Transcript Ch. 5: Factory Location as a Cost

Ch. 5: Factory Location as a CostMinimizing Exercise
Transportation, cost minimization and
location
Aly Konkol, Carine Lefevre
Neoclassical Location Theory
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Form of economic determinism in which location of
factories is ‘dictated’ by economic forces
Interprets firm as an Economic Man (Homo
Economicus) with perfect information and rationality
Competition ensures than only economically rational
outcomes survive
Follows tradition begun by Alfred Weber in 1929
Two schools of neoclassical
location theory
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Profit-maximizing
Focus more on
distribution costs
Incorporate effects of
rival behavior on
location
Applied mainly to
personal and retail
services
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Cost-minimizing
Focus more on transportation
costs of inputs
Incorporate effects of location
conditions on spatial variations
in cost structures
Applied mainly to
manufacturing
Types of inputs in costminimization theory
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Ubiquitous: can be obtained in any location
Pure: experience no change in physical
characteristics during processing
Impure: experience change in physical
characteristics during processing
Material Index (MI) for impure
materials
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MI = weight of localized raw materials
weight of final product
If MI>1, then activity is input-oriented
If MI<1, then activity is output-oriented
Isodapane Analysis
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Used when an activity has more than one
impure input from different sources
Calculate isotims (lines of equal
transportation cost around each location
factor)
Sum relevant isotims to identify least total
transportation cost location (P)
Labour, external economies, etc.
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Similar cost surfaces such as
labor and external economies
of scale can be combined
with transportation cost
surfaces to form a total cost
surface
If L or E is inside the critical
isodapane (where savings
equal increased
transportation cost), factory
should relocate there
Spatial Margins to Profitability
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As long as revenues exceed costs, plant
locations are viable
Viable locations defined by spatial margins to
profitability
Graphically summarized by a space-cost
transect derived from a cost surface
Allows personal location preferences to be
taken into account
Principle of Substitution
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Location of factories uses substitutions or
trade-offs among various factors
Ex. Procurement and distribution costs
For a factory of a given size, can also
substitute among factors of production (land,
labor, capital)
Graphing Substitution
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Isoquant (line of equal output or scale) shows
different combinations of two inputs, X and Y
Isocost lines show the relative costs of X and Y
based on their slopes
When isoquant and isocost lines are combined,
point on isoquant where costs are lowest
determines ideal input combination
Endless variety of substitutions
Christaller’s Central Place Theory
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Range of a good: maximum distance consumers will
travel to purchase good, or maximum distance good
can be transported to consumers economically
According to law of demand, demand will decrease
with increased distance from factory
Threshold population: minimum level of demand
necessary to sustain factories of at least minimum
economically viable size
Inner range of a good: distance within which threshold
population exists
More Central Place Theory
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Additional factories are
possible until all
demands are met and
surplus profits are
eliminated
Ensures that threshold
population exists within
inner range of good
Assumes demand is
evenly distributed and
rival factories produce
identical goods
Even More Central Place Theory!
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Predicts an optimal location
pattern for minimizing
distribution costs
Factories serve hexagonalshaped market areas
Ensures all possible demands
are met in spatially distributed
market
Notes on C.P.T.
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If factories produce different goods with
distinctive thresholds and ranges, most
accessible locations will attract factories whose
goods have largest threshold/range
requirements, as well as lowest
Less accessible locations attract only lowest
Hotelling’s Duopoly Model
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Uncertainty over rival behavior may encourage
concentration
Two sellers supplying a homogeneous product
to a spatially distributed, linear market would
locate at the center of the market
Any other location would be unstable because
of uncertainty
Distribution costs would be minimized if sellers
communicated and located at quartiles
Adopt-Adapt Dichotomy
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Firms must “adapt” to changes in markets,
resources, technology, or competition, or else
they fail
Firms can also be “adopted”, or saved, by the
actions of others (eg. government)
Adoption chances are much better for larger
companies than smaller, and can be
unintended through unexpected currency
devaluations, etc.
Location Adjustment Possibilites
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Adjustments to changes in economic
environment can be in space, organization, or
time dimension
Space : adjust operations onsite, change them
between sites, develop new sites
Organization : small firms can respond faster,
multi-plant firms have more decision-making
capabilities
Location Adjustment Possibilities,
Related to Time
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Short-term: small firms can use plant more
intensively or use more labor, large firms can
shift orders among plants
Medium-term: limited for small firm, large firms
can do some expansion/consolidation
Long-term: new site locations, M&As
Locational Evolution
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Old factories in “obsolete” locations may still be
viable because they have paid off investments
in fixed capital, which is cheaper than building
a new factory
In general: many small firms and plants -->
fewer, more dispersed,and larger plants
Product innovation --> process innovation
Industrial Location Policies
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Advocated government policies include
increasing worker and capital mobility
Regional equilibrium is achieved between core
and peripheral regions when demand drives
labor prices up in core regions, so firms
relocate to peripheral regions for cheaper labor
Eventually, wage rates rise in peripheral
regions too, but movement of workers to core
region decreases wage pressure
More Industrial Location Policies
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In the 1950s and 1960s, subsidies were
granted to locate factories on social and
political rather than economic grounds
This promoted inefficiency and an unneccesary
duplication of facilities
Market solutions were not seen as relevant
During the 1980s and 1990s, many countries
reduced or eliminated industrial location policy
Cost Structures and Locational
Orientation
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Locational patterns of industries vary because
of different cost and revenue structures
Cost structure calculations are based on actual
production costs or hypothetical costs of
production for brand new state-of-the-art mills
Primary manufacturing: material and
transportation costs remain important
Secondary manufacturing: labor inputs are
relatively more important
Primary Manufacturing: ex.
Sawmills
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Input-oriented, principal raw material is timber
Compare PNW and US South regions with
hypothetical mills as of mid-1980s
Wood costs are relatively lower in South, but
energy costs are relatively lower in PNW
(overall cheaper in South)
Scale economies have been pushing down
average costs of production
Secondary Manufacturing: ex. Auto
Industry
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Traditionally has been located in industrialized
countries to take advantage of skilled labor and
scientific/engineering expertise (external
economies)
Seek lower-cost labor in Mexico and Brazil,
South Korea, and Spain
Although Japanese wage rates are average,
Japan has a cost advantage through
“management systems and techniques”
(organization), which increase productivity
Conclusion
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Neoclassical location theory emphasizes the
“relentless and rational pursuit of lower costs
and more profits”
Criticism (Barnes 1987): denies or simplifies
roles for local agency and local and political
context, so demeaning the richness of
economic geography
Regions are only spaces where capital may or
may not be deposited