Ch. 5: Factory Location as a Cost- Minimizing Exercise Transportation, cost minimization and location Aly Konkol, Carine Lefevre Transportation, cost minimization and location Aly Konkol, Carine Lefevre

Neoclassical Location Theory 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 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 Profit-maximizing Focus more on distribution costs Incorporate effects of rival behavior on location Applied mainly to personal and retail services Profit-maximizing Focus more on distribution costs Incorporate effects of rival behavior on location Applied mainly to personal and retail services 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 cost- minimization theory Ubiquitous: can be obtained in any location Pure: experience no change in physical characteristics during processing Impure: experience change in physical characteristics during processing 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 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 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 Used when an activity has more than one impure input from different sources 1. Calculate isotims (lines of equal transportation cost around each location factor) 2. Sum relevant isotims to identify least total transportation cost location (P) Used when an activity has more than one impure input from different sources 1. Calculate isotims (lines of equal transportation cost around each location factor) 2. Sum relevant isotims to identify least total transportation cost location (P)

Labour, external economies, etc. 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 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 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 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 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) 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 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 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 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 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 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 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! Predicts an optimal location pattern for minimizing distribution costs Factories serve hexagonal- shaped market areas Ensures all possible demands are met in spatially distributed market

Notes on C.P.T. 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 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 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 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 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. 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 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 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 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 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 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 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 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 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 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 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 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 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 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 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 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 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 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 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