Exploring Direct Trading Relationships between Manufacturers and Large Retailers in Japan

Introduction

The Japanese distribution system, particularly its multi-layered wholesale system, has provided one of the most significant and persistent challenges for foreign firms that are attempting to tap the Japanese consumer market (Aoyama, 2007). Even large-scale retailers commonly engage in sourcing through multiple layers of wholesalers (Takaoka, 1999). This phenomenon is frequently explained as a result of the institutionalised character of Japanese distribution routes (Samiee and Mayo, 1990; Martin et al., 1998). Although distribution channel relationships may be more stable and long-term oriented in Japan than in other markets (Lackman et al., 1997), external shocks can subvert the taken-for-granted character of existing systems (Schneiberg, 2005). An example of this type of external event is the bursting of the Japanese asset price bubble (1986-1991) in the early 1990s, which caused shock waves that triggered large-scale changes not only in the Japanese economy but also in Japan’s social and political spheres.

Large-scale changes were also expected to have occured in the Japanese distribution system as a result of this economic collapse. Stagnant or falling retail sales should have induced large retailers to streamline their supply chains, producing more direct trading relationships with manufacturers (Johansson and Hirano, 1996). These expectations were based on the assumption that, compared with their small-scale rivals, large-scale retailers generally tended to source a larger share of their goods directly from manufacturers because of the increased efficiency that direct sourcing can provide (WTO, 1998; Maruyama, 2004).

The question of whether the burst of the Japanese economic bubble and the subsequent years of slow economic growth triggered changes in the sourcing strategies of large Japanese retailers is highly relevant to foreign firms that are attempting to tap the Japanese consumer market because these types of changes would significantly enhance the ability of foreign firms to access Japanese retailers directly. However, although the structure of Japan’s distribution system has been an extensively discussed topic (for an overview, see Kikkawa and Takaoka, 1998, among others), the issue of direct trading relationships between large Japanese retailers (department stores and supermarkets) and manufacturers after 1990 has been largely neglected by both the business and scientific community. There are two possible explanations for this paucity of studies. First, official statistics from the Ministry of Economy, Trade and Industry (METI) do not include data regarding direct transactions between manufacturers and retailers (with no explanation provided). However, these official statistics do include data on the sales of consumer goods through wholesale markets. Efforts to gather similar large-scale primary data regarding direct trading relationships between retailers and manufacturers would be resource-intensive and would require access to a large number of organisations in the distribution sector. These efforts would be further complicated by the difficulty of collecting primary data in Japan (Bestor et al., 2003). Second, an increase in direct trading relationships between Japanese retailers and Japanese manufacturers is assumed to be a given, and therefore the situation with respect to this topic has not been further investigated due to the widespread belief that the Japanese wholesale sector is moribund (Larke and Davies, 2007).

This exploratory study seeks to address this gap in the extant literature and to obtain insights regarding the subject of direct sourcing by relying on primary data and the relevant literature to ensure the accuracy and applicability of future primary research. Section 2 introduces the framework that guides our exploratory effort. Our starting point to explore the issue of retailer-initiated direct trading relationships is the retailer’s sourcing strategy. In case that a switch from sourcing through wholesalers to direct sourcing at manufacturers is a strategy priority, the next questions are whether (a) the retailer has the power to shift the distributive functions performed by wholesalers to manufacturers, or (b) whether the retailer has the resources to integrate the distributive functions. In sections 3 and 4, we present a synthesis of the existing data and research that address the research questions derived from the framework introduced in section 2, namely (1) Was establishing direct trading relationships with manufacturers a priority for large Japanese retailers? (2) Did large retailers have the necessary power to shift the distributive functions that were performed by wholesalers to manufacturers? (3) Did large retailers have the necessary power to circumvent the wholesale sector? And (4) Did large retailers have the necessary resources to integrate the distributive functions? Section 5 provides an overview of the main findings of the study.

Framework

The Japanese distribution system has been a source of dispute between Japan and its trade partners, above all the United States (WTO, 1998). According to United States representatives, the Japanese distribution system inhibits competition, denies Japanese consumers the full benefits of a free and strong economy, and limits product availability as well as the opportunity of American businesses to sell competitive products (Verity, 1988). However, the revision of the Large-Scale Retail Stores Law, enacted in 1974 with the objective of protecting small- and medium-sized retailers against large retailers, in favour of large stores at the beginning of the 1990s was expected to lead to a substantial increase in the number of large retail stores on the expense of small traditional retailers. Once the number of large retailers and retail concentration increased, trading routes would shorten and facilitate market entry of new competitors (Stern and Weitz, 1997).

The data of the Japanese Statistics Bureau confirm indeed a continuous increase in the number of large stores during the time frame studied. The term “large store” refers to department stores and supermarkets with 50 employees or more. Between 1990 and 2005, the number of large stores increased by 82%, from 2,358 stores in 1990 to 4,285 stores in 2005. The largest increases occurred between 1993 and 1994 (9%) and between 1997 and 1998 (8%). With regards to wholesale circuity, referring to the number of separate title-holding intermediaries between a manufacturer and a retailer or individual demander, the commonly used measures, the W/R (wholesale sales/retail sales) ratio and w/W (sales from wholesalers to other wholesalers/total wholesale sales) ratio, indicate that distribution routes shortened. The W/R ratio declined from 4.1 in 1991 to 3.0 in 2004, and the w/W ratio for wholesalers dealing with consumer goods declined from 1.71 in 1991 to 1.65 in 2002 (Statistics Bureau, Historical Statistics of Japan, Chapter 13; METI 2004; METI 2005). Consistent with this trend, the number of wholesale establishments declined by 21% from 476,000 in 1991 to 375,378 in 2004 (Statistics Bureau, Historical Statistics of Japan, Chapter 13). Total wholesale sales declined by 27%. Sales per wholesale establishment were only down 10% between 1991 and 2004, indicating a concentration process within the wholesale industry (Statistics Bureau, Historical Statistics of Japan, Chapter 13). The data don’t indicate, however, whether direct trading relationships between retailers and manufacturers in Japan increased. Thus, the question that arises is whether alongside the shortening of distribution routes and concentration within the wholesale sector, direct trading relationships between retailers and manufacturers in Japan also increased during the time frame studied.

Our starting point to explore this question is the retailer’s sourcing strategy. In case that a switch from sourcing through wholesalers to direct sourcing at manufacturers is a strategy priority, the next questions are whether (a) the retailer has the power to shift the distributive functions performed by wholesalers to manufacturers, or (b) whether the retailer has the resources to integrate the distributive functions (see Figure 1).

We start with an explanation of the terms used in our framework.

Direct sourcing

For manufactured goods to pass from manufacturers to retailers, a number of distributive functions have to be performed, such as shipping, inventory holding, or bulk breaking. Depending on how the distributive functions are distributed among manufacturers, wholesalers, and retailers, various distribution system structures can be distinguished. Manufacturers, for example, can ship their goods directly to consumers (direct channel), retailers (retailer channel), or use wholesalers (intermediaries) to cater the retail market (wholesaler channel). Similarly, retailers can procure goods directly from manufacturers (referred to as direct sourcing, factory-direct model, or direct trading relationship) or through one or several layers of wholesalers.

Retailers include wholesalers in their distribution arrangement if the wholesalers perform certain functions at higher levels of efficiency and/or effectiveness. Otherwise, retailers will eliminate wholesalers from their sourcing arrangement. The functions performed by wholesalers, however,  cannot be eliminated. They must either be assumed by the retailers themselves, or the retailers must make the manufacturers assume the functions. To do so, retailers must have the power to shift the functions from wholesalers to manufacturers and make them bear the additional costs or, alternatively, to integrate the functions, retailers must possess the necessary resources to do so.

Power

Power in a distribution channel refers to the extent of one channel member’s ability to influence decision variables of another channel member at a different level of distribution (Coughlan et al., 2006). Retailer size is regardedas an important factor that affects the power of retailers within a distribution channel. A key determinant of retailer size is the number of goods that an outlet stocks (Inderst and Mazzarotto, 2008). Size increases a retailer’s power in a number of ways. Large retailers can act as “gatekeepers” and threaten to deny manufacturers access to retailers’ markets (Galbraith, 1952; Etgar, 1976). If they are large enough, retailers can threaten to incur substantial costs and integrate backward, rendering the manufacturer redundant (Katz, 1987; Sheffman and Spiller, 1992). Retailers might also threaten to switch to other manufacturers or increase the threat of entry by “sponsoring” a new manufacturer. Large retailers can also put pressure on the manufacturer’s price. Several studies have found a negative relationship between retail concentration (the market share of the largest retailers in a retail market, usually the top four or five retailers) and manufacturers’ profit margins (Inderst and Mazzarotto, 2008). In addition, large retailers can reduce the value of the manufacturers’ alternatives. When a manufacturer loses a large contract, the search for alternative distribution channels may reduce the price, thereby reducing the profit the seller can realise (Inderst and Mazzarotto, 2008). Market share is a necessary condition and proxy market for retailer power. It is, however, only a starting point for analysis because other factors, such as a favourable image among consumers, influence retailer power as well (Amato and Amato, 2009).

Because a market has both a demand and a supply side, the power of both the retailer and the manufacturer over supply contracts depends largely on the availability and value of outside options (Inderst and Mazzarotto, 2008). Therefore, as Biggar (1999) writes, not much can be deducted in terms of retail power from high retail concentration ratios, unless the ratios are interpreted, at a minimum, through comparison with concentration levels prevailing in manufacturing markets. A large retailer has only relative power over a manufacturer if competing supply options are available (Amato and Amato, 2009). Thus, the negotiations between a retailer and a manufacturer will depend, in part, on the following (Biggar, 1999):

• From the point of view of the retailer, how quickly and easily the retailer can find a substitute for the product in question, and how the retailer’s customer will react to not being able to buy a certain product.
• From the point of view of the manufacturer, how quickly and easily the manufacturer can find alternative outlets for its present line of goods and on what terms or, alternatively, how quickly and easily the manufacturer can produce a different line of goods.

An important factor that shapes retailer size and retail market concentration is legislation. The impact of legislation on retailer size is well documented (Leunis and Francois, 1988; Hollander and Ohmura, 1989; Davies and Harris, 1990; Treadgold and Sanghavi, 1990; Davies and Itoh, 2001). Such legislation is usually intended to restrict large-scale retailing businesses. Planning legislation restricts the ability of retailers to build larger outlets, whereas pricing legislation affects the ability of large retailers to use their purchasing power to gain a competitive advantage by offering lower prices. Both planning and pricing legislation restrict the power of large-scale retailers to use any economies of scale or scope that can be derived from the nature of their operations (Davies and Itoh, 2001). In a market either limited or unrestricted by regulations, the number of small-scale retail businesses is expected to decline over time because larger retail stores are more economical and cost efficient to operate as a result of economies of scale. Furthermore, because small-scale retailers tend to purchase through wholesalers more often than their larger rivals, which, in an unconstrained market, can result in preferential discounts in direct negotiation with manufacturers, legislation directed toward the retail sector can have an indirect, unintentional impact on the wholesale sector as well (Davies and Itoh, 2001).

The second factor affecting retailer power is private labels. Private labels are products owned and exclusively distributed by one or more retailers. The significant increase in the share of retail sales accounted for by private labels and a general growth in retail concentration in national markets are the two most important changes in retailing in recent years (Biggar, 1999). The retailers’ greater ability and willingness to produce and sell private brands is viewed as an important driver of retail market concentration (Dobson, 1998). The rationales for retailers selling private labels can be categorised as efficiency-related and power-related. Efficiency gains can be realised by avoiding efficiency losses through double marginalisation and, in the case of a bilateral monopoly, reducing transaction costs. In addition, the retailer may be able to provide some branding services more economically than the manufacturer by creating a synergy between a store’s reputation and that of the goods it carries (Biggar, 1999). The introduction of private labels by retailers leads to more competitive manufacturing markets (Dobson, 1998). Private labels enhance retailer power by augmenting the costs of switching stores and reducing the costs to consumers of switching brands. After all, it is regarded as a powerful means of retailer differentiation (Biggar, 1999).

Resources

In the case where retailers cannot or do not want to shift wholesaler functions to manufacturers, they can choose to integrate such functions if viewed as efficient and/or effective for their operation. In recent years, large retailers have increasingly become more vertically integrated (Nordås, 2008). They have taken over wholesale, and to some extent, logistics functions and source merchandise directly from suppliers. Drivers behind this development are the need for inventory control, and potential sources of economies of scale that can be derived from trading off inventory and transport costs on a broader product range by coordinating delivery from many suppliers. This requires retailers to have large enough financial resources covering the necessary investments as well as the ongoing distribution costs. Furthermore, retailers need also to have the necessary merchandising know-how to make the right sourcing decisions.

Summarising the above discussion, our research focuses on the following four issues. Given the exploratory nature of this study, we chose the below research questions in lieu of formal hypotheses.

1. Was establishing direct trading relationships with manufacturers a priority for large Japanese retailers?
2. Did large retailers have the necessary power to shift the distributive functions that were performed by wholesalers to manufacturers?
3. Did large retailers have the necessary power to circumvent the wholesale sector? 
4. Did large retailers have the necessary resources to integrate the distributive functions?

We limit our analysis to the years 1990 to 2005 for the following reasons:

• Revised retail market regulation: In 1990/1991 and 2001, retail market regulation in Japan was revised twice. In 1990/1991, the Large-Scale Retail Stores Law was revised in favour of large retailers as a result of the Structural Impediments Initiative (SII) talks between Japan and the United States, that were initiated in 1989 and addressed a number of anticompetitive practices and structural factors inhibiting manufactured imports into Japan. The revised statute was enacted in 1992 (Kusano, 1994). In 2001, the revised statute was replaced with a new statute, the Law Concerning Measures by Large-Scale Retail Stores for Preservation of the Living Environment, which further deregulated large store establishments (Japan Credit Rating Agency, 2011).
• Stagnating or decreasing retail sales: The sluggish economic environment along with stagnant or falling retail sales after the burst of the Japanese asset price bubble should have provided an incentive for retailers to streamline their supply chain and cut distribution costs by eliminating wholesalers from their distribution arrangements as a means to adapt to intensified competition in the post-bubble era. After 1991, retail sales stagnated, and after 1998, they decreased. Only in 2005 did retail sales increase for the first time in nine years to 130 trillion yen (JETRO, 2007).

Retailer resources and sourcing strategy

We start with the questions of retailer sourcing strategy and retailer resources.

The 1990s were characterised by stagnating or even decreasing sales at Japanese retailers, a low operating profit margin and high levels of interest bearing debt (Dawson and Larke, 2004). The situation somewhat improved after 2000. As of 2003, outstanding debt in the retail industry had returned to the levels of the beginning of the 1990s, and the return on assets (ROA) had modestly increased, reflecting a reduction of debt and a withdrawal of companies with low productivity (Cabinet Office, 2004). Both department stores and supermarkets tried to cope with the troubling (financial) situation the retail industry was in by expanding sales space and reorganising their supply chain.

• Sales space expansion: Both department stores and supermarkets invested in the expansion of sales space during the time frame studied, i.e., the opening of new stores and the enlargement of existing stores (JETRO, 2004; 2007). According to data provided by the Statistics Bureau Japan, sales space of department stores increased by 10%, while that of supermarkets increased by 112% (Statistics Bureau of Japan, Historical Statistics, Chapter 13 Domestic Trade, Table 13.11). The number of department stores decreased from 378 in 1990 to 345 in 2005 (-9%), while that of supermarkets increased from 1,980 in 1990 to 3,940 in 2005 (+99%). Such sales space expansion was a continuation of a trend that had started in the latter half of the 1980s when retailers were eager to capitalise on the increasing consumer demand during the bubble economy. The favourable business environment induced retailers to expand their businesses to meet increased consumer demand. Between 1982 and 1985, the number of stores with sales floor space of 500 m2 or more grew by only 1%, while between 1985 and 1988 the corresponding number was 10%, and between 1988 and 1991, it was 6% (METI, 1999). According to Dawson and Larke (2004), large retailers expanded sales space because they had no other choice for serving their large bank loans, a relict of the bubble economy when the favourable business environment in the second half of the 1980s had induced retailers to expand their businesses to meet increased consumer demand. Banks were the main providers of these funds. Eventually, the bubble burst at the beginning of the 1990s, and retailers were trapped because servicing bank loans was tied to increasing sales. Retailers tried to increase sales by increasing sales space, which increased the loan burden even more, by expanding product selection and by frequently introducing new products, with the hope that consumer confidence would eventually return. Consumer confidence, however, weakened further throughout the 1990s, and retail spending per household fell as did floor space productivity and sales (JETRO, 2004). Nevertheless, large retailers continued to invest in their store network even after debt levels were back to 1990 levels (JETRO, 2007).
• Supply chain reorganisation: At the same time, large retailers cut costs by reducing the number of wholesalers they contracted with, but, according to Maruyama (2004) and The Economist (2004), they did not increase direct sourcing. This led to a series of mergers and acquisitions in the wholesale industry. Given the retailers’ strategy of concentrating the financial resources on maximising sales space and competing on product selection, reducing the number of wholesalers they contracted with is plausible for a number of efficiency-related reasons.
• Ordering function: Ordering through wholesalers allowed retailers to access a large number of manufacturers and, simultaneously, to keep the number of manufacturers they dealt with and the related costs at a comparatively low level.
• Storage and delivery function: The expanding of sales space and the number of product items required that storage space be minimised. Retailers relied on wholesalers for storing goods and the frequent and reliable supply of merchandise in accurate, small quantities because of the limited availability of retail store space due to a general scarcity of habitable land and high population density in Japan, especially in metropolitan areas (Izuhara, 2000). As a result of these smaller orders, delivery frequency increased from once per week to twice per week or more; sometimes deliveries were made daily (Maruyama, 2004). Thus, relying on wholesalers for the delivery and storage of goods allowed retailers to maximise sales space.
• Lower risk and personnel costs: Furthermore, including wholesalers in their supply chain allowed retailers to lower the risk associated with the frequent introduction of new products and, at the same time, lower personnel costs by means of consignment purchases. Under consignment purchase arrangements, products that do not sell can be returned to the manufacturer through wholesalers at no cost. Under such an arrangement, the risk of new product introductions is borne by manufacturers. Manufacturers reduce this risk by dispatching their own sales personnel (i.e. sales clerks dispatched to retailers, employed and paid by manufacturers) and acquiring expertise in closely following and anticipating consumer trends. This eventually results in manufacturers controlling sales floor operations (Kikkawa and Takaoka, 1998) and retailers depending on manufacturers’ market expertise and dispatched employees for both know-how and cost-related reasons. Even as late as the 1990s, some department stores had failed to introduce the buyer function responsible for selecting merchandise and tracking the saleability of the merchandise. Department stores also failed to implement an effective tenant mix management as they were not able to evaluate each manufacturer’s and wholesaler’s product mix to create an attractive portfolio of products to consumers (McKinsey Global Institute, 2000). According to The Economist (2000), this is due to Japanese department stores having few retailing and merchandising skills and acting more like property developers, earning most of their revenue by renting out space. The use of consignment sales and supplier-employed sales staff in department stores increased since 1990 as retailers sought support from their suppliers and tried to reduce costs associated with directly paid employees (Dawson and Larke, 2004). According to a survey of selected department stores by The Japan Institute of Labour (JIL), the use of dispatched sales personnel was still on the rise after 2005 (Ono, 2005). The retailers’ dependence on consignment sales and dispatched sales personnel not only significantly undermined the retailers’ bargaining position toward manufacturers, it also meant that retailers wishing to integrate wholesalers’ functions must incur substantial investment both with regards to their payroll and their own merchandising know-how. Collected data suggest that during the time frame studied and from a resources point of view, retailers refrained from doing so.

Retailer power

In this section we focus on the question whether supermarkets and department stores had the necessary power to shift the distributive functions performed by wholesalers to manufacturers.

Market concentration levels

We start with analysing market concentration ratios (CR) and the Herfindahl Hirschman Index (HHI) of the retail market, supermarket and department store industries, as well as selected product markets. The CR is the sum of the market shares of the largest retailers in the market in question, while the Herfindahl Hirschman Index (HHI) is calculated as the sum of the squares of the market shares of all firms in the market. The most commonly used concentration ratio is the four firm concentration ratio (CR4). We use the following structural descriptions of CR4 levels:

• CR4 below 40%: effective competition
• CR4 between 40% and 60%: loose oligopoly
• CR4 over 60%: tight oligopoly

We also use the standards adopted by Japan’s Fair Trade Commission (JFTC). According to those standards, a monopolistic situation prevails in markets with a concentration rate in which one player has more than 50% of the market share (CR1 > 50%) or two players have more than 75% of the market share (CR2 > 75%), annual output is > 100 billion yen and entry into the market is “difficult” (no further explanation provided). An oligopolistic situation prevails in markets with CR3 > 70% and an annual output > 60 billion yen (Kobayashi, 2003). Measuring market concentration levels, however, provides only limited information about the actual market structure. Therefore, we also consider the HHI of the markets in question. The HHI is influenced by both the number of firms in the market and the differences in their relative size. The value of the HHI decreases as the number of firms in a market increases. Similarly, the value of the HHI will be greater as the degree of inequality in firm size increases. According to the U.S. Department of Justice 1982 Merger Guidelines, an industry is regarded as unconcentrated if HHI is < 1,000, moderately concentrated if HHI is between 1,000 and 1,800, and concentrated if  HHI is > 1,800.

Data sources

The JFTC provides data on 988 product and service markets in Japan. The data include CR3, CR4, CR5, CR8 and CR10 levels and HHI figures for the years 1975 to 2008. We limit our data analysis to the years 1990, 1995, 2000 and 2005. The data include market concentration figures and HHI for the supermarket and department store industries, defined as industries with large stores. Data for total retail market industry are not provided. We compute total retail market concentration by relying on data provided by JETRO (2007), Dawson and Larke (2004), and Nikkei Marketing Journal (1992; 1996; 2005).

Of the data mentioned above on 988 product and service markets, we selected 40 food products and 37 non-food products that are likely to be found in either department stores or supermarkets. The selected food products include ham & sausages, milk, milk-based drinks, condensed milk, butter, cheese, cream, ice cream, canned processed marine products, sausage and ham made out of fish, Miso (fermented soybean paste), soy sauce, mayonnaise and French dressing, tomato ketchup, vinegar, curry, sugar, wheat flour, bread, biscuit & cracker, chocolate products, chewing gum, potato chips, salad oil, oil for Tempura, margarine, corn starch, instant noodles, soft drinks, carbonated drinks, coffee drinks, tea drinks, sports drinks, beer, refined sake, shochu (clear distilled liquor), whisky, brandy, instant coffee, regular coffee; the selected non-food products include  tobacco, pet food, panty stockings, disposable diaper, disposable diaper for adults, disposable diaper for babies, sanitary items, tissue paper, adhesive tape, toilet soap, laundry soap, laundry detergent, kitchen detergent, household detergent, cosmetics, perfume and eau de cologne, foundation, lipstick & rouge & eye make-up, lipstick, face cream, face powder, hair products, toothbrush, photo film, bath agents, leather shoes for men, leather shoes for women, binders, household sewing machine, pocket calculator, golf balls, ball pen, lighter, Thermos bottle, compact disk, child car-seat. Unfortunately, product market concentration levels are not provided for all four years analysed (i.e., 1990, 1995, 2000, and 2005). In addition, there is no information provided on the annual output of a certain product market or on market entry barriers. Thus, power in both retail and product markets is analysed based on quantitative factors only (retail market concentration and share of private label products). Qualitative factors such as market entry conditions that can also affect negotiations between a retailer and a manufacturer, and other sources of power, such as a favourable image among consumers, are not considered.

Retail market concentration

We first calculate total retail market concentration ratios and find that between 1990 and 2005, total retail market concentration more than doubled (Figure 2).On the CR3 level, it increased from 3.1% in 1990 to 7.7% in 2005, and on the CR4 level, it increased from 3.8% in 1990 to 8.7% in 2005.

Next, we look at market concentration levels and HHI for the supermarket and department store industries in Japan for the years 1990, 1995, 2000, and 2005 (2002 for the supermarket industry, as figures are not available) (Table 1).

In the supermarket industry, we do not find a significant increase in concentration. On the CR3 level, concentration increased by only 1%, and on the CR4 level it remained unchanged at 43%. The HHI also decreased from 678 in 1990 to 633 in 2002, indicating that the supermarket industry became more competitive in the time frame studied.

In the department store industry, the concentration ratio increased between 1990 and 2005 by 9% from on the CR3 level, and by 10% on the CR4 level. The HHI, however, decreased from 266 to 160, indicating that the supermarket industry too became more competitive in the time frame studied.

Source: Japan Fair Trade Commission website. http://www.jftc.go.jp/katudo/ruiseki/ruisekidate2122.html (in Japanese) *Source: http://www47.tok2.com/home/nakamura/po.pdf **Source: http://www.yamaguchi-real.co.jp/report.html

Judged by the definition of the Japan Fair Trade Commission and the U.S. Department of Justice 1982 Merger Guidelines, all markets analysed, the total retail market and both the supermarket and the department industries can be considered as unconcentrated.

Product market concentration

In this section, we analyse the product market concentration levels (CR3 and CR4) of selected food and non-food products for the years 1990, 1995, 2000 and 2005 (Table 2 and Table 3).

Our findings can be summarised as follows:

• The number of product markets classified as competitive (CR4 < 40%) is small compared to the product markets classified as having a loose oligopoly (CR4 between 40% and 60%) or a tight oligopoly (CR4 > 60%). 
• An oligopolistic situation prevails in a considerable number of product markets (CR3 > 70%).

These findings are consistent with Cortes (2006). Cortes analysed 202 product markets in Japan in 1990, 217 product markets in 1995 and 331 product markets in 2000. He found that 81% in 1990, 93% in 1995, and 83% in 2000 of the product markets analysed can be classified as tight oligopolies.

The product market concentration levels are considerably higher than total retail market concentration. The same conclusion applies when comparing supermarket and department store industries with the selected product markets, although supermarket and department store industries show higher market concentration ratios than total retail market concentration. Table 4 summarises our findings and highlights the different levels of market concentrations. It shows CR3 and CR4 levels of total retail industry, the supermarket and department store industries, as well as selected food and non-food industries.

Value share of private labels

According to a study by Planet Retail (as reported in Kunmar and Steenkamp, 2007), the worldwide average of the value share of private labels in packaged consumer goods in 2000 was 14%. The share in Western Europe and in the United States was 20%, and in Australasia, it was 15%. In Japan, in contrast, the value share of private label was only 2%, which is significantly below the worldwide average. Only Central and Eastern Europe, as well as China, showed lower figures (Table 5).

In its 2005 retail report, ACNielsen, a market and consumer research firm, compared retail sales across 38 countries for 80 categories and listed the value share of private label products and growth rates of private label products for each country (Table 6). They found that the value share of private label products was 17% over the 12 months ending the first quarter of 2005 compared 15% in 2003 across all countries and categories. They also found that the share of private label products varies widely across the countries included in the study. Switzerland records the highest share of private label products at 45%, and the Philippines registers the lowest at less than 1%. The emerging markets in Asia Pacific and Latin America had less developed private label markets than Europe or North America. Japan’s share of private label products was 4%, with no change from the figures in the 2003 report.

ACNielsen (2003) further reports that Japan ranked tenth among the top ten fastest-growing private label markets. Growth rates were highest in the Asia Pacific region, emerging markets, and Latin America. ACNielsen (2003) attributed these growth rates to the expansion of large multi-national retailers in these regions, including Japan, that were introducing private label products. Two years later, however, Japan had already dropped off the list of the fastest-growing private label markets.

How can the low value share of private labels in Japan be explained? Regarding the two retail store categories studied here, Japanese department stores largely refrained from developing their own private label products due to their strategy of selling high-brand goods and, in recent years, also due to the risks and costs associated with it (Kojima, 2010). Japanese supermarkets, on the other hand, have quite a long history of introducing private labels. According to a study by the Food Marketing Research & Information Center (FMRIC) (2010), 9.7% of the surveyed supermarkets started to introduce private label processed food products before 1970, 19.4% between 1970 and 1979, 16.1% between 1980 and 1989, 25.8% between 1990 and 1999, and 29.1% since the year 2000. The share of private labels in supermarkets, however, remained low. In 2008 and 2009, after the so-called “PB Boom” took place in Japanese supermarkets, which was mainly a reaction to the emergence of discount stores (Food Marketing Research and Information Center, 2010), the share of private labels is estimated to be, at most, 10% (Kim, 2011). Before the PB-Boom, it was considerably lower (confirming Japan’s low figure of 4% in Table 6) because supermarkets focused on selling national brand products since the 1960s (Cho, 2008).

The results of our analysis of market concentration ratios and private label value share can be summarised as follows.

a) Market concentration ratios: Market concentration levels in the analysed food and non-food markets in Japan are considerably higher than totals for retail, department store and supermarket industries. Even the biggest retailer in 2005, Aeon, had a market share of only 3.4%. This would explain why even Aeon had difficulties in convincing manufacturers to develop direct trading relationships (Aoyama, 2007). The low figure in total retail concentration is supported by the fact that only a few nationwide retailers operated at the time (JETRO, 2004). In the drug store market, for example, even the industry-leading chains were only regional, and there were no national players. Similarly, in the home improvement industry, there were no nationwide chains. The industry leaders were all regional chains. Japan still has a large number of department store chains, whereas in many Western nations, the number of department stores has been reduced to only a few. As of July 2003, there were 99 department store operators in Japan. Only 10 out of these 99 operated nationwide, and the same 10 accounted for 57% of the total department store sales. The remaining 43% were regional department stores that focused on their respective prefectural capital (JETRO, 2004).

Factors contributing to high retail concentration include the presence of aggressive discounters who sell a limited selection of products (mainly shelf-stable food) at a very low price and with high purchase frequency. In Japan, although shopping frequency is high, Japanese consumers expect a large selection, including a variety of fresh products (Aoyama, 2007). In the time frame studied, Japanese retailers intensified competition on product selection rather than price and increased the number of products offered to consumers (Davies and Itoh, 2001; JETRO, 2007). Both factors, a large selection of goods and a variety of fresh foods, discourage increases in retail concentration. Competition on product selection rather than on price would also explain why only some of the largest retailers took advantage of the new regulatory environment by opening large numbers of new stores. According to Davies and Itou (2001), there was an increase in the average store size among large retailers, but there was less of an increase in the total number of large stores. Retailers sought to benefit from an increase in scope (that is, obtaining a wider range of products at the same location by increasing store size) rather than scale (i.e., generating greater purchasing power from greater sales of the same goods by increasing store numbers).

b) Private labels:Both the value share and the growth rate of private labels in Japan were comparatively low during the time frame studied. According to ACNielsen (2005), the extent of private label development correlates with the level of retail concentration. It is unclear, however, whether the share of private labels in Japan is low because of a consumer preference for branded goods, or whether it is due to low retail concentration.

Wholesale industry dynamics

A third power-related argument that speaks against an increase in direct trading relationships between retailers and manufacturers is the developments in Japanese wholesaling.

The widespread belief in recent years regarded Japanese wholesaling as moribund (Larke and Davies, 2007), especially as the increased use of the Internet for business transactions rendered more and more wholesalers redundant as order-processing intermediaries between retailers and manufacturers (Nusbaum, 2000). However, the increasing involvement of General Trading Companies (GTC) in domestic distribution actually strengthened the role of the wholesale sector in Japan, thereby affecting the ability of supermarkets and department stores to establish direct trading relationships with manufacturers.

GTC are large and highly integrated wholesale organisations, belonging to the category of primary wholesalers. Their functions and importance, especially for Japanese international trade since their formation in the second half of the 19th century, have been extensively described elsewhere (see, for example, Yonekawa and Yoshihara, 1987). Important for our context is the fact that the GTC have started to establish large company group portfolios within Japanese consumer goods distribution (Larke and Davies, 2007). Large GTC have not only strengthened their position in Japan’s domestic wholesale sector by investing in wholesale firms, but they have also assumed control of major retailers, which represents a new direction in GTC strategy. For example, in 1998, Itochu acquired a 30% stake of FamilyMart, a convenience store company; in 2000, Mitsubishi acquired 20% in Lawson, and in 2002, the company acquired a 10% share of am/pm, both convenience store companies; in 2000, Marubeni acquired a 10% equity stake in the leading supermarket company Maruetsu from Daiei, and increased the share to 30% in 2001; later, the company became a shareholder of Daiei itself by acquiring 5% in the company; in 2003, Maruetsu and Marubeni together acquired a 17.5% share of Tobu store, a mid-sized operator of food supermarkets; in 2000, Sumitomo purchased an equity stake of 12.5% in Seiyu, a major operator of food supermarket and general merchandising stores (Meyer-Ohle, 2004). Capitalising on both their existing embeddedness in the domestic market and their existing international supply network GTC can efficiently supply Japanese retailers with both domestic and imported products. As Larke and Davies (2007) write, all of Japan’s largest retailers organise some imports themselves, but they rely on GTC for the bulk of their imports. According to the 2002 Census of Commerce by the METI, sales of primary wholesalers purchasing goods from overseas and selling them to retailers increased by 58% between 1994 and 2002. The GTC’s international supply chains can be considered as near equivalents to the global supply chains operated by international retailers such as Wal-Mart, Carrefour and Tesco. Food and apparel have become almost entirely import driven sectors (Larke and Davies, 2007).

The close relationship between the GTC and retailers reduces the latter’s ability to establish direct trading relationships with manufacturers because the GTC may insist on using their own facilities (Meyer-Ohle, 2004). In other words, with GTC increasingly controlling the retailers as well as their own supply chain, it is unlikely that large retailers can bypass them.

Conclusion

This study focuses on the issue of whether large Japanese retailers (department stores and supermarkets) increased direct sourcing from manufacturers between 1990 and 2005. The following four research questions were used to guide our exploratory effort:

• Was establishing direct trading relationships with manufacturers a priority for large Japanese retailers?
• Did large retailers have the necessary power to shift the distributive functions that were performed by wholesalers to manufacturers?
• Did large retailers have the necessary power to circumvent the wholesale sector?
• Did large retailers have the necessary resources to integrate the distributive functions?

The results are as follows.

First, establishing direct trading relationships with manufacturers was not a priority for large Japanese retailers for strategy- and efficiency-related reasons. To service their bank loans, retailers sought to increase sales by maximising their sales space and by competing with their rivals with respect to product selection. This strategy made trading through wholesalers a more efficient approach for many retailers. Furthermore, the use of consignment sales and of sales personnel who were dispatched by manufacturers or wholesalers increased, allowing various retailers, particularly department stores, to reduce the costs and risks associated with their strategies of frequently introducing new products. Concurrently, these operational practices (namely, the use of consignment sales and of dispatched sales personnel) increased retailers’ financial and skill dependence on wholesalers and manufacturers.

Second, large retailers lacked the power to shift functions that were performed by wholesalers to manufacturers. This lack in power was exacerbated not only by the existence of a very low value share of private label products but also by the fact that department store and supermarket industry concentration ratios were considerably lower than product market concentration ratios.

Third, general trading companies (GTCs), which belong to the category of primary wholesalers, have increasingly assumed a stake in or control of major Japanese retailers and wholesalers. Given the involvement of these GTCs in national distribution, it is unlikely that large retailers could considerably increase direct sourcing from manufacturers in Japan by circumventing the GTCs. Furthermore, due to the retailers’ increasing dependence on the international supply chains of the GTCs, it is also rather unlikely that large retailers would source a large share of their internationally sourced goods directly from foreign manufacturers.

Thus, contrary to the widespread belief, the findings of this study suggest that retailer-initiated direct trading relationships with manufacturers in Japan did not significantly increase between 1990 and 2005. More research is needed to elucidate the sourcing strategies of large Japanese retailers. This study emphasises various areas requiring further investigation and serves a basis for future empirical studies which are urgently required.

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Article copyright Stefania Lottanti.

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