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Dismissed CEO Turns Focus on Troubles at Olympus

Where Did This Established Company Stumble?

  • October 31, 2011
Many questions remain relating to acquisitions by a solid company that has emphasized excellence in technology. The root of the current scandal lies, ironically, in the successes of former chairman Kikukawa. But following the failure of his acquisition strategy, Olympus' insular culture has further damaged the company.

Corporate governance problems have been exposed at Olympus Corporation, belying its image as an excellent firm. In fact, suspicions over the functionality of Olympus' corporate governance policies had surfaced four years ago when the company covered up an internal report.

In June 2007, Masaharu Hamada, an Olympus employee responsible for nondestructive testing equipment, contacted the company's Compliance Desk with information that his supervisor was trying to improperly recruit a worker from a client firm. That worker was in a position to know confidential information, and Hamada thought the recruitment might violate the Unfair Competition Prevention Act.

Olympus had set up its Compliance Desk a year before the 2006 enforcement of the Whistleblower Protection Act, to deal appropriately with improprieties that can only be grasped within the company. However, the Compliance Desk manger, in violation of his duty to maintain confidentiality, reported Hamada's name to his supervisor, and Hamada was transferred to a nominal post outside his expertise in October 2007.

Hamada sued the company for violating its internal regulations against disadvantageous treatment of whistleblowers. His demands were dismissed in the initial trial by the Tokyo District Court, which ruled that “the Company had not abused its powers." But that was overturned at the end of August this year by the Tokyo High Court, which nullified his transfer and ordered Olympus to pay damages. Olympus immediately appealed.

There is some criticism of the present Whistleblower Protection Act―that the requirements for protecting whistleblowers are too strict. But looking at the actions taken by the Compliance Desk in this case, Olympus clearly did not act to strengthen its corporate culture by nipping internal improprieties in the bud. The charge can be made that Olympus' corporate governance polices exist in name only, to improve the company's image.

The digital camera success story that changed the corporate culture

Olympus made things look squeaky clean on the surface, but in reality the old corporate constitution remained unchanged. The exceptional choice of a foreigner as President may also have been dressing.

Even so, why did the technology-oriented Olympus rush into a colossal M&A strategy, starting with the British medical equipment manufacturer Gyrus? That mystery cannot be solved without Tsuyoshi Kikukawa, who ruled over Olympus as president and then chairman for 11 years.

Olympus is a long-standing optical manufacturer founded in 1919. The company began with the microscope business, entered the camera business in the 1930s and the medical endoscope business in the 1950s, and has maintained its position in the industry by its technological strengths. The corporate culture was said to be cautious but relaxed because Olympus holds the goldmine of a 70% global share in endoscopes.

This corporate culture was greatly changed by Kikukawa. Kikukawa worked overseas for many years, including time at Olympus' U.S. subsidiary, but it was his success in the digital camera business that suddenly made his name famous.

Kikukawa launched his high-resolution product development strategy at a time when other companies' products offered around 300,000 pixels. Olympus released an 810,000-pixel digital camera for the mass market in 1996, and increased performance to 1.41 million pixels a year later. By seizing the initiative in the race for higher resolution, Olympus' digital camera sales grew―in just five years from 1996, sales surpassed Y100 billion a year.

While many inside the company opposed this entry into the digital camera market, Kikukawa insisted the business would “realize a profit on a stand-alone fiscal year basis in three years and recover all its cumulative losses in five." He pushed a technology team obsessed with creating a perfect product to advance development quickly, and purchased large quantities of the main components―before there were even any prospects of a launch―to achieve the target retail sales price of Y100,000 or less.

For Olympus, which had remained dependent on profits from the endoscope business since in the 1980s, achieving stronger growth in its camera division was a perpetual management issue. Kikukawa's comment at a management seminar in late 1997 seems to reflect the confidence he gained from having achieved just that. “People wonder why a company like Olympus with an exceedingly cautious culture succeeded in a fast-changing field like digital cameras." But Kikukawa had seen the growth potential in smashing the conservative, technology-oriented corporate culture and switching to a strategy that emphasizes speed, even if that meant taking risk.

Attention now focuses on the mystery of Olympus' acquisitions

In recognition of these accomplishments, Kikukawa was promoted to managing director in 1998 and president in 2001. But Olympus began a mysterious metastasis after he was appointed president. One typical example of this change was a new focus on venture investments.

Kikukawa has not been seen in public since the Oct. 14 press conference

Olympus purchased shares in the corporate investment and development firm ITX from what was then Nissho Iwai Corporation, becoming the top shareholder in 2003. The following year, ITX became a subsidiary of Olympus. Olympus has subsequently made many investments, some through ITX, in ventures that have little connection to its mainline medical equipment and camera businesses.

The downturn in the digital camera business, which Kikukawa himself had developed, may have been a factor hastening his venture investments. Olympus once held the third largest global share in digital cameras, but was overtaken by rivals with technological developments such as thinner models and image stabilization. The company's digital camera business turned unprofitable, posting Y11.8 billion in losses in the fiscal year ended March 2005. Kikukawa must have been pressed to quickly develop another major revenue source after endoscopes.

He bought time by advancing the acquisition strategy, but most of the acquisitions were far from successful. ITX, whose shares Olympus began purchasing in 2000, slumped with the collapse of the IT bubble and the financial crisis that began in 2008, and Olympus lost most of the tens of billions of yen it had invested. Olympus posted valuation losses on its venture investments almost every year, and investors began to cast a wary eye on the company's stock.

The three Japanese firms―Altis (medical waste disposal), Humalabo (cosmetics sales) and News Chef (microwavable cookware)―that Olympus purchased from 2006 to 2008 also had very little to do with Olympus' main businesses. Olympus invested over Y70 billion in what informed sources mockingly call “shell companies" that have no content. Soon after the acquisitions, Olympus wrote off much of their purchase price as a loss. Even if proper acquisition procedures were followed, as the company insists, these are vast losses which could very well call management responsibility into question.

It is still unclear where this Y70 billion went. According to one investment banker, “It looks like the deal was made for intentional loss." If that is the case, then what was the aim? An Olympus employee confides that “only certain executives known as the Financial Affairs Group have knowledge regarding M&A and the flow of funds." Various rumors are circulating because the ultimate destination of the funds remains unknown.

That is a key factor in the plummeting valuation of Olympus stock: its share price fell by over half after President Michael Woodford was dismissed on October 14. Overseas investors saw the fact that Olympus, which had been viewed as a Japanese manufacturer with superior technologies, had governance problems that could not be explained away.

Southeastern Asset Management, a major U.S. shareholder holding 5% of Olympus shares, sent Olympus nine questions on October 20 regarding the series of acquisitions and has demanded a response by November 16.

David Harris, chief investment officer of the overseas investment division at U.S. investment firm Harris Associates, which owns 4% of Olympus shares, says that this issue demands an urgent third-party investigation. Harris says that he does “not understand why Japanese investigative authorities and relevant agencies are not taking action when the problem has grown to these proportions." He also warns of distrust, pointing out that this case will become a touchstone for investment in Japanese companies, and hopes that Olympus is an exception.

The shady implications surrounding this series of acquisitions is no longer a problem involving a single company. Why was this opaque corporate conduct left unchallenged for so long? The world is now watching, calmly waiting to see if Japanese corporate society can cleanse itself.

(Chikako Ishiguro, Masaki Kodani, and Masamichi Ito, Nikkei Business)


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