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The hidden growth story within Japanese technology is one of our highest-conviction and most differentiated investment ideas. And in the wake of the COVID-19 crisis, we believe some of our more compelling long-term themes in Japan — like digital transformation, payments, and work-from-home (WFH) capabilities — are increasingly relevant. For example, before the crisis, fewer than 20% of Japan’s companies were set up to work remotely and just 10% of workers had WFH experience.1 Notably, Japan has recently passed a digital transformation bill to improve digitization across its government entities.2 We believe improvement in these areas creates a long runway for growth.
Still, Japan is not typically a market associated with high growth, and many investors are apathetic on Japanese equities or believe there are only a few large multinational hardware companies worth investing in. In our view, demographic trends and idiosyncratic cultural factors are among the powerful long-term growth drivers fueling the strong case for a wide range of Japanese tech companies, including distinct and persistent software opportunities like fintech and online recruitment.
The evolution of Japanese tech
More than consumer electronics
Japan has long been known for high-quality and precision technology manufacturing, having honed this skill set since early in the history of the sector. Through years of manufacturing experience as an outsourced supplier, Japan built sophisticated supply chains and began to specialize in manufacturing high-end tech.
Electronics, consumer appliances, cameras, laptop computers, and industrial robots were among the products that drove Japan’s tech success in the 80s and 90s. But most of the large Japanese tech conglomerates may have seemed less exciting in recent years as US, South Korean, and Taiwanese companies have fueled smartphone innovation.
We believe Japanese tech is much more than consumer electronics and will see significant growth throughout the 2020s, both from local trends and from its status as a high-quality-component manufacturer.
Why are we excited about Japanese tech now?
The rapid, locally driven shift to digital
Japan has an aging population that needs to gain efficiencies and productivity as its workforce shrinks. The elderly population is at its highest level ever while the percentage of children is at its lowest.3 The country’s work culture has also historically been very manual-process (and paper) driven. The digitization of its industries is critical to success in a global marketplace, especially given these demographic shifts and the impact of the current environment.
Fintech and online recruitment are two areas that are helping society shift to digital and catch up to global trends. For example, we think the growth of digital payments can enable other industries to follow suit. In fact, Japan could soon allow wages to be paid in digital cash.4
Notably, the government spends nearly US$10 billion on paper billing and businesses spend roughly US$74 billion to process cash transactions each year.5 At 20%, Japan’s percentage of digital payments also lags significantly behind its neighbor, South Korea, which conducts 96% of transactions digitally. This offers a substantial growth opportunity as Japan seeks to double its share by 2025.6 For example, the number of monthly active users using a QR code to make payments on digital payments apps increased rapidly in 2020 (Figure 1).
Importantly, not all companies are able to achieve digital transformation on their own. Consulting firms are therefore increasingly helping small- and medium-sized companies make the leap into the digital era and the cloud. This helps firms increase efficiency and shift paperwork into an online process. Notably, we believe the winners in this growing space will be local firms, as a strong understanding of Japanese working culture and language are key barriers to entry for foreign competitors.
One digitization example that we’re following is a cloud and IT outsourcing company that seeks to raise companies’ operational efficiency and thereby help address several societal pain points (such as a declining population, labor shortage, and increasing demand for work/life balance). By using its cloud-based platform to take organization, filing, and reporting of expense management out of companies’ hands, the firm has enabled its clients to focus on their own areas of expertise. This has the potential to reduce time spent on these activities by 80% and management costs by 65%.7
The exponential growth of high-end components (and other opportunity sets)
Japan is one of the foundations of the semiconductor industry, with significant market share in semiconductor capacity (26%), CMOS sensors (42%), semiconductor equipment (33%), and materials (>50%).8 The growth of connected devices and smart tech is therefore another potential tailwind for Japanese technology. For example, as autonomous and electric vehicles advance, automobile supply chains evolve along with them. And with this burgeoning opportunity set’s keen focus on safety — as these digital components are increasingly critical to a car’s functionality — we think Japan’s reputation as a high-end tech manufacturer is a key differentiator for buyers of components like computer chips.
Notably, new markets for high-end components are not limited to the auto industry. Smart tech’s use cases are constantly expanding. For instance, machine vision cameras have the potential to offer predictive maintenance on everything from train tracks to elevators. This is one of many examples of Japanese tech that is increasing efficiency and safety while reducing cost. We believe these Japanese component suppliers have many potential use cases as the connected device market grows.
Finally, we believe Japanese tech will be a key beneficiary of the rapid growth of the gaming industry, a trend that has accelerated during the COVID-19 pandemic. Japan is home to two of the largest players in gaming, with nine of the top-10 selling consoles in the history of the sector.9 As the industry shifts to mobile and cloud-based gaming, we believe Japanese gaming companies will evolve along with it and continue to be industry leaders.
Potential risks for Japanese tech
Investing in Japanese tech is not without risks. In our view, there are several potential risks to our long-term outlook for Japanese tech and the Asia tech sector more broadly. Technology is an economically sensitive industry and may underperform if Japan’s growth or global growth slows. The pace of technological adoption may also vary between countries and industries.
In addition, tech is made up of subsectors that have their own mini cycles within the overall tech cycle, which can cause dispersion within the sector. Valuations in some areas are also a potential concern given the sector’s strong recent performance, making active management critical to the opportunity set, in our view. Furthermore, regulations are likely to have an increased impact on the sector as countries react to tech’s growing importance to consumers and economies alike. Finally, interest rates are very low today and if they do increase substantially, this could affect the sector’s outlook.
Japan’s hidden tech story
Japanese tech is among our team’s highest-conviction themes. We believe it offers an increasingly compelling opportunity set that is fueled by lasting secular and demographic trends, a strong local tech industry with high barriers to entry, and rapidly expanding opportunity sets.
1Japan Ministry of Internal Affairs and Communications, Fortune.com, as of 2018. | 2Bloomberg, The Straits Times, May 2021. | 3Statistics Bureau of Japan, 2019. | 4Japan Times, March 2021. | 5BBC, Nomura Research Institute, Mizuho Financial Group, March 2020. | 6 “Japan wants to go cashless, but elderly aren’t so keen”, Reuters, November 2019. | 7Company reports, estimates as of March 2019. | 8“Japan – A thriving, highly versatile chip manufacturing region”, Semi.org, October 2018. | 9VGChartz, May 2021.