Hibiki Path Advisors Website

Equity investing and advisory business

A “Good” Company

You can read this content about 30 minute(s)

Hibiki Message

A “Good” Company

Having met many managers and executives from various companies over the years, and while following their activities and making investments, I always ask myself, “What is a good company?” It’s a difficult theme, and an endlessly interesting question that doesn’t have just one answer. For us, companies can mean companies in our investment portfolio, then there are customer “companies”, our partners and vendor “companies”, as well as my own company, Hibiki.

Today, I would like to introduce a company that I encountered recently that I felt was a truly excellent company – something I haven’t felt for a long time (we have left the company name anonymous). Meeting with the CEO was just about an hour, but it stayed with me, and I would like more people to know about the unique character this company has developed over time. The existence of such an earnest yet amazingly naive company as a listed company stirred a fresh feeling within me. Before that, let’s bring us back to the fundamental question of “what is a company”. Supposedly the “East India Company” is well known as the start point for the form of a company in terms of the way it gathered capital (from wider audience) and thus reduced risk of the owners. In undertaking maritime voyages and trade with developing nations, which was incredibly risky at the time, it was groundbreaking in the sense of understanding the necessity of diversifying the risk through limited liability and allowing larger number of equity participants. There is no doubt that this is one of the starting points for the development of capitalism.

However, this is the view of the company from a capitalists’ perspective, and it leads us to the philosophical discussion of the legal nature of a “corporation”, but today I would like to approach this from the perspective of constituent, or in other words, immune system of the “company” which is basically the organizational design and how human capital (labour) is functioning within it. “Management studies,” which is a relatively new field of research, was famously developed by Professor Peter Drucker, but in my view the first to bring light to this organization matter was Adam Smith, which predicates on the “division of labour” as stated in his famous “The Wealth of Nations”.

It’s a historical fact that the industrial revolution was developed in Britain in which the production of a single product was divided into several processes, for which people were employed specializing in each process in an assembly-line system, and this flow rapidly increased productivity through the acquisition of specialist skills. However, Adam Smith said that such collective production and such a style of manual labour is an inevitable consequence that is born from human nature. That nature is expressed as “selfishness” and “self-love.”

Adam Smith spoke of division of labour and division of business in the same context, but there is no doubt that the division of business developed from self-love in terms of “the comprehensive (two-way) benefit to co-operating with each other and dividing the economic functionality.” However, when talking of division of labour in narrower sense, “self-love” or “selfishness” is insufficient in describing the powerful drive that has led to the ascent of what we see in modern day companies. Management studies is an academic area that has developed to try to explain the key factors underlining the growth of “companies”.

It is interesting to discuss such academic issues, but let’s move on to an actual example.

My personal definition of a good company (though explained roughly above), is asfollows.

① Management has a healthy aspiration towards obtaining profits – which it genuinely asks for “proper” price for its valuable services.

② Management has a clear view of what the company’s role should be in the society, and or how the company should contribute to the society; it expresses its view openly, and strive to gain empathy from customers, employees and their family, partners, banks, and shareholders.

③ Vector of employees’ self-fulfillment and vector of the company’s growth is “rhyming”. The meaning of “rhyming” in this context does not mean that both vector must be in the exact same direction but, whether intentional or unintentional, various constructive combination between the two is provided to help each other which may result into better overall happiness.

④ The ownership mind is penetrated to not just the management but to all employee levels.

Now, this “good company” has extremely well defined its own

① Business domain and what to focus
② Way or interacting with the customer
③ Ultimate importance

This company is a manufacturer of joints and pipes, and is an unsung hero of a heavily industrialized world. Their products are used by companies such as machinery makers, power plants, semiconductor and LCD production equipment. The company transformed itself when the current chairman took over and became president in 1999, after being managed for two generations by the member from the founding family. The company’s earnings were deteriorating at that time, and it is apparent that the current chairman was the key person who has turned the company around back on its feet. As this current chairman is not an outspoken person, there is no public record in detail about the turn-around of the company, but it is apparent from their long-term business results as in the chart below.

Before the current chairman took over, the company’s operating margin was about fromnegative to 5%, and especially in 1998, EBITDA also turned in the red, putting the company’s state in jeopardy. But after him taking over, it was just not just the revenue that started to grow, but their margins also recovered and went up considerably. This was due to the chairman’s endless pursuit of their company philosophy.

Their start was to “do their very best as a piping/joint company”.
Its customers, i.e. the equipment manufacturers, usually pay very close attention to the performance and configuration of their key components, but not much to piping where the cost and valueadd attribution is so small over its total cost. In the product development of a new
machines, piping matter was insignificant and so orders were typically given to those with the lowest price. The current chairman threw a stone into this stereotype definition of “piping” business with his belief to “crush any past common-sense of doing things”.

First example of his such unconventional initiative, was to decrease the number of joints used in the equipment. As a manufacturer of joints, and pipes, this would lead to a decrease in revenue and impact may be fatal to the company, but by replacing few fittings/joints by one well-made module designed by the company, it will bring many merits such as 1) it will decrease customers’ work-logs, 2) it will reduce the fluid resistance which will result in longer duration (life-cycle) of the parts, 3) it will decrease the risk of leakage at connection points as number of connection points are minimized,4) it will reduce pressure loss, and etc.

By providing these merits, customers can reduce risk of machine troubles and number of maintenances, thus reducing the total operatingcost. This tireless effort has led to increased confidence from its customers and thus can charge extremely high price with less number of parts it provides. Another unconventional initiative it took, was to introduce “one stop shopping” by fully internalizing product designing, material procurement, assembly, system inspection and just deliver the final product to the customer. For customers, they will only need to connect the IN and OUT part to complete, which will reduce their work log thus improve
productivity.

And of course, as relationship and trust is built up as much as this example,the company’s work and its existence itself will be essential for its customers, whichmakes it hard to change the relationship. It is a well-designed ring-fencing strategy. Two above cases demonstrate the Chairman’s strong aspiration and dream to become“World’s most amazing” piping-company. He is deeply re-configuring the real value-add that pipes and joints are meant to deliver to customers, which is in fact resulting in out-of-the-box mindsets to develop goods and services that makes customers happy thusthey are not complaining (to lower the price) even if it is clear this company is enjoying aphenomenal profitability.

We would also like to share with you two unconventional examples regarding the definition of relationship with customers. First, it will take even one single orders from customers. Naturally, as a manufacturer, running a factory line involves fixed cost to pay for the machinery so just moving it for one small order does not make any sense and usually set some minimum lot requirements. However, based on reverse thinking, it has been taking one-lot orders as that can be a serious differentiation factor in terms of how to position it with its customers.

Companies, however, will go bankrupt if they act like servants taking such tedious orders from customers at a loss. So this company has completely changed the production design. These pipes and joints are precision materials which require micro-meter accuracy and would need a dedicated machine tools and molds to manufacture, and not surprisingly they are very expensive. This company has taken a completely opposite route to combine many different all-purpose inexpensive machines so that (1) total cost is far smaller, and (2) if the process is divided in 10 steps, it can utilize idle tools for other use when it does not involve in manufacturing this specific product. With such maneuverability in manufacturing it has made itself capable to take such small orders from clients, which obviously made it to stand out from its competitors.

Second thing that makes the company unique in terms of its relationship with customer is the fact that it has no “product quality control” division. In any manufacturing business, minimizing the defect is crucial and a key for success and is normally controlled by some different division to monitor the whole process as well as to be the go-in-between with the customers when something bad does happen. The company has no such division in the belief that “when each and every employee and the functions are doing their job properly with upmost attention, there should be no defects”. When there are no defects or no claims the company’s production line will not be stopped and then the profitability will increase massively. It is as simple as that but it is also something most of the management cannot execute due to ‘fear’ of not being able to manage the various reputational risks arising from not having such function in the firm. This protocol is something that maybe regarded as fatal from customers’ point of view but this company didn’t oblige and went its own way and demonstrated its credibility over its capability to execute and deliver without defects.

As you can see it is a unique company that has continued its tireless unconventional challenges to build its positions in the business. What is supporting such hard work and enthusiasm is the fact that bonding between the management and its employees are so strong. The company has not introduced stock options or restricted stocks to its board members or to its employees so technically speaking there are no strong ‘ownership mentality’ among its management and employees in a narrowly defined financial context. Company’s surprising measures to develop ‘ownership mentality’ is to abolish the ‘retirement age’ system. It is open for employees to work until he or she feels like retiring but if not, the company will ask for commitment to values and discipline. Currently more than 20% of the group’s employees are over 60 years old.

In Japan’s traditional labour system, those employees in their earlier part of the careers are under-paid compared to their value-add and then the company will reward senior employees with ‘over-pay’ which is almost designed as taking the capital as hostage for longer-term commitment and it can be seen as ‘deemed equity participation’ to the company. It is one of the key component of life-time employment protocol in Japan’s modern corporations but also becoming dysfunctional when many companies started to introduce early retirements as well as cut them off at a certain age, say at 60. In a way, by doing that company is breaching the deemed agreement with the loyal employees.

This company, on the other hand, has in fact perfected this system by not having any threshold based on age and with such, employees will devote their lives to the company based on ‘trust’ or maybe based on something closer to ‘fiduciary relationships’. It is striking and surprising to see how the Chairman managed to develop this strong ‘ownership mentality’ without relying on financial metrics such as options or ESOP. This company views “taking good care of customers” and “taking good care of employees” as one coherent issue; if we rephrase it in the form Chairman believes, it is – “employees who takes good care of customers are the jewels”. He is emphasizing this throughout his management philosophy, organizational designs, employee management and production controls.

Maybe because of such stance, its revenue is still quite small, at around 20 billion yen and total employees as a group only amounts to 500. If it is larger things might be a little more difficult to control. So, it is a difficult but an exciting challenge when we see the company thinking of getting bigger and thinking of truly going out of the country to deal with global customers while trying to maintain its integrity as an “amazing company”.

Its current CEO has been invited by the chairman from a large and famous Information Technology giant in 2011 and became the CEO two years ago. He is demonstrating a great combination and balance between an energetic and visionary chairman with his warm hearted but organized approach to things that he has obtained throughout his career. Also, he is demonstrating huge value-add based on his many years of running the overseas business of a large company when this company is trying to go global for the first time in its history. It has been opening subsidiaries in Taiwan, China, Korea and US since 2012 planting seeds for its new challenges and we can imagine how his network and experience helped monumentally. We can now see that Chairman’s aim to become “World’s most amazing” pipe and joint company was not a bluff.

~~~~~~~~~~~~~~~~~

There are various styles of “good companies” that have different stories, and the fact that they do not fit into a single “framework” is a deep and endlessly interesting theme. As with humans, even good companies have troubles, weaknesses and other problems that they face every day as they drive forward, and they often stop being good companies due to managerial or business landscape changes. This example is of a company with one style among many. It is nothing more, and nothing less. However, the unique common factor among all good companies is that they keep on making the effort to “continuously evolve and improve,” just as Darwin’s theory of evolution states. As I stated at the outset, everything begins with “the division of labour,” and this magnificent system was the dawn of today’s capitalism in which companies are the major constituent. Managements are individuals in the division of labour system, as are employees that are tied to the production line. If such people think only about their line of work, the company will probably fall into decline eventually. A company where people work while bringing to mind the faces of the people surrounding them and even the faces of customers is a company where the employees have a heartfelt attitude of considering how they can further add value, and this is essentially a “good company” regardless of whether earnings are doing well or not at that specific point of time, and as a result this great value will be shared among ‘long-term’ shareholders.

The “selfless devotion (滅私奉公)” is a virtue of Japanese people that has both a virtuousaspect and a negative aspect. Recently, a certain major express delivery service company reported that it would raise its prices for the first time in 27 years due to the excessive workload of its employees. It is about time. It is in fact a great company that can even be considered as blood vessel of the economy, but that does not mean it can be something similar with ‘air’ which people breathe for free. The courage to justifiably demand added value as an enterprise is a “job” for managers. Normally, a price increase in any sense would face some opposition from the public, but in this case, judging from the atmosphere around the country, there has been a favorable reaction. Maybe it is a sign that Japan’s society is moving forward into a positive direction.

We want to keep on evolving together to be a “good company.” It is not easy but it is something we should all keep trying as valuable members to this exciting world.


Chief Investment Officer
Hibiki Path Advisors Pte. Ltd.

Yuya Shimizu