The Epic Tale of Japan's Mightiest Companies: The Sogo Shosha
The history of the Japanese trading conglomerates that literary built the Japanese economy
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Introduction
This text is mainly inspired by Marubeni Research Institute’s excellent research papers on the matter (2014, 2017), the 12-part Sogo Shosha series from Patrick Ryan at the Japan Times (2018), and Nikkei Asia’s coverage of the resurgence of the Sogo Shosha (2019,2021). I have also taken inspiration from multiple smaller articles and videos that can be found in the appendix.
At the height of Japan's economic boom in the latter half of the 20th century, the Sogo Shosha stood tall as the powerhouse conglomerates that dominated the global and Japanese business world. They were the epitome of Japan's rise as an economic superpower, a symbol of the country's unrivaled might and prowess in the corporate world. With their vast networks and immense resources, these trading companies came to control a large portion of the country's exports, imports, and investment flows. They were the kingmakers, the power brokers, and the gatekeepers of the Japanese economy.
However, the Sogo Shosha's reign was not meant to last forever. As the Japanese economy matured and globalization intensified, the landscape of the business world began to shift. Companies that focused on specific segments, such as electronics, automotives, and finance, rose to prominence, pushing the Sogo Shosha to the sidelines. The once mighty conglomerates were considered outdated, their business models no longer relevant in a rapidly changing world.
But, like a phoenix rising from the ashes, the Sogo Shosha clawed their way back. Through a combination of strategic investments, divestments, and cost-cutting measures, they managed to weather the storm and remain relevant in the 21st century. While they still trade at low multiples compared to the overall market, these conglomerates continue to play a significant role in the Japanese economy, demonstrating the resilience and tenacity that made them the dominant forces they once were.
What are Sogo Shosha?
Japan's Sogo Shosha is a business model like no other. Dating back to before World War II, these behemoth organizations led the nation through its postwar reconstruction period and the subsequent period of rapid economic growth.
Unlike other companies, the concept of Sogo Shosha is a purely Japanese one. While there are "trading companies" worldwide, they do not hold a candle to the might of Japan's Sogo Shosha. These conglomerates are engaged in diverse businesses, from natural resources and energy to machinery, chemicals, and consumer goods. The seven major Sogo Shosha companies, often referred to as the "kings of commerce," have a significant impact on the global stage that cannot be overstated.
The seven biggest Sogo Shosha are:
Itochu Corporation
Mitsubishi Corporation
Marubeni Corporation
Mitsui & Co., Ltd.
Sumitomo Corporation
Sojitz Corporation
Toyota Tsusho Corporation
These giants have their fingers in almost every sector, allowing them to navigate the complexities of international trade and supply chain management with ease. Their extensive networks and global reach have cemented their status as powerhouses in international commerce, and their influence continues to grow as they forge new partnerships and expand into emerging markets.
The roots of the Sogo Shosha can be traced back to the end of the Edo period (1603-1867), where the first private trading company, Kameyama Shachu (later Kaientai), was established by Ryoma Sakamoto in 1865.
Sogo Shosha companies can be broadly divided into two categories: Regional Sogo Shosha that specialize in a specific region, such as Europe or the Middle East, or Industry-specific Sogo Shosha that concentrate on a particular business sector, such as food or fashion.
However, the biggest Sogo Shosha are truly a one-stop-shop, handling everything from hardware and software development to construction, farming, factories, retail, medicine, and even government functions, such as laws and infrastructure procurements.
While trading companies can be found around the world, only a few can boast the scale of operations and versatility of a Japanese Sogo Shosha. These giants have a global distribution network and utilize their financial resources to their fullest, with economic sizes that could rival some countries, truly making them a force to be reckoned with.
The Sogo Shosha have led some of the biggest projects in the world, and many of the largest factories, bridges, railways and buildings have been created directly or indirectly through these companies.
The Origins of the Sogo Shosha: The Meiji Period (1868-1912)
The emergence of the Sogo Shosha we can recognize today can be traced back to the late 1800s. This is when Japan emerged from a civil war and when the country was forced to open its borders to the West due to their superior military technology.
The new government, under the auspices of the young Meiji emperor, set out to build a strong military and rapidly industrialize the country to avoid being divided up by European powers after seeing how China was ruthlessly divided and conquered by them.
To do this, the government took on the responsibility of developing various industries with the help of foreign experts, but as the government began to run out of money, it turned to private Japanese enterprises, selling off parts of various industries to them at extremely low prices. This was the beginning of the close cooperation between businesses and the government in Japan.
To speed up the industrialization efforts, the Japanese government encouraged size and economies of scale within these enterprises, leading to the formation of family-owned, vertically integrated conglomerates known as the Zaibatsu.
By the 1900s, these conglomerates dominated the Japanese economy, with the top 4 making up 60% of the shares of the Japanese stock exchange. They became involved in a number of different industries, typically using one main bank and one main trading company to handle the needs of the entire value chain.
This created efficiencies through the pooling of resources and allowed each company to concentrate on their core business. The trading firms for these organizations had to handle the supply and export needs for all the different companies in different industries in the group, making them the early precursors of the modern Sogo Shosha.
The Pre-World War II Era (1912-1939)
During the Meiji period, the textile industry became Japan’s largest, accounting for around 70% of Japan’s exports by 1920. While there were many Japanese trading companies before World War II, only a few, such as Mitsui and Mitsubishi, can be considered true Sogo Shosha at that time, as most of the others were specialized traders, involved in only one or two industries.
With the dawn of World War II on the horizon, the Japanese government started forcing the Sogo Shosha (or Zaibatsus, as they were called at the time) to exclusively produce military equipment or excreting direct control by outright nationalizing them.
The companies basically became vessels for the government’s war effort and their structures got melded together with overall military-machine. Simply put, the for the time being, the Sogo Shosha seized to exist…
The Post-World War II Era: The Keiretsu is Born (1949-1964)
The formation of the modern Sogo Shosha began to take shape in the ashes of the previous ones in the years following World War II. This was determined by a number of important developments, including the dissolution of the former Zaibatsu-families and their companies following the war, the prevailing economic circumstances at the time, and the government's industrial policy aimed at rebuilding Japan.
In the wake of World War II, The US-led occupation of Japan broke up the Zaibatsus, imprisoned many of their controlling family members, and forced them to sell many of their companies, as they were associated with the former military government. This provided an opportunity for large specialty traders that were less associated with Japan’s former military government, like Marubeni, Itochu, Nichimen, Iwai, and others, to begin filling the void, gaining size and diversity in the process.
As much of Japan's infrastructure had been destroyed during the war, the government embarked on a policy of division of labor among Japanese industry. The government ordered the large manufacturers to substantially increase their output by forcing the largest banks to loan the major manufacturers whatever funds they had available, and the trading companies to concentrate on import and export of the manufactured goods. Given Japan's lack of raw materials, energy resources, and foreign currency at the time, the Sogo Shosha’s role in rebuilding Japan's economy would become significant.
As the Korean War broke out in the early 1950s, the former Zaibatsu Sogo Shosha began to re-emerge, forcing many trading companies to merge or be bought-out by others in order to compete. The result was the emergence of 12 so-called Keiretsu ((Japanese: 系列, literally grouping of enterprises) which would be further reduced to 9 by the latter half of the 1970s through further reorganization.
While Zaibatsu and Keiretsu are similar, they differ substantially in their ownership structure. Zaibatsu were powerful family-controlled conglomerates that dominated the Japanese economy before World War II, while Keiretsu are a collection of different shareholder groups that owned each other’s companies to cooperate and achieve economies of scale.
The Keiretsu Sogo Shosha supplied the raw and intermediate materials, industrial machinery, and equipment that Japanese industry needed to rebuild and reindustrialize, while also importing energy resources and foodstuffs to support the Japanese economy. As Japan's heavy industry re-emerged, the Sogo Shosha began to export heavy, intermediate, and other goods, gaining the foreign currency that Japan needed. They didn't focus on any one industry, but provided supply and handled the goods for various different industries, becoming the super suppliers of the Japanese economy.
The Emergence of Japan as a Consumer Economy (1964-1973)
The 1964 Tokyo Olympics marked a new era in Japan's history, an era of growth and prosperity. The population was growing, incomes were rising, and the economy was expanding at an unprecedented rate. In fact, the Japanese economy averaged over 10% annual growth between 1957 and 1972, making it one of the fastest-growing economies in history. With this growth came a surge in the sales of consumer goods such as televisions, refrigerators, automobiles, and housing.
To sustain this growth, Japan needed to import increasing amounts of raw and intermediate materials. Given the country's lack of natural and energy resources, the government encouraged the Sogo Shosha to invest in natural resource development. This decision was a turning point for the Sogo Shosha, as their role increased from handling the distribution of consumer product manufacturing to also handling the extraction and imports of the sophisticated raw and intermediate materials to make them.
The Sogo Shosha also expanded into new areas of business, such as domestic real estate development and food wholesaling and distribution. They were already supplying the construction industry with construction materials and equipment upstream. However, to handle the Japanese building boom, construction companies needed the Sogo Shosha’s financing, distribution, and planning functions for this larger-scale type of real estate development.
As incomes continued to rise, and the Japanese diet shifted to more processed foods, the Sogo Shosha further entered food wholesaling and downstream food distribution. With many small food processors turning to the Sogo Shosha to handle their logistics and distribution, they developed more integrated and expansive logistics networks.
In addition to their growing presence in the domestic market, the Sogo Shosha also began to export higher-value-added manufactured goods, such as industrial machinery, and market consumer products like automobiles and electronic appliances to markets overseas.
This expansion of the Sogo Shosha’s overseas networks marked the most notable development during this era and the emergence of their completely integrated supply-chain business model. Simply put, they basically handled every part of a supply chain, from the mining of the raw material, the production of the good, to the store that sold the good to the end consumer.
Japan Becomes an Advanced Economy and Faces the Oil-Crisis Head-On (1973-1984)
In the wake of the first oil shock in 1973, the world was thrown into chaos as the price of oil skyrocketed. The cause of the shock was the outcome of the Arab-Israeli war, in which Israel, supported by the US, emerged as victors. The oil-producing Arab countries and their allies soon embargoed oil to the US and their allies, sending prices soaring.
The devastating oil embargo dealt a crippling blow to the US, knocking it out of the infrastructure supply picture. While US manufacturers floundered, Japan's advanced engineering and technology capabilities shone. Driven by a need for efficiency and resource frugality due to the country's lack of natural resources, Japan's technological prowess proved to be a game-changer. The Sogo Shosha were perfectly positioned to seize the opportunity and take full advantage of the ensuing infrastructure development boom.
Japan, however, was also hard hit by the oil embargo. It imported 90% of its oil from the Middle East and had a stockpile that was good for just 55 days. In December of 1973, the Japanese government ordered an immediate 20% cut in oil use and electric power to Japan's major industries, and cutbacks in leisure automobile usage. Economists predicted the growth rate would plunge from 5% annually down to zero or even negative territory, and inflation hit 9%.
To assure future oil flows, Japan added suppliers outside of the Middle East, invested in nuclear power, imposed conservation measures, and provided funding for Arab governments and the Palestinians. The crisis was a major factor in the long-run shift of Japan's economy away from oil-intensive industries, with investment shifting to electronics.
This was also the start of Japan as a peacekeeper on the global stage by becoming the largest contributor of official development assistance (ODA) to developing countries. This further aided the Sogo Shosha abilities to cement global relationships and expand abroad.
Japanese automakers also benefited from the crisis, as the jump in gasoline prices helped their small, fuel-efficient models to gain market share from the "gas-guzzling" Detroit competition. This triggered a drop in sales of American brands that lasted into the 1980s (Fukai, 1988).
Meanwhile, with their network of partners, logistics expertise, and project finance knowledge, the Sogo Shosha quickly became the go-to for the planning and organization of large-scale projects, especially in oil and resource-rich countries. Their success in these ventures helped to establish Japan as a major exporter of advanced manufacturing and technology and set the stage for the Sogo Shosha's continued expansion and growth in the decades to come.
The Bubble Economy and the Shift to Services and Investments Abroad (1984-1994)
Read more about the Japanese bubble-burst here:
The late 1980s was a time of crisis for the Sogo Shosha, as large Japanese manufacturers began to rely less on their services and develop their own logistics departments. A worldwide recession brought on by the second oil crisis only worsened matters, plunging the Shosha into what was dubbed the "winter of the Sogo Shosha." But these players would not go down without a fight.
In a bold move, they doubled-down on their role from an intermediate to an owner of supply sources. They increased their investment in manufacturers, processors, and distributors, securing the goods and materials necessary to protect themselves in the supply chain.
The appreciation of the yen following the Plaza Accord in 1985 fueled the Sogo Shosha's overseas investments and alliances with foreign companies throughout the 1980s and 1990s. They went on a buying rampage of which the world had never seen, gobbling up assets worldwide.
No industry was off-limits to the Sogo Shosha, and during the 1990s, they owned or had a stake in some of the most notable companies in the world. They acquired a 10% stake in Compaq Computer, held a 20% stake in BAA, which operated Heathrow Airport, and even acquired a controlling stake in Universal Studios. They were also involved in the purchase of the iconic Rockefeller Center in New York and owned a stake in the major US juice company, Tropicana Products.
They also started buying up companies in the service industry, from fast food chains like Dunkin' Donuts and KFC Japan to health clubs like Bally Total Fitness, and financial services, such as a stake in American International Group (AIG).
As Japanese manufacturers moved overseas in the 1980s and 1990s, the Sogo Shosha provided logistics and distribution support, and even entered into joint ventures. They became increasingly sophisticated in their handling of products, taking on more and more risk through investments and alliances abroad.
Despite the warning signs of the Japanese bubble economy of the late 1980s and early 1990s, the Sogo Shosha remained undeterred. They continued to invest heavily in supply sources upstream and expand into service businesses downstream, buying up more assets. Their relentless pursuit of growth led them to take on even greater risks, and even as most asset prices were inflating, the Sogo Shosha showed no signs of slowing down.
Post-bubble: Low Growth, A Mature Economy, Deflation and the Asian Crisis (1994-2006)
But as the 1990s gave way to the new millennium, the Sogo Shosha found themselves facing a series of devastating challenges. The IT revolution brought the world closer together, but also paved the way for new, powerful competitors. The rise of China, the globalization of markets, and the Asian crisis all combined to create a perfect storm of economic uncertainty and mega-competition.
Desperate to keep pace, the Sogo Shosha recklessly invested in a number of new fields, including the IT industry, the environmental sector, and the medical-health care business. They poured billions into broadband infrastructure, server storage, and media contents, as well as into highly advanced materials and large-scale infrastructure projects.
But their ambition proved to be their undoing. The bursting of the Japanese economic bubble which resulted in a mature and low-growth economy, and the deflationary pressures of the deregulation the Japanese government was engaged in all took their toll. The Sogo Shosha were struggling with cash flow problems and mounting financial losses, and their once-impregnable balance sheets were starting to show signs of strain.
The credit crunch of the 1997 Asian financial crisis was the final nail in the coffin, as the bad debt portfolios of banks grew, and more and more small and medium-sized businesses were unable to pay back their loans.
The Sogo Shosha attempted to restructure their balance sheets and revamp their management systems, but it was too little, too late. They emerged from the period of restructuring weakened, not stronger, and their once-proud reputation laid in tatters. Their aggressive investment in energy, metal and mineral resources, and food commodities failed to pay off, and they found themselves struggling to compete in a rapidly changing world. They were forced to sell of many of their investment and return to a leaner and less asset heavy structure.
The Resurgence of the Sogo Shosha and Their Rocky Future (2006-Now)
In the mid-2000s, the Japanese economy was still in a state of stagnation and the Sogo Shosha were facing many challenges. Globalization and the rise of other Asian economies were eating into their market share, while a rapidly aging population and a shrinking workforce were putting pressure on their bottom line. It seemed as if the heyday of these trading giants was at an end.
To survive, the Sogo Shosha had to change their business models, as the profits from their traditional trading commissions have become increasingly uncertain with local competitors in China, Taiwan and Korea taking an ever-increasing share. They therefore shifted their focus towards long-term investments, to provide more predictable and consistent returns.
Their new investment strategy included a focus on cash-flow instead of growth, with more “boring” companies in their crosshairs. For instance, Itochu, one of the largest Sogo Shosha, acquired a stake in the Danish company Vestas Wind Systems, the world's largest wind turbine manufacturer. This investment allowed Itochu to expand its business into the renewable energy sector and establish a strong presence in the global market.
Another major strategy by Sogo Shosha was the acquisition of companies in emerging markets. Marubeni, another prominent Sogo Shosha, acquired a controlling stake in the Brazilian company Gavilon Group, a leading provider of agricultural and energy commodities. This investment allowed Marubeni to tap into the growing demand for commodities in the fast-growing Brazilian market and increase its global reach.
In addition to acquisitions, the Sogo Shosha also invested heavily in infrastructure projects around the world. Mitsubishi Corporation, the largest Sogo Shosha, was a key investor in the development of the Kashganj Power Plant in India, a project aimed at providing reliable and affordable electricity to millions of people in the country. This investment helped Mitsubishi establish a strong presence in the fast-growing Indian market and contribute to the development of the country's infrastructure.
Finally, the Sogo Shosha have also invested heavily in the technology sector, particularly in the areas of artificial intelligence and robotics. Itochu, for example, invested in Boston Dynamics, a leading robotics company, which allowed the Sogo Shosha to expand its business into the cutting-edge technology sector and stay ahead of the curve.
However, one of the biggest consequences of the Sogo Shosha’s focus on cash-flow was their increased investments on energy, metal and mineral resources. Over the years, the earnings of these companies have become highly dependent on the prices of these resources, with 63% of the net earnings of the top five Sogo Shosha coming from these sources between 2008 and 2012. This dependence has made these companies vulnerable to the volatility of the commodity markets, leading to a decline in earnings between 2013 and 2015.
However, the Sogo Shosha have been taking steps to address this issue and reduce their dependency on natural resources. By expanding and strengthening their other business segments, they have been able to bring more balance to their profit structure and reduce the ratio of profits from energy, metal and mineral resources. This has been reflected in the average net profit of the top five Sogo Shosha, which increased from around $1.75 billion a year between 2013 and 2015 to $2.85 billion at the end of 2016 despite an ongoing downturn in most natural resources.
Finally, there is a further challenge for the Sogo Shosha in terms of capturing future overseas growth as the Japanese market is saturated. Most of the population and economic growth in the coming years is expected to come from developing countries, which presents both opportunities and challenges for these companies. On the one hand, these countries represent a huge potential market for the Sogo Shosha, but on the other hand, there are significant risks and uncertainties associated with doing business in these markets.
Despite these challenges, the future for the Sogo Shosha remain bright. With their broad range of interests and expertise, these companies are well-positioned to adapt and evolve in the changing global economy. By continuing to reduce their dependence on energy, metal and mineral resources, expanding their business in overseas markets, and capturing growth in developing countries, the Sogo Shosha can continue to be a dominant force in the Japanese business world for years to come.
The Sogo Shosha amazing recovery on their balance sheet have not made it to their valuations
However, the stock-markets have not rewarded the Sogo Shosha pivot as they are often still seen as old, inflexible conglomerates with heavy administrative burdens that would dilute the profits of any investments they undertake.
This mindset has changed somewhat in 2020 when Warren Buffett's Berkshire Hathaway stepped in to invest massively in five of the country's leading Sogo Shosha - Itochu, Mitsubishi Corp., Mitsui & Co., Sumitomo Corp. and Marubeni. Berkshire acquired slightly more than 5% of each company and stated that it may increase its stake up to 9.9%, as well as exploring opportunities for partnerships between the Sogo Shosha and its own businesses. This has sparked a renewed sense of optimism in the Sogo Shosha, who are keen to work more closely with their new shareholder.
Itochu, in particular, has been determined to lead the resurgence of the Sogo Shosha. The company has recently taken full control of FamilyMart in a $5.5 billion transaction. With the takeover, CEO Masahiro Okafuji stated that he wanted to "attack areas related to household consumption" and is using Itochu's sprawling business network to do so.
This investment by Berkshire Hathaway could be the catalyst for a new era of growth and success for the Sogo Shosha. With their new shareholder providing support, and with their proven ability to adapt and evolve, the future is looking bright for these trading conglomerates.
And there is a lot more potential upside in these stocks. The Sogo Shosha continue to trade at very low multiples compared to the overall market. For example, Mitsubishi Corporation, one of the largest Sogo Shosha, has a price-to-earnings (P/E) ratio of around 8, while the overall market in Japan has a P/E ratio of around 17. Similarly, Sumitomo Corporation, another large Sogo Shosha, has a P/E ratio of around 9. These low multiples are indicative that there is still a lot of market skepticism towards the Sogo Shosha and their ability to remain competitive in the face of rapidly evolving market conditions.
In summary, the low multiples of the Sogo Shosha present a potential opportunity for investors who are willing to take a long-term view and believe in the ability of these companies to continue evolving and adapting to changing market conditions. While there may be risks and uncertainties associated with investing in these stocks, the potential upside is significant for those who are patient and willing to weather any short-term volatility.
Conclusion
The Sogo Shosha, with their illustrious history and their formidable influence in the world of finance and commerce, have become the backbone of Japan's economy. Their journey from Zaibatsus to Keiretsus, and the struggles they faced in the wake of the oil shock and the 1997 Asian financial crisis, have been nothing short of dramatic. But despite these challenges, the Sogo Shosha persevered, building a reputation for themselves as innovators and trendsetters.
Their storied past is one of incredible achievements and groundbreaking innovations, but it is also one of tattered remains and risky gambles. The Sogo Shosha have experienced their share of failures, but they have learned from their mistakes and emerged stronger for it.
Thank you for taking the time to read about the fascinating history of the Sogo Shosha. Despite the ups and downs, this powerful and influential group has made an incredible mark on the global economy.
As the Sogo Shosha continue to evolve and face new challenges, we can only imagine what the future holds for this iconic group. It will be interesting to see how they adapt to the changing global economy and how they continue to shape the world of finance and commerce.
Thanks for the article. Gavilon was actually a company based in Omaha - Buffett's (and my) hometown. It is widely believed that Marubeni paid too much for Gavilon. It was sold to Viterra last year.
What an absolute banger ! Legendary work