Poor Corporate Governance Fueled Sony’s Meltdown

What’s Up with Sony?

There is no end in sight for the decline of Sony Corp. The company announced in its February 2014 financial report that its forecast for consolidated earnings in fiscal 2013 has been revised downward significantly, from an expected ¥30 billion profit to a ¥110 billion loss. This is despite the fact that over the past year the company sold shares in its consolidated subsidiary M3, sold its US head office building and the NS Building in Tokyo’s Shinagawa district that once housed its headquarters, and also unloaded its shares of DeNA. The culprit is the slump in electronics sales, as Sony’s electronics division suffered its third straight year of losses. This selling frenzy has subjected the company to a fair amount of ridicule, with some wondering if Sony intends to make the sale of assets its de facto mainstay business.

Sony has had some marketplace success with its cellphones, and its new PlayStation4, released in March, is selling fairly well so far. But those bright spots are not sufficient to say with any confidence that Sony is making a comeback or that it has come up with a clear strategy on how to move forward.

Sony has come to be branded a below investment grade company. On January 27, 2014, the US-based rating agency Moody’s downgraded Sony’s debt rating to “junk” status, just as the European rating agency Fitch Ratings had done earlier.

These company troubles can hardly be pinned on Hirai Kazuo, who only took the helm as CEO in April 2012. So how far back was it that Sony began to lose its edge?

Sony’s Peak and the “Digital Dream Kids” Vision

The days when Sony was running on all cylinders, in terms of business performance and stock value, date back to around 2000, when Idei Nobuyuki was Sony’s CEO. In 1995, Idei leapfrogged over 14 more senior directors to assume the position of company president at the age of 57. It was the first time in the company’s history to select a president from the ranks of its lifetime salaried employees. That appointment happened to coincide with the year that preceded Sony’s fiftieth anniversary, and Idei used the occasion to confidently raise the slogans “Regeneration Through Team Spirit” and the “Challenge of the Digital Dream Kids.”

"Digital dream kids" was a phrase describing how Sony intended to become a company that could fulfill the dreams of its future customers, children raised in the digital age. Under the slogan, Sony employees were encouraged to set their sights on innovating within the new technological environment.

The first step toward its “digital” transformation was the declaration by Idei, then company president, that Sony would revive its PC business. And the announcement of the launch of Sony’s VAIO computer in the United States was greeted with enthusiasm. Idei also viewed it as important for Sony to connect the possibilities of the Internet to its own audiovisual and IT-related devices, and on the basis of that outlook the company established the Sony Communication Network Corporation (present-day So-net) in November 1995.

In terms of its contents business, CBS/Sony Records (name later changed to Sony Music) was established in 1968, and Sony purchased Columbia Pictures (later Sony Pictures) in 1989; at the same time the company developed physical devices like its CD/MD “Walkman,” videogame devices, VAIO computers, its “Handycam” camcorder, digital cameras, and even computer memory sticks. At that stage for Sony, all of these audiovisual and IT devices were capable of being networked. Considering that Apple only launched its iPod in 2001, it is rather remarkable that Sony had everything in place in the late 1990s to make its “digital dream kids” vision a reality.

No “Game-changing” Online Device

This forward-looking stance of Idei reaped benefits, as Sony posted record business results in 2000 amidst the Internet bubble, its stock rising above ¥13,000 per share—compared to the ¥4,240 per share when Idei assumed the presidency. But in the years that followed Sony was unable to launch a game-changing online device. The company also got a late start for the production of flat televisions, adding to the sense that Sony had a disjointed lineup of products. And in the stock market the first signs began to appear that confidence in Sony was waning.

On April 24, 2003, Sony had to downwardly revise its original forecast for consolidated operating profit for the year ended March 31, 2003 by ¥100 billion, and it also became clear that the company’s forecasted earnings for the year ended March 31, 2004 would be 30% lower year-on-year. This news set off a massive selling wave among Sony’s investors, starting on the following day. The “Sony shock,” as it was dubbed, saw buyers flee from the company’s stock, which plunged to ¥3,220.

On top of this, Sony’s bid to reverse the negative trend by launching the Sugoroku DVD recorder at the peak end-of-year sales season ended up cannibalizing market share from Sony Computer Entertainment’s newly launched PSX, which was equipped with hard-drive and DVD recorders. This blunder at a crucial time revealed the lack of leadership at Sony to coordinate the actions of its various affiliates.

The “Curse” of Sony’s Success

How was it, then, that Sony failed to promptly link up all of its digital devices to the Internet around 2003, when it had a product lineup that even surpassed that of Apple? Looking at the situation for Sony at the time, it becomes clear that the company’s past success laid the essential groundwork for its later demise.

This was a time when Sony was the world’s top producer of CDs and when its CD/MD Walkman was a huge hit. The CD and MD were both developed under the direction of the CEO who preceded Idei, Ōga Norio. Producing a hard-disk device like the iPod would run completely counter to the CD/MD model, fundamentally departing from the approach of selling CDs and the MD Walkman.

On top of this, Sony Music, with its lineup of famous recording artists, saw the diffusion of music on the Internet as a threat to its own interests. The artists held the view that they were creating albums as unified concepts and it was out of the question to sell songs individually online. And record companies were caught up in the essential issue to them of figuring out how to protect copyrights in the case of online music streaming.

In the realm of televisions, as well, the company was averse to changes that seemed to threaten vital interests. In 1996, Sony succeeded in developing a flat-screen version of a cathode-ray-tube television—its “WEGA” lineup of FD Trinitron televisions. The product series was a huge hit among consumers worldwide.

Yet, even though Sony knew the main trend would be toward flat-panel devices, the company was reluctant to turn its back on its existing Trinitron technology that was generating profits in order to make the leap into the uncertain market of flat panels, which would require a large-scale investment. Sony’s success in developing the FD Trinitron television lineup ended up sowing the seeds for its late entry into the market for flat panel screens not equipped with cathode-ray tubes.

During this period it was becoming clear that the strength of Sony’s business model up to then and strong track record was coming into conflict with the effort to digitize its products and make them Internet compatible, thereby stifling innovation. Sony was struck by the “curse of success,” where its impressive record of success made it that much harder for the company to adopt an innovative new business model that departed sharply from the previous approach.

Poor Corporate Governance

The curse of success arises when there is conflict between the efforts of specific company divisions to exclusively optimize their own operations and head office moves toward company-wide optimization. But Idei thought that he could create a structure for decision making not prone to the conflicting interests among company divisions by dividing the executive functions between the directors in charge of overall management, on one side, and the executive officers in charge of actual operations, on the other. This structure was implemented around 1997. Sony’s system aimed to overcome internal divisions and make the “digital dream kids” vision a reality by separating the formulation of corporate strategy outlining Sony’s future direction as a whole from the day-to-day management of its operational divisions. All that was needed was to put this system into action.

Yet the management restructuring plan that Idei and other executives proposed did not meet with success and failed to stem the losses of Sony’s electronics division. In 2005, with the company’s stock price languishing at the ¥3,000-mark, criticism against top management grew louder in the stock market, among Sony employees and former executives, and in the pages of the Japanese and foreign business press. In June of that year, Chairman and CEO Idei resigned his post to become a corporate adviser to Sony.

Far from taking responsibility for Sony’s miserable performance, Idei was actually allowed to choose his successor. Even though the problem the company faced was a loss-generating electronics division that was disappointing consumers and the market as well as a lineup of devices that were not Internet-capable, Idei decided to appoint as his successor a man with strong ties to the movie and entertainment business, Howard Stringer.

It may have seemed a welcome development that Stringer announced a “Sony United” vision for integrating its product line with the Internet, but in fact, despite proclaiming that goal of integrating the company as a whole, he had no engineering concept of how to seamlessly integrate Sony devices via the Internet. In order to overcome that weakness in the hardware divisions Chūbachi Ryōji, who had a technical background, was appointed COO, but there was no sign of cooperation between the two toward the integration goal.

Ultimately, both Stringer and Chūbachi had to step down from their executive positions when the company posted four consecutive annual losses for 2012 (totaling ¥919.3 billion).

Sony’s share price, which had been hovering around the ¥3,000 level at the time Stringer and Chūbachi assumed their posts, plummeted at one point to below ¥1,000, striking a major blow to the company’s shareholders. Despite this situation, neither of the two were forced to take responsibility and both received a generous compensation package as well as seats on Sony’s board of directors.

The Mismatch Between Strategy and Executive Ability

The decay of Sony stemmed from a mismatch between the strategy the company needed and its management prowess, as well as lack of clarity about executive responsibility. This is a problem that can be seen at other Japanese manufacturers as well.

The issue posed by the 2003 “Sony shock” was the need to restructure the electronics division to be able to once again produce distinctive Sony products and seamlessly integrate those devices with software offerings; in other words, the world of "digital dream kids" and of Sony United. But neither Idei nor Stringer (nor the new president, Hirai) had the engineering minds required for the task.

Although they put forth wonderful visions for the company, none of these executives took the risks necessary to make the dream a reality, nor did they give ample thought to the sorts of new technologies that were needed. As the biography of Steve Jobs makes clear, it is essential to have the passion and persistence necessary to work out how to connect devices in a stress-free way and iron out their operational details in order to integrate those devices.

In facing a paradigm shift in technologies, what a company needs—more than high-blown slogans or speeches—are tenacious leaders who can implement the strategy needed to work out the details for creating devices and then link them within a network. Unfortunately, at Japan’s electronics firms today, there is a huge mismatch between the corporate strategies needed and the abilities of executives to implement them.

Panasonic Also Hemorrhages Losses

The unclear way that Sony handled the issue of executive responsibility was another of its problems. Even though Idei and Stringer stepped down from the position of CEO, both handpicked their successors as members of the board of directors, while also earning huge bonuses and a cushy retirement payoff. That was an intolerable situation from the perspective of those Sony employees who had lost their jobs in the wake of the company’s poor performance or stockholders who were forced to swallow massive losses. The issue was brought up at the time that Idei and then Stringer resigned, and harsh comments and questions were raised at the general meeting of stockholders, but following their resignations they were appointed, respectively, to head the Advisory Board and to chair the Board of Directors.

The same irresponsible attitude was seen at Panasonic, which spewed losses of over ¥700 billion for two straight fiscal years. Even after the 2012 resignation of Nakamura Kunio, the president and CEO who had made the executive decisions responsible for the company’s losses, he was still pulling the strings behind the scenes in his role as advisor, in much the same way that the company’s founder, Matsushita Kōnosuke, had once done. These were two electronics companies that were drivers of the Japanese economy. Their failure to hold their top executives responsible for the hemorrhaging losses clearly eroded trust in Japan’s corporate governance to a large extent.

Getting to the bottom of the causes behind the selection of inappropriate executives and the lack of responsibility will require interviews with those involved and the publication of internal documents. But in any case, if Japanese corporations hope to make further progress it seems necessary for this problem of corporate governance to be properly addressed, without treating corporate problems as resulting from some random factor or from the individual shortcomings of executives at Sony and Panasonic.

(Article originally written in Japanese on March 20, 2014.)