Why the Japanese economy is not growing: Food processing sector

By Bill Lewis, James Kondo, Makiko Shinoda, Naoko Shozuzawa, Yoshinori Yokoyama, Angelique Augereau, Ali Rowghani
Why the Japanese economy is not growing: Food processing sector

While food processing is one of Japan's major manufacturing sectors, companies in this fragmented industry suffer from a lack of scale. Consolidation and increased competition would be healthy for the industry, increasing productivity without sacrificing freshness or product variety.

While food processing is one of Japan's major manufacturing sectors, companies in this fragmented industry suffer from a lack of scale. Consolidation and increased competition would be healthy for the industry, increasing productivity without sacrificing freshness or product variety.

Productivity performance

Productivity is low, compared to the United States and France. Labor productivity and capital productivity are at 35 and 45 percent of US levels respectively. As a result, total factor productivity (TFP) is 39 percent of that in the United States. Productivity in France and the United States are nearly equal. Due to the heterogeneity of processed food products, we categorized the industry into four segments. Productivity was measured and causality analyzed for each of the four segments: Perishables (such as milk)—32 percent; packaged goods (such as confectionery)—37 percent; commodities (such as pork processing)—60 percent; and traditional goods (such as rice vinegar)—18 to 38 percent.

Operational reasons for productivity gaps

The main reason for the productivity gaps is small scale. All categories in the industry suffer from lack of scale, leading to less automation. A less important reason for the productivity gap is product proliferation. This is chiefly a packaged goods phenomenon. Since so many items are produced for a plant of a given scale, many cannot achieve minimum efficiency and, thus, some processes cannot be automated.

Industry Dynamics

There is little competition with global best practices as observed by protective trade barriers in commodities and lack of FDI in packaged goods. Domestic competitive intensity is generally low in all categories. There are many small, local processors that do not compete nationally.

Important external barriers to productivity and output growth

The most important barrier is fragmentation in the retail industry. If the retail industry were consolidated, large retail chains would demand that processors supply throughout Japan and provide marketing support. Only processors with sufficient scale would be able to respond to such demand. Some small processors may survive by producing highly value-added goods; if not, they would be forced to exit from the market. In the absence of such retail pressure, there is little incentive for processors to consolidate, sell, or exit. Fragmented retailing encourages product proliferation, since nationwide marketing that targets the "average" customer is less effective for fragmented retailers who each face a very different clientele. Another external barrier to labor productivity growth is the high trade and price/volume controls for some commodities. Since commodities are internationally traded, it would be expected that imports would generate competitive pressure; however, import barriers allow domestic processors to remain unproductive.

Future outlook and recommendations

The food processing industry has the potential to improve its productivity to 64 percent of US levels in 10 years, that is, grow productivity by 6.3 percent annually, as opposed to -0.4 percent today. The Japanese food processing industry has the potential to achieve higher productivity without sacrificing consumer demand for freshness or product variety. We found that the best-practice milk processors, who have sufficient scale, are as productive as the US average. Even without addressing product proliferation, industry consolidation would double productivity in packaged goods.

Experiences in the French food processing industry suggests what the Japanese industry may look like when high productivity is achieved. The majority of the French market is dominated by large processors that supply large retail chains. Small processors and retailers have survived competition from large players by carving out a high-end niche—being equally productive by being high value-added. For such healthy competition and productivity growth to take place, government reforms of the retail sector (detailed in the Retail Case) need to be pursued. This will improve productivity in perishables, packaged goods, and traditional goods.

In addition, removing import barriers and other price/volume restrictions will improve productivity in commodity goods, while removing subsidies will improve productivity in perishables.

More from the McKinsey Global Institute
Article

The next-generation operating model for the digital world

Article - McKinsey Quarterly

What makes a CEO ‘exceptional’?

Article - McKinsey Quarterly

Three game changers for energy

Article - McKinsey Quarterly

How functional leaders become CEOs