Lessons from Broken Japanese Supply Chains


07/11/2011 By Dr Harald Malmgren

Some analysts are forecasting a capital spending rebound in Japan as businesses “rebuild” after the Great Earthquake of March, 2011.  I believe a new wave of Japanese corporate investment is likely – but it is not evident where such investment will take place, whether at home or abroad.

Many Japanese manufacturers have learned hard lessons from breakdown in supply of specialized parts and components caused by the combination of earthquakes, tsunami, and nuclear power generation disruptions.  Among the lessons learned:  (1) single source suppliers pose high risk to global operations; (2) long supply chains may be more risky than shorter supply chains with production hubs closer to markets; (3) just-in-time inventory management may be cost efficient, but limited inventories pose low probability, high impact risks of disruptions; (4) electric power irregularity can render precision manufacturing facilities inoperable (especially for wafers, semiconductors, and nanotechnology).  These lessons were learned by automakers and are now being studied by corporate managers in many other industrial sectors around the world.

The Japanese corporate sector suffers from aging society and shrinking labor force.  For decades, Japanese manufacturers exploited computerized “intelligent manufacturing” in order to increase productivity.  This process of substituting capital for labor through computerization also provided collateral benefits, most notably advances in precision manufacturing and improved quality control.  Japanese companies also built production facilities in other nations to exploit more plentiful labor supplies and closer proximity to markets.  This resulted in gradual “hollowing out” of manufacturing inside Japan.

Looking forward, the Japanese corporate sector will likely step up capital spending.  However, with long experience in establishing production in a multiplicity of nations and continents, Japan’s corporate sector has a choice of whether to rebuild facilities inside Japan or expand and upgrade abroad.  The Yen continues to hover at a noncompetitive level of ¥80 to the dollar.  Domestic economic policy remains bogged down in political paralysis.  Nuclear plants are one by one being shut down for inspection, and as public confidence has fallen in electric power companies’ mastery of nuclear power, it is becoming harder to restart the power plants when they are shut down.  The future electric power capacity of Japan has become uncertain.  High value added, computerized precision manufacturing cannot be sustained in a context of inadequate or uncertain electric power capacity.  Added to these considerations are the painful supply chain lessons learned from the Tohoku/Fukushima disaster.  In response, many large Japanese manufacturers will likely accelerate “hollowing out” by establishing new production facilities in, or closer to, foreign markets or where resources and electric power are more readily available.

In the future, labor costs will be a less critical determinant of geographic location for companies that are moving up the ladder of product and production technologies.  This raises interesting questions about the future deployment of manufacturers in other countries.  For example, electric energy supplies in Germany haves been seriously diminished by the recent political decision to halt nuclear power.  Germany will have to increase purchases of electricity from France, reducing available electric capacity for the Eurozone industrial heartland.  Germany will become more dependent on energy supplies from Russia, which has a long record of manipulating its energy leverage on other countries to achieve broader economic and political benefits.  Germany’s industrial technology profile is similar to that of Japan.  Both rely on exports of machinery and equipment to increase industrial capacity in other nations, and of automobiles dependent on complex, semiconductor based control mechanisms.

Japanese government officials now recognize there is need to discourage faster “hollowing out” of its corporate sector after the Great Earthquake of 2011.  There is need to develop new political consensus on the future shape of the domestic economy and the role of the corporate sector in the future of Japan.  However, during the present extended period of political confusion and paralysis among all political parties in Japan, this does not seem feasible.

There are lessons here in contemplating worldwide reconfiguration of manufacturing in coming years.  The “outsourcing jobs to China story” is already last year’s story.

Chinese labor costs have risen so far that Chinese coastal manufacturers are no longer competitive.  If China is to develop a domestic consumer-driven engine of growth to replace past reliance on its export engine, the government will have to allow wages to rise even more.  In manufacturing, global manufacturers have learned the hard lesson that Chinese quality control is poor, and that using Chinese parts and components for incorporation into products sold in the US leads to breakdowns and expensive product recalls.

Bringing more advanced manufacturing technologies to China to cure the quality control weaknesses simply results in unintended transfer of such technologies as Chinese competitors replicate the industrial technologies, which the foreigners bring to China.

Yes, producing cars inside China for sales to the Chinese will continue attractive, but producing parts, components, and subassemblies in China for incorporation in products sold in the US and other advanced economies is decreasingly attractive.

More important than the fading China outsourcing story is the growing recognition that geographic location of manufacturing needs rethinking, with much less attention to labor costs and much greater attention to considerations of sufficiency of supplies of electricity, especially for advanced, computerized production technologies;, co-location of R&D with rapidly evolving production technologies; likely future costs of oil and energy and their effects on processing, transportation and distribution costs; fiscal and monetary policies and their effects on exchange rates and growth of markets.

The era of ever-expanding supply chains in combination with just-in-time inventory management may have quietly ended, and a new era of calculated redundancy and greater localization may have begun.