As a result of the combination earthquake/tsunami in Japan, “manufacturing executives from San Mateo to Stuttgart are scrutinizing production schedules, searching for backup suppliers, and figuring out how to cope with rising component prices.” [“Now, a Weak Link in The Global Supply Chain,” by Bruce Einhorn, Tim Culpan, and Alan Ohnsman, Bloomberg BusinessWeek, 17 March 2011] Einhorn, Culpan, and Ohnsman report that this particularly true for electronics manufacturers. They explain why:

“Japanese factories produce about one-fifth of the world’s semiconductors and 40 percent of electronic components, according to CLSA Asia-Pacific Markets. Sony makes 10 percent of the world’s laptop computer batteries, and other Japanese companies are the dominant suppliers of chemicals that manufacturers need to make chips. ‘Japan has higher and higher market share of specialty materials as you go up the supply chain,’ says Tony Tseng, an analyst in Taipei with Bank of America Merrill Lynch.”

For companies that maintain substantial levels of inventory, sporadic, short-term supply interruptions are not a big deal. For example, Einhorn, Culpan, and Ohnsman report that “big players such as TSM [Taiwan Semiconductor Manufacturing] keep a four- to six-week stock of chemical products used to make chips, so uncertainty about maintaining supply from Japan is not a problem for now.” But maintaining inventory raises costs and so for years many companies have used a “just-in-time” (JIT) supply chain strategy. The logic behind JIT is undeniable. As Michael Hugos explains in his book Essentials of Supply Chain Management, “The idea is to minimize the assets and cash tied up in inventory.” An article from the web site Accounting for Management provides a more detailed explanation:

“Under ideal conditions a company operating a JIT manufacturing system would purchase only enough materials each day to meet that day’s needs. Moreover, the company would have no goods still in process at the end of the day, and all goods completed during the day would have been shipped immediately to customers. As this sequence suggests, ‘just-in-time’ means that raw materials are received just in time to go into production, manufacturing parts are completed just in time to be assembled into products, and products are completed just in time to be shipped to customers. Although few companies have been able to reach this ideal, many companies have been able to reduce inventories only to a fraction of their previous level. The result has been a substantial reduction in ordering and warehousing costs, and much more efficient and effective operations. In a just in time environment, the flow of goods is controlled by a pull approach. The pull approach can be explained as follows. At the final assembly stage a signal is sent to the preceding work station as to the exact amount of parts and materials that would be needed over the next few hours to assemble products to fill customer orders, and only that amount of materials and parts is provided. The same signal is sent back to each preceding workstation so a smooth flow of parts and materials is maintained with no appreciable inventory buildup at any point. Thus all workstations respond to the pull exerted by the final assembly stage, which in turn respond to customer orders. As one worker explained, ‘Under just in time system you don’t produce anything, anywhere, for anybody unless they ask for it somewhere downstream. Inventories are evil that we are taught to avoid’. The pull approach described above can be contrasted to the push approach used in conventional manufacturing system. In conventional system, when a workstation completes its work, the partially completed goods are pushed forward to the next work station regardless of whether that workstation is ready to receive them. The result is an unintentional stockpiling of partially completed goods that may not be completed for days or even weeks. This ties up funds and also results in operating inefficiencies.” [“Just in Time (JIT) Manufacturing and Inventory Control System“]

Up to this point, the benefits of JIT have been extolled and none of the risks revealed. The article just cited does eventually expose JIT’s Achilles’ heel. It explains:

“JIT manufacturing also opens businesses to a number of risks, notably those associated with your supply chain. With no stocks to fall back on, a minor disruption in supplies to your business from just one supplier could force production to cease at very short notice.”

In other words, JIT supply chains are efficient but brittle. As a result, “from the Birmingham Post to the Christian Science Monitor via the Korea Herald, the severe impact of the earthquake and tsunami in Japan on global companies is making observers question the risks implicit in the country’s ‘vaunted “just-in-time” approach to business’ (as the New York Times put it).” [“Just-in-time is not past its sell-by date,” by Andrew Hill, Financial Times, 21 March 2011] As the headline states, however, Hill doesn’t believe that JIT’s time has come and gone. He continues:

“This veiled indictment of modern supply chain management implies that companies were irresponsible to expose themselves to the aftermath of a once-in-a-generation earthquake. Like the French with their Maginot Line, they should have been building rigid and expensive fortifications to see off future threats. But I predict few businesses will have their profits eviscerated, most will suffer no lasting impact, and all will continue to favour the leanest possible supply chain in future. No one outside business (and possibly few within) takes much interest in the chains that link supplier, manufacturer, distributor and end-customer – until they break. Everybody remembers high-profile product shortages.”

I’m a little more sanguine than Hill when it comes to the level of interest that businesses take in supply chain operations. Companies from Cargill to IBM to FedEx to UPS have heavily advertised the benefits of better supply chains and efficient logistics. Hill believes that just-in-time logistics will ride out the current disaster because parts shortages, he believes, are generally less costly than “product or inventory gluts.” He provides one costly example of such a glut:

“In 2001, Cisco – the technology company that touted itself as a model of inventory management, able to monitor revenues by the hour – misread the post-bubble collapse in demand for its products. It had to write off $2.5bn in unsold stock and lay off thousands of workers. John Chambers, chief executive, called the slump a ‘100-year flood’. If only such crises were that infrequent.”

Hill believes that companies should count on disruptions and have plans in place to mitigate them. He writes:

“When a natural disaster occurs, it disrupts supply in obvious ways – a gap in the shipping of Japanese-built products to North America – and less obvious ones. One Taiwanese chipmaker, with no direct supply chain link to Japan, had to re-route its data feed after a subsea cable was unexpectedly cut by this month’s earthquake. This is what business continuity plans are made for. … The wider point, however, is that the short-term disruption should force companies to reassess just how resilient their supply chains are – and to integrate continuity planning and risk management into the apparently simple task of getting component to customer promptly.”

To learn more about supply chain risk management, read my four-part series on “Supply Chain Risk Management and Disaster Mitigation” [Part 1, Part 2, Part 3, Part 4]. Hill continues:

“As my colleague Gillian Tett pointed out, … companies may have inadvertently increased their exposure to potential supply bottlenecks. More companies now source more goods and components from the same faraway markets, using the same routes. But supply chains have also evolved in other ways for the better. Some have become shorter. Local supply of components to, say, Japanese carmakers in France helps cement community acceptance of inward investors, as well as reducing environmental impact. By sourcing clothes from Turkey or eastern Europe rather than Asian markets, retailers such as Zara of Spain or Marks and Spencer in the UK offset the higher unit cost with lower transport bills and can boast about a greener supply chain, while reacting more quickly to fashion trends.”

If you have been following my posts about challenges created by events in Japan, you know that I agree with Hill that regionalization of supply chains (i.e., making supply chains shorter) is likely to occur at an increasing pace. Hill continues:

“At the same time, the technology that companies use to keep tabs on their inventory has improved. Supply chain managers have learnt how to track goods more accurately by copying techniques used by armies or charities in the very emergencies that mess with companies’ business continuity: wars (the delivery of munitions) and disaster areas (the supply of medicine and food). In the process, managers operating the tightest chains have fostered relationships with suppliers and customers that equip them to react more flexibly to any disruption. ‘They respond in a very creative way to threats,’ says Dominic Elliott of the University of Liverpool.”

Flexibility and adaptability are two terms liberally used in discussions about future supply chains. Building flexibility into a JIT system that favors brittleness (i.e., the leanest possible system) is not as easy as it sounds. Hill concludes:

“Jin Whang at Stanford’s Graduate School of Business says the ideal supply chain will be both agile and robust – a hard balancing act to achieve. But once companies have been able to assess the impact of the Japanese disaster, they won’t start fattening up supply chains. Dread of a Cisco-style inventory glut and global competition mean they simply cannot build expensive buffers. In other words, not only is it wrong to scapegoat the just-in-time model, it is pointless: supply chains will emerge from this crisis – as they have from past crises – older, wiser and, undoubtedly, leaner.”

I agree with Hill that supply chains will probably emerge from this latest crisis both “older and wiser.” I’m not so sure that they will be “leaner.” Both robustness and flexibility require some redundancy. A robust and flexible supply chain can’t be leaner and incorporate a calculated amount of redundancy. Does that mean that I disagree with Hill’s assessment that “just-in-time is not past its sell-by date”? It doesn’t. In fact, on that point, I believe that Hill is dead on. Business executives understand that global competition requires them to operate their companies as efficiently as possible. Companies that manage to create agile supply chains and have solid business continuity and disaster mitigation plans in place are the ones you will still be reading about fifty years from now.