5.4 Location

Full video class on YouTube, summary and notes on Instagram, class extracts on TikTok, text below. Have fun!

The main point of this class is to distinguish between outsourcing/subcontracting, offshoring, insourcing, reshoring.

Location is a particular place or position of an organisation. Since we’re currently in Unit 5, we will be focusing on location of production facilities (e.g. factory, production line, assembly line, etc.). For starters, let’s go through some essential concepts that’ll help us understand the importance of location decisions in business management: footloose industries, bulk-increasing industries and bulk-reducing industries.

Footloose industries are industries that can be located anywhere without effects from factors of production. Simply speaking, all organisations that don’t really care where to locate are in footloose industries. For example, for Alibaba or Google it does not really matter how closely they are located to customers or suppliers because they operate online and location is not very important.

Bulk-increasing industries prefer locating near customers in order to reduce transportation costs. That is because the final output weighs more than raw materials, so it is important to be closer to customers. An example of a bulk-increasing industry could be beverage production.

Bulk-reducing industries prefer locating near suppliers of raw materials in order to reduce transportation costs. That is because the final output weighs less than raw materials, so it is important to be close to suppliers of raw materials. Examples of a bulk-reducing industries are steelmaking and meat packing.

Sometimes, in literature, bulk-increasing industries are called weight-gaining industries and bulk-reducing industries are called weigh-losing industries.

Now let’s see what might be some of the reasons for a specific location of production. Keep in mind that there may be plenty of reasons and they are situational, meaning that reasons for location decisions depend on different circumstances and are unique in different situations. However, I will suggest some of what I think are the most common reasons and factors that impact the choice of specific location of production.

Nature of the industry. As we learnt in the previous paragraphs, organisations may be in bulk-increasing, bulk-reducing or footloose industries. Depending on the industry organisation is in, location decision will differ: either organisation will choose to locate closer to customers, or closer to suppliers, or location might not matter at all.

Costs. Some of the costs that determine where to locate production are transportation costs, costs of labour, costs of raw materials. All organisations definitely consider all the relevant costs while making a location decision.

Infrastructure. Infrastructure refers to a combination of systems and facilities that operate in a specific location. It usually includes transportation networks (roads, highways, rail transit, public transport, etc) and telecommunication networks (internet, research, employment, tourism, etc). Some locations have developed infrastructure, which means swift and convenient delivery and reliable networks. Some locations have less developed infrastructure, which means that delivery and transportation times might be an issue. Regardless, infrastructure is definitely something that organisations take into consideration when they are selecting a specific location for production.

Government incentives. Different governments offer different degrees of support to businesses. One common way of doing so is by organising enterprise zones — areas that offer tax concessions and/or reduced regulations to businesses that locate in those areas. This, of course, might be one of the reasons for location. For example, there are several enterprise zones in Shanghai and other cities in China. It makes it easier for foreign businesses to locate in China through enterprise zones and at the same time it attracts foreign investment into China.

Regional specialisation. It refers to a concentration of a certain area on one or several industries. For example, many organisations in Suzhou (an ancient city in China) have been for centuries specialising in silk manufacturing. Even though they are competing with each other and fighting for customers, there is a benefit for them to locate in one place: they might split some of the costs and they may attract more customers, since the region is so famous for its specialisation. This is clearly an important factor in location decisions.

External economies of scale. Regional specialisation (above) is actually one of the examples of external economies of scale (EOS). Additionally, there might be other kinds of EOS. Please review this class to see what they are.

STEEPLE factors. STEEPLE analysis is a business tool from the Toolkit that examines external environment in terms of 7 factors: social, technological, economic, environmental, political, legal and ethical. All of these factors matter in making location decisions. Let’s take political stability as an example. A more politically stable location implies less risk. Politically unstable locations might result in having to deal with extra threats.

Those were some of the reasons for location of production. The list can be prolonged almost infinitely. Additionally, reasons may be divided into qualitative and quantitative, internal and external, opportunities and threats, or any other category that makes it convenient for organisations to make a location decision. Some of the decision-making tools that might assist in making location decisions are SWOT, STEEPLE, Force Field Analysis, Business Plan and Decision Tree.

Before we learn the ways of reorganising production, please copy the table below and fill it in as you read.

Outsourcing (subcontracting) refers to transferring some of the operations to another organisation. This way, organisations can outsource some of the non-core activities and focus on core activities only. Catering, audit, recruitment, call centres, security and advertising are some of the most common outsourced/subcontracted activities. For example, if organisation XYZ has no expertise in creating attractive ads, they might hire advertising agency ABC as a subcontractor to do it for them.

On the one hand, subcontractors might not only be reliable professionals who are good at whatever they are doing, but they might also offer competitive prices for their work, helping organisations to cut costs. Besides, outsourcing is a great opportunity to focus on core activities. For example, imagine your school has to arrange security itself. Your school specialises in providing education to high school students, so putting security cameras and hiring experienced guards is not something school is good at and wants to deal with. So, in order to focus on education (the school’s core activity), they might just outsource it to a security agency.

On the other hand, subcontracting means having to rely on subcontractors. If they are not reliable or professional enough, it might be threat to the brand value. Watch the video below to see how Foxconn (a factory in China that assembles iPhones) is treating its employees and think about how it might affect Apple’s brand value.

The picture below illustrates how outsourcing/subcontracting works.

Insourcing means bringing outsourced operations back. We might say that insourcing is “backwards” outsourcing. If we use the previous example, when XYZ outsourced advertising to ABC, then firing ABC advertising agency in favour of internal marketing department of XYZ would be an example of insourcing, i.e. taking some of the subcontracted activities back.

On the one hand, insourcing allows organisations to retain full control over operations: no need to rely on subcontractors, everything is under control. On the other hand, organisations clearly have to deal with new tasks if they insource some of the activities.

Offshoring is transferring some of the operations abroad. Offshoring does not necessarily involve outsourcing to another organisation! If it is a combination of offshoring (moving some of the operations abroad) and outsourcing (subcontracting some of the operations to another organisation), then it is called offshore outsourcing. Some examples of offshoring and offshore outsourcing are manufacturing of goods in China or call centres of multinational companies in India.

Outsourcing + Offshoring = Offshore outsourcing

On the one hand, offshoring might result in cost reduction, especially if labour costs in another country are lower than in the home country. Additionally, multinational companies might avoid protectionism if they locate some their operations in markets they exported their products to. On the other hand, exchange rates might not always be in favour of the organisation and cultural differences might hinder communication.

The video below from The IT Crowd (one of my favourite TV shows) illustrates in an amusing way some of the communication barriers that customers have to deal with when organisations offshore their call centres.

Reshoring refers to bringing offshored operations back to the home country. We might say that reshoring is “backwards offshoring”. Keep in mind that reshoring does not necessarily involve insourcing! One of the examples of factors that impact reshoring decisions is rising labour costs in China, that force many businesses to relocate their production.

One thing you have to know about is industrial inertia. This happens when alluring factors of a certain location are gone but operations are run there anyway. For example, even though labour costs in China have risen and are no longer an alluring factor for locating production in China, many organisations still keep their production there, simply because relocation is too troublesome and costly, hence industrial inertia.

On the one hand, reshoring might enhance the brand image of an organisation because provision of employment opportunities in the home country might be perceived well by stakeholders. However, similar to insourcing, bringing some of the activities back means having to deal with new tasks.

Make sure you can define all of these:

1. Location
2. Footloose industries
3. Bulk-increasing industries
4. Bulk-reducing industries
5. Infrastructure
6. Enterprise zones
7. Regional specialisation
8. Outsourcing/subcontracting
9. Insourcing
10. Offshoring
11. Offshore outsourcing
12. Reshoring
13. Industrial inertia