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Opportunities and Investment in Japan Mr David Baffsky AO ASIA SOCIETY SPEECH
Thank you Richard for your introduction and thank you to the society for allowing me the privilege of speaking today. I should begin by confessing that I have been fascinated with Japan for more than 30 years – in my previous life as a lawyer I had the opportunity of representing Japanese trading companies, industrial companies and banks. As you can imagine, that gave me a quite different perspective but taught me many valuable lessons. I was fortunate that very early on I was advised by a Japanese executive of one of our clients to read a book titled the Chrysanthemum and the Sword so as to gain some insight into Japanese culture and society. This book was commissioned by the US Office of War Information in 1944 and used by General McCarthur and his administration. I am sure that many of you have read it and for those of you who have not I would highly recommend it even today. It is worth reading more than once. I am sure everyone is familiar with what has happened in Japan over recent years in relation to one of the most dramatic banking and property crises ever. Today, investors recognise that although the local economy has been weak it still remains the second largest in the world; that Japan is the largest exporter to China (US$174.1 billion last year - mainly electronics). That there are exponential increases in pension funds and investment dollars in Japan are piling up increasing the already high levels of liquidity; and that structural reforms are taking place. In some ways Japan is not unique in facing structural reform. There are some striking similarities with other countries which are also having difficulty in making some very necessary and fundamental changes. But Japan is changing; and in many ways. Even though the Prime Minister, Mr Kozumi, is regarded today as a bit of a lonely figure, we are seeing advertisements featuring the Japanese Prime Minister speaking in English and welcoming foreign tourists to come to Japan. Something unheard of just a few yeas ago and unimaginable by a Japanese Prime Minister let alone any Prime Minister. For Accor, 1999 represented a key opportunity in Japan. It was then that we decided to purchase the Sofitel Tokyo which is a very distinctive hotel in Ueno, often referred to as the ‘Christmas-tree’ hotel because of its peculiar architecture. The hotel was constructed in 1994 and by 1999 the owning company – like many other Japanese companies at the time – was haemorrhaging because of their debt and the state of the economy. Accor has always recognised the importance of a strong presence in Japan – because of both its domestic market and its significant outbound potential – so we took the opportunity to purchase the hotel at what turned out to be 20% of the original development cost. I remember Hotel Asia Pacific magazine referring to it as the “deal of the decade”, though in reality even at 20% of the development cost, the small size of the hotel means that it will always be difficult to make it a significant commercial success. The purchase was an important event in Japan’s tourism property sector, because this was the first time a foreign company had acquired an international-standard hotel as freehold in Japan. Previously, international hotel groups had gained a foothold in Japan through leases or franchise arrangements, but the impact of the 1997 economic slowdown and the burst of the bubble economy were to have profound consequences for the future of the Japanese hotel sector. The acquisition of the Sofitel established a new benchmark in hotel pricing, by acquiring the hotel on a cash flow basis rather than replacement cost of the property. For the first time, the purchase was seen as more than just a real-estate play, it was all about buying a business. This has had a positive impact on the whole Japanese hotel market, because it has encouraged more realistic pricing, allowing other foreign investors to enter the market. This process of transparency is set to be further enhanced with the new International Accounting Standards requiring corporations to reflect the true market value of their assets in their accounts, resulting in further transactions. Already we have seen an increase in the hotel investment market since 2003 with the bankruptcy and restructuring of companies resulting in the sale of non performing assets and loans. Most of these major purchasers have been mainly US Investment banks and funds (Goldman Sachs, Lone Star, Morgan Stanley, Soros) and various domestic companies. The US investors are currently managing most of their purchased properties themselves under the existing Japanese branding. Many Japanese hotel companies are still in financial difficulties because of floundering non-hotel related ventures undertaken by parent or related group companies, excessive gearing and or expensive leases signed at the peak of the bubble period. In contrast, the newcomers are very professional and only prepared to enter the market under commercially viable terms and conditions and there is a positive shift by Japanese owners towards embracing more realistic terms and conditions. Large up front non interest bearing unsecured deposits and fixed leases are no longer the norm. Hotel owners have come to appreciate the merits of joint risk and reward with a skilled and respected international operator, as against a fixed lease with no upside in the hands of a subsidiary or inexperienced hotel management company (which was often one and the same). For instance, we have entered a management agreement with Mitsui Fudosan who have their own hotel division, but who decided to appoint Accor to manage a new hotel for them in Ginza. This hotel was another first in Japanese hotel history because it was created in a former office block that had been built only a decade ago but wasn’t achieving appropriate returns as commercial office space. To develop a mid-market hotel from scratch in such a location would have been prohibitive, but because of our experience in converting such buildings, we are able to offer a quality product in a prestige location and aimed directly at the midscale market. The hotel is also different from the usual Japan hotel model, most of which boast large function space and were built as much for the wedding and functions market as they were for accommodation. Those markets today are much smaller and more cost conscious. The Mercure Ginza is all about rooms, with the only public facility being a very good French restaurant and with special floors for women only. The market for women in Japan is very significant and often not recognised. The Mercure Hotel Ginza is Accor’s 8th hotel in Japan and we are looking to build the network largely through joint ventures. The early success of the hotel is very positive for further such conversions. Our strategy is concentrated largely on the mid-market, because this is Accor’s principal strength and it is also the area of greatest potential for international groups to make an impact. In the past, foreign companies have had considerable difficulty penetrating this market, as it is highly fragmented, which makes a strategic play (via an acquisition or joint-venture) more challenging. But Japan is neither harder nor easier to penetrate than most countries – it is just different. We believe that the combination of commitment, transparency, professionalism and product excellence ultimately will prevail. Remarkably, Accor is the fourth
largest international hotel operator in Japan with just eight
hotels. Those figures would suggest that globalization is still a long way from having a dominant role in the Japan market, but anyone who walks through the Ginza and sees the proliferation of brand names – particularly French brand names – will know that Japan is very much part of the world economy. In fact, in December, just a short walk from our new Mercure, the largest Chanel boutique in the world will open, featuring a restaurant by Alain Ducasse. There is indeed a love affair with France and Accor is fortunate that it is the only global hotel brand that is not seen to be American and with French and European heritage. As a market differentiator, it gives us a significant advantage. One of the most fundamental factors involved in succeeding as a foreign company operating in Japan is understanding the local market. For instance, the internet has had remarkable penetration in the Japanese market and already some 25% of our bookings at the Mercure Ginza are coming via the internet, but Accor is the only global hotel group in Japan that has a Japanese language booking engine attached to their internet site. Other hotel groups may have
presented their hotels in Japanese, but when the customer comes
to book the room via the web, the site reverts to English or another
language. It is another example of companies seeing the opportunities,
but not understanding the mechanisms of satisfying the needs of
local consumers. Accor will continue to expand the Sofitel brand if opportunities arise, but it has been Accor’s primary aim to get its full galaxy of brands into the marketplace because brands such as Novotel, Mercure, Ibis and Formule 1 are very suited to the Japanese domestic market. Equally important is exposing all of these brands to Japan’s vast outbound travelling market to many parts of the world. All eyes seem to be on China these days – and I can assure you Accor places China as one of its highest priorities – but to ignore or underestimate the power of Japan is to be naïve and short-sighted. Some 15 to 17 million Japanese travel offshore per annum and they are still some of the highest-spending travellers in the world. But this is a very sensitive market and the impact was only too apparent recently when the market ‘switched off’ during the SARS crisis. Japanese numbers to Australia shrank by 40% and the affect on the 5-star end of the market has lingered ever since. In fact, Japanese inbound
to Australia is still down 20% compared to pre-1997 days and it
remains an imperative for Australia’s tourism sector to
rebuild the market. Competition in our sector is enormous and
to some extent the vacuum created by the loss of Japanese business
has been filled by other Asian and regional business, but for
tourism in Australia to return to full health we need to build
our presence and re-establish a positive image for the country
among potential Japanese travellers. Most of you here today will have exposure in some way to the Japanese economy and possibly it is regarded as something of an ‘old world’ economy compared to the likes of China and Korea, but foreign investment is still in its infancy in Japan, so the potential remains enormous. Foreign direct investment in Japan in 2000 was measured at 1.1% of GDP, compared to 24% for Germany, 28% for the USA and 32% for the UK. The incredibly low level of foreign direct investment could be considered a result of perceived barriers, a lack of confidence in the Japanese financial system or just a failure to understand and cater appropriately for the market. Whatever the reasons, the fact remains that Japan is a market that cannot be ignored. We have learned through our experiences in Japan over the past decade, and those experiences have already started to pay dividends. As with China, it does take time to work out which organisations offer the best partnership potential. Mistakes will be made along the way, and lessons learned. As I have said, we strongly believe in penetrating the domestic market as there has been a strongly growing preference among Japanese to travel within their own country, and not only for security and safety reasons. For instance, we had an ambitious plan to roll out our Formule 1 brand in Japan and we invested in two prototypes on the outskirts of Tokyo. One, in particular, was very successful, and the Formule 1 concept forced change amongst local operators of budget accommodation. But within two years of launching Formule 1 in Japan, the concept was copied and rolled out aggressively by Japanese groups that could quickly deal with complex legal and tax issues and be satisfied with much lower returns. That doesn’t mean that we have abandoned the idea of expanding Formule 1, but given the high cost of land, new greenfield developments in Japan are more difficult to materialize than in other parts of Asia. In fact, I am sure that it won’t take long before we see other offices converted to budget or midscale hotels, following the lead of the Mercure Ginza, but this time we have the largest Japanese real estate company as our partner. But we have to ensure that our products are attractive and we service the Japanese markets appropriately. There is no other industry in the world that has the potential to employ such large numbers of people in an incredible variety of opportunities as tourism. Consequently it will play a very important role in the transformation occurring in Japan. At the same time the Japanese outbound market will drive greater development, particularly in emerging countries and I believe this is going to be one of the key issues that our industry will have to face in the future: the balance between development and sustainability. Sadly, our industry is anything but a pioneer in sustainable development principles, though I am confident that more and more tourism-based companies are beginning to see the value and benefits of taking a more responsible and holistic approach to development and operations. The development of ethical indices and the requirement for triple bottom line reporting will force international companies to take an ever-increasing role in environmental and social issues. Japanese tourists can and will help this process as they are very selective and have a strong and growing interest in the environment. After my visit to Japan last week, I continue to be excited and optimistic about Japan’s potential. It is a complex and fascinating society that does require an equally complex approach. Getting the right team in place on the ground is one of the most essential priorities. From our experience, that is not always easy and does take some time, but foreign companies cannot just assume that Japan is an outpost of their own country and that it should operate on the same terms. It doesn’t work like that and we will continue to invest significant time and money into cultural awareness programmes for our team. The opportunities in Japan and for the Japanese market are significant and any truly global group must be well represented in Japan. Thank you.
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