Forum magazine recently spoke with Mari Sako, Professor of Management Studies at Saïd Business School, about the legal market in Japan and the challenges there, including digital transformation, and the risk and compliance issues surrounding environmental, social and governance (ESG) factors
The Japanese Ministry of Economy, Trade and Industry (METI) in 2018 released its report Overcoming the IT System “2025 Digital Cliff,” which talked about the possibility of Japan’s workforce shrinking 20% by 2040. METI said Japan is reaching a “digital cliff” due to lack of growth in innovation. Since the onset of the pandemic, how far do you believe the corporate sector has come in driving digital transformation within their organizations?
Mari Sako: Just as in other countries, the COVID-19 pandemic was a catalyst for a shift to digital transformation in Japan. The need for digital transformation became imperative in all aspects of Japanese society in a way it had not been in a relatively wealthy and stable society. In the first half of 2020, the government swiftly set up its digital transformation policy by promoting digitalization, away from the submission of paper documents using traditional seals (hanko or inkan) and toward electronic signatures. September 2021 saw the establishment of the Digital Agency that centralized the government’s IT budget and policy initiatives on digital transformation. The government is even promoting a certification program for digital transformation-ready companies.
Additionally, there are signs of digital transformation from within the corporate sector, centered around using digital technologies to improve operational processes. A recent 2022 survey conducted by the Japan Industrial Location Center on domestic manufacturing and logistics industries shows 34.5% of respondents expect to increase investment in digital transformation, with greater focus on business operations, and less on developing new products, services and business models. For the latter to happen, it is often said partnerships between incumbent firms and start-ups would be necessary, and Japan has a relative dearth of tech ventures.
There have been some references in Japan to the “cliff of 2025” but this requires context. That “cliff” refers to the inertial cumulative aging of mission-critical IT systems and that IT talent shortage could lead to a loss of up to 12 trillion yen (2% of GDP) per year after 2025. The “digital cliff” – whether the cliff pointed downward to an abyss or upward to that which is too steep to climb – was a justifiable call to arms. While a handful of leading corporations and IT providers have responded, the litmus test is whether it will lead to digital transformation in all corners of Japanese society and economy.
Forum: Where are these efforts succeeding or falling short?
Mari Sako: We should focus our attention on why the Japanese corporate leadership in electronic hardware did not transcend to software, which is central to digital transformation. A bit of history might help to shed light here. Japan’s industrial might was built on manufacturing – monozukuri – with a hardware mentality among workers and senior executives. Trailblazing industrial companies such as Toyota created a model for process improvement; this inspired many global corporations that wished to learn not only the principles of lean production and supply, but also how to implement them. Digital transformation is partly about creating new value via applying digital technologies to process improvement. Many Japanese firms should have a head start in this respect, although applying a firm’s process improvement capability to the manufacturing shop floor is no guarantee it can be translated into legal operations, for example.
The hardware mentality, however, led Japanese corporations to regard software as secondary and introduced certain biases. First, corporations rely heavily on customized software provided by third-party vendors; and this lack of standardization is bad news in the growing world of Software as a Service (SaaS). Second, IT systems are deployed for a long time – 17 years, on average – reflecting an emphasis on incremental innovation (kaizen) and the need to defray high maintenance costs made worse by the use of legacy systems. Third, the relative absence of Chief Information Officers in large Japanese organizations and a lack of understanding about information and communications technology among senior executives are said to have caused an underinvestment in enterprise software and communications technology more generally. [Between 1995 and 2017, communications technology investments remained flat in Japan while they tripled in the US and France, according to the Organisation for Economic Co-operation and Development.]
Of course, there are general obstacles to digital transformation faced by corporations of all nationalities, such as lack of strategic focus, dealing with legacy systems and the lack of talent. All of these apply to Japan in varying degrees. However, it’s fair to say over and above these common issues, Japanese corporations’ digital transformation strategies have suffered from corporate structures that reward and reinforce the aforementioned hardware mentality.
Forum: Corporations in Japan are required to maintain compliance across a range of areas, including financial regulations, data privacy and supply chain regulations. Promoting the importance of ESG issues such as sustainability, climate change, modern slavery, diversity & inclusion, and corporate governance are also rising in prominence. How is this impacting Japanese business sectors? And how should Japanese corporations handle these complex risks and prepare for the future?
Mari Sako: The Japanese government is good at setting the tone by promoting a vision of what they call Society 5.0. This vision of Japan leverages digital transformation (including artificial intelligence, the Internet of Things and robotics) to create a super-smart society, not only to realize economic growth but also to address social problems including aging and sustainability. With this backdrop, ESG has certainly become an important issue for corporate governance and reporting in Japan.
The current phase of ESG investment in Japan is very much led by the Government Pension Investment Fund, which is actually the world’s largest single pension fund, accounting for US$1.6 trillion in assets. The diffusion of ESG ratings in Japan is attributed mainly to the Fund.
Forum: Over the past decade or so, law firms around the world have found ways to innovate and leverage legal technologies. What is the approach in the Japanese legal market regarding client service delivery and interaction with technology?
Mari Sako: Lawyers in Japan are scarce. The majority work takes place either in the court system or in law firms. Law firms have the pick of the crop among university graduates, who must pass a very tough bar exam. The Japanese legal market is marked by law firms that are relatively small in size by US or UK standards. These firms also interact with corporate clients’ in-house legal departments, which are traditionally staffed by employees who may have a bachelor’s degree in law but are not licensed to practice law.
I don’t think the small size of law firms or the presence of nonlegal talent in corporate legal departments in themselves affect the adoption (or non-adoption) of legal technology. Instead, a significant barrier to the digitization of contracts and other legal documents has been the broader paper-based culture for official documentation, reinforced by the pervasive use of personal seals (hanko), as I’ve mentioned. This affects government affairs and the judiciary as well as business transactions.
In spite of these barriers, legal innovation is happening in Japan as elsewhere. It takes the form of law firms partnering with, and investing in, legal tech start-ups. In late 2019, for example, Nagashima Ohno & Tsunematsu, one of the four largest Japanese law firms, formed an alliance with MNTSQ Ltd., a Tokyo-based legal tech start-up and an affiliate of Tokyo-listed machine-learning technology company PKSHA Technology Inc., worth some US$7 million. MNTSQ will help the firm conduct due diligence using its natural language processing technology to flag contract clauses that pose risks.
In November 2020, Nishimura & Asahi became the first Asian law firm to invest in Reynen Court, a UK-based app store-like platform to host legal technology applications, with investment from the likes of Clifford Chance; Latham & Watkins; and Orrick, Herrington & Sutcliffe. This, in effect, paves a way for the internationalization of the Japanese legal tech market, over and above the internalization of the legal services market.
Still, the legal tech sector in Japan is at a nascent stage with no more than 30 or so ventures. However, founders have a mission to use digital technology to solve a key problem, namely inefficient and cumbersome practices that drive up the cost of legal service delivery.