Theories of Plant Location

• Median Location Principle

• Linear Market Competition (Hotelling)

• Weber

• Lösch

• Isard’s Space Economy

• Smiths Spatial Margins

• Webber’s Uncertainty Effect

Median Location Principle:Minimize Transport Cost

A B C D E1 2 3 4 5 6 7

Distance from C

Distance from D

A 3 4B 2 3C 0 1D 1 0E 3 2

Sum 9 10

Hotelling’s Vendors on the Beach Solution to such Competition

Essentially iterative competitive movements within the agglomeration space

A B C D E

If seller 1 starts at A, thenseller 2 jumps to B, then seller 1 jumps to C, and seller 2 could proceed to D, but that is inferiorto also locating at C, splitting the market in half.

Weber’s Model of Manufacturing Industry Production

• Developed in the early 20th Century in southern Germany

• Input factors are not ubiquitous

• This means that:– physical resources are not found everywhere– human labor is differentiated by skill & ability – capital availability varies– other inputs are also differentiated

Weber hypothesized that:

• Given market prices, producers would seek to minimize production costs to maximize profits.

• This leads to a taxonomy of production cost situations, considering

– factor costs– transport costs on products– transport costs on finished goods

In the Weber Model, If producers Minimize Costs, then:

Min: Ipiqi+ Iriqidi +rqqdj

e.g.

Minimize sum of factor costs + transport costs

on factor inputs + transport cost on shipment of product to the market

If factor costs are “given,” then the problem becomes how to minimize transport costs.

The Material Index Principle as a guide to manufacturing location

Material index = weight of localized material

weight of product (unit)

If M.I. < or = 1.0, locate at market

Material types:

“Pure” materials: no weight loss in production

“Weight-losing materials”

“ubiquities”

Weber’s Cost Minimizing Model & the Principle of Material Orientation

Example: 2T local materials

3T ubiquities

MI = 2/5 = .4, locate at market

Alternative Situations

(1) Ubiquities only, MI = 0, locate at market

(2) Pure Materials only

(a) 1 pure material, MI = 1M C

Material Index Cases, Cont.(b) 1 pure material + ubiquities

MI < 1, locate at market

(c) several pure materials only

MI = 1, locate at market

(d) several pure materials + ubiquities

MI < 1, locate at market

(3) Weight Losing Materials

(a) 1 weight losing material

MI > 1, locate at material locationM C

Material Index Cases, Cont. (b) 1 weight losing material + ubiquities

If MI > 1, locate at material site

If MI <1, locate at market

If MI = 1 ?, probably at market

( c) Several weight losing materials

M1

M2

CLocate away from C

An Example of (c)

P1 = 10, q1 = 2, r1 = .1 rq = .1, q = 5

p2 = 5, q2 = 4, r2 = .1 MI = 6/5 = 1.2

M1 C

M2

7

7

5

At M1: 40 + 0 +2.0 + 3.5 = 45.5At M2: 40 + 1 + 0 + 3.5 = 44.5At C: 40 + 1.4 +2.8 + 0 = 44.2At L: 40 + 1.225 + 2.45 + .5 = 44.175

L

6.125

6.125

1

Material Index Situations, Cont.

(d) Several weight-losing materials + pure materials: MI decreases, outcomes as in (b) above

(e) Several weight-losing materials + pure

materials + ubiquities: outcomes as in (d)

Upshot: Most situations are like c, d, and e.

3 classic locational outcomes: 1. Market,

2. Resource, and 3. Intermediate, sometimes “footloose”

Labor Cost Deviation

• M1

• M2

• C

• P

• L1 • L2

P - Transport Cost Minimum LocationL1, L2 - Low Labor Cost LocationsC - MarketM1, M2 - Raw Material Sites

CriticalIsodapane

Weber’s Approach to Agglomeration Economies

Scale of Output

$

Q1 Q2

a1 a2

For some index of agglomeration (e.g. a1 or a2):

A

C

BSeparateMarket Regionse.g. A,B,C,or agglomeration

A B

CCriticalIsodapanes

Competition for Location in Agglomerations

S

T

U

T T

S

SU

U

S1

T1

U1

S, T, and U can get agglomeration savings at T1, S1, and U1,but need to bargain to move to a location realizing them in

S, T, and U are separate Markets, whose critical isodapanes areSS, TT, and UU

Critique of Weber

• Conception of market demand limited

• Transport costs not defined realistically

• Labor is typically mobile, not fixed in space

• Many manufacturing plants produce complex sets of products with complex sets of inputs

• Treatment of agglomeration is rigid

• Lösch: Location based on maximum profit, not minimum cost

Isard’s Substitution Framework

Input-factors can often be used substitutability

although the degree of substitution can vary by scale and by technology

A

B

Q1

Q2

“Perfect” substitutability

A

B

••

•

No substitution

Q1

Q2

Q3

Substitution possibilities

Isoquants - Equal levels of output

Substitution is possible over a range

A

B

Q1

Q2

but factor proportions change

Substitution possibilities

Isocosts - Equal levels of cost, C1<C2<C3

A

B

Q1

Q2

Q1Q2

C1

C1 C2C3

C2

C3

Y

X

X is the ideal amount of A,Y is the ideal amount of Bfor production at level Q1

Expansion Curve - joins optimal factor combinations across scale

of output

Factor X

Factor Y

Q1

Q2

Q3

Q1

Q2Q3

C1

C1

C2

C2

C3

C3

Expansion Path

Spacing of isoquants and scale economies and/or diseconomies

Factor X

Out

put

Diseconomies

Linear

Scale Economies

Isoquants displaying scale economies & diseconomies

Factor XFactor X

Fac

tor

Y

Fac

tor

Y

10 2030

1020 30 40

Diseconomies

Economies

Isard’s Substitution Model: two point location model - pure materials

M C

Transformation Line

Distan

ce from M

Distance from C

Isard’s Substitution Model, 3 point location problem

Market

Material A

Material BS

O

R P

Distance from B

Dis

tan

ce f

rom

A

O

P

R

S

T

UW

Y

V X Distance from B

Dis

tan

ce f

rom

A X

Y

V

W

T

U

OP

RS

Smith’s Space-Cost Curve•Weber’s isodapane concept: equal transport costs from a reference point

• Formed by adding transport costs for individual factors - mapped as “isotims”

X and Y are the “spatial margins of profitability”

Tot

al C

ost

(M

ater

ial &

Pro

du

ct)

Material Source Market

Area of Profit

$

X Y

Webber’s Uncertainty Effect

• In reality, we do not have perfect knowledge about markets and factor costs

• Uncertainty deters (large) investments

• Uncertainty enhances the importance of external economies - new entrants get the benefits caused by existing sellers

• Ex ante versus ex post evaluations, leading to satisficing behavior

Businesses in a Volatile Environment: A Two-Way Relationship

Business as a “black box”: unpacking the contents

Inputs Firm OutputsMaterials,CapitalLabor

Finished orsemifinishedproducts

Motives for behaviorin space:

profit: maximum?Or: a “satisficing” level“bounded rationality”

HerbertSimon

Competing elementsinternal to the firm

Forces influencing the decision-making process

Organized G

roups

Values of societyEXTERNAL

Objectives

Expectationsof Individuals

Expectatio

ns

of Stakeh

oldersExpectations

of Coalitions

Hist

ory

and

age

Leade

rshi

p

and

mgt

.styl

eSt

ruct

ure

and

syst

ems

CU

LTUR

E

Market Situation Products and technology

NATURE OF BUSINESS

Organizing with regard to the value chain

Vertically integrated versus specialized in parts of the value chain

Determination of scope via transactions costs - Coase’s theorem: The firm will carry out a particular task up to the point at which “the costs of organizing an extra transaction within the firm are equal to the costs involved in carrying out the transaction in the open market, or to the costs of organizing by another entrepreneur.”

Williamson: internal activities organized hierarchically; external organized horizontally

Dynamism: vertical integration & disintegration related to changes in transactions costs

The Uncertain and Volatile Business Environment

BusinessOrganization

Firm EnvironmentBoundary

Task EnvironmentDomain Environment

Societal Environment

Global EnvironmentMacroenvironment

The Task Environment

FIRMSuppliers Customers

Regulators

Government Labor Unions

Competitors

IndustryCompetitors

PotentialEntrants

SubstituteProducts

BargainingPower

BargainingPower

But, Production Networks are Inherently Unstable

• Factor prices change

• Factor supply availability changes

• Market tastes change

• Market demand mix/levels change

• Process and product technology changes

• In the globalized and oligopolistic market environment, organizational change is rampant

Upshot: Trajectories & Adjustment

Turbulent Environments

ComplexTurbulentConditions

SimpleStaticConditions

Low levelsof uncertainty

IncreasingUncertainty

Increasing complexity

Increasing dynamism

A Common Outcome of this Turbulence: The Product Life Cycle

DemandConditions

Very fewbuyers

Growingnumber of

buyers

Peakdemand

Decliningdemand

Steep falloffin demand

CompetitiveStructure

Very fewcompetitors

Entry of newcompetitors

Shakeout ofweakest

competitors

Stablepopulation

ofcompetitors

Exit of somecompetitors

Technology Rapidchange

Less rapidchange

Some change, but increasingly stabletechnology

SalesVolume

Initial Growth Maturity Decline Obsolescence

development

Examples of the Product Life Cycle

Fashion clothes

Automobiles

Generations of Boeing airplanes

…….but not all products follow this trajectory:

Levi 501 shrink-to-fit jeans

“Coke” & name brands that play off product stability: Tiffany; L.L Bean; Campbell’s Soup

Like Schumpeter, Freeman’s view that economic systems experience “creative gales of destruction: Campus computing as an example

Era Mode of Interface Mode of Output~1959 to ~ 1975 Hollerith Cards 11 x 17 line printer paper

(FORTRAN)~ 1970 to ~ 1988 Magnetic Tape 11 x 17 line printer paper,

mainframe files (FORTRAN)~ 1983 to now CD’s for data Laser Printers & PC files

(early EXCEL; SPSS)~ 1993 to now The WWW; CD’s start to

dieLaser Printers & PC FilesVast Expansion of Modes ofanalysis

~ 1997 to now The WWW Multi-mode display devices;Huge expansion of analyticalenvironments

Where next? Who knows Technology will driverestructuring

Mode of Input: varied also over time!

Impacts of IT in the Current Business World

• Are we in a new era of techno-economic adjustment due to IT?

• Symptoms: Geographic realignments of employment, industrial power, and multiplier effects

• Consequences: reshaping of political, social, and economic systems

• Consequences that we cannot forecast!

So, do big businesses really have advantage?

Yes, and No.

Yes, as measured in most narrowly defined industrial categories, but within many are powerful competitors in the small firm cohort

Scale economy factors that we covered are important in creating advantage, but they can also be an impediment.