Japan's Dot Bombs

Back to Contents of Issue: September 2001

Was it a rash of tech entrepreneurialism last year, or just a lot of rash tech entrepreneurialism? Judging from some companies, more of the latter.

by Sumie Kawakami

From a media standpoint, the dot-bomb story is already stale. The fact that young tech ventures are exploding -- or imploding -- all over the world is well established. But, as always, there's a unique Japan angle to tell, and J@pan Inc is here to tell it. So with the same curiosity that makes drivers passing an accident crane their necks, let's check out some of Japan's dot-bombs.

MORE THAN A FEW Japanese Net startups have been blown to bits over the past several months, and the survivors have been wounded by the shrapnel. The dot-com downturn started to hit Japanese tech ventures late last year, says Takatomo Nakagawa, a senior Net venture researcher at Tokyo Data Bank, a private investigation firm. In February, J-side.com, a community site with over 560,000 registered users, bid farewell, as did the much publicized portal boook.com, despite its 60,000 users. In April, women's site Xaque.com disappeared, and even major news site CNN.co.jp cut almost half its staff. In June, the troubled ADSL Net access provider Tokyo Metallic Communications was taken over by Softbank, while Mitsui-backed DSL provider-to-be Garnet Connections Planning never even got started.

Many more tech ventures have simply disappeared without drawing attention. Neither the Japanese government nor private research companies seem to have exact figures on just how many ventures went out of business, or how many dot-com employees went jobless. Many startups that launched late last year - when several major players began failing - ran out of money before they really got going.

Fortunately, there haven't been a lot of harakiri (suicide attempts) or teary group-therapy sessions. Unlike the post-Bubble period of the early 1990s, the Net Bubble hasn't had a huge impact, simply because most startups didn't enter the market until late, Nakagawa says. The market climate in the US changed before Japanese tech ventures ran out of money. Many are still hanging on to their nest egg, waiting for a better chance, a better climate, and a better plan, says Yoshio Minato, general manager at IBJi Investment.

Yet most industry watchers agree that the collapse of Japan's Net ventures has just begun. Internet "pure plays" here are having an especially difficult time, says e-biz analyst Kazuko Ichikawa at Jupiter Research. And not only are dot-coms suffering from a decline in revenue from banner ads, but many traditional companies that were initially reluctant or unprepared to enter e-commerce have been gradually catching up. Mix this online competition from the old guard with the unfavorable economic climate, says Ichikawa, and you can expect many more dot-coms to disappear over the short term.

Confession time: The writer of this article is also a former dot-com employee. I joined the Japan branch of a Canadian Net venture in late 2000, eager to launch an investment site in this country. Nasdaq was already diving, but the company received a huge investment from a Hong Kong firm, and I convinced myself that its business model would work in Japan. I tried to think of the Nasdaq plunge as "just another technical correction," but within a few weeks the parent company - obviously having troubles of its own back home - abandoned its plan to support our Tokyo operation. So instead of launching the site as planned, my boss and I - the only two in Tokyo - sat in endless fund-raising meetings, hoping if not for cash then at least for a tie-up, buyout, or merger deal. Nothing came. The company closed its Japanese operation in April. In a period of six months, this writer had experienced the birth and death of a venture company.

It's easy to criticize such startups by saying they didn't have the brains to think ahead. The argument may have some truth - some ventures obviously lacked a proper business model - but there are many other factors that have contributed to the overall hardship for tech ventures in Japan:

The most obvious is Japan's IPO market, which is more difficult than most and this year even more difficult than last. While Japanese companies are shelving their IPOs, VCs that were once willing to back no-name startups in return for splendid IPOs are now tightening their belts. "The most important criteria for a VC to invest in a startup is whether the company can go public in the short term," says Shinichiro Ishibashi, executive director of IT-focused incubator SunBridge.

While most funds in Japan are set up with a maturity of 10 years, VCs normally invest heavily during the initial three to four years. But whereas VCs used to wait for three or four years for a startup to become profitable, they're now becoming even more impatient. "Come back to us when you become profitable" is a common response these days, Ishibashi says.

According to the Nikkei Weekly, the amount of offering money from Japan's three startup-weighted stock exchanges - the OTC, Nasdaq Japan, and Mothers - during the first half of FY2001 declined by 39 percent from last year, even though the number of companies (51 compared to 50) holding IPOs was about the same. Of course, last year was exceptional: Rakuten, Japan's biggest operator of online shopping malls, raised ¥49.5 billion - over 70 times more than its annual income. And a 26-year-old named Isao Matsushima, the founder and then president of Crayfish, led his company to a ¥13.2 billion IPO on Mothers in March (gaining attention as the youngest president of a company listed on stock markets in Japan and the US in the process).

This year, things are more subdued, the valuations more cautious. One of the year's most notable IPOs, that of usen, a Tokyo-based cable radio company providing fiber-based Net access, in April raised ¥43.2 billion (about half its annual income), but it's tough to find a tech IPO that comes close to matching that.

Digital Advertising Consortium, the second-largest online advertising agency, raised ¥2.8 billion on Nasdaq Japan in July, but its opening price was 21.6 percent lower than its IPO price. (Note that the company's latest annual income is around ¥4.5 billion N bigger than Rakuten's latest figures.)

Technology-oriented startups are harder hit by the tightening of VC money, notes Takashi Hosoya, a technology analyst at Jupiter. "IT-related ventures - say, ASDL, for example - generally need quite a bit of initial investment. The refusal from VCs to refinance is likely to kill any genuine effort."

Many Net ventures that had no problem getting funding initially have failed to secure more cash from their investors. Tokyo Metallic, for example, reportedly failed in a ¥21 billion capital increase plan, as foreign investors decided not to fund it.

Many VCs are now diversifying into Japan's biotech scene, which until recently they've largely ignored. Even fund managers whose funds are specifically focused on IT are shifting to software and semiconductor businesses - after all, says Minato of IBJi, at least their cash flow and profit models are clearer than those of pure Net plays.

Japanese tech ventures also suffered from the withdrawal of foreign VCs from Japan. Whitney & Co., for example, has reportedly decided not to disburse additional investment in Japan. The company had invested in major Net-related ventures, including Tokyo Metallic. When Yazam's parent company was acquired by US Technologies, it sold its Japanese operation to members of its Japanese management team.

Another obvious factor: the decline of banner ads. One need only look at Yahoo Japan, who, in its latest earning report (March-June quarter), reported that advertising revenues declined by 3.7 percent from the previous quarter to ¥3.4 billion. The company attributed the decline to "a series of reports that US Net advertisement has been on the decline, and the uncertainty over the future of the Japanese economy." Yahoo Japan has managed to keep 18 percent growth in total revenues, as its new ADSL service, Yahoo!BB, generated income. As a result, the company's dependency on ads as a source of revenue declined from 91 percent to 74.7 percent in the March-June quarter. The company is clearly trying to diversify its source of revenue, but the report had a severe impact on its share prices in mid-July.

Yahoo Japan is not alone. Share prices of online ad agencies, including Japan's largest, Cyber Communications, have been slashed significantly over the past year.

The online ad market in Japan, however, isn't quite the same as the one in the US. "The impact of declining banner ads on Japanese Net ventures is not as severe as it is in the US," says Hideki Tanaka, a senior associate at Fujitsu Research Institute. Unlike their US counterparts, he says, Japanese Net ventures depended less heavily on other Net ventures for banner ads. And because the Net bubble started later in Japan, most startups weren't really making money on banner ads anyway, he adds.

The combination of VCs' reluctance to invest or reinvest and the decline of banner ads are obvious, but there's more to be learned from Japan's dot-bombs. Let's take a look at the following examples of companies and the primary lessons that can be learned from their hardships. (Note that each case that follows was caused by a combination of different factors.)


There's no point rubbing this in - former Crayfish president Matsushima has been bashed hard enough - but there's no better example of what immature behavior can do to a tech startup.

Both Crayfish and Hikari Tsushin are tech ventures that made their debut in the wake of rising Internet-based businesses, and both companies subsequently suffered free-falling stock prices. Mobile phone retailer Hikari Tsushin held about 46 percent of Crayfish's shares.

The scandal went like this: Matsushima borrowed ¥200 million from e-Capital, a consumer finance company, using about 10 percent of the company's outstanding shares as collateral. But then the stock certificates ... went missing. "As president of the company, I used the company's stock as collateral," Matsushima told Nikkei Business.

"Of course, there were good reasons to believe that would be good for the company, but now that we cannot even trace where the certificates are, I have to take personal responsibility."

Crayfish is also faced with a class-action lawsuit filed by a group of US investors claiming they had not been adequately informed of the firm's ties with Hikari Tsushin in the prospectus for its IPO on US Nasdaq. Shortly after that offering, Hikari warned of heavy losses - and Crayfish's shares collapsed.

The companies's relationship started when Matsushima, who reportedly dropped out of college when he was 21 to launch Crayfish, met Hikari's president Yasumitsu Shigeta in 1997. Hikari Tsushin was then rapidly expanding its business in mobile phone sales. The tie-up did well for a while, but the relationship went bitter, and Matsushima nullified the tie-up, making Hikari a distributor of its products.

After an extraordinary shareholders meeting in June, Crayfish named Kouji Yamamoto, an advisor at Hikari, as the new president. On the same day, Hikari announced that Crayfish would become its consolidated subsidiary. (Crayfish still had ¥18.6 billion in cash and savings as of last March that it can use to develop new businesses if it wants to.)

"Crayfish hasn't been making much income on its main business. It's still making losses, and its future remains quite doubtful," says Internet analyst Ortwin Gierhake at West LB Securities Pacific. With Hikari Tsushin itself still in the process of restructuring, how exactly it will manage to revive both companies remains to be seen.


Zero Inc., as its name implies, started as a free ISP. Seven months after beginning operations, however, its services were no longer free. The company set up a budget of over ¥30 billion for advertising between September and March 2001, which amounted to nearly three-fourths of its total revenue of the previous fiscal year. It also planned to spend an additional ¥40 billion for infrastructure during the same period. Despite massive TV advertising late last year, though, the company failed to secure its projected membership and income levels.

Originally, the company aimed at acquiring 1.5 million members within a year. It planned to expand its members to 4.5 million within three years, and projected an annual income of ¥15 billion from that business alone. Instead, its members remained at around 230,000 (as of June); in the last earning report (FY2001 ending in March), the company posted as much as ¥3.66 billion in losses, while its annual income was at ¥5.08 billion.

Why did the company expect free ISP service to be so profitable? It originally hoped to expand income from optional mail transfer services to mobile devices, but, coupled with the sluggish growth in overall membership, only a small portion of members chose to receive such services, according to industry sources.

"We had hoped the massive media exposure would help, but the environment has changed so rapidly. No one expected that ISP fees would drop this much," says one of the companyOs employees, requesting anonymity. Due to the spread of cheaper and faster platforms, ISP fees are dropping significantly in Japan. Now that users can get an always-on connection for less than ¥3,000 a month, many would prefer to pay a little to receive faster and more secure connections than to rely on a free service, he says.

The company froze advertising spending between April and June. It restarted advertising in July, but not on TV. "We would spend a minimum, perhaps on magazines," says the source, adding that the company has also reviewed infrastructure spending.

Zero raised as much as ¥94 billion from changing its listing from OTC to Nasdaq last year. And as a result of restructuring efforts, Zero went profitable on an operating basis for the month of May. However, because of massive losses posted in the last fiscal year, it is not expected to go profitable overall for the year, the source adds.

The lesson from Japan's short history of dot-coms would seem to suggest that offering free tech anything doesn't make much sense in this country. Vertex Link withdrew from the free PC rental business in August 2000, after just a year in business. The company offered free PCs on the condition that customers would use its ISP service. The business model didn't work because ISP fees were declining, PC makers were constantly offering new models, and users didn't like sticking to the same old PC just for the ISP services.

One of the few remaining free ISPs, Livedoor, has recently announced a new revenue model. In July, it introduced a new marketing tool, One-Click Contact, in which the company customizes its console bar for its 10 partner companies. According to the plan, the console bar, with links to the partner companies, will be shown on the users' desktops all the time when they are online. As the console bar, in trials from July to December, makes it easier for users to jump to their sites, it may be a useful marketing tool for its partners. Some analysts, however, say that while LiveDoor is good at mobilizing the media, the new model remains unproven.


An important lesson learned from Zero: Big spending is a waste if it doesn't contribute to income growth. Sounds obvious, but it wasn't for many of Japan's dot-coms.

Consider Hikari Tsushin-backed startup J-side.com. The company set up a \10 billion advertising budget last year -- nearly 10 times its annual income. Despite the massive advertising (using well-known TV celeb Kyosen Ohashi), J-side.com was liquidated in February after a year in business. Banner ads didn't bring much income, and its dream of an IPO never materialized. Industry sources say the company was counting too much on an IPO, and didn't really care how it would generate income.


In February, portal site boook.com suddenly closed its doors, after only six months in operation. "Money went out even before the company had a chance fully to develop the site," says Ichikawa at Jupiter Research Japan. According to industry sources, the reason for its closure was simple: A VC simply canceled a promised investment.


"We've already given up on banner ads," says a senior editor at one of Japan's many women's sites. "The market condition is very, very severe. We cut our costs, try to focus more on marketing. All we can do is to patiently keep knocking on the door for potential clients."

The market condition is similarly tough for every other women's site, meaning for each there's severe competition on the one hand and a sluggish ad situation on the other. Despite the massive media attention in late 1999 to early 2000, many women's sites are barely surviving. Looking at Jupiter Media Metrix's ranking, only two women's sites -- woman.co.jp and shees.net - are listed with those whose digital media reach is over 1 percent. "Others are having an extremely difficult time. Some are not uploading as much as they used to; some are cutting their staff," says Ichikawa at Jupiter Research Japan.

Already, at least two major women's sites, Xaque.com and styleones.com, disappeared this year, while e-life.com stopped its community services. In the case of styleones.com, VCs suddenly pulled out their money before the staff knew it, say industry sources. The company was not available for comment.


The financial crisis at Tokyo Metallic and Softbank's subsequent takeover of the company has gotten much media attention. Behind this event, however, yet another Net venture quietly disappeared in June. Garnet Connections Planning announced a plan for its own liquidation, as it decided not to enter the DSL market after a year-long feasibility study. The announcement was made just a few days before Softbank announced its entry into the ADSL business through its portal arm Yahoo Japan (51 percent owned by Softbank) in August. Yahoo Japan will charge a minimum monthly fee of \2,280, almost one-third of what NTT charges for a similar service.

"Yahoo's announcement made me feel relieved. After all, we made a good decision not to enter," says an informed source in Mitsui Co., which had a major stake in Garnet Connections. The company was established a year ago - with Mitsui and US company Rhythms NetConnections each having 34.3 percent shares - to study the possibility of entering the DSL market. OAt that time, we weren't expecting NTT to enter the market, let alone Yahoo. Yes, the DSL business is feasible, but not for Mitsui. Not with NTT, anyway," he says.

According to the most recent statistics from the Ministry of Public Management, Home Affairs, Posts, and Telecommunications, about 300,000 people were subscribing to DSL connections at the end of June. The number grew by about 30 times over the past six months. Early last year, NTT showed no interest in entering the market. Instead, it simply bullied potential DSL providers. How exactly NTT bullied them has been much talked about, but, using its monopolistic position to its advantage, for example, it didn't cooperate with DSL providers' request to allow them to access local switches. Even the Fair Trade Commission gave an "administrative warning" to NTT East and West not to block other firms' entry to the market.

NTT East Japan reacted by saying it would open its facilities as soon as possible, all the while launching its own ADSL services. "How curious it was!" says Ryuichi Kamoshita, former president of the liquidated Garnet. "NTT, who kept saying ADSL was difficult in Japan, was fully ready for action when it was forced to open its facilities." Within a few months, the NTT group had rapidly expanded its shares in the market. Now, it has nearly 60 percent of the market.

"The market changed so rapidly. We were only planning to be a wholesaler. We couldn't have competed with NTT when we had to depend on it for its facilities," says Kamoshita.

Now that Softbank has entered the market and acquired Tokyo Metallic, the competition in the DSL market looks even tougher. "Softbank's position is a little different. Even if it fails in its competition with NTT, the competition would surely lower Net connection fees. Yahoo Japan would still benefit from faster Net connections with lower prices," says Hosoya at Jupiter Research. Yahoo Japan has 20 million unique users and runs a popular auction site as well as shopping malls. Softbank also has a multitude of e-commerce channels under its umbrella, and all of that would benefit if NTT were forced to lower its ADSL connection fees. Softbank expects 1 million customers by year's end and 2 to 3 million by next year.


Does all this mean the future of Japanese startups is hopelessly bleak? Not quite. People learn from mistakes, and so do dot-coms. Kamoshita puts his experience in failed Garnet in perspective: "Within a year, I experienced the starting up and closing down of a company. The entire experience was very creative. I wouldn't have been able to learn this much if I had stayed inside Mitsui Co." Kamoshita returned to Mitsui after closing Garnet Connections, but heOs eager to start a new venture, with or without Mitsui. Japanese corporate culture does not easily allow those who fail to rise again, but venture businesses do, he adds.

Many dot-bombers are starting up new dot-coms, taking advantage of their experience in failing once, says Nakagawa. Even ex-Crayfish head Matsushita plans to start a broadband-related new business. Matsushita has reportedly secured a ¥20 million loan from a Swiss investment firm.

Hopefully, the business environment will improve to help these never-give-up challengers. In the field of online advertising, many analysts expect that the quality of Net advertisements will improve with broadband. "With the advance of broadband, Net advertising is likely to secure a solid status," says Tanaka at Fujitsu Research Institute. According to Tanaka, most banner ads have until now been created by Web designers with no advertisement background, and this has limited the quality and expression. But with faster connections Net ads will gain market recognition. If more TV ad creators join the industry, it will surely raise its status, he says.

Also, Japan's e-commerce market is still underdeveloped. According to research by the Electric Commerce Promotion Council of Japan, the Ministry of Economy, Trade, and Industry, and Accenture, only 0.25 percent of Japanese consumer spending was done via the Net in 2000, compared to 1.37 percent in the US. But e-commerce in this country is expected to expand rapidly over the next few years. Jupiter Media Metrix expects Japan's online shopping to expand to \2.3 trillion (referring to the amount settled through the Net) by 2003, and ¥4.7 trillion by 2005, from ¥400 billion in 2000.

And while it's true that many of Japan's tech startups have failed, others are surviving - and some are doing very well. "Some of those startups that we invested in are also getting investment offers from other VCs. Good ones are there, no matter what," says Minako Marushima, of the Finance and Administration division of SunBridge.

A specialized and competitive technology or service, a skilled management team, a good business model, and focus seem to be the keys for survival. Unlike in the US, where it seemed for a while that anybody could start a venture, take on the big boys, and become a tech celeb, the dominance of traditional companies is still very strong in Japan, says Ishibashi at SunBridge. In order for a startup to do well, it needs to have a secure business relationship with those companies. "An ability to shake hands with traditional companies," as Ishibashi puts it, seems to be one of the most important criteria for a dot-com's survival here.

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