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CIAO DATE: 4/00
Good Fences Make Good Neighbors: Cooperation Between Firms and Property Rights in Japan
W. Mark Fruin
Secrecy and Knowledge Production
Judith Reppy, Editor
Peace Studies Program, Cornell University
Occasional Paper #23
October 1999
In Robert Frost’s turn-of-the-century day, Yankee ingenuity held that borders, boundaries, and fences were essential for managing human activity and private property. Without them, Frost believed that the desire to own property and to profit therein are frustrated. In Mending Wall, Frost asserts a primacy of property rights in relations characterized by specialized assets, writing:
And on a day we meet to walk the line
And set the wall between us once again,
We keep the wall between us as we go. 1
Today, Frost’s commonsense runs counter to a groundswell of writing that trumpets an imminent arrival of borderless national economies and effortless interfirm cooperation. Property rights are rarely mentioned in this global call-to-arms although they are regarded as a sine qua non of economic development (North 1990). Japan’s model of widespread cooperation between firms, especially among assemblers and suppliers in Toyota-like production systems, is a touchstone of this new age philosophy.
Japan’s property rights regime is unusual because property rights are frequently not assigned to property owners and originators, thus contradicting Frost’s “Good Fences” rule. Property rights embody the normal expectations and legal guarantees that encourage investment, without which economies will not grow, enterprises will not profit, and entrepreneurs will not take risks. Such expectations and guarantees are termed “good fences” in this essay.
Good fences require that the sources of good ideas are identifiable and that rewards accrue in proportion to value added. In short, property rights are needed for cooperation or, as Robert Frost puts it, “good fences make good neighbors.” However, property can be appropriated and expropriated, thereby breaking the chain between property origination, ownership, and profit-making. In less developed economies where low levels of legal protection are associated with high levels of appropriation and expropriation, property rights claims and the rents that flow from them are weakly supported. Identifying where good ideas come from and profiting from them are not one and the same thing (Teece 1986, 1998).
Japan’s low legal protection and high appropriation of intellectual property is surprising, given Japan’s high level of economic development and reputed status as a developmental model. Low property rights protection appears part and parcel of Japan’s late industrialization when firms raced pell-mell to catch up to and surpass the leading firms of the West. Property rights were overlooked, neglected, and ignored in this long march toward industrialization, so much so that low property rights protection has become an institutionalized feature of Japan’s economy and business system (Aoki 1988; Fruin 1992; Gerlach 1992; Odagiri 1992).
In partial response, firms clustered together to generate and protect property, and this introduces us to the appropriation part of the story. Within clusters, property rights are shared or at least made available as means for developing common practices and standards. Access to clusters and, thus, to property and community practices is tightly controlled. In this sense property rights are organizational, in that their recognition, protection, and promotion are group-based. This well describes the functioning of technology-based clusters, like Toyota Motor’s group of companies. This essay, using examples from Toyota’s and Toshiba’s groups of companies, identifies distinctive features of Japan’s property rights system and discusses various mechanisms that have arisen to recognize and assign property rights among Japanese firms.
Firm Boundaries and Property Rights in Japan
Japan industrialized late. Industrial catch-up required firms to focus on selective transfer of technology and to specialize by function and product. Without focus and specialization, the century to half-century gap in technical knowledge and production experience between Japan’s fledgling firms and leading Western firms would not be bridged. Focus and specialization pushed firms into coalitions with other firms to secure needed resources outside their areas of concentration. Instead of internalizing resources and capabilities in ever-larger, Western-style, M-Form firms (Chandler 1962, 1990), widespread co-specialization of assets resulted in an institutional environment and property rights regime remarkably different from those of the West (Kester 1991; Fruin 1995; Gerlach 1992).
An undeveloped market for corporate control may be another consequence of Japan’s late development. The relative infrequency of mergers and acquisitions prevents individuals from cashing in on their good ideas (Kester 1991; Gerlach 1992). Although business lines are often spun-off from core firms within business groups (kigyo shudan or busunesu gurupu), broad diversification by single firms is discouraged by the interlocking nature of groups (Fruin 1992). The group effect can be seen in R&D as well. Seventy-five percent of industrial R&D funding and 80 percent of R&D activity are undertaken by large private firms, all of which are enmeshed in business groups, so government-backed big-science and high-technology projects are relatively fewer than in the West (Fransman 1996).
Long-term or relational contracting is prized, not unexpectedly in a country so geographically limited and demographically dense. Relational contracting assumes a degree of long-term, asset co-specialization on the part of transacting parties. In addition, the institutionalized personnel practices of large firms, such as lifetime employment and seniority-weighted reward, encourage low levels of occupational mobility and turnover (Abegglen 1958). Given the closed market for corporate control and the relatively low levels of government R&D funding, firms either generate intellectual property themselves or create circumstances that allow for co-generation and sharing of intellectual property. Such circumstances are seemingly threefold: first, interfirm relations are punctuated by long-term reciprocity; second, job-hopping between firms is constrained; third, unfriendly efforts to take over proprietary resources are eschewed.
All of which contributes to the distinctiveness of Japan’s property rights regime. Valuable ideas are mostly generated and paid for privately, either by single firms or by firms clustered in groups, alliances, and coalitions. Within groupings, firms cooperate frequently without too much concern for property rights. The Toyota Production System (TPS) is based on a combination of open firm borders and low levels of property rights protection with other Toyota group members, as depicted Figure 1.
Toyota’s lean production model relies on transaction-specific as opposed to residual property rights. Transaction-specific property rights (TSPR) are a means of recognizing the value of intellectual property in transfer pricing between firms. TSPR parcel out rewards and benefits on a transaction-by-transaction basis. In most cases, this is a straight, fixed cost calculation: x number of people times y number of hours. However, another part of the reward is more directly tied to the firm-specific, self-developed technologies of suppliers. Fair valuation of this variable cost is a function of assembler-supplier experience and interfirm governance arrangements, as illustrated in the following auto and electronics industry examples (Clark and Fujimoto 1991; Fruin and Nishiguchi 1994; Fruin 1998a).
Figure 7.1: Open Borders and Property Rights Protection
The Auto Industry and Property Rights in Japan
The excellent work of Kim Clark and Takahiro Fujimoto on product development performance in Japan’s motor vehicle industry finds that effective product development hinges in large measure on what they call “heavyweight product managers” and “heavyweight product development organizations” (Clark and Fujimoto 1991). Heavyweight means organizations are well led and provisioned, sitting amidst divisionalized and matricized firms.
What is fenced-in is more important than what is not because speed, quality, and efficiency are interdependent qualities of effective product development. Fencing in projects with sufficient authority, autonomy, and team-specific assets is critical because if these are borrowed extensively from “under the table” or “over the wall,” speed, quality, and efficiency suffer. Also fencing in avoids resource “hold-up” and allows for integrated problem solving, multifunctional coordination, and intensive product/process communications. Everything and everyone necessary to product development effectiveness are closely coupled.
Not fencing in key resources at the start or along the way blurs functional, technical and organizational requisites of product development effectiveness. Overlap of functions is more easily achieved within product development organizations, and in this sense intramural coordination is different in any number of ways from interdepartmental coordination. The former economize on time and resources by creating project teams that are typically small, polyvalent, and well experienced while the latter often aggregate functional specialists without emphasizing their previous experience and time-to-market performance. 2 Intramural and interdepartmental coordination suggest different strategies: one of self-contained tasks in the former and good lateral relations in the latter (Galbraith 1974).
Project Team Size
Clark and Fujimoto find that–beyond a certain critical mass–the larger the team, the lower product development performance. Size seems related to bureaucratization (DiMaggio and Powell 1983) and to problems of appropriation because the larger the team, the more sharing of value added is problematic. The sharing of value added is critical because in Toyota’s case, Japanese auto components, sub-assemblies and sub-systems are about 70 percent “black box” parts. Black box parts are where suppliers provide parts and components of their own proprietary design to meet assemblers’ functional requirements. That is, about 70 percent of the parts, components, and sub-assemblies that go into Toyota cars are based on suppliers’ self-developed technologies.
The high proportion of parts, components, sub-assemblies, and sub-systems that are “black box” means that the function, performance, and integrity of Toyota’s lean production system depend heavily on supplier capabilities. The high reliance mirrors both the comparatively high systems engineering capabilities of suppliers and the quality of transactional relations imbuing supplier networks (Clark and Fujimoto 1991). Asanuma calls these “relation-specific” skills (Asanuma 1989).
Such capabilities and relations are embedded in frequent communications and information exchange across firm borders. These depend on good fences because a Denso employee (Denso is one of Toyota’s largest, most critical, and independent suppliers), no matter how much time and effort s/he expends on behalf of Toyota, is a Denso employee. Long-term or “lifetime” employment is the rule in large firms and compensation is heavily weighted in favor of experience coupled with individual contributions to firm welfare. Because such employment practices are coupled with firm-specific internal labor markets, borders between firms can be open and intellectual property freely traded.
Product development team members benefit more from continuing their current employment than they do by seeking greener pastures elsewhere. This helps explain the high ratio of black box parts (newly designed parts compared to in-house engineering) and Aoki’s characterization of the purchasing manager’s role in auto assembly firms (Aoki 1986). Or, in the words of this essay, good fences make good neighbors. Expectations of reward are tied to transaction-specific property rights and personnel policies of long-term employment and seniority-based compensation.
The Electronics Industry and Property Rights in Japan
Autos and electronic goods are quite different products. In Japan’s motor vehicle industry product development projects are relatively long-lived, some forty odd months or so. But forty-month long development cycles are unheard of in the electronics industry, except for heavy power generation and transmission equipment segments of the industry (Fruin 1998b).
Industry-specific features may frustrate a simple carry-over of lean production and heavyweight product development models from the auto industry. A wide reading of the literature and months of fieldwork investigation and observation suggest that two variables and not one are important in electronics. First, product development and product life cycles have to be appraised. These are positively correlated in Clark and Fujimoto’s study, meaning the shorter the life cycle, the shorter the product development cycle.
Second, the degree of intergenerational differences between products must be assayed. Intergenerational product differences are typically not significant in the case of the autos and in some electronic industry products. For example, at Toshiba’s main photocopier (PPC) factory in Japan, PPC development activities amount to little more than a kind of set-aside from normal production activities (Fruin 1997). However, in the case of laser printers (LP) at the same plant, technical discontinuity between generations is sufficiently great that design engineers re-consider LP systems and sub-systems in terms of functions, features, performance, design for manufacturability, and operating costs. They also review hardware and software specifications in light of the latest microchip and semiconductor devices on the market.
For LP development projects, much like heavyweight development projects in the auto industry, projects are well stocked with their own resources and raison d’etre. If most electronic products are like LPS rather than PPCs, heavyweight product development organizations may be needed when either product development cycles are short or intergenerational product differences great.
The autonomy of product development organizations in the electronics industry, however, hinges on two additional variables: organizational slack and the breadth and depth of team members’ skills. When resources are not fully committed within firms, and hence slack resources are available, openness between development projects and the rest of the firm allows for an easy pass through of resources. When project assets are borrowed in this way and as long as problems of appropriation do not arise, the authority of product development managers is not diminished by relying on resources outside of his/her control.
Borrowing resources is likely under three conditions: first, when property rights disputes are unlikely, the best available know-how and knowledge within a firm, its affiliates, and suppliers will be secured; second, when development skills are highly specialized, they cannot be easily substituted for and hence resources outside the immediate control of development projects may be sought; third, when development cycles are short, employees are more easily loanable. Along these lines, Clark and Fujimoto report that product development organizations in North America and Western Europe are typically more specialized in design and engineering skills and that product development cycles are typically longer (Clark and Fujimoto 1991). Or, larger-sized product development teams are the rule when product development teams are more highly specialized. Larger and more specialized teams result in longer product development cycles and, significantly for our purposes, more property rights claims.
But in Japan, team polyvalence, kaizen activities, and an emphasis on minimizing organizational slack may keep a lid on team size. Teams make up in breadth what they lack in depth. Development teams are not large, several dozens at best, although some recent research has emphasized the importance of redundancy or slack in product development activities (Imai, Nonaka, and Takeuchi 1985; Nonaka and Takeuchi 1995). 3 But practices like synchronous engineering are not exclusively Japanese. As Mr. William Reed, President of Semiconductor Equipment & Materials International wrote to Senator Bensen: “I find it plausible that in some cases suppliers will work more closely with their local customers in the development stages of their equipment. This practice is understandable, given proximity, cultural similarities and traditional customer/vendor relationships. An increasing number of US equipment suppliers are working closely with their American customers,” Financial Times, 17 May 1991: 18. If resources can be borrowed easily, breadth can be finessed by openness. However, the effectiveness of this solution depends on the quality of cooperation in the technology transfer processes among firms in the same group.
Presumably this is why assemblers rank the quality of their relations with suppliers as highly as the quality of supplied parts and components in Japan (Asanuma 1989; Fruin 1998a). Where relations are good, resources are available and loanable, and property rights claims are not generally prosecuted. The degree of cooperation within groups also hinges on the degree of intergenerational product differences and the length of product development cycles. Where intergenerational differences are low and development cycles long, borrowing is an alternative to stockpiling resources (Clark and Fujimoto 1991). In fact, smaller numbers of more widely skilled development team members are preferable, given transaction-specific property rights and lifetime employment norms (Hashimoto 1979; Fruin 1997). But ultimately, this hinges on the nature of the property rights regime and cooperation within business groups.
Cooperation and Property Rights: Japan versus Silicon Valley
The necessity of interfirm coordination and cooperation are acute today. Product numbers and varieties are growing as product life cycles are shortening. It is increasingly difficult for single firms to manage the development, production, and distribution of complex products worldwide. As a result, cooperation between firms is growing.
Models of interfirm cooperation differ significantly in the degree to which they recognize and protect property rights. Japan and Silicon Valley are quite different in these respects. Japan’s firms are highly praised for a strong learning orientation based on open borders with stakeholders, such as suppliers, labor unions, group (keiretsu) affiliates, and banks. Learning and cooperation in Japan’s case centers around a core firm or firms clustered in a well defined business group. Defining which firms are in and which are not underlies learning and cooperation in Japan. Perhaps for this reason Japan’s firms are hardly ever touted for spillover effects or, as we have seen, property rights protection (Cole 1989; Porter 1990; Fruin and Nishiguchi 1993; Liker et al. 1999). 4
Two explanations for the cooperation of Japan’s firms have been offered. The first, more or less a cultural explanation, relies on trading experience, proximity, and transactional frequency to build up “trust” between parties. A business ethic infused with “goodwill” rather than “opportunism” is the result (Dore 1983; Fruin 1983; Williamson 1985). The second comes from classical game theory, especially non-cooperative Nash equilibrium games, in which neither player (company) is motivated to change, nor agrees not to change (Morrow 1994). Such games allow for intensive information exchange and emergent norms of fair governance that are like the non-contractual, co-specialized activities of Toyota assemblers and suppliers (Womack et al. 1990; Clark and Fujimoto 1991). In either case, cooperation is particularistic, not a general outcome.
In Silicon Valley cooperation between firms brings not only firm profits but also regional prosperity with spillover effects (Piore and Sabel 1984; Helpman and Krugman 1985; Porter 1990; Saxenian 1994). Cooperation is based on open standards combined with strong property rights protection. While the costs of legal protection are high, the benefits of cooperation coupled with strong property rights protection go far in explaining Silicon Valley’s wealth-generating cornucopia. However, it is worth noting that this combination may be more exceptional than normative, even in the United States (Saxenian 1994; Bratton 1989).
Japan and Silicon Valley’s models of cooperation are very different. Toyota’s lean production model requires co-evolutionary experience as a prerequisite for the tight cooperation that involves sharing co-specialized and proprietary information. Silicon Valley networks are less particularistic, with low entry costs for joining transactional networks but with substantial legal and opportunity costs associated with living and working in the San Francisco Bay Region. (Perhaps these costs help explain why Silicon Valley is still a regional, and not a national, model). Cooperation is concerned with the setting of open standards, such as Sun Microsystem’s Java software that works with almost any hardware and operating system.
Japan’s cooperation is particularistic with a business group while Silicon Valley’s is more general, such as setting industry standards. For such reasons, Toyota’s lean production system and associated property rights pivot on three elements:
1) flexible transfer prices between assemblers and suppliers;
2) multilateral exchange of know-how mediated by governance arrangements;
3) pay for performance in rewarding project team members.
These interactions and behaviors occur within a particular group of companies, and as such, they are a recognition and adaptation of the universality of Frost’s property rights concerns. But the rule of law, especially as it applies to property rights protection, is institutionally embedded in business practices that cut across industries in Japan–witness the similarity in Toyota and Toshiba’s assembler-supplier practices.
Good fences make good neighbors, even in Toyota’s and Toshiba’s worlds, by allowing for adjustments in how property ownership is recognized and rewarded, thereby minimizing transaction costs in spite of high levels of interfirm resource dependency. Expectations of reward based on suppliers’ product/process innovations are built-into human resource policies, and research suggests that such expectations powerfully affect productivity and innovation (DeAlessi 1983; Rosenberg and Frischtak 1983). The payoffs for cooperation are great in spite of a property rights regime characterized by high appropriation and low protection.
Black-box suppliers, who supply most of the intellectual property generated with the Toyota Production System, are especially unlikely to defect. They enjoy a privileged position as “systems suppliers,” providing entire, integrated solutions to Toyota Motor. They often control the flows of proprietary technology and are in strong positions to be well paid for their contributions in the form of transaction-specific property rights, goodwill transfer prices, and flexible wage payments. As a result, transaction costs, based in part on transactional frequency and on multilateral bargaining arrangements in supplier associations, appear low (Williamson 1985; Nishiguchi 1995; Dyer 1998; Fruin 1998a).
Toyota’s lean production system arose in a particular historical and institutional setting when, at first, Japan needed to catch-up and more recently when, for the most part, applied research and knowledge creation were generated privately within firm clusters. Such circumstances were part and parcel of Japan’s late industrialization as are other features of Japan’s institutional environment, such as low labor mobility, interfirm governance arrangements (like supplier associations), and the absence of a market for corporate control. The rule of law, especially property rights law, did not develop as an independent feature of the institutional environment outside the rough and rumble of corporate practice.
For such reasons, the nature of cooperation between firms in Japan is distinctive, and the institutional features that underlie cooperation there are unlikely to be repeated elsewhere. The singularity of Japan’s institutional response among advanced industrial economies seems likely to hinder the worldwide spread of Japanese production and product development systems. So global best practices, like the Toyota Production System, are not necessarily global because they cannot be transferred intact. Adjustments, adaptations, and transformations are to be expected (Liker et al. 1999).
There are advocates for the worldwide spread of Japanese production and development systems without significant changes (Womack et al. 1991; Nishiguchi 1995). However, our own view is that the transfer of technology and resources between countries, even within the same company, always requires some degree of adaptation and change. In this respect, Silicon Valley rather than Toyota’s lean production model appears to “have legs” or greater international currency. The Silicon Valley model is grounded in a rule of law where property rights are not dependent on particularized institutional or organizations settings, as in Japan’s clustered model. Given that property rights are publicly acknowledged and enforced in the Silicon Valley model, switching, monitoring and enforcement costs are lower than would otherwise be the case (Bratton 1989). The rule of law in this public sense appears to be a more efficient institutional setting for property rights development and protection than Japan’s closed corporate system.
Japan’s national strategy of late industrialization and low property rights protection is unlikely to be repeated elsewhere, at least not in the same ways that it unfolded in Japan. Today, property rights protection is a widely recognized condition, if not precondition, of international technology transfer and economic development. Laws and institutions that facilitate the creation of common standards across corporate, national, and international borders are the norm. They seemingly excel at eliciting and ensuring cooperation.
Robert Frost was actually ambivalent about fences, walls, and boundaries. He celebrated them as indispensable for good relations but decried them as contrary to the human spirit. “Something there is that doesn’t love a wall,” he lamented, even while tumbled stones and fallen fruit seem to make good boundaries a neighborly necessity. Without fences, what’s mine and yours are unclear. Ambiguity in property rights as in most everything else makes for poor performance.
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Endnotes:
Note 1: I am using the metaphor of fences for firm borders, and I admit to borrowing Robert Frost’s mastery of the metaphor in “Mending Wall,” North of Boston (New York: H. Holt & Co., 1915). Back.
Note 2: My emphasis on product and production specialization as opposed to functional specialization differs from other accounts. See Paul Adler (1991). Back.
Note 3: Japan’s firms are reputedly better at interorganizational coordination, yet a top American executive told me, “no matter how I spoke to my Japanese counterparts about ‘synchronous engineering,’ they could not understand my point. Either they were feigning ignorance or the problem was not framed sensibly to them.” Conversation with J.B. in Fontainebleau, France on May 25, 1991. Back.
Note 4: There are parallels between Toyota’s system of knowledge production and the defense contracting system in the United States. Both are closed systems and, as a result, knowledge spillover benefits are limited. Both have strong supplier/contractor qualifying requirements, which are more stringent than public standards, and in general decisions are made in-house without reference to public standards. Recently the Department of Defense has engaged in a serious effort to move to commercial standards in order to remove some of the barriers inhibiting product and knowledge flows between the two sectors, but thousands of military-specific standards and requirements remain. Back.
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