Letter from Executive Alumnus Tamotsu Iba to the Sony Board and Executive Officers

Interestingly, the letter refers to Mr. Loeb’s proposal as one that may merit consideration, and cites a number of provisions of the Corporate Governance Code at the end.

June 1st, 2015

Dear Sony Corporation
Outside Board Members
The Managements (including Deputy President)
Executive Officers
Copy to: The Board of Directors Secretariat
Tamotsu Iba
(Executive Alumnus)

The Day Sony Spirit Revives

Sony share price has surged to near 4,000 yen recently, reaching close to the prior financial crisis level. The stock market seems to be praising the current managements’ mid-term plan. However, whether this is a result of Sony managements’ real ability is in question. Isn’t the price appreciation merely due to the effect of restructure and the company explanation targeting equity analysts (setting financial performance metrics including a target to achieve more than 10% ROE during F.Y.2017 and enhancing portfolio management and recurring business)?

There are important management issues yet to be resolved. The low equity ratio, Ba1 credit rating by Moody’s, and so on.

As I have mentioned in previous articles of The Quest for Best Management Structure and The Origin of Sony’s Management Philosophy Is in The Prospectus of Establishment, I think I have delivered the messages I wanted to tell the managements and the board members. Several months passed, I am still looking forward to hear back for an answer. I would like to request for recall the Sony culture, which is to respect different opinions and encourages free discussions.

This time, discussions will be focused on the revival of the bright electronics business in order to increase the corporate value in the mid and long term. I think the managements and board members must be sharing the same feeling as to the revival of the bright electronics business, or is it just my imagination?

Sony used to be a unique and extraordinary company. As described as the free, pleasant, and vigorous ideal factory, the company has led Japan’s electronics industry and export, it managed to do globalization/localization, was a leader in not only the products but also the management model. The
philosophy and guideline of the top management were clear, thus employees were motivated and everyone has done their best in innovation, to create new products and services that did not exist, and the company was able to create new markets. However, since the 50thanniversary of the company, the innovation that creates new product, service, and market has weakened, except for the Play Station business. During the past 10 to 20 years, Sony spirit for innovation has been diluted, and as a symbol, the SONY brand has become weak. Business fields have expanded, management changed, and lots of innovative engineers who were labeled as strange/ weird(kizinn/hennjin) have left. It seems that the bright era for Sony group has passed. But I believe that it is still possible to revive the brightness in electronics business as of now.

Sony is the pioneer. Its window is always open to the unknown world and full filled with vivid breath. Do what others do not do, and bravely tackle the difficult missions that others avoid, and incorporate it into the business. Here, creative activities are required, expected, and committed in every process of R&D and sales of new products. This is the pure joy of a Sony person. – from the Sony Spirit urged by Masaru Ibuka, 1973 edition.

Sony spirit has become the action guideline for managements and employees, and they were proud of putting products and services that represents Sony spirit into shape. Engineers were most encouraged by Masaru Ibuka, Akio Morita, Kazuo Iwama or Norio Ohga to say “This is it! This is what I want.” Not only for products and services, by taking Sony spirit into shape, extensive intellectual properties including patent portfolio have also formed. This is intellectual strength of Sony.

The role of Sony spirit has changed after the 50th anniversary. In 1995, Nobuyuki Idei became president, and he advocated act on the internet era and digital era. Regardless of whatever Nobuyuki Idei advocates, the engineers in front line have tried hard to create new products and services that represents Sony spirit, but it was disappointing that the management’s sense never matched with what the engineers work for dream. Sony spirit no longer bridges managements and the front line. In retrospect, there are projects that should have been kept, there were innovations that belong to Sony but were not well organized, and as a result, the company fell behind others.

Ironically, escaped from head quarter’s control, PlayStation business, which were led by Ken Kutaragi in a joint effort with Sony Music, has succeed. It is the personification of Sony spirit.

It was a pity that the qualification of the top management has become unclear in the management change of Ohga to Idei. Until then, what was required for the top management was clear. In Akio Morita’s words, Sony management should “know technology, use technology to draw a path for the future business”, “tell the direction of R&D”, and also “motivate employees, cheer them up and unlock their potential talents”, “enrich people’s lives”. These are the requirements for top management of the electronics business. And I do not see a reason to change these requirements.

Under the management of Howard Stringer, who succeeded Idei, electronics business was more and more deteriorated. Sony-born engineers were kicked out from the Board of Directors, and were limited in executive positions. The path to educate engineers into management has been shut. CEO Kazuo Hirai, as the successor of hard time of electronics business, has not achieve any significant result in the revival of electronics business during the first three year of the 2012 mid-term plan.

The new mid-term plan announced on February 18th, 2015 can be seen as a plan aiming to improve the endangered financial position of the company. Apply the US style management, and introduce performance metrics to establish business discipline. Invest in businesses with foreseeable profits, but refrain from investments with unknown returns. It sounds like a strategy of US style portfolio management.
On February 27, 2015, CEO Kazuo Hirai explained in the Sony group quarterly meeting, “…innovation and customer value creation are deteriorating. This means the power to create innovative products, contents, and services through new technology, idea, and to break the take for granted notions and concepts,” and “the goal of turning into a highly profitable company is to enable employees who struggled so far to innovate in new products, services and contents more than ever, to create a new Sony.”
CEO Kazuo Hirai could not realize the reason why the power to create innovation has deteriorated. Therefore, he could not show the solution. In addition, while the company remains to be not a highly profitable one, it sounds like (money consuming) innovations will be suppressed.

Why innovation is no longer in place? I think there are various explanations. Former Sony officers and employees, and people outside who love the company have stated various opinions in the hope of reviving the bright electronics business.

Among the stated opinions, in 2009, Kozo Ohsone (former deputy president) wrote an article called Sony, “What You Are Doing by Falling into an Ordinary Company (working title). The article has pointed out management issues accurately, such as management must be able to look ahead of technology trend, “The flag sign for `in which way strategy shall be carried out ’ cannot be seen, and there is no mindset to listen to others”. (For a certain reason, Ohsone gave up publishing the article on a certain magazine. But the draft was widely circulated, and there was the same effect.)

The following is one perspective summarizing the opinions exchanged with some engineer/managements. <There are three types of engineers. ① The first type which devote himself to faithfully working on the assigned duties. ② the second type that just want to develop what he want, and what would be great to have. He will be greedily looking for technology and components when necessary. ③ the third type do not know whether the thing he works on is useful or not, but he devotes himself to new technology development. A competent boss who sees through his subordinates’ tendency and capabilities will facilitate his engineer’s talents to the utmost extent. Both type ② and ③ engineers are not amenable to an organization, but a competent boss, as a result, will well grow these kinds of engineers. On the other hand, there are bosses who’d like to work with easy-to-use type ① engineers, but they are often times far from innovation. During the high-growth era, the company had room to invest in uncertainty and the possible future, so it welcomed type ② and ③ engineers as the the nail that sticks out. They are, (if not blessed with a competent boss, would be secretly) work hard for their dream come true, and breakthrough innovation was born among them.

However, triggered by the 1985 Plaza Accord, relocation to overseas manufacturing aimed at cost cut began as a counter measure to strong yen. In addition, Japanese talents flew to South Korea and Taiwan, followed by technology transfer to China.

Japanese electronics makers including Sony started to outsource not only the production but also the design to South Korea, Taiwan and China manufacturers who were gaining power. It did not carried out its own technology development that ought to be in-house, but just passed the specifications to outsiders. Product planning as well is not thought out, just to meet then-current competition. Therefore, the company does not make sharp and competitive products, and innovative products have decreased, as compared to the old days. The company found an easy way to make use of the strength of ‘SONY’ brand, so established. These are not due to the FX rate and intensified international competition, but rather it was a poison of decline digested by the company itself. >
Thus, the business environment surrounding the electronics business has significantly changed.

Now, as the prospect of structural reform in the electronics business becomes clearer according to new mid-range plan, based on the changes in the business environment, the direction that Sony group is heading towards shall be evaluated. Five years or 10 years from now, it is important to draw the blue print of the Sony group. The Board of Directors has the responsibility to discuss vision and strategy in depth. As seen in the new mid-term plan, the stable profitability focusing on imaging devices, PlayStation business and entertainment business (and financial business?) can be centered in the company as an option. However, it is a waste not to take advantage of the extensive intellectual property including the patent portfolio, and human resources that are committed to innovation. If appropriate management is put in place, in 5 years or 10 years from now, the electronics business will be the core of the Sony group, and I believe that it will contribute to improving corporate value.

Is it really possible to bring back brilliant electronics business? Let’s look at the Xerox and Apple’s cases.
Xerox: An M. Mulcahy was appointed CEO in 2001. She was a rare female CEO among the Fortune 500 companies at that time. She positioned her management philosophy to be customer-oriented and employee-centric. In order to cut cost and strengthen fund management, she appointed women for vice president, CFO and Treasurer, etc., she also focused on R & D and marketing of color copying machine … , Board of Directors structure in 2005, unlike Kodak, was very diversified on purpose. As the future US`s Xerox would emphasis on information service and telecommunication services, she brought in 3 board members from TV, Internet, and information services industries, and she also brought in 2 people who knows finance well because the company had a large debt, besides, because she had changed one of the management philosophy to customer-oriented, she had also put 2 chairman from J&J and P&G. (from What Is Management Dominated (Yu Imai))

Apple: Steve Jobs felt, in order to revive Apple , he need to align the outside directors with a strong affection towards the company and familiar with the technology and industry with insight and imagination, the Board of Directors would not work if there is no trust in the outside directors, the Board of Directors is a part of the management team, the outside directors would be able to challenge the management team’s decision, find out business opportunity, establish relationship between the government, the society, and investors and other stake holders (network building), if they love the company and are capable in forming visions (Understanding the Board of Directors after the Financial Crisis, from ECGI-Law Working Paper No.229 )

Xerox and Apple, in any case, the appointment of the members of the Board of Directors match their vision and strategy. Clear vision and strategy is essential to the optimization of the Board of Directors structure. Clear vision and strategy is necessary for forming a capable Board of Directors. Vision and strategy shall be modified according to business environment. It is one of the Board of Directors’ roles to carry out such modification at an appropriate timing.

Referring to the above, the following actions may be considered:
①The ambiguous vision of the electronics business is re-checked, and clear vision shall be presented with a specific image. Vision may vary depending on the business environment, but any vision needs to confirm that it is derived from Sony sprit, which shall be revived also.
②Strategy likewise. The goal of financial strategy has been revealed, and it is aimed at a short-term shareholder value improvement. However, to take advantage of the vast intellectual property including patent portfolio, and to encourage innovation by Sony spirit, this type of strategic thinking that will improve corporate value in the mid-to-long term, has not been incorporated. The status of the electronics business 5 years from now, 10 years from now shall be shown.

Some former engineer / managements are showing example of the future electronics business, taking advantage of the strengths of the current electronics business, such as: various robots utilizing mechatronics technology, sensor modules of ‘Internet to Things’ era, real-time control technology, medical support equipment, sports support equipment, image recognition system, AI for next-generation entertainment, cloud services for home and personal use. If discussed, more and more will come out.
③The strategy of spin-off of electronics business unit is ambiguous. Is it a part of the portfolio management?
If the company is taking the revival of electronics business seriously, and aiming for an autonomous management system, then electronics business should be grouped together rather than spin-off separately.
④If the vision and strategy of the electronics business becomes clear, then the Board of Directors can be formed in an objective manner. The Board of Directors and management team will be appointed based on knowledge and experience in electronics business regardless of internal or external personnel.
⑤If funding for research and development of new businesses is necessary, issuance of class shares can be considered, such as the one Toyota announced in April. Toyota described it as follows:

From the product planning to production and sales, the business cycle of the automobile business is a mid-to-long term activity, while the innovation in the automotive industry is accelerating, research and development and infrastructure development for the next generation of innovation to support the future automotive industry is essential… As a method to raise fund for R&D that matches automotive industry’s business cycle, Toyota decided to issue class shares aiming at mid-to-long term investment.” (The preferred stocks have conversion rights to common shares after 5 years. They are unlisted, and there are transfer restrictions over the entire period. There are voting rights, and dividends will increase stepwise.)

Alternatively, the proposal made by Third Point in 2013, to partially list the entertainment business can be also a choice.

Even financially stressed, for the sustainability of the electronics business, and for the investment that enhance corporate value, it is the role of CFO to think hard for funding.

The annual shareholders’ meeting of this year is approaching. If you look at the changes in the past year for the electronics business, the appointment of engineers to executive officers in April is advancement. I think it should be praised, but there are still many things yet to be done. The road to revive the bright electronics business might be distant. But I would not give up, and would continue to promote the reform of the electronics business for revival in the coming year.

In addition, Japan’s Corporate Governance Code will apply to listed companies from June 1st. It is expected that ambiguous things become apparent and management structure reform is driven. I will watch closely on how the company will respond to the following points: review of not meeting the medium-term plan (Supplementary Principles 4-1-2), remuneration of the senior management and director (Principle 3-1(ⅲ), Board policies and procedures in the nomination and appointment of senior management, and the nomination of directors and kansayaku candidates(Principle 3-1(ⅳ),4-3), measures for a considerable number of dissenting votes on re-election of top management (Supplementary Principles 1-1-1), oversight of succession planning (Supplementary Principles 4-1-3), Preconditions for Board and kansayaku Board Effectiveness (Principle 4-11, Supplementary Principles 4-11-3), and constructive dialogue with shareholders (Principle 5-1).

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