Sunday, March 27, 2011

Is just-in-time nearly out of time?

Some things are worth repeating. This piece, which was originally posted in August 2006, takes on added significance given events in Japan where worldwide links in the just-in-time supply chain are breaking down. Essentially, nothing has changed. In fact, we appear to be more vulnerable to disruptions than ever before. The only thing (surprisingly) that seems no longer applicable is my worry about North American natural gas supplies. Other than that, the piece is almost as fresh today as it was when when I wrote it five years ago. Several links were updated and others removed because they no longer lead anywhere.

Civilization, that is, the congregation of people in large settlements we call cities, is thought to owe its origins in part to the invention of agriculture. By growing surpluses of food crops farmers enabled the creation of an urban non-farming class who engaged in all manner of cultural, governmental, and commercial activities. These activities now preoccupy the vast majority of people in advanced economies.

From year to year the new settlements of ancient civilizations ensured their continuity through one very important measure: the storage of surplus food crops, especially grain. This enabled them to withstand a bad harvest or even two or three without facing collapse.

What a supreme irony then that the sine qua non of civilization--maintaining a store of essential materials--should in our time be considered a source of inefficiency and waste to be avoided at all costs. The long tradition of saving for a rainy day (or as we will see, in our case, a drought-stricken decade) has now been rejected in favor of the so-called just-in-time revolution. For those who didn't get the memo, just-in-time inventory management means that everything needed for the manufacture of any good is delivered to the factory just as it is needed or nearly so. Inventory levels are kept at minimal levels which frees up cash for other purposes.

Just-in-time methods have become synonymous with lean, well-managed international corporations. And, they are now the Achilles heel of a global trading system at risk on several fronts.

It is no accident that just-in-time methods came of age in the 1990s and were adopted by nearly every organization big enough to benefit from them. The relative tranquillity of the '90s made fears of any widespread disruption of supply lines fade from memory. With the collapse of the Soviet Union, there were no more superpower confrontations. The ambitions of Saddam Hussein to control a vast portion of the world's oil supply were contained. The sea-lanes were secured by the dominance of the U. S. fleet. Cheap energy meant cheap transportation which encouraged the expansion of trade. And, this allowed the wholesale removal of industries from places of high cost to places where labor and resources were the cheapest. In addition, the bear market in raw materials continued. This lulled purchasing managers into believing that needed materials would be cheaper tomorrow and the day after that and the day after that. So, why keep anything but minimal inventories?

These conditions created fertile ground for just-in-time ideas in almost every corner of the globe and in almost every organization including government and nonprofits. And, under such conditions it was inarguably better to keep inventories lean. As a result, spartan inventories soon became a necessity as company after company sought competitive advantage through this type of cost-cutting.

Whether just-in-time inventory is an idea for all time or was merely suited to a unique moment in history is now being tested. Prices for many critical industrial commodities have now skyrocketed. At the end of 2001 copper could be had for about 65 cents a pound. Last week it closed at about $3.50 a pound. Nickel hovered near $2 a pound in 2001 and now sells for almost $13 a pound. Oil sold for about $20 a barrel in late 2001 and now sits above $70. And, the list goes on. Memo to purchasing managers: Things are not getting cheaper anymore! [For comparison, last Friday, March 25, 2011 cash prices for the commodities mentioned above were as follows: copper $4.41, nickel $12.24, and oil $105.]

The United States military now sits astride one of the greatest known reservoirs of oil in the world, Iraq. But that military appears impotent to increase oil production in the face of continuing chaos and an emerging civil war in the country. Iran and North Korea now ignore demands from the world's only putative superpower whose strength, financial and military, is being sapped every day by its engagement in Iraq.

U. S. friction with China over high Chinese trade surpluses, an undervalued currency, Taiwan, and China's increasingly close relations with Venezuela and Iran--which were sought in order to secure precious oil and natural gas--does not bode well for the future stability of the world and the free movement of goods.

The willingness of Russia to curtail gas supplies to the Ukraine and ultimately to Europe demonstrates the precariousness of energy supplies. In our own hemisphere, Hurricane Katrina laid bare the vulnerability of both the U.S. and world energy infrastructure to natural disasters. And, the recent pipeline problem at Alaska's Prudhoe Bay oil field showed our vulnerability to mere poor maintenance. The world now appears to have a razor thin cushion of excess oil production capacity.

Rising energy costs are starting to take their toll on the trucking industry. But despite rising fuel costs, marine and rail shipments remain relatively affordable even if capacity is being strained.

All of this has been put down to temporary and cyclical factors such as the general bull market in commodities and increased demand from the growing economies of China and India. And, if that's true, then there is little cause for alarm except among those companies that can't obtain the supplies they need at prices that allow them to be competitive.

However, the drop in world grain stocks paints a more ominous picture. Those stocks have declined to about 57 days of supply. The last time grain stocks were this low was in 1972, just before grain prices doubled. [For comparison, world grains stocks had fallen to 72 days of consumption by August 2010. Corn supplies are projected to fall to just 18 days supply by August 2011.] And, as more and more grain is converted into fuel rather than food, the situation may worsen. High oil prices encourage such conversion.

Low grain stocks are also partly the result of declining harvests. And, declining harvests are partly due to drought in critical grain growing regions of the world: the U. S. western and Plains states, Canada, southern Africa and much of Europe. If global warming is the culprit, this problem is not going away.

Of more immediate concern is the way just-in-time ideas have filtered into the retail food system. Grocery stores are believed to have no more than a three-day supply of food. That means those who don't grow their own food (which is most of us) will find themselves going hungry within a week of an emergency that shuts down the just-in-time delivery system to stores. What could do that? Try an avian flu pandemic.

And, that brings us to the medical field which has long been applying the minimalist, just-in-time view to its operations. The corporate mentality driving both for-profit and non-profit hospitals has resulted in an attempt to keep capacity to a minimum in order to drive down costs. But, the effect has been to undermine surge capacity, that is, the capacity to treat large numbers of patients from a mass casualty event such as a terrorist attack or a flu pandemic. The issue also applies to vaccines, drugs and medical equipment that might be needed in an emergency.

As for energy supplies, one almost certain near-term crisis will come to North America when its natural gas production begins to decline. [New shale gas production turned this situation around.] That crisis could arrive as early as this winter and it's one reason the U. S. Federal Energy Regulatory Commission is trying to encourage the creation of additional natural gas storage.

When it comes to oil, there is a recognition on the part of nearly every major importing nation that just-in-time inventories are not enough. The United States, the European Union and China all have plans for or already have in place large state-run petroleum inventories, normally referred to as strategic petroleum reserves.

Perhaps the ultimate expression of the just-in-time idea is Wal-Mart's so-called warehouse-on-wheels. Only in a cheap oil environment would the idea of motion be added to the idea of warehouse. Wal-Mart tries to keep much of its inventory on the road in trucks to maintain low costs and flexibility. This is the ultimate in just-in-time delivery. But, those who believe world peak oil production will soon be upon us with its skyrocketing oil prices think that Wal-Mart would quickly crumble under the resulting financial and logistical strain.

When any resource becomes scarce, the natural tendency of people is to hoard it. That has the effect of sending the price higher which makes people think they should hoard it all the more.

In the coming years we may be faced with such a dynamic in many markets. The most devastating and far-reaching effects could come in the energy markets. Will the just-in-time religion which swept the world in the 1990s survive such a dynamic? Will the new fashion be to plan ahead and make sure we have extra supplies of metals, fuel, medicine and food on hand to run our factories and our civilization when disruptions occur?

Such a novel idea, isn't it? Or maybe it's an idea that's as old as civilization itself.

1 comment:

Crocodile Chuck said...

Another cracking post. There are significant externalities with Just-in-Time. Try to drive in Tokyo-at least a third of traffic is freight/goods, replenishing factories/stores/warehouses daily or multiple times through it. But, we know what happens to externalities..... (we wear it)