Some fortunate staff at Merrill Lynch's retail brokerage business in Japan have just returned from an unusual jaunt - the company's management took its 50 top salesmen and woman to Hawaii for a short holiday. "It was a recognition trip," explains Winthrop Smith, chairman of Merrill Lynch International.

The move marks a striking innovation, but such steps are now being watched extremely closely by other western banks.

Late in 1997 Merrill Lynch set a milestone in Japan by purchasing 33 branches - together with their staff - from Yamaichi Securities, which was Japan's fourth-largest broker until it collapsed in the autumn of 1997.

This step made Merrill Lynch the first western concern to attempt to build an independent brokerage network in Japan. It raises two crucial questions: are purchases of distressed assets really the best way for foreign companies to enter Japan? And can this allow foreign groups such as Merrill Lynch to make serious inroads in Japan's tightly-guarded domestic retail markets?

The first issue is particularly critical, because as "Big Bang" gets under way foreign companies are employing a range of strategies to enter the market. Some are remaining fiercely independent: Goldman Sachs insists that it has no intention of forming a binding alliance, and points out that its strategy has earned it considerable success. It has become the country's sixth-largest mutual fund manager in the past three years, for example, by managing the funds by itself and then distributing them through "rented" networks at a range of brokers.

Some other western banks retort that such strategies could prove short-lived. One reason is that "renting" distribution space in the retail market leaves foreign companies at the mercy of domestic groups. But, in the wholesale market as well, independent foreign companies cannot match the client network of their domestic rivals, who have developed corporate relationships over decades.

This has left other groups, such as Putnam Asset Management, concluding product alliances instead. But others are forming more lasting arrangements as well. Salomon Smith Barney has created a wholesale banking joint venture with Nikko Securities, and may take up to a 25 per cent stake in Nikko. GE Capital has formed another, subtly different, form of "joint venture": last year it formed a joint company with Toho Mutual to market life assurance products. This employs former Toho staff, but is effectively controlled by GE Capital.

Some bankers insist that these mergers and alliances provide an easy way to achieve a distribution system and corporate client network. Salomon Smith Barney claims that its coverage in the wholesale banking sector is now unrivalled by any western firm, and is forecasting profits in its first year of operation.

But these alliances face at least two problems. One is the fiendish management challenge of combining Japanese and non-Japanese corporate cultures. Although the NSSB venture has tried to tackle this by appointing "co-heads" of every department and introducing a single pay scale, this has not been achieved without considerable friction.

The second problem is the unresolved issue of whether a western company will be forced to provide assistance if its Japanese partner fails. GE Capital insists it has completely "ring-fenced" its venture from the liabilities of Toho's old business. But this arrangement may be strained in the coming months, since Toho has just collapsed with Y200bn of liabilities.

What makes Merrill Lynch's own approach particularly intriguing, however, is that it may have found a solution to both these problems. By "cherry-picking" the assets of a company which had already failed, Merrill Lynch has assured that there are no looming liabilities left to emerge. And by hiring the staff, it has also created a ready-made workforce of 1,000 that it can - in theory - control.

But even this approach is not without pitfalls. The manner in which Merrill Lynch acquired the assets meant that Yamaichi's accounts did not automatically pass to the US broker, but instead each account holder recontracted. This created a significant "leakage" of assets. Consequently, although the company has 5,000 accounts, it has assets of only Y625bn, less than half that of Goldman Sachs. Furthermore, in fiscal 1998 it recorded a ¥25bn loss.

These assets are now rising, at around $30m to $40m each day. Mr Smith insists that the company was never seeking fast profits with marketing gimmicks, but was trying instead to develop long-term financial relations with its customers. The model, in effect, is similar to that of US-style financial planners rather than traditional Japanese brokers, he claims.

To achieve this new business style the company will need to educate not only its salesmen but also their customers into a new style of selling mutual funds. Although Merrill Lynch is trying to reform its management practice to create equal incentives for all its staff, it admits that imparting a new style of business to Japan will not be an easy task.

"We always said this would be a multi-year effort," says Mr Smith. "I think the real outcome is to be judged a few years from now."


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