Two product features affect location decisions. The first is the product’s value-to-weight ratio because of its influence on transportation costs. Many electronic components and pharmaceuticals have high value-to-weight ratios; they are expensive and they do not weigh very much. Thus, even if they are shipped halfway around the world, their transportation costs account for a very small percentage of total costs. Given this, other things being equal, there is great pressure to produce these products in the optimal location and to serve the world market from there. The opposite holds for products with low value-to-weight ratios. Refined sugar, certain bulk chemicals, paint, and petroleum products all have low value-to-weight ratios; they are relatively inexpensive products that weigh a lot. Accordingly, when they are shipped long distances, transportation costs account for a large percentage of total costs. Thus, other things being equal, there is great pressure to make these products in multiple locations close to major markets to reduce transportation costs.
The other product feature that can influence location decisions is whether the product serves universal needs, needs that are the same all over the world. Examples include many industrial products (e.g., industrial electronics, steel, bulk chemicals) and modern consumer products (e.g., handheld calculators, personal computers, video game consoles). Because there are few national differences in consumer taste and preference for such products, the need for local responsiveness is reduced. This increases the attractiveness of concentrating production at an optimal location.
LOCATING PRODUCTION FACILITIES
There are two basic strategies for locating production facilities: concentrating them in a centralized location and serving the world market from there, or decentralizing them in various regional or national locations that are close to major markets. The appropriate strategic choice is determined by the various country-specific, technological, and product factors discussed in this section and summarized in Table 15.1.
TABLE 15.1 Location Strategy and Production
Concentrated Production Favored
Decentralized Production Favored
Differences in political economy
Differences in culture
Differences in factor costs
Important in industry
Not important in industry
Minimum efficient scale
Flexible manufacturing technology
Serves universal needs
As can be seen, concentration of production makes most sense when:
• Differences among countries in factor costs, political economy, and culture have a substantial impact on the costs of manufacturing in various countries.
• Trade barriers are low.
• Externalities arising from the concentration of like enterprises favor certain locations.
• Important exchange rates are expected to remain relatively stable.
• The production technology has high fixed costs and high minimum efficient scale relative to global demand, or flexible manufacturing technology exists.
• The product’s value-to-weight ratio is high.
• The product serves universal needs.
Alternatively, decentralization of production is appropriate when:
• Differences among countries in factor costs, political economy, and culture do not have a substantial impact on the costs of manufacturing in various countries.
• Trade barriers are high.
• Location externalities are not important.
• Volatility in important exchange rates is expected.
• The production technology has low fixed costs and low minimum efficient scale, and flexible manufacturing technology is not available.
• The product’s value-to-weight ratio is low.
• The product does not serve universal needs (i.e., significant differences in consumer tastes and preferences exist among nations).
In practice, location decisions are seldom clear-cut. For example, it is not unusual for differences in factor costs, technological factors, and product factors to point toward concentrated production while a combination of trade barriers and volatile exchange rates points toward decentralized production. This seems to be the case in the world automobile industry. Although the availability of flexible manufacturing and cars’ relatively high value-to-weight ratios suggest concentrated manufacturing, the combination of formal and informal trade barriers and the uncertainties of the world’s current floating exchange rate regime (see Chapter 10) have inhibited firms’ ability to pursue this strategy. For these reasons, several automobile companies have established “top-to-bottom” manufacturing operations in three major regional markets: Asia, North America, and western Europe.
ANOTHER PERSPECTIVE Nestlé Goes on Investing in Turkey
According to Nestlé Turkey’s CEO, Mr Hans Ulrich Mayer, Turkey has been a great place to invest—“Turkey has been the recipient of several Nestlé investments many times greater than we invest in other markets” reported Mayer. Nestlé has invested about 500 million USD in Turkey over the last 4 years and following its successful breakfast cereal investment in March 2011 intends to go on investing because of the strong Turkish economy compared to other European economies. Nestlé products sold in Turkey, ranging from pet food to chocolates, are manufactured in Turkey and also exported to North Africa and the Middle East.
Source: Invest in Turkey, www.spotblue.co.uk/turkey-property-news/11577/nestle-goes-on-investing-in-turkey/.
THE HIDDEN COSTS OF FOREIGN LOCATIONS
There may be some “hidden costs” to basing production in a foreign location. Numerous anecdotes suggest that high employee turnover, shoddy workmanship, poor product quality, and low productivity are significant issues in some outsourcing locations.17 Microsoft, for example, established a major facility in Hyderabad, India, for four very good reasons: (1) The wage rate of software programmers in India is one-third of that in the United States. (2) India has an excellent higher education system that graduates a lot of computer science majors every year. (3) There was already a high concentration of information technology companies and workers in Hyderabad. (4) Many of Microsoft’s highly skilled Indian employees, after spending years in the United States, wanted to return home, and Microsoft saw the Hyderabad facility as a way of holding on to this valuable human capital.
However, the company has found that the turnover rate among its Indian employees is higher than in the United States. Demand for software programmers in India is high, and many employees are prone to switch jobs to get better pay. Although Microsoft has tried to limit turnover by offering good benefits and long-term incentive pay, such as stock grants to high performers who stay with the company, many of the Indians who were hired locally apparently place little value on long-term incentives and prefer higher current pay. High employee turnover, of course, has a negative impact on productivity. One Microsoft manager in India noted that 40 percent of his core team had left within the past 12 months, making it very difficult to stay on track with development projects.18
Microsoft is not alone in experiencing this problem. The manager of an electronics company that outsourced the manufacture of wireless headsets to China noted that after four years of frustrations with late deliveries and poor quality, his company decided to move production back to the United States. In his words: “On the face of it, labor costs seemed so much lower in China that the decision to move production there was a very easy one. In retrospect, I wish we had looked much closer at productivity and workmanship. We have actually lost market share because of this decision.”19 The lesson here is that it is important to look beyond pay rates and make judgments about employee productivity before deciding whether to outsource activities to foreign locations.
• QUICK STUDY
1. Outline the main country factors that influence the location of production.
2. What technological factors influence the location of production?
3. How do product factors influence the location of production?
4. What are the possible hidden costs of locating production in a foreign nation?