14 Factors Affecting Location Decisions

Vikas Singla

14.1 OBJECTIVES

This chapter would help students to understand:

importance of location decision
nature of location decisions
various factors affecting location decisions

14.2 INTRODUCTION

Location decision by a firm relates to adopting a systematic approach towards making a decision regarding its geographic location. Making such a decision is important for every organization in every sector. Such a decision has a long term impact on profitability of an organization. Location decision entails investing a large sum of money which makes a huge part of operating cost. For instance, in retail sector where either a company buys or rents a retail space, more than 40 percent of its operating cost is attributed as location cost.

Location decisions although important are dictated by different factors depending on whether the organization is into manufacturing or service. A fast food chain, a bank, an ATM, multiplex etc. providing services to customers have to be located close to customers. Whereas, firms which are in to manufacturing end of supply chain such as agriculture, mining, soap production etc. need not to be close to customer but their location decision are governed by factors such as close to raw material, availability of cheap labor etc. Thus, there are number of factors which affect an organizations’ location decision. This chapter would discuss such factors by taking into consideration

nature of industry i.e. manufacturing or service and
type of product/service

Another important aspect to be considered is establishment and enormous growth of web-based retail industry. Services provided by players such as flipkart, amazon and other numerous players can be accessed from anywhere and at any time of the day. So, provision of services by these companies is much less dependent on location decisions. Reduction of operating cost by removing the facility of providing products and services through traditional brick and mortar way is being adopted by numerous service companies. Banks encourage customers to access numerous services through their web sites, clothes can be bought online and other needs can also be fulfilled by buying online. But this is predominantly true for service oriented companies. Manufacturing companies still have to produce so location decision is an important strategic decision for them.

14.3 NEED FOR LOCATION DECISIONS: A CASE STUDY OF RETAIL SECTOR

Location decisions are considered as strategic decisions as they have long term impact on profitability of an organization. Most of the location decisions are irreversible. Once a company decides to locate its plant or retail outlet after incurring huge cost it becomes very difficult for it to change or renew the location of that outlet.

The importance of such a decision has been explained by taking illustration from retail sector. This sector has shown huge growth in recent times. The organized retail in the form of shopping malls has indicated their presence in almost every major city of the country. The demand side characteristics such as moderately high economic growth, ever expanding middle and upper class consumer base has fuelled a greater penetration of modern retail in the economy. These shopping malls house variety of stores. Shopping experience of stores such as apparel, jewellery, grocery, book, electronic, movie theaters etc. are provided under one roof in such malls. Thus, such shopping malls have become increasingly attractive for a retailer.

These shopping malls compete with traditional city markets for location decisions. These traditional markets have several advantages such as proximity, familiarity and high personal service. But changing dynamics of marketplace are persuading local retailers to move into malls and adapt to compete with bigger domestic and international retailers. Similarly to tap into traditional customer base and in pursuit of providing a better alternative to street shopping, mall retailers are venturing into these high streets. This dynamics provide numerous location alternatives for a retailer while making an important location decision. So, question is where to locate.

One of the major influencers to such a decision is rental cost of retail space. Retail space in prime locations in the big cities is scarce and available only at high rental costs. Fig. 14.2.1 shows increase in rental rates of shopping malls in three big cities of country and Fig. 14.2.2 shows increase in rental rates of shopping street in these cities. The data depicts that rents of prime properties in major cities have increased substantially in last year.

Source: Knight Frank Research 2012

Therefore, opening of a new establishment is a critical factor for firms in the retail sector because the decision carries with it a series of very serious financial and corporate image risks.

This case has intended to illustrate importance of location decision as it has direct and major impact on profitability and success of an organization.

14.4 NATURE OF LOCATION DECISIONS

Understanding the illustration given in 14.2 would help in understanding the kind of location decisions an organization makes:

Location decisions are strategic in nature and have direct relation with long term objective of the company. For instance, if a company operates in low cost provider business environment then it would make a location decision which does not have huge impact on its cost structure. It would be close to customer to reduce its transportation cost, would hire locally to have low labor costs, would supply from local suppliers and would tend to adopt mass production system to achieve its objective of low cost producer. Barber shop, banks local sweet shop fall in this category.

A strategy of increasing profits by providing high quality products would ask for locating in a geographic area which would provide highly skilled labor, high quality raw material would produce in batches taking into needs of different customers even if it increases cost structure. Car manufacturing, IT service providers fall in this category. Thus, different location decisions would be governed by long term objectives and strategy of an organization to beat its competition.

There may be number of acceptable locations. In many instances, no single location might be better than other locations. There might be number of acceptable locations. But selection of location is dictated by acceptable location factors such as proximity to customers, availability of raw materials etc. Availability of all these factors might not be possible for a particular location. A location might score highly on some factors and lacks on others. Thus, it becomes highly important that an organization decides systematically which factors are important and which can be ignored. A systematic study of these factors would facilitate selection of one best location.
Importance of factors on which location decision would be based varies from sector to sector. Proximity to customers might be important for a barber shop but not for a shopping mall which are mostly located outside the city on a large scale.

14.5 FACTORS AFFECTING LOCATION DECISIONS

There are number of factors that influence location decisions. But there are only few factors that play a deciding role in location decision making. For manufacturing industry, producing at low cost is the most important factor. A location would be decided which mostly fulfills this criteria. A service industry would try to be close to the market and intend to provide quality service. So, all factors that fulfill this criterion would be included in making a decision about selecting a location.

14.4.1 Location of Raw Materials:

Companies will be persuaded to locate their operation close to source of material for following three reasons:

Necessity: Mining can only be done where minerals re present. Agriculture can only happen in fertile and irrigated area. Hydro power can only be produce near source of water. In all such cases mining, agriculture and hydro power industry would be located close to their source of raw material because in such case raw material cannot be transported.

Perishability: Sugar mills are located close to sugarcane fields. Tyre manufacturing industry is ideally located close to rubber producing areas. Industries involved in processing of perishable goods such as fruits, vegetables, milk etc. should be located close to source of their raw material.

Transportation: Firms which work on strategy of low cost producers tend to adopt operations which would lower the cost of their final product. Fruit and vegetable vendors tend to locate close to residential areas. Warehouses like ‘Best Price’ are located close to retailers as they are suppliers of bulk material to retailers and not to final customer. Big manufacturing plants which require variety of raw material in huge quantities tend to locate close to source of that raw material which is required in maximum quantity. For example, steel industry requires coal and iron ore. Another interesting example is of car industry. All car industry like Ford, Maruti Suzuki etc. tend to locate their plants close to sea ports. One of the major reasons is that with increasing competition and saturation n domestic market they are focusing on exports of cars. Locating at sea ports would help them to reduce their transportation cost in terms of accessing consumers and also in terms of importing raw material or semi-finished goods for their produce in India.

14.4.2 Proximity to Markets:

Services are characterized by their production and consumption at the same time. Also most of the services cannot be stored. Because of these attributes majority of the service providers locate themselves close to their consumers. For instance, barber shop, car wash, service stations etc. Thus, service industry’s location decision is primarily governed by ability to locate close to consumer. This factor has a disadvantage to it. Cities where services tend to locate themselves have higher utilities cost which ultimately increase operating cost of these services. Thus, in case of services proximity to markets become predominant factor in location decision making process.

Service companies tend to locate their operations close to final consumer for following reasons:

Competition: Vehicle dealers, apparel stores are clustered with each other. It is observed that most car dealers are located close to their competitors. Similar is the case with apparel stores. The reason for this can be attributed to providing options to the consumer. A visitor looking to buy apparel would like to visit a competitor store located close by in order to increase his/her options.

Convenience: Retailers providing low cost products such as soaps, toothpaste etc., impulse buying products such as candies, magazines etc. tend to locate close to markets to provide easy accessibility to consumers. Traditional shopping markets tend to sale more variety of products than a shopping mall because of their closeness to consumer.

Perishability: Retailers such as flower shops, dairy products, meat shops etc. selling products which are perishable in nature locate close to consumer to reduce distribution costs.

In case of manufacturing firms only those companies with low cost and perishable products such as

bakery, sweet shop etc. tend to locate themselves close to markets. Big manufacturing industries such as car manufacturing, leather and textile are located away from consumer because such industries require large space, dedicated freight area etc.

14.4.3 Labor Factors:

Two factors that are to be considered while deciding about labor factors are:

Skill set of labor: Skill set of labor can be divided into three categories: namely, highly skilled, semi-skilled and unskilled. Industries such as Information Technology, Aircraft Manufacturing, R&D etc. require a highly skilled set of labor. That is the reason such industries are found in major cities with abundant good quality education facilities. Semi-skilled labor with low to medium scale wages is required in call centre industry. Thus, India became a hub of call centers and majority of such industry was located in India. Industries such as construction, agriculture, mining etc. which require labor in abundance but of low skill set are located in area where low skilled labor is available at low wages.

Cost of Labor: is a huge factor in deciding location of a firm. China became manufacturing hub because of availability of low and semi-skilled labor in abundance at very low wages. That is the reason majority of industry from US shifted to China. But as the industry got matured and labor shifted from semi-skilled to high skilled category their wage level increased. So, the benefit of low cost service provider was nullified and now many manufacturing firms are relocating themselves back to US. Similar case is happening with call centre industry of India. With increasing wage levels companies have lost cost advantage so they are relocating their operations to other South East Asian countries.

Thus, selection of a location with respect to labor depends on type of product/service being produced by the firm.

14.4.4 Taxes:

Taxes are sometimes considered as additional burden or cost by many firms. So many companies tend to locate their operations in the regions which offer tax benefits. Many states such as Himachal Pradesh, Uttrakhand and North East states have benefited from such clause. But sometimes tax benefit is only a minor consideration in location f operations. In recent times, it has been seen that Vodafone in spite of being having difficulty with tax authorities stayed put its operations in India because of India’s huge market size.

14.4.5 Community Considerations:

Companies generating local employment, taking care of environment and providing schools, hospitals to local community are always being attracted by some communities in lieu of some benefits such as tax breaks etc. Tata Nano plant in Singur, Kolkata, POSCO plant in Orrisa encountered huge problems in establishing their plants because local community was not convinced that these manufacturing plants would be of any help to them. These plants were perceived as destroyers of local habitat, polluting natural resources and working against the benefits of local community. So, community considerations especially in manufacturing plants such as steel, power plants, nuclear plants etc. play sometimes deciding role in location decisions.

14.4.6 Utilities:

Availability of utilities such as water, electricity and transportation facilities play a major role in deciding location of manufacturing facilities. In present modern and hyper-competitive business environment availability of such facilities in abundance at reasonable prices are sometimes predominant factors in location decision making process. This aspect is clearly evident from highly industrialized regions of the country such as coastal areas of Tamil Nadu, Gujarat and Maharashtra. Major car companies, mobile phone manufacturers and other big industrial establishments select these areas for setting up their manufacturing plants. Also, presence of facilities such as schools, hospitals, recreation services for employees of the companies are considered in location decision making. Many of major global companies have employees from other countries. Bigger cities with developed infrastructure become major attractive destinations for such companies as these cities are equipped with provision of all such utilities. Thus, service companies which are dictated by close to market factors enjoy these facilities as they decide to locate themselves in cities.

14.4.7 Site Related Factors:

Costly land is a major deterrent in establishment of companies. Cities lack in provision of ample land at reasonable prices. Service firms which because of their operations need to be close to consumers are also now locating themselves at the outskirt of city because of very high land prices. Educational institutions are a prime example of this aspect. In recent times it has been observed that schools and colleges are located outside the city which provides them abundant land at low prices. This results them to be located away from their consumer. This bottleneck is removed by providing bus services to children thus increasing transportation costs.

These illustrations discussed under various factors clearly explain that there are number of factors that are considered in location decision making process. The importance of such factors varies from industry to industry. It becomes highly important for every firm to decide which factor influences location decision making process the most. The quantitative methods to identify such factors would be discussed in next chapter.

14.5 SUMMARY

Deciding on geographical location is an important strategic decision for every firm as such decision has far reaching financial implications. In present hypercompetitive business environment such a decision has gained increasing importance for every firm operating in manufacturing as well as service area. This chapter has discussed in detail various factors that govern such decision making. No one factor is considered as the sole deciding reason in location decision making approach. Identification of most important factors is directly associated with objectives of an organization. A firm focusing on low cost objective would consider different factors for its location of plant as compared to a firm which focuses on profit making. This chapter has studied regional factors such as location of raw materials, proximity to markets, labor factors and taxes; community related factors including utilities; and site related factors such as availability of land and transportation facilities.

14.6 REFERENCES/ SUGGESTED READINGS

Chase, B.R., Shankar, R., Jacobs, F.R. and Aquilano, N.J., Operations & Supply Chain Management, 12th Edition, McGraw Hill.
Stevenson, W.J., Operations Management, 9th Edition, Tata McGraw Hill.
Lee J. Krajewski, Operations Management, Prentice-Hall of India, New Delhi, 8th Edition.

14.7 SHORT ANSWER QUESTIONS

1. Location decisions are strategic in nature

(a) True (b) False

Answer: a

2. Location decision criteria are different for service and manufacturing firms

(a) True (b) False

Answer: a

3. Out of the following factor is most important for educational institutions’ location decision making?

(a) Proximity to customers (b) Labor costs

Answer: d

4. IT firms are clustered in major cities. Why?

(a) Cities have adequate and reliable utility infrastructure.

(b) Cities have good educational facilities

(d) All of the above

Answer: d

5. Which factor out of the following makes local population is wary of setting up of nuclear plants in their neighborhood.

(a) Regional factors (b) Site Related factors (c) Community factors Answer: c

14.8 MODEL QUESTIONS

How are manufacturing and non-manufacturing location decisions similar? Different.
What community factors influence location decisions?
“The importance of location decisions is often vastly overrated, the fact that virtually every type of business is located in every part of the country means there should be no problem in finding a suitable location”. Comment.