Factory location as Factory location as a cost-minimizing a cost-minimizing

exerciseexerciseElena KozlovaElena Kozlova

Sandra LundinSandra Lundin

Neoclassical location Neoclassical location theoriestheories

Profit-maximationProfit-maximation transportation transportation

costs (distribution costs (distribution to markets)to markets)

incorporate the incorporate the effects of rival effects of rival behaviour on behaviour on locationlocation

Used for: personal Used for: personal and retail servicesand retail services

Cost-minimizationCost-minimization transportation transportation

costs (materials)costs (materials) location conditionlocation condition spatial varaitions in spatial varaitions in

cost structurescost structures Used for: Used for:

manufacturingmanufacturing

FIRMS AS BLACK BOXES : FIRMS AS BLACK BOXES : LANSCAPE AS SPACE COST LANSCAPE AS SPACE COST

(REVENUE) SURFACES(REVENUE) SURFACESA. Weber : A. Weber :

-TRANSPORTATION( procurement and -TRANSPORTATION( procurement and distribution costs) is the most distribution costs) is the most IMPORTANT general principle of IMPORTANT general principle of location.location.

-LABOUR and EXTERNAL ECONOMIES -LABOUR and EXTERNAL ECONOMIES of SCALE are the two most important of SCALE are the two most important regional principles of locaton.regional principles of locaton.

The effets of transportation The effets of transportation costs on industrial location:costs on industrial location:Weber,Weber, INPUTSINPUTS::

--ubiquitous ubiquitous

--purepure(distribution costs are more significant (distribution costs are more significant than procurement costs) ->the location of than procurement costs) ->the location of markets exerts a stronger pull on location than markets exerts a stronger pull on location than the sources of inputsthe sources of inputs

--impureimpure( procurement costs are more ( procurement costs are more significant than distribution costs)->the significant than distribution costs)->the sources of such inputs matters more than the sources of such inputs matters more than the location of markets location of markets

Location matters in terms Location matters in terms of minimizing costs (figure of minimizing costs (figure

5.1.)5.1.) Material Index: Material Index:

weight of localized raw materialsweight of localized raw materials MI = ___________________________MI = ___________________________ weight of final productweight of final product

MI >1 activity is input-oriented (saw mills, cotton MI >1 activity is input-oriented (saw mills, cotton compression, fish processing)compression, fish processing)

MI<1 activity is output-oriented (paper-box MI<1 activity is output-oriented (paper-box manufacturing, soft drink bottling, bakeries, the manufacturing, soft drink bottling, bakeries, the coking of coal)coking of coal)

More than 1More than 1 impure input + different sources -> impure input + different sources ->

mimimum mimimum transportation transportation

cost location is cost location is the 'intermediate' the 'intermediate' between input sourcesbetween input sources

Isodapane analysisIsodapane analysis (figure 5.2) -the method of (figure 5.2) -the method of calculating the least-cost location; STEPS:calculating the least-cost location; STEPS:

1)a transportation cost surface is calculated for 1)a transportation cost surface is calculated for each location factor;each location factor;

2)the transportation costs relevant to each location 2)the transportation costs relevant to each location factor are summed to create a total factor are summed to create a total transportation cost surface and the least total transportation cost surface and the least total transportation cost location is identified.transportation cost location is identified.

Labour, external economies Labour, external economies and other costs (Isodapane and other costs (Isodapane

analysis)analysis)

P

L

P= minimum transportation cost location

L= minimum labour cost location

Critical isodapane= the isodapane which equals the labour cost savings

4 €

8 €

Isodapane

12 €

Spatial margins to Spatial margins to profitabilityprofitability

- as long as revenues exceed costs, - as long as revenues exceed costs, plant locations are viable.plant locations are viable.

personal locational preferences can personal locational preferences can be exercised as long as they remain be exercised as long as they remain within the constraints of within the constraints of profitability.profitability.

The principle of The principle of substitution -the substitution -the

fundemental principle of fundemental principle of neoclassical location theoryneoclassical location theory Procurement and distribution Procurement and distribution

costs are substituted for one costs are substituted for one another.another.

lower labour costs + higher lower labour costs + higher transportation costs OR lower transportation costs OR lower transportation costs + higher transportation costs + higher labour costslabour costs

The principle of The principle of substitution cont.substitution cont.

land, labour and capitalland, labour and capital whether a factory should be more or whether a factory should be more or

less labour intensive depends upon less labour intensive depends upon the relative cost of labour within the the relative cost of labour within the realm of substitution possibilitiesrealm of substitution possibilities

Y

X

X*

Y*

Selected isocost lines

Isoquant (scale of factory) X*, Y* is the optimal combination of inputs

Locational interdependence and Locational interdependence and revenue surfaces- how revenue surfaces- how

competition among rival firms competition among rival firms affects the location and market affects the location and market

areas of factories.areas of factories.Central place theory(1966Central place theory(1966) - general principles of ) - general principles of location wich are relevant to manufacturing location wich are relevant to manufacturing activities.(Figure 5.5)activities.(Figure 5.5)

a) single good: single sellera) single good: single seller

b)single good: several sellersb)single good: several sellers

c)single good: optimal ocation pattern minimizing c)single good: optimal ocation pattern minimizing distribution costsdistribution costs

Products are differentiated only by distance and Products are differentiated only by distance and consumers are assumed to prefer nearer(and consumers are assumed to prefer nearer(and cheaper) sources of supply than more distant cheaper) sources of supply than more distant sources of supply.sources of supply.

Hotelling duopoly modelHotelling duopoly model

2 sellers2 sellers a homogeneneous producta homogeneneous product spatially distributed, but linear spatially distributed, but linear

marketmarket Both sellers would locate at the Both sellers would locate at the

center of the marketcenter of the market

A Ba b

Uncertainty and the Uncertainty and the principles of adaption and principles of adaption and

adoptionadoption In reality firms don’t have perfect In reality firms don’t have perfect

information.information. Circumstances change; technology, rival Circumstances change; technology, rival

behaviour, market dynamics etc.behaviour, market dynamics etc. Even if once rationally located factories Even if once rationally located factories

will have to adapt, adopt or risk failure as will have to adapt, adopt or risk failure as the environmental conditions change.the environmental conditions change.

Adaption= response on the part of the Adaption= response on the part of the firmfirm

Adoption= firm is saved as an result of the Adoption= firm is saved as an result of the actions of others, notably governmentsactions of others, notably governments

Location adjustment Location adjustment possibilitiespossibilitiesThree dimensionsThree dimensions::

1) SPACE1) SPACE on-site ( firms expand,contract,modernize or change a factory's on-site ( firms expand,contract,modernize or change a factory's

operations)operations) inter-site adjustments (firms reorganize their production among a set inter-site adjustments (firms reorganize their production among a set

of existing locations)of existing locations) new site (firms can relocate or establish branch plants) new site (firms can relocate or establish branch plants) Example: the cotton textile mills in EnglandExample: the cotton textile mills in England

2) ORGANISATION2) ORGANISATION small single plant (in terms of on-site change, it is able to make faster small single plant (in terms of on-site change, it is able to make faster

decisions than multi-plant firm , but inter-site adjustments are not decisions than multi-plant firm , but inter-site adjustments are not available for it)available for it)

multi-plant firm multi-plant firm

3) TIME3) TIME -short -short -medium-medium -long -term planning horizons-long -term planning horizons

Locational evolution in Locational evolution in neoclassical perspectiveneoclassical perspective

Old factories can survive for a long Old factories can survive for a long period of time because their capital period of time because their capital costs are zero. -> substitute low costs are zero. -> substitute low capital costs for high operating costscapital costs for high operating costs

Factories that are not willing to Factories that are not willing to adapt or adopt will probably have adapt or adopt will probably have failure as the only optionfailure as the only option

In general: large number of small In general: large number of small firms and plants-> fewer, large firms and plants-> fewer, large plants dominate the industryplants dominate the industry

Industrial location policy in Industrial location policy in a neoclassical landscapea neoclassical landscape

Minimal policy interference Minimal policy interference by government -> Freely by government -> Freely operating market forces operating market forces

resolve regional problemsresolve regional problems

Industrial location policy in Industrial location policy in a neoclassical landscapea neoclassical landscape

Critiques:Critiques:

1. The mobility of workers:1. The mobility of workers:- social and family commitments- social and family commitments

- migration involves costs and - migration involves costs and uncertaintiesuncertainties

2. Continued investment in core regions2. Continued investment in core regions

- likely to reinforce agglomeration - likely to reinforce agglomeration economies and effects of inertiaeconomies and effects of inertia

COST STRUCTURES AND COST STRUCTURES AND LOCATIONAL LOCATIONAL

ORIENTATIONORIENTATIONWithin the same industry and region, cost Within the same industry and region, cost

structures can vary considerably. structures can vary considerably. -Primary manufacturing :-Primary manufacturing :Examples:Examples: -Sawmill cost structures-Sawmill cost structures -newsprint industry cost structures (the cost -newsprint industry cost structures (the cost

structures are based on the average costs for structures are based on the average costs for a sample of existing mills in each regiona sample of existing mills in each region

-other raw material using activities-other raw material using activities

-Secondary manufacturing:-Secondary manufacturing: - cost structures in the auto industry- cost structures in the auto industry