Regional Focus

Japan renews focus on supply chains

Published: Oct 2023

Japanese companies led the world with their supply chain management and ‘just in time’ methods. Now, however, the country is looking afresh at supply chain resilience in the wake of natural disasters, Covid lockdowns and to become less dependent on China.

Pile of ripe potatoes in farmers field

Potatoes are a critical ingredient for potato chips and if you’re in the business of making them and you don’t have potatoes, well… you have a problem. This was the situation that Calbee, a Japanese company and major Asian producer of potato chips (or crisps) experienced in 2021. The company sourced the majority of its potatoes from the northern island of Hokkaido, Japan, and when drought hit, the company faced a major potato shortage. According to CNN, it tried to source potatoes from the US, but at the time there was also shortage of shipping containers and prices had skyrocketed.

This was a reminder of the havoc that a supply disruption can cause. And it’s not just a potato shortage that Japan has faced in recent years, as Nikolaus Boltze, Country Representative for Japan at German industrial and technology multinational thyssenkrupp points out. Japan has also been affected by the wider semiconductor shortage. Because of this, in October 2022 it was reported that Toyota was limiting the number of smart keys to one per new vehicle. And in another example of the impact, the train operator JR East faced a shortage of smart metro cards because of the chip shortage.

Such examples have been something of a wake-up call for Japan, which for decades has been viewed as the leader in supply chain management and lean production. The Toyota Production System, for example, gave the Japanese company a competitive edge and its ‘just in time’ methods were admired around the world. As Mireya Solis, Director of the Center for East Asia Policy Studies at Brookings, writes, “Japanese companies were active participants in the supply chain revolution that transformed patterns of international trade and investment and rewired economic integration in Asia.” She continues: “supply chains transformed Japan as well. For starters, economic activity became more closely integrated with overseas production.”

It wasn’t always this way, and Japanese multinationals have gone through different phases. For many years, the entire production process was consolidated and focused in Japan, explains Shujiro Urata, Professor Emeritus, Waseda University, Tokyo. “However, in the mid-1980s when the yen appreciated sharply products made in Japan were less competitive.” For that reason, companies pursued a fragmentation strategy where the production process was broken up into pieces or tasks, with the labour-intensive tasks moving to low-wage locations. “That fragmentation strategy worked very well and was the most efficient production system,” Urata explains.

The days of multinationals just focusing on production efficiencies are long gone, however. Given the issues that Covid exposed, as well as other supply chain shocks such as the semiconductor shortage in recent years, multinationals are now moving from a ‘just in time’ system to a ‘just in case’ system, explains Urata. “Multinationals have to consider the risks – they cannot continue by just looking at efficiencies and the cost of doing business. Before the crisis they just focused on the cost of production; now they have to consider other risks,” he says.

Urata explains that supply chain resilience came into focus after the 2011 earthquake that resulted in the nuclear accident at Fukushima’s power station. “Since then policymakers, business people and researchers became very interested in the possible impacts from disruption to supply chains,” he says. Also, in 2011 there were severe floods in Bangkok, Thailand, which impacted Japanese companies operating there. However, despite shortage of certain parts and components for automakers, which stopped production, the recovery from these incidents were quicker than expected.

Fast forward a decade and the disruption brought by Covid exposed weaknesses in accessing supplies, such as medical equipment. At the same time, economic security has also become an issue – especially in the context of the US-China trade war and Japan (and other countries) wanting to reduce their dependence on China, especially for critical materials.

Reducing the dependence on China is both because of China’s perceived security threat and because of the concentration risk of having so many supplies being sourced from a single country. “The issue of supply chain resilience has been there for many years and has been heightened by these security-related issues,” comments Urata.

Thyssenkrupp’s Boltze puts this in a wider context. From a geopolitical viewpoint, Japan is an island nation that does not have any natural resources, such as raw materials or fossil fuels. Because of this, explains Boltze, “Japan is highly dependent on a ‘free and open Indo-Pacific’ with uninterrupted shipping routes.” The Japanese government, as well as industry, are fully aware of the implications of this situation, he notes. However, “the earthquake of 2011, the recent Covid lockdowns, and the US-China trade tensions are shifting priorities even more towards the topic of resilient supply chains,” comments Boltze.

The Japanese government has been improving such resilience and has introduced a number of measures. For example, Urata explains there were two specific programmes that were proposed: a subsidy for companies reshoring back to Japan, and another programme to help companies diversify away from China to ASEAN [the Association of Southeast Asian Nations]. From an economists’ perspective, many researchers were not in favour of the first programme, explains Urata, because of the concentration of risk in focusing production in Japan. “We have many earthquakes,” he comments.

The heightened attention to economic security has led the Japanese government to take action at the highest levels. In February 2023, for example, Reuters reported that officials from South Korea, the US and Japan held an economic security meeting to discuss supply chain resilience in the context of a more assertive China. There have also been reported concerns about the disruption that increased cross-Strait tensions could bring to multinationals in the region. In light of such geopolitical tensions, and a need to decrease dependence on China for supplies, especially critical materials, there has been a move towards ‘friendshoring’, where supplies are sourced from countries that are deemed to be political and economic allies.

In May 2022 Japan’s parliament approved the Economic Security Act which supports Japanese companies that are intending to diversify their supply chains. This act covers areas such as securing the stable supply of important products; securing Japan’s critical infrastructure; making its critical technologies resilient; and providing more protection for intellectual property in patent applications. A number of goods have been designated as specifically important, including semiconductors, rare earths, medical supplies, fertilisers, ship parts, liquefied natural gas, aircraft parts, cloud applications, antimicrobials, storage batteries, industrial robots and machine tools.

Japan meanwhile has been bolstering its alternatives to China. With raw minerals, for example, the government is exploring ways for the refining and smelting process to be brought to Japan, comments Urata. And with semiconductors, Boltze says, “Japan is clearly on the path to revitalising its own and independent production with a huge effort.”

One way that Japanese companies can avert supply chain disruption is by sourcing from a number of different places. Yuzuka Kashiwagi, Assistant Professor, Department of Business Economics, School of Management, Tokyo University of Science comments, “There is still a lot of room to improve diversification in Japanese firms,” adding that this diversification is also good for economic growth in the longer term. However, there is a reluctance by some companies to diversify their suppliers because some of their company information is confidential and they do not want to widely share their company practices.

Also, the nature of Japanese supplier relationships is typically less flexible when compared to European companies, Kashiwagi comments. In Japan, there is an emphasis on long-term relationships, and this sometimes means that efficiencies – and flexibility in stopping and starting contracts – can be sacrificed in favour of maintaining these bonds. Many of Japan’s big-name brands do not produce the goods themselves, but rather operate a ‘keiretsu’ model that comprises a network of smaller companies, which may be exclusive suppliers, that fall under the umbrella of the large brand. These relationships are particularly sticky and long-standing, which may mean companies are reluctant to make changes in favour of diversification.

One area that could be improved, notes Kashiwagi, is the communication and information sharing within supply chains. She points to the system that Toyota Motors introduced, called RESCUE (Reinforce Supply Chain Under Emergency) which is a database of supplier information that can identify if there is a problem and update with accurate information in order to avoid supply disruption.

For non-Japanese multinationals that are seeking to diversify away from Japan, they may find they cannot find alternative countries to source certain goods. Kashiwagi comments that while non-Japanese multinationals may be able to switch suppliers easily, because they have more flexibility in their supply chains, with Japan this may not be the case because its companies offer unique products. This point is echoed in Solis’ paper entitled ‘The Big Squeeze: Japanese Supply Chains and Great Power Competition’: “Japanese firms developed core competencies in advanced materials, high tech inputs, and sophisticated machinery, thereby becoming a technological pivot of the Asian supply chain.” Although Japan may have been overtaken by South Korean and Chinese rivals in the consumer electronics market, “examples abound of the critical role that Japanese advanced inputs and machinery play in strategic supply chains in the Asia-Pacific region.” With smartphones, for example, Japanese firms supplied 23% of the total value of parts for the Huawei P30, Solis writes.

Given its expertise in certain sectors, Japan is working on becoming a more attractive destination for foreign direct investment. On the question of whether Japan will be able to attract multinationals to its shores in this way, Urata comments that in recent decades the country has struggled to do this. He cites the language barrier as a major impediment to doing business in Japan. Urata comments that the ratio of inward foreign direct investment (FDI) to GDP for Japan is one of the lowest in the world, while the outward FDI/GDP ratio for Japan is one of the highest. “There has been general interest by the Japanese government to attract FDI investment with the hope that foreign capital will revitalise the economy,” says Urata.

The country has been having some success in this regard, however, Boltze gives several examples of German companies that have been investing in Japan, and says that many non-Japanese multinationals are relocating their regional headquarters, sourcing departments or sales coordination units from China (including Hong Kong) to Japan. Bosch, the German engineering and technology company, invested Y39bn in a new research and development facility in Yokohama. And in another example, Evonik Industries, a German chemicals company announced in February 2023 that it has invested in fumed aluminium oxide production plant expansion for battery applications in Yokkaichi, Japan. “As the only G7 country in Asia, Japan is benefiting from its political stability and economic strength,” says Boltze. Also, he notes, labour costs are reasonable, and combined with a certain degree of automation, the country is attractive as a production hub.

As Japan works on these measures to improve supply chain resilience, for both its own companies as well as foreign multinationals, it will enter a new phase where production won’t be focused on efficiencies and ‘just in time’ production but rather a ‘just in case’ approach.

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