JAPAN: JAPAN'S SLASH AND SELL. - Price deflation has affected all sections of the Japanese economy. But those who were able to turn it into 'price destruction' have created huge opportunities for themselves.

by David Kilburn.
Last Updated: 31 Aug 2010

Price deflation has affected all sections of the Japanese economy. But those who were able to turn it into 'price destruction' have created huge opportunities for themselves.

Kakaku hakai - it sounds like a samurai battle cry; and for many Japanese it is no less than that. Literally translated as 'price destruction', the guttural phrase aptly sums up many feelings about the relentless downward trend in retail prices. True, you can still buy melons at £70 apiece and sip coffee at £6.25 a cup but now there are much cheaper alternatives to the pricey products that used to prevail throughout Japan.

The downward spiral has left no sector of the economy untouched. Asset prices, for the likes of land and equities, have now been falling for five years. Commercial property prices have collapsed over 50% since 1990. Newly built condominiums that cost £270,000 last year now go for £190,000. Wholesale prices have been falling for four consecutive years, and consumer prices are also on the slide. The price of wide-screen TV sets has dropped 15% over the past year, stereos are down 20% and VCRs by over 10%. Brand-name lipsticks that used to cost £30 or more in Tokyo department stores, now sell for half that price at discounters.

Japan is the only industrialised country to experience general price deflation since the 1930s. Not even the tomes about Japanese management techniques provided much help to companies as they were abruptly forced to forge survival strategies. But now after almost five years' free fall, lessons are emerging not only about how companies can manage massive price deflation, but about the marketing opportunities it can bring.

'Two factors sparked the decline in prices,' says Toshie Ikenaga, deputy director of the Economic Planning Agency's (EPA) domestic research bureau. 'Weak business conditions as a result of a lengthy recession created an increasing imbalance between supply and demand. Manufacturers cut prices to try to reduce inventories. At the same time, the yen's appreciation has made imports far cheaper. The net result was price competition - it's a classic scenario for price decline.' From price decline to price destruction proved an easy step. 'In trying to cope with the pressures, manufacturers tried to cut their costs by moving production overseas - especially to Southeast Asia - and exporting the products they made there back to Japan. Meanwhile retailers were busy trying to reduce their costs by cutting wholesalers and, at the same time, were seizing the opportunities deregulation offered to develop new stores.

The repeal of legislation which had protected small shopkeepers from competition gave many of Japan's entrepreneurial retailers their first opportunity to expand quickly, and into the cities. Falling land prices have made it cheaper to open new city stores, while stock exchange listings have provided the capital for expansion. Take Aoyama Trading Co, now one of Japan's leading retailers of men's suits. Founded in 1964, the company pioneered roadside retailing, and attracted customers with prices at 50% or so less than those of department stores. It bought direct from manufacturers, both in Japan and overseas. With lower land and operating costs than in city centres, Aoyama could sell cheaply without sacrificing either quality or margins. In 1993, the company opened stores in Tokyo and Osaka selling standard business suits from £16 upwards. Other city centre stores followed. By early 1994 Baring Securities reckons that Aoyama was selling about 15% of all men's business suits in Japan.

'If you are spending between £250 and £500, you can now buy a better-quality man's suit in Japan for a lower price than in the west coast of the US,' says Mike Allen, analyst at Baring Securities, Tokyo. 'Men's suits were a big focus of price-cutting a couple of years back, but not any more. Some say that this indicates deflation has ended but in fact it just shows that the focus has shifted somewhere else, where there is room for price reduction.' For example, Daiei Inc, Japan's largest supermarket chain, is testing how far facilities, service and the range of goods can be cut in order to lower retail prices at its experimental Hypermarket Sakaide. The 15,240 square-metre unheated store was built from pre-fabricated units and iron sheeting for 40% less than the average cost of a supermarket. It stocks the expected categories of merchandise but only offers the most popular lines.

Daiei also has its own label, aptly called 'Savings', undercutting manufacturer's brands by almost 50%. This year, it introduced its own brand of 'Savings Cola' at 24p for 350ml, sharing shelf space with Virgin Cola at 55p for 500ml, both cheaper than Coca Cola's 350ml for 69p. 'There's an increasingly widespread belief that private labels offer equal quality to branded products. People have developed an acute sense of the price value equation,' says Chris Beaumont, managing director of Infoplan Ltd, a Tokyo market research firm.

The strength of the mighty yen has also played its part in transforming prices. 'A large number of consumer goods that can be imported from overseas are competitive in Japan at exchange rates anywhere up to Y170 to the dollar, and recently it has been trading at around Y100,' says Allen. Daiei has formed alliances with leading manufacturers. Ajinomoto, one of Japan's biggest food processors, is developing low-priced retailer brands at a factory in Thailand. Kanebo, a major spinning firm, is making a range of low-cost women's wear from wool imported from its processing factory in Australia, which will be woven and dyed in Japan and finished in China. Marubeni Co, a leading general-trading firm, is helping source products from overseas manufacturers. Other leading supermarkets are following similar strategies.

Despite direct imports of finished goods still accounting for less than 10% of total retail sales, imports are putting strong downward pressures on a much larger number of domestically produced goods by setting price points to shoot for. Previously retailers were under no pressure to take the risks of going overseas to buy merchandise. 'Buying overseas, they have to pay for the goods directly, whereas in Japan it is common to take them on a sale-or-return basis,' says Allen. 'Now with selling space growing and consumption basically flat, retailers have to take those risks. But imports are not the only way to get prices down. They have been able to reduce the number of personnel per square metre so that while there is growth in selling space, there's no growth in personnel. It is becoming a leaner, more efficient industry.' The new retail environment opens doors to foreign retailers. For example, California's Tower Records now has 25 record stores in Japan, including an eight-storey 5,000-square-metre outlet in Tokyo's trendy Shibuya district visited by up to 30,000 people daily. By importing CDs directly from the US, Tower sells them in Japan for £11.25 compared to £15.65 in Japanese shops. Rather than cut prices, Japanese recording firms compete by trying to add value, by including bonus tracks and more extensive liner notes. Tower sells both varieties and leaves it to the customer to decide if the extras are worth an extra £4.40. Virgin and HMV pursue similar strategies.

Price destruction has forced manufacturers as well as retailers to retool themselves just to survive. 'Japanese companies are pursuing cost reduction strategies. They recognise the need to bring costs down to survive. This does not necessarily mean they intend to sell at ever lower prices - I think there's a realisation that that would be self-defeating - but they need to improve margins and regain flexibility in pricing in a world where the prices consumers will accept are lower than before,' says Beaumont.

But it is not just a question of goods being priced cheaply enough. Falling prices have not triggered a boom in consumer spending. 'Consumers are not buying things because they are cheap,' says Beaumont. 'Price is certainly very important to them, but they are looking for more than low prices. Value is a much better word to use. If a product or a service offers the value and the quality someone is looking for, and has a relevancy to their lives and aspirations, then they are willing to make a purchase. Even in the current climate, sales of many high-priced items, such as recreational vehicles, are doing well. Consumers are better informed and keener to make comparisons.' In a study of price trends the Economic Planning Agency welcomed price cuts that were the result of improved productivity and cost reductions. Price destruction raises the real income of consumers because people can buy the same goods and services at lower prices. Straight price deflation on the other hand, caused by weak demand, leads to lower income and higher unemployment.

Adjusting to the new environment has been painful. Low-cost imports put a drag on domestic production and oblige companies to cut jobs or restructure their operations, or both. Manufacturers are investing in low-wage countries, instead of at home. But the report rejects the notion that domestic industry is 'hollowing out'. In the EPA's view, the change is not an erosion of the industrial base but a process of improving the country's industrial structure, improving productivity in inefficient industries, and creating new and more sophisticated ones.

'Immediately, price destruction makes foreign products more attractive and gives their makers new opportunities to sell in Japan,' says Beaumont. 'But in the longer term, once Japanese firms have adjusted, the best of them will be more competitive internationally, both in price and quality, than ever before.' Aside from the new selling opportunities, price destruction in Japan has lessons for marketers in other countries. 'By radically challenging generally accepted ideas about production and patterns of distribution, a number of Japanese companies succeeded in bringing their costs down way below norms in their industries while maintaining product quality,' says Beaumont. 'They could then sell at competitively low prices. As a result, their sales increased very rapidly - even in static markets and despite a sluggish economy.

'By the time their competitors caught on, and began to bring their own costs down, the price leaders had consolidated stronger positions. Companies that simply slashed without bringing down costs lost margin and so found themselves progressively weakened as a result.' For those in the latter group, kakaku hakai has become far more chilling than any samurai battle cry.

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