Vertical Integration: Some Remarks About Japanese Manufacture

The Japanese rely much more extensively on subcontracting than is true in the United States. The experience of Toyota Motor Company, which has crafted an unusual relationship with its parts suppliers, is frequently cited in this connection. What explains Toyota’s success with subcontracting? What is the Japanese experience more generally? Definitive answers to neither question are attempted here. Some perspective is nevertheless attempted.

1. Toyota

As remarked earlier, the “study of extreme instances often provides important leads to the essentials of the situation.”8 In particular, case studies are often selected not because they are believed to be representative but because they permit the issues in question to be illustrated in a particularly dramatic way.9 That is the spirit in which the Toyota experience with its subcontractors should be interpreted. Among large Japanese corporations, Toyota has been especially successful in forging a mutually profitable and durable relation with its subcontractors. Some features of that situation are noteworthy:


Toyota began manufacturing automobiles in 1937, and its relations with many of its present subcontractors go back to the very earliest years. The fact that the automobile industry was well established by 1937 meant that state of the art technology could be borrowed and contracting relations crafted accord-ingly. The initial conditions facing Toyota were thus different from those confronting earlier entrants to the industry.


Toyota emphasized from the outset that the parent company, its subsidi- aries, and its subcontractors face a common destiny.” The parties were thus encouraged to regard the relation as a long-term one. A presumption that relations would be continued and differences would be worked out was maintained.


A pervasive aura of goodwill notwithstanding, transaction cost rea- soning is nevertheless respected. Both strategic investments and those of a highly specific kind are undertaken by Toyota. Contract renewals for work done by outside contractors are never automatic, moreover. Annual contracts are always subject to the discipline of competitive bidding. Exclusive reliance is avoided by adherence to a “two-vendor policy,” whereby Toyota divides the work between two or more suppliers. Occasionally, Toyota both makes and buys, though that is rare.


Many Toyota subcontractors sell almost their entire annual product to Toyota. Their dependence is reinforced by the site-specific nature of the investment, which is especially significant. Thus although the plant, equipment, and most of the labor force of the subcontractors are not highly specialized, the location of the plants in the immediate neighborhood of Toyota assembly plants makes them remote from other manufacturing.10 Those suppliers are therefore exposed to an expropriation risk.

As will be developed in Chapter 7, it is commonly in the mutual interest o trading parties to devise safeguards against opportunism. One type of safeguard is to develop a machinery whereby reputation effects are more accurately and reliably recorded and experiences shared among interested parties. Collective organization can and often does serve this purpose. In- erestingly, Toyota and its subcontractors evidently recognize this and have organized supplier associations others.


Toyota’s growth in the postwar period is remarkable. The company produced its millionth car in 1962. The cumulative total reached 20 million in 1976 and 40 million in 1983. Toyota suppliers shared in that growth and in the attendant prosperity.

Recent strains, however, have begun to develop as the growth of the world auto market has slowed and domestic content pressures on imported automobiles have increased in the United States and elsewhere. Although a serious divergence of interest has not developed, the presumption of identical interest is no longer as strong. Toyota, for example, did not consult its supplier organizations before reaching a joint venture agreement with General Motors to manufacture cars in GM’s then idle Fremont, California plant. (Indeed, it apprised its leading suppliers only hours before making the agreement public.) Although its suppliers recognize the need to adapt to changed circumstances, they also feel some unease. Toyota, moreover, has recently expressed concern lest its suppliers attempt to maintain their growth by selling parts in which Toyota has a design or other proprietary interest to rival automobile firms.

The strength of a relationship is tested when it is put to strain. Although Toyota and its suppliers appear to recognize the benefits of continuing their cooperation, and the famed Kanban system does not appear to be in jeopardy, future relationships between Toyota and its suppliers should not be projected as a simple extrapolation of the past.

2. Subcontracting More Generally

Although the Japanese reliance on subcontracting is great, the same principles that inform make or buy decisions in the United States and in other Western countries also apply in_Japan. What differs are the margins. The hazards of trading are less severe in Japan than in the United States because of cultural and institutional checks on opportunism.


Zentaro Kitagawa, a leading contract law specialist, describes the Japanese negotiating process as follows: “Japanese businessmen place more emphasis on building up a personal relationship than on drafting a detailed contract; all decisions are made by the group rather than the individual; lawyers are usually not consulted during the negotiations” (1980, p. 1-24). A greater sense of commitment to see the contract through to completion and to accommodate to the needs of the other is believed to result.


The propensity to litigate is vastly smaller in Japan than in the United States. As Frank Gibney observes, “The total number of civil actions in Japan in one year (1980) was about 500,000—about half the number of cases of California. On a per capita basis, there is one lawsuit in Japan for every twenty in the United States” (1982, p. 106). The Japanese emphasis on harmony in relation to justice helps to explain that condition. Gibney contends that compromise is preferred by the Japanese to confrontation and that “the process of discussion and consultation is in itself often more important than the precise kind of decision that may be reached” (1982, p. 108). Accordingly, although Japanese courts are formally committed to dispense justice, they are more interested than an American court in restoring harmony (Gibney, 1982, p. 109). The fact that the number of lawyers in Japan is deliberately kept small serves further to preserve this nonlitigous tradition.

Whether U.S. firms can or will improve their record in contracting respects is problematic. The issues are examined in Chapter 7. Suffice it to observe here that there is growing dissatisfaction with the prevailing adversary approach to law (Bok, 1983; Gilson, 1984). Public policy attitudes toward complex interfirm contracting are regarded more sympathetically today than was true only a decade earlier.

Source: Williamson Oliver E. (1998), The Economic Institutions of Capitalism, Free Press; Illustrated edition.

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