Contrary to everything you've been told, Japan's future will depend more and more on small, innovative, R&D-oriented companies. Sound familiar?

If you're like most Americans -- particularly the policymakers, journalists, and industry observers who promote the well-worn image of Japan as a national economic juggernaut -- then Shinji Matsuda will surprise you.

Matsuda is what you'd call a grease monkey. Today the president of his own small research-and-development firm, Matsuda R&D Co., Matsuda has loved to play with engines and cars since childhood, and even now is happiest when his hands are covered with oil.

"I never had any resistance to hard work," he boasts. "Actually, I like to get dirty." Sitting in his cramped offices in Itabashi, a grim outer ward of Tokyo, he calmly takes out a cigarette lighter and torches his own thumb. "I have worked so long in the machines and the grease that my skin is too thick to hurt."

Like the legendary Soichiro Honda of car-company fame, Matsuda never attended college. He chose instead the gritty work of constructing car bodies, tinkering with engines, rebuilding anything mechanical -- passions that led him to a job at Honda Motor Co.'s sprawling research facility north of Tokyo.

But when Matsuda reached Honda in 1971, he discovered he had arrived perhaps a generation late. "Honda says educational background is nothing, but in the company there's a strong preference for it," he recalls with a little bitterness. "I could not go upward like a college graduate even if I did three times the effort. The road was very narrow."

With the track to promotion largely blocked by college-educated superiors, Matsuda left Honda in 1982 to launch his own company. He had no significant outside capital and worked 16-hour days for two years without a day off. At first, opportunities were sporadic and uninspiring; for a time he developed bumpers for such companies as Daihatsu, Nissan, and Toyota.

Yet Matsuda slowly began moving into new and more original areas. Responding to a request by the Tokyo branch of Domino's Pizza, Matsuda designed what he calls the MRD Community Vehicle -- an all-purpose delivery-truck chassis that fits on a motorcycle and can maneuver easily through the traffic-choked Tokyo streets.

It proved a winner. Accounting now for nearly 40% of the company's sales, the Community Vehicle's genius lies in its flexibility. With a small portable oven, for instance, the vehicle turns into a pizza truck; a refrigeration compartment readies it for ice-cream delivery; still other adaptations enable it to ferry photocopiers between office buildings.

Matsuda's originality has earned him a roster of major corporate customers, including Honda itself. But he has been careful not to become a traditional, captive subcontractor -- manufacturing just a piece of some product for a larger company's disproportionate benefit. Instead, he reverses the usual Japanese hierarchy, creating all his own products while contracting out their manufacture to such giant corporations as Hitachi, Nippondenso, and Yamaha. Matsuda hopes to reduce this dependence, too, by setting up his own manufacturing operation someday.

Even then, however, his plan will be to emphasize R&D, which last year equaled 16% of his more than $2.5 million in revenues. "The critical process today is not producing the product, but originating the idea and executing it more quickly than a big company can," Matsuda says. "Eventually, you might want a factory, but the only safe thing is originality. Research and development must be the core."

Though impressive on its own, Matsuda's story is additionally worth attention because: (1) it is being repeated by other small, entrepreneurial companies all over Japan; and (2) it depicts a Japanese economy utterly unlike the one that U.S. opinion leaders are always talking about.

Far from the faceless and monolithic Japan Inc. we've been taught to fear, Shinji Matsuda looks a lot like us.

Few in Washington would believe it. Many observers -- such as former U.S. trade official Clyde V. Prestowitz Jr. and author Karel van Wolferen -- believe Japan's economic ascendancy grows out of rigidly planned cooperation between that nation's largest businesses and the economic planning arm of a powerful government bureau-cracy. The authentic entrepreneur, claims pundit van Wolferen in his influential book, The Enigma of Japanese Power, is marginalized as a bit player at the service of the giant institutions.

Such perspectives can have serious ramifications given the reverence felt for the Japanese model by U.S. economic policymakers. To contend with Japan, they say, we must understand and learn from it. Faced with competition from a supposedly giant-centered economy, such policy gurus as Prestowitz urge U.S. businesspeople to mimic it, to desert our own entrepreneurial tradition for a more closely controlled system dominated by government and huge corporations. Those same gurus would completely dismiss proposals to aid small business -- from reducing capital-gains taxes to protecting against antitrust violations.

The trouble with all this is that the premise it rests on may be wrong. Japan's real strength and true direction, say some of its own economic observers, lie elsewhere; the Japanese future may have more to do with Matsuda R&D than with the federal Ministry of International Trade and Industry (MITI).

To Hosei University economist Tadao Kiyonari, the success of so many companies like Matsuda's -- based on design and originality rather than raw manufacturing power -- points out the true course for his nation's economy in the 1990s. In contrast to the past, when Japanese companies acquired technology from abroad and grew by excelling at production, Kiyonari envisions a new Japan Inc. led by innovative R&D-oriented businesses.

Driving these changes has been a massive shift in the basic economic realities facing Japanese companies, large and small alike. Over the past few decades giant Japanese companies and their legions of manufacturing subcontractors, whose nimble adjustments to new production methods underlie much of Japan's success, built their strategies on perfecting the art of mass production. In executing their manufacturing-oriented strategies, they took advantage of generally low yen rates to boost exports and increase production runs -- while relatively low-cost Japanese labor got the manufacturing job done with stunning efficiency.

Today, however, these conditions are fading. Other companies, largely in Asia but also in North America and Europe, have adopted many of the Japanese techniques for mass production, from statistical process control to employee-suggestion boxes. At the same time, a high yen, soaring land prices, and a tight labor market have pushed manufacturing costs in Japan to among the world's highest.

For many traditional subcontractors, dependent on their large customers for orders and technology, the results have been disastrous. Many of the products that used to be exported are now produced elsewhere. Production lines outside of Japan now account for significant percentages of such staples as electric fans, 35-millimeter cameras, and calculators, forcing many Japanese subcontractors either to move abroad or close up shop.

"The era of mass production is over, and that will transform the whole nature of our industrial system," predicts the white-haired Kiyonari, a longtime adviser to MITI. "The key Japanese company of the future will have fewer than 150 employees with very specialized products and technology."

In the new economic environment -- where speed from conception of design to availability in the marketplace has replaced pure manufacturing cost efficiency as the key economic determinant -- such small R&D-oriented businesses boast significant advantages, Kiyonari believes. According to a 1988 government survey, about 30% of small manufacturers needed less than one year to move products from the R&D phase to commercialization. Fewer than 5% of larger businesses were able to match this.

While the economic trend-setting of upstart companies contrasts sharply with conventional U.S.-held views of Japan, it isn't entirely new. Much of the country's historical and mercantile development, Japanese historians say, has happened in precisely this way.

Japan is far from the simple top-down society it is often described to be. It functions more like a wheel. At the center, conformist instincts are strong, and cultural and economic changes evolve slowly. Near the edge of the wheel, however, exist innovators, eccentrics, and entrepreneurs -- the marginal forces who nevertheless force the direction of change.

This pattern of outsiders forcing change has long been part of Japanese history, notes Hidetoshi Kato, one of Japan's leading social theorists. Hideyoshi Toyotomi, for instance, the man who united Japan in the sixteenth century, was himself the child of poor peasants. The architects of the modernizing Meiji restoration period during the late nineteenth century were largely rural samurai, and the key entrepreneurs of the time -- the Mitsuis, Iwasakis, Sumitomos -- also came from relatively lower-class origins.

Since the end of World War II, says Kato, the pattern has again repeated itself. The conventional wisdom in the early 1950s was that Japan would rebuild on the foundation of established large enterprises -- the holdovers of the Mitsui, Mitsubishi, and other great zaibatsu, the great family-controlled banking and industrial combines.

Viewing their operations, we would have concluded that the future of Japan was in such industries as textiles, coal mining, heavy-metal manufacturing, and ship building. And of course, we would have been wrong, missing entirely most of the businesses that today constitute the basis of Japan's economic ascendancy.

Instead of the old giants in established industries, the real leaders were more marginal inventors, such as the then-unknown Soichiro Honda, who spearheaded Japan's technical dominance first in motorcycles and later autos; an anonymous engineer named Akio Morita, who cofounded Sony Corp., perhaps the world's most innovative electronics giant; or visionary Osaka entrepreneur Konosuke Matsushita, founder of one of the world's largest consumer electronics companies, Matsushita Electric Industrial Co.

By ignoring the existence of start-ups such as Matsuda R&D, today's U.S. opinion leaders -- the corporate elite, the media, and public-policy shapers -- may be making the same mistakes. Most in Washington, D.C., and elsewhere would rather believe that Japan's technological engine is generated not by entrepreneurs but by government and giant industry, often linked with top research scientists at universities.

Yet here again, the common perception is off the mark. One reason, suggests Hiroshi Takeuchi, chairman of LTCB Consulting & Research Institute Inc., may be Westerners' unwillingness to acknowledge the differences in the kinds of innovation taking place in Japan as compared with North America or Europe.

Unlike Westerners, Takeuchi insists, Japanese do not generally excel at abstract principles and pure research, the kind of work often best conducted in large corporate and government facilities. The true Japanese technological genius is the individual who, in Takeuchi's phrase, "understands the spirit of the machine."

This kind of knowledge, he asserts, does not come easily to university-trained personnel, but to classic tinkerers -- the Hondas of the past, the Matsudas of the present. "Understanding the mind of the machine is important," Takeuchi explains. "When someone works with the machine, he understands its spirit, how to change it, how to make it do something useful."

This may help explain the massive -- though rarely reported -- failure of high-profile Japanese government efforts to leapfrog Western, particularly U.S., technology. Despite enormous hype in Japan and abroad, many of the programs have met with little success -- leaving U.S. leadership in the fields of microprocessors, personal computers, and software virtually intact. "In the end we still cannot create original microprocessor chip designs or commercially usable system software," notes Tosiyasu L. Kunii, chairman of The University of Tokyo information science department and a key adviser to many industry-government technology programs.

Nor have the large Japanese companies themselves been much more successful in their efforts to capitalize on massive investment in R&D, observes Kinji Gonda, a professor at Tokyo Denki University and another longtime adviser to the Japanese government on technology policy. Like their U.S. counterparts, large Japanese companies have been stymied by their conservative bureaucracies, which make it difficult for new ideas, particularly from younger scientists, to rise inside the corporation.

"Big companies are basically very reluctant to do anything with a new product until it's totally proven," Gonda explains. "The middle management is just interested in following the company policy. They don't like the risk. In Japan you can't have a failure. You are judged by avoiding failure, not by achieving success."

The small size of the entrepreneurial enterprises and the public hype accorded the giants are only two of the factors obscuring the existence of this new Japan Inc. for Western observers. Another is that much of Japan's industrial innovation derives from areas outside the central core of Tokyo. The economy in regions such as the Kansai, which includes Osaka, Kyoto, and Hyogo, for instance, is disproportionately oriented to smaller manufacturing companies, with 29% more industrial enterprises than its share of the national population.

But perhaps the most outstanding example of the beyond-Tokyo phenomenon can be seen in Shizuoka Prefecture. In this century alone, Shizuoka has produced a prodigious number of remarkable companies. Among the local heroes of this relatively quiet region are motorcycle-and automakers Honda, Suzuki, and Toyota; musical-instrument manufacturers Yamaha and Kawai; and Hamamatsu Photonics, Japan's top optical-electronics company.

Shizuoka's strengths lie largely in its location, which made it a natural conduit for ideas and products flowing between Osaka and Tokyo. More recently it has been helped by the enormous inflation in land values in both those major centers, particularly in Tokyo -- where land prices, the world's highest, are as much as seven times those in Shizuoka. In addition, the area -- home to Mount Fuji and many of Japan's most scenic settings -- seems more hospitable to the traditional Japanese values of hard work and craftsmanship than does bureaucracy-dominated, Westernized Tokyo. In Shizuoka it is easy to find entrepreneurialism and innovation quite unlike the fast-growth, venture capital backed superstars across the Pacific. Here most companies tend to be older, family-owned operations whose pattern of development reflects a slow but steady evolution toward higher-value-added products.

Take, for instance, Suzuki Sogyo Co., a growing technology company located in Shizuoka. Like many Japanese companies, Suzuki's origins lie in the wreckage of World War II. Company founder Tamotsu Suzuki, an army captain trained at the elite Japanese military training academy, returned from war nearly penniless, his training without obvious commercial value.

But Suzuki's military background provided intangible advantages, including a penchant for organization. His background also earned him the widespread respect of his neighbors. Using his connections and good credit, he was able to procure rubber boots to sell along the bombed streets of the town. Later he branched out into other areas involving rubber and plastic, even developing a system for washing and canning the area's renowned orange crop.

"He took his skills from the military," recalls his son and the company president, Tsuyoshi Suzuki. "At the bottom line, whether it's the army or business, it's all leadership, management, and strategy. In the army, you didn't organize like a battleship with centralized command, but depended on separate and decentralized organizations going after different goals."

As a largely self-financed family-business operator, the elder Suzuki carefully avoided direct confrontation with larger, well-heeled competitors -- instead he seized opportunistically on promising market niches. The yawning lack of storage facilities in bombed-out Japan, for instance, prompted him to move into the business of building canvas warehouses, which were half as expensive as and much more quickly built than conventional structures.

But by the mid-1960s the company faced growing competition from larger companies crowding the field. So while maintaining a division devoted to the canvas business -- which still accounts for roughly one-quarter of company sales -- the Suzukis shifted their attention toward other, more defensible niches. Most promising to them, the younger Suzuki remembers, were fields in which patents could provide some protection from the depredations of larger companies.

So the company set out to develop a series of small, dedicated units, each concentrating on new and promising technologies. But rather than try to beat the larger companies at manufacturing, the company sought to develop unique products, secure patent protection and customers, and then approach larger companies and universities as partners and licensees.

"I save myself by originality, by a patent strategy, because that's all a small company can do," says Suzuki, 41. "We take advantage of the big companies, instead of their using us. We can use their money while we offer them the technology we already have. And we are careful not to try competing with them at mass production."

Suzuki's approach rests on a basic assumption of the new Japan Inc.: that smaller, tightly focused teams can outdesign, outinvent and outpace larger organizations in bringing new products to market. Critical to his own success, he believes, has been his company's decentralized structure -- which divides the business's 150 employees into five separate units, each with broad autonomy to identify promising niches and market its own products.

Similarly, Suzuki also offers considerable freedom to his 20-member R&D staff. This has been particularly important in the case of a single technologist, Motoyasu Nakanishi, a little-known engineer recruited from his own company back in 1974. Today holder of more than 400 original patents, Nakanishi's inventions have provided the basis for most of Suzuki's key business units -- including absorbent materials called the alpha gel series, which are marketed by Geltec Inc., one of the five units; a technology that enables fine images to be printed on curved metallic surfaces; and a whole new line of deodorizing agents.

So far the approach has worked brilliantly. Sales of new technologies, largely in the form of licensing agreements, now account for the majority of the company's 1990 sales of nearly $60 million, almost double the total of five years earlier. Its licensees make up a veritable who's who of the old Japan Inc. -- Hitachi, Toshiba, Nissan, and Toyota.

"The laboratories of the big companies, with all their doctorates, can't invent and develop commercially attractive goods as quickly as we can," Suzuki says confidently. "My idea of research and development is that quantity is not so important. If you have one Edison in your group, you can conquer the world."

Suzuki's emphasis on individuals contradicts yet another of the commonly held assumptions about Japan -- that its people prefer blind obedience to organizations over personal development. Like other shibboleths, this perception ignores not only the important role played by individual inventors for centuries, but the rapidly changing dynamics of modern Japanese society.

In sharp contrast with older Japanese, many in the under-40 generation reject the basic values of mass production society (see "Japan's New Face," page 5). The overwhelming majority of young Japanese disdain both the concept of lifetime employment and the idea of working in manufacturing industries. Even among engineers and computer scientists, the majority seek employment in softer fields such as fashion, media, finance, insurance, and real estate. "When college students go out looking for a job, they want to avoid the three Ks -- kiken [dangerous], kitsui [hard], and kitenai [messy], so manufacturers are having a hard time," asserts Hosei University's Kiyonari. "These days even the NECs and the Fujitsus are being avoided by new workers because kitsui is there."

Yet what may be a challenge to traditional mass-production companies, Kiyonari believes, also offers opportunities to smaller, design-oriented companies. At Nuno Corp., a Tokyo textile company, there has been no problem recruiting new workers. Most of Nuno's six-person permanent staff is under 30, and all are women.

Reiko Sudo, Nuno's 37-year-old founder, believes her company -- which produces unusual textiles and garments -- naturally appeals to a generation turned off by the monotony of Japan's mass-production-dominated society and attracted to more traditional, artisan-based values. She knows these sentiments from personal experience.

Before launching Nuno, Sudo was a successful designer for Kanebo Ltd., one of Japan's leading textile companies. She was well respected, well paid, and increasingly alienated. "What I designed sold like hotcakes, but at Kanebo I didn't feel it was connected to me," the designer said in her tiny showroom in Tokyo's fashionable Roppongi district. "The businesspeople took care of things, but I felt empty. I felt part of a process but not responsible."

Sudo found her way out in 1982, when she met a designer named Junichi Arai. One of the pioneers of Japan's burgeoning textile-design industry, Arai used computers to design new textures and structures, most owing their inspiration to traditional Japanese design. He also invented new kinds of blended materials, for instance, laminating layers of oxidized titanium and nylon film to make what he called Titanium Lamé Silk.

Arai's genius, however, did not extend to business management. So Sudo, with financing from a friend and her contacts in the interior- and architectural-design industries, launched Nuno as a means to market and manufacture Arai's techniques and her own designs. At the same time she also established close ties with a series of small family workshops -- most with fewer than a dozen employees -- in Gumma Prefecture, a traditional artisan center 75 miles north of Tokyo. But Sudo's innovations did not stop there. To keep her technically complex products from being too expensive, she decided to sell directly to the public, cutting out the layers of distributors that can double the retail price of garments. She set up her own direct retail distribution through her Tokyo shop, with showrooms in New York City and Los Angeles. She also launched a wholesale business by selling her fabrics to other designers and interior decorators. Today each channel accounts for roughly half the company's more than $1.5 million in sales.

"The only way we could survive was to change the structure of the textile industry itself," Sudo explains. "I wanted to avoid the system of wholesalers, trading companies, and retailers that jack up the price of everything. I wanted an honest price, so I could sell a quality product."

To Sudo, such breakthroughs -- in design, manufacturing, distribution, and marketing -- are critical not only for Nuno, but for Japan's textile and garment industry. Once Japan's foremost sector for exports, textile industries suffered a trade deficit in 1988, mostly due to imports from lower-wage Asian nations. To survive in the future, she believes, the old mass-production psychology of not only the textile companies, but also of Japan's entire industrial system, must change.

And Sudo, like other creators of the new Japan Inc., is confident that it will change. After all, she reasons, if a woman who thought of herself as an alienated artist can build one of Japan's most lionized young fashion companies, a changing of her nation's industrial guard may very well be taking place -- even if few in the West, or even Japan, recognize it.


Changing Attitudes toward work, self, and society

Of all the factors contributing to the shift toward a new Japan Inc., the most surprising may be the changing values of the country's young. The sort of work force that drove Japan's mass-production manufacturing machine is vanishing. Today's young people express attitudes so profoundly different from those held by their elders that they call themselves shinjinrui, the new race.

Raised in the affluence and Western influences of the 1970s and '80s, Japanese in their twenties reject the postwar generation's scale of values -- service to country first, company second, family third, and self last. Job and nation have slipped. Individualism, long considered un-Japanese, has arrived. And that, Japanese observers believe, bodes well for companies such as Matsuda R&D, Nuno, and Suzuki Sogyo, which emphasize innovation and individual creativity.

Some evidence:

* Shinjinrui differ radically from the previous generation in their attitudes toward self and society. Surveys indicate that among Japanese in their twenties, the aim for individual fulfillment is more important than making a contribution to society as a whole. The priorities of their parents' generation are reversed.

* Contrary to Western stereotypes and the characteristics exhibited by their own parents, fewer Tokyo young people identify work as the center of their lives than do their New York City and Los Angeles counterparts.

* The jobs that built the old Japan Inc. are out of favor. Now high among career preferences listed by college students are trade, medicine, banking, and hotels and travel. Placing low: industrial manufacturing, including high tech.

* Lifetime employment, long the great lure of the giant companies, is rapidly losing its appeal. According to a government study, only 29% of Japanese 20 to 29 years old plan to stick with one company throughout their working lives, in contrast to 70% of Japanese aged 55 and older.