Operations Management- Case 2

ACRJ This case was prepared by Dr Bin Jiang and William Willette of The University of Texas at Arlington, as a basis for classroom discussion rather than to illustrate either effective or ineffective han- dling of an administrative or business situation.

Please address all correspon- dence to: Dr Bin Jiang, Department of Information Systems and Operations Management, The Univer- sity of Texas at Arlington, Box 19437, 535 Business Building, Arlington, Texas 76019-0437, USA. E-mail:

[email protected] ASIAN CASE RESEARCH JOURNAL, VOL. 8, ISSUE 1, 37–56 (2004) © 2004 by World Scientific Publishing Co. Why Giants Change Their Minds BACKGROUND INFORMATION Ten years ago China’s endless supply of cheap labor pro- duced an endless supply of cheap (and often shoddy) products, primarily toys and textiles. China still makes those plus much more. It is now the world’s fourth-largest indus- trial producer behind the U.S., Japan and Germany. China produces more than 50% of the world’s cameras, 45% of its microwave ovens, 30% of its air-conditioners and televisions, 25% of its washing machines and nearly 20% of all refrigera- tors. Now China is emerging as the workshop of the world.

The ability to make nearly anything in China with high quality at a very reasonable cost, then sell it to customers both near and far, is having a big impact on multinational companies.

Most large, multinational, manufacturing firms, rang- ing from consumer personal care companies such as Johnson & Johnson and Unilever to auto manufacturers such as Gen- eral Motors and Volkswagen and high tech manufacturers such as Intel and Dell, have developed production and export bases in China. Sino-international joint ventures are even more numerous. How to integrate China into their glo- bal supply chain systems is becoming a popular topic for multinational companies (MNCs).

According to A.T. Kearney’s “2002 FDI Confidence Index”, the United States lost its lead in the foreign direct investment (FDI) attractiveness race to China. For the first time in five years, the United States was knocked out of the top spot as the number one foreign investment destination 38 ACRJ for global investors from the world’s largest 1,000 corpora- tions (Table 1). Nearly one-third of senior executives from the world’s largest 1000 MNCs are looking to China for first-time investments over the next three years, three times more than those interested in entering the United States. For foreign in- vestors with operations throughout the world, China’s entry into the WTO (World Trade Organization) is a good opportu- nity to shift production bases from their home countries and other Asian countries to China. Further to China’s benefit, the anti-terrorism campaign and security concerns in coun- tries such as Malaysia, Indonesia and the Philippines may further lessen their attractiveness to MNCs’ executives.

In China, most FDI inflows go into building manufac- turing facilities for foreign-invested enterprises (FIEs) rather than into financial assets like stocks, bonds or other service industries. There are more than 400,000 FIEs in China, and most of them concentrate on manufacturing industries. For- eign investors are finding that using China as a manufac- turing and export base is often more profitable — and almost always far easier — than selling goods inside the country.

The result is that China, once viewed by wide-eyed execu- tives as the market of future riches, has instead become the world’s factory floor. Today, FIEs contribute more than half of all China’s exports. Table 2 shows the significant role of FIEs in China’s exports. This means that China’s emergence as a reliable, stable producer of high-value, technologically- sophisticated products is rewriting the economics of a wide range of global manufacturing industries and their global Rank 2002 2001 2000 1999 1998 1 China U.S. U.S. U.S. U.S.

2 U.S. China U.K. China Brazil 3 U.K. Brazil China U.K. China 4 Germany U.K. Brazil Brazil U.K.

5 France Mexico Poland Mexico Germany Table 1. The FDI Confidence Index Source: A.T. Kearney, “FDI Confidence Index”, September 2002. WHY GIANTS CHANGE THEIR MINDS 39 supply chain systems, not just in industries that are labor intensive.

Matsushita and Sony, the two largest consumer elec- tronics makers in Japan and in the world, inevitably stretched their supply chains to their low-cost manufacturing neighbor, China, to reduce costs. Among Matsushita’s 144 overseas manufacturing subsidiaries, 49 of them are scattered Table 2. FDI Flows, Total China’s Exports, FIEs’ Exports Performance (1980–September 2002) FDI (billions of US$)China’s Exports (billions of US$)FIEs Exports (billions of US$)FIEs’ Share of China’s Export s 1980 na 18.12 0.01 0.0% 1981 na 22.01 0.03 0.1% 1982 na 22.32 0.05 0.2% 1983 1.80 22.23 0.33 1.5% 1984 1.26 26.14 0.07 0.3% 1985 1.66 27.35 0.30 1.1% 1986 1.87 30.94 0.58 1.9% 1987 2.31 39.44 1.21 3.1% 1988 3.19 47.52 2.46 5.2% 1989 3.39 52.54 4.91 9.4% 1990 3.49 62.09 7.81 12.6% 1991 4.37 71.91 12.05 16.8% 1992 11.01 84.94 17.36 20.4% 1993 27.52 91.74 25.24 27.5% 1994 33.77 121.01 34.71 28.7% 1995 37.52 148.77 46.88 31.5% 1996 41.73 151.07 61.51 40.7% 1997 45.26 182.70 74.90 41.0% 1998 45.46 183.76 80.96 44.1% 1999 40.39 194.93 88.63 45.5% 2000 42.09 249.21 119.44 47.9% 2001 46.90 266.16 135.45 50.9% 2002 55.01 325.57 166.94 51.3% Source:China Statistical Yearbook 2001. The data for 2001 and 2002 are taken from the official website of National Bureau of Statistics of China. 40 ACRJ in China; six of Sony’s 35 factories abroad are located in China. However, in 2002 when Matsushita was accelerating its pace on stretching the supply chain in China, Sony unex- pectedly decided to shift some of its manufacturing business in China back to Japan.

ERADICATING AND CREATING: MATSUSHITA’S SUPPLY CHAIN REBUILDING STRATEGY Matsushita’s Embarrassing Loss Since 1993 Matsushita Electric Industrial Co., Ltd, the largest home appliances and household equipment (HAHE) pro- ducer in the world, has competed with low-priced Chinese counterparts in the international market. The managing di- rector Yukio Shohtoku, who is responsible for Matsushita’s overseas business, continuously hears bad news from overseas branches: Chinese producers keep grabbing Matsushita’s market shares by working as OEMs (original equipment manufacturer). Because the Chinese price is be- coming the world price, Matsushita must continue cutting its profit margin to follow its Chinese competitors’ low price, otherwise it will lose more market share in the world.

Table 3 shows the influence of some low-priced Chinese commodities on the U.S. market:

Table 3. The Impact of Chinese Products Price ($) Price ($) Commodities (without Chinese imports) (with Chinese imports)Decrease (%) DVD 491(in 1997) 165 (in 2001) 66.4 Fax Machine 314 (in 1997) 136 (in 2001) 56.7 VHS 157 (in 1997) 70 (in 2001) 55.4 Telephone 19 (in 1997) 12 (in 2001) 36.8 Glass Windshields 27.41/sqm (in 1997) 18.5/sqm (in 2000) 32.5 Source: Nikkei BP Network, National Automotive Glass Consultants. WHY GIANTS CHANGE THEIR MINDS 41 However, in these endless price wars, Matsushita has a fatal weakness — high cost; Chinese labor costs are only one- twentieth of the Japanese and Chinese land prices are only one-thirtieth of the Japanese. Four decades ago, when Japa- nese manufacturers began to beat their U.S. counterparts, the Japanese labor cost was one-fifth of the American. Recalling this experience, Matsushita is very worried about its HAHE segment which is experiencing huge pressure from cheap Chinese substitutes.

To maintain its leadership in the HAHE market, Matsushita believed that the combination of Japanese ad- vanced techniques/parts and Chinese low-cost labor will en- hance its competitive advantage in the world. So it gradually established some assembly lines in China. For example, in 1994 Matsushita established Shanghai Panasonic Microwave Oven Company that was able to produce 500,000 units annu- ally. Since 1987 Matsushita has established 49 subsidiaries or joint ventures in China. All of them import most of their nec- essary parts or materials from Japan and assemble the final products with Chinese workers. Matsushita believed that this operation model could maintain the traditional advan- tage of Japanese products — high quality, and also make use of China’s traditional competitive advantage — low cost la- bor and land. This model greatly helped Matsushita cut its products’ prices. The Shanghai subsidiary’s “Panasonic” mi- crowave oven was thirty percent cheaper than its counterpart made in Japan. Matsushita dreamed that this operation model would eliminate or at least alleviate the impact of low-priced Chinese products.

However, Matsushita’s dream did not come true. The Shanghai subsidiary only produced 120,000 units per year and had to stop producing one month in 1998 to lay off many employees. By the end of 2000, the Shanghai subsid- iary was facing bankruptcy. At the same time, Guangdong Galanz Enterprise Group Co., Ltd, Matsushita’s largest com- petitor of microwave ovens in China and in the world, was producing 12 million units per year and beating the Matsushita’s microwave ovens in every individual market around the world. For other HAHE products, such as DVDs, 42 ACRJ TVs, and refrigerators, Matsushita is facing similar stories: it keeps losing its market share to Chinese counterparts.

The fundamental reason for Matsushita’s loss is high price. The Nikkei BP Network reports, for example, that in the U.S.market, a “Panasonic” iron is $29, but a Chinese fa- mous brand “Haire” iron is only $9.90; a “National” DVD player is $169.99, but a Chinese OEM product under the American brand “APEX” is only $99.99. In China, the cheap- est “Galanz” microwave oven was RMB299 ($36) in 2000, but the cheapest Shanghai subsidiary’s “Panasonic” microwave oven was RMB630 ($76).

Matsushita possesses world-class brand names, cut- ting-edge techniques, perception of high quality, powerful promotion campaigns, and affluent capital, as well as the low-cost Chinese labor in production processes, but it still lost so painfully. The embarrassing loss forced the Matsushita management to think hard about the reasons why it could not organize its valuable resources effectively and efficiently along its supply chain.

At last, Mr. Kunio Nakamura, the CEO of Matsushita, believed that the current supply chain was obstructing the development of Matsushita. He decided to initiate a supply chain revolution in Matsushita, and named his strategy as “Eradicating and Creating.” Rebuilding the Matsushita’s Supply Chain in China Managing director Yukio Shohtoku was in charge of this “Eradicating and Creating” supply-chain rebuilding project.

Before becoming the managing director of overseas business, Mr. Shohtoku worked as the president of Matsushita Electric (China) for six years. His motto is: “Once you are beaten in China, you will also be beaten consequently elsewhere in the world by the winner in China.” He believed that Matsushita would be in an unassailable position in China and in the world as long as its new supply chain could make full use of China’s competitive advantages.

Under Mr. Shohtoku’s supervision and direction, Matsushita began its supply-chain rebuilding project in 2001. WHY GIANTS CHANGE THEIR MINDS 43 Compared to its former supply chain, there are four funda- mental changes in Matsushita’s new supply chain:

Move manufacturing activities to China Matsushita closed its fax machine factory in Germany by the end of 2000, and closed its microwave oven subsidiary and air-compressor factory in the U.S. in 2001. Matsushita is now asking more than 10,000 Japanese employees in its manufac- turing sector to retire early. All of these closed businesses and cancelled job positions were or are being moved to China. By 2005, Matsushita will transfer its one-third of its manufacturing business from Japan and the rest of the world to China.

Establish the new “brain” in China Although Matsushita entered China twenty years ago, there are only around 1000 technicians in China compared to its total Chinese employees of over 30,000. In Matsushita’s former supply chain model, all important parts were de- signed and produced in Japan. China’s subsidiaries only handled the pure assembly tasks. However, the Japanese de- signed the products based on their understanding of Japa- nese manufacturers. For example, Japanese designers would like to increase equipment costs rather than increase labor costs. But in China the labor cost is much lower than in Japan. So the original Japanese design only increases costs in China’s factories. On the other hand, Japanese designers do not know Chinese customers’ demands very well. For example, Japanese customers want the microwave oven with the barbecue function, but Chinese customers rarely taste barbecue.

In February 2001, Mr. Yoichi Morishita, the Chairman of Matsushita, arrived in China just to announce that Matsushita decided to establish a new “brain” — Matsushita Electric R&D Center (China) in Beijing. This center would be the second largest one among Matsushita’s sixteen R&D 44 ACRJ centers around the world (the largest one is in Matsushita’s headquarters). He said that it was too difficult to explain everything about China to Japanese designers; to really make use of China’s special competitive advantages and to really meet Chinese customers’ demands, Matsushita decided to hand over its China-related development and research issues to local researchers and engineers. “We have definitely made up our mind to rebuild our supply chain in China from the very beginning point—the design paper,” Mr. Morishita said.

Localize material supplies After carefully studying China’s logistics industry, Matsushita surprisingly found that not only could it access all its longtime Japanese suppliers in China, but also the Japanese suppliers’ prices in China were twenty to thirty percent cheaper than in Japan. Polystyrene, a common mate- rial in the home appliance industry, is a typical example that explains this unbelievable result.

Because China’s undeveloped infrastructure and re- gional fragment distribution channels make it impossible for polystyrene suppliers to reach as many potential customers as possible and vice versa, the Chinese government estab- lished a national polystyrene distribution and trade center in Zhejiang province. In this center, a customer can meet more than 700 polystyrene suppliers from China and other major polystyrene producing countries. After investigating each supplier ’s price, the center will publish the average prices of different products everyday. Armed with this pricing infor- mation, the customer can save a lot of negotiation cost and the individual supplier cannot increase the price arbitrarily.

The competition among these suppliers not only decreases the price level, but also increases the customer supply chain’s flexibility. Supported by several hundred suppliers, a cus- tomer can easily build up a highly agile polystyrene supply link.

Matsushita has a few fixed longtime polystyrene suppliers in Japan and their prices are negotiated at the beginning of a year. Even though the fixed suppliers can WHY GIANTS CHANGE THEIR MINDS 45 decrease Matsushita’s supply chain risk, the fixed prices are generally much higher than the flexible prices. Adding the transportation costs from Japan to China, the polystyrene in Matsushita’s former supply chain in China is more expensive than in Japan.

There are many other material distribution and trade centers in China providing steel, paint, hardware, and so on.

All of them function with a similar mechanism as the poly- styrene distribution and trade center. After investigating relevant distribution centers and its Chinese competitors’ suppliers. Matsushita decided to use as many Chinese sup- pliers as possible for its operations in China.

Stretch the distribution link In 2000, when Matsushita’s Shanghai subsidiary produced 140,000 microwave ovens annually, its Chinese competitor Galanz produced 12,000,000 units in the mean time. The ob- vious reason for such a huge sale difference is the price gap.

The cheapest “Panasonic” microwave oven was sold at RMB630 ($76), but Galanz’s lowest price was only RMB299 ($36). Beyond the price reason, however, the distribution link also contributed to the huge sale gap.

Low-cost labor and large economy of scale are two competitive aces in the Chinese producers’ hands. Foreign companies can make use of the first one quickly and easily, but they usually cannot enjoy the second one even if they have been in China for a long time. Generally, foreign com- panies concentrate in China’s coastal cities where markets will mature, but the rural and inland markets, in which 70 percent of Chinese customers live, rarely offer foreign com- panies’ HAHE products. On the contrary, powerful Chinese firms (such as Galanz, Haire and TCL) continue working hard to increase their sales in rural and inland markets. The huge demand of the one billion rural and inland customers encourage Chinese firms to keep improving their economy of scale and cut their costs further.

With undeveloped infrastructure and low-income levels, however, the rural and inland markets have too many 46 ACRJ special requirements for delivery, services, and credit man- agement. So Matsushita selected TCL, the largest TV pro- ducer in China, as its strategic partner to stretch its supply chain to Chinese rural and inland markets. TCL has 32 re- gional distribution subsidiaries, 174 distribution centers, and 4000 sales agents. Its products can reach nearly 20,000 retail- ers in China.

According to the agreement between Matsushita and TCL, Matsushita can use TCL’s established distribution net- works to sell its products in China’s rural and inland market.

In return, Matsushita provides its latest patents for DVDs, digital TVs and air-conditioners to TCL.

Exciting Dawn of Success By the end of 2001, Matsushita’s new supply chain promoted its first product — NN-MX20WF microwave oven. From the design paper to the final product, NN-MX20WF passed the following phases along this new supply chain:

Design: Chinese engineers dominated the design of NN- MX20WF. These low-cost Chinese talents only took RMB3000 ($362) salary per month, but they creatively reduced the cost of parts by thirty percent. They overthrew Matsushita’s de- sign mode by devoting themselves to applying local materi- als or parts and to exploiting Chinese factories’ competitive advantages to the fullest.

Purchase: Based on the new product design, Panasonic (Shanghai) used local supplies for polystyrene and electronic components. Only the sheet iron was imported from Japan because the oversupply of sheet iron in Japan lowered its price even cheaper than in China.

Produce: After closing its microwave oven factory in the U.S., Matsushita also stopped producing low-end microwave ovens in Japan. All these production capacities were moved to the Shanghai subsidiary, raising its capacity from 500,000 units to 2 million units. Such a scale dramatically cut this subsidiary’s operation cost. WHY GIANTS CHANGE THEIR MINDS 47 Marketing: By the end of 2001, Matsushita simultaneously promoted the NN-MX20WF oven in China, Japan, and the U.S. The prices were RMB398 ($48), ¥9980 ($82), and $69 in these three markets, respectively. The average price cut was over thirty-seven percent. Even though these prices were not the lowest in the three markets, the combination of reason- able low price and high brand/quality perception of Matsushita still deeply touched customers’ hearts.

From November 2001 to January 2002, Matsushita sold nearly 40,000 units of the NN-MX20WF in China, 50,000 units in Japan, and almost 120,000 units in the U.S. The three-month sales of microwave ovens in the three countries almost equaled Matsushita’s total microwave oven sales in the global market in 2001. Even though the Shanghai subsid- iary ran to capacity, its outputs still could not meet the in- creasing demand. Its monthly market share in China rapidly rose to second place. After promoting the NN-MX20WF microwave oven, Matsushita’s new supply chain continued promoting DVD players at RMB730 ($88), automatic washers at RMB800 ($96), and 29-inch TVs at RMB 3400 ($411) in China. Because all of them sold out quickly, Matsushita (China) had to apologize to its wholesalers for delivery lag.

The exciting success of NN-MX20WF aroused Matsushita’s enthusiasm for rebuilding its global supply chain by using more of China’s competitive advantages. Mr.

Shohtoku, the supply-chain rebuilding project leader, or- dered all branch directors and all subsidiary presidents to describe how to use China’s competitive advantages to im- prove Matsushita operations in their 2002 business plans. He warned: “I will refuse your plans bluntly if you do not con- sider China or do not provide detailed action steps in China.” GOING AGAINST THE TIDE: SONY’S SUPPLY CHAIN REBUILDING STRATEGY While Matsushita was increasing its supply chain presence in China, Sony in July of 2002 unexpectedly decided to shift 48 ACRJ production of its camcorders and digital cameras from China back to Japan. The reason behind this shift was tied less to China’s manufacturing capabilities and more to the unique supply chain requirements associated with these innovative, leading-edge products. Sony’s story demonstrates that differ- ent products demand different types of supply chains. There is a message here that extends beyond any one company or any one region of the globe: When designing a supply chain, a company needs to look beyond cost and consider such fac- tors as the characteristics of the product and market, the company’s core competencies, and overall profitability.

Sony’s Innovative Products Within the dynamic environment of the consumer electronics market, Sony established an important source of competitive advantage by developing new technology and products.

While other companies such as Matsushita and Sanyo con- centrated on being customer intimate, Sony has differenti- ated itself by focusing on product leadership. Sony has consistently been successful at commercializing new tech- nologies into innovative products such as the transistor ra- dio, tape recorder, Beta-Max video recorder, CD, Walkman, minidisk, DVD, and recently the digital camera and camcorder. During the 1980s and 1990s, Sony created 572 dif- ferent innovative products — more than Aiwa, Toshiba, Sanyo, and Matsushita combined.

This strategy of innovation and product leadership has enabled Sony to achieve high profit margins. Yet, the very newness of these innovative products also makes the com- pany more vulnerable to unpredictable demand. At the same time, Sony must deal with the fact that product life cycles for innovative products have become increasingly shorter. As imitators erode the competitive advantage that innovative products enjoy, Sony is forced to introduce a steady stream of ever-newer products. The short life cycles and the great vari- ety which are typical of these products further increase the unpredictability of the supply chain. WHY GIANTS CHANGE THEIR MINDS 49 Coping with this unpredictability has become a grow- ing challenge for Sony’s digital camera and camcorder sup- ply chain. When digital cameras first appeared on the market in the early 1990s, Sony only had a few competitors, such as Canon and Olympus. At that time, digital cameras were very expensive and companies gained a competitive advantage by reducing prices. To become the leader in the market, Sony placed its digital camera and camcorder production into China in an effort to reduce the product’s assembly and manufacturing costs.

During the late 1990s, however, more competitors en- tered the digital camera market. At the same time, advances in technology and manufacturing techniques significantly re- duced production costs. Under these new market conditions, companies gained market share not just from price but also by introducing the latest, most technologically advanced product. In essence, digital cameras now started to assume the characteristics of a high-fashion product.

These new market characteristics set the stage for Sony’s decision to pull production of digital cameras and camcorders out of China. In making this decision, Sony acted counter to most other multinational companies — such as Matsushita, Intel, Dell, and Motorola — that continue to move aggressively into China as they build up their global supply chains. Even other digital camera and camcorder companies, like Canon and Olympus, decided to keep their production facilities in China. For these companies, cost is still a significant competitive advantage. They are not inter- ested in competing with Sony on product leadership and are content to follow Sony’s lead in technology. Instead, they compete by quickly following any new release from Sony with a similar imitation product at a lower price.

Cycle Time as the Driver For Sony, however, there is one core activity that takes prece- dence over lowering manufacturing costs: reducing cycle time. As Yoshihiro Taya, the vice president in charge of 50 ACRJ Sony’s move, said: “For high value-added products, such as camcorders, minimizing the cycle time is much more impor- tant than focusing on manufacturing costs only.” Cycle time is the total elapsed time required to com- plete a business process from receiving the order to deliver- ing the final product. It includes the design, engineering, manufacturing, logistics, and customer service processes. The shorter the cycle time, the more flexible the supply chain, and the quicker it can react to changes in demand. Quicker responsiveness, in turn, lowers a company’s vulnerability to demand uncertainty. For high value-added or innovative products, minimizing the cycle-time contributes more to the firm’s competitive competencies than minimizing physical costs.

Sony’s camcorders and digital cameras fall into the cat- egory of high value-added but time-sensitive (short product life cycle) products. Table 4 displays the weekly ranking of digital camera sales on the Japanese market during June 2002. This chart shows that the life cycle for a bestseller is never longer than three months. In such an intensely com- petitive, fast-moving market, if the delivery of a new product were delayed by even one week, Sony would suffer huge losses in sales and profits.

According to Taya, only a few years ago the product life cycle for Sony’s main products was generally ten months to one year. The life cycle for these products has now dropped dramatically to two or three months. Therefore, to realize the maximum profit in such a short product life cycle, Sony has to minimize each product’s cycle time, otherwise, the company will miss fleeting market opportunities. Be- cause transportation times of the finished product to custom- ers are already about as fast as they can physically be, shorter cycle times must come from design or manufac- turing, the parts of the supply chain that precede the final shipment to the customer. But if we list all potential pos- sible candidates for cycle-time reduction along the supply chain (see Table 5), we will find that manufacturing in China will not help Sony reduce the cycle times of its camcorders and digital cameras. For example, the lack of real-time com- munications between the marketing department in Japan WHY GIANTS CHANGE THEIR MINDS 51 Ranking Producer Bestsellers First Time on the MarketTotal Time on the Market (in days) (June 3–9) 1 Sony DSC-P2 June 8 2 2 Canon IXYDIGITAL200a May 25 15 3 Olympus C-720ZOOM May 8 31 4 Sony DSC-P7 May 29 11 5 Olympus C-2ZOOM April 28 42 (June 10–16) 1 Sony DSC-P2 June 8 9 2 Canon IXYDIGITAL200a May 25 22 3 Olympus C-2ZOOM April 28 49 4 Olympus C-300ZOOM June 8 9 5 Sony DSC-P7 May 29 18 (June 17–23) 1 Sony DSC-P2 June 8 16 2 Fuji Film FinePix F401 June 19 5 3 Casio EX-S1 June 21 3 4 Canon IXYDIGITAL200a May 25 29 5 Olympus C-300ZOOM June 8 16 (June 24–30) 1 Fuji Film FinePix F401 June 19 12 2 Sony DSC-P2 June 8 23 3 Sony DSC-P9 April 19 73 4 Casio EX-S1 June 21 10 5 Canon IXYDIGITAL200a May 25 36 Table 4. Top 5 Bestselling Digital Camera Products in Japan Market in June 2002 Source: BP GFK SalesWeek3200. 52 ACRJ and the manufacturing base in China creates a longer purchasing-order cycle and customer-order processing cycle.

Additionally, the natural complications that arise from sup- plying a foreign manufacturing base with domestic-made re- sources or parts increase the cycle time for material receipt/ inspection, material review activities, warehousing opera- tions, and transportation and logistics. For example, bad weather or administrative procedures at China’s Customs office may delay transportation of supplies or parts from Japan.

The rapidly changing market reaction to digital cameras and camcorders also increases Sony’s risk from shortages or excess supplies. Because early sales for next- generation digital cameras are crucial in establishing market share and high profit margins, the cost of experiencing short- ages of these products are far more costly than shortages of more mature products. The shorter product life cycle of digi- tal camera also increases Sony’s risk of obsolescence and, therefore, the cost of being caught with excess supplies.

Recognizing that it needed to reduce cycle time and risk, Sony decided to re-evaluate its decision to manufac- ture digital cameras and camcorders in China. “We produce commodities in China because we can purchase materials Possible Candidates for Cycle-Time ReductionCan Be Improved in Japan?Can Be Improved in China?

Materials planning and scheduling Yes No Purchase order cycle Yes No Inbound transportation Yes No Material receipt/inspection Yes No Material review activities Yes No Manufacturing processes Yes No Customer order processing Yes No Warehousing operations Yes No Outbound transportation Yes No Return materials/reverse logistics Yes No Table 5. Opportunities for Cycle-Time Reduction WHY GIANTS CHANGE THEIR MINDS 53 locally,” says Yoshihiro Taya, vice president of Sony MECS.

“But in the case of camcorders, we could not buy the neces- sary materials locally. In the past, we sent these materials from Japan to China for final assembly of the camcorders in order to minimize our manufacturing costs. At the same time, we have lots of engineers in Japan developing the next generation products by tracking the market responses. Time is important. For example, we use two shifts of engineers to accelerate our R&D speed. And we request that the process from design to engineering to manufacturing to marketing be seamlessly connected. Today, when we carefully compare the saved manufacturing costs with the total process costs, we find that manufacturing camcorders in Japan has more merits.” Purchasing and Production Flexibility Perspectives In addition to reducing cycle time, Sony’s decision to move its digital camera and camcorder production from China to Japan needs to be understood from two other important perspectives — purchasing and production flexibility.

Purchasing: closer to suppliers Many MNCs find that they can easily purchase supplies in China for commodity or low-end products. In fact, these sup- plies are often cheaper in China than they are in Japan. Un- like commodities such as polystyrene, however, many of the special high-tech parts found in camcorders and digital cam- eras are not produced in China. These include crucial parts such as full-color LCD screens, precision optical machinery parts, digital camera memory, the charge-coupled device (the eye of a digital camera), and some unique semiconductor chips. Today Japanese digital cameras hold almost 90 percent of the global market share because only Japanese manufac- turers possess this advanced technology. These special high- tech parts are a core competency for these Japanese manufacturers. They, therefore, do not want to produce these 54 ACRJ knowledge-intensive products in other countries out of con- cern that manufacturers in the host country will learn the technology.

There is good reason for their concern. The govern- ment of China requires all foreign companies seeking to manufacture in the country to train their local partners in the advanced technology. As a result, over the past decade, many Chinese manufacturers have dramatically improved their product quality by applying what they have learned from participating in joint ventures with Japanese companies. In many cases, they have quickly beaten Japanese products on the global market by combining this new higher quality with their low cost advantage. In turn, this has driven down the overall price of these goods around the globe.

At the same time, the shorter product life cycle for camcorders and digital cameras forces Sony to purchase its necessary materials more frequently, more quickly, and more agilely. Such a frequent purchasing pattern reduces the quan- tity of each individual order. This means that if Sony had continued to assemble its camcorders and digital cameras in China, its inbound transportation costs for these materials would have increased dramatically because of the more frequent deliveries.

More flexible production Because camcorders and digital cameras are innovative prod- ucts, their production and supply chain requirements are more easily met in Japan than in China. Innovative products tend to have high profit margins, but also volatile demand and short product life cycles. Sony’s camcorders and digital cameras obviously belong to this category. There are two co- ordinated supply chain strategies that Sony could have pur- sued to reduce the risk of uncertainty for innovative products: (1) reduce uncertainty by developing better sup- ply-chain wide forecasting systems or, (2) avoid uncertainty by cutting lead times and increasing supply chain flexibility so that it can quickly produce what is needed when it is needed. WHY GIANTS CHANGE THEIR MINDS 55 Using either strategy to continue production in China would have been ineffectual for the following reasons:

·The latest digital camera on the Chinese market is typically six months behind products in the primary markets — Japan and the United States. Therefore, by pro- ducing these items in China, the manufacturer cannot gain any useful information for the supply chain-wide forecasting system.

·Sony’s research and development center, critical suppliers, and customer service are concentrated in Japan. As Mr.

Taya explained, it is important for these resources to be located close to a target customer base because high-end digital cameras and camcorders only have a three-month product life cycle,. Sony’s R&D center, for example needs to be able to quickly gain feedback from customers and incorporate that feedback into the next round of product design. When the manufacturing function is located in China, it is removed from these upstream and down- stream links and is unable to cooperate with them seamlessly in real time. Furthermore, Chinese manufac- turers have less experience fixing highly technical, inno- vative product problems through collaboration with innovation-producing companies such as Sony; Chinese manufacturers typically have experience with functional rather than innovative products. For these reasons, locat- ing in China increases the lead time and decreases the flexibility of Sony’s supply chain.

Considering all of these factors, Sony made the deci- sion that seemed to defy conventional wisdom, but made ultimate supply chain sense. In July of 2002, the company moved all of its production facilities for digital cameras and camcorders to Japan.

FURTHER READING Possible background readings include: 1. “What is the right supply chain for your product?”, by Fisher, L. M., Harvard Business Review, March–April 1997, pp 105–116. 56 ACRJ 2. “Aligning supply chain strategies with product uncertainties”, by Lee, L. H., California Management Review, Vol. 44, No. 3, 2002, pp 105–119.

3. “China shock: it’s all made in China now”, by Powell, B., For- tune, March 4, 2002.

4. “Burying the competition”, by Leggett, K. and Wonacott, P., Far Eastern Economic Review, Volume 165, Issue 41, 2002.

5. “What pulled Sony out of China?”, by Jiang, B., Supply Chain Management Review, January/February 2003. Copyright of Asian Case Research Journal is the property of World Scientific Publishing Company and its content may not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express written permission. However, users may print, download, or email articles for individual use.