Factory location as a costminimizing exercise
Elena Kozlova
Sandra Lundin
Neoclassical location theories

Profit-maximation
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transportation costs
(distribution to markets)
incorporate the effects of
rival behaviour on
location
Used for: personal and
retail services

Cost-minimization
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transportation costs
(materials)
location condition
spatial varaitions in cost
structures
Used for: manufacturing
FIRMS AS BLACK BOXES :
LANSCAPE AS SPACE COST
(REVENUE) SURFACES
A. Weber :
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-TRANSPORTATION( procurement and
distribution costs) is the most IMPORTANT
general principle of location.
-LABOUR and EXTERNAL ECONOMIES
of SCALE are the two most important
regional principles of locaton.
The effets of transportation costs on
industrial location:
Weber, INPUTS:
-ubiquitous
-pure(distribution costs are more significant than
procurement costs) ->the location of markets exerts a
stronger pull on location than the sources of inputs
-impure( procurement costs are more significant than
distribution costs)->the sources of such inputs matters
more than the location of markets
Location matters in terms of
minimizing costs (figure 5.1.)

Material Index:
weight of localized raw materials
MI = ___________________________
weight of final product
MI >1 activity is input-oriented (saw mills, cotton compression, fish
processing)
MI<1 activity is output-oriented (paper-box manufacturing, soft
drink bottling, bakeries, the coking of coal)
More than 1
impure input + different sources -> mimimum
transportation
cost location is
the 'intermediate'
between input sources
Isodapane analysis (figure 5.2) -the method of calculating the leastcost location; STEPS:
1)a transportation cost surface is calculated for each location factor;
2)the transportation costs relevant to each location factor are
summed to create a total transportation cost surface and the least
total transportation cost location is identified.
Labour, external economies and
other costs (Isodapane analysis)
12 €
8€
4€
L
P
Isodapane
P= minimum transportation cost location
L= minimum labour cost location
Critical isodapane= the isodapane which equals the labour cost savings
Spatial margins to profitability
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- as long as revenues exceed costs, plant
locations are viable.
personal locational preferences can be exercised
as long as they remain within the constraints of
profitability.
The principle of substitution -the
fundemental principle of
neoclassical location theory

Procurement and distribution costs are
substituted for one another.

lower labour costs + higher transportation
costs OR lower transportation costs +
higher labour costs
The principle of substitution cont.
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land, labour and capital
whether a factory should be more or less labour
intensive depends upon the relative cost of
labour within the realm of substitution
possibilities
X
X*, Y* is the optimal
combination of
inputs
Isoquant (scale of factory)
Selected isocost
lines
X*
Y*
Y
Locational interdependence and revenue
surfaces- how competition among rival firms
affects the location and market areas of
factories.
Central place theory(1966) - general principles of location wich are
relevant to manufacturing activities.(Figure 5.5)
a) single good: single seller
b)single good: several sellers
c)single good: optimal ocation pattern minimizing distribution costs
Products are differentiated only by distance and consumers are
assumed to prefer nearer(and cheaper) sources of supply than
more distant sources of supply.
Hotelling duopoly model
2 sellers
 a homogeneneous product
 spatially distributed, but linear market
 Both sellers would locate at the center of the
market
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a
A
B
b
Uncertainty and the principles of
adaption and adoption
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In reality firms don’t have perfect information.
Circumstances change; technology, rival
behaviour, market dynamics etc.
Even if once rationally located factories will
have to adapt, adopt or risk failure as the
environmental conditions change.
Adaption= response on the part of the firm
Adoption= firm is saved as an result of the
actions of others, notably governments
Location adjustment possibilities
Three dimensions:
1) SPACE
 on-site ( firms expand,contract,modernize or change a factory's operations)
 inter-site adjustments (firms reorganize their production among a set of existing
locations)
 new site (firms can relocate or establish branch plants)
Example: the cotton textile mills in England
2) ORGANISATION
 small single plant (in terms of on-site change, it is able to make faster decisions than
multi-plant firm , but inter-site adjustments are not available for it)
 multi-plant firm
3) TIME
 -short
 -medium
 -long -term planning horizons
Locational evolution in neoclassical
perspective
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Old factories can survive for a long period of
time because their capital costs are zero. ->
substitute low capital costs for high operating
costs
Factories that are not willing to adapt or adopt
will probably have failure as the only option
In general: large number of small firms and
plants-> fewer, large plants dominate the
industry
Industrial location policy in a
neoclassical landscape
Minimal policy interference by
government -> Freely operating
market forces resolve regional
problems
Industrial location policy in a
neoclassical landscape
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Critiques:
1. The mobility of workers:
- social and family commitments
- migration involves costs and uncertainties
2. Continued investment in core regions
- likely to reinforce agglomeration economies and
effects of inertia
COST STRUCTURES AND
LOCATIONAL ORIENTATION
Within the same industry and region, cost structures can
vary considerably.
-Primary manufacturing :
Examples:
 -Sawmill cost structures
 -newsprint industry cost structures (the cost structures
are based on the average costs for a sample of existing
mills in each region
 -other raw material using activities
-Secondary manufacturing:
 - cost structures in the auto industry