Location
Introduction
Most business studies textbooks can’t resist starting a section on business location with the following phrase:
“The three most important things in retailing are – location, location and location”.
However, although it is a well-worn cliché – it still has some merit. It was reputedly first said by the former boss of Marks and Spencer (Lord Sieff) to describe the main success factors in his business. And certainly in retailing, if you get the location wrong, it can have a serious and often disastrous effect on the business.
For businesses in some sectors, location really is critically important. For others, it is a relatively minor decision. The key is to consider the main issues faced by a business choosing a business location and to address the most appropriate way of making a choice.
Location decisions are usually pretty important – to both large and small businesses. The location decision has a direct effect on an operation’s costs as well as its ability to serve customers (and therefore its revenues).
Also, location decisions, once made, are difficult and costly to undo. The costs of moving an operation are often significant and run the risk of inconveniencing customers and staff. It is always best to get the location decision right first time.
Main factors influencing choice of business location
The main aim of choosing a business location is to achieve a balance between three related objectives:
• The costs of the operation
• The customer service that the business wants to provide
• The potential revenues that can be achieved from the location
The factors that influence the choice of business location can be divided into two broad kinds:
Supply factors These are mainly concerned with the operating costs of the location Demand factors These factors mainly affect customer service and revenues
Looking at these two groups of factors in a little more details, here are some of the issues a business needs to consider:
Supply factors (costs)
Labour costs Often a major factor, particularly if the decision is to locate in the UK, or overseas. Labour costs vary from region to region in the UK, but the
biggest difference is between the UK and low labour cost countries overseas.
Land costs Sometimes the land will be purchased, but more often it will be rented along with the business buildings and facilities. Rentals can vary
enormously depending on the location and the facilities provided.
Government grants and other incentives are also often available to reduce the land costs of locating in poorer regions.
Energy costs Some businesses use substantial amounts of energy (e.g. gas, electricity) but they should be able to negotiate a good price for their energy needs regardless of location in the UK.
Transport costs Transport includes the cost of getting inputs into the business (e.g. raw materials for the production line or stocks for sale) and also the cost of getting products delivered to customers. A business needs to be close to its source of supply if the cost of transporting raw materials is high or difficult (e.g. food processing is often carried out close to the farms).
For many businesses the cost of distributing to customers is not a significant issue. Delivery firms might carry out the transportation (for which the customer pays). In many cases the customer comes to the business – e.g. in a hotel
Community factors
The costs of a business location can be influenced by many non-financial factors, but which can still be significant when making the choice. These include:
Local amenities & services (e.g. schools, professional services)
Local government attitude to supporting business (including financial assistance)
Language Political stability
Demand factors (customer service and revenues) Customer
convenience
Probably the most important factor. Many businesses need to be located where customers find it quick, easy and cheap to access the service being provided. E.g. a fast-food outlet needs to be somewhere close to a strong customer footfall, not hidden away out of site. Out-of- town retail parks are situated within a convenient short drive from major population centres.
Labour skills Where specialist skills are required, this can be a big issue. For example, technology firms tend to locate themselves in areas where there is well- established expertise (e.g. M4 corridor and Cambridge in the UK) Site suitability A site may need to have some particular characteristics to maximise
customer satisfaction and revenues. E.g. a luxury restaurant or hotel needs to be located somewhere that customers find attractive – not in the middle of a trading estate.
Image This is more intangible, but often important. Some customers associate a product with a certain area and prefer to buy from there (e.g. walking equipment – a business based in the Lake District might enjoy a better perceived reputation
Expansion potential
Future production capacity often has to be taken into account. A location might tick many other boxes, but if it provides limited scope for expansion then it might be rejected. If a location restricts output, then revenues are potentially damaged.
Methods of making location decisions
Making a decision on a business location involves weighting and balancing the important factors.
• Are cost (supply) issues much more important than customers and revenues (demand)?
• Is the decision strategically important (i.e. it could affect the achievement of corporate objectives) or is it a relatively minor decision?
• Can quantitative methods be used to evaluate alternative location options (e.g. by using investment appraisal techniques?)
• Do qualitative factors, including senior management preferences, outweigh the financial considerations?
For a significant decision on business location, it is considered good practice to undertake some investment appraisal. The decision may involve a substantial capital investment (e.g.
buying land & buildings, fitting out retail or other outlets, installing IT and production facilities). The two main approaches would be:
• Discounted cash flow – which evaluates a project’s cash flows in terms of the business’ required rates of return on investment (by calculating a net present value for each option)
• Payback – Also focusing on cash flows; this would help estimate the period of time it takes to repay the investments in the business location
• Average rate of return – an accounting calculation that looks at the estimated average accounting returns as a percentage of the investment
In reality, the final choice of business location is often made using non-financial criteria – particularly when it comes to choosing the location for the start-up of a business. An entrepreneur will often begin the business at home and then, when extra space and staff are required, select somewhere nearby.
Benefits of the right location
There is no such thing as the perfect business location. Every choice made involves some trade-off between supply (cost) and demand (revenue) factors.
However, a good location is one which delivers the following benefits:
• Competitive unit costs – through a combination of a productive and efficiency labour supply, acceptable location overheads and cost-effective access to inputs (raw materials, components etc)
• Optimal revenue opportunities – customer service is not inconvenienced through the choice of location
• An acceptable rate of return on investment – all business projects compete for scare cash resources; a business location decision is no different
• Sufficient production capacity to meet demand and future flexibility in capacity management decisions
• Access to a labour force which enables the business to achieve the objectives of its workforce planning
Industrial inertia and relocation
This is another factor which affects the choice of location. A business, once established, will often decide to stay in its original location even if other factors suggest a new location would be beneficial. The term for this is “industrial inertia”. Why does this happen?
A positive reason is that the existing location provides advantages from external economies of scale. Over a long period of time, a location or region that has become associated with a particular industry develops specialist skills and experience. The pool of potential recruits is like to contain many people with relevant training and experience. Specialist suppliers are likely to be nearby.
Another reason is the cost and disruption that can arise from relocation. A decision to relocate involves potentially significant costs including:
• Recruiting and training staff in the new location
• Duplicated property costs – e.g. remaining periods on the original lease + upfront payments on a new lease
• Costs of physical transfer – moving production equipment, transferring stocks A third reason is a more intangible and qualitative reason – simply the desire to “stay put where the business has established its roots”. Ask an entrepreneur why she started the business on the outskirts of York and she might simply say “because it was near to home”.
Ask her 15 years later why the business is still there, the answer could easily be “because we’ve always been here”!
Issues in multi-site location
Many businesses start and continue to trade from just one business location. However, for others, the growth of the business necessitates the opening of locations on more than one site. For example:
• A retailer who expands by launching the same format in other locations nearby and then across the UK
• A franchisor that expands by selling geographical territories to franchisees
• A financial services business that opens a call centre operation overseas
In all these and other examples, the decision to operate multi-site creates opportunities and issues in relation to the four main functional areas. A summary of the main points is provided below.
Advantages of multi-site locations
• Most importantly – closer to customers; the business operates in the geographical markets when it can compete
• Greater potential for promotion amongst junior management
• Recruitment may be easier, particularly is done locally
• Marketing and management economies of scale – costly resources can be spread across more business locations, customers and revenues
• Easier to flex capacity – by adding or removing locations
• Less risk of the business disruption from problems at just one location
• Better understanding of local market cultures & conditions Disadvantages of multi-site locations
• Potential duplication of activities (diseconomy of scale)
• Harder to control operations – though IT systems can make this much easier
• Communication across the business is more challenging
• Increased strategic risk – the risk that the business does not understand the local market which it is entering
Issues in international location
Many larger businesses now have operations of some kind in more than one country.
The factors that influence the decision to operate overseas are very similar to those a business considers when it chooses a domestic business location. However, the issues and challenges tend to be a little more complicated!
Amongst the factors driving the increasing internationalisation of business are:
• Cross-border mergers and acquisitions (e.g. a UK manufacturer buys a competitor in the USA)
• Organic growth overseas (e.g. Tesco opening superstores in Thailand)
• Moving production overseas – to enable faster lead times to customers
• Increasing use of offshoring (see further below) The reasons for operating in international markets include:
Accessing demand in suitable markets
This is by far the most important reason for most businesses. Emerging markets like China, India and Brazil have enjoyed significantly better rates of economic growth in the last
decade and increasing consumer incomes and business investment in those markets create attractive sources of revenue and profits.
The sheer size of demand in emerging markets, in addition to the fast growth, is also a major motivator.
Successful large businesses often find that their revenue growth prospects in the domestic market are constrained by:
• Lower growth – perhaps because the market is saturated
• Regulatory concerns about excessive market share
So they turn to international expansion as a way of driving forward revenues and profits for the shareholders.
Cost reduction
This is another major reason for operating overseas. Increasingly skilled labour is available at lower cost, which encourages businesses looking to reduce their cost base without
compromising customer service.
To put the advantage of low-wage economies into perspective, the hourly cost of labour in India and China is around 5% of the cost of equivalent labour hours in economies like the UK and Germany. A business that has a labour-intensive production process is bound to be attracted by the potential cost savings – particularly if the business has to handle
competitors based in those low-wage economies.
A decision to operate overseas raises several more issues for a business:
Issue Key Points
Exchange rates Operating in another country almost certainly exposes a business to the effects of fluctuating exchange rates. The impact of exchange rates on business is covered in detail in BUSS4.
Trade barriers The extent of protectionism varies around the world, but locating a business to avoid trade barriers is certainly important for businesses looking to compete effectively. Common types of trade barrier include quotas, tariffs on imported goods and government subsidies for domestic industries.
The European Union is an example of a free trade area, where there are no trade barriers for countries within the EU. However, the EU itself erects trade barriers against countries outside the EU – which is a common reason why firms choose to set up locations inside the EU Political stability Most developed economies enjoy relative political stability – i.e.
there are no sudden or dramatic changes in the political landscape which impact on businesses. Other territories are less predictable. A possible danger of location in less stable political environments is that short-term changes to legislation can directly affect the viability of an overseas operation.
Operating overseas using offshoring
The first point to remember about “offshoring” is that it is not the same as outsourcing!
Here is a simple way to remember the difference between these two similar terms:
Looking at these two definitions, it is possible to illustrate some different options for a business looking to change its operations:
Operations Decision Offshoring? Outsourcing?
A UK business sets up its own call-centre in Bangalore (India) to serve UK customers
Yes No
A toy manufacturer contracts with overseas suppliers to produce certain components which it imports into the UK
Yes Yes
A UK-based firm hands over its payroll and IT transaction processing activities to a specialist supplier in the UK
No Yes
A UK supermarket retailer opens its first stores in the USA managed by a team based in the USA
Yes No
The fundamental advantage of offshoring is the potential gains for competitiveness:
• Access to lower unit costs
• Access to more specialised suppliers and services
• Economies of scale from operating in larger international markets
However, the decision to take operations offshore should not be taken lightly. There are many examples of businesses that have undertaken offshoring and experienced problems relating to:
• Customer service: a combination of poor training, cultural differences and local management sometimes lead to worse customer satisfaction
• Higher than expected costs: low-wage economies like India and China might seem attractive, but there are many hidden costs associated with offshoring and some
firms find that lower productivity from the overseas location actually means higher unit costs
• Public and employee relations: a decision to “move jobs” from the UK to a low-wage economy is a sensitive one. Handled poorly, the damage to public and employee goodwill can be significant
• Protection of intellectual property: the legal protections for business information, processes and brands are not as strong in many countries as they are in the UK. A risk of offshoring is that intellectual property (know-how, trade secrets) is lost and that a potentially stronger future competitor is born.
