Purchasing also wants to reduce the purchase spend. Price paid may reduce at a constant rate each month during production window. Sales price may decay equally fast. It is vital for companies to pay and ensure that they do not buy too much too early and, therefore, be left with high-cost finished goods that are commanding lower sales prices. Spot purchases at lower and lower prices can offset lowing constant spot sales prices. While price decay at the point of sale is noted, B2B contracts over as much as a 10 year horizon tend not to permit any price rises. In many cases, the aim is to reduce price per unit via total quality, supplier development, reengineering, scrum, and any other improvement scheme that is "flavor of the month." The argument here is that by eliminating unnecessary costs, these benefits may be divided between the participants that helped achieve them. Customers that help their suppliers reduce costs can agree to share half or third of

Logistics aims to transport materials and goods at the lowest cost per unit. Cost of transport for small, high value, goods can be in the order of <0.3% of the cost of the goods being transported. More costs of transportation per unit maybe incurred by the consumer going to the retail point of sale and returning home than the goods' entire logistics costs incurred through the supply chain. In the pursuit of ever lower logistics costs per unit, greater volumes are required in order to divide the

has against the commitments made on their behalf by their suppliers.

administrative and transport service costs to the desired level.

**28**

these reductions.

Costs of organizing a container movement from low-labor-cost manufacturing base to distribution center or customer in the market region can vary, typically in the region of €9000–€15,000. These costs typically include carriage and insurance elements. These costs are carried as part of the resale price or as a separate transportation contract agreed between sender and receiver. INCO terms will be agreed in advance.

With potentially <10% of the pipeline liability—cost of materials in the supply chain, and many smaller deliveries, transportation costs can rise dramatically as a *percentage* of costs of materials in the supply chain. However, percentage is misleading. The real saving as a result of lean manufacturing is the 90%+ reduction in pipeline liability. Lean aims to reduce risk to profit, rather than increasing profit *per se*.

The result of outsourcing to low-labor-cost countries is to turn the operation located in the original country into a reseller. Goods printed with the US' stars and stripes, and the UK's union flag may be made in China or other Asian countries. Moves to change the law to ensure Nations' flags are printed only in the nation start to emerge.

The Government of the nation, with massive spending power, may change purchasing policy. They may insist that purchases made on behalf of the people for the benefit of the people should have proven local content. "Local jobs for purchased goods that service local needs" can become a mantra, political, and fiscal policy.

Lean manufacturing focuses on eliminating waste by minimizing effort, movement, space, raw materials, work-in-process materials, finished goods, human effort, rework, and scrap. There is a vast difference between lean processes and a lean supply chain. Lean processes have very small material waiting buffers, produce rapidly without defects, and have very small buffers that have undergone the process. These goods are moved to the next process in very small lots, typically one at a time. To achieve this, they may be transferred via robots, conveyors, or gravity feed. Goods may be produced in the sequence they are required, rather than produced in batches. Key to this is the ability to change the setup economically between units. Single minute exchange of dies (SMED) may be used, combined with computer numerical control (CNC) part production program direct feeds from a synchronizing controller. Use of fully integrated flexible manufacturing cells has become relatively rare. The investment cost of automated cells and systems reduces the return on investment. Use of robots continues as a means of learning how to manipulate and orientate parts. Once learned, these lessons maybe taught to people in order that they may become more efficient. Learning does not stop there. The workers in time will develop their own ways of doing the work with less effort. In effect, people can outperform robots.

From a cost perspective, employing low-labor-cost employees has been considered by offshoring proponents as a means of reducing unit costs. If suppliers exist in low-labor-cost regions, then the investment on new plant and equipment can be avoided. Unit costs come closer to the variable cost element as a result.

Each unit produced may have a very slight margin between costs and price they are sold for. In order for suppliers in such locations to generate profit for themselves, they must rely on multiplying the margin per unit. This is achieved by requiring their customers to place very large orders. A consequence of this strategy is that there are a lot of products to ship. This in turn requires efficient packaging and space utilization in containers and other types of vessels. The benefits of efficient interprocess movements using one-piece flow within lean manufacturing plants can be written off against the huge volumes of finished goods that are stock piled because the customer does not want delivery yet. Months of production output can be held pending the dispatch.

### **7. Plant location as a key factor**

Governments represent their electorate in constituencies located in their national boundaries. It is in the individual representative's own self-interest to ensure that existing plants and businesses located within their constituencies remain viable and employment opportunities are not lost due to outsourcing. Corporations typically are managed by professionals that aim to maximize returns for their investors. Other stakeholders, including local and state government (tax revenue) and employees (salaries and wages) may be secondary to the commercial exploitation of opportunities.

Outsourcing all value-adding activities including part production, subassembling, and final assembly to low-cost countries can reduce the unit cost. Content sourced from the final market may be significantly reduced as a result. The knock-on effect of outsourcing final assembly to low-cost countries halfway round the world can also be to transfer part production work undertaken by suppliers in the market to suppliers closer to the new low-labor-cost manufacturing center. The effect is to strip out many of the supply chain jobs that had existed. If the economy is fully open for business, new jobs will emerge to replace the old ones. Entire regions may undergo periods of deindustrialization, depression, and then regeneration.

Intellectual property (IP) rights in the form of knowledge process may be transferred to franchisees, only to be disseminated locally without consent of the IP owner. Other risks become apparent when outsourcing to countries that have widely divergent cultures. Quality expectations may differ. Entire batches may be written off due to defects introduced by the subcontractor. To ensure they follow orders and comply with specifications, entire teams may need to jet off frequently to review what is going on and to bring the supplier back on track. Local representatives that are "on our side" and speak both languages may be recruited to undertake this vital role. Their salaries increase the overhead element on top of the purchase price. The company must aim to identify other factors that put the commercial viability at jeopardy. Risks to be mitigated include wage rises, lack of literate and skilled employees, language barriers, dishonest and unethical behavior, transport failure including train derailment, fire, ships sinking, new trade barriers, incoming border inspections, and administrative compliance issues that lead to refusal to admit the consignment.

A further factor that needs to be considered is the ability of the organization to respond to changes in volume demanded and sudden emergences of rival technologies and new competitor products. This can lead to significant discounting in order to sell the goods available, consignment recalls, and enforced upgrading activities. Lean aims to reduce the pipeline liability and obsolescence risk in the supply chain. If the goods are heavily discounted, revenue decreases. If they cannot be sold, their value must be paid for from profit and the goods are written off as obsolete. This can significantly reduce the viability of any business. To counter this, companies may mitigate the effects by producing a range of goods. Distance from market incurs logistics distribution time. Time-sensitive priced goods suffer from price erosion. It is necessary to ensure that goods are made, distributed, and sold as quickly as possible in order to minimize the stock holding cost associated with reducing prices. Companies like to reduce the time between placing orders with suppliers and receiving the goods. This is because the earlier they buy the parts, the higher the price that would have been paid for them. If purchase prices are high because orders were placed too early, and sale prices have dropped due to price erosion, then margins will be squeezed.

To reduce the price erosion, design teams should be included throughout the production life cycle in order to supply a constant stream of product upgrades. Each variant or iteration is only produced for a short period of time. All of the goods should be designed to be produced using the same production processes and

**31**

*Sourcing and Manufacturing in the Market Region DOI: http://dx.doi.org/10.5772/intechopen.87073*

may be permitted.

alongside the producer.

assembly sequence. This avoids constant plant redesigns. An optimum sequence from supplier to customer should be identified in each plant. Designers should be instructed to design future iterations that fit that forward flow sequence from raw materials to finished goods. Group technology concepts including rank order clustering and to/from techniques can be used to identify the most efficient process sequence. Creating manufacturing cells can allow some backward flow without incurring overly long walks between the processes; (if we are walking, we aren't working). Minimizing the distances between processes eliminates the space beside each process to put work-in-process. One-piece flow can then be created where the material is walked from machine to machine. Some conveyor and robot movements

Plant location is a vital issue. Land cost, energy prices, average labor hour wages, and staff salaries, tax rates, transportation duration, and costs are vital pieces of the puzzle. Honda Corporation's motto can be summed up as "make where you sell, buy where you make" (adapted from [14]). In effect, it is necessary to identify major markets, make there, and buy from suppliers that are already there or can be encouraged to install themselves there as a global partner that sets up transplants

Different locations have different ethical and responsible business practices. Emphasis may range from strict compliance through completely lacking on environmental protection, emissions control, pension contributions, healthcare schemes,

Ford Motor Company initially set up assembly plants in East London and Germany. These plants were supplied with kits from Detroit. It soon became apparent that it was more efficient to establish complete part and subassembly facilities to supply the final assembly plants. Ford's Dagenham plant had the largest brand dedicated iron and steel foundry in Europe. It was industrial disputes, repeated strike action, and union demands for higher equal pay for women that led to Dagenham's

Four basic supply chain configurations are possible. Using a two-by-two matrix, we can map long and short inbound supply chains and outbound logistics: (1) Long inbound, long outbound is mass production; (2) Short inbound, long outbound is just in time; (3) Long inbound, short outbound is just in time; (4) Short inbound

Strategic financial commitment may be less than expected if most or all of the value-adding activities are undertaken in subcontractors. Empirical testing using a supply chain game [15] showed lower initial investment with JIT3, which reduces the volume required to breakeven. While salaries may be higher closer to the market, they should be few in number. Initial starting stock of 10% is achieved and maintained. Overall cost savings in terms of lower space, working capital, and cost of inventory offset the higher salaries. Profitability of a JIT3 operation is higher due to lower total costs and lower lost sales to competitors. Agile/mass production applied to the game using JIT3 enabled significantly increased capacity with the same number of people involved in JIT3, together with about 4% of the starting stock of mass production. Higher overall average revenue is achieved via more

Many managers today believe it is cheaper to buy parts from low-labor-cost countries, import the goods, produce the finished product, and export these to the market that may be in high-labor-cost countries. Products with infinite inventory

frequent product upgrade releases that maintain the sales price.

employee training and education, and employee family education.

assembly plant being shut and production sent to Spain.

**8. Supply chain configurations**

and short outbound is just in time 3.

### *Sourcing and Manufacturing in the Market Region DOI: http://dx.doi.org/10.5772/intechopen.87073*

*Modern Perspectives in Business Applications*

**7. Plant location as a key factor**

exploitation of opportunities.

Governments represent their electorate in constituencies located in their national boundaries. It is in the individual representative's own self-interest to ensure that existing plants and businesses located within their constituencies remain viable and employment opportunities are not lost due to outsourcing. Corporations typically are managed by professionals that aim to maximize returns for their investors. Other stakeholders, including local and state government (tax revenue) and employees (salaries and wages) may be secondary to the commercial

Outsourcing all value-adding activities including part production, subassembling, and final assembly to low-cost countries can reduce the unit cost. Content sourced from the final market may be significantly reduced as a result. The knock-on effect of outsourcing final assembly to low-cost countries halfway round the world can also be to transfer part production work undertaken by suppliers in the market to suppliers closer to the new low-labor-cost manufacturing center. The effect is to strip out many of the supply chain jobs that had existed. If the economy is fully open for business, new jobs will emerge to replace the old ones. Entire regions may

undergo periods of deindustrialization, depression, and then regeneration. Intellectual property (IP) rights in the form of knowledge process may be transferred to franchisees, only to be disseminated locally without consent of the IP owner. Other risks become apparent when outsourcing to countries that have widely divergent cultures. Quality expectations may differ. Entire batches may be written off due to defects introduced by the subcontractor. To ensure they follow orders and comply with specifications, entire teams may need to jet off frequently to review what is going on and to bring the supplier back on track. Local representatives that are "on our side" and speak both languages may be recruited to undertake this vital role. Their salaries increase the overhead element on top of the purchase price. The company must aim to identify other factors that put the commercial viability at jeopardy. Risks to be mitigated include wage rises, lack of literate and skilled employees, language barriers, dishonest and unethical behavior, transport failure including train derailment, fire, ships sinking, new trade barriers, incoming border inspections, and administrative compliance issues that lead to refusal to admit the consignment. A further factor that needs to be considered is the ability of the organization to respond to changes in volume demanded and sudden emergences of rival technologies and new competitor products. This can lead to significant discounting in order to sell the goods available, consignment recalls, and enforced upgrading activities. Lean aims to reduce the pipeline liability and obsolescence risk in the supply chain. If the goods are heavily discounted, revenue decreases. If they cannot be sold, their value must be paid for from profit and the goods are written off as obsolete. This can significantly reduce the viability of any business. To counter this, companies may mitigate the effects by producing a range of goods. Distance from market incurs logistics distribution time. Time-sensitive priced goods suffer from price erosion. It is necessary to ensure that goods are made, distributed, and sold as quickly as possible in order to minimize the stock holding cost associated with reducing prices. Companies like to reduce the time between placing orders with suppliers and receiving the goods. This is because the earlier they buy the parts, the higher the price that would have been paid for them. If purchase prices are high because orders were placed too early, and sale prices have dropped due to price erosion, then margins will be squeezed. To reduce the price erosion, design teams should be included throughout the production life cycle in order to supply a constant stream of product upgrades. Each variant or iteration is only produced for a short period of time. All of the goods should be designed to be produced using the same production processes and

**30**

assembly sequence. This avoids constant plant redesigns. An optimum sequence from supplier to customer should be identified in each plant. Designers should be instructed to design future iterations that fit that forward flow sequence from raw materials to finished goods. Group technology concepts including rank order clustering and to/from techniques can be used to identify the most efficient process sequence. Creating manufacturing cells can allow some backward flow without incurring overly long walks between the processes; (if we are walking, we aren't working). Minimizing the distances between processes eliminates the space beside each process to put work-in-process. One-piece flow can then be created where the material is walked from machine to machine. Some conveyor and robot movements may be permitted.

Plant location is a vital issue. Land cost, energy prices, average labor hour wages, and staff salaries, tax rates, transportation duration, and costs are vital pieces of the puzzle. Honda Corporation's motto can be summed up as "make where you sell, buy where you make" (adapted from [14]). In effect, it is necessary to identify major markets, make there, and buy from suppliers that are already there or can be encouraged to install themselves there as a global partner that sets up transplants alongside the producer.

Different locations have different ethical and responsible business practices. Emphasis may range from strict compliance through completely lacking on environmental protection, emissions control, pension contributions, healthcare schemes, employee training and education, and employee family education.

Ford Motor Company initially set up assembly plants in East London and Germany. These plants were supplied with kits from Detroit. It soon became apparent that it was more efficient to establish complete part and subassembly facilities to supply the final assembly plants. Ford's Dagenham plant had the largest brand dedicated iron and steel foundry in Europe. It was industrial disputes, repeated strike action, and union demands for higher equal pay for women that led to Dagenham's assembly plant being shut and production sent to Spain.

### **8. Supply chain configurations**

Four basic supply chain configurations are possible. Using a two-by-two matrix, we can map long and short inbound supply chains and outbound logistics: (1) Long inbound, long outbound is mass production; (2) Short inbound, long outbound is just in time; (3) Long inbound, short outbound is just in time; (4) Short inbound and short outbound is just in time 3.

Strategic financial commitment may be less than expected if most or all of the value-adding activities are undertaken in subcontractors. Empirical testing using a supply chain game [15] showed lower initial investment with JIT3, which reduces the volume required to breakeven. While salaries may be higher closer to the market, they should be few in number. Initial starting stock of 10% is achieved and maintained. Overall cost savings in terms of lower space, working capital, and cost of inventory offset the higher salaries. Profitability of a JIT3 operation is higher due to lower total costs and lower lost sales to competitors. Agile/mass production applied to the game using JIT3 enabled significantly increased capacity with the same number of people involved in JIT3, together with about 4% of the starting stock of mass production. Higher overall average revenue is achieved via more frequent product upgrade releases that maintain the sales price.

Many managers today believe it is cheaper to buy parts from low-labor-cost countries, import the goods, produce the finished product, and export these to the market that may be in high-labor-cost countries. Products with infinite inventory

shelf lives could achieve a sustained sales price. However, overall sales volume per period may stagnate. Cost of holding the inventory may counter the savings from sourcing from low-labor-cost countries.

**Figure 1** shows dyads from supplier to assembler and assembler to client. Many supply chain tiers can exist that can require many inbound and outbound kilometers. Mass production is induced by long inbound and distribution chains. To make long journeys, a viable option, large volumes are transported. Large loads deliver more volume than immediately required. Lean philosophies consider this to be a waste.

Lean supply chains can be setup in three configurations that enable inbound JIT, outbound JIT, or both. These correspond to JIT1, JIT2 and JIT3.

JIT1 is typified by Toyota City. This was developed following Toyota engineer's extensive study tours at Ford's Crystal Palace. Suppliers are encouraged to be "close by the plant" [16]. The issue Japan had, when they were the workshop of the world from the 1970s through the 1990s, was that they produced goods in a far-away country. Japan had to import much of the ore and energy required to produce basic engineering materials. Just-in-time deliveries were achieved from part producers, through module assemblers, and on to final assembly plants. They also required huge fleets of ships to transport their goods to markets, particularly in North America and Europe. In effect, only inbound just in time was used.  The key metric for distribution is not just in time. Instead the metric is *just on* time, where the just changes meaning to "only." Ships are expected at the docks neither too early, nor too late. If they are early, they have to wait until the current ship is off-loaded and new cargo is loaded. If they arrive too late, they use time reserved to service the next ship.

In a JIT2 scenario, the factory is close to the market, including locations with much passing trade and key account high-volume customers. McDonalds is a good

**33**

*Sourcing and Manufacturing in the Market Region DOI: http://dx.doi.org/10.5772/intechopen.87073*

a result of radical supply chain reengineering.

**9. Pipeline liability trumps low labor cost**

that may be sold with a higher margin.

into finished goods.

frequency is low.

come from Atlanta.

example of this strategy. Food must be fresh for people to eat it. Hence, the company cooks and assembles Big Mac's only a few meters from where they are bought. While in most cases, to reduce the purchase spend, suppliers may be faraway in low-labor-cost countries, but this is not the strategy taken by McDonalds. McDo' buy in UK and Ireland for that market. They buy in France/Belgium for that market, etc. Only two ingredients for the European market are imported in bulk. They are the sesame seeds on the buns from Mexico and the syrup for sodas that

JIT1 and JIT2 reduce pipeline stock and the number of people involved typically by half. However, this is not the 90%, *order of magnitude* [17] reduction hoped for as

To achieve the 90% reduction in inventory espoused by just-in-time advocates, JIT3 is used. JIT3 is based on buying and making close to the point of sale. Many SMEs do this. A small-family-run bar or shop for example typically buys from cash

This chapter proposes that a loaded supply chain is a risk to profit. This risk trumps low labor costs when demand for the product can be switched off rapidly. To sell remaining products, companies typically reduce the price. A key performance indicator is how much of total volumes ordered are sold at less than the full price. This represents over-ordering or late deliveries to points of sale. If we take Christmas trees as an example, it takes years to grow each unit. They start to have value at the beginning of October. Peak sales price is sought from November 1 through December 24. No one is buying on December 25. They have zero value from December 26. Any residual inventory in the pipeline is 100% obsolete. Consumers may discard their tree in the street as trash. Remaining inventory must be paid for from the high margins made from goods sold. This reduces trader's overall contribution to profit. Traders may store long-term nonperishable goods in anticipation of demand build up during next season. However, they will have incurred holding costs and the older goods shall compete against the new inventory

Pipeline liability is the value of stock loaded into a supply chain. Orders placed with suppliers are translated into orders they then place on their suppliers. They in turn place orders with their suppliers. Despite this loading, in many cases, materials can be used for other orders and other clients. If this is not the case, the client will be liable for orders placed on their behalf up to a maximum level. The brand owner may buy materials directly and act as an agent to sell their materials to suppliers. They then buy back the finished units. They therefore can control supplier's material costs and can gauge the supplier's ability to efficiently transform materials

In just in time three (JIT3), suppliers are close to the factory and the factory is close to the market. The resulting reduction in pipeline inventory, and hence reduction in risk to profit, can support higher wages. German auto workers earn ~37€/hr., compared to equivalents in Poland on 7€/hr. (Automotive News Europe). Making in Poland is "nearshoring." Goods made there could be transported to European sales regions within 1 or 2 days, with delivery on a regular basis. Other costs including plant costs, taxes, and indirect managerial overheads significantly may be more advantageous than German sites. Achieving apparently lower unit prices by outsourcing in relatively near lower labor cost countries can become a fallacy if delivery

and carry outlets. They may add value in their location and sell there.

**Figure 1.** *Four general supply chain configurations.*

*Sourcing and Manufacturing in the Market Region DOI: http://dx.doi.org/10.5772/intechopen.87073*

*Modern Perspectives in Business Applications*

sourcing from low-labor-cost countries.

shelf lives could achieve a sustained sales price. However, overall sales volume per period may stagnate. Cost of holding the inventory may counter the savings from

**Figure 1** shows dyads from supplier to assembler and assembler to client. Many supply chain tiers can exist that can require many inbound and outbound kilometers. Mass production is induced by long inbound and distribution chains. To make long journeys, a viable option, large volumes are transported. Large loads deliver more volume than immediately required. Lean philosophies consider this to be a waste.

Lean supply chains can be setup in three configurations that enable inbound JIT,

JIT1 is typified by Toyota City. This was developed following Toyota engineer's extensive study tours at Ford's Crystal Palace. Suppliers are encouraged to be "close by the plant" [16]. The issue Japan had, when they were the workshop of the world from the 1970s through the 1990s, was that they produced goods in a far-away country. Japan had to import much of the ore and energy required to produce basic engineering materials. Just-in-time deliveries were achieved from part producers, through module assemblers, and on to final assembly plants. They also required huge fleets of ships to transport their goods to markets, particularly in North America and Europe. In effect, only inbound just in time was used.  The key metric for distribution is not just in time. Instead the metric is *just on* time, where the just changes meaning to "only." Ships are expected at the docks neither too early, nor too late. If they are early, they have to wait until the current ship is off-loaded and new cargo is loaded. If they arrive too late, they use time reserved to service the next ship.

In a JIT2 scenario, the factory is close to the market, including locations with much passing trade and key account high-volume customers. McDonalds is a good

outbound JIT, or both. These correspond to JIT1, JIT2 and JIT3.

**32**

**Figure 1.**

*Four general supply chain configurations.*

example of this strategy. Food must be fresh for people to eat it. Hence, the company cooks and assembles Big Mac's only a few meters from where they are bought. While in most cases, to reduce the purchase spend, suppliers may be faraway in low-labor-cost countries, but this is not the strategy taken by McDonalds. McDo' buy in UK and Ireland for that market. They buy in France/Belgium for that market, etc. Only two ingredients for the European market are imported in bulk. They are the sesame seeds on the buns from Mexico and the syrup for sodas that come from Atlanta.

JIT1 and JIT2 reduce pipeline stock and the number of people involved typically by half. However, this is not the 90%, *order of magnitude* [17] reduction hoped for as a result of radical supply chain reengineering.

To achieve the 90% reduction in inventory espoused by just-in-time advocates, JIT3 is used. JIT3 is based on buying and making close to the point of sale. Many SMEs do this. A small-family-run bar or shop for example typically buys from cash and carry outlets. They may add value in their location and sell there.

### **9. Pipeline liability trumps low labor cost**

This chapter proposes that a loaded supply chain is a risk to profit. This risk trumps low labor costs when demand for the product can be switched off rapidly. To sell remaining products, companies typically reduce the price. A key performance indicator is how much of total volumes ordered are sold at less than the full price. This represents over-ordering or late deliveries to points of sale. If we take Christmas trees as an example, it takes years to grow each unit. They start to have value at the beginning of October. Peak sales price is sought from November 1 through December 24. No one is buying on December 25. They have zero value from December 26. Any residual inventory in the pipeline is 100% obsolete. Consumers may discard their tree in the street as trash. Remaining inventory must be paid for from the high margins made from goods sold. This reduces trader's overall contribution to profit. Traders may store long-term nonperishable goods in anticipation of demand build up during next season. However, they will have incurred holding costs and the older goods shall compete against the new inventory that may be sold with a higher margin.

Pipeline liability is the value of stock loaded into a supply chain. Orders placed with suppliers are translated into orders they then place on their suppliers. They in turn place orders with their suppliers. Despite this loading, in many cases, materials can be used for other orders and other clients. If this is not the case, the client will be liable for orders placed on their behalf up to a maximum level. The brand owner may buy materials directly and act as an agent to sell their materials to suppliers. They then buy back the finished units. They therefore can control supplier's material costs and can gauge the supplier's ability to efficiently transform materials into finished goods.

In just in time three (JIT3), suppliers are close to the factory and the factory is close to the market. The resulting reduction in pipeline inventory, and hence reduction in risk to profit, can support higher wages. German auto workers earn ~37€/hr., compared to equivalents in Poland on 7€/hr. (Automotive News Europe). Making in Poland is "nearshoring." Goods made there could be transported to European sales regions within 1 or 2 days, with delivery on a regular basis. Other costs including plant costs, taxes, and indirect managerial overheads significantly may be more advantageous than German sites. Achieving apparently lower unit prices by outsourcing in relatively near lower labor cost countries can become a fallacy if delivery frequency is low.

### **10. Fast-moving consumer clothing case**

The example provided in **Table 1** compares "as it is in Asia and Morocco" and a modified version of Moroccan initial conditions that result from supplier development and a changed ordering philosophy. The Asian purchase model uses the mass production supply chain configuration of long inbound supply pipelines and long outbound distribution. It requires suppliers to produce goods for 9 months with a single delivery date scheduled before the most significant seasonal sales period. The Moroccan supply chain initially takes the same delivery schedule as Asia. Modifying this to a short lead time and frequent delivery mode significantly reduces pipeline liability.

North Africa offers a relatively low-labor-cost alternative that logistically is near Europe. Moroccan workers in a clothing company were reported by a client to earn 3.80€/hr., whereas Asian workers about 1.30€/hr. Moroccan labor initially was 20% less efficient than Asian counterparts. Thus, more workers were required at a higher wage rate. This motivated the client to source from Asia, based on a single "headline" budget line. Various minor import and export duties apply to Asia and Morocco that negate these charges. Making goods in Morocco appears expensive by comparison. Making in Poland, with labor at around 7€/hr. seems to double the cost compared to Morocco. Making in Germany at 37€/hr.—*hell is not that stupid*? The simple answer to that, from a total cost perspective, is a counter intuitive *No*. Better training is required to improve workers' efficiency. That is half the issue. The other is pipeline liability and the consequent risk to profit.

This research found that using JIT3, companies could cover wages and costs up to 60€/hr. and still make a profit, provided that productivity is equivalent to the best and providing pipeline liability dramatically is reduced. To achieve the labor productivity, benchmarking and activity training are required, together with known productivity targets.

Given a JIT3 supply chain structure, greater productivity can be achieved by better line balancing. This enables JIT3 to double productivity over mass production. Using JIT3 as a basic supply chain structure, modular product assembly to reduce hand time, sharing some assembly work with suppliers and some customer coproduction, and agile mass production, therefore, may double productivity *again*. This enables more revenue from more products being made and sold in less time. As a result, labor cost per unit is significantly reduced. Simultaneously, capacity per time period can be raised. Capacity utilization can be increased prior to major sale seasons. This approach avoids stockpiling finished goods that have been made months in advance, because capacity has not been created or is not available to respond to actual market demand.

Full cost analysis beyond pipeline liability, direct cost, and taxation should include other factors such as plant space costs, management overhead differential costs, legal administrative requirements and bureaucracy, healthcare and pension overheads, site security, and maintenance. These arguments are not well understood by operations managers, and even less so by managerial accountants/CFOs. This article aims to explain the logic of "making where you sell and buying where you make." By contrast, KPMG [12] perspective is that near- and reshoring is to set up facilities near the corporate headquarters. They suggest "an 'in country for country' approach that encompasses not just manufacturing, but the location of product management and R&D functions." That article is from the headquarters' perspective of where the market is. Based on research for this article, advice proposed is "produce within or close to both large and rapidly expanding markets." In summary, "buy, make, and sell locally."

**35**

**11. Conclusions**

risk)

**Table 1.**

the markets are rather than on the headquarters.

*Summary of mass to JIT3 financial comparisons for fast-moving consumer goods.*

Buy locally, make locally, and sell locally—the so-called "Glocal" strategy operates by making the goods tailored for local markets. The focus should be on where

Total margin clear of stock risk € 7,296,285 € 8,880,991 € 19,344,363

*Sourcing and Manufacturing in the Market Region DOI: http://dx.doi.org/10.5772/intechopen.87073*

Total number of stock pipeline liability

Avg. human time needed to prepare

Total margin (excluding any sales or

Number of work days/year 286 Total number of days worked/year 365 Working hours per day 8 Number of work days/week 5.5 Efficiency factor of Asia over EU 0%

Daily production volume 19930

Annual production demand 5,700,000 units

volume

one unit

Customer assembler order window (w) 40 15 1.6

Customer assembler order window (d) 280 105 11.2

Material BOM cost € 4.02 € 4.38 € 4.38 Transport cost percentage € 0.10 € 0.06 € 0.06 Transport cost unit € 0.10 € 0.06 € 0.06 Tax % 10% 0% 0% Total material cost € 22,433,286 € 9169,605 € 978,091 Total transport cost € 558,041 € 125,559 € 13,393 Total tax € 2,243,328 € 0.00 € 0.00 Total mat cost + transport + tax € 25,234657.34 € 9295165.38 € 991,484.31 Number of employees 1287 1545 1287 Mean cost per labor hour € 1.29 € 3.86 € 3.86 Total labor cost € 3,786,428 € 13,634,845 € 11,359,285 Working capital € 26,777,757 € 22,930,011 € 12,350,770

**Asia pacific Morocco Morocco improved**

5,580,420 2,092,657 223,217

€ 29,729,571 € 18,046,894 € 20,322,454

61% 68%

122% 265%

31 mins

weeks

days

### *Sourcing and Manufacturing in the Market Region DOI: http://dx.doi.org/10.5772/intechopen.87073*

*Modern Perspectives in Business Applications*

reduces pipeline liability.

known productivity targets.

respond to actual market demand.

"buy, make, and sell locally."

**10. Fast-moving consumer clothing case**

is pipeline liability and the consequent risk to profit.

The example provided in **Table 1** compares "as it is in Asia and Morocco" and a modified version of Moroccan initial conditions that result from supplier development and a changed ordering philosophy. The Asian purchase model uses the mass production supply chain configuration of long inbound supply pipelines and long outbound distribution. It requires suppliers to produce goods for 9 months with a single delivery date scheduled before the most significant seasonal sales period. The Moroccan supply chain initially takes the same delivery schedule as Asia. Modifying this to a short lead time and frequent delivery mode significantly

North Africa offers a relatively low-labor-cost alternative that logistically is near Europe. Moroccan workers in a clothing company were reported by a client to earn 3.80€/hr., whereas Asian workers about 1.30€/hr. Moroccan labor initially was 20% less efficient than Asian counterparts. Thus, more workers were required at a higher wage rate. This motivated the client to source from Asia, based on a single "headline" budget line. Various minor import and export duties apply to Asia and Morocco that negate these charges. Making goods in Morocco appears expensive by comparison. Making in Poland, with labor at around 7€/hr. seems to double the cost compared to Morocco. Making in Germany at 37€/hr.—*hell is not that stupid*? The simple answer to that, from a total cost perspective, is a counter intuitive *No*. Better training is required to improve workers' efficiency. That is half the issue. The other

This research found that using JIT3, companies could cover wages and costs up to 60€/hr. and still make a profit, provided that productivity is equivalent to the best and providing pipeline liability dramatically is reduced. To achieve the labor productivity, benchmarking and activity training are required, together with

Given a JIT3 supply chain structure, greater productivity can be achieved by better line balancing. This enables JIT3 to double productivity over mass production. Using JIT3 as a basic supply chain structure, modular product assembly to reduce hand time, sharing some assembly work with suppliers and some customer coproduction, and agile mass production, therefore, may double productivity *again*. This enables more revenue from more products being made and sold in less time. As a result, labor cost per unit is significantly reduced. Simultaneously, capacity per time period can be raised. Capacity utilization can be increased prior to major sale seasons. This approach avoids stockpiling finished goods that have been made months in advance, because capacity has not been created or is not available to

Full cost analysis beyond pipeline liability, direct cost, and taxation should include other factors such as plant space costs, management overhead differential costs, legal administrative requirements and bureaucracy, healthcare and pension overheads, site security, and maintenance. These arguments are not well understood by operations managers, and even less so by managerial accountants/CFOs. This article aims to explain the logic of "making where you sell and buying where you make." By contrast, KPMG [12] perspective is that near- and reshoring is to set up facilities near the corporate headquarters. They suggest "an 'in country for country' approach that encompasses not just manufacturing, but the location of product management and R&D functions." That article is from the headquarters' perspective of where the market is. Based on research for this article, advice proposed is "produce within or close to both large and rapidly expanding markets." In summary,

**34**

### **Table 1.**

*Summary of mass to JIT3 financial comparisons for fast-moving consumer goods.*

### **11. Conclusions**

Buy locally, make locally, and sell locally—the so-called "Glocal" strategy operates by making the goods tailored for local markets. The focus should be on where the markets are rather than on the headquarters.

Mass production configuration supply chains are operated because it seems to be obvious. Buy cheap and sell expensive. However, pipeline liability from loaded inbound supply and outbound distribution chains creates increased end-to-end times. This reduces the flexibility to respond to market changes. If the good is stable in terms of technology and design specification, with high demand and unrestricted supply, the strategy may enable organizations to achieve viable cash flow. Taking an end-to-end perspective, working capital is excessive and represents a significant risk to profit if the sales window closes.

JIT1 and JIT2 reduce the amount of goods in the supply chain approximately halfway between mass production and JIT3. JIT1 can make use of low-cost material and labor to produce a finished good. Logistics infrastructure may be used to transport finished goods to other regions where premium sales prices justify the extra risk from a loaded distribution network. If the goods are made and supplied to other corporations as part of agreed volume contracts, the risk to profit is minimized.

JIT2 can use low-cost parts from low-cost countries. Using nearshoring for final assembly and offshoring for part production is a strategy noted near Monterrey, Mexico. Between the city center and the airport, the majority of the companies are Chinese owned. Parts are produced in China. Finished goods are assembled in Mexico from these parts. Since the majority of the value add is undertaken in NAFTA, duty among Mexico, the USA, and Canada is avoided.

Risk to profit needs to be minimized. This is achieved by sacrificing a loaded supply chain that is filled with millions of examples of cheap goods. Instead, emphasis is placed on productive labor that is comparatively cheap compared to home markets, but may be much more expensive compared to remote lowlabor-cost countries. In Europe, the highest salaries tend to be within the triangle Liverpool, Hamburg, and Paris. The further East and South the production site is located, the lower the general factory wage tends to be. A one-day distribution circumference can determine likely "nearshore" production locations. While total cost per unit may seem to increase, focusing on doubling the productivity and doubling it again should be primary design team and operations' objectives. This can be achieved by simplifying the product, reducing hand time to make them, worker training, supplier, and customer co-production.

A fast-moving consumer goods case supplying own-branded sport clothing outlets is presented. Reduced end-to-end pipeline times were achieved via adopting buy, make, and sell close to market point of sales. Now, redundant continental and regional distribution centers can be converted from cost centers to profit centers by undertaking "late configurability" value-adding activities. The products must be designed to permit this and must become part of the market offering. Premium prices may be commanded, for example, The Bear Factory.

The summary shown in **Table 1** is an example of financial effects of JIT3 versus mass production provided in Section 9 "Pipeline liability trumps low labor cost." Financial analysis is shown highlighting critical factors that need to be managed that are *force multipliers* for the supply chain configurations.

The analysis given in **Table 1** shows the ability of the client to reallocate work to Morocco from Asia. They have understood the potential risk to profit from having a loaded supply chain, and significant discounting that was required to sell remaining goods after the end of the sales window. Total margin clear of stock risk is significantly higher for the baseline Morocco "near–production" scenario. The revised plan with more frequent deliveries doubles more than that. The client adopted JIT3 strategies, making closer to reduce pipeline inventory yet not too close that skyrocket labor wages. JIT3 can be enhanced with agile/mass customization approaches. This can enable the corporation to delay the point of variation and facilitate assemble-to-order strategies.

**37**

**Author details**

David J. Newlands\* and Fawaz Baddar Al Hussan

provided the original work is properly cited.

\*Address all correspondence to<EMAIL_ADDRESS>
IÉSEG School of Management (LEM, CNRS 9221), Lille, France

© 2019 The Author(s). Licensee IntechOpen. This chapter is distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/ by/3.0), which permits unrestricted use, distribution, and reproduction in any medium,

*Sourcing and Manufacturing in the Market Region DOI: http://dx.doi.org/10.5772/intechopen.87073*

exclusively for export to other, richer, markets.

and remote regions.

productivity are consistent.

Making in country, or trading region, primarily for sales, does not prohibit sales abroad, except where they are contractually bound to do so by intellectual property owners. Excess production beyond local market absorption may be exported to other market regions. This approach differs from make in low-cost countries

Specification and legal compliance in sales regions imposes two options: comply with each market requirement separately or supersede requirements of both home

Mass production could yield higher margins; however, this strategy has higher potential risk of obsolescence that would yield the smallest total margin. The amount of profit free from pipeline obsolescence risk is significantly higher than JIT3 supply chain configurations. Mass production in remote low-labor-cost countries would suit "pile 'em high and sell 'em to everyone." This also suits undeveloped markets and monopoly technology scenarios. The results in the table indicate that nearshoring in inefficient plants yields the smallest total margin, while ensuring more than 20% higher minimum margin as a result of reduced pipeline liability. Optimizing nearshoring performance maximizes risk-free total margin, at least 250% more than the mass production model. The strategic choices must be re-evaluated as BOM cost approaches zero and as BOM costs become significantly more than total labor costs. This model is static rather than stochastic. Static models are viable when distance to market, order-fulfilment lead time, delivery duration, and price and

*Sourcing and Manufacturing in the Market Region DOI: http://dx.doi.org/10.5772/intechopen.87073*

*Modern Perspectives in Business Applications*

risk to profit if the sales window closes.

Mass production configuration supply chains are operated because it seems to be obvious. Buy cheap and sell expensive. However, pipeline liability from loaded inbound supply and outbound distribution chains creates increased end-to-end times. This reduces the flexibility to respond to market changes. If the good is stable in terms of technology and design specification, with high demand and unrestricted supply, the strategy may enable organizations to achieve viable cash flow. Taking an end-to-end perspective, working capital is excessive and represents a significant

JIT1 and JIT2 reduce the amount of goods in the supply chain approximately halfway between mass production and JIT3. JIT1 can make use of low-cost material and labor to produce a finished good. Logistics infrastructure may be used to transport finished goods to other regions where premium sales prices justify the extra risk from a loaded distribution network. If the goods are made and supplied to other corporations as part of agreed volume contracts, the risk to profit is minimized. JIT2 can use low-cost parts from low-cost countries. Using nearshoring for final assembly and offshoring for part production is a strategy noted near Monterrey, Mexico. Between the city center and the airport, the majority of the companies are Chinese owned. Parts are produced in China. Finished goods are assembled in Mexico from these parts. Since the majority of the value add is undertaken in

Risk to profit needs to be minimized. This is achieved by sacrificing a loaded supply chain that is filled with millions of examples of cheap goods. Instead, emphasis is placed on productive labor that is comparatively cheap compared to home markets, but may be much more expensive compared to remote lowlabor-cost countries. In Europe, the highest salaries tend to be within the triangle Liverpool, Hamburg, and Paris. The further East and South the production site is located, the lower the general factory wage tends to be. A one-day distribution circumference can determine likely "nearshore" production locations. While total cost per unit may seem to increase, focusing on doubling the productivity and doubling it again should be primary design team and operations' objectives. This can be achieved by simplifying the product, reducing hand time to make them, worker

A fast-moving consumer goods case supplying own-branded sport clothing outlets is presented. Reduced end-to-end pipeline times were achieved via adopting buy, make, and sell close to market point of sales. Now, redundant continental and regional distribution centers can be converted from cost centers to profit centers by undertaking "late configurability" value-adding activities. The products must be designed to permit this and must become part of the market offering. Premium

The summary shown in **Table 1** is an example of financial effects of JIT3 versus mass production provided in Section 9 "Pipeline liability trumps low labor cost." Financial analysis is shown highlighting critical factors that need to be managed

The analysis given in **Table 1** shows the ability of the client to reallocate work to Morocco from Asia. They have understood the potential risk to profit from having a loaded supply chain, and significant discounting that was required to sell remaining goods after the end of the sales window. Total margin clear of stock risk is significantly higher for the baseline Morocco "near–production" scenario. The revised plan with more frequent deliveries doubles more than that. The client adopted JIT3 strategies, making closer to reduce pipeline inventory yet not too close that skyrocket labor wages. JIT3 can be enhanced with agile/mass customization approaches. This can enable the corporation to delay the point of variation and

NAFTA, duty among Mexico, the USA, and Canada is avoided.

training, supplier, and customer co-production.

prices may be commanded, for example, The Bear Factory.

that are *force multipliers* for the supply chain configurations.

facilitate assemble-to-order strategies.

**36**

Making in country, or trading region, primarily for sales, does not prohibit sales abroad, except where they are contractually bound to do so by intellectual property owners. Excess production beyond local market absorption may be exported to other market regions. This approach differs from make in low-cost countries exclusively for export to other, richer, markets.

Specification and legal compliance in sales regions imposes two options: comply with each market requirement separately or supersede requirements of both home and remote regions.

Mass production could yield higher margins; however, this strategy has higher potential risk of obsolescence that would yield the smallest total margin. The amount of profit free from pipeline obsolescence risk is significantly higher than JIT3 supply chain configurations. Mass production in remote low-labor-cost countries would suit "pile 'em high and sell 'em to everyone." This also suits undeveloped markets and monopoly technology scenarios. The results in the table indicate that nearshoring in inefficient plants yields the smallest total margin, while ensuring more than 20% higher minimum margin as a result of reduced pipeline liability. Optimizing nearshoring performance maximizes risk-free total margin, at least 250% more than the mass production model. The strategic choices must be re-evaluated as BOM cost approaches zero and as BOM costs become significantly more than total labor costs.

This model is static rather than stochastic. Static models are viable when distance to market, order-fulfilment lead time, delivery duration, and price and productivity are consistent.

### **Author details**

David J. Newlands\* and Fawaz Baddar Al Hussan IÉSEG School of Management (LEM, CNRS 9221), Lille, France

\*Address all correspondence to<EMAIL_ADDRESS>
© 2019 The Author(s). Licensee IntechOpen. This chapter is distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/ by/3.0), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

### **References**

[1] Khan SAR. Introductory Chapter: Introduction of Green Supply Chain Management [Online First]. Rijeka: IntechOpen; 2018. DOI: 10.5772/ intechopen.81088. Available from: https://www.intechopen.com/onlinefirst/introductory-chapter-introductionof-green-supply-chain-management

[2] Khan SAR, Dong Q, Zhang Y, Khan SS. The impact of green supply chain on enterprise performance: In the perspective of China. Journal of Advanced Manufacturing Systems. 2017;**16**(3):263-273

[3] Khan SAR, Dong Q, Zhang Y. Role of ABC analysis in the process of efficient order fulfilment: Case study. Advanced Engineering Forum. 2017;**23**(7):114-121

[4] Khan SAR, Zhang Y. Introductory Chapter: Purchasing and Supply Management [Online First]. Rijeka: IntechOpen; 2019. DOI: 10.5772/ intechopen.85380. Available from: https://www.intechopen.com/onlinefirst/introductory-chapter-purchasingand-supply-management

[5] Brad S, Bogdan M, Emilia B, Mircea F. Environmentally sustainable economic growth. Amfiteatru Economic Journal. 2016;**18**(42):446-460. The Bucharest University of Economic Studies, Bucharest. ISSN: 2247-9104

[6] Robert P. New Minimum Wage Too High, Business Owner Says; 12 August 2015. Available from: http://www. bbc.com/news/business-33885991 [Accessed: 12 August 2015]

[7] Lamming R. Beyond Partnership: Strategies for Innovation and Lean Supply. London: Prentice Hall International; 1993

[8] Andrew A. Companies increasingly turning to US cities for their outsourcing locations. 2015. Available

from: http://www.supplymanagement. com/news/2015/companiesincreasingly-turning-to-us-cities-fortheir-outsourcing-locations [published 28 May, Site Accessed: 28 May 2015]

[9] Marino D. Keeping Manufacturing in the UK Even More Important than Reshoring'. 2015. Available from: http://www.supplymanagement.com/ news/2015/keeping-manufacturingin-the-uk-even-more-important-thanreshoring?utm\_source=Adestra&utm\_ medium=email&utm\_term [published 16 May, Site Accessed: 18 May 2015]

[10] Friedman TL. The World Is Flat: The Globalized World in the Twenty-First Century Paperback. 2Rev ed. Penguin; 2007

[11] CCTV News. Trans-Eurasia Railway Connects China with Europe. 2013. Available from: https://www.youtube. com/watch?v=5Z0kT8P6XDE

[12] KPMG. Production's Coming Home: What Companies Need to Know About Reshoring. 2014. Available from: http://www.kpmg.com/Global/en/ IssuesAndInsights/ArticlesPublications/ ConsumerCurrents/Pages/productionscoming-home.aspx

[13] Automotive News. Ford Opens Engine Plant in Russia to Reduce Dependency on Imports. 2015. Available from: http://europe.autonews.com/ article/20150904/ANE/150909931/ ford-opens-engine-plant-inrussia-to-reduce-dependency-onimports?cciid=email-ane-daily

[14] Nelson D, Mayo R, Moody P. Powered by Honda: Developing Excellence in the Global Enterprise. New York: John Wiley & Sons; 1998

[15] Newlands D. Supply Chain Games, Operations Management, Vol 38, No. 4, Toyota Beefs up U.S build. August Purchasing, 15 December 1994. 2012

**39**

*Sourcing and Manufacturing in the Market Region DOI: http://dx.doi.org/10.5772/intechopen.87073*

[16] Treece J B. Nissan Purchasing Boss Embraces Common Sense. Heresy! Quoting Interview Text from Rebecca Vest; North American Purchasing Head; 3 August 2011. Available from: http:// www.autonews.com/article/20110803/

BLOG06/308039990/1129

[17] Hammer M, Champy J. Reengineering the Corporation: A Manifesto for Business Revolution. London: Nicholas Brealey Publishing

Ltd; 1993

*Sourcing and Manufacturing in the Market Region DOI: http://dx.doi.org/10.5772/intechopen.87073*

[16] Treece J B. Nissan Purchasing Boss Embraces Common Sense. Heresy! Quoting Interview Text from Rebecca Vest; North American Purchasing Head; 3 August 2011. Available from: http:// www.autonews.com/article/20110803/ BLOG06/308039990/1129

[17] Hammer M, Champy J. Reengineering the Corporation: A Manifesto for Business Revolution. London: Nicholas Brealey Publishing Ltd; 1993

**38**

*Modern Perspectives in Business Applications*

[1] Khan SAR. Introductory Chapter: Introduction of Green Supply Chain Management [Online First]. Rijeka: IntechOpen; 2018. DOI: 10.5772/ intechopen.81088. Available from: https://www.intechopen.com/onlinefirst/introductory-chapter-introductionof-green-supply-chain-management

from: http://www.supplymanagement.

increasingly-turning-to-us-cities-fortheir-outsourcing-locations [published 28 May, Site Accessed: 28 May 2015]

[9] Marino D. Keeping Manufacturing in the UK Even More Important than Reshoring'. 2015. Available from: http://www.supplymanagement.com/ news/2015/keeping-manufacturingin-the-uk-even-more-important-thanreshoring?utm\_source=Adestra&utm\_ medium=email&utm\_term [published 16 May, Site Accessed: 18 May 2015]

[10] Friedman TL. The World Is Flat: The Globalized World in the Twenty-First Century Paperback. 2Rev ed. Penguin;

[11] CCTV News. Trans-Eurasia Railway Connects China with Europe. 2013. Available from: https://www.youtube.

com/watch?v=5Z0kT8P6XDE

coming-home.aspx

[12] KPMG. Production's Coming Home: What Companies Need to Know About Reshoring. 2014. Available from: http://www.kpmg.com/Global/en/ IssuesAndInsights/ArticlesPublications/ ConsumerCurrents/Pages/productions-

[13] Automotive News. Ford Opens Engine Plant in Russia to Reduce

[14] Nelson D, Mayo R, Moody P. Powered by Honda: Developing Excellence in the Global Enterprise. New York: John Wiley & Sons; 1998

[15] Newlands D. Supply Chain Games, Operations Management, Vol 38, No. 4, Toyota Beefs up U.S build. August Purchasing, 15 December 1994. 2012

Dependency on Imports. 2015. Available from: http://europe.autonews.com/ article/20150904/ANE/150909931/ ford-opens-engine-plant-inrussia-to-reduce-dependency-onimports?cciid=email-ane-daily

2007

com/news/2015/companies-

[2] Khan SAR, Dong Q, Zhang Y, Khan SS. The impact of green supply chain on enterprise performance: In the perspective of China. Journal of Advanced Manufacturing Systems.

[3] Khan SAR, Dong Q, Zhang Y. Role of ABC analysis in the process of efficient order fulfilment: Case study. Advanced Engineering Forum. 2017;**23**(7):114-121

[4] Khan SAR, Zhang Y. Introductory Chapter: Purchasing and Supply Management [Online First]. Rijeka: IntechOpen; 2019. DOI: 10.5772/ intechopen.85380. Available from: https://www.intechopen.com/onlinefirst/introductory-chapter-purchasing-

and-supply-management

[5] Brad S, Bogdan M, Emilia B, Mircea F. Environmentally sustainable economic growth. Amfiteatru Economic Journal. 2016;**18**(42):446-460. The Bucharest University of Economic Studies, Bucharest. ISSN: 2247-9104

[6] Robert P. New Minimum Wage Too High, Business Owner Says; 12 August 2015. Available from: http://www. bbc.com/news/business-33885991

[7] Lamming R. Beyond Partnership: Strategies for Innovation and Lean Supply. London: Prentice Hall

[8] Andrew A. Companies increasingly

outsourcing locations. 2015. Available

[Accessed: 12 August 2015]

turning to US cities for their

International; 1993

2017;**16**(3):263-273

**References**

**Chapter 4**

**Abstract**

Rental Market

new functions was roughly—5%.

obsolescence, cohort effect

**1. Introduction**

**41**

production and pricing analysis

*Takeshi So and Chihiro Shimizu*

Supply Management of Rental

Changes in the Quality of Housing

The Tokyo housing market is considered to be one of the fastest evolving markets in the world. In recent years, functions such as TV intercoms, bathroom dryers, system kitchens, and toilets with washlets, which are not often seen in European and US houses, have spread and become common in Japanese houses. Under such circumstances, the importance of various equipment ancillary to housing, together with the location and quality of the building, is increasingly a factor for determining the value of housing in Tokyo. This is because when a new product appears, the old product is ordered to be withdrawn from the market, or its commodity value is greatly depreciated. This study measured the economic value of improving the quality of housing with new equipment in the Tokyo rental housing market and clarified the extent of economic depreciation that is occurring due to obsolescence. According to the obtained results, new functions are being added sequentially to the Japanese rental housing according to the age of the building, and these functions are non-negligible in the determination of housing rent, even when compared with location and building structure. The effect of obsolescence due to the addition of

**Keywords:** quality change, housing equipment, hedonic approach, depreciation,

In the past, Japanese houses were ridiculed as being "rabbit hutches" as they were smaller in scale, lower in quality, and shorter in average service life than those of Western countries, and examples were often given illustrating Japan as having the worst residential environment among major advanced countries. However, after

**JEL classification:** R31—housing supply and markets; R32—other spatial

Equipment in the Tokyo Housing

Housing Facilities: Effect of

### **Chapter 4**

## Supply Management of Rental Housing Facilities: Effect of Changes in the Quality of Housing Equipment in the Tokyo Housing Rental Market

*Takeshi So and Chihiro Shimizu*

### **Abstract**

The Tokyo housing market is considered to be one of the fastest evolving markets in the world. In recent years, functions such as TV intercoms, bathroom dryers, system kitchens, and toilets with washlets, which are not often seen in European and US houses, have spread and become common in Japanese houses. Under such circumstances, the importance of various equipment ancillary to housing, together with the location and quality of the building, is increasingly a factor for determining the value of housing in Tokyo. This is because when a new product appears, the old product is ordered to be withdrawn from the market, or its commodity value is greatly depreciated. This study measured the economic value of improving the quality of housing with new equipment in the Tokyo rental housing market and clarified the extent of economic depreciation that is occurring due to obsolescence. According to the obtained results, new functions are being added sequentially to the Japanese rental housing according to the age of the building, and these functions are non-negligible in the determination of housing rent, even when compared with location and building structure. The effect of obsolescence due to the addition of new functions was roughly—5%.

**Keywords:** quality change, housing equipment, hedonic approach, depreciation, obsolescence, cohort effect

**JEL classification:** R31—housing supply and markets; R32—other spatial production and pricing analysis

### **1. Introduction**

In the past, Japanese houses were ridiculed as being "rabbit hutches" as they were smaller in scale, lower in quality, and shorter in average service life than those of Western countries, and examples were often given illustrating Japan as having the worst residential environment among major advanced countries. However, after the period of high economic growth since the chaotic postwar period, this environment has already greatly improved. In recent years high-performance housing stock has accumulated, and housing with functions not found in other countries have become common.

strengthened, thereby rapidly increasing the performance requirements of

the stock as a whole has been shortened over a long period.

summarize the results by way of a conclusion.

**43**

Japanese houses and have greatly improved household living standards.

This history is also closely related to the shortness of service life, which is a characteristic of the previously ridiculed Japanese houses. Several reasons can be envisaged to explain the short service life of Japanese houses, but the two most influential factors are considered to be the urgent task of promoting the renovation of low-quality housing stock that was built to temporarily compensate for the housing shortage after the war and the fact that the stock renewal was promoted by strengthening public regulations due to large-scale earthquakes and other disasters. In addition, the high urban renewal rate can also be cited as a reason. In the rapid economic growth of postwar Japan, the main industrial structure shifted from primary to secondary industry in a single stroke, and urbanization was promoted throughout the country in the 1970s by developing highway and railway networks across the country, known as "Japanese archipelago remodeling." In the 1980s, a policy was developed to transform the industrial structure, which was centered on secondary industry to tertiary industry. The transformation of Tokyo into an international financial center was a symbolic policy, and against this background, redevelopment rapidly advanced in major cities. Under such circumstances, the conversion of building use of even physically usable housing into offices, commercial facilities, and so on was promoted through rebuilding, and the advancement of land use was promoted [1]. As a result, it can be said that the average service life of housing seen throughout

*Supply Management of Rental Housing Facilities: Effect of Changes in the Quality of Housing…*

In addition to these features, it should be noted that the speed of technological innovation in Japanese housing is fast. "Technological innovation" here refers not only to the improvement of productivity on the manufacturing side but also the significant improvement of household welfare levels through the release of new products developed by R&D. In recent years, smart houses utilizing IOT and so on have become symbolic of advancing technology, but functions such as TV intercoms, bathroom dryers, system kitchens, and toilets with washlets, which are not often seen in European and American houses, have become common functions in

However, in a market where products with such new features arrive so quickly, the speed of obsolescence also increases. In these markets, when a new product appears, the old product is ordered to be withdrawn from the market, or its commodity value is greatly depreciated, that is, the service life of products is shortened. This study aims to measure the economic value of the functions of housing with new quality in the rental housing market in Tokyo, where technological advancement has been the greatest, and to clarify how much economic depreciation is occurring due to obsolescence. In Section 2, we present the model and the framework for empirical analysis together with the data, and in Section 3, we present the estimated results. According to the obtained results, new functions are being added sequentially to Japanese rental housing according to the age of the building, and these functions are non-negligible in the determination of housing rent, even when compared with location (LC) and the building structure (ST). The effect of obsolescence due to the addition of new functions was roughly—5%. In Section 4, we

<sup>5</sup> In response to major disasters, the Japanese Building Standards Law was revised. The first major revision of the Building Standards Law was in 1991, and the revision strengthened the earthquake resistance standards. After that, following the two great earthquakes, the standards strengthened.

housing.<sup>5</sup>

*DOI: http://dx.doi.org/10.5772/intechopen.86163*

Needless to say, when attempting an analysis of a housing market, it is necessary to fully understand the characteristics of the country. Below, we set out the reasons that have led to the false perception of Japanese housing still belonging to the era when they were ridiculed as rabbit hutches.

Although commonalities can be found in many parts of the Japanese housing market in comparison with the European and US housing markets, the following heterogeneity is conceivable as the postwar historical origin is different. It is possible that these are the cause of many misunderstandings.

In Japan, many houses were destroyed due to the large-scale air raids during the Second World War, not only in metropolitan areas but also in regional cities. In particular, a large number of houses were destroyed in the Tokyo metropolitan area,<sup>1</sup> and very-low-quality houses were built in a disorganized manner to satisfy the urgent housing demand in the chaotic postwar period. In the so-called high economic growth period that began in the mid-1950s, such houses were rapidly upgraded as large numbers of apartment buildings came up throughout Japan.<sup>2</sup> In addition, the drastic change in Japanese lifestyle through the rapid economic growth triggered the renewal of old housing stock by Westernizing the traditional housing style of Japan.

The private sector led construction to realize such a large-scale housing supply because the public sector was saddled with the large financial burden of postwar reconstruction. In particular, the government established a personal loan system to promote housing investment by households, and as a result, the ownership rate in postwar Japan significantly increased in comparison to before the war. Furthermore, as the supply of public housing was limited, a dedicated housing market for single-person renters formed in the rental housing market, which was rarely seen in Europe and the United States.

As a result of these short-term housing renewals, Japanese housing was brought into a state where their style, quality, and housing equipment were greatly different depending on the period of construction. In addition, due to natural disasters such as the Great Hanshin earthquake<sup>3</sup> and the Great East Japan earthquake,<sup>4</sup> housing earthquake resistance and other legal regulations have been successively

<sup>1</sup> The Bombing of Tokyo was a series of firebombing air raids in Second World War. This was conducted on the night of 9–10 March 1945, 16 square miles (41 km<sup>2</sup> ) of central Tokyo were destroyed, leaving an estimated 100,000 civilians dead and over 1 million homeless.

<sup>2</sup> Although the improvement of low-quality stock developed during the postwar reconstruction period has been carried out in many areas, some areas remain in which stock has not improved, referred to as "high density wooden structure areas." Since these areas are vulnerable to earthquake disasters and so on, improvement is urgently required.

<sup>3</sup> The Great Hanshin earthquake, or Kobe earthquake, occurred on January 17, 1995 in the southern part of Hyōgo Prefecture, Japan, when combined with Osaka, known as Hanshin. Up to 6434 people lost their lives.

<sup>4</sup> The Great East Japan Earthquake occurred on March 11, 2011. The report from the Japanese National Police Agency report in 2018 confirms 15,896 deaths, 6157 injured, and 2537 people missing across twenty prefectures.

*Supply Management of Rental Housing Facilities: Effect of Changes in the Quality of Housing… DOI: http://dx.doi.org/10.5772/intechopen.86163*

strengthened, thereby rapidly increasing the performance requirements of housing.<sup>5</sup>

This history is also closely related to the shortness of service life, which is a characteristic of the previously ridiculed Japanese houses. Several reasons can be envisaged to explain the short service life of Japanese houses, but the two most influential factors are considered to be the urgent task of promoting the renovation of low-quality housing stock that was built to temporarily compensate for the housing shortage after the war and the fact that the stock renewal was promoted by strengthening public regulations due to large-scale earthquakes and other disasters.

In addition, the high urban renewal rate can also be cited as a reason. In the rapid economic growth of postwar Japan, the main industrial structure shifted from primary to secondary industry in a single stroke, and urbanization was promoted throughout the country in the 1970s by developing highway and railway networks across the country, known as "Japanese archipelago remodeling." In the 1980s, a policy was developed to transform the industrial structure, which was centered on secondary industry to tertiary industry. The transformation of Tokyo into an international financial center was a symbolic policy, and against this background, redevelopment rapidly advanced in major cities. Under such circumstances, the conversion of building use of even physically usable housing into offices, commercial facilities, and so on was promoted through rebuilding, and the advancement of land use was promoted [1].

As a result, it can be said that the average service life of housing seen throughout the stock as a whole has been shortened over a long period.

In addition to these features, it should be noted that the speed of technological innovation in Japanese housing is fast. "Technological innovation" here refers not only to the improvement of productivity on the manufacturing side but also the significant improvement of household welfare levels through the release of new products developed by R&D. In recent years, smart houses utilizing IOT and so on have become symbolic of advancing technology, but functions such as TV intercoms, bathroom dryers, system kitchens, and toilets with washlets, which are not often seen in European and American houses, have become common functions in Japanese houses and have greatly improved household living standards.

However, in a market where products with such new features arrive so quickly, the speed of obsolescence also increases. In these markets, when a new product appears, the old product is ordered to be withdrawn from the market, or its commodity value is greatly depreciated, that is, the service life of products is shortened.

This study aims to measure the economic value of the functions of housing with new quality in the rental housing market in Tokyo, where technological advancement has been the greatest, and to clarify how much economic depreciation is occurring due to obsolescence. In Section 2, we present the model and the framework for empirical analysis together with the data, and in Section 3, we present the estimated results. According to the obtained results, new functions are being added sequentially to Japanese rental housing according to the age of the building, and these functions are non-negligible in the determination of housing rent, even when compared with location (LC) and the building structure (ST). The effect of obsolescence due to the addition of new functions was roughly—5%. In Section 4, we summarize the results by way of a conclusion.

the period of high economic growth since the chaotic postwar period, this environment has already greatly improved. In recent years high-performance housing stock has accumulated, and housing with functions not found in other countries have

Needless to say, when attempting an analysis of a housing market, it is necessary to fully understand the characteristics of the country. Below, we set out the reasons that have led to the false perception of Japanese housing still belonging to the era

Although commonalities can be found in many parts of the Japanese housing market in comparison with the European and US housing markets, the following heterogeneity is conceivable as the postwar historical origin is different. It is possi-

In Japan, many houses were destroyed due to the large-scale air raids during the Second World War, not only in metropolitan areas but also in regional cities. In particular, a large number of houses were destroyed in the Tokyo metropolitan area,<sup>1</sup> and very-low-quality houses were built in a disorganized manner to satisfy the urgent housing demand in the chaotic postwar period. In the so-called high economic growth period that began in the mid-1950s, such houses were rapidly upgraded as large numbers of apartment buildings came up

throughout Japan.<sup>2</sup> In addition, the drastic change in Japanese lifestyle through the rapid economic growth triggered the renewal of old housing stock by Westernizing

The private sector led construction to realize such a large-scale housing supply because the public sector was saddled with the large financial burden of postwar reconstruction. In particular, the government established a personal loan system to promote housing investment by households, and as a result, the ownership rate in postwar Japan significantly increased in comparison to before the war. Furthermore, as the supply of public housing was limited, a dedicated housing market for single-person renters formed in the rental housing market, which was rarely seen in

As a result of these short-term housing renewals, Japanese housing was brought into a state where their style, quality, and housing equipment were greatly different depending on the period of construction. In addition, due to natural disasters such

as the Great Hanshin earthquake<sup>3</sup> and the Great East Japan earthquake,<sup>4</sup>

housing earthquake resistance and other legal regulations have been successively

<sup>1</sup> The Bombing of Tokyo was a series of firebombing air raids in Second World War. This was conducted

<sup>2</sup> Although the improvement of low-quality stock developed during the postwar reconstruction period has been carried out in many areas, some areas remain in which stock has not improved, referred to as "high density wooden structure areas." Since these areas are vulnerable to earthquake disasters and so

<sup>3</sup> The Great Hanshin earthquake, or Kobe earthquake, occurred on January 17, 1995 in the southern part of Hyōgo Prefecture, Japan, when combined with Osaka, known as Hanshin. Up to 6434 people lost their

<sup>4</sup> The Great East Japan Earthquake occurred on March 11, 2011. The report from the Japanese National Police Agency report in 2018 confirms 15,896 deaths, 6157 injured, and 2537 people missing across

) of central Tokyo were destroyed, leaving an

become common.

when they were ridiculed as rabbit hutches.

*Modern Perspectives in Business Applications*

the traditional housing style of Japan.

Europe and the United States.

on, improvement is urgently required.

lives.

**42**

twenty prefectures.

on the night of 9–10 March 1945, 16 square miles (41 km<sup>2</sup>

estimated 100,000 civilians dead and over 1 million homeless.

ble that these are the cause of many misunderstandings.

<sup>5</sup> In response to major disasters, the Japanese Building Standards Law was revised. The first major revision of the Building Standards Law was in 1991, and the revision strengthened the earthquake resistance standards. After that, following the two great earthquakes, the standards strengthened.

### **2. Empirical analysis: data and estimation model**

### **2.1 Literature review**

A technique known as the hedonic approach is effective to decompose prices of commodities corresponding to different qualities. Since the hedonic approach theoretically depicts the behavior of suppliers and consumers in a market with diverse quality and presents a framework for empirical analysis, it is possible to approximately measure the household limit shadow price for new functions and to identify economic deterioration accompanying obsolescence [2, 3].

functionality such as *environmental performance* differs greatly when taking the

*Supply Management of Rental Housing Facilities: Effect of Changes in the Quality of Housing…*

As can be understood from these facts, attention must be given to the kind of variables that are used in estimating the hedonic function. According to Nelson [14], housing characteristics to be considered in function estimation are classified as follows. Excluding characteristics related to traffic convenience, Nelson [14] considers it possible to categorize the positional characteristics of housing into *housing equipment* and *location*. Of these, "housing equipment" is variable and depends on the owner of the house, and "location" is an element that cannot be changed. Meanwhile, Chau and Chin [15] and Shimizu [11] add *neighborhood characteristics*. In addition to location and building structure, this study classifies housing equipment into equipment ancillary to the room (room equipment (RE)) and to the building (building equipment (BE)) and also takes the conditions of the contract into account to estimate their marginal price effect by estimating the hedonic function and to estimate the extent of obsolescence caused by the appearance of

Since the latter half of the 1990s, the use of the Internet for real estate advertising has expanded rapidly in Japan, and websites dealing with a large amount of rental advert data have been developed. This study uses the data on homes managed

Multiple real estate companies post concurrent advertisements for the same property on the real estate website, so we eliminated the duplicates from the data by grouping them by the criteria of address, property name, and room number.<sup>7</sup> Furthermore, we independently assigned daytime railway travel time from Tokyo station to the nearest station to the property (minutes), which was not included in

Since the aim of this study is to identify the effect due to the addition of new functions over time, we hypothesize that the price structure will change according to the period of construction.<sup>8</sup> Data were segmented into the following three stocks:

<sup>6</sup> It should be noted that the data used are only for adverts appearing as of October 2018, and do not

<sup>7</sup> Analytical data were prepared using the following conditions. (a) The average and standard deviation of the rent was calculated, and data of a value that is the average plus twice the standard deviation (249,000 yen) were deleted. At the same time, data on rents of 30,000 yen or less that market

participants recognize as the lower limit of market rent were deleted (this level is a value larger than the average minus twice the standard deviation). (b) Data on floor area less than 15 m2 (rental housing of floor area less than this is generally considered unsuitable for habitation) or over 100 m<sup>2</sup> (generally housing of over 100 m2 is for the very wealthy) were deleted. (c) Data on housing exceeding 50 years of

<sup>8</sup> When the market structure changes, it is necessary to construct a model to absorb the change [16, 17]. In addition, Karato et al. [18] propose an estimation method to discriminate between aging, period of construction, and time effects. In this research, we avoided these problems by using cross-sectional data

by LIFULL Co., Ltd. which is a major real estate portal site.<sup>6</sup>

household's annual income into account.

*DOI: http://dx.doi.org/10.5772/intechopen.86163*

products with new performance.

the data posted on the portal.

• Old stock: built between 1968 and 1981

• Main stock: built between 1982 and 1999

• New stock: built between 2000 and 2018

age (built before 1967), which were exceedingly few, were deleted.

and simply classified it into three period categories according to age.

represent the situation of the entire housing stock.

**2.2 Data**

**45**

Generally, the construction of household selection models in the residential market faces many difficulties compared to regular commodities and service markets. Not only is consumption expenditure high for housing, but consumers are also troubled by its highly nonuniform nature. Even when located in the same place, prices vary depending on the quality of housing, and even if the buildings are of the same quality, prices vary depending on the location. Furthermore, since housing has durability, depreciation has to be taken into consideration.

In such a market, the law of one price assumed by traditional pricing theory cannot be applied. Furthermore, the application of a model that deals with differentiated products as analyzed by Lancaster [4] is not effective both theoretically and in empirical analysis. Accordingly, Rosen [5] theoretically clarified the type of market mechanism that is generated when commodity price data are a bundle of such attributes. Specifically, the relationship between the offer function of the commodity supplier, the bid function of the commodity consumer, and the market price function established by the equilibrium of these is closely examined, and the market price is characterized from the behavior of consumers and producers [6].

However, when attempting to estimate the hedonic function, we face various difficulties. The first is the existence of unobservable variables, the so-called omitted variable bias problem [7]. In general, in the estimation of a hedonic function for the housing market, only the location and building attributes, which are easy to obtain, are taken into consideration. However, it is also easy to envisage that the actual market price of housing will change depending on the environment surrounding the house and the various kinds of performance of the building.

As for variable selection in the estimation of hedonic functions in Tokyo's rental housing market, Nishi et al. [8] have conducted an exhaustive survey of the previous research. Nishi et al. [8] pointed that the housing amenities used in hedonic analyses are categorized as "location or accessibility," "housing features," and "site advantages." This paper is focused on housing features, because they can be reflected in the rent due to the technological progress in the information systems and supply management.

Accessibility is defined as the "main accessibility related to commuting." Housing features are defined as "amenities that can be changed by landlords." Accessibility and housing features are the basic characteristics used as explanatory variables in hedonic models and are widely used in previous studies [2, 6, 9, 10].

Site advantages have also been researched recently using variables calculated using geographical information system or GIS [11, 12]. Shimizu [11] demonstrates that the environment surrounding housing is important in the case where house prices are determined by building use conditions and the *characteristics of neighboring residents* and suggests that in the case such variables are not taken into consideration and the estimated statistics of the hedonic function lack robustness. Nishi et al. [8] also show that there is a similar problem with estimated statistics when housing equipment is not taken into consideration. Fuerst and Shimizu [13] show that in the new condominium market in Tokyo, the offered value for highly novel

*Supply Management of Rental Housing Facilities: Effect of Changes in the Quality of Housing… DOI: http://dx.doi.org/10.5772/intechopen.86163*

functionality such as *environmental performance* differs greatly when taking the household's annual income into account.

As can be understood from these facts, attention must be given to the kind of variables that are used in estimating the hedonic function. According to Nelson [14], housing characteristics to be considered in function estimation are classified as follows.

Excluding characteristics related to traffic convenience, Nelson [14] considers it possible to categorize the positional characteristics of housing into *housing equipment* and *location*. Of these, "housing equipment" is variable and depends on the owner of the house, and "location" is an element that cannot be changed. Meanwhile, Chau and Chin [15] and Shimizu [11] add *neighborhood characteristics*.

In addition to location and building structure, this study classifies housing equipment into equipment ancillary to the room (room equipment (RE)) and to the building (building equipment (BE)) and also takes the conditions of the contract into account to estimate their marginal price effect by estimating the hedonic function and to estimate the extent of obsolescence caused by the appearance of products with new performance.

### **2.2 Data**

**2. Empirical analysis: data and estimation model**

*Modern Perspectives in Business Applications*

economic deterioration accompanying obsolescence [2, 3].

durability, depreciation has to be taken into consideration.

A technique known as the hedonic approach is effective to decompose prices of commodities corresponding to different qualities. Since the hedonic approach theoretically depicts the behavior of suppliers and consumers in a market with diverse quality and presents a framework for empirical analysis, it is possible to approximately measure the household limit shadow price for new functions and to identify

Generally, the construction of household selection models in the residential market faces many difficulties compared to regular commodities and service markets. Not only is consumption expenditure high for housing, but consumers are also troubled by its highly nonuniform nature. Even when located in the same place, prices vary depending on the quality of housing, and even if the buildings are of the same quality, prices vary depending on the location. Furthermore, since housing has

In such a market, the law of one price assumed by traditional pricing theory cannot be applied. Furthermore, the application of a model that deals with differentiated products as analyzed by Lancaster [4] is not effective both theoretically and in empirical analysis. Accordingly, Rosen [5] theoretically clarified the type of market mechanism that is generated when commodity price data are a bundle of such attributes. Specifically, the relationship between the offer function of the commodity supplier, the bid function of the commodity consumer, and the market price function established by the equilibrium of these is closely examined, and the market price is characterized from the behavior of consumers and producers [6]. However, when attempting to estimate the hedonic function, we face various difficulties. The first is the existence of unobservable variables, the so-called omitted variable bias problem [7]. In general, in the estimation of a hedonic function for the housing market, only the location and building attributes, which are easy to obtain, are taken into consideration. However, it is also easy to envisage that the actual market price of housing will change depending on the environment surrounding the house and the various kinds of performance of the building.

As for variable selection in the estimation of hedonic functions in Tokyo's rental housing market, Nishi et al. [8] have conducted an exhaustive survey of the previous research. Nishi et al. [8] pointed that the housing amenities used in hedonic analyses are categorized as "location or accessibility," "housing features," and "site advantages." This paper is focused on housing features, because they can be reflected in the rent due to the technological progress in the information systems

Accessibility is defined as the "main accessibility related to commuting." Housing features are defined as "amenities that can be changed by landlords." Accessibility and housing features are the basic characteristics used as explanatory variables in hedonic models and are widely used in previous studies [2, 6, 9, 10]. Site advantages have also been researched recently using variables calculated using geographical information system or GIS [11, 12]. Shimizu [11] demonstrates that the environment surrounding housing is important in the case where house prices are determined by building use conditions and the *characteristics of neighboring residents* and suggests that in the case such variables are not taken into consideration and the estimated statistics of the hedonic function lack robustness. Nishi et al. [8] also show that there is a similar problem with estimated statistics when housing equipment is not taken into consideration. Fuerst and Shimizu [13] show that in the new condominium market in Tokyo, the offered value for highly novel

**2.1 Literature review**

and supply management.

**44**

Since the latter half of the 1990s, the use of the Internet for real estate advertising has expanded rapidly in Japan, and websites dealing with a large amount of rental advert data have been developed. This study uses the data on homes managed by LIFULL Co., Ltd. which is a major real estate portal site.<sup>6</sup>

Multiple real estate companies post concurrent advertisements for the same property on the real estate website, so we eliminated the duplicates from the data by grouping them by the criteria of address, property name, and room number.<sup>7</sup> Furthermore, we independently assigned daytime railway travel time from Tokyo station to the nearest station to the property (minutes), which was not included in the data posted on the portal.

Since the aim of this study is to identify the effect due to the addition of new functions over time, we hypothesize that the price structure will change according to the period of construction.<sup>8</sup> Data were segmented into the following three stocks:

<sup>6</sup> It should be noted that the data used are only for adverts appearing as of October 2018, and do not represent the situation of the entire housing stock.

<sup>7</sup> Analytical data were prepared using the following conditions. (a) The average and standard deviation of the rent was calculated, and data of a value that is the average plus twice the standard deviation (249,000 yen) were deleted. At the same time, data on rents of 30,000 yen or less that market participants recognize as the lower limit of market rent were deleted (this level is a value larger than the average minus twice the standard deviation). (b) Data on floor area less than 15 m2 (rental housing of floor area less than this is generally considered unsuitable for habitation) or over 100 m<sup>2</sup> (generally housing of over 100 m2 is for the very wealthy) were deleted. (c) Data on housing exceeding 50 years of age (built before 1967), which were exceedingly few, were deleted.

<sup>8</sup> When the market structure changes, it is necessary to construct a model to absorb the change [16, 17]. In addition, Karato et al. [18] propose an estimation method to discriminate between aging, period of construction, and time effects. In this research, we avoided these problems by using cross-sectional data and simply classified it into three period categories according to age.

Earthquake resistance standards were greatly revised in 1981 according to the *Building Standards Act*, which stipulates building quality in Japan, and the earthquake resistance of buildings differs greatly according to whether they were built in or before 1981 or in or after 1982; buildings were therefore categorized using 1981 as a basis. There was also a major change in earthquake resistance standards in 2000, so this was also used as the standard for a category. In addition, the data used are for the 23 wards of Tokyo where a large volume of housing stocks was supplied due to a large population inflow.

As a result of this process, 53,550 data points were acquired as data for analysis.<sup>9</sup>

### **2.3 Estimation model**

A general hedonic model can be expressed as

$$y = \log p = \sum\_{i} \beta\_i \mathbf{x}\_i + a\mathbf{\#} \tag{1}$$

**3. Verification analysis**

(m<sup>2</sup>

**3.1 Descriptive statistics for analysis data**

*DOI: http://dx.doi.org/10.5772/intechopen.86163*

depending on the period of construction:

Number of observations (all) = 53,550

**Table 1.**

**47**

*Descriptive statistics.*

Before analysis, we calculated the descriptive statistics of the data to be analyzed

(**Table 1**). From the descriptive statistics, there are several features as follows,

*Supply Management of Rental Housing Facilities: Effect of Changes in the Quality of Housing…*

**Variable Type Mean Std. dev. Min. Max.** Monthly rent All 94,779 34,873 30,000 249,000 (JYE) Old stock 84,968 30,631 30,000 240,000

Floor space All 31.3 13.4 15.0 100.0

Monthly rent/m<sup>3</sup> All 3192<PHONE_NUMBER> (JYE) Old stock 2717 668 1076 6528

Age of unit All 18.5 12.7 0.0 50.0 (year) Old stock 42.3 3.8 37.0 50.0

Time to the nearest station All 7.7 4.6 0.6 41.0 (minutes) Old stock 7.4 4.4 1.0 41.0

Time to Tokyo station All 27.2 8.6 1.0 48.0 (minutes) Old stock 26.5 8.3 4.0 48.0

) Old stock 32.5 12.4 15.0 91.4

Main stock 85,305 32,566 30,000 249,000 New stock 103,040 34,994 45,000 249,000 New/old 121.3% 114.2% 150.0% 103.8%

Main stock 32.0 15.3 15.0 100.0 New stock 30.6 12.1 15.0 99.5 New/old 94.3% 97.7% 100.0% 108.9%

Main stock 2864<PHONE_NUMBER> New stock 3501 766 1165 8134 New/old 128.9% 114.8% 108.3% 124.6%

Main stock 27.4 4.4 19.0 36.0 New stock 8.3 5.5 0.0 18.0 New/old 19.7% 144.0% 0.0% 36.0%

Main stock 8.1 4.8 1.0 40.0 New stock 7.4 4.4 0.6 38.0 New/old 99.4% 98.8% 62.5% 92.7%

Main stock 28.8 8.1 4.0 48.0 New stock 26.2 8.8 1.0 48.0 New/old 99.1% 105.4% 25.0% 100.0%

where *y* is the explanatory variable, *p* is the housing rent, *xi* is the explanatory variable (housing characteristic), and *β<sup>i</sup>* and *α* are the estimation parameters.

In this study, in addition to the commonly used *location* and *building structure*, housing equipment was added to the estimation of the hedonic function for the housing market. Specifically, we classified housing equipment into equipment ancillary to the room (*room equipment*) and equipment ancillary to the building (*building equipment*) and took the *conditions of contract* (CC) into account to construct a hedonic function.

Eq. (1) can be rewritten as follows:

$$\log p = \alpha + \sum\_{j} \beta\_j^{LC} \text{LC}\_j + \sum\_{k} \beta\_k^{ST} \text{ST}\_k + \sum\_{l} \beta\_l^{RE} \text{RE} + \sum\_{m} \beta\_m^{BE} \text{BE}\_m + \sum\_{n} \beta\_n^{CC} \text{CC}\_n \# \tag{2}$$

Here, the actual estimation formula can be expressed as follows:

$$\begin{aligned} \#\log p\_{it} &= \beta\_0 + \beta\_1 \cdot \text{Age}\_{it} + \sum\_{j=1}^3 \beta\_{2j} \cdot \text{ST}\_{jit} + \beta\_3 \cdot \text{S}\_{it} + \beta\_4 \cdot \text{TS}\_{it} + \beta\_5 \cdot DT\_{it} \\ &+ \sum\_{k=1}^5 \beta\_{6k} \cdot \text{Str}\_{kit} + \sum\_{l=1}^{23} \beta\_{7l} \cdot W\_{lit} + \sum\_{m=1}^2 \beta\_{8m} \cdot TR\_{mit} \\ &+ \sum\_{n=1}^{20} \beta\_{9n} \cdot RE\_{mit} + \sum\_{p=1}^{15} \beta\_{10p} \cdot BE\_{pit} + \sum\_{q=1}^9 \beta\_{11q} \cdot CC\_{qit} + \varepsilon\_{it} \end{aligned} \tag{3}$$

In Eq. (1), *ln pit* represents the log rent for *i* property at time *t* (October 2018). *Ageit* is the years since construction, *STjit* is the period of construction dummy (old/ main/new), *Sit* is the floor area, *TSit* is the number of minutes on foot from the nearest station, *DTit* is the number of minutes by train from Tokyo station, *Strjit* is the structure dummy, *Wmit* is the ward dummy, *TRhit* is the high-rise condominium and ground floor room position dummy, *REkit* is the room equipment dummy, *BEkit* is the building equipment dummy, *CCkit* is the contract condition (CC) dummy, *β*<sup>0</sup> is a constant term, and *εit* is an error term.

<sup>9</sup> The number of old stock data for 1968–1981 was relatively small at 4868, the number of properties built between 1992 and 1999 was 19,982, and the number of properties built between 2000 and 2018 was 28,700.

*Supply Management of Rental Housing Facilities: Effect of Changes in the Quality of Housing… DOI: http://dx.doi.org/10.5772/intechopen.86163*

### **3. Verification analysis**

Earthquake resistance standards were greatly revised in 1981 according to the *Building Standards Act*, which stipulates building quality in Japan, and the earthquake resistance of buildings differs greatly according to whether they were built in or before 1981 or in or after 1982; buildings were therefore categorized using 1981 as a basis. There was also a major change in earthquake resistance standards in 2000, so this was also used as the standard for a category. In addition, the data used are for the 23 wards of Tokyo where a large volume of housing stocks was supplied due to a

As a result of this process, 53,550 data points were acquired as data for analysis.<sup>9</sup>

*i*

where *y* is the explanatory variable, *p* is the housing rent, *xi* is the explanatory

In this study, in addition to the commonly used *location* and *building structure*, housing equipment was added to the estimation of the hedonic function for the housing market. Specifically, we classified housing equipment into equipment ancillary to the room (*room equipment*) and equipment ancillary to the building (*building equipment*) and took the *conditions of contract* (CC) into account to con-

*βixi* þ *α*# (1)

*<sup>m</sup> BEm* þ ∑

*β*11*<sup>q</sup>* � *CCqit* þ *εit*

*β*2*<sup>j</sup>* � *STjit* þ *β*<sup>3</sup> � *Sit* þ *β*<sup>4</sup> � *TSit* þ *β*<sup>5</sup> � *DTit*

*β*8*<sup>m</sup>* � *TRmit*

2 *m*¼1

> 9 *q*¼1

*n βCC*

*<sup>n</sup> CCn*# (2)

(3)

*y* ¼ log *p* ¼ ∑

variable (housing characteristic), and *β<sup>i</sup>* and *α* are the estimation parameters.

*<sup>k</sup> STk* þ ∑

Here, the actual estimation formula can be expressed as follows:

3 *j*¼1

> 23 *l*¼1

> > 15 *p*¼1

*l βRE <sup>l</sup> RE* þ ∑ *m βBE*

*β*7*<sup>l</sup>* � *Wlit* þ ∑

In Eq. (1), *ln pit* represents the log rent for *i* property at time *t* (October 2018). *Ageit* is the years since construction, *STjit* is the period of construction dummy (old/ main/new), *Sit* is the floor area, *TSit* is the number of minutes on foot from the nearest station, *DTit* is the number of minutes by train from Tokyo station, *Strjit* is the structure dummy, *Wmit* is the ward dummy, *TRhit* is the high-rise condominium and ground floor room position dummy, *REkit* is the room equipment dummy, *BEkit* is the building equipment dummy, *CCkit* is the contract condition (CC) dummy, *β*<sup>0</sup>

<sup>9</sup> The number of old stock data for 1968–1981 was relatively small at 4868, the number of properties built between 1992 and 1999 was 19,982, and the number of properties built between 2000 and 2018 was

*β*10*<sup>p</sup>* � *BEpit* þ ∑

large population inflow.

*Modern Perspectives in Business Applications*

**2.3 Estimation model**

struct a hedonic function.

*j βLC*

log *p* ¼ *α* þ ∑

28,700.

**46**

Eq. (1) can be rewritten as follows: