Interview with the Chairperson of the Board Seeing a once-in-a-century grand transformation as an opportunity for dramatic growth Chieko Matsuda Professor Department of Management, Graduate School of Management Tokyo Metropolitan University × Yoshiaki Nishimura Chairperson of the Board

Dialogue with Stakeholders
Shareholders and Investors, Customers, Suppliers and Other Trade Partners, Employees, Local Communities, Global Environment

* This dialogue is appeared in "Integrated Report 2018".
* The position titles are as of the date in which the dialogue was held.

Linking Corporate Value and Public Value to Create New Social Value

Automotive technological innovation, such as electrification of vehicles and autonomous driving, is accelerating rapidly, spurred by the tightening of environmental regulations and growing interest in safety and comfort. The Sumitomo Riko Group considers this change in the business environment a once-in-a-century grand transformation and has drastically revised the mid-term management vision in order to pursue expansion of the business scale while simultaneously helping resolve social issues, such as those addressed in the Sustainable Development Goals (SDGs). Yoshiaki Nishimura, the Chairperson of the Board, discusses what is at the heart of 2022V.

From 2020V to 2022V
Why was the Revision Necessary?

MatsudaI heard that you just launched the Sumitomo Riko Group 2022 Vision (2022V), having revised the midterm management vision for the period up to 2020 (2020V).

NishimuraThe business environment surrounding the Group has changed dramatically over the past one or two years. In 2016, when we announced 2020V, U.S. President Donald Trump had not yet taken office, and there was no Brexit. Another environmental change affecting our mainstay automotive parts business is that the shift to electric vehicles (EVs) is rapidly progressing. Faced with this powerful wave of change, we considered a drastic revision of the mid-term management vision necessary so that we can successfully deal with the exigencies of the global business of tomorrow.

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MatsudaThe trends in the automotive industry are global megatrends, aren't they?

NishimuraMany of the anti-vibration rubber products, hoses, interior equipment products, and sound controlling/insulation products that we manufacture are delivered to automakers. Until now, our policy stance has been to act in concert with automakers and engage in joint development. The shift to electric vehicles means that anti-vibration rubber products, which have been made for gasoline engines, will be made for electric motors, and that it will also be necessary to make sound controlling/insulation products for use in electric vehicles. Although there won't be a complete transition to EVs in the coming ten years or so, it is predicted that Google, Facebook, and other IT giants will emerge as rivals to automakers.

MatsudaRelationships with the suppliers that supply parts to automakers may change dramatically, too.

NishimuraThe Sumitomo Riko Group does business with many of the world's automakers. Many automakers that operate globally are flexible in terms of their attitude to excellent technologies and have an open policy. Even if a supplier refines a certain technology jointly with one automaker, the supplier is allowed to sell products applying that technology to other automakers.

MatsudaIn Japan, the principle of self-sufficiency has long reigned supreme. However, in the automotive industry, which competes with the rest of the world, automakers have changed to a policy stance of seeking to collaborate with parts manufacturers and requesting suppliers to openly make proposals. There is a growing sense of crisis reflecting recognition that if a parts manufacturer is passive, it will be left behind. How is Sumitomo Riko reading the changes in automotive trends and how are you responding?

From an Automobile Parts Manufacturer to a Global Systems Supplier

NishimuraWe use the acronym "CASE" to describe these megatrends. The "C" is taken from "Connected." Some think automobiles will acquire a new role as communications equipment and the IT industry will become a key player in automobile production. The "A" comes from "Autonomous." IT companies may also lead the way in ambitious development in the area of autonomous driving. The "S," taken from "Sharing," expresses the idea that automobiles will be valued for their functions, rather than as the possessions of individuals. While this may lead to a decrease in production output, automobiles may embody new value in terms of durability, reliability, and price. The "E" comes from "Electrification." Emerging-market countries may promote electrification of cars as a national policy, as a trump card in response to environmental regulations. China is actually moving in that direction.

MatsudaSo, parts manufacturers must not only look at automakers but also be conscious of consumers. Given that the automotive industry is a business in which the pursuit of scale brings benefits, parts manufacturers that lack a certain scale may perish.

NishimuraAutomakers are searching for partners capable of supplying high-quality parts globally. The Sumitomo Riko Group is among the top-tier global market share leaders and poised to fulfill a new role as a systems supplier.

Positioning Resolution of Social Issues as the Next Pillar of Business Growth

MatsudaOn the horizon, beyond 2022V, is the company's centenary in 2029. You have set the challenging target of net sales of ¥1 trillion. I am thinking that you have to lay a solid foundation under 2022V, as a waypoint toward the goal. Is that correct?

NishimuraA certain business scale is necessary to inform the world of who we are and what we do. The Sumitomo Riko Group currently has 106 business sites in 23 countries around the world, and I believe that we can't be globally competitive unless we have net sales of around ¥500 billion. However, it would be difficult to reach that level of sales with only automotive parts.

MatsudaSo is it necessary to cultivate new businesses?

NishimuraYes, under 2020V, in addition to the automotive field, we have entered such fields as infrastructure, housing environment and health and nursing care, and electronics. For instance, in the infrastructure field, we offer hydraulic hoses used in construction machinery and anti-vibration rubber used for rolling stock. Anti-vibration rubber ensures the riding comfort of Shinkansen train cars. In the housing environment & health and nursing care field, we offer seismic dampers. We have heard that in the Kumamoto earthquakes of 2016, homes built using our dampers did not suffer major damage, let alone collapse.

MatsudaThat is gratifying to hear.

NishimuraI should also mention Smart Rubber sensors applied in the health and nursing care field. Taiatsu Bun-san mattresses incorporating these flexible sensors made using rubber detect and distribute body pressure to prevent bedsores. Refleshine window films have thermal barrier and insulation functions in addition to preventing the shattering of broken glass. They repel heat in summer and prevent indoor heat from escaping in winter. In the electronics field, we sell products used in toner cartridges. We think that while increasing corporate value through these products, we can increase public value*1, by which we mean helping resolve social issues, such as those addressed in the Sustainable Development Goals (SDGs) proposed by the United Nations, through technological innovation.

Matsuda"Public value" is a new term, I believe.

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NishimuraA point you make in your book is that the enhancement of corporate value is not the sole overriding imperative for companies. There must have been a compelling mission and purpose and a goal to be permanently pursued that led to the founding of the company or, in other words, pursuit of a corporate philosophy. You call enhancement of corporate value a "left-brain platform" and pursuit of a corporate philosophy a "right-brain platform." Hoping to find an expression comparable to "right-brain platform," we arrived at "public value."

MatsudaI find it is an original concept rich in meaning.

NishimuraAs you know, there are 17 SDGs comprising 169 targets related to global issues, and nearly all the social issues Sumitomo Riko should address are included. We believe that we can contribute even more in areas such as social infrastructure investment, environmental and energy problems, the aging of society, and preventive medicine by using the latest technology to help resolve these social issues.

*1 Public value:
Public value is an objective independently established by Sumitomo Riko. It includes contributions to society and communities through the resolution of social issues, provision of employment, and other activities. Specifically, Sumitomo Riko aims for enhancement of environmental technology, development of environmentally friendly products, zero occupational accidents, and business expansion in emerging-market countries.

The Sumitomo Spirit and the SDGs

MatsudaThat's great. Incidentally, when you consider what Sumitomo Riko aspires to be, there is also the Sumitomo Spirit...

NishimuraThe Sumitomo Spirit is the foundation on which the Group's business operations are based. However, since the terms Shinyo-kakujitsu*2 and Fusu-furi*3 do not encompass everything, we coined the term "public value." If you really think about it, the roots of the Sumitomo Spirit and the SDGs are one and the same. Teigo Iba, the second Director-General of Sumitomo, laid the foundation for Sumitomo as it exists today. When he was manager of the Besshi Copper Mines, he implemented a project of planting a million trees each year on mountains stripped bare in the course of development spanning many years. Our predecessors at Sumitomo were keenly aware of both their business responsibility and their social responsibility.

MatsudaThe Sumitomo Spirit contains principles that should be universally treasured. It simultaneously refers to the importance of economic value and warns against the pursuit of immediate gains or unethical, unfair profits. However, some tweaking may be required to convey the meaning to young people or those of other nationalities.

NishimuraIt may be difficult to convey the profound implications of the terms Shinyo-kakujitsu and Fusu-furi written in kanji characters. That is why we came up with the concept of public value linked to the SDGs and are endeavoring to explain it.

MatsudaThe question is how to create a bridge between the wisdom of our forerunners and people today, isn't it?

*2 Shinyo-kakujitsu:
This expression succinctly summarizes Article 1 of the Business Principles of the Sumitomo Spirit: "Sumitomo shall achieve prosperity based on a solid foundation by placing prime importance on integrity and sound management in the conduct of its business." It proclaims the importance of valuing integrity above all else in business.
*3 Fusu-furi:
Article 2 of the Business Principles in the Sumitomo Spirit states, "Sumitomo's business interests must always be in harmony with the public interest. Sumitomo shall adapt to good times and bad times but will not pursue immoral business." This emphasizes the importance of harmonizing business gains with the public interest and rejects the pursuit of temporary, short-term profits or easy gains.

Corporate Governance Befitting a Global Enterprise

MatsudaLooking at the business performance of Sumitomo Riko during the past year, I get the impression that although sales are steadily growing, profits are not keeping pace.

NishimuraWe cannot compete globally without a certain business scale. The recent rampant inclination of certain countries to pursue their own interests, a theme to which President Trump frequently refers, suggests that it is also necessary to increase the number of production sites so as to engage in local production for local consumption on a global scale. As a result, we now receive orders from not only Japanese companies, but many foreign companies as well. But although such initiatives lead to higher sales, it takes time for production to ramp up and the costs of starting up new plants mount, and profits have not developed as planned.

MatsudaYou are also actively engaging in M&A.

NishimuraWe acquired four overseas companies in 2013. Those four companies finally went into the black collectively in fiscal 2017 after previously operating unprofitably.

MatsudaAccording to a survey by the Ministry of Economy, Trade and Industry and other institutions, fewer than 20% of the companies listed on the First Section of the Tokyo Stock Exchange have engaged in multiple cross-border M&A deals. Although we get the impression that M&A deals are a daily occurrence, they are relatively infrequent. And although the number of companies that consider their cross-border M&A deals successful has recently increased a little, even so it is only about 30%. This suggests that Sumitomo Riko is accumulating valuable experience.

NishimuraSome companies look only at the near term and quickly sell off acquired companies that do not produce the expected results. However, we look at business from a long-term perspective, and results seem to finally come only after the injection of capital and human resources.

MatsudaSo the target of net sales of ¥1 trillion in 2029 when Sumitomo Riko celebrates its centenary is reasonable provided the global business structure is strengthened.

NishimuraWe began discussing net sales of ¥1 trillion when things were at low ebb after the collapse of Lehman Brothers. And then following the Great East Japan Earthquake, which dealt a heavy blow to people's spirits, we held an overnight brainstorming retreat for young employees to consider the company's future and come up with a positive objective. The objective that emerged from the retreat was net sales of ¥1 trillion. At that time, our net sales were only about 230 billion yen.

MatsudaWhat key performance indicators, other than sales and profits, does Sumitomo Riko use and disclose?

NishimuraAs is the tendency nowadays, we accord importance to return on equity (ROE: return on equity attributable to owners of the parent company). In 2022V, our targets are an operating profit ratio of 5%, return on assets (ROA: operating profit to total assets) of 6%, and ROE of 7%.

MatsudaThere's room for improvement in ROE, isn't there?

NishimuraYes, there is. Since the Ito Report*4 recommended a minimum ROE target of 8%, that figure became a common target even though it is not mentioned as much as previously nowadays.

MatsudaThat is an astute observation. Given that far too few companies paid attention to capital efficiency at the time the Ito Report was issued, the figure of 8% was probably included in the report as an easy-to-understand target. However, perhaps because it was thought that only superficial ROE improvement had been made an objective and companies remained inattentive to the primary issue of capital efficiency, the cost of capital has been included in the recent revision of the Corporate Governance Code*5.

NishimuraIf the cost of capital were the only focus of attention, we might be forced to largely abandon efforts to create new businesses and new customers. A perspective emphasizing the nurturing of businesses over the long term, not a short-term perspective, is necessary.

MatsudaI think that without question there are businesses that must be developed over ten to twenty years. At the same time, investors love to hear from diversified companies that they are building effective business portfolios, including such businesses, and that synergies generated between businesses and products are making one plus one equal three. Creating an effective business portfolio necessarily involves deciding which businesses to invest in and which to withdraw from.

NishimuraIt is risky to make such decisions solely from the perspective of efficiency. We consider the continuity of companies. This is another aspect of the Sumitomo Spirit. Achieving net sales of ¥1 trillion in 2029 hinges on our ability to develop a management foundation capable of competing globally on the basis of 2022V. To succeed, we must accomplish the three business strategies: "Creation of new businesses and new customers," "MONOZUKURI innovation," and "Strengthening of global business foundations."

MatsudaWhat are your views on shareholder value?

NishimuraI accord importance not only to increasing the share price, but also to providing shareholder returns in the form of long-term, stable payment of dividends. Considering Japan's super-aged society, since seniors cannot live on short-term trading of stocks, I think it is important to create a framework for rewarding loyal shareholders with dividends.

MatsudaI think that is a sound way of thinking. Excessive pursuit of gains in the short-term share price makes a share price decline all the more likely. Continuously delivering solid business performance leads to the enhancement of true corporate value over the medium to long term and also has an effect on the formulation of a fair share price.

NishimuraShare price and market capitalization are not the only measures for evaluating companies. They are also evaluated in terms of their social sustainability, which has a longer time span. If we think of the share price and market capitalization as measures of corporate value, then social sustainability is a measure of public value. I want to articulate a vision that strikes a balance between these two types of value.

*4 Ito Report:
The Ito Report was compiled in a Ministry of Economy, Trade and Industry project chaired by Hitotsubashi University Professor Kunio Ito and issued in August 2014. The aim of the report was to achieve the penetration of "Japanese-style ROE management" and is a guideline for achieving sustained growth based on a relationship of collaborative creation, not antagonism, between companies and shareholders. It promotes management grounded in a long-term perspective through innovation and places importance on non-financial information.
*5 Revision of the Corporate Governance Code:
The Corporate Governance Code, guidelines for corporate governance providing a code of conduct to be observed by listed companies, was revised in June 2018. The revision incorporates 1) strengthening of explanations of the rationale for cross-shareholdings 2) strengthening of the role of asset owners, 3) strengthening of the effectiveness of the Board of Directors, and 4) strengthening of explanations of management strategies.
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