Commercial Risk Under JIT

Manufacturers across the business sectors have latched onto what is widely seen as a revolutionary new business process approach, “just-in-time” (JIT) supply chain management, which has produced significant cost-efficiency savings.

However, as recent business losses resulting from weather catastrophes and even labor disruption show, companies having adopted the JIT approach have opened themselves to new disruption risks. Essentially, under JIT, a minor disruption in the supply chain can grind manufacturing to an expensive halt.

Hurricane Floyd did not hit anywhere near southwestern Ontario. Yet the monster hurricane did, in an indirect manner, spur the shutdown of Daimler Chrysler’s minivan plant in Windsor. A Daimler Chrysler plant located in Greenville, North Carolina was flooded as a result of the Hurricane, leading to a shortage of suspension parts. The result of which meant a two-business day shutdown for seven of the company’s other plants across North America, including the Windsor minivan plant.

And, through corporate globalization, the impact of disruption can be far broader than one region. For instance, the earthquake that struck Taiwan on September 21 this year knocked out production of some of the world’s top computer chip manufacturers. Taiwan Semiconductor Manufacturer Co. said that it expects to lose US$88.2 million in sales due to the quake, with insurance only covering about US$57 million of the loss. The Associated Press (AP) reported on September 30 that the quarterly profits of at least one Canadian high-tech firm will likely take a hit as a result of the tremor. Genesis Microchip, the maker of semiconductors for flat-panel screens and home theatre equipment, said earnings in its third and fourth quarters may be down. Semiconductor makers in Taiwan produce 10% of the world’s chips and about 80% of the motherboards used to run personal computers. Hundreds of chips were damaged or ruined in the quake. Production was restarted at 50% capacity in the last week of September — however, it was unclear how long it would take to resume full output. Analysts say the quake will eventually likely cost chipmakers about US$200 million to US$300 million in total lost revenues.

The risk of enhanced business disruption through JIT is not only limited to catastrophes. A strike of 3,400 employees at a General Motors stamping plant in Flint, Michigan on June 5, 1998 and a second strike of 5,800 workers at a nearby parts plant on June 12th temporarily closed 25 of GM’s North American plants. The dispute ended July 29, but not before it affected nearly 90% of GM’s production capabilities and over 150,000 workers in Canada and Mexico. The strikes also led to temporary shutdowns at plants owned by third-party suppliers.

Natural catastrophes, manmade accidents, labor disputes, and equipment breakdowns. If a company receives raw materials, packaging or components under a JIT method, occurrences such as these can have a major negative impact on the corporate bottom-line. And with the globalization of business, the cause can be on one side of the world while the effect is on the other.

What is JIT?

JIT is much more than just a method of controlling a company’s inventory. It’s an entire management philosophy centered on the elimination of sources of manufacturing waste by producing the right part in the right place at the right time. According to Ashland University in Ohio, “waste results from any activity that adds cost without adding value, such as moving and storing. JIT should improve profits and return on investment by reducing inventory levels (increasing the inventory turnover rate), improving product quality, reducing production and delivery lead times, and reducing other costs (such as those associated with machine setup and equipment breakdown). JIT applies primarily to repetitive manufacturing processes in which the same products and components are produced over and over again.”

The objective of JIT is to ensure that all materials, resources, operators, and other elements needed for a production process are available at the necessary location just at the time they are needed for the process to continue. JIT was pioneered by Toyota of Japan and, hence, is also known as the Toyota Production System. Other names include: lean production, stockless production or flow production. Benefits of this process include: doubled labor productivity, 90% reduction in throughput times, 90% reduction in inventory, improved quality and reduced time to market.

Good of JIT for insurers

If an insurer provides a commercial property cover for an operation which uses JIT and a disaster strikes, the system can minimize losses because there would be little if any destruction of raw materials or component parts. Similarly, there would be little or no destruction of finished goods as part of the JIT philosophy includes the elimination of such inventories. If a disaster should occur on the supplier’s premises, the same theory would apply. That company would also not stockpile components because it would only produce on an “as needed” basis.

JIT also emphasizes the desire to reach perfection through continuous improvement, with the goal of eliminating unplanned stoppages and all causes of defects. This can benefit insurers providing commercial property/business interruption or liability covers because it means the mplementation of preventative maintenance programs, which minimize or eliminate down time due to the failure of a machine, for example. It also means that the company is constantly striving to produce a perfect product, which will minimize or eliminate defects. This could result in fewer or no recalls and product liability claims (it can also mean that the insurer covering a company’s warranty program may see fewer losses).

The bad of JIT

While JIT means that less capital is tied up in inventory, it also means that the business is more vulnerable to risk as it would not have any stock in reserve to cushion potential disruptions — no matter how minor. What’s more, in order to operate under a JIT environment, a company’s suppliers must also use the system. This could propagate any negative implications surrounding the JIT business philosophy.

Toyota Industrial Equipment Manufacturing, Toyota’s Indiana-based manufacturer of forklifts, receives parts deliveries five times a day. This is a common occurrence for a JIT-based manufacturer. Consequently, the method has been accused of putting more heavy trucks on the road (total tonnage carried by Canadian truckers went from 108.15 million tonnes in 1976 to 228.97 million tonnes in 1996). It has also been blamed for pressuring truckers to drive harder, longer and faster because the customer must have the delivery in order to prevent a costly shutdown. Both side effects, according to opponents, have lead to an increase in major road accidents.

Considering JIT

when underwriting

When considering the binding of a commercial account, insurance and facultative reinsurance underwriters may consider asking questions about the company’s management philosophy. If JIT (a.k.a. the Toyota Production System, lean production, stockless production or flow production) enters the picture, it should make the underwriter look a little closer at the risk and ask more questions about the company’s history of output. Have there been any major stoppages in production? What caused the stoppage(s)? What measures have been taken to ensure they don’t happen again? Does the company have a sound disaster/contingency plan? What of the company’s suppliers — do they use JIT? What has their experience been?

Once thought to be a short-term management trend, JIT is here to stay. Knowing how the system works, and its potential downfalls can mean the difference between writing a profitable account and taking a potentially hard hit to the bottom line.