Factory location as a cost-minimizing exercise

1. Factory location as a cost-minimizing exercise Elena Kozlova Sandra Lundin

2. Profit-maximation transportation costs (distribution to markets) incorporate the effects of rival behaviour on location Used for: personal and retail services Cost-minimization transportation costs (materials) location condition spatial varaitions in cost structures Used for: manufacturing Neoclassical location theories

3. FIRMS AS BLACK BOXES : LANSCAPE AS SPACE COST (REVENUE) SURFACES A. Weber : • -TRANSPORTATION( procurement and distribution costs) is the most IMPORTANT general principle of location. • -LABOUR and EXTERNAL ECONOMIES of SCALE are the two most important regional principles of locaton.

4. The effets of transportation costs on industrial location: Weber,INPUTS: -ubiquitous -pure(distribution costs are more significant than procurement costs) ->the location of markets exerts a stronger pull on location than the sources of inputs -impure( procurement costs are more significant than distribution costs)->the sources of such inputs matters more than the location of markets

5. Location matters in terms of minimizing costs (figure 5.1.) • Material Index: weight of localized raw materials MI = ___________________________ weight of final product MI >1 activity is input-oriented (saw mills, cotton compression, fish processing) MI<1 activity is output-oriented (paper-box manufacturing, soft drink bottling, bakeries, the coking of coal)

6. More than 1 impure input + different sources -> mimimum transportation cost location is the 'intermediate' between input sources Isodapane analysis (figure 5.2) -the method of calculating the least-cost location; STEPS: 1)a transportation cost surface is calculated for each location factor; 2)the transportation costs relevant to each location factor are summed to create a total transportation cost surface and the least total transportation cost location is identified.

7. Labour, external economies and other costs (Isodapane analysis) 12 € 8 € 4 € Isodapane P= minimum transportation cost location L= minimum labour cost location Critical isodapane= the isodapane which equals the labour cost savings

8. Spatial margins to profitability • - as long as revenues exceed costs, plant locations are viable. • personal locational preferences can be exercised as long as they remain within the constraints of profitability.

9. The principle of substitution -the fundemental principle of neoclassical location theory • Procurement and distribution costs are substituted for one another. • lower labour costs + higher transportation costs OR lower transportation costs + higher labour costs

10. The principle of substitution cont. • land, labour and capital • whether a factory should be more or less labour intensive depends upon the relative cost of labour within the realm of substitution possibilities

11. X X*, Y* is the optimal combination of inputs Isoquant (scale of factory) Selected isocost lines X* Y Y*

12. Locational interdependence and revenue surfaces- how competition among rival firms affects the location and market areas of factories. Central place theory(1966) - general principles of location wich are relevant to manufacturing activities.(Figure 5.5) a) single good: single seller b)single good: several sellers c)single good: optimal ocation pattern minimizing distribution costs Products are differentiated only by distance and consumers are assumed to prefer nearer(and cheaper) sources of supply than more distant sources of supply.

13. Hotelling duopoly model • 2 sellers • a homogeneneous product • spatially distributed, but linear market • Both sellers would locate at the center of the market a b A B

14. Uncertainty and the principles of adaption and adoption • In reality firms don’t have perfect information. • Circumstances change; technology, rival behaviour, market dynamics etc. • Even if once rationally located factories will have to adapt, adopt or risk failure as the environmental conditions change. • Adaption= response on the part of the firm • Adoption= firm is saved as an result of the actions of others, notably governments

15. Location adjustment possibilities Three dimensions: 1) SPACE • on-site ( firms expand,contract,modernize or change a factory's operations) • inter-site adjustments (firms reorganize their production among a set of existing locations) • new site (firms can relocate or establish branch plants) Example: the cotton textile mills in England 2) ORGANISATION • 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 available for it) • multi-plant firm 3) TIME • -short • -medium • -long -term planning horizons

16. Locational evolution in neoclassical perspective • Old factories can survive for a long period of time because their capital costs are zero. -> substitute low capital costs for high operating costs • Factories that are not willing to adapt or adopt will probably have failure as the only option • In general: large number of small firms and plants-> fewer, large plants dominate the industry

17. Industrial location policy in a neoclassical landscape Minimal policy interference by government -> Freely operating market forces resolve regional problems

18. Industrial location policy in a neoclassical landscape • Critiques: 1. The mobility of workers: - social and family commitments - migration involves costs and uncertainties 2. Continued investment in core regions - likely to reinforce agglomeration economies and effects of inertia

19. COST STRUCTURES AND LOCATIONAL ORIENTATION Within the same industry and region, cost structures can vary considerably. -Primary manufacturing : Examples: • -Sawmill cost structures • -newsprint industry cost structures (the cost structures are based on the average costs for a sample of existing mills in each region • -other raw material using activities -Secondary manufacturing: • - cost structures in the auto industry