Ready for Prime Time: Japan’s Maturing Startup Ecosystem

Japan’s Startup Ecosystem: Overview and Snapshot

One of Japan’s main economic challenges in the past few decades has been to increase the flexibility in its economic structure to compete in fast-changing industries that have been transformed by developments in information technology (IT). The startup ecosystem, which grew as a relatively peripheral segment of Japan’s economy throughout much of its recent history, is now front and center in getting attention from the government and big business and enjoys social legitimacy at a level that has not been seen since the early postwar years when many of today’s big Japanese businesses were established.

Linkage between startup ecosystems is also a focus of U.S.-Japan relations. As articulated in the U.S.-Japan Competitiveness and Resilience Partnership first put forth in 2021, much technology commercialization occurs in startups, and collaboration among startup ecosystems is an important aspect of U.S.-Japan science and technology cooperation.

Promoting Japan’s startup ecosystem is a domestic policy priority as well. The growth strategy plan announced in June 2022 includes promoting Japan’s startup ecosystem as an engine of growth. Keidanren, Japan’s large business association, has also welcomed a prominent entrepreneur, a woman, as vice chair and issued recommendations to strengthen Japan’s startup ecosystem.

It is therefore high time that an analytical overview of Japan’s startup ecosystem contributes to the policy debate.

Framing is important, as is an understanding of Japan’s economic structure, in order to evaluate what the challenges are and what should be done to address them. A working mental model or framing of the ecosystem is much needed to engage in meaningful discussions. But first, a brief review of Japan’s startup ecosystem is in order.

A Snapshot of the Ecosystem

First, let us take a quick view of Japan’s most highly valued, pre–initial public offering (IPO) startups as of September 2021, along with the startups that raised the most capital that year (see table 1). Before delving into comparisons, there are a few overarching characteristics to notice. First, the range of sectors is broad, with deep learning, news, human resources, technology services, new synthetic materials, biotech, space-related technology, education technology, and mobility services.

Second, the educational background of the entrepreneurs should be noted. Many are from Japan’s top universities, including the University of Tokyo, Keio University, and Kyoto University. For much of the last half century, graduates of these elite universities were absorbed into large firms in lifetime employment arrangements, or they tended to join elite government ministries to serve as career civil servants. However, the fact that these elite university graduates are founding startups is evidence that Japan’s startup ecosystem enjoys greater social legitimacy than it has for much of the postwar period. The reverse is also true, with social legitimacy increasingly conferred to the startup ecosystem by elite university graduates who share common background with the leadership of major corporations and government ministries and who are now often at the helm of a startup. At the same time, some of the firms were founded by people whose education background deviates far from Japan’s mainstream elite, including alumni of non-Japanese universities and a high school dropout.

Third, in both tables 1 and 2, the age of entrepreneurs is notable. Most were born in the 1970s and 1980s, and many of them founded their firms in the early 2010s, when they were in their late twenties and early thirties. There is a generational dynamic at work, in which the entrepreneurs came of age well after Japan’s economic bubble burst in 1990. They grew up in the slow growth era of the 1990s, and never experienced (as working professionals) the elation when Japan’s economic growth was poised to rapidly close the gap with the United States. They were also spared the deep disillusionment with Japan’s corporate economy felt by many who spent their core working years experiencing corporate retrenchment. Instead, these entrepreneurs grew up in post-bubble Japan, when younger generations were less likely to see lifetime employment at a large firm provide the glamor and stability that had been the postwar promise.

Meet Some Startups

Beyond names and descriptions, it is useful to illustrate the stories of a few startups to provide some texture.

Preferred Networks was founded in 2014 by computer scientists originally from the University of Tokyo. The company provides machine learning algorithms and tools. Japan’s top manufacturers, including carmaker Toyota and factory robot producer Fanuc, have partnered with Preferred Networks to jointly develop systems for factory robotics that enable the robots to learn new movements and tasks by themselves without operators programming them. A large array of big industrial firms provided initial funding, as Preferred Networks was spun out of a previous company focused on providing search functionality from non-text data.

One of the employees of Preferred Networks’ early incarnation, Ohta Kazuki, also a University of Tokyo graduate, left the company and co-founded Treasure Data, a data management platform company for enterprises, in Silicon Valley. Treasure Data was founded in 2011, and in 2018 it was acquired by Arm, a semiconductor firm owned by the Softbank Group, for an estimated $600 million.

SmartNews delivers news feeds curated to people’s preferences as revealed by their news consumption patterns. Its founders were engineering and computer science PhDs who secured funding from one of Japan’s newer independent venture capital firms, Globis, and others. Co-founder Suzuki Ken was initially a researcher, publishing about the effects of information technology on democracy and society. When SmartNews expanded into the United States in 2014, it built a feature specific to the U.S. market called “News from All Sides” that clearly marked where news sources fell on the partisanship spectrum, enabling readers to switch between them rather than stay in ideological echo chambers. It found that showing users views from multiple sides of political issues led to greater engagement and built a political bias algorithm into its U.S. product, with its offices based in San Francisco and Silicon Valley. SmartNews grew to become one of Japan’s few unicorns in 2019 and completed additional fundraising that included American investors.

Spiber, founded in 2007, successfully created synthetic spider silk by decoding the genetic information of fibroin, a protein that is the main component of spider silk. The technology grew out of a laboratory at Keio University, with then graduate student Sekiyama Kazuhide and then undergraduate Sugihara Junichi  making the discovery in early 2007 and starting the company later that year. Given the unfavorable investment climate immediately following the global financial crisis, it took Sekiyama and Sugihara two years to make a technological breakthrough to produce artificial spider silk thread and subsequently secure VC funding. In 2012, the company entered into an alliance with Kojima Industries, an auto parts supplier for Toyota, and together they set up a factory for mass production.

Wantedly, not on the top-funded lists but a notably successful startup, combines aspects of a social networking service with recruiting, and underwent an IPO in 2017. The career of founder Naka Akiko , a Kyoto University graduate, took her from Goldman Sachs after graduation to the early days of Facebook Japan. Wantedly rode the rise of mid-career hiring and labor dynamism in Japan’s information technology industry and startup ecosystem and was quickly adopted by over a thousand companies and more than a million users.

VC Funding Grew Rapidly Over the Past Decade: A Structural Shift

The amount of VC investing in Japan has grown more than tenfold over the past decade. Following a downturn in the aftermath of the global financial crisis of 2007–2008 that led to a sharp recession in Japan, VC investing grew rapidly. From 2018, the number of startups receiving funding dropped while the amount of capital invested rose, indicating larger funding sizes (see figure 2).

While the overall size of Japan’s VC industry and the amounts raised by Japanese startups are small compared to Silicon Valley, Japan’s startup ecosystem is not dramatically smaller than European G7 countries such as France, Germany, or the United Kingdom, as shown in the latter installments of this series.

The important point here is that Japan’s startup ecosystem is growing, and even the next economic downturn is unlikely to undo the growth experienced by the ecosystem, since many underlying dynamics have shifted substantially, as will be shown in later installments.

Japan’s Startup Ecosystem Is Not as Small as It Is Often Made Out to Be: A Preview

Japan’s startup ecosystem, as commonly portrayed, looks extremely small compared to startup ecosystems elsewhere. VC investment in Japan is a small fraction of that in the United States, and there are fewer unicorns—private companies valued at over a billion dollars—than in the United States, China, and several other advanced industrialized countries.

However, many of the metrics used to measure Japan’s startup ecosystem are chosen to make the point that Japan’s startup ecosystem is extremely small. For example, VC investment as a percentage of gross domestic product (GDP) is a common measure that makes Japan’s VC industry look tiny, with Singapore and Israel at the top, followed by the United States and other countries such as the United Kingdom, France, and Germany. Yet, in absolute dollar terms, Japan’s VC industry is not abnormally small compared to other top member countries of the Organisation for Economic Co-operation and Development, except for the United States. In fact, the United States’ VC investment is so large that without some distortion of the vertical axis, all other G7 countries are compressed at the bottom. Compared to the United States, any country has a very small venture capital industry, but the U.S.-Japan comparison is often used to accentuate the small size of Japan’s startup ecosystem despite it being the United States that is disproportionately large.

When the United States is removed from the chart, Japan looks far more typical in comparison with other G7 countries. The reasons for looking at absolute dollar amounts rather than a proportion of GDP will be discussed in subsequent installments, but it is not obvious that a certain proportion of a country’s GDP should be composed of venture capital. Japan had a larger number of competitive large firms in the Forbes Global 2000 list of the world’s largest companies than Germany, France, or the United Kingdom as of 2021. Japan ranks third following the United States and China. So why would we expect startups to make up a comparable proportion of Japan’s GDP, which is larger than those of Germany, France, or the United Kingdom? These figures alone may not convince the reader that Japan’s startup ecosystem isn’t small—and indeed, it could be larger—but the purpose is to suggest that some of the more dramatic portrayals of its small size are also exaggerated.

Japan actually had greater amounts of VC funding than the United Kingdom, Germany, France, and South Korea from 2009 until 2016, when the United Kingdom began to grow rapidly (see figure 4). South Korea received a large boost in 2019 and pulled ahead as well. Japan fell behind in 2020 and 2021 as the global pandemic hit.

Rather than a story of anemic VC funding, this suggests that Japan did have a reasonable amount of VC funding until it was somewhat left behind after 2019, when VC investment worldwide grew rapidly, as seen by the rapid growth in the United States and South Korea.

However, as the events of 2022—including Russia’s war on Ukraine, surging oil prices, rising inflation, and higher central bank interest rates—hit the global economy, it is not clear that the surge of VC funding will continue, and Japan’s position may look better in comparison, even though it did not share in this large boost of global equity. Why Japan did not receive the boost of VC investment that other countries did is another question to be addressed in subsequent pieces. One contributing factor may be its essentially closed borders due to COVID-19 and the focus of large Japanese companies on investment abroad.  

This introduction is likely to leave the reader with many questions. Subsequent pieces will provide many answers, and several topics raised here will be covered in greater depth. The second piece will take the next step by introducing a useful analytical framework for understanding and evaluating startup ecosystems. It will show how Japan’s startup ecosystem grew alongside the main core of its economy, maturing rapidly over the past decade to the point that it now enjoys positive feedback loops in each of its components.