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So Much For Hollowing Out

Japan's giants are investing in plants at home again. Why the switch?

Lying 800 kilometers south of Tokyo on the island of Kyushu, Oita prefecture is hardly the kind of place you would expect to find the trendsetting titans of Japan Inc. Until recently the biggest contributors to the economy in bucolic Oita were the hot spring resorts in the coastal town of Beppu.

But this year, Oita is flourishing as Japan's corporate giants invest billions in new manufacturing plants. Canon Inc. (CAJ ) is building a 29,000-square-meter digital camera facility near Beppu Bay. Down the road in Oaza Matsuoka , Toshiba Corp. (TOSBF ) in October plans to open a semiconductor plant that's part of a $1.8 billion, five-year investment in Oita. And auto producer Daihatsu Motor Co. is building a factory in nearby Nakatsu, which will gear up production of Hijet vans and Atrai miniwagons in December. "These companies are activating the economy," says Kazuhiro Nakao, who oversees the prefecture's efforts to attract investment.

It's not just Oita's economy that's being activated these days. After years of hand-wringing by authorities over the hollowing out of Japan's manufacturing industries, Corporate Japan is investing at home again. Expenditures on plants and equipment in Japan rose 10.3% during the first half over the same period of 2003, the Ministry of Finance reported in September. "These movements are very favorable for the Japanese economy," says Kenji Yumoto, chief economist at the Japan Research Institute. He expects capital expenditure to grow 10% in the current quarter and nearly 7% in the fourth.

Sure, Japan's recovery appears to be losing some steam. Gross domestic product growth slipped from an annual rate of 6.1% in the first quarter to just 1.3% in the second, and the stock market has come off its recent highs. But the Organization for Economic Cooperation & Development in September increased its forecast for annual growth for Japan from 3.0% to 4.4%, despite the weak numbers of late. And confidence in the recovery is strong in the business community.

Churning Out TVs

That confidence shows up in the way capital investment has changed. During Japan's lean post-bubble years, new spending on plants was doled out sparingly, usually on new technologies to keep up with competitors or to bring costs down through improved productivity. No one thought of really ramping up capacity -- until now. "This is the anti-hollowing out," says Jesper Koll, chief Japan analyst at Merrill Lynch & Co. (MER ) in Tokyo.
Japan's consumer electronics giants have been leading the way. In the central city of Kameyama, Sharp Corp. (SHCAY ) in August boosted capacity at its LCD TV plant by 80%, to 27,000 sets monthly. In Hyogo, 100 km to the west, Matsushita and chemicals producer Toray are jointly investing $860 million in a plasma display plant that will churn out 3 million TVs annually when it opens next year. Way up north in Hokkaido, Seiko Epson in October plans to inaugurate a $315 million flat-panel TV plant. And on Sept. 14, Toshiba and Canon announced plans for a joint venture to develop and build next-generation flat TVs at a plant to be constructed in Kanagawa.

The trend doesn't stop with tech companies. In September, Nippon Steel Corp., Japan's largest steel producer, said it plans to spend $360 million retooling nine facilities to boost production 7% by March, 2006. JFE Steel Corp. reversed a decision to shutter a plant that produces electro-galvanized steel sheets at a foundry in Chiba Prefecture near Tokyo. Tofu maker Shinozakiya Inc. in June said it plans to build a $9.2 million, 8,800-square-meter factory in Tochigi prefecture. And Onward Kashiyama Co., a Tokyo clothing maker, is moving 10% of its production back to Japan from China as it upgrades its sewing equipment.

Why the shift? On one level it's because Japanese companies have already reaped most of the potential gains from moving production overseas. In the past decade the share of Japanese-owned productive capacity located abroad has grown to 45% from just 8%, Merrill Lynch estimates. That's almost as high as the 50% level seen in the U.S, which means Japan Inc. overall now has a cost structure that's as competitive as most rivals from developed countries. Canon, for instance, has made 80% of its capital investments overseas for the past decade, and today, 42% of its total production is abroad. This year the company decided to reverse course and is pledging to spend 80% of the $7.2 billion in capital outlays it plans for the next three years at home.

One factor pushing the trend is a growing realization that the savings from producing in China aren't all they're cracked up to be. Sure, China has low wages -- typically 5% of Japan's -- but they're rising in coastal areas. And the cost advantage is increasingly eroded by supply bottlenecks and power shortages, which shut down plants in many coastal cities over the summer. Osada Co., a Tokyo producer of parts for air conditioners, refrigerators, and elevators, has been plagued by high employee turnover and quality problems at the Chinese facility it opened in 1999. So instead of expanding on the mainland, it's building a $4 million factory at home.
Moreover, land prices are falling in Japan, and labor cost isn't the issue it once was. Most of the plants being built in Japan are capital-intensive operations where labor represents a small fraction of the total cost of the finished products. "With factory automation and other production techniques, we can manufacture certain goods at a lower cost in Japan," Canon CEO Fujio Mitarai remarked in a statement.

Japanese companies are also finding that it pays to have researchers work closely with -- and in tight proximity to -- production teams. Canon, for instance, has slashed the time it takes to develop and produce new digital cameras by a third, to 12 months, by encouraging its Japan-based research and development teams and production managers to work together on new products from the outset. Toshiba has realized similar gains by going local, which it says fosters closer coordination between production, R&D, and software engineers. Different divisions "need to cooperate early on in product development," argues Masashi Muromachi, president of Toshiba's semiconductor division.

Far More Loyal

Then there's the question of security. Japanese companies are boosting production of the latest generations of flash memory chips and plasma display panels for TV sets, where much of the value lies in proprietary technologies. These manufacturers feel more protected from would-be intellectual-property pirates by keeping production at home. Canon reports that its Japanese employees are far more loyal than those abroad -- typically staying with the company for their entire careers -- so they're less likely to walk off with knowledge of the latest technological developments.

Japanese companies, of course, will still open new plants abroad. Auto manufacturers such as Toyota Motor Corp. (TM ) and Nissan Motor Co. (NSANY ) continue to ramp up in China to take advantage of the fast-growing market there. And electronics makers such as Sharp, Canon, and Toshiba have no plans to close existing Chinese operations, particularly given their high hopes for fast growth in the mainland market. But that scary feeling that Japan had no future as a manufacturing center is finally starting to ebb.By Ian Rowley, with Hiroko Tashiro of Business Week in Tokyo.