Hiryu vol.44

Presentation: "CSK Group, The Present and Future"

Isao Okawa, Chairman of CSK Corporation

from CSK Group Magazine "Hiryu" Vol.44

Introduction

On November 13,1997, we invited clients from financial institutions and the press to attend a presentation titled "CSK Group, The Present and Future" at the ANA Hotel in Tokyo, Japan. The presentation was a great success with 314 participants representing 181 companies.
We would hereby like to publish an extract of the above mentioned presentation. made by Isao Okawa, Chairman and CEO, CSK Corporation, and Representative Director Chairman, SEGA Enterprises, Ltd.

Part One CSK Group's Direction

My name is Okawa, I am CEO and founder of CSK Group. I would like to thank all of you here today for sparing the time to attend this meeting.
I would like to speak to you today about the history of CSK Group so that those of you not so familiar with the company may have a better understanding of our business. I would also like to spend some time talking about our vision as we head towards the year 2000. My Osaka dialect will be quite evident at times because I want to show you my true colours. I will make an effort not to bore you the next hour and a half. I will conclude the presentation by making clear to you that CSK Group is seriously thinking about how to strive forward in the new "information and network society" of the coming 21st century.

CSK Group's management style equals my philosophy

First of all I would like to say that large Japanese corporations will be hard to cope with the recent changes in both social and business environment. Companies that have been in protected and regulated industries such as finance, and government offices are looking quite helpless in these turbulent times. In my view, small to medium sized companies have toughness to survive in these challenging times.
The future will not be an easy hill upwards. Especially the information service industry is at a stage where it must explore yet unknown territories. Most crucial behaviour for companies in such an environment is the one to make decisions. A "salary man" executive in a Japanese corporate organisational structure is not able to make the timely decisions. I am prepared to make decisions in my business as a company owner. We are in a time of "big change", which means it is a time for "big opportunities".
At first CSK as well as many companies in our group was started up by an owner. Hence the founder's management style and philosophy are evident in the corporate culture. If the founder is an hasty person, the management style of the company will be hasty, if the founder is a technically oriented person the company will be technology oriented. This is to say that their management style is equivalent to their philosophy. One's philosophy is shaped out of experience, not only physical experience but also thoughts and teachings, things we have seen, dreams we have such as the desire to marry a beautiful woman, all these thoughts and experiences are tucked away in our unconscious as images. At CSK Group, I am now able to live out the dreams I hoped to realise in my next reincarnation.

Why the software industry?

I was born as the son of a cloth merchant and inherited a merchants blood, I could not suppress the need to try and start something. However, I became ill and could not hold a position in a company. That is when I was introduced to computers. At first I was running a taxi company, which I later sold to raise capital for a new business. During this period I learned a lot. My older brother was an accountant and through him I became aware of problems with the labour unions. I studied many books on accounting and revenue tax laws. The knowledge I acquired then is of great value now. As I pondered over what to do with my leftover money, I tried investing in shares of various companies. I learnt that it was impossible to make any money dealing in stocks, and also I learnt about the tax system. The only bookmaker can make money. I came to the conclusion that it was the wisest to start my own company and list it on the stock exchange. Once I founded CSK my main goal was to list the company as soon as I could.
The reason I entered this industry was because the following two thoughts crossed my mind when I first saw a computer. First, if the United States had the use of computers it was inevitable that Japan would loose the war. Second, if American accounting firms were using computers then soon their technology would be introduced into Japan. If this was to be the case it seemed like a great business opportunity. I became obsessed with the idea.
CSK was founded in 1968. I was searching for business which required a relatively small initial capital in vestment, did not have barriers to entry and could be expanded during my lifetime. I concluded this to be the service industry. Due to high entry barriers I could not start a trading company, I could not set up a bank because I did not have a licence , I could not start almost any business. Fortunately, I could attain a license of a taxi company. So, I could start the business, at first. Then I started a software company and did not know how much I could expand during my generation. There was no concept of a software company being independent. Software was just something that complemented hardware. The software business was also unique in that its only capital was the knowledge and know how of its employees. I experienced many problems because of this uniqueness.
I started this software company with nothing. The challenge is how big I can expand this company within my lifetime in terms of revenue and profit. However, there were some problems. I could not find anyone who wanted to join my company 30 years ago. Besides, computers were so expensive that a small town calculation centre could not afford to install. I soon had to realise that technology cost time and money. Matsushita Electric, Sekisui Chemical, Asahi Chemical appointed our company and we would collaborate on projects with them and this is where I learned the most. In this way I steadily expanded my company.

Why was my goal to list the company?

Since founding the company in 1968 I struggled for 5 years and finally made my first profit in 1972. In 1980 we were listed on the Tokyo OTC market, in 1982 on the Tokyo Securities Second Section. In 1984 we bought SEGA from Paramount.
We were the first software company listed on the Tokyo Stock Exchange by selling intangible products. At the listed time, we did company presentations at Nomura or Daiwa Securities we had an audience of blank faces. People did not even know what OA meant. When we first handed in our listing documents to the Tokyo Stock Exchange for examination we had frequent enquiries regarding unfamiliar terminology. We were asked what COBOL, OS and application meant. We finally put together a small dictionary to help the examiners. A half year later when the examination was completed, the examiners at the Tokyo Stock Exchange were knowledgeable about those terminology as well as we were.
The principal reason for wanting to list my company was to improve our status. As the subsidiary of a company in the software industry it would be considered inferior. I was not content with this so I studied the structure of construction and engineering companies. I found that these companies could hire good employees because they were a listed company. It was vital for us to find talented staff. I visited private colleges to ask professors for introductions to their students, but the reply I got was "you are in the software business, it is a difficult business to understand. I would recommend my students to you if you were in steel or banking." In order to attract talented students I had to create a company that employees would be proud to work for. I wanted to improve the status of the industry and as well as the status of the people working in it. I thought it would be to the benefit of Japan, a country lacking natural resources, to have an industry in which educated employees export value added software. I was excited with anticipation in seeing the next 100 software companies listed on the Tokyo stock exchange. Soon INTEC became public. It was around this time we made a request to the Ministry of Finance to add an "Information" section on the share price pages in the newspapers. Companies such as Secom, and CSK were until then categorised under "Other Services". My dream was to see 100 software companies listed by the year 2001. My dream was for the software industry to become an influential force. I thought if society were to become aware of the software industry it might interest politicians, who then might feel compelled to reform corporate and income tax laws to cope with the upcoming information age.

After the listing.

Our strategy after the share listing was important. Technology and services soon become commonplace so we must constantly be innovative. Any profits we earned did not go into building a beautiful new office, it was invested in developing new technology. We also invested in our people by building a staff education centre.
The question now was, how will the future look? The first trend was towards a "network oriented society". We therefore set up United Net Corp. which has now changed it's name to CSK Network Systems. The next trend was AI, artificial intelligence and then came data base. These were the so called "Three Sacred Treasures" to support the upcoming "information society and industry". The reason we divided up our companies was because all areas were highly specialised. It is difficult to hire employees for differently skilled jobs when paying them under the same wage scale. It is also difficult to manage a large number of people. When I spoke to Kounosuke Matsushita (the founder of Matsushita Electric) he said that Matsushita Electric was a collection of small to medium sized companies. When I asked him why he said that there are many people in Japan who strive to become president of a company. That's why I divide up the company." This is one chain of thought.

Why did we buy SEGA?

We bought SEGA in 1984. The then 13 years old company was getting old and was in need of some restructuring. I think of it in the same way as Majong game, the pieces need to be shuffled between games. You may be familiar with automated Majong tables, I wish I had such a machine which would reshuffle CSK every 5 years.
There is a logical reason having bought SEGA from Paramount for 10bln Yen. First, if you can imagine an information-oriented society to look like Mount Fuji, the peak is represented by large corporations. At first only the tip of the mountain (large corporations and government offices) can afford computerised information systems. Slowly this computerised information systems began to flow down to medium sized companies, then small companies, then shops, and then finally to the individual. Why do I say Mount Fuji? Because it is a beautiful mountain and has a broad base. What I mean by broad base is that the consumer sector is broad based. Second, we are living in a network based society. Third, today's world values a sense of beauty and creativity. Just as I was having such thoughts, SEGA was put up on the market and I immediately thought that "This is it! Games are the thing of the future. Games will be eventually connected to form networks." I was especially interested in the point about the new era being based on networks. I envisioned consumers paying for beautiful and gorgeous itemsŽ¡Ž¥ I have been planning in this way for over a decade now. Current total earnings for SEGA is 350 billion Yen and 800 billion Yen for the entire CSK group, we employ 16,000 people.

What is vital for an information-oriented society to develop?

Today we can do most anything over the internet. We are in an information oriented society when consumers are willing to pay for intangible things. For example a patent, a design or intellectual property. If the consumer feels something is beautiful, interesting or delicious they will pay for such a service. The industrial age was when consumers paid for material things. In today's age we value human intelligence, sensitivity and creativity.
The difference between an industry oriented society and an information oriented society is that in an information oriented society we pay for human sensitivity and intellect. During the industrial age machinery and mechanics were developed to increase the capacity of the hand, leg, eyes and ears. Man used to be able to walk only 50km a day but with the invention of the airplane, we can now fly 5,000km a day. A hand cannot lift too heavy an item but now forklifts and cranes do the job for us. Telescopes allow us to see very far, microscopes permit us see the microscopic world. Our ears are reinforced by hi-fis. Microphones increase the capacity of our mouths. However we have not yet fully developed technology to augment the capacities of the nose or brain. An information oriented society is one in which technology extends or complements the functions of the brain. Through the brain we experience a beautiful scene or an unforgettable flavour. The floppy disk was invented because the human brain is forgetful. Continued research of the human brain must not be neglected.
I believe the sudden expansion of the information-oriented society began when the vacuum tube evolved into a transistor which in turn evolved into an IC which evolved into a LSI which evolved into a super-LSI. A computer so large it would have filled this entire room, is now so small it could easily fit in my hand. Needs for computers was apparent, the seeds or technology was available, the problem was it was not affordable. A personal computer such as we use today would have been worth 2 billion Yen in those days. Computers of today are of much more capacity and affordable.
I would like to show you a chip our company has newly developed. It is the world's first single chip encoder with MPEG2 standard to compress visual images. It is a prerequisite for a network oriented, image oriented society. This chip integrates infinitesimal size, low cost and high quality. It is an ideal component for use in medicine or most any field. This chip may claim to represent defacto standard.
Mating seeds and needs effect economies of scale, smaller yet better computers were developed, more and more people began using computers. There was a sudden boost and the information industry boomed.

Why are there so few venture businesses in Japan?

Through these developments the definition of wealth evolved. It used to be that a country was considered rich if it had oil, nickel or any other primary products. Now wealth is defined by whether a country has possession of high-tech knowledge and the ability to make use of this technology. That is all that matters. It is not of importance whether a country owns vast areas of desert abundant with minerals and oil. Japan was so poor after the war that it could not even feed itself. Why has such a country become the world's greatest owner of dollars? Why have we attained personal wealth of over 1,200 trillion Yen? How did we save so many dollars? Please think about this for a moment. It is because we have made a conscious effort to thoroughly computerise and informationalise our country We automated our factories to reduce the need for manual labour. We cut costs, we made our products more price competitive and we then moved our manufacturing sights abroad. This is true for many of our industries starting with ship builders, household appliance producers and even computer hardware companies.
Why did New York stock prices reach 7,500 dollars this year? Because high-tech shares took the lead. The reason why America is so full of vigour lies in the simple fact that there are more company start ups than closures. Unfortunately, it is the other way around in Japan. There are fewer and fewer small to medium sized companies and shops in Japan due to government tax policy. New companies constantly spring up in America. Of course one can not deny a fundamental difference in culture. I am now chairman of the "New Business Committee" and I would like to change our culture to give venture businesses a chance. I am strongly in favour of tax reform, removing barriers, legislative reform and educational reform. I am actively involved in volunteer work, helping to develop a venture business friendly business environment.
I was recently asked why Japan lacks creativity? However the fact is that Japan does export animation, manga (comic book) and game software worth 200 billion Yen. All these areas that used to be despised are now considered respectable. However it is also true that we import most of our business software. Microsoft and Oracle are the leaders in this field. Most Japanese software companies are a subcontractor's subcontractor. A company that must worry about its finances for tomorrow is not in a state to be creative.

The future of the game business.

Next I would like to talk about SEGA. For this company I must make resolute decision as the owner of the company. We are finally able to quantify a synergy effect between SEGA and CSK Group. We are in an age in which creativity and a sense of beauty is valued, from an advanced information oriented society to a character culture, from an age of the written letter to an age of visual images.
As it is time consuming to send visual images it is better to compress the images before transmission. The compressed image is then sent via telephone lines or satellite. This is what we call visual image compression technology. This is the most crucial technology available today. This technology will first be used to send visual images and someday it may be incorporated in personal computers, games, televisions or even cameras.
SEGA Soft America has developed gaming network "HEAT", this is the network in which a player can play with a real opponent somewhere in the United States rather than play the game by himself. Registered participants of this game now count 90,000. The basic essence of games is changing. Simple games are a thing of the past. There is no so such thing as just a game anymore. Games are evolving and being linked with CDs, music, movies, characters, manga, illustrations and commercials.
Television images have become much faster than PC images. They are faster and clearer. On the other hand personal computers are also developing. I do not know whether the two will grow together or apart but I believe that in the multimedia era there will be screens where if you press button(1)and it turns into a game screen, when you push button (2) it becomes a PC screen and if you push button (3)it becomes a TV screen. The key is that man can not live alone, communication is important. If you are playing a solitary game you will get bored and quit. Games in the future will be played 1 to 1, maybe 1 to N or even N to N. These games will be connected by satellite and expand to electric commerce and hyper media. We are not just a game producer or software producer anymore. We must start thinking in terms of a systems producer. We must also develop our sensitivity. All new ideas will soon be old but this is the challenge and energy that develops the entertainment business.

Observations on a business trip to the US.

I have recently travelled to New York, Boston, San Francisco, Las Vegas and Phoenix over a two week period. The Ohkawa Information Technology Foundation has started including overseas candidates eligible for the Ohkawa Award and research subsidies. I was in America to attend the presentation ceremony. At present we are limiting candidates to residents of southern California. We presented 10 researchers with 10,000 dollars each in research subsidies. The Ohkawa award including a prize of 10 million Yen was presented to professor emeritus John R. Whinnery at the University of California. In November of this year we awarded the same prize to professor emeritus Saitoh at Tokyo University and last year to professor Nishizawa of Touhoku University.
We visited Loral a satellite communications company which provides technology for our gaming network "HEAT". The HEAT technology will be essential for future digital television development. We held a US-Japan wise men conference for the first time in 2 years. We invited more than ten leaders of the information technology industry in Silicone Valley. Paul Allen, one of the founders of Microsoft, attended our meeting to discuss CSK's overseas strategy. I hope to organise the meeting annually, hereafter.
I also attended the most popular information technology conference in America called "Agenda '98". Many gurus of silicone valley such as Bill Gates, John Scurry the founder of Apple Computer, Scott McNealy, CEO of Sun Microsystems and Mitchell Kertsman, CEO of Sybase were present. Bill Gates and another guest held an open debate, criticising each other without ill feelings. The audience was then asked to choose the winner by pressing the button of the speaker they supported. Business deals, mergers and acquisitions are often discussed during these conferences. It is difficult to imagine a conference in Japan where the president of Toshiba and Hitachi hold an open debate. The 30-40 year old manager of silicone valley are still going strong.
I was back in Phoenix for the first time in 26 years. When I was first there GE had just sold it's computer division to Honeywell because they could not compete with heavyweight IBM. The word "BUNCH" was also in fashion, B standing for Burroughs, U for Univac, N for NCR, C for CDC and H for Honeywell. In those days only large corporations did business in computers. However downsizing changed the structure of the industry. Software ventures such as Microsoft and Oracle are leading the pack today. I am utterly ecstatic to be involved in this industry.

Ž£ŽÐŽ£â¥„¥ô Ž£Ž² "CSK Group, The Present and Future" in numbers

Please refer to figure 1. CSK Group turnover including SEGA is estimated at 818.4 billion Yen for 1997. This is a simple sum and not yet a consolidated number. A company built from scratch has grown to this size. Figure 2 is a list of the companies we have founded in the past. There are many synergy now to be exploited. Please look at figure 3. Sales at CSK bottomed out in 1993 and have grown steadily since. We swiftly transformed our focus from mainframe based computer business to personal computer business and adapted the necessary technology. Turnover in 1996 was 96bln Yen. We hope you take into account that all our turnover is based on services. A manufacturing company would require 3 times and a retailing company 5-6 times our turnover to compare with us in terms of size.
Since the beginning of the 90s we have been competing not with other software companies but with NTT data, Nomura Research Institute, IBM and Fujitsu. The environment is constantly changing. Also for SEGA. The game industry has become huge. It is trying to pioneer the multimedia industry. It is shifting into consumer's homes. The environment is constantly changing. We must constantly review our vision. We must be creative in an artistic sense as well as in technological terms. Sony, Matsushita and Hollywood are sure to be our future competitors. Without a well founded strategy we will not survive.
Figure 4 displays revenues for CSK and all other subsidiaries and affiliates except SEGA as well as revenues for CSK and its subsidiaries (IT and IS). This graph has grouped companies according to their field of expertise. For example, CKS Network Systems, CSI and JIEC all develop software for larger scale computers. 1996 turnover was 385.6 billion Yen, 1997 turnover is expected to be 460 billion Yen. When SEGA's turnover of 350 billion Yen is added we come to a sum of 818.4bln Yen for the whole group. Over a trillion yen in turnover has been my goal since year 1985, our efforts may be rewarded this year.
Figure 5 shows companies whose activities are diversified ranging from business to entertainment. These companies are not directly involved with CSK head office. These companies are well prepared to enter a network oriented, multimedia society. It took over ten years for these companies to make a profit.
By referring to figure 6 I would like to explain a bit about our group. CSK Network Systems was set up in 1984, paid in capital was 400mln Yen, this is what we refer to as VAN business. We expect to list this company in the year 2000. Expected sales at the time of listing is 35 billion Yen.
Service Ware Corporation runs helplines for Microsoft, Lotus, Just Systems, IBM Japan and Compaq. This means they are also first to hear about new technology and market trends. We also hope to list this company in 2000.
CSI is a solution provider servicing small to medium sized companies. It is a joined venture with IBM which owns 35% while CSK holds 65% of the company. Our next project is to develop and market standardised industry specific system packages.
JIEC specialises in mainframes. It may sound old fashioned but financial institutions and airlines still require these computers. Airline reservation systems require TPF technology which only this company can provide. We hope to list this company in December 2000. Turnover at the time of listing is expected at 20 billion Yen.
Japan Card Center is a prepaid card company. Sales have been growing since about three years. There has been a drastic increase in the number of Seven Eleven cards in circulation. The service has also been extended to include Japan Petroleum, Mitsubishi Petroleum and General Petroleum. Turnover for this company is expected at 200Ž¡ŽÝ300 billion Yen by 2001 to 2002. We are currently discussing going into business with Family Mart(a major convenience store chain in Japan) next year. We are also looking into developing smart card.
Business Extensions is a database company and is also involved in outsourcing. It for example maintains automobile industry data. However it does not only provide maintenance services but will provide information on request for example new car model information, motor show schedules and even sector trend forecasts. The company does not only process data but is also involved in outsourcing. The company provides data maintenance services and is also a multimedia planner and producer.
Nextcom is in the same business as Netone Systems an already listed company. It markets network integration and LAN equipment as well as internet related software and hardware. If the environment permits we hope to list this company by March 2000.
Nippon OA Services is still a very small company. It provides systems maintenance services for CSK and Ando Denshi shops around the country.
CSK Research Institute is a advanced technology company. It is Japan's leader in multimedia related digital contents development. Spike is a publisher, a network constructor as well as a digital contents provider and producer.
Digital Media Lab was set up in April 1995. This is a company which has great potential. It was the first company in the world to have developed a single chip to compress visual images with MPEG2 standard. This technology has the potential for becoming defacto standard in the game and multimedia fields. We are thinking of listing this company in the year 2002.
Lastly, CSK Venture Capital. If this company retains just 5% of each of the IPOs we have mentioned above, it has potential to make a lot of money. All the IPOs I have mentioned today are certain to go through. This company will also be listed, consequently.
I have briefly run through all the material we have distributed to you today. As you can see we are planning 12 IPOs by the year 2003. I am focusing on achieving high EPS for my companies and creating unique companies that can differentiate themselves in this competitive environment.
CSK has always been a shrewd operator following a policy of no debt management. We also attach great importance to off-the-book profits. Recently there have been many companies realising their off-the-book profits have been disappeared. At the time when each SEGA share was worth 10,000 Yen CSK had off-the-book profits of 180 billion Yen when accounting for all its subsidiaries. Last year off-the-book profits were at 80 billion Yen and now 40 billion Yen. If IPO plan mentioned previously will be realised, we estimate hidden profits of about 200-300 billion Yen.
With the trend towards internationalisation we feel the need to focus on consolidated profits. We plan to increase capital of our affiliates and increase our holdings to 25-50%. CSK Venture will be set up like a holding company retaining 5-10% of all IPOs. We will continue to focus on EPS growth as well as keeping the number of shares outstanding at low level. ROE is also one of our concerns. We are also interested in M&A.
You may ask why there are so many separate companies held by CSK Corporation. The reason is because we believe each company should be established management based its own function. Management need to remain small and integrated. In Europe there is a company called ABB (Asea Brown Boveri), every single business unit in this company is 50 people. From kindergarten through to high school we have been in units of 50. Management can cope with this sort of number but it is also the limit. I envision small organisations each focusing on their specialised area of expertise. It is easy to make something big from something small, it is possible to stick two companies together if it is necessary to create a big company. It may be difficult for a single company to raise 200 billion Yen in financing, but then why not have several companies each raise 15 billion Yen. This is the way I think.
I would like to briefly mention internal reserves. If a company turns over 100 billion Yen and has a profit of 10 billion Yen, that is a profit ratio of 10% which is good. If the company's profit ratio is 5% this company would have to turn over 200 billion Yen to make the same profit of 10 billion Yen. From there taxes of 6 billion yen will be deducted leaving an after tax profit of 4 billion Yen. From there we subtract shareholder's dividend payout and management's bonus of 1.5 billion Yen which leaves us with 2.5 billion Yen. This money is what is defined as internal reserves.
Currently CSK shares have come down and off-the-book profits have dropped to just under 40 billion Yen. To keep calculations simple let us assume off-the-book profits at 40 billion Yen. We hope to increase this to 200-300 billion Yen by the year 2003. In order to raise profits of 160 billion Yen (internal reserves: 40 billion Yen) from a company with a 10% profit ratio we require a turnover of 1.6 trillion Yen. If the company had a profit ratio of only 5% it would need a turnover of 3.2 trillion Yen. This is impossible to achieve. Isn't it then better to develop new subsidiaries and increase profits that way? I mean that a company which has off-the-book profits at 40 billion Yen is worth 1.6 trillion or 3.2 trillion Yen sales of a company. Please compare the internal reserves (40 billion Yen) and off-the-book profits (40 billion Yen), and which is easy to make for a company. This is my philosophy. If someone were to come now to try and sell SEGA shares to me I would not buy them. CSK is currently a much better buy. If you buy one CSK stock, you will get a 0.2 SEGA share attached for free because CSK owns 21% of the company. I do not know of a cheaper stock around. If the IPOs mentioned today were executed then a CSK shareholder would get a 0.2 SEGA share and a percentage share of all the listed companies CSK kept a stake in for free. From this point of view, I say that the CSK's stock price should be higher and higher.
I have mentioned these last few points because we have many representatives of financial institutions attending our presentation today. We realise that EPS and ROE figures are crucial. However, I hope you will asses the company in the view point of what I have mentioned as well. There is still great synergy potential within our corporation.
With these words I would like to finish my presentation for today. Thank you very much for your attention.