Is Japan Still a Stable Location for High-Tech Manufacturing?

In the wake of the terrible earthquake, tsunami, and explosions at the Fukushima Daiichi nuclear plant, I think it is fair to ask: What are the implications for Japan as a stable location for high-tech manufacturing?

There are many factors that influence C-level manufacturing and supply chain executives, who decide where to build manufacturing plants. Operating costs, the cost of capital equipment, the level and quantity of skilled labor, the location’s proximity to markets, the country’s tax rate, the foreign exchange rate, and other factors are pivotal to the decision-making process.

Much less attention has been paid to whether a country is prone to natural disasters such as earthquakes and tsunamis. In fact, many high-tech locations, such as California, Taiwan, and China, for example, are susceptible to earthquakes.

Earthquakes aside, when compared to China, Japan's competitiveness as a preferred location for high-tech manufacturing has been waning. China's low wage rates, low production costs, and large population of 1.3 billion people have drawn high-tech manufacturers to China, and this played a significant role in China replacing Japan last year as the second-largest economy in the world.

Japan has other drawbacks. In recent times it has struggled with a weak consumer economy, a labor force searching for work, and a political system unable to implement reform. Additionally, more than 20 percent of its population is over 65, and estimates show that this figure will double by 2050.

In addition to having a population that is not quite conducive to high-tech manufacturing growth, Japan, unlike other countries such as the United States and Canada, has lacked a program to establish a skills-based immigration system that would attract engineers and other highly-skilled workers that can help prop up its high-tech manufacturing base.

With these considerations in mind, the horrendous situation in Japan should make us question whether, in a global economy, Japan is the right place to produce around 60 percent of the world’s silicon for making semiconductor chips. Japan’s economic troubles are one thing; its geographic location is another. The country is located in the Pacific Rim seismic zone and suffers many significant earth tremors each year. Since the March 11 earthquake, aftershocks have caused continuing interruptions at Japanese semiconductor plants.

According to research firm IHS iSuppli, Japanese suppliers accounted for more than one fifth of global semiconductor production in 2010, but tremors in the days after the earthquake are causing production delays. "Semiconductor facilities in Japan that had suspended manufacturing activities after the earthquake cannot truly commence full production again until the aftershocks cease," the research company said. "Earthquakes ranging from 4 to 7 on the Richter scale will make it impossible to fully restart these fabs until the earthquakes stop happening with such frequency. Every time a quake tops 5, the equipment automatically shuts down."

In an extreme case of supply shortfalls, it will be interesting to see if Japanese high-tech companies outsource more of their work to plants located outside of the country; and if they do, how much.

Toshiba Corp. (Tokyo: 6502), the world’s second-largest producer of NAND flash, said shipments of NAND from its central Japan plant could drop by up to 20 percent in January and February, iSuppli reported. To fill the gap, the research group said leading NAND supplier Samsung Electronics Co. Ltd. (Korea: SEC) should be able to partially compensate for the shortfall.

By the same token, many high-tech companies outside the devastated region that had orders to buy components from Japan will now have to find alternatives, and it is unclear what long-term impact this will have on the levels of future sourcing of Japanese-made electronic components.

Daniel Heyler, head of global semiconductor research at Merrill Lynch & Co. Inc. , estimates that it will take six months for global technology hardware supplies to resume normal flows following disruptions. He predicts that in the earthquake's aftermath, manufacturers will reexamine supplies in Japan, look for outside suppliers if needed, and finally sort out component mismatches resulting from deals with new vendors.

Amidst the uncertainty, what is clear is that the high-tech supply chain is fast-moving, cost-sensitive, and not particularly loyal to any location when the requirement to fulfill supply and demand obligations is imminent.

Of course, there is always the possibility that a short-term shift in component sourcing may develop into a long-term supply line. This would open the door for other nations to build up their electronic component supply capabilities, and that fact alone has consequences for the way in which supply chain executives view Japan as a high-tech manufacturing location.

Another news item seizes on this notion: Fernando Sierra Ortiz, the president of Mexico’s National Chamber of Electronics Industry, is reported as saying that a number of large Japanese electronics companies damaged by the earthquake and tsunami plan to move part of their production lines to Mexico in the near future. He pointed to Mexico’s close proximity to the US as a favorable factor in relocating high-tech production facilities, and he predicted that the country would produce $15 billion worth of high-tech equipment by 2013.