Japan's Telecommunications Industry:

Where It's Been, and Where It's Going

by Louis Ross

It is difficult to discuss telecom without also considering the electronics industry. After WWII, when Japanese government and private industry decided to move from mechanical technology to electronics, Japan initiated a modernization effort that would create a relatively large number of domestic competitors. The Japanese strategy differed from other nations in that companies specializing in one sector also developed in-house expertise in the other, even though it was hard to imagine just thirty years ago how highly integrated these technologies would become. This foresight has put Japanese industry on track to take advantage of the current technology-integration trend.

NTT (Nippon Telegraph and Telephone) was an engine of growth for Japanese industry during the immediate post-war period. NTT has long provided a vital source of demand for such firms as NEC, the largest telecom equipment vendor in Japan (and which also holds by far the largest share in the Japanese PC market). Japanese firms have licensed foreign technology to develop products for the home market, and NTT has purchased those products. NTT's R&D budget has also contributed to the development of both the telecom and electronics sectors.

Telecom deregulation
Japanese telecommunications firms have traditionally relied on the (protected) home market for their revenues. With the large and stable flow of orders coming from NTT - whose standards were largely proprietary and used only in Japan - Japanese telecommunications equipment suppliers had little incentive to enter the highly competitive global telecom equipment market.

The current wave of deregulation, though, has served as a catalyst for change. In early 1996, Japan's Ministry of Posts and Telecommunications (MPT) implemented a comprehensive deregulation plan - one that impacted not only NTT, but also CATV carriers, broadcasters, NCCs (new common carriers), and related industries (such as computer/�@electronics and software manufacturers). This plan culminated 11 years of liberalization measures initiated in 1985 through the First Reform of the Telecommunications System (which helped to create, for example, competitive new firms offering international and domestic phone services).

The reform of 1985, however, did not end the all-encompassing control that NTT exerts over Japan's local telecommunications networks. Efforts by the MPT in 1990 (and within the past couple of years) to break up NTT have not led to an AT&T-style dissolution scenario - and perhaps will not in the foreseeable future.

[For a brief history of Japan's post-war telecommunications market and some insights into the 1995 Deregulation Action Program, refer to "Form Over Substance: Japan's Telecommunications Deregulation Debate" in our June Online Extras section (see page 6). -Ed.]

One impetus for the recent push for telecom deregulation has been the perceived need for Japan to "catch up" to foreign initiatives. With popularization of the Internet in the US helping to create a burgeoning multimedia infrastructure of highly competitive and innovative startup firms, Japanese companies found themselves falling behind because of the stifling regulations that have limited the development of the domestic market. Deregulation was seen as vital to the establishment of a truly competitive Japanese telecommunications market.

But are these domestic deregulation efforts sufficient to loosen the tightly regulated Japanese telecom market and spur continued growth and competition? Will Japanese adherence to the recent WTO (World Trade Organization) agreement contribute to further opening of the domestic market? This is an important issue not only for the Japanese market, but also for the US government (which is closely monitoring the progress of deregulation in Japan).

Many observers suggest that, since NTT remains dominant, the Japanese telecom market will continue to be difficult for foreign firms to penetrate. NTT still controls nearly 98% of local switching equipment, and has maintained its ability to charge high access fees to potential competitors (such as foreign firms that must obtain access to the NTT network in order to offer services to their customers).

Japan's new "Multimedia Wars"
Last year, the domestic media began to play up Japan's "desperate race" with foreign telecom giants in developing multimedia technologies. But the constant chatter of Japan lagging behind the US and other countries - in nearly everything and anything - is merely Japanese social etiquette at work, and should be taken with a grain of salt.

This is not to suggest that Japanese companies don't face daunting challenges, or that promoting such fear isn't an effective call to action. But it is important for the Western observer to realize that Japanese culture promotes an acute over-sensitivity to real or imagined "threats" to the nation. Such themes serve to provide an incentive to "dig in and work hard." Burgess Laird of the Los Alamos National Laboratory refers to this as "national rallying cries," the objective of which are to focus energies and investment across society.

In fact, Japanese telecom firms last year experienced a sharp increase in pretax earnings. Lower profits were reported in 1996, however, due to price cuts and higher capital investment, which increased depreciation write-offs.

Regardless of any short-term setbacks, Japan's telecom firms should do well in the long term. They have received a considerable boost from government initiatives triggered by the national "emergency" of falling behind in critical technologies like telecom, multimedia, and the like. The government has set in motion several projects to act as a catalyst for private sector initiatives. Deregulation is one arrow in the quiver.

Playing catch-up
Japanese elite policymakers have shown overwhelming support for multimedia-promotion policies. In 1992, NTT invested over $25 million to establish a Tokyo multimedia center focusing on digital technologies. And as has traditionally been the case, several Japanese electronics OEMs (original equipment manufacturers) receive "directions" on how to produce related equipment.

The Japanese government is supporting a number of initiatives, ranging from huge increases in R&D budgets to promoting a homegrown satellite industry. Two areas that are very high on the totem pole of telecom related-objectives are the promotion of Japanese standards as world standards, and encouragement of expanded capital investment budgets. (The huge expansion in Japan's science and technology budget - initiated during a recessionary period, by the way - is one example of the latter.)

Deregulation was seen as vital to the establishment of a truly competitive Japanese telecommunications market.

Superior foreign technology is often used as a benchmark when attempting to create indigenous technological capabilities in Japan. NTT, NEC, and many other Japanese information/communications firms have developed venture capital- related subsidiaries whose mission is to find promising foreign companies that offer cutting-edge, innovative technologies.

The MPT and its associated Telecommunications Technology Council have issued a number of reports emphasizing the future importance of telecom technologies and multimedia in Japan. The MPT's budget for computer- and telecommunications-related programs in 1996 increased by nearly 70%, from around $4 billion to $6.8 billion, and a study group report submitted last year recommends the creation of a fund to subsidize research into new technologies beyond telephone-related services. The MPT also has been very aggressively promoting PHS (personal handyphone system) via the creation of the PHS MoU Group.

The Ministry of International Trade and Industry (MITI), meanwhile, has decided to ease the lending requirements for funding that supports R&D cooperation between industries and universities. This is part of MITI's effort to bolster the capabilities of the university research system (and one reason for the large increase in science and technology funding). The Japan Development Bank will provide up to 50% of the funds required for new low-interest loans.

Fiber-optic to the home
Though currently behind schedule, Japan's "omnibus digital network" - a new nationwide network infrastructure through which households will be connected to telephone switching stations - should be completed by the year 2010. The Construction Ministry plans to spend �7 trillion over the next 15 years to lay a nationwide network of fiber-optic cables under major roads, an initiative that complements the cable already being laid by NTT and other domestic firms. This network, also referred to by NTT as the "fiber-to-home network," will serve as the foundation for high-speed, digitized audio and streaming (continuous) video.

The MPT plans to assist development of the network by deregulating the current separation between cable TV and telephone regulation. Also, the broadband allocation system will be integrated in order to combine information communications and broadcasting. The switch from analog technology to code division multiple access (CDMA) - a technology that has twice the capacity of the analog system - will help spur Japan's plan to become a digitized nation by the beginning of the century. (This switch, by the way, was aided by the licensing of chip technology from a midsize American company named Qualcomm.)

Today, the previously closed NTT-Japanese supplier relationships have opened up to foreign participation. Several members of the NTT family of suppliers - including NEC, Fujitsu, and Matsushita Communications - are being joined by Ericsson, Lucent Technologies, and Nokia to produce CDMA-based base stations and handsets.

Foreign firms, such as Motorola and Ericsson, will play a very important role in developing this new digital infrastructure. According to Skipp Orr, director of government relations at Motorola, "the MPT standard-setting process on CDMA was pretty open. Everyone had a fair shot." Motorola will produce narrowband base stations for the announced DDI/IDO partnership - perhaps aharbinger of things to come. NTT, meanwhile, is gearing up to initiate major investments in a wideband infrastructure.

The government was the catalyst in getting Japanese producers to switch from copper cable to fiber-optic production several decades ago. This push was in line with its policies promoting electronics technologies rather than attempting to refine mechanical technology, and it helped nurture the tandem development of the telecom and computer industries. Japan plans to spend more on R&D than the US (for the first time in history) by the year 2000.

NTT's strategy
The core of the Japanese telecommunications industry begins with NTT and its "family" of suppliers: mainly NEC, Fujitsu, Toshiba, Hitachi, and Mitsubishi Electric. NTT itself does not produce products; it offers services. Of the electronics firms in the NTT family, NEC is its largest supplier, and has been since the beginning of the post-war period.

NTT's revenues are the largest of any telecom firm in the world (surpassing �7 trillion in 1994). In comparison, the largest US carrier, AT&T, earned only a little more than half of what NTT earned. With the specter of deregulation on the horizon, NTT is gearing up to meet new competitive threats. So far, it has met the challenge. Even though its earnings from access charges and other traditional sources have decreased, NTT is expected to earn record-high profits after a relatively lackluster performance during most of the decade.

With the impending regulatory changes, technological convergence, and industry consolidation, however, NTT will need to be aggressive if it is to remain Japan's dominant telecom market force. NTT will most likely seek to set up a strong overseas network infrastructure for communications and multimedia services (as was announced by its president last year). This comes several years after the establishment of multimedia facilities here in Japan.

Currently, NTT is experiencing tremendous growth in its mobile and data communications businesses. NTT - through its mobile phone subsidiary DoCoMo - and DDI (Japan's largest PHS operator) control over 70% of the mobile communications market in Japan, a market that grew from $13 billion in 1994 to $20 billion in 1995.

A big issue in the Japanese telecommunications industry, of course, is the future of NTT - both domestically and internationally. It is clear that there will be a host of opportunities for foreign firms to enter the lucrative Japanese telecom market, from which NTT derives the bulk of its revenues. The development of NTT's fiber-to-home network will offer tremendous opportunities for foreign firms that can provide the key technologies needed for the project. Through strategic alliances with foreign firms, and by increasing the amount of equipment procured from them, NTT may be able to develop a formidable competitive global presence.

What will happen if NTT aggressively enters other markets - including the world's most competitive in the US - while telecommunications deregulation in Japan is not aggressively implemented? This possibility concerns US policymakers, and such a situation could be a future source of trade friction between Japan and its trading partners.

All in the family
Japanese electronics firms have aggressively expanded into the telecommunications field, primarily by focusing on the development and mass production of multimedia-related equipment and semiconductors. For example, more powerful and faster semiconductors will enable multimedia-oriented data to be transferred in greater amounts at faster speeds over digital lines. There has been an unprecedented surge in domestic capital investment in information, telecommunications technologies, and infrastructure. For example, DDI/IDO's focus on developing a narrowband digital network infrastructure in Japan has provided a booming business for firms constructing the base stations to operate such networks. NEC, Fujitsu, Matsushita Communications, Ericsson, and Lucent Technologies are the suppliers for this project.

In the wideband area, NTT/DoCoMo plan to invest in infrastructure in 1998. During the past several years, these firms have been slowly digitizing their consumer electronics products - for example, digital cameras, personal digital assistants, and minidisc players. Such devices are increasing the need to transfer data over digital networks and creating new opportunities. High transfer speeds for a wireless unit, for example, require stronger batteries, an area where Japanese technology can reduce power consumption considerably.

The boom in the telecommunications business will permit Japanese firms to develop new markets, and thereby decrease their dependence on "commodity" semiconductors.

As these technologies are developed, tested, and enhanced in Japan, Japanese telecom firms (and their suppliers, both Japanese and foreign) can slowly move into markets where such advanced infrastructure does not exist on a mass scale. The deregulation of the world telecom markets (at least theoretically) should permit this.

Conclusion
Fortunately for Japan, its telecommunications market has developed in tandem with the nation's electronics/ computer industries since the beginning of the post-war period. As a result, Japanese firms stand better positioned than many of their foreign rivals to take advantage of the accelerating merger of technologies.

Japanese industry (and the government) realizes that Japan needs to become more competitive in certain areas. An emerging broad-based consensus has pushed for increased funding to develop not only Japan's IT industry, but others as well (since the government recognizes that the value of spin-off technology from telecommunications is also great). Deregulatory efforts, both at home and abroad, will set the stage for Japanese firms to learn whether they are up to the challenge of competing (and cooperating) with foreign firms. At the same time, Japan's deregulatory efforts will allow foreign firms a foot in the Japanese telecom market door.

There is no foregone conclusion, but don't be surprised if Japanese competitiveness in the telecom arena suddenly seems to jump up out of nowhere.

Next month: Japan in the world telecom market

Louis J. Ross (louis_ross@japan.ml.com) is a Strategist, Assistant Vice President, Research Department, at Merrill Lynch Japan (Tokyo). He has followed the relationship between capital markets and the funding of high-technology industries both in the US and Japan for over five years.

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