Separation Anxiety

There's no place like home.

At least that's what Japan's Canon Inc. is betting on.

Since the mid-1990s, Japanese companies have been focusing on moving manufacturing abroad to cut labor costs. First, they moved production to emerging Southeast Asian economies like Thailand and Malaysia and more recently to China.

But now one of those companies is halting that approach. Canon has decided that when it comes to making the latest high-end products like digital cameras, it can do so faster and more efficiently if it actually keeps production at home.

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In making the move, Canon is deciding to place its money on innovation rather than low cost. As Canon sees it, the key to creating the newest products quickly is for its production team to physically work near the developers of its products so there's more input and communication. This shift comes with a bigger price tag, however -- both for the company in terms of labor costs and in the price of the products themselves. But Canon is confident consumers will pay up for, say, a digital camera with a quality picture and the newest features.

"We can't compete on price against newly industrialized countries," Canon President Fujio Mitarai said recently. "But if picture quality is the issue, there's no way Japanese manufacturing will lose."

Mr. Mitarai last year declared the importance of keeping production in Japan, and Canon now plans to maintain around 60% of manufacturing at home. There's also talk of bringing back some operations. Earlier this year, the company announced that it would spend 80% of its capital outlays over the next three years in Japan in order to strengthen research and development.

THE WAGE GAP Though monthly wages in China have grown rapidly, they're still dwarfed by those in Japan     JAPAN CHINA 2003 $3,737 $125.80 2002 3,652 110.7 2001 3,697 98.4 2000 3,697 88.1 1999 3,628 78.4 1998 3,707 71.1 1997 3,753 59.7 Sources: National Bureau of Statistics, China; International Labour Organization

Canon's logic appears to make sense to others as well. "If you look at just production costs, it has short-term cost demerits," says Shin Horie, an analyst at Goldman Sachs & Co. in Tokyo. "But long term, as part of an integrated product strategy, I think it will go well."

Loosening the Belt

Canon's decision to keep a large part of manufacturing in Japan follows big changes in the way it makes products. First, back in 1998, Mr. Mitarai decided to abolish the symbol of 20th-century manufacturing: a production line centered on a conveyer belt.

In its place, people started working in small groups called "cells," where they would perform multiple tasks. Huddled in their cells, workers talked more about how to improve the assembly process. They reported feeling more responsibility for the work.

People "have more work to do," says Junji Ichikawa, a managing director in charge of global manufacturing at Canon, "but they work better as a team."

By 2002, Canon had thrown out 66,000 feet of belts and abolished their use throughout Japan. The new system required less parts inventory, cutting factory operating costs by nearly 1.5 billion yen ($14 million) since 1998. Reducing space through the abolition of production lines enabled Canon to reduce the number of warehouses leased for the storage of parts and equipment to eight from 37, cutting 30 billion yen in real-estate costs.

The efficiency and cost savings reaped from the cells helped Canon to address a growing challenge: making innovative products faster.

Constant advances in microchips and technology like liquid crystal displays have significantly cut the shelf life of digital cameras. While old cameras had a shelf life of three or four years, digital cameras now last about a year before new technology makes them outdated.

So in order to stay competitive while raising the quality and value -- and, consequently, the prices -- of its products, Canon needs to speed up and streamline the development and production process.

Canon has done away with conveyer belts in its plants

Mr. Mitarai's idea: Keep a large portion of the production of high-quality products like digital cameras in Japan so that design and production teams could each see what the other is doing and more easily exchange ideas. It's what Canon calls concurrent engineering, where production operations play an active role in product development.

For instance, instead of waiting passively to be handed a blueprint, production engineers can look over the shoulders of designers. And they can suggest design changes that will make a new product easier to manufacture.

"Maybe we could make a three- or four-year product more efficiently in China," says Mr. Ichikawa. "But it's better to have everything in Japan so that the development and production teams are involved with each other. You can't just throw a blueprint at people."

And there are some more immediate savings. Domestic production allows Canon to build and customize its own production tools, which can be much cheaper and more efficient than buying generic ones from elsewhere. Because the production engineers are seeing hands-on how a product is being developed, they know ahead of time exactly what they will need to build it.

Record Breaker

The higher overall costs of keeping production at home -- among other things, the average monthly wage for a factory worker in China was about $126 last year, compared with $3,737 in Japan -- don't appear to be crimping the company's bottom line.

In July, Canon announced a 36% rise in profit in the quarter ended June 30. The gains are attributed to the brisk demand for color copiers and digital cameras. Canon says there's brisk demand for its color copier and digital cameras -- even though its cameras are priced higher than those made in cheaper places like China. The company also said it expects a 16% improvement in consolidated profit from all operations and affiliate for 2004. At an estimated 320 billion yen, this would be Canon's fifth straight year of record profit.

"Saying [we want to manufacture at home] used to be taboo," says Mr. Ichikawa. "But more people are agreeing with this now, and others are building factories in Japan."

Mr. Moffett is a staff reporter in The Wall Street Journal's Tokyo bureau.