Monday, 25 April 2011

Japan's earthquake must force JIT supply changes

It is, perhaps, ironic that the first country to adopt Just-in-Time (JIT) supply techniques avidly should now be the cause of a rethink on JIT global supply chain deliveries that could leave Japan worse off.

JIT supply issues have done much to cut costs by reducing inventories at every level of the supply chain. The West's outsourcing of much production to Far Eastern countries, particularly China, has also raised living standards of their peoples sharply and helped western countries keep a lid on their inflation through cheaper imports. As a technique, therefore, JIT is here to stay but as the Japanese quake and tsunami of March 11 clearly showed, many supply chains have become too rigid and wedded to outsourcing components to low-labour cost countries prone to high earthquake risks, floods and typhoons. "In many cases, tightly stretched global supply chains do not make sense any more," said Robert Martichenko, chief executive of Leancor, a US logistics company.

In my blog of April 23, 2010, headed: " Has volcanic ash lessons for logistics?" which touched on the supply chain effects of the Icelandic volcanic eruption, I warned that "vulnerability to disruption must be reduced." That disruption was on a far lower scale than last month's Japanese quake but big enough to spur a JIT rethink. But it is clear that many companies have failed to put in place back-up plans to cope with emergencies like the Japanese catastrophe. They were content to place all their eggs in one basket like Japan or China owing to low production costs while ignoring the obvious risks of natural disasters. But even where companies had a disaster-recovery plan in place, room for manoeuvre depends largely on the nature of the industry. What use, for example, is a disaster-recovery plan if parts cannot be duplicated outside of Japan, as is the case with parts for Boeing jets?

The degree of dependence on Japan for critical parts is alarming. Japanese factories produce about 40% of the world's electronic components and Hitachi Chemical has 70% of the global market for a type of slurry used by chipmakers to polish wafers, and its plant was damaged by the tsunami. In China, mainly in Guangdong province, 80% of the world's basic electronics components production, along with a great deal of final assembly, shows the potential for disruption here to affect global industries. In such industries there are few opportunities to mitigate the consequences of severe natural disasters in south-eastern China.

The March 11 quake and resultant tsunami expose the over reliance on one source of component supply. The costs, this time around, are so huge that, hopefully, some lessons will be learned and acted upon. Japan's earthquake and tsunami are estimated to have cost the three big Japanese car makers at least a $1 billion hit to profits. One consultancy estimates that the tsunami-related disruption will cut worldwide light vehicle output by 2.7 million vehicles in this year's second quarter of which one million will be in Japan and 475,000 each in North America and Europe. In Britain, Toyota was the third car company to announce production cuts owing to the Japanese quake. Toyota's plants in France, Turkey and Poland will also be subject to cutbacks.

In time, rising production costs in China will favour a shift of production back to countries concerned to have a more secure source of supply unaffected by natural disasters. There are, however, other reasons favouring a production shift back to regions close to their markets, like flexibility to react to market changes more responsively. This process has already begun but it is not to argue that countries like China and Japan should be eschewed entirely as a manufacturing base for components. Rather, China and Japan should be considered as only one of several supply sources so that disruption in one country can quickly be compensated by production ramp ups elsewhere . This will require key investment in more geologically and climatically favourable countries.

The problem for many global corporations is that they are mesmerised by cheap production costs in disaster-prone countries. They know the natural disaster risks but feel that their infrequent occurrences on a major scale justifies the risks. But the past record of natural disasters is no guide to future trends and so, hopefully, the Japanese quake last month will be a wake up call for greater diversity of supply. Nature, is should be added is not the only threat to the supply chain. There are also significant political risks.

Uneasy though it is for me to assume Cassandra's role, I have strong feeling that a natural disaster, be it seismic or flooding, will slam south-east China within months, despite this area's
relatively low seismic activity. The last serious quake to strike Guangdong was in 1918, leaving around 1,000 dead. Another severe quake here could, perhaps, test the global supply chain in some products to almost breaking point, unless companies act now.

It is a tragedy that when history is ignored it becomes as dust-laden garbage. It becomes far greater and crasser tragedy still when it is deliberately ignored for commercial expediency. History, after all, can bight back.

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