Friday, 15 July 2011

China poses high JIT supply risks

Logistics industry 'experts' are beginning to question the practicality of just-in-time (JIT) manufacturing following natural disasters like Katrina, Iceland's volcanic ash cloud and Japan's costliest earthquake in March but there is nothing wrong with the JIT concept, and its savings will ensure its permanence. It is the need to diversify supply sources which must be addressed, even if that means financing new investment in areas less prone to natural disasters and, perhaps, paying higher prices through less advantageous economies of scale.

Businesses cannot feign ignorance of the natural risks to the global supply chain and their stupidity of putting too many eggs in one basket. Insurance companies have long since developed models of the likelihood of earthquakes, floods, hurricanes and tornadoes for America and other countries. The simple fact is that global corporations were mesmerised by the low production-cost economies of the Far East and so were prepared to brush aside supply chain disruption risks

Japan's March earthquake and tsunami caused over $300 billion in damage, reveal Government estimates, but its broader impact on the global economy may prove even more profound. As I warned last year in my blog: "Has volcanic ash lessons for logistics," the Icelandic eruption was a wake up call to reassess JIT techniques. Japan's tremblor was more of a thunderclap call because Japan is home to nearly 100 manufacturing choke points that would affect businesses worldwide.

Japan, however, is not the only worry about risks to the JIT-oriented global supply chain. A similar crisis in China's heavily industrialized Guangdong province could have even more widespread economic effects. In my April 25 blog: "Japan's earthquake must force JIT supply changes," I mentioned that Guangdong produced many electrical products upon which the world depended for its JIT supplies and which was also exposed to disruption from natural calamities. I even warned that "south-east China will be slammed by a natural calamity, be it seismic or flooding, within months." Just two months later much of south-east China and elsewhere was deluged by the worst floods in 55 years, directly affecting 37 million people, causing over $5 billion of damage, killing over 200 people and destroying or damaging over 500,000 homes. It seems that this time round those export industries in Guangdong were not seriously affected but the lesson is clear. Global industries must now wean themselves from total dependence on China for its purchases.

The risks, however, do not end with natural calamities. There are also political and mercantile risks as the recent spat over China's almost monopoly grip on rare earth elements (REEs) demonstrates. There is nothing rare about the 17 rare earth elements but they are essential for communication devices, weaponry, computers, hybrid cars and flat screen televisions, to name but a few. The disturbing fact is that China has 97% of total world production. It also has the biggest reserves, about 36% of the world's total. China recently announced its export quotas for REEs would remain unchanged for 2011 but the inclusion of rich "ferro alloys" in the quota system means a fall in rare earth exports of 10%. Consequently, some rare earth prices have risen 10-fold this year.

China's reliability must also be questioned following its cuts of REEs to Japan last year after a diplomatic dispute. Mining companies are now rushing to develop new deposits in America, South Africa, Australia and other countries but these supplies will not be available for another year or two and there still needs to be investment in capacity to refine and fabricate them.

If natural disasters are not enough to convince global corporations to reassess their JIT practices then perhaps when both nature and the dark side of mercantilism combine forces to squeeze supplies the lesson will be learnt. Wiser heads, however, will not wait that long.