What are the reasons for firms to locate near their raw materials and suppliers?
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Triple A Learning - Location The choice of location is probably the single largest expense when setting up a new business. It is likely to have a significant impact on the number of customers a firm attracts, its sales revenues and, consequently, its profit levels. Choosing a location is investment in the same way as purchasing equipment and machinery and other fixed assets. Investment appraisal tools such as payback, ARR and discounted cash flow should be applied where appropriate and expenses on purchasing or renting property should be incorporated into break-even analysis. Other quantitative business tools, such as decision trees and contribution costing may also be part of the location decision-making process. However, these will only be aids to decision making, and the firm will also have to consider a range of non-quantifiable (qualitative) factors, including employee motivation, company objectives, ethics and corporate image. Location, Location, Location Why do firms choose to locate where they do? Although, there is rarely a single answer because different firms choose their locations for different reasons, one of the major determinants of a location decision relates to the firm's factors of production. In general, economic theory states that firms locate where they can reduce the costs of their factors of production and where they have access to inputs that meet their quality standards at a relatively low cost. However, because firms are different, the relative importance of different factors of production varies both across industry and even more importantly, across the type of firm. For example, a firm that spends a large proportion of its total costs on labour will be attracted to a location where labour is relatively inexpensive, whereas a firm requiring a significant location space may give more weight to areas where rental values are relatively cheap. However, the mantra of real estate agents is that the crucial aspect of any property decision is 'location, location and location'. Buildings can be updated, redeveloped or improved, but the location itself cannot be changed. Naturally, the price of land varies according to its desirability; with supply and demand operating to establish price. A location will be relatively cheap when it is less sought after; retail locations with the highest footfall and business offices in 'high class' areas, attract the highest prices. A small retailer may wish to locate in the central shopping mall, but lacks the funds to pay the high rents, so must compromise and accept a less than perfect location that is, however, affordable. When reflecting on business location, it is important to remember that there is no one place that is perfect for all firms. Each location has its strengths and weaknesses. Some places have exceptional attractions, while others have may have both positive and negative aspects. Nevertheless, selecting the best spot for a particular firm is invariably something of a balancing act between the benefits of a particular location and its costs. Source - https://phis.rchk.edu.hk/pluginfile.php/43100/mod_resource/content/4/B_M_T5/Operations_management_student/page_109.htm
The reasons for a specific location of productionFactors affecting location Sectoral Location Primary industry needs to locate near to raw materials. Businesses which are still located close to raw materials tend to be ones which have extremely bulky raw materials which are then reduced to easier-to-transport final products. Suppliers of component and intermediate goods may set up close to their main customers. The introduction of JIT manufacturing has encouraged component manufacturers to locate nearer to their business customers. A footloose industry is those industries which are neither influenced by their market or the source of raw materials when deciding where to locate. Some firms in recent years have opted to move their premises out of traditional industrial areas to Greenfield sites – these are rural locations generally found on the outskirts of towns and cities. The use of Brownfield sites for business location is also increasing – a Brownfield site is an area of land which was once used for urban development. When businesses in the same industry locate in an area with similar businesses, this is referred to as Industrial Inertia. Location Decisions The decision about where to locate is crucial to many businesses. It can affect their sales, costs, profitability and perhaps even their survival. Why might a company need to make a decision about where to locate? ● New businesses will need to carefully consider where to locate their initial premises. ● Existing businesses may need to expand, but may be unable to do so on their present sites. ● The modernization of a business may involve moving to more up to date premises. ● A business aiming to cut its costs might achieve this by relocating. ● Multi-national companies aiming to set up a new plant in another country for the first time may evaluate a variety of possible locations worldwide. Location decisions will have an impact on all aspects of the profit equation: ● Fixed costs of different sites, such as purchase or rent of land can vary greatly. ● Variable costs, such as labour wage rates, and transport costs of raw materials, will depend greatly on location. ● Revenue earned by the business, especially if in a service industry, will be influenced by location proximity to market. Quantitative Factors influencing the location decision ● Site costs: These are the most important fixed costs of location. They include purchase or rent of land and property as well as conversion of fitting out costs. ● Regional incentives: Certain regions of most countries are able to offer financial and other incentives to businesses which decide to locate there. ● Transport costs: These are particularly significant for manufacturing businesses as they need to transport raw materials and components as well as finished products. ● Labour costs: The quality and productivity of staff should be important considerations in this area. ● Revenue generation: Certain location gives businesses the opportunity to both increase sales volume – due to market proximity – and to add value to sales on account of t the prestige of the area such as, a lawyer’s office in a city centre location. ● Infrastructure: The quality of the local infrastructure, especially transport and communication links, will influence choice of location. ● Environmental and Planning Considerations: A business might be reluctant to set up in an area that is particularly sensitive from an environment view point as this could lead to poor public relations and actions from pressure groups. ● Management Preferences: Senior managers often influence a location decision if there is an opinion to set up in an area with substantial ‘quality of life’ benefits. ● Clustering: The benefits of the businesses in the same industry locating in the same region are well recognized but are difficult to quantify. For example, the computer industry in the USA is heavily clustered around ‘Silicon Valley’ in California. These benefits include proximity to existing and potential customers and suppliers and the availability of well-qualified staff. Other issues The state and public opinion often have a very strong influence over some industries, particularly power stations and sensitive defense industries, but location has another strategic importance for governments. It needs to ensure the stable economic development of the nation and that requires it to divert businesses away from some areas and attract them to others. It is difficult to have good policy in this respect, simply because the areas that are not the most attractive usually costly to locate in and even short-term gains from government grants and tax relief will rarely overcome this problem. Many firms want the same facilities and the same labour skills, and they can gain from specialist training provision and useful general facilities. This lead them to localize-locate in the same areas. Often is has been development over time that has led to this clustering and new industries often gravitate naturally towards the same areas. Task 1: Why are iPhones made in China?What are the reasons given in the video for the success of iPhone manufacturing in Shenzhen, China but not in Brazil? Zhengzhou - China's iPhone City Task 2: What makes Shenzhen such an attractive location for locating hardware-related activities? Task 3: Watch the video below on the advantages presented by locating in Le High Valley, Pennsylvania. Try and identify the type of qualitative & quantitative factors mentioned in the video Impact of globalization on Location International Location- Globalization offers additional opportunities Location decisions for many businesses are no longer merely national decisions. Most large business organizations now have the option of establishing sites in more than one country- and even relocating existing sites into other nations. The reduction in barriers to the movement of capital which is such a feature as globalization means that international options are now a real possibility for many firms. Factors affecting the choice of international location (1) Bypass protectionist restrictions in the chosen export market. If a firm produces and sell products in a country despite it being incorporated in a foreign jurisdiction, the output produced will be classified as domestic. (2) Legislation and bureaucracy: Businesses are more likely to locate in countries where there is a liberal approach to issues like health and safety, the environment and employment legislation. (3) Growth of ICT: It is now possible for a Portuguese company to have its head office in Portugal; its orders department in a low-cast country like India and production in the Far East. (4) Political Stability: Businesses will avoid locating in areas with political instability. (5) The Labour Force: Companies will locate plants in countries where the workforce is flexible, cooperative, highly motivated, well trained and talented. (6) Market opportunities and transport costs: When trying to enter a new market it may be more cost effective to supply the market from within i.e. motor car production. (7) Financial incentives: Businesses may be attracted to a particular country or area if cash or other financial incentives are offered if they locate there. (8) Globalization: Selling into a global market rather than a single country market or area, is likely to be more effective if a business produces and sells in many different countries. E.g. taking into account regional characteristics. Driving and restraining forces for locating overseas The main driving forces or push factors for locating overseas include: ● Cost reduction - labour and materials may be considerably cheaper overseas. These savings have to be considered together with any the additional distribution and transportation costs. Employers in Western Europe looking to save on wage costs are increasingly relocating operations to Eastern Europe, Asia and Latin America. The Federation of European Employers publishes statistics on competitive wage costs within Europe and between Europe and other nations. ● Avoiding excessive government regulation and interference - large MNCs often threaten to relocate to minimise what they see as unnecessary regulation and interference in their business activities by local and national governments. Sometimes the threat to move is sufficient to persuade politicians to change unpopular restrictions and regulations and laws. If these are not amended, the firm may carry out its threat to move operations to other countries. ● Avoiding protectionism - import restrictions can be by-passed by manufacturing in the country or community concerned. This is a significant reason for the inward investment into the EU trading bloc. Asian car manufacturers have developed significant production facilities in Europe to avoid trade barriers. Cars assembled or manufactured within the EU may be moved and sold without import taxes or other trade barriers, even if the firm's headquarters and ownership is not within the EU. ● Economies of scale - large international, multinational industries, such as oil and petrochemical industries, have gained high levels of economies of scale from operating globally. ● Access to global markets - a huge growth in newly-industrialised and developing countries are changing the epicentre of economic and commercial power activities. By 2050, the BRIC grouping of countries: Brazil, Russia, India and China are expected to account for over 40% of the world's population, and 60% of global GDP. Firms presently located in the mature economies such as the US, Japan and Europe recognise that location within these rapidly developing markets is preferable to simply exporting to them. ● Competitive strategy - business decisions to move operations overseas may be to obtain 'First Mover Advantage' or as a defensive strategy in response to competitors, which have decided to make the move. ● Impact of exchange rate fluctuations - firms may locate production facilities in a number of different countries a protection against movements in currencies relative to others. For example, as a currency in one country strengthens against the currencies of its trading partners, exports will appear to be more expensive in those countries, China, for example has maintained the value of its currency, the Renminbi at an artificially low level against the US dollar to ensure that Chinese exports to the US remain relatively cheap and therefore competitive, whereas US exports will appear expensive in China compared to local manufacturers. One solution for US companies is to open production facilities in China. ● Overcoming a saturated domestic market - it is common for certain businesses to find it difficult to expand in a domestic market which is already working near capacity. Supermarkets have found this problem in many European countries. Chains like Carrefour and Tesco have sought expansion in new markets overseas. Overseas location may be used as an extension strategy. However, there are problems and disadvantages associated with locating overseas. These restraining forces can include: ● Language and communication barriers - this may seems obvious, but it still needs to be tackled. Language issues may relate to communication between staff and between the organisation and external groups such as suppliers and customers. This may be the result of different languages, dialects, or simply caused by distance ● Cultural differences - this can be a real problem if it is not considered in advance, and the necessary adjustments made. Dress, food and behaviour are major areas where problems can occur, if one is not careful. Cultural differences are of particular concern to the marketing department which must be aware of consumer preferences, religious taboos and traditions, when deciding on product ranges. The HRM department will also need to be sensitive to the cultural differences in the workplace that will affect relationships and working behaviours. ● Regulations and legal restrictions - health and safety legislation, transport restrictions, ingredients and dietary regulations will differ from country to country. A firm would be advised to seek local agents and/or partners who understand the local environment, to guide them through the location and settlement process. This can, however, be costly. ● Ethics, morals and social responsibility - firms will do well to exercise extreme care when relocating all, or some of their operations overseas, to ensure that they and all their suppliers act with the utmost ethical integrity and do not seek to exploit labour in the countries where they are locating operations. US firms such as Nike have faced adverse publicity about alleged use of child labour and the operation of 'sweatshops in countries such as China, Vietnam, Indonesia and Mexico, which negatively affected their corporate image, and consequently sales. Nike has been forced to spend millions of dollars attempting to improve their ethical reputation, but failed to persuade all their critics of their true commitment to the highest ethical standards. Source - https://phis.rchk.edu.hk/pluginfile.php/43100/mod_resource/content/4/B_M_T5/Operations_management_student/page_117.htm Impact of Globalisation on Location Pull factors – external to the firm · Improved IT – communications · Dismantling of trade barriers · Deregulation of the world’s financial markets · Increasing economic and political power of MNCs Push factors – internal to the firm · Reduce costs – ability to achieve economies of scale · Increase market share – look to gain first mover advantage · Put extension strategies into place – extend the life cycle of the product · Defensive strategies – try to ensure that global rivals do not gain a monopoly position in a virgin territory Task 4: Take notes on how variables such as locational strategies, labour costs and supply chain considerations have affected the globalisation of location. Reorganising Production Outsourcing A practice used by different companies to reduce costs by transferring portions of work to outside suppliers rather than completing it internally. Outsourcing is an effective cost-saving strategy when used properly. It is sometimes more affordable to purchase a good from companies with comparative advantages than it is to produce the good internally. An example of a manufacturing company outsourcing would be Dell buying some of its computer components from another manufacturer in order to save on production costs. Alternatively, businesses may decide to outsource book-keeping and accounting duties to independent accounting firms, as it may be cheaper than retaining an in-house accountant. Business operations that are commonly outsourced include:
Generally, business functions and processes outsourced to an external company bring cost savings and/or productivity gains. For example, a specialist accountancy firm may be contracted to prepare tax returns and investor reports at a cost far less than having to employ an accountant to do this internally. Likewise, specialist manufacturers will be able to supply components and products far more cost effectively and efficiently than a firm who does not have that area of expertise. How should a firm determine if it should outsource production? Not all companies engage in outsourcing, and if they are it will not necessarily be to the same extent. Outsourcing comes with problems of its own, which need to be weighed strategically by management. Generally speaking, outsourcing is appropriate for peripheral, non-core activities. To outsource strategic or core competencies could lead to loss of competitive advantage and risk the collapse of the whole organisation. Outsourcing of non-core activities is widely acknowledged as having the potential to achieve important cost savings. However, it can be difficult to distinguish between core and non-core competences Threshold competencies are activities that an organisation must possess in order to be a realistic competitor in a market. Outsourcing may be the only way for some organisations to obtain this type of competence. Cox categorises competencies into three groups: 1. Core competencies are those that result in competitive advantage. They should not be out-sourced e.g. product design 2. Complementary competencies aren’t core themselves but are connected/essential to core competencies These may be outsourced but only to trusted key suppliers with whom a strategic relationship is formed e.g. IT 3. Residual competencies aren’t in any way core and are suitable for outsourcing e.g. payroll. The Simpsons' take on 'Outsourcing' Why Chinese manufacturing wins Why outsourcing is bad for business Offshoring The practice of basing some of a company's business functions (account and book-keeping), processes (manufacturing) or services (IT solutions) overseas, usually so as to take advantage of lower costs. Offshored functions can remain within the functional control and ownership of the business or they can be entirely outsourced to a separate offshore organisation – this is termed offshore outsourcing. Offshoring is outsourcing to a firm in a different country. The same advantages apply, and these advantages can likely be boosted. Costs can be further reduced (a Philippine-based call centre is likely less expensive than one based in the US. This could be from additional economies of scale being achieved, lower operating costs (especially labour costs) and lower tax rates. Manufacturing (production) and services are the two categories of offshoring. Call centres, IT and accountancy services are common examples of business functions that are offshored. Factories producing entire products or component products account for a much larger share of the world’s offshored business processes than services do. Offshoring often gains negative publicity. Jobs in the home country are lost and environmental controls and labour regulations may be lax in some countries – there has been a backlash over the exploitation of workers in general and women and children specifically in many developing economies such as Bangladesh. Offshoring also comes with additional risks over outsourcing, especially political risks, increasing supply chain complexity and fast-rising wages in developing countries. In China wages are growing at double digit rates whereas in many European countries average workers have not seen a real wage increase in years. Venezuela and Argentina were perceived as being business friendly, in the last five years the governments of this country have seized business operations of large firms with token compensation (if any) being paid. Offshoring brings jobs, increased incomes and human capital investment to host countries. Both developing and developed economies compete to attract foreign direct investment because of the advantages it brings. There are relatively few disadvantages to a host country as long as there is good industry regulation, oversight and enforcement. Unfortunately, in many poor and corrupt countries this regulatory framework is inadequate or entirely absent. Environmental and labour exploitation may then occur. Insourcing Assigning a project to a person or department within the company instead of hiring an outside person or company to do the work. While outsourcing is commonly thought of as a way for companies to save money, it is sometimes more cost effective to have the work done in-house. Another reason for insourcing is that a firm may not be happy with the quality of the service or manufacturing they have outsourced. Bringing that process back ‘in house’ provides better control of the process at all levels as long as the company has the resources and knowledge to re-establish these effectively. In the United States, insourcing can also refer to the use of U.S.-based subsidiaries by foreign multinational corporations. These insourcing companies contribute to research and development, capital investment, exports and job creation. So, while outsourcing is often looked upon as a negative effect of globalisation that sends U.S. jobs abroad to countries with cheaper labor, outsourcing actually works both ways because it also sends jobs to the United States from foreign countries. When previously offshored business functions or processes are insourced back to the country of domicile, then this is termed re-shoring. As the relocation decision is likely to be costly, insourcing will not be entered into likely. In fact, industrial inertia (geographical) describes a stage at which an industry prefers to run in its former location although the main alluring factors are gone. Source - http://www.businessmanagementib.com/?bnc=1&rsn=noOb&fromProt=&lng=#.WU83TzOB00o Task 5: What is the difference between outsourcing and insourcing - watch the following video to identify the difference and understand the conditions for when is best to use each particular strategy Basic introduction to practice of Re-shoring Task 6: What are the reasons given for why some US firms have decided to re-shore their production? Task 7: Group work. Each group will take one article. The objective is to ascertain how locational factors are affecting the firm’s manufacturing strategy. Why would a business need to be located close to raw materials?Proximity to materials
In this situation, the raw materials are cheaper to transport than the final finished item. For bulk-reducing products , where the product is smaller than the raw materials used to produce it (eg bottles of smoothie), it makes sense for a business to be located close to the raw materials.
How does raw material affect the location of a business?Factories usually locate close to the source of their raw materials. This is because the cost of the raw material includes the cost of transporting it to the factory. By locating close to the raw material, a factory can reduce the cost of manufacturing its products.
Why is a firm located near a market?If the business is bulk-gaining because the finished item is larger than its components e.g. furniture, firms locate close to the market place to minimise transport costs.
Why is proximity to competitors important?Increase profits. More clients/customers means higher sales and higher sales mean higher profit. So even if some clients/customers go to the competitors, the business can still count on an increased demand just because the competitors are near.
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