THE ROLE OF JUST-IN-TIME INVENTORY
Pioneered by Japanese firms during that country’s remarkable economic transformation during the 1960s and 1970s, just-in-time inventory systems now play a major role in most manufacturing firms. The basic philosophy behind just-in-time (JIT) inventory systems is to economize on inventory holding costs by having materials arrive at a manufacturing plant just in time to enter the production process and not before. The major cost saving comes from speeding up inventory turnover. This reduces inventory holding costs, such as warehousing and storage costs. It means the company can reduce the amount of working capital it needs to finance inventory, freeing capital for other uses and/or lowering the total capital requirements of the enterprise. Other things being equal, this will boost the company’s profitability as measured by return on capital invested. It also means the company is less likely to have excess unsold inventory that it has to write off against earnings or price low to sell.
Just-in-Time (JIT) Inventory
Logistics systems designed to deliver parts to a production process as they are needed, not before.
In addition to the cost benefits, JIT systems can also help firms improve product quality. Under a JIT system, parts enter the manufacturing process immediately; they are not warehoused. This allows defective inputs to be spotted right away. The problem can then be traced to the supply source and fixed before more defective parts are produced. Under a more traditional system, warehousing parts for weeks before they are used allows many defective parts to be produced before a problem is recognized.
The drawback of a JIT system is that it leaves a firm without a buffer stock of inventory. Although buffer stocks are expensive to store, they can help a firm respond quickly to increases in demand and tide a firm over shortages brought about by disruption among suppliers. Such a disruption occurred after the September 11, 2001, attacks on the World Trade Center and Pentagon, when the subsequent shutdown of international air travel and shipping left many firms that relied upon globally dispersed suppliers and tightly managed “just-in-time” supply chains without a buffer stock of inventory. A less pronounced but similar situation occurred again in April 2003, when the outbreak of the pneumonia-like SARS (severe acute respiratory syndrome) virus in China resulted in the temporary shutdown of several plants operated by foreign companies and disrupted their global supply chains. Similarly, in late 2004, record imports into the United States left several major West Coast shipping ports clogged with too many ships from Asia that could not be unloaded fast enough, which disrupted the finely tuned supply chains of several major U.S. enterprises.35
There are ways of reducing the risks associated with a global supply chain that operates on just-in-time principles. To reduce the risks associated with depending on one supplier for an important input, some firms source these inputs from several suppliers located in different countries. While this does not help in the case of an event with global ramifications, such as September 11, 2001, it does help manage country-specific supply disruptions, which are more common.