How to Manage Retention of High-Performer and High-Potential Employees in Japan

February 26, 2025 [No. 134 – 2024]

 

Prof. Kuriyama Naoki
Faculty of Business Administration
Dean of the Graduate School of Economics, Soka University

 

 

 

In the 1980s, attention focused on Japanese management due to its international competitiveness. Doeringer and Piore's internal labor market theory presented a persuasive theory about the factors underlying its strength. This theory explained the benefits of an internal labor market as follows: based on the assumption of employment security, employees avoid pressure from the external labor market and are able to obtain preferential rights and privileges through promotions, transfers, etc. The effect of the internal labor market favors the development of skills within the company. Through a long period of employment, the company has the peace of mind of knowing that it can gain the return of its investment in training, and through the formation of company-specific skills, employees generate a competitive advantage that is inimitable at other companies. These are benefits that stay in the internal labor market. This was a factor in the spread of on-the-job training (OJT) in Japan. It led to the creation of an environment in which senior employees actively transfer their skills to junior employees.

In a revised version of their theory, Doeringer and Piore emphasized that internal labor markets are not formed purely based on economic rationality. Instead, they function based on complex factors, including social, cultural, and historical elements. The late Dr. Ikujiro Nonaka explained that Japanese companies are always able to secure the inflow of high-quality middle management based on the functioning of the internal labor market. This level of management is an intersection point that receives information from higher-level management and information from lower-level employees. The exchange and integration of this information leads to knowledge creation at Japanese companies.

When you consider that the labor mobility rate (turnover rate) for all employees has remained low (around 10%) over a long period of time, it is clear that Japanese companies are based on an internal labor market. As a result, even now, Japan's unemployment rate is the lowest among major countries, at the 2% level. The youth unemployment rate is also remarkably low compared to other countries, at 4.2% in 2022.

In Japan, the seniority system is important in making the internal labor market function well. This system ensures that employees' income increases based on their years of service. To promote long-term employment, the system also has to limit young employees' starting salaries and create a slope that ensures they expect higher wages for longer service. Therefore, there has been social standardization in Japan that keeps starting salary levels remarkably low compared to other industrialized countries. Major recruitment is based on new graduates, and both large corporations and SMEs have been able to hire large numbers of new graduates based on a starting salary market rate aligned at a low level. This standardization provides benefits to companies from many perspectives. Due to the so-called "mass hiring" of new graduates (simultaneous recruitment by all HR departments starting on April 1), companies have been able to save greatly on the transaction costs for individual hires.

However, in the past two or three years, turnover of high performers and high-potential employees has increased abruptly. This is due to changes in the industrial structure, the labor shortage, and increased activity in the external labor market. Even in Japan, the necessity of retention is now being emphasized. In the past, this issue was handled through variable pay, such as bonuses and allowances. However, it is notable that some companies have finally begun to increase their fixed pay (starting salary or basic salary considered as fixed labor cost) and are making efforts to hire top talent. However, this creates a difference in the starting salary of senior employees hired under the previous system and the starting salary of newly hired junior employees. Increased dissatisfaction among senior employees, who think this is unfair, has been reported. It is possible that unfairness in the workplace could disrupt the spirit of collaboration with others, which is another advantage of Japanese companies. Various companies in Japan are therefore facing a new challenge with respect to employee retention.