971), who focused on the functions of wholesalers in Tokyo's Joto area.
These have been referred to by various names, including "system organizers" (Yamazaki, 1977), chukakugata("core firms") (Watanabe, 1997), juyo hannyu kigyo ("demand-input firms") (Itami, 1998), and "linkage firms"(Takaoka, 1998). Yoshida (2002) confirmed that kouza-holding firms corresponded to the "core firms" cited by
Watanabe (1997) and that kouza-holding firms based on the volume of work subcontracted per company
fulfilled the role of Itami's "demand-input firms."
8

Japanese industrial district theory.
(1) Over the period November 2006 to April 2007, we interviewed 21 small firms located in Tokyo's
Ota Ward and Joto area, asking them about their transaction relationships and kouza. We
interviewed management of or persons in corresponding positions in each company, from one tothree times each. Most of these firms were small firms in the machine and metal industries, whilesome belonged to the chemical industry or light industries. In terms of size, seven of theinterviewed firms had from one to nine employees, 11 had from 10 to 49 employees, two hadfrom 50 to 99 employees, and one had 100 or more employees. Most of these were kouza-holding
firms having kouza with large enterprises.
(2) We also interviewed the person formerly responsible for the order management system and theperson responsible for planning of locally produced products in a large retailer. We interviewed
the person formerly responsible for the order management system for approximately two hours
and interviewed both these persons together for approximately two hours as well. We asked them
primarily about relations with suppliers and about kouza.
4.3. Fact findings
The results of these interviews made it clear that by nature large manufacturers and distributors
in Japan employ the business practice of dealing directly only with suppliers and subcontractors thathave kouza or numbers (i.e., kouza-holding firms), and furthermore that the extent of this businesspractice is as outlined below:
1 First, when supplier and subcontractor firms are formally authorized by large enterprises as
trading partners, they are registered and assigned supplier numbers. These are kouza.
2 These kouza numbers were intended originally for use in identifying suppliers when issuing
various forms such as order forms and statements of delivery.
3 However, in actual practice the presence of a kouza has come to signify credit. That is, evensmall firms can borrow operating funds from financial institutions by showing them order forms
with kouza numbers issued by large manufacturers or large distributors.
4 Since these kouza have come to have credit implications, the large enterprises that issue them
have also come to carry out (a) comprehensive examination of firms prior to issuing kouza,
instead of focusing solely on relevant products and transaction details, and (b) strict subsequentexamination, for example closing kouza in the event of problems with deliver times or failure
rates.
5 In some cases, this evolution has progressed further into the business practice known as chouai.
In this business practice, an enterprise dealing with a large number of small firms will designate
one kouza-holding firm as the chouai-saki, charged with coordinating and serving as a liaison
with other small firms (with only one order form issued, to the chouai-saki) and managing
delivery times and quality control, in return for commissions of several percentage points.
The business practice whereby large enterprises on the purchaser side deal only withkouza-holding firms is employed to enable risk avoidance by dealing directly with such9

kouza-holding firms that have passed strict examination both before and after being granted kouza
and that can provide guarantees on their transactions. Also, by designating as a chouai-saki akouza-holding firm that can provide a guarantee on the transaction, a large enterprise will seek toavoid risk even in a case in which an order cannot be handled by kouza-holding firms alone. In
addition, dealing with a chouai-saki alone in a case that ordinarily would involve dealing with anumber of small and medium-sized enterprises provides benefits in reduced administrative costs andimproved efficiency.
4.4. Purchaser-side logic
Taking this business practice on the purchaser side into consideration shows that the following
mutual relationships may exist between firms inside and outside industrial districts.
First, for many individuals and small firms the process of examination for opening a kouza isitself very difficult. For this reason, skilled laborers and small firms can receive orders for work fromlarge enterprises only via kouza-holding firms that already have kouza or numbers as supplier. As aresult, an initial requirement for securing work is a relationship with a kouza-holding firm.
Next, a large enterprise on the purchaser side needs to organize the trading partners withflexibility in accordance with the needs of each order because their orders vary both quantitatively
and qualitatively. However, it is difficult under this business practice. On this point, if akouza-holding firm is located inside the industrial district, the purchaser can reduce the costs
associated with distribution, administration, and production for such orders that vary quantitatively
and qualitatively by using such a kouza-holding firm as a chouai-saki. This is because when akouza-holding firm serves as a chouai-saki it assumes (i) distribution functions such as purchase, sale,
replenishment, and distribution of products completed within the industrial district, (ii) production
control functions with regard to subcontractor firms within the industrial district, such as designationof designs, quantities, and delivery times and providing technical assistance, and (iii) someproduction functions such as assembly, processing, fitting, and packing.
Furthermore, kouza-holding firms serving in the role of linking large enterprises with small
firms within the industrial district face the risk of losing their kouza if they fail to pay close attention
to delivery times and failure rates at all times. For this reason, when accepting an order large enoughto involve concerns about meeting delivery times such firms will, as noted above, hire skilled laborfrom outside the company as immediate reinforcements or subcontract work to small firms(Watanabe, 1997). Whatever the case, due to the need to manage delivery times and failure rates such
firms will, in general, choose neighboring companies and plants since they are easier to manage.
In such cases, the kouza-holding firms serving in the role of linking large enterprises with small
firms within the industrial district themselves benefit from being able to secure relatively stableorders. Originally, it is difficult for small firms such as those making up industrial districts to secureorders. What's more, due to their small size such firms are affected strongly by fluctuations indemand, which can become a factor affecting such companies' continued existence. To such small
enterprises, holding a kouza—that is, the existence of a continuous transaction relationship with alarge enterprise instead of conducting only spot transactions—is highly significant for purposes ofbusiness stability. Furthermore, Yoshida (2002) points out the following four points as additional
10benefits available to kouza-holding firms: 1) the high likelihood of being able to receive orders fromlarge enterprises not limited to existing transactions, 2) the ability to carry out sales activities witheasier access to large enterprises, 3) the ability to gain the trust of other small and medium-sizedenterprises in the area, and 4) the ability to familiarize themselves with various management methods
in areas such as document preparation and quality control. All if these can be considered beneficial tosecuring orders.
Japanese industrial district theory has looked only at the presence or absence of ordering
relationships and distribution of labor within industrial districts, without directly addressing these
Japanese business practices of kouza and chouai (Takaoka, 1998). For this reason, it has left largely
untouched the issues of why and how firms in industrial districts receive demand from outside these
districts. In addition, even when focusing on the existence of firms serving as points of contact
between firms inside and outside industrial districts, it has not discussed sufficiently the mutual
relationships between and roles played by firms inside and outside industrial districts. However, alook at business practices involving kouza-holding firms and chouai-saki makes it possible tosummarize these matters as outlined below.
(1) By using kouza-holding firms and chouai-saki that will provide guarantees for transactions, large
manufacturers and large distributors on the purchaser side can derive the following benefits: 1)
they can avoid transaction risks, and 2) they do not need to cover directly costs related toprocesses such as distribution, administration, and production.
(2) Small and medium-sized enterprises on the supplier side can derive the benefits of having the
kouza-holding firms and chouai-saki assume the difficulties of the level of credit required and of
responding to fluctuations in demand and managing delivery times when dealing with large
manufacturers and large distributors on the purchaser side.
(3) The kouza-holding firms serving to link large enterprises on the purchaser side with small andmedium-sized enterprises on the supplier side can derive the benefits of being able to secure
relatively stable orders by holding kouza with such large enterprises.

5. Conclusions
5.1. An integrated model of support for economies of agglomeration
In this paper, after first proposing that the point of dispute in research into industrial districts isfound in elucidation of the mechanisms of maintenance and development of economies ofagglomeration, we have discussed supplier-side logic abstracted and generalized from Japaneseindustrial district theory and purchaser-side logic from an independent survey conducted for the
purposes of this paper. Although it may be advisable to avoid too easy generalization from our results
due to the limited subjects of the survey reported on in this paper, in conclusion we would like topropose a new model of industrial districts through combination of supplier-side and purchaser-side
logic.
A look at the business practices pointed out in the preceding section shows the need to analyze
industrial districts by differentiating the following three actors: 1) first- and second-tier enterprisesthat place orders with firms in industrial districts, 2) kouza-holding firms that act as liaisons, and 3)
11

small firms that receive orders from kouza-holding firms (see Fig. 2) 4. Of these, it is thought thatindustrial districts consist primarily of firms in categories 2 (kouza-holding firms) and 3 (small firms).
On this point, it must be noted that since kouza-holding firms vary by purchaser, a firm belonging tocategory 2 (kouza-holding firms) in one case may belong to category 3 (small firms serving as
subcontractors) in another, and vice-versa.

Industrial District…①Large Firms… ② Kouza holding
Order

Fi
…③SMEsFigure 2: Three primary actors in industrial districts
Japanese industrial district theory has studied the logic of economies of agglomeration from the
supplier side. Costs place limits on the ability of individual firms to reorganize production facilities
flexibly in response to demand that fluctuates quantitatively and qualitatively. However, location
inside an industrial district makes it possible for a firm to respond to fluctuating demand by using
local markets for special skills. In short:
Required condition from the supplier side: Local markets for special skills must be present within
the industrial district.
This paper has elucidated the logic of economies of agglomeration from the purchaser side tosome extent. Large manufacturers and large retailers on the purchaser side employ the businesspractice of dealing directly only with kouza-holding firms 5. At the same time, while the ability torestructure transactions flexibly is a requirement of placing orders that fluctuate quantitatively and
4Fig. 2 depicts a simplified labor-distribution structure in an industrial district. In actual transactions, small
firms receiving subcontracting orders from kouza-holding firms may also subcontract operations to other firms.
5
It is highly likely that this business practice will continue to persist in the future as well. This is because ISO
certification has come to be taken into consideration by large enterprises in choosing direct trading partners. In
fact, according to the survey covered in this paper since it is unlikely even in areas such as Ota Ward that small
firms would have appointed the specialized environmental managers required under ISO 14000, large
enterprises have adopted the makeshift approach of dealing directly with suppliers that have attained ISO
certification, and the tendency toward requiring of firms serving as liaisons administrative efforts such as
document control as one part of governance activities is strengthening.
12

qualitatively, doing so is difficult under this business practice. On this point, if a kouza-holding firm
is located within an industrial district it is possible to place orders for such fluctuating orders bydesignating the kouza-holding firm as a chouai-saki and dealing through it. In short:
Required condition from the purchaser side: A kouza-holding firm must be present within theindustrial district.
Furthermore, the following mutually reinforcing relationships exist between these two
requirements on the supplier side and on the purchaser side:(a) Since the presence of local markets for special skills in the vicinity makes it possible to accept
orders from purchasers and maintain kouza even for large orders relative to their own capabilities,
kouza-holding firms will locate in areas with such local markets for special skills.
(b) Since subcontractors can secure stable orders in the vicinity of kouza-holding firms, even if insmall quantities, local markets for special skills will form around kouza-holding firms.
Put another way, the presence of local markets for special skills encourages kouza-holding firms tolocate in the area, and the location of kouza-holding firms in the area encourages the formation of
local markets for special skills (see Fig. 3). Based on this mutually reinforcing mechanism,
economies of agglomeration appear, maintaining and promoting the industrial district. By looking at
the purchaser side instead of just the supplier side alone, as has been conducted in traditional
Japanese industrial district theory, we have been able for the first time to complete the mechanism of
economies of agglomeration in industrial districts.

13

Required

Requiredcondition on

condition on

supplier sidepurchaser side

Local market for

Kouza holding

special skills

firms

Figure 3: Required conditions of economies of agglomeration
5.2. Implications for regional development policies
Understanding such business practices we reveal, we can design more efficient policies forregional economies and small and medium-sized enterprises. Recent years, policies for regional
economies have been designed and implemented at local government level to national level (e.g.
Industrial Cluster Project has been implemented in Japan since 2001). They aim to encourage small
and medium-sized enterprises in certain areas. However, most of them seem to be ineffective: These
policies succeed only in bringing small orders to industrial districts, and they cannot bring big orders
from large manufactures and distributors. Assuming the business practices we reveal, firms, and thus
industrial districts, can receive orders from large companies only via kouza-holdings firms. Hence,
policy-makers have to take such business practices into consideration to bring big orders which arenecessary to encourage regional economies and small and medium-sized enterprises.
5.3. Toward future research
Since the subject of the survey described in this paper is limited, research with a broader subject
matter should be needed in the future. We would like to conclude this paper by proposing three issues
that should be verified in such research.
The model proposed above has the following two characteristics: (i) purchasers andkouza-holding firms are individual actors, and (ii) moreover, kouza-holding firms are determined
individually for (i.e., vary by) each purchaser. In fact, this also could explain the primarycharacteristics and phenomena of industrial districts as pointed out in Japanese industrial district
theory: confrere trading, the structure of the social division of labor like a mountain chain, and14

location of purchasers outside industrial districts. This model should be used to make clear theconditions for formation of these characteristics and phenomena in greater detail.
Confrere trading: If orders received from individual purchasers are unstable and not in
sufficient quantity, transaction relations between kouza-holding firms will switch with each order,
since work accommodations will be made for each order. For this reason, confrere trading (Watanabe,1997), in which orders are placed in both directions between small firms in the same industry, takes
place (see Fig. 4). This phenomenon has been pointed out frequently in Japanese industrial district
theory. For example, in Ota Ward, against the background of the existence of other firms within thesame area, kouza-holding firms can accept orders they could not handle alone (Yoshida, 2002). In thecase of tool-and-die manufacturers, when industry-wide production capacity cannot increase quickly
enough in times of rapid growth in demand or in order to avoid the risks involved in facilities
expansion, the phenomenon is apparent of manufacturers mutually accommodating excess orders
received by outsourcing some work to other tool-and-die manufacturers for specific processing only
(Saito, 1994).

α

β

α

β
a

a
b

b
e

c
d

e

c
d

Figure 4: Confrere-trading structure: When the purchaser changes, the directions of transactions
between firms in the industrial district change as well. (Firms shown in the same positions in the
diagrams at left and right represent identical firms.)
Structure of social division of labor like a mountain chain: When two or more purchasers
place relatively stable orders in sufficient quantity, a structure similar to the structure of social
division of labor like a mountain chain (Watanabe, 1997) 6 will emerge in industrial districts.
6

The structure of social division of labor like a mountain chain is a concept proposed by Watanabe (1985,
1997) to describe the structure of division of labor in the Japanese machine industry. Watanabe (1985, 1997)
depicts the concept of the structure of social division of labor like a mountain chain in a graph with company
size on the vertical axis and market extent in the machine industry on the horizontal axis. Although the15However, since in general firms can choose locations irrespective of existing industrial districts forstable business in large quantities (Watanabe, 1997), this structure is not unique to industrial districts.
Location of purchasers outside industrial districts: When considered from the perspective ofindustrial district mechanisms, purchasers need to be confined to locations within the industrial
district when information stickiness as proposed by von Hippel (1994) is high. When a kouza-holding
firm fulfills distribution, production control, and production functions targeted at outside
subcontractors in lieu of the purchaser, information stickiness weakens and the purchaser itself can belocated outside the industrial district. To summarize, even if the location in the area of the large
manufacturer serving as the purchaser is the initial impetus for formation of the industrial district(Seki and Kato, 1990; Itami, 1998), it is not a requirement for the functioning and continued
existence of the industrial district. Although at a minimum the location of kouza-holding firms andsubcontractors within the industrial district is a requirement, large enterprises such as manufacturers,
retailers, and trading companies serving as purchasers can be located either inside or outside theindustrial district.

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