EMMA RUITERS: Japan offers nearly $60bn chance to Africa’s start-ups amid fierce competition

While China is experiencing a slowdown, the Financial Times recently named Japan one of the “Economic Wonders of a Worried World”. Is there a new sun rising in the east, and to whom should African nations look for increased investment?

There has been renewed global interest in African countries, with large, young populations as potential consumer markets. Many African countries have rapidly growing economies with a burgeoning affluent class. The UN has shown that of the world’s top 30 fastest-growing cities between 2018-2035, 21 will be in Africa, including Kampala, Uganda, and Abuja, Nigeria. African cities are urbanising the fastest, which is generating new demand for goods, services and infrastructure.

Coupled with positive population growth and a young population, many commentators see African countries as possessing a demographic dividend that will further fuel growth, while the African Continental Free-Trade Agreement (AfCFTA) will unlock intra-African trade potential across the continent.

Industrialised nations have taken note, competing to secure access and market share. Facing an ageing population and declining levels of nominal domestic growth, low-debt and cash-rich Japanese companies see African countries as promising markets. Japanese investment into has Africa risen significantly in three stages: from 1983 to 2021, Japanese foreign direct investment (FDI) increased 2,575%, and in 2007/8 as well as 2015/16 there were signs of notable acceleration.

The late Shinzo Abe’s leadership in advocating for business advancement into African markets drummed up interest from the Japanese private sector, and rising competition from other international actors in the continent due to demonstrable high growth is starting to make investors sit up.

Japan’s engagement on the continent is not new. This year, the eighth Tokyo International Conference on African Development was held, hosting over 300 business leaders and 50 African heads of state. The message was overwhelmingly optimistic, naming the high return on FDI in Africa at 11.4% above the global average of 7.1%.

Fierce competition

Further, Japanese investors are no longer looking solely at infrastructure. Rather, they are investing in African start-ups and private companies, as well as Africa’s rapid digital transformation. They tend to favour the traditional sectors of consumer goods, infrastructure and logistics, but also increasingly fintech and autonomous vehicles.

China has not penetrated the market in the same way. In the venture capital (VC) space it is the US, EU countries and the UK that are seen as competitors by Japanese firms. It can be argued that part of the reason for Japan’s struggle to make itself prominent in the African market is precisely because of the fierce competition in the public and private sectors from other global powers.

However, it is undeniable that Japan’s own, unique economic imperatives are increasingly shaping its interest in Africa. Several Africa-focused VC firms have emerged, such as Samurai Incubate, Leapfrog Ventures, and Kepple Africa.

Japan was and is a major funder of economic development, growth and industrialisation in Asia, from South Korea to Thailand and beyond. However, Japanese investors have long struggled to penetrate the African market. Even so, it is increasingly being perceived as a priority due to saturation of Japanese engagement in South East Asia and high-levels of competition from other late developers in this increasingly attractive region.

Initial forays into the African market, with the business practices of South Asia in mind, were fruitless and fraught with miscommunication. There was some degree of information asymmetry on both sides, which led to frustrations. Yet, new ways of partnering and doing business are being sought by Japanese firms in the African market.

Many analysts have emphasised the ageing, feeble Japanese economy in recent years. This is not inaccurate, but often lacks nuance. Masayoshi Son is (in)famous for his Softbank Vision fund, at $100bn the world’s largest tech-focused investment fund. This is not unique. Rising global Japanese FDI may reflect the significant cash reserves of Japanese corporations held on their balance sheets.

Acceleratory effects

About 53% of Japanese companies on the Topix Index are net cash, compared with only 14% of US companies in the S&P 500. Non-financial companies on the Topix 500 maintain $2.6-trillion of tangible assets. Japanese firms are shifting towards increased market liberalisation. The government has also pushed to unlock corporate savings. This year Japan’s government and business sector are pushing for increased planned capital investment, which includes encouragement of global expansion for Japanese start-ups.

Japanese companies are aiming to invest 25% more into equipment, real estate and other physical assets from 2022 to advance in decarbonisation. The Government Pension Investment Fund (GPIF) of Japan, one of the world's largest institutional investors, will begin investing in Japanese start-ups. Thus, it’s likely these reforms, including Abe’s corporate governance reforms, will have had some acceleratory effects on FDI as the reforms are supportive of outward-bound M&A through tax reforms and deregulation, as reflected in increasing outflows in FDI.

Under Abe’s third arrow of Abenomics, corporate governance reform has ensued, starting with the Japanese Stewardship Code in 2014 and the Corporate Governance Code of 2015. Japan’s challenges have also spurned a new global engagement strategy. Ulrike Schaede’s conceptualisation of the choose-and-focus approach describes Japanese businesses as using M&A as a means to build out new technology niches and expand their market presence to seek new customers.

This has been through an increase in global M&A, in which Japanese firms are acquiring foreign firms as “an integral part of the second wave of choose-and-focus”. Japanese banks are also acquiring foreign banks and developing M&A advisory businesses for foreign markets. Companies are exiting noncore businesses and redefining business focuses. An example may be Sony’s recent diversification into a non-traditional industry, namely into the car sector through imaging sensors. In 2022, Sony launched an electric vehicle division and a joint venture with Honda to make cars.

Correspondingly, Japanese private sector actors, namely trading companies and VC funds, have used M&A, private equity and venture capital as tools to enter the African market, in sectors ranging from healthcare to logistics, mobility and energy. This is because African entrepreneurs and businesses naturally have a closer understanding of domestic conditions, and are thus critical partners in market success particularly through localisation and innovation.

Increased activity

However, innovations to suit local market needs can be used and adopted in developed markets, a phenomenon known as reverse innovation. It is common for Japanese companies to establish laboratories for R&D in emerging markets to be able to better localise products as well as manufacture products more cheaply. Studies have shown that between 2013-2019 business extension in terms of local branches of Japanese companies into Africa growed rapidly, especially in the car, trading companies and financial services sectors.

While traditional hubs such as SA and Egypt experienced increased activity, since 2017 new hubs were emerging in Kenya, Morocco and Nigeria. However, as a proportion of total Japanese FDI and in comparison to other developing markets, African economies are not yet capturing a significant amount of Japanese FDI, despite the long term trend of increasing total Japanese FDI and increasing Japanese FDI to Africa.

In 2020, total African FDI inflows were about $40bn. Japanese FDI flows thus contributed 7.5% of total FDI to the continent in that year. In the same year China contributed 14%. Japanese FDI stock in Africa was just more than $7.5bn in 2021. While this compares poorly to China’s nearly $45bn in FDI stock in 2020, Japan’s FDI flows are higher and rising faster than Chinese FDI flows over the previous five-year period.

Investment is growing, but it is still growing more slowly compared with other Japanese FDI recipients. This may suggest residual difficulties and perceived risks Japanese investors find in the African market, as well as a potential absence of a clear value proposition. It is on African start-ups, the private sector and government to ensure Japanese businesses are increasingly encouraged to invest in the continent. There is nearly $60bn at stake here, as per Abe’s pledge. We have the ability to take advantage of a rare, unique opportunity, and strengthen ties with dynamic partners.

• Ruiters,  a participant in the Japan Exchange & Teaching (Jet) Programme who founded The Japanese Language Club SA, works in technology and public policy in the UK.