For Part One go here
For Part Two go here
The ’50s, due to both the end of US meddling in the Japanese economy and improved general conditions in Japan, saw the broken remains of the zaibatsu morph into the keiretsu, the modern day “conglomerates” which have defined Japanese economic life ever since.
The keiretsu is a different institution that the US corporation or the European multinational. It can be defined as a group of firms (ranging from the gigantic to middle-sized family owned enterprises) tied among themselves by cross-shareholding, informal ties and, much more critically, the use of a common main bank and sogo shosha (often translated as trading house) which constitute the true beating heart of the keiretsu. Very much like an onion, a keiretsu is made up of “layers” of companies: however being close to the core does not mean being a huge company. Toyota, for example, belongs to the most external layer of companies of the Mitsui keiretsu despite being one of the world’s largest manufacturing companies. The same can be said for Matsushita Electronics and Sumitomo.
It’s very hard to explain the concept of layers. For a Japanese “it’s just the way it is”. Positioning is affected by a huge number of factors, such as the entity of loans taken from the core bank, cross-shareholding patterns and tradition. In some keiretsu, companies which can directly trace their lineage to the original zaibatsu are held to be “closer to the core” despite not having being major players for decades.
This concept of “belonging to a keiretsu” is further muddled by two other factors.
The first is a company can be part of more than one keiretsu at once: for example Hitachi is part of both the Fuyo and Mizuho keiretsu. This is because of their cross-shareholding pattern, use of more than one main bank and sogo-shosha and, not to be underestimated, the fact that Hitachi can trace its lineage back to the old Nissan zaibatsu. 
The second is a company can be nominally part of no keiretsu but having “friendly relationships” or “close ties” with one. For example Honda Motor Co, while priding itself of a “strongly independent stance”, has “friendly relationships” with Mitsubishi. This is because Mitsubishi Bank is their main creditor and companies belonging to the Mitsubishi keiretsu (Tokyo Marine and Fire Insurance, Mitsubishi Trust etc) are among its major shareholders.
A further round of muddling is provided by Toyota: originally part of the Mitsui zaibatsu, it grew so large in the post-WWII period it became a major keiretsu in its own right, to the point the company barely needs loans to function. Despite having developed its own financial and trading structure, however, Toyota is still considered part of the Mitsui keiretsu: traditions and cross-shareholding are the main reasons.
Informal ties are exemplified by the practice called shacho-kai (presidents’ assembly), a regular meeting of presidents and chairmen of the member companies. These meetings are not open to all member companies: for example Matsushita Electric, despite being a truly gigantic company and member of the Sumitomo keiretsu, cannot send its own president and chairman to the Hakusui-kai (White Water Club), the Sumitomo presidents’ assembly. This is because Matsushita doesn’t belong to the “inner core” of the Sumitomo keiretsu but to the outer layers and only those closest to the core are deemed worthy of sending representatives to the shacho-kai.
Each keiretsu has different traditions regarding the shacho-kai.
Mitsubishi has two of them, one for for presidents and chairmen, the Kin’yo-kai, and one for the somu bucho (roughly equivalent to the US junior CEO’s), the Getsuyo-kai.
Sumitomo’s Hakusui-kai meets in Tokyo and Osaka in alternate months and those taking part make a point in making it last at most two hours, as a representation of Sumitomo efficiency.
What goes on in these meetings is the source of much speculation in Japan. Transcripts and proceedings, if they actually exist, are kept secret and it’s considered highly impolite to ask participants about what’s discussed during these meetings.
Cross-shareholding is a relatively recent innovation and goes back to the late ’60s. Two reasons spurred its rapid development.
First, Japanese companies were exporting increasingly large quantities of high quality goods to Europe and the US and there were many who feared foreign corporations may start buying Japanese companies to have access to their highly efficient production methods. These fears were confirmed in 1969 when General Motors attempted to buy a controlling stake in Isuzu Motors.
Second, in 1967 Mitsubishi willingly bankrupted (causing a major scandal) Marusho Motors, one of the leading Japanese motorcycle and power equipment manufacturers of the period. 
Both were seen as unacceptable and steps were taken to both avoid a foreign company from completely taking over a keiretsu member and a repetition of the Marusho scandal. There was no coercion in conventional sense: this was done by the companies involved willingly.
While this is surely a safety net, Japan’s Lost Decades are weakening this system. While the drive to avoid a repetition of the Marusho scandal is still strong, keiretsu are increasingly unwilling (or unable) to avoid foreign companies from taking over a healthy Japanese company to have access to its patents and manufacturing methods.
This exemplified by engine manufacturer Zenoah (formerly part of the Komatsu group, itself part of the Sumitomo and Mitsui keiretsu) being bought by Swedish group Husqvarna to have access to their advanced two stroke engine technology.
Use of a single main bank goes beyond mere financing. In Japan a bank doesn’t merely provide capital but also market information (this is closely tied with the sogo shosha, as will be seen in a moment), business advice, political protection and, in time of crisis, management assistance. This extends even to small family owned businesses.
One peculiar characteristic of the big keiretsu banks is their role as “company doctors”. If a member company deemed important enough is going through a crisis or if the causes of a failure are scandalous enough, the main bank will either quietly arrange for the management to be replaced or will negotiate a merger or takeover.
Sometimes, the bank can do no more than make the company’s demise as quiet as possible. This is exemplified by the 1977 bankruptcy of a very large independent trading company, Ataka & Co. Sumitomo Bank, the main lender, swallowed most of the firm’s debt and arranged for the profitable parts of Ataka to be taken over by another trading company. Not a single Ataka customer lost a single yen in the operation: Sumitomo’s reputation was at stake.
Sometimes the bank will continue to support even a faltering firm, if they believe there’s any worth (economical or political) in it. Examples are how Akai Electric was kept afloat for many years by Mitsubishi Bank until the situation became so desperate it had to be sold off to a foreign buyer (Hong Kong conglomerate Grande Holding) or how Sumitomo kept on financing Toyo Kogyo (now Mazda Motor Co) for almost a decade until a buyer could be found. 
And finally we come to the trading house, or sogo shosha. As Michael Yoshino wrote: “ A sogo shosha is like no other type of company. It is not defined by the products it handles or even by the particular services it performs, for it offers a broad and changing array of goods and functions. Its business goals are equally elusive , for maximization of profits from each transaction is clearly not the major goal, at either the operating or philosophical level”.
So what do they do? They procure raw materials and sell finished products around the world, they serve as eyes and ears of their major customers, they help smooth out both domestic and international transaction, they invest overseas (chiefly in the raw material business), they help set up major supply network.
But their major role is to act as intermediary between buyers and sellers and to provide trade credit.
The system works like this: the buyer places an order and the seller delivers the goods (which can be anything from bags of rice to industrial robots) on credit. Very often, especially when small and medium firms are involved, the buyer knows little about the seller but knows a prestigious sogo shosha (like Sumisho, the giant trading house of the Sumitomo keiretsu) will handle the deal. That is guarantee enough. The buyer will issue a bill of payment to the sogo shosha. In turn the sogo shosha will issue a bill to the seller. The seller then can either cash the bill when it comes due or take it to any bank in Japan to obtain immediate credit, something the seller would be unable to do with a note coming from some little known small firm.
This system may sound convoluted, it provides a huge benefit for Japanese firms, especially small ones. If a reputable sogo shosha handles the deal, the seller will always be paid and the buyer will always receive what he paid for, even if this means the sogo-shosha will lose money (and they do). Sogo shosha live by their reputation (especially given the fact they work on paper thin margins, profits not being their chief reason of existence) and cannot afford a mistake. It also provides benefits to the banks: the sogo shosha handle the bulk of background and financial checks and hence relieve the banks of the need of carrying thousands of operations each day, allowing them to concentrate on their “customary” tasks.
One type of keiretsu which has been steadily grown in importance in the last few decades is the so called vertical keiretsu.
This can be imagined as a pyramid, with a giant parent company sitting at the top (good examples are Toyota and Hitachi) and four or, in some cases, five levels of contractors underneath. The parent company is in direct contact with first level contractors (sometimes giants in their own right, like Denso, a first level contractor of the Toyota keiretsu), owns equities in them and sends directors to their boards. Sometimes the parent company has similar arrangements in place with second level contractors but, more often than not, leaves this task to first level contractors. Second level contractors are in contact with third level contractors and so on, down to the very bottom of the pyramid. 
From the outside, this may look a pretty straightforward system but there are many peculiarities that differentiate it from Western corporations.
Let’s take the car industry for example. Western car manufacturers, like GM or BMW, design components for their own cars in-house and then ask independent contractors to bid for it. The lowest bid wins. This is repeated yearly and, in case of some low-margin models, every six months. In short the contractor which built a given component in the first year may be replaced the moment somebody else offers to build it for less.
Japanese car companies work in different fashion. They submit the specs (including price) for a component to contractors belonging to their own keiretsu and leave them to design it and arrange manufacturing through the lower levels of the pyramid. Sometimes an external society may be involved in the process for political considerations: for example Honda Motor Co traditionally have brakes for their own cars and motorcycles designed and manufactured by Nissin Kogyo, a member of their own vertical keiretsu. In recent years, however, some Honda models have been equipped with Tokico brakes, manufactured by a company from the Mazda vertical keiretsu, as a token of goodwill toward Sumitomo (Mazda’s main bank and political patron). Also, members of the vertical keiretsu are actively encouraged by their parent company to aggressively pursue deals outside the keiretsu production system: these deals are a good source of revenues, revenues which are often sorely needed by suppliers working on paper thin margins.
Many large Japanese companies, like Toyota, don’t like dealing with a multitude of independent contractors. This is seen as time-wasteful and with potential for affecting the meticulous quality control system many Japanese manufacturers built their reputation on.
While it may be argued this system removes the benefits of a large number of independent contractors, each frantically bidding to lower prices, in reality the system has served Toyota, Honda, Matsushita, Hitachi and other Japanese companies very well.
Once Japanese companies started expanding abroad, they exported their vertical keiretsu method. When a large company such as Honda opens a factory in, say, Thailand, it’s invariably followed by members of its own keiretsu which set up the same supplying network as in Japan by opening foreign subsidiaries which simply function as their Japanese counterparts.
In the last two decades the emergence of Factory China has deeply influenced the vertical keiretsu method. Chinese contractors can supply components at rock bottom prices and, in a desperate attempt to keep prices low in face of heating inflation, many Japanese companies altered their vertical keiretsu structure to accommodate Chinese contractors.
However this transition has proven to be problematic. Quality control issues have multiplied and savings do not seem to be as dramatic as originally expected. This is a source of embarrassment, especially for companies like Honda which built their image upon unbelievable build quality.
There’s currently a hot debate if the vertical keiretsu system just cannot be adapted to Factory China or if Japanese companies willingly sacrificed their legendary quality on the altar of low prices, using less than reputable Chinese suppliers as a ready excuse. 
 As seen before, Nissan was taken apart in 1945 and its companies forbidden from forming direct ties among themselves. Most of them ended up entering the Dai-Ichi (Shibusawa) and Sanwa keiretsu. Sanwa was the largest casualty of the Bubble Economy burst in 1989-1990.
 Marusho, an otherwise highly profitable manufacturer, was bankrupted by Mitsubishi by first unloading upon them the ailing Fuso motorcycle division at inflated price and then by not honoring contractual obligations regarding distribution (Mitsubishi was to buy a fixed number of motorcycles each year to sell through its car dealerships) and financial (Mitsubishi was to guarantee Marusho’s investments in the new venture for a number of years) terms. Mitsubishi executives got out of the following trials squeeky clean, hinting at political intervention. The bankrupted Marusho company was purchased at bargain price by Honda.
 Sumitomo ended up selling a controlling stake in Mazda to Ford, since no Japanese company of the period wanted anything to do with the brand, seen as a hopeless case. Mazda remained Ford property until 2008, when the US car manufacturer had to sell its control stake to obtain much needed liquidity.
 The vertical keiretsu is actually much more complicated than this but discussing it in full would require a much lengthier treatment. For example the contractors’ work on less than paper thin margins and their profit model is based on quantity: to turn profits they need to massively increase production constantly. This is starting to be a problem since most of modern industries are sinking in massive overproduction issues worldwide.
 The Japanese production system is mostly based around the so called Lean Production Method (LPM) invented by Toyota in the ’50s and which reached maturity in the early ’70s. This system, which takes the integration among suppliers and assembler and employees and employer to its extremes, is very ill suited to the Chinese system, which is mostly built around the classic Ford “mass manufacturing” system and dirt cheap but poorly qualified and badly motivated manpower.