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COVID-19 pushes Japanese firms to overhaul supply chains



When China went into lockdown a year ago following the coronavirus outbreak, Japanese automakers operating key factories there or procuring parts from the country saw their production thrown into chaos.


The heavy reliance on China was not just about cars and auto parts. In Japan and many other countries, people faced shortages of masks and protective gowns, many of which come from China.


For companies, reducing supply chain dependence on China had been on their minds over the past few years as trade conflict between Washington and Beijing intensified. But the global health crisis served as a wake-up call, forcing them to review their strategies.


U.S. President Joe Biden’s signing of an executive order in February to review U.S. supply chains for critical items, including pharmaceuticals and semiconductors, also shows that other countries share the concerns.


Thanks to a government subsidy program, though, some Japanese firms are shifting their manufacturing bases from China to Japan and Southeast Asian nations in hopes of reducing their exposure to disruptions.


But with China being the world’s factory for so long, is it really possible to become less reliant on the country?


Ace Japan Co., a Yamagata-based firm that makes drug ingredients and pharmaceutical intermediates, is one company that decided to retool its supply chain.


“We had been actually thinking about it before the coronavirus outbreak, but the pandemic really forced us to go ahead with it,” said Yoshinori Maeda, administration manager of Ace Japan.


The firm has been importing about 80% of materials needed for its products from China, India and Southeast Asian countries, but procurement became less stable from the second half of 2019.


That was because of tighter environmental regulations in China, which shut down plants producing chemical materials that India and other countries were also importing. Then came the COVID-19 pandemic, forcing other similar plants to halt operations as well to prevent infections.


“We had no choice but to make the decision to manufacture the materials by ourselves,” said Maeda, adding that the firm had been doing research and development to prepare for such a situation.


However, it came at a price.


“In terms of production costs, they will be nearly double compared with what we paid for the imported materials,” said Maeda.


Still, what Ace Japan will get in return is stable production and procurement.


Since the COVID-19 crisis has disrupted global supply chains, domestic pharmaceutical firms have been looking to secure more drug ingredients from Japanese suppliers such as Ace Japan, Maeda said.


Fortunately, Ace Japan was able to receive a subsidy offered by the Ministry of Economy, Trade and Industry to encourage companies to shift their production bases to Japan.


The program is for companies whose production is concentrated in certain countries or those producing goods vital for the health of people in Japan. It covers up to two-thirds of the costs for small and midsize firms, up to a maximum of ¥15 billion.


The government allocated ¥306 billion for the program in its budget last year, and it has approved 146 applications so far. It has been soliciting more applications, with another ¥210.8 billion earmarked for the program.


In the past, the government has funded domestic companies making capital investments, but this is probably the first program specifically targeting a shift toward domestic manufacturing to reduce the concentration of production overseas, a METI official said.


But the official said it is not the the government’s intention to bring production that moved overseas back to Japan wholesale.


“We are not using terms like ‘reshoring’ and not thinking that this program is meant for that purpose,” he said, adding that concentrating production in Japan would be problematic as well.


“Our intention is to strengthen supply chains by diversifying them as much as possible, so companies can continue their operations even when they face various risks.”


It also aims to secure domestic production of some products critical to people’s health, such as face masks, as the country faced severe shortages of those items.


The trade ministry has introduced a subsidy program for companies wishing to move their production bases to Southeast Asian nations as well. That shift had actually been taking place before the COVID-19 pandemic to a certain degree because of the trade war between the U.S. and China.


But it is difficult for many firms to scale down their dependence on China because of the country’s advantage in terms of costs and resources, said Yuji Miura, a senior economist at the Japan Research Institute.


“When you think of production bases that can produce at scale and meet delivery times as well as clients’ cost needs, China is the choice for many products,” said Miura.


It’s true that the U.S.-China trade war and the pandemic have prompted many companies to review their supply chain strategy. But Beijing will likely remain the world’s factory.


According to the 2020 China Business Report by the American Chamber of Commerce in Shanghai, 70.6% of over 200 respondents said they were not planning on shifting their production bases from China.


This is partly because Chinese firms are becoming more technologically advanced with more skilled engineers.


That may be evident in Apple’s list of suppliers, as Chinese companies have increased their presence over the past decade, Miura said. With the better automation and labor-saving technology that China has heavily invested in, the nation’s production efficiency is likely to improve, making it more attractive as a global workshop, Miura said.


On top of that, it makes economic sense for businesses to manufacture goods in a country with one of the largest markets in the world.

With all that in mind, one solution is to seek a balance by diversifying the network to other countries, such as Vietnam, Thailand and India, over the next few years.


“It has to do with how heavy the dependence (on China) is,” Miura said.


But diversifying supply chains is not the only thing necessary to ensure the stable procurement of parts and materials. What is also crucial is to be able to grasp the fact that complicated supply chains consist of multiple tiers, Miura said.


For instance, after supply chain disruption caused by the Great East Japan Earthquake in 2011, Toyota Motor Corp. created a system that visualizes the situations of its suppliers including nondirect partners.


Before launching this system, it took about two weeks to spot supply chain problems — now the automaker can identify them in half a day. Thanks to this improvement, Toyota said it was able to avoid running out of inventory when the lockdown was imposed in China during the early stage of the pandemic.


Daikin Industries Ltd., a major air conditioner-maker, is also one of the companies aiming to better understand the inventory of its suppliers, thereby enabling the firm and its supply chain partners to share information in real time.


“We have been undertaking this issue since the quake (in 2011), but it was not enough,” as the firm was unable to efficiently collect information on its suppliers outside of the top tier that don’t provide parts directly to Daikin, said Takashi Abe, a Daikin spokesman.


To find out what was going on with parts makers, Daikin had to rely on contacting them by phone and email, prompting the firm to realize the need to create better a system visualizing the supply chain network and share information with partners.


Daikin, which has built more than 85 production bases in 28 countries, has the principle of “local production for local consumption,” since air conditioners are seasonal products that need swift delivery to markets.


Daikin uses global channels for parts procurement according to their price competitiveness. But since the pandemic highlighted that procurement was actually concentrated in China, Daikin had to make adjustments, such as having its plant in Thailand manufacture compressors that it would normally make in China.


Still, if the lockdown in China had continued for longer, it might have forced the firm to halt production, Abe said.


“We were purchasing some parts from only one supplier, but we are now considering diversifying and also keeping more stock to downplay risks even though it will increase costs.”

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