After decades of deadly dull retailing and artificially high prices, Japanese consumers are voting with their wallets for change, and the global giants are getting serious. But just how many stumbling blocks will they encounter? Dr Ira Kalish looks at the potential of the last frontier News that Tesco is considering moving into Japan raises intriguing questions. If Japan is in dire economic straits, why are foreign retailers taking a strong interest? And if Japan has such an inefficient distribution system, what hope do they have of offering a competitive advantage in the local market? But Japan's economic crisis could be the catalyst for revolutionary change in its retail sector. Despite historically weak consumer spending, large scale foreign retailers are seriously considering investing. Mass retailers such as Tesco and Wal-Mart are exploring the market; Costco and Carrefour have already taken firm action to enter it. Having seen the real estate bubble burst, outside investors are eager to grab choice sites while they are relatively cheap. Moreover, at a time when traditional government policy levers seem impotent to reverse economic catastrophe, the likelihood of true deregulation of Japan's distribution system seems higher than ever. Japanese consumers are clearly ready for change, though, and are voting with their wallets, abandoning department stores in favour of new speciality formats, discount retailers and factory outlet stores. Three factors are involved here. First, having travelled widely and experienced the price disparities between Japan and the rest of the world, consumers are demanding more for less ­ or, at the very least, the same for less. Second, having seen the modern merchandising techniques of US based retailers and global branded suppliers, they are demanding an end to dull homogeneity. Thirdly, having experienced job insecurity for the first time ever, consumers are becoming more valueconscious and are actively seeking bargains. Many of Japan's venerable retailers are on the threshold of making major changes. In order to survive, they must become better at merchandising and less focused on managing real estate, they must be responsive to the rapidly changing needs of their customers, and they must dramatically improve their operating efficiency in order to reduce prices and restore profits. To accomplish these goals, they have several choices: drastically change their formats; develop alliances with major foreign retailers; dispose of much of their real estate (which is already happening); merge with other Japanese retailers; liquidate their assets; and even arrange to be bought up by foreign retailers. The possibilities are dizzying, especially considering that few of these actions would have been considered remotely possible just a few years ago. Until recently, Japanese retailing has changed only at a snail's pace compared with the rest of the world. Protected from competition by government rules, they had no reason to budge. Japanese retail executives defend the relatively high prices in the shops by pointing out that their consumers have some special attributes. Among them are unusually strong concerns about the quality and freshness of food, and the importance of brands. Japanese consumers, they claim, just don't care as much about price as consumers in the rest of the world. Well, it is true that Japanese consumers care a great deal about quality and freshness. Moreover, they have become accustomed to a level of personal service rarely found elsewhere and that is expensive to provide. More important explanations for high prices, on the other hand, include protectionism and distribution inefficiency. But now Japanese consumers are determined to obtain lower prices. When several major retailers recently offered a one-day tax holiday, on which the 5% sales tax would be rebated, sales increased 40-50% above normal levels. The recent success of factory outlet shopping centres, the continuing gains in market share by general merchandise stores at the expense of department stores, and the increasing popularity of low cost speciality stores indicate price is not a small consideration for Japanese shoppers. The big question, however, is whether consumer interest in lower prices will create pressure to reform those aspects of the Japanese distribution system that contribute to maintaining high ones. In Japan, it is rare for retailers, even large ones, to interact directly with manufacturers ­ except when it comes to branded clothes. Instead, retailers rely on a vast wholesale network that arose to service the needs of small retailers but has remained in place despite rising retail concentration. There are several layers of wholesale distribution, ranging from national distributors to regional and local operators. Relationships between retailers and wholesalers often go back generations. Various sinister explanations have been offered for the persistence of the current system, including the role of organised crime and the political power of wholesalers. These are eclipsed, however, by another factor. Japan is so dense and its real estate so expensive that it would be difficult and costly for large retailers to operate their own distribution centres. An alternative would be for retailers to acquire wholesalers ­ as happened with 7-11 Japan as well as by Matsumoto Kiyoshi, Japan's largest drug retailer. Another possibility is for wholesalers to acquire retailers ­ this has already happened. But the physical realities of Japanese retailing mean the wholesaling function must remain in place. Moreover, many retailers prefer to deal directly with independent wholesalers rather than manufacturers because they can return unsold merchandise, whereas manufacturers often won't accept returns. Wholesalers are thus forced to manage inventory risk. Essentially, power in the supply chain belongs to large manufacturers and, increasingly, to large retailers. Wholesalers do not exert much power, but their existence remains unchallenged. Now that several large foreign retailers are entering or planning to enter the Japanese market, change could sweep through the system. Big retailers such as Costco, Carrefour, Boots, Tesco and Wal-Mart will surely want to purchase directly from manufacturers or, at the very least, streamline the wholesale channel. Maybe they will want to acquire wholesalers. Once they become significant retail players in Japan, their existence will force local retailers to change the way they obtain merchandise lest they become competitively disadvantaged. On the other hand, the experience of Toys 'R' Us in Japan is instructive for any foreign retailer planning to revolutionise Japanese distribution. When the company entered Japan, it sought to offer consumers substantially discounted prices by cutting out the wholesalers and dealing directly with manufacturers. Most toy manufacturers in Japan refused to deal with the US giant lest they offend other Japanese toy retailers. So Toys 'R' Us was not able to offer discounts as deep as originally planned. Foreign retailers might also face problems because they do not already have relationships with Japanese wholesalers ­ relationships that could be a competitive advantage for venerable Japanese retailers. In the absence of acquiring wholesalers, building such relationships might be difficult because major wholesalers will be anxious not to offend their Japanese retail customers. But the most important regulatory obstacle to further retail modernisation and concentration in Japan is the notorious Large Scale Retail Store Law, which imposes severe restrictions on store size. The Japanese Diet recently agreed the law be fully repealed in June 2000. Although this should send large retailers out into the streets to dance and small retailers rushing for cover, nothing of the sort is happening. It all comes down to international relations, with the Japanese government putting on a show in order to ease pressures applied by the US government. While repealing the Large Scale Retail Store Law, the Japanese enacted the Large Scale Retail Store Location Law. The net effect is that almost nothing will change ­ indeed, the situation might even get worse. Specifically, while the new law ends the ability of small retailers to block the development of large stores with impunity, it transfers responsibility for regulating the opening of new stores from national to local authorities. Local government bodies are authorised to restrict new store openings if they have an adverse effect on traffic flow, the environment or other social factors. In addition, local government may require retailers to pay for environmental or transportation improvements as a condition for building new stores. The effect of the new law has been to accelerate the process of large store development prior to June 2000. Many retailers fear that the business environment will actually deteriorate following the change. The old law applies to any new store that opens prior to January 2001 and retailers are rushing to meet that deadline. In the past year, nevertheless, foreign retail interest in Japan has increased. And the economic crisis has led many observers to expect radical reforms to take place in the not too distant future ­ reforms that would free up the distribution system. The cost of real estate has dropped, creating an opportunity to lock in low costs for several years to come. And the early success of some foreign retailers has raised the confidence of others. Japan is the last frontier for many global retailers. To be a global retailer and not be in the second largest retail market in the world seems ludicrous. At a time when the pace of retail globalisation is increasing, Japan is becoming too powerful an attraction to resist. Dr Ira Kalish is director, global retail intelligence system, PricewaterhouseCoopers, Los Angeles {{MANAGEMENT FEATURE }}