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Managerical Economics


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1.The guiding principles in the search for a location should be for a place where the cost of the raw materials and of fabrication, plus the cost of the marketing of the finished product will be minimum". Elaborate.
What is plant location?

Plant location refers to the choice of region and the selection of a particular site for setting up a business or factory.
But the choice is made only after considering cost and benefits of different alternative sites. It is a strategic decision that cannot be changed once taken. If at all changed only at considerable loss, the location should be selected as per its own requirements and circumstances. Each individual plant is a case in itself.

COMPANY should try to make an attempt for optimum or ideal location.
What is an ideal location?

An ideal location is one where the cost of the product is kept to minimum, with a large market share, the least risk and the maximum social gain. It is the place of maximum net advantage or which gives lowest unit cost of production and distribution. For achieving this objective, small-scale entrepreneur can make use of locational analysis for this purpose.

Locational analysis is a dynamic process where entrepreneur analyses and compares the appropriateness or otherwise of alternative sites with the aim of selecting the best site for a given enterprise. It consists the following:
(a) Demographic Analysis: It involves study of population in the area in terms of total population (in no.), age composition, per capita income, educational level, occupational structure etc.
(b) Trade Area Analysis: It is an analysis of the geographic area that provides continued clientele to the firm. He would also see the feasibility of accessing the trade area from alternative sites.
(c) Competitive Analysis: It helps to judge the nature, location, size and quality of competition in a given trade area.
(d) Traffic analysis: To have a rough idea about the number of potential customers passing by the proposed site during the working hours of the shop, the traffic analysis aims at judging the alternative sites in terms of pedestrian and vehicular traffic passing a site.
(e) Site economics: Alternative sites are evaluated in terms of establishment costs and operational costs under this. Costs of establishment is basically cost incurred for permanent physical facilities but operational costs are incurred for running business on day to day basis, they are also called as running costs.

Two sites A and B are evaluated in terms of above mentioned two costs as follows: Table 7.1: Comparative Costs of Alternative Locations
Costs Site A (Rs.) -------Site B (Rs.)
Cost of establishments:
Land and Buildings 350000 -----230000
Equipment 60000 -------60000
Transport facilities 20000------- 30000

Cost of operations:
Materials, freight and carriage 34000---- 24000
Taxes and insurance 10000----- 7500
Labour 100000---- 70000
Water, power and fuel 10000------ 8000
Total 584000---------- 429500
The above cost statement indicates that site B is preferable to site A keeping in mind economic considerations only although in some respects site A has lower costs. By applying the definition of ideal location which is the place of maximum net advantage or which gives lowest unit cost of production and distribution, site
B would be preferred.

The important considerations for selecting a suitable location are given as follows:
a) Natural or climatic conditions.
b) Availability and nearness to the sources of raw material.
c) Transport costs-in obtaining raw material and also distribution or marketing finished products to the ultimate users.
d) Access to market: small businesses in retail or wholesale or services should be located within the vicinity of densely populated areas.
e) Availability of Infrastructural facilities such as developed industrial sheds or sites, link roads, nearness to railway stations, airports or sea ports, availability of electricity, water, public utilities, civil amenities and means of communication are important, especially for small scale businesses.
f) Availability of skilled and non-skilled labour and technically qualified and trained managers.
g) Banking and financial institutions are located nearby.
h) Locations with links: to develop industrial areas or business centers result in savings and cost reductions in transport overheads, miscellaneous expenses.
i) Strategic considerations of safety and security should be given due importance.
j) Government influences: Both positive and negative incentives to motivate an entrepreneur to choose a particular location are made available. Positive includes cheap overhead facilities like electricity, banking transport, tax relief, subsidies and liberalization. Negative incentives are in form of restrictions for setting up industries in urban areas for reasons of pollution control and decentralization of industries.
k) Residence of small business entrepreneurs want to set up nearby their homelands

One study of locational considerations from small-scale units revealed that the native place or homelands of the entrepreneur was the most important factor.
Heavy preference to homeland suggests that small-scale enterprise is not freely mobile. Low preference for Government incentives suggests that concessions and incentives cannot compensate for poor infrastructure.
Table given below also suggests that the locational choice undergo change with differences in the levels of development across the regions (hills and plains).

Factors Affecting Location Decision
Entrepreneur’s DECISION
BETWEEN Hills –Plains--TOTAL
Total Considerations
--------------No. % --No. % --No. %
Homeland 15 67 --11 39--- 26 52
Incentives 3 14----- 1 4 ------4 8
Availability of
Raw material 0 0---- 1 4------ 1 2
Availability of
Labour 2 9----- 0 0------ 2 4
Availability of
Market 0 0 ------5 18 ----5 10
Availability of infrastructure Facilities 1 5 -------9 32 ----10 20
Others 1 5 -------1 4 --------2 4
Total 22 100 ---28 100 ---50 100

From the discussion above, we have already learnt that location of a plant is an important entrepreneurial decision because it influences the cost of production and distribution to a great extent. In some cases, you will find that location may contribute to even 10% of cost of manufacturing and marketing. Therefore, an appropriate location is essential to the efficient and economical working of a plant.
A firm may fail due to bad location or its growth and efficiency may be restricted.

LOCATION Why do firms locate where they do? There is no single answer—different firms choose their locations for different reasons. Key determinates of a location decision are a firm's factors of production. For example, a firm that spends a large portion of total costs on unskilled labor will be drawn to locations where labor is relatively inexpensive. A firm with large energy demands will give more weight to locations where energy is relatively inexpensive. In general, firms choose locations they believe will allow them to maximize net revenues: if demand for goods and services is held roughly constant, then revenue maximization is approximated by cost minimization. The typical categories that describe a firm's production function are: • Labor. Labor is often and increasingly the most important factor of production. Other things equal, firms want productivity, in other words, labor output per dollar. Productivity can decrease if certain types of labor are in short supply, which increases the costs by requiring either more pay to acquire the labor that is available, the recruiting of labor from other areas, or the use of the less productive labor that is available locally. • Land. Demand for land depends on the type of firm. Manufacturing firms need more space and tend to prefer suburban locations where land is relatively less expensive and less difficult to develop. Warehousing and distribution firms need to locate close to interstate highways. • Local Infrastructure. An important role of government is to increase economic capacity by improving quality and efficiency of infrastructure and facilities, such as roads, bridges, water and sewer systems, airport and cargo facilities, energy systems, and telecommunications. • Access to Markets. Though part of infrastructure, transportation merits special attention. Firms need to move their product, either goods or services, to the market, and they rely on access to different modes of transportation to do this. While transportation has become relatively inexpensive compared to other inputs, and transportation costs have become a less important location factor, access to transportation is still critical. That long-run trend, however, could shift because of decreasing funds to highway construction, increasing congestion, and increasing energy prices. • Materials. Firms producing goods, and even firms producing services, need various materials to develop products that they can sell. Some firms need natural resources: a manufacturing sector like lumber needs trees. Or, farther down the line, firms may need intermediate materials: for example, dimensioned lumber. • Entrepreneurship. This input to production may be thought of as good management, or even more broadly as a spirit of innovation, optimism, and ambition that distinguishes one firm from another even though most of their other factor inputs may be quite similar. The supply, cost, and quality of any of these factors obviously depend on market factors: on conditions of supply and demand locally, nationally, and even globally. But they also depend on public policy. In general, public policy can affect them through: • Regulation. Regulations protect the health and safety of a community, and help maintain the quality of life. However, simplified bureaucracies and straightforward regulations can help firms react quickly in a competitive marketplace. • Taxes. Firms tend to seek locations where they can optimize their after-tax profits. But tax rates are not a primary location factor, they matter only after corporations have made decisions on labor, transportation, raw materials, and capital costs. Within a region, production factors are likely to be similar, so differences in tax levels across communities are more important in the location decision than are differences in tax levels between regions. • Financial incentives. Governments offer firms incentives to encourage growth. Generally, economic research has shown that most types of incentives have had little significant effect on firm location between regions. However, for manufacturing industries with significant equipment costs, property or investment tax credit or abatement incentives can play a significant role in location decisions. Incentives are more effective at redirecting growth within a region than they are at providing a competitive advantage between regions. Firms locate in a city because of the presence of factors other than direct factors of production. These indirect factors include agglomerative economies, also known industry clusters, location amenities, and innovative capacity. • Industry Clusters. Firms tend to locate in areas where there is already a concentration of firms like their own. The theory works in practice because firms realize operational savings and have access to a large pool of skilled labor when they congregate in a single location. • Quality of Life. A region that features many quality amenities, such as good weather, recreational opportunities, culture, low crime, good schools, and a clean environment attracts people simply because it is a nice place to be. A region's quality of life attracts skilled workers, and if the amenities lure enough potential workers to the region, the excess labor supply pushes their wages down so that firms can find skilled labor for a relatively low cost. • Innovative capacity. Increasing evidence suggests that a culture promoting innovation, creativity, flexibility, and adaptability will be essential to keeping MANY cities economically vital and internationally competitive. Innovation is particularly important in industries that require an educated workforce. High-tech companies need to have access to new ideas typically associated with a university or research institute. Government can be a key part of a community's innovative culture, through the provision of services and regulation of development and business activities that are responsive to the changing needs of business. =================================================== THE OTHER FACTORS ARE ---INCLUDING ECONOMIC [ E ] / NON ECONOMIC [ NE ] FACTORS 1.SHIPPING / TRANSPORTATION COSTS. [E] 2.LAND AVAILABLE FOR EXPANSION.[E] 3.PROXMITY OF SUPPLIERS [E] 4.ACCESS TO MARKETS [E] 5.AREA IDENTIFIED WITH YOUR INDUSTRY.[NE] 6.SUPPLY OF TRAINED LABOR [E] 7.FAVOURABLE WAGE RATES [E] 8.PRESERVATION OF THE ENVIRONMENT [] 9.OPPORTUNITY TO EMPLOY MINORITY GROUP 10.PERSONAL PREFERENCES OF TOP MANAGEMENT 11.TAX ADVANATGES [ E ] 12.AVAILABLE FACILITIES AT LOW INITIAL COST [E ] 13.LOCAL CRIME RATE ] 14.UNION ACTIVITY [NE ] 15.COMMUNITY'S ATTITUDE TOWARDS
Strategic DECISIONS--location plays a critical part.
• Strategic network optimization, including the number, location, and size of warehouses, distribution centers and facilities.
• Strategic partnership with suppliers, distributors, and customers, creating communication channels for critical information and operational improvements such as cross docking, direct shipping, and third-party logistics.
• Product design coordination, so that new and existing products can be optimally integrated into the supply chain, load management
• Information Technology infrastructure, to support supply chain operations.
• Where-to-make and what-to-make-or-buy decisions
• Aligning overall organizational strategy with supply strategy.

Tactical DECISIONS ---location plays a vital part.
• Sourcing contracts and other purchasing decisions.
• Production decisions, including contracting, , scheduling, and planning process definition.
• Inventory decisions, including quantity, location, and quality of inventory.
• Transportation strategy, including frequency, routes, and contracting.
• Benchmarking of all operations against competitors and implementation of best practices throughout the enterprise.
• Milestone payments
• Focus on customer demand.

] Operational DECISIONS --location plays an important part.
• Daily production and distribution planning, including all nodes in the supply chain.
• Production scheduling for each manufacturing facility in the supply chain (minute by minute).
• Demand planning and forecasting, coordinating the demand forecast of all customers and sharing the forecast with all suppliers.
• Sourcing planning, including current inventory and forecast demand, in collaboration with all suppliers.
• Inbound operations, including transportation from suppliers and receiving inventory.
• Production operations, including the consumption of materials and flow of finished goods.
• Outbound operations, including all fulfillment activities and transportation to customers.
• Order promising, accounting for all constraints in the supply chain, including all suppliers, manufacturing facilities, distribution centers, and other customers...

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