Location Decisions From the Perspective of the Business

1
Location Decisions From the Perspective of the
Business

• The location unit is the entity which is at risk
  to being moved.
• The location decision unit is the entity which
  makes to location decision for the location unit
• The location unit may be, but is not necessarily,
  the location decision unit.

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Why do businesses care about location decisions?

• Because it costs something to move and the new
  location can drastically affect overall returns
  for the business.

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Some Examples of the Costs

• In the United States over 250 billion dollars
  are spent annually on the construction of new
  facilities
• It is estimated that depending on the application
  20 to 80 per cent of a facility's total operating
  cost is spent on material handling within
  facilities
• Proper location and design of facilities can
  potentially result in savings of 5 to 50 percent
  of operating costs.
• Apart from the magnitude of costs involved in
  facilities, the frequency with which facility
  location and layout decisions are made is also
  important.
• It is estimated that the layout of most
  facilities is modified approximately every 2 to 5
  years.
• In the United States over 250 billion dollars
  are spent annually on the construction of new
  facilities.

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When is a location decision made? Only at
critical junctures of the firms life.

• Birth, when the initial location must be chosen
• When expansion capacity is required
• When a new process or line of output is
  introduced
• When there has been a major change in
  transportation rates
• When the composition of output changes
• When there is a major change in input
  requirements
• When there is a shift in markets
• When there is a change in supplier locations
• Or some combination of the above.

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A location decision evaluation assumes something
is wrong with the current location!
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Fundamental Location Factors
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The locational choice generally represents a long
range substantial commitment which must be made
in the face of uncertainty.

• Because there is uncertainty and because of the
  substantial costs of such a relocation, the
  strongest location factor is intertia

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Other Important Location Factors

•  The supply (including availability, price, and
  quality) of local or nontransferable inputs.
  Nontransferable or local inputs are those inputs
  which are present at a location and which cannot
  realistically be moved. Examples Land, climate,
  water quality soil composition amenities.
• The ability to dispose of nontransferable outputs
  in the local area. Nontransferable outputs ore
  outputs which have to be disposed of locally and
  are not realistically transferable elsewhere.
  Examples include air and water pollution and
  other waste (some is indeed transferable).
• Transferable inputs (those input factors which
  are relatively easily moved to a given location
  from their origin. This includes things like
  fuel, materials, and some services and
  increasingly, information.
• Outside demand for transferable outputs. This is
  really the availability of the market for the
  output of the business and reflects the relevant
  transfer costs.

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Transportation Cost Minimization Models
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Market versus Material Orientation
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Market Orientation

• Tend to locate near the market because the final
  product tends to be more expensive to ship from
  the production site to the market.
• Weight gaining activities or those who add a
  ubiquitous resources tend to locate near the
  market.
• Products that are hazardous to transport, bulky,
  perishable, or fragile locate near the market

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Material Orientation

• Activities which are weight losing (final product
  weighs less than the weights of the principal
  inputs tend to locate near the source of the
  input.
• If inputs are bulky, perishable, hazardous, or
  otherwise expensive to transport there is a
  tendency to locate near the input source.

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End Point and Transshipment Location

• If and only if, the transportation costs of
  shipping the input material to the market are the
  same as the costs of shipping the final product
  to the market is a point between cost effective.

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The pull of the market is and material site is
strengthened by two factors

• Extra handling costs because a location between
  the material site and the market site would
  require extra handling (loading and unloading).
• Non-linear rate structures-It costs less than
  twice as much to ship twice as far. So one long
  trip is cheaper than two shorter trips that
  together equal the longer trip

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The Principal of Median Location

• Illustrates the tendency of a market oriented
  activity to locate at the point where half of the
  customers are on either side.
• This is the model developed by Harold Hotelling
• Assumes two competitors who are on a linear
  bounded market with zero production costs and
  identical customers distributed along the market.
• The demand for the good is not effected by price
• Each customer purchases one good per period of
  time and prefers to buy it from the nearest
  seller.

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The Hotelling Model

• In panel (a), the linear market is segmented into
  two protected or uncontested parts, a and b, and
  one contested part, x y, that is shared equally
  by the sellers. The two sellers, A and B, can
  move to any location on the line that will
  maximize their profit, and they do so believing
  that the rival will not change its location in
  response to their competitive action. We will
  assume that these moves are costless, in the
  sense that the sellers confront neither moving
  costs nor costs associated with disposing of
  fixed assets that might be associated with a
  given location.
• From Hoover, Introduction to Regional Economics,
  Chapter 4.

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More on the Hotelling Model

• Profits are always enhanced if a seller increases
  its market area.
• Since production is costless, larger market areas
  imply greater sales and, therefore, greater
  profits.
• If each seller believed that the others location
  was fixed, the first seller to act, say A, would
  move to a position adjacent to its rival,
  ensuring itself the largest possible market area.
  If the initial positions are as depicted in panel
  (a), the first seller to move would seek to
  eliminate the contested portion of the market and
  maximize its protected portion. Thus panel (b)
  would represent such a move. The second seller is
  similarly motivated, however, and would leapfrog
  its rival to obtain competitive advantage. This
  type of movement would continue until neither
  seller stood to gain from further action. Such a
  situation would prevail if both sellers assumed
  central locations, each sharing one-half of the
  market.
• These results demonstrate that some aspects of
  spatial competition may actually lead to the
  mutual attraction of sellers.
• Other factors may encourage clustering of this
  sort are examined in depth.
• From Hoover, Introduction to Regional Economics,
  Chapter 4.

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Road Systems and Multiple Inputs

• Ideal weights are the most important aspect of
  cost minimization even with a transportation
  system.
• The ideal weight is the cost of shipping one unit
  one mile.

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Production costs are becoming more important than
transportation costs because

• Manufacturing is decreasing in relative
  importance
• Technology has lowered the cost of transportation
  relative to other cots

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Labor costs are also becoming more important than
transportation costs in many industries

• Such firms are labor oriented
• The regions prevailing wage is a good indicator
  of labor costs.
• Prevailing wage rates are important in selecting
  between regions but not within them.

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Wage rates alone do not accurately reflect labor
costs because

• Location decision makers are concerned with
  compensation including
• Fringe benefits
• Productivity
• Some workers may work at less than prevailing
  wages, particularly in high unemployment areas.

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Quality of Life (amenities) is increasingly
important

• Amenities are life enhancing features
• Includes museums, good weather and climate,
  roads, schools, public services, universities,
  junior colleges, parks, etc.
• Are more important because many industries have
  become footloose.
• Are more important because more productive and
  highly educated workers count amenities as
  important in choosing an employer.

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Taxes as a location factor

• Not traditionally considered to be a major
  factor, because taxes are so small relative to
  overall business costs
• Corporate income taxes may be important depending
  on the situation
• Personal income taxes may be important in
  attracting workers
• Perceived taxes relative to perceived
  benefits more important than actual taxes or
  benefits.

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Government Incentives and Infrastructure

• State interest subsidies
• Loan guarantees
• Regulatory exemptions
• Sale of land below market
• Tax credits
• Infrastructure constructed at public expense
• Roads, water, sewer, lighting

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Local Business Climate

• Slippery concept
• Includes taxes, expenditures, and attitude
• Public efforts to accommodate business
• Community respect for business
• Large scale computer generated site selection
  using business climate criticized

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• Artificially rigorous
• Concept of business climate is vague and may be
  different for different businesses
• Rankings of business climate are not good
  predictors of where business will locate

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Other Factors

• Political climate
• Energy Costs
• Site costs
• Site availability
• Communications infrastructure

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Changing Relative Importance of Location Factors

• Markets and materials, labor, and transportation
  remain most important
• But, traditional factors have diminished in
  relative importance
• Technology has reduced the importance of material
  and market location thru reduced transportation
  costs, increased steps in production, reduced
  importance of raw materials.
• Taxes and subsidies becoming more important in
  close jurisdictions but not in regional choices