For much of its 72-year history, Hitoshi Fujita’s company operated as a typical small family business producing metal parts. However, it broke the mold for small Japanese manufacturers by expanding and acquiring two neighboring companies in the past decade. Fujita believes that more small companies need to follow this path; otherwise, Japan’s once-thriving manufacturing sector faces a bleak future.
Japan’s small and medium-sized enterprises (SMEs), which provide around 70% of jobs, have been struggling due to years of economic stagnation and population decline. Many of these firms have relied heavily on government assistance and low-cost funding. With the end of pandemic-era support and a rise in interest rates for the first time in 17 years, these companies now face significant challenges.
The Japanese government is prepared to let more underperforming companies fail, according to three senior officials. This shift marks a departure from the country’s traditional approach of avoiding bankruptcies and protecting jobs, even at the expense of productivity. The officials, who spoke anonymously, emphasized the need to replace stagnant businesses with those capable of driving growth.
This change aims to redirect workers and investments to more productive companies, ultimately boosting wages. The government expects this transformation to occur primarily through mergers and acquisitions (M&A) rather than widespread bankruptcies and layoffs. Help centers have been established to guide small businesses through the M&A process.
Interviews with government officials, bankers, industry experts, and business owners reveal several obstacles to this new approach, including Japan’s long-standing social contract. Fujita, who runs Sakai Seisakusyo in central Japan, noted that many small business owners lack the necessary skills for acquiring other companies.
Fujita’s company produces parts for faucets and semiconductors, and he aims to expand into higher-value components. Japan’s Ministry of Economy, Trade and Industry stated that it would continue to support SMEs with funding and other measures, encouraging them to enhance their earning power through investment and increased productivity. The ministry also noted a slight upward trend in bankruptcies returning to pre-pandemic levels, with workers changing jobs for better wages and conditions.
The issue of “zombie” companies—those unable to cover interest payments with their profits—remains a significant problem. According to Teikoku Databank, there were 251,000 zombie companies last year, the highest number in over a decade. Recent government measures encourage banks to help these weak companies improve rather than simply propping them up with loans.
Although the government cannot openly state its intention to allow more companies to fail due to potential public backlash, it is gradually implementing this strategy to boost productivity. Japan’s labor productivity, as measured by GDP per capita, lags behind other OECD countries, highlighting the need for change.
However, there are limits to how much economic disruption Japan can tolerate. In rural areas, even underperforming businesses are crucial to local communities. The government remains cautious about appearing to abandon support for small companies, aiming to redirect workers to growing businesses instead.
Prime Minister Fumio Kishida has pushed for higher wages, resulting in the largest pay increases in three decades. Despite this, many small, non-unionized companies have not seen the same wage growth.
During the pandemic, Japan provided significant financial support to SMEs, including “zero-zero” loans, which required no collateral and offered grace periods for interest payments. As these loans come due, bankruptcies have surged. In the first half of the year, nearly 5,000 companies went under, the highest first-half tally in a decade.
Repeated M&A is seen as a way for smaller companies to expand into higher-margin industries and for employees to acquire new skills. Fujita’s company made its most recent acquisition in 2020, purchasing a maker of auto and medical parts. The government subsidized half of the consultant fees for the deal, which was facilitated by a help center for small business acquisitions.
Government data show that 1,681 small companies were acquired with the help of these centers in the year ending March 2023.
Some small firms are managing to innovate and thrive despite the challenges. For example, Yukiko Izumi transformed her family’s cookie company, Izumiya Tokyoten, by cutting costs, relocating the headquarters, and raising prices for the first time in 15 years. She introduced a new product line with a cat theme, which faced initial resistance but has become a major success, selling 120,000 packages annually and returning the company to profitability.
Despite these success stories, many businesses face a tough road ahead as the era of easy money ends and a weak yen drives up costs. Yasushi Noro, president of NBC Consultants, noted that more companies are struggling with debt, a problem likely to worsen as interest rates rise. The traditional SME model that relied on low interest rates is no longer sustainable.
