BS1 2 Producing Goods and Services
BS1 2 Producing Goods and Services
BS1 2 Producing Goods and Services
• Franchising
• Optimisation of location.
DUTTSONROCKS
Six months in the Royal Marines followed by six years as a DJ is perhaps
not the most obvious route to starting up a business selling diamonds.
Neil Duttson left school with no qualifications and at 26 he realised that
his life was going nowhere. It was at this point he started thinking about
diamonds. “I had always had a passion for diamonds. When I was 18, I
bought a book on gemmology,” said Duttson. He searched the internet
and found a school in Antwerp that ran a six month course. He mortgaged
his flat and took out £50 000 equity to pay for the course and support
himself while doing it. He said: “I loved it. At the weekends I travelled
around Europe going into jewellery shops pretending I was getting
engaged”. Armed with his new-found knowledge, Duttson set himself up
as a diamond jeweller. Duttson’s first clients were friends who were
getting engaged. Without funds to buy stock, he adopted the innovative
approach of showing potential customers a selection of fakes in every
single cut and shape of diamond, and only when they had chosen and
paid a deposit, would he buy the real diamond. The diamond was then
passed on to a jeweller to be made into a ring. Neil Duttson was
successful and in 2002 he formed Duttson Rocks Ltd.
Adapted from the Sunday Times, 2
September 2007
EXAM QUESTIONS
We are constantly being reminded that we are an ageing population and
the Government is introducing legislation allowing people to remain in
their jobs beyond the age of 65 in order that they can maintain a decent
standard of living. This change in the pattern of employment is well
illustrated by Asda, the supermarket chain, which recently announced
plans to take on 3,300 over fifties for the festive period. This followed an
initiative earlier in the year called the ‘Goldies’ campaign to boost the
number of over fifties working in its stores by 20%. [BS3 June 2003; 1a]
EXAM QUESTIONS
Foot-and-Mouth returns to the UK in 2007
British farmers were horrified to hear the news that yet another case of
foot-and-mouth disease had been discovered on a farm in Surrey, just
when it was hoped that the outbreak on a farm some 30 miles away in
August was an isolated case. The European Commission has banned
British meat exports and this will place some farmers in severe financial
difficulties. This is yet another blow to workers in the UK’s primary
sector where the number of workers employed continues to decline.
Adapted Daily Telegraph, 13
September, 2007
(a) What is the primary sector? [3]
(b) Explain why the number of workers employed in the
UK’s primary sector continues to decline. [6]
Physical Resources
Whatever the product or service provided by firms, they will all need some
combination of all four factors of production to be produced. The actual
mix will depend on the product or service, for example the key factor for
an oil well is land, but without the other 3 factors no oil will be produced.
For a bank, capital is the most important factor, and for a football team
labour - but again without the other factors there is can be no Barclays
Bank, no BP or Tesco and there is no Manchester United.
The four factors of production are:
Land
Labour
Capital
Enterprise
Of these the Physical resources are Land and Capital.
Land
Raw Materials
From land we can extract raw materials. Raw Materials are the inputs from which manufactured
goods are produced. Oil, iron ore, and coal are examples of raw materials. Access to raw
materials is currently a major concern especially for rapidly developing economies such as China
and India. As a result the price of raw materials has been increasing over the last few years as
demand has boomed.
Capital
Capital means money invested into a business. But be-cause the money
invested does not just sit in a bank, but is turned into productive goods
that are used within the business, a businesses capital can include,
machinery, buildings, vans, computers etc., as well as cash.
It is important for businesses to turn money capital into
physical capital that produces a profitable return for the business. So firms
purchase with money capital producer goods such as equipment, machinery
and vehicles that can be efficiently used within the business. Capital
intensive firms rely on invested capital the produce the greatest part of value
added. Management of physical resources is a complex part of large firms.
Capital has to produce targeted rates of return, oil fields and mines are
expected to achieve set levels of output, and equipment must be quickly and
effectively integrated into the production process.
Labour
Labour is perhaps the most important resource in any developed country.
Labour includes the skills of those who work, as well as the quantity of people
who work or who are available for work. In the UK there are labour shortages,
often for skilled jobs, but also for manual workers in areas where the cost of
living is high. For more information on Labour as a resource, read the notes
on ‘Human Resources’.
Enterprise
Enterprise is the ability to combine the other factors of production, and then
to use them to provide profitably, goods or services. Your local plumber will
be an entrepreneur, and so are Richard Branson the founder of Virgin Group,
and Alan Sugar, famous for the Apprentice programme. For more on the
importance of entrepreneurs see notes on ‘Functions of the entrepreneur’.
Financial Resources
Businesses can use a wide range of sources of funds to help finance their
expansion plans and their trading activities. Not all of them take the form
of cash, some take the form of assets that the business can use, which
then releases cash for other uses.
Shareholders' Capital
Shareholders are of course the owners of a Limited Company, they invest
money in the hope of capital growth, (that is the business makes profits,
grows, makes more profits, so as the business becomes bigger their
investment will be worth more), and Dividend (the shareholders share of
the companies profits).
Ordinary Shares
The holder of an ordinary share has a share in the ownership of a limited
(or joint stock) company. Ordinary share holders will expect to receive an
annual dividend (their share of the profits), but this is in no way
guaranteed. Payment of dividend depends upon the performance of the
company, and the dividend policy adopted by the company.
Preference Shares
These will pay a fixed annual amount to the holder, again known as a
dividend. Preference share holders will receive their dividends from
profits, or reserves, before the dividend to ordinary shareholders is paid.
This means that preference shares are less of a risk that ordinary shares,
but the payment of dividend, or return of capital is not guaranteed.
Debentures
These are a form of loan stock. The holder of a Debenture has made a
secured loan to the business, and these Debentures will have a fixed
redemption date (the time the loan must be repaid). Debentures are more
secure than ordinary shares or preference shares, but again if the
business fails there is no guarantee of repayment of capital. But
Debenture holders do get their 'bite of the cherry' before ordinary and
preference share holders. From the businesses point of view Debentures
are an effective way of raising capital because the Debenture holders
have no say in how the company is run. This means that the issue of
Debentures does not dilute control; the directors still run the business.
An overdraft
An overdraft is a form of bank loan. A business becomes overdrawn when
it withdraws more money out of its cheque account than there is in it, this
leaves a negative balance on the account. This is often a cheap way of
borrowing money, as once an overdraft is agreed with the bank, the
business can use as much of the overdraft as it needs at any time, up to
the agreed overdraft limit. But the bank will of course charge interest on
the amount overdrawn, and will only allow an overdraft if they believe the
business is credit worthy i.e. is very likely to pay the money back. A bank
can demand the repayment of an overdraft at any time. Many businesses
have been forced to cease trading because of the withdrawal of overdraft
facilities by a bank. Even so for short term borrowing an overdraft is often
the ideal solution, and many businesses often have a rolling (on going)
overdraft agreement with the bank. This then is often the best solution for
overcoming short term cash flow problems, e.g. funding purchase of raw
materials, whilst waiting for payment on goods produced and sold.
Bank Loan
This is lending by a bank to a business. A fixed amount is lent e.g.
£10,000 for a fixed period of time, e.g. 3 years. The bank will charge
interest on this, and the interest plus part of the capital, (the amount
borrowed), will have to be paid back each month. Again the bank will only
lend if the business is credit worthy, and it may require security. If
security is required, this means the loan is secured against an asset of the
borrower, e.g. his house if a sole trader, or an asset of the business. If the
loan is not repaid, then the bank can take possession of the asset and sell
the asset to get its money back!
Loans are normally made for capital investment, and if a loan is obtained
then this frees up other capital held by the business, which can then be
used for other purposes.
Leasing
With leasing, a business has the use of an asset, pays a monthly fee for its
use and will never own it. If a sole trader set up business as a parcel
delivery service, he could lease the van he needs from a leasing company.
He will have to pay a monthly leasing fee, say £250, which is very useful if
he does not wish to spend £10,000 on buying a van. This will free up
capital, which can now be used for other purposes.
A business looking to purchase equipment may decide to lease if it wishes
to improve its immediate cash flow. In the example above, if the van had
been purchased, the flow of cash out of the business would have been
£10,000, but by leasing the flow out of the business over the first year
would be £3,000, leaving a possible £7,000 for other assets and
investment in the business. Leasing also allows equipment to be updated
on a regular basis, but in the long run, it does cost more than outright
purchase.
Hire Purchase
This is similar to leasing, but at the end of the hire period the asset
belongs to the company that hires it.
Buying on Credit
This creates Creditors. If a business which sells shoes buys on credit from
Clarkes shoes, it may not have to pay Clarkes until 30 or 60 days after
delivery. This means it could sell the shoes at a profit, and have the
money at the end of the credit period, to pay its bill to Clarkes. Extending
a credit period will help solve short term finance problems. Extension of
credit could be achieved by delaying paying bills for an extra 14 days,
meaning there will be more cash in the bank for this period. Unfortunately
this type of action may upset businesses' suppliers; after all they have
their own cash flows to think of. The next time the business wanted credit
from a supplier that they had been very slow in paying in the past, they
may be turned down!
Slow payment by debtors is a problem for many businesses, and in fact
the government has tried to take action against this type of behaviour in
several budgets.
Selling Assets
A business can sell assets it owns to raise capital! This is often a last gasp
measure as assets are usually vitally necessary to business activity. In
some cases the business may lease back the asset, so that it still retains
its use. But this often the preserve of big business e.g. the sale and lease
back of office blocks.
Debtors
If a firm is in immediate need of cash it could chase its debtors for
repayment. This may involve giving discounts for early repayment.
Chasing debtors for early repayment may lead to long term loss of trade,
as the debtors may buy from another business next time, but it can be an
effective method of solving short-term finance problems.
Factoring
For larger firms, with a turnover (sales) of £100,000 or more a year, it is
possible to let a Factor manage your debts for you.
The factor (a type of finance company) will pay 80% of the value of an
invoice at the time of sale, and will take responsibility for receiving
payment from the debtor. The balance of the debt will be passed on when
the money is received by the factor. There is of course a charge for this
factoring service and the amount of charge will depend upon several
issues such as, number of debtors, size of debts, and past bad debt
history. But factoring does improve a business’s cash flow and it
popularity amongst small to medium size businesses, proves that many
managers and owners regard this service as good value for money.
Venture Capital
A venture capital company is a business that specialises in investing in
small to medium sized firms that are expected to grow quickly,. The
venture capital company will purchase a shareholding in the business –
providing needed funds, and will help manage the business. The venture
capitalist will expect to sell their share holding, at a profit, with 3 to 5
years. Venture capitalists can provide investment funds from £10,000 up
to £10’s of millions.
Retained Profit
At the end of the trading year a business will complete it’s Profit and Loss
Account. All of this profit earned can be taken by the owners, (this would
be a dividend in a Limited Company), or alternatively some or all of it
could be reinvested in the company, to help the business grow and
therefore make even more profit in the future. If a business needs to raise
finance it can increase the proportion of profit it retains within the
business, but this does mean that dividends paid will fall.
Stock management
Often finance problems arise because too much of a business’s capital is
tied up in working capital, such as raw materials, work-in-progress and
stock.
Many firms are now implementing practices such as just-in-time, and Kan
Ban, which are designed to reduce working capital levels and release
capital, which can then be used in more effective ways within the
business.
Manpower management
Examining and restructuring labour costs can reduce outflows of cash. Is it
necessary to have permanent contracts for all workers? Can some work
be sub-contracted, or can some work be transferred to temporarily
contracted workers? Restructuring Human Resources in this way can save
expenditure on pensions, National Insurance, holiday pay etc.
Improved Budgeting
Why base next years budgets on last year's budgets? Why not start with a
clean slate and opt for zero budgeting? Also budgets need to be managed
effectively, and variances analysed as they arise.
EXAM QUESTION
Expansion for CareBeds Ltd
Following a recent trip to research the hospital beds’ market in the USA,
Gareth Palmer, CareBeds Sales Director, had reported his findings to the
rest of the Board of Directors. He believed they should try and compete
for a share of the huge American market. To do so, he felt that the
company needed to expand by investing in a factory extension as well as
new machinery. Gareth had done some preliminary costing and
anticipated a cost of around £8 million to £10 million. Lucy Cartwright, the
Financial Director, felt it necessary to point out that both the US and UK
economies were facing difficulties and that interest rates were fairly high
at present. In addition, she pointed out that the business was
experiencing some bad debts at present and the working capital
situation was a matter of some concern. She felt the proposals needed
very careful consideration and asked for another meeting in two weeks’
time. By then, every member of the Board could have given some
consideration as to how such a significant investment might be financed.
(1) What is meant by the term ‘liabilities’ when used on a
balance
sheet? [1]
(5) Explain why net current assets (working capital) are such an
important figure on a company’s balance sheet. [4]
Job,
Batch
Continuous/flow production
Job Production
With Job Production single items, usually to the buyer’s specification are
made. Examples of goods made by Job Production are bridges, wedding
dresses, tailor made suits. Employees producing goods using job
production can be highly skilled, and there-fore paid well, and have
interesting a challenging jobs. Goods can take a long time to make
compared to goods made by mass production; prices are also likely to be
a great deal higher. Firms may use Job Production to differentiate their
products from the mass market, and allow them to target niches within
the market, or it may be the nature of the product that forces the firm to
apply Job Production methods.
Batch Production
With Batch Production goods are produced in sets (batches) and then
other using the same equipment and labour, batches of different goods
are made. An example of an industry us-ing batch production is baking,
where bakers will use ovens to make bread, and then use the same ovens
to make cakes, then savouries etc. Batch production is also used by
potters, and furniture manufactures. Cadbury apply Batch Production
techniques in their Birmingham factory. One type of bar is produced for 5
days, then the equipment is adjusted to produce an-other type of bar.
Employees are likely to be semi-skilled, and there can be a reliance on
capital investment. Batch production allows firms to aim at niche markets,
using the same assets or capital equipment to produce a range of goods.
But time is lost when ma-chines have to be reset for new production
(down time), and the firm may not be equipped to deal with large scale
orders.
EXAM QUESTION
Briefly explain:
(1) Why Sally Jean wants a BSI Kitemark? [2]
Increase in sales
This could be measured in units or value. A firm may increase sales from
50,000 to 55.000 sales or alternatively from £1,000,000 to £1,200.000.
This though may not be the best judge of growth as it ignores growth in
the market and the effects of inflation. To overcome some of these
problems of measurement firms may look at increases in like-for-like
sales.
Increase in profits
If profits increase this is normally a sign of growth, but alternatively could
be caused by a reduction in costs.
Organic growth also identifies whether managers have used their skills to
improve the business. Many firms show how well they have performed by
giving like-for-like comparisons, this represents an accurate measure of
organic growth for the firm.
For more detail on methods of achieving organic growth, it is worth
reading up on how the Ansoff Matrix gives firms a structure for using
existing customers and markets to achieve growth.
External Growth
Growth can also be achieved through external methods. This type of
growth is sometimes called inorganic growth and involves taking-over or
merging with another business. Growth through mergers or take-overs
can come in 4 varieties.
These are:
Horizontal Integration - occurs when a firm mergers with or takes
over another at the same stage in the production process. So Somerfield
merged with Kwik Save, Lloyds bank took over the TSB. Often the
objective is to benefit from economies of scale, and so reduce costs and
in-crease profits. Sometimes the word synergy is used in this type of
growth - synergy implies that the 2 firms together will, because of the way
they work, and the products they offer, be more profitable together than
apart. A good ex-ample of this synergy is the merger of Guinness Brewers,
and “Grand Met” the hotel chain to form Diageo.
Backward Vertical Integration - this is when a firm mergers with or
takes-over another at the previous stage in the production process. The
objective here might be to reduce costs or secure supplies. An example of
backward vertical integration would be Birdseye owning large farms,
Dunlop owning rubber plantations.
Forward Vertical Integration - when a firm mergers with or takes-
over another at the next stage in the production process. This will
guarantee outlets for products. Examples include Life Insurance
Companies taking over chains of Estate Agents, Oil Companies buying up
service stations.
Conglomerate - in this case there is little if any obvious relationships
between different parts of the business. A conglomerate may include
companies as diverse as concrete producers, hotels, and pharmaceutical
companies, all under the same overall ownership. Conglomerates can
arise simply because the directors see the chance of buying firms cheap,
or because they wish to enter entirely new market areas.
Money also needs to be raised to pay for growth (unless profits are
reinvested). Money can come from banks, shareholders, venture capital
companies. All these methods imply some loss of control, and perhaps
high borrowing costs, and increased risks. Also shareholders may receive
less in dividends if profits are used to pay for investment.
Mergers and Take-overs can bring fast growth, and can be especially
useful in achieving growth in new product or geographic markets. On the
other hand there have been plenty of examples in recent years where
incredible rates of growth have been achieved organically, for example,
Google, Face Book, Friends Re-united etc.
Franchising
Franchisee. Individual or firm who buys or leases the right to use the
brand name, products and trading style developed by the franchisor
The financial relationship between the franchisor and franchisee does not
end with the payment of the franchise fee. The franchisee will often be
required to buy supplies, raw materials, stock etc from the franchisor (the
seller of the franchise), pay annual fees, and may even have to pay a
share of his profits to the franchisor. The franchisor will also regularly
check on the performance of the franchisee to ensure that the brand is
not being de-valued in any way and that standards are being maintained.
So the franchisee is in somewhat of a straightjacket, paying a monopoly
supplier for stock, paying over to the franchisor a portion of his profits and
being regularly checked on. So with these restrictions, why is franchising
so popular? There are in fact, a number of advantages to the franchise
system for the franchisee, these include:
Use of an established brand name– this should help guarantee
customers.
Help in training and recruiting staff, and set-ting up business
systems
Nationwide marketing campaigns - from franchisors like McDonalds
and Body Shop.
Easier to sell a franchise, than an unbranded business.
There are nearly 800 franchising firms operating in the UK, covering
everything from accountancy, to pet care. Some are very similar to each
other, for example there are 4 franchisors whose business model is based
on lawn care, each claim-ing to be the leading lawn care specialist.
Fastest growing franchise chains include coffee shops such as Coffee
Republic, and community magazines.
Buying a franchise does not guarantee success, not all franchise formats
succeed, and not all people will be successful entrepreneurs, no matter
how much back-up they receive. But figures show that franchises are a
good way of starting up in business, and greatly reduce the risks of going
it alone. Before buying a franchise, the potential franchisee should
research the market carefully, and find out exactly what they are paying
for. Franchises can cost anything from a few thousand to £100,000 plus
and the potential franchisee should ask the question ‘would the cash
spent in buying the franchise, be better used by myself in setting up my
own business’?
EXAM QUESTION
(c) Briefly explain two problems that Bruce and Bryan may
face when operating as franchisors. [4]
BODY SHOP
Dame Anita Roddick, who died recently aged 64, was the energetic founder
and guiding spirit of The Body Shop, the international cosmetics and toiletries
empire built on a combination of soap, bubble bath and ethical conviction. In
countless ways, Roddick was an inspiration: she was a grafter, a risk taker,
and that rarest of creatures – a successful female entrepreneur who, from a
single shop in Brighton in 1976, presided over a franchise of 2,000 stores in
53 countries just 30 years later. All this was achieved with a bank loan of just
£4,000, which she was at first refused! However, returning to the bank with a
convincing business plan, she finally persuaded her bank manager to back
her. The key to The Body Shop’s success was the identification of its
products (e.g. Fuzzy Peach Shower Gel, Brazil Nut Conditioner, Raspberry
Shampoo) with the social and political preoccupations of the young women
who constituted its main customer base: such as animal welfare, the
protection of the Brazilian rain forest, Third World poverty and, of course, the
age-old pursuit of youth and beauty. Her husband, Gordon was considered by
many to be the financial and business brains behind the enterprise, while
Anita provided the passion, the activism, the ideas and the publicity.
Source: Adapted from The Guardian, 10 September,
2007
(a) (i) What is a franchise? [2]
(ii) Briefly explain two requirements of franchisees that you might expect
to find in a
Body Shop franchise agreement. [4]
(b) Explain the benefits to a business of taking out a franchise with The Body
Shop rather than operating independently. [6]
To understand this division between short and long run, we can look at a
simple example. Jenkins Carriers are a local delivery firm, they run 2 vans
both of which are leased, with 2 years to run. The leasing charges of £300
per month are fixed for the term of the lease. For the firm (assuming that
they have no other longer term commitments), the short run will be two
years, as part of their costs are fixed for this period of time. If at the end
of the two year period they are able to negotiate better leasing terms
because they have established the company as a good risk, or because
they now wish to lease 6 vans, they are benefiting from economies of
scale. Alternatively they may wish to buy the new vans or, if things have
not gone well, even withdraw from the business. The fixed costs, until
they commit themselves to a new agreement, become variable. Each
firms long run average cost curve is made up of a series of short run
average cost curves.
As a business grows it moves and from one short run average cost curve
to another short run average cost curve, each one being progressively
lower and so reducing average costs of output - e.g. cheaper leasing of
vans. This is represented in the graph below.
If we look at a second example we can see how average costs are reduced
in the short run. Imagine a building site with one foreman and one worker.
The workers role is digging trenches the foreman's role is to oversee the
digging of trenches. The foreman earns £10 an hour the workers wage is
£5 an hour. The worker is capable of digging 5 metres of trench in an
hour. With one worker each metre of trench would therefore cost £3, that
is the £5 wages of the worker and the £10 wages of the supervisor divided
by 5 meters dug, = £3 per metre.
If another worker was taken on then we would now have 10m of trench
per hour at a total cost of £20, therefore the cost per metre of the trench
is now £2. With three workers we now have 15 m of trench at a total cost
of £25 which gives is a cost of £1.66 per metre. We therefore see
decreasing average costs in the short run.
In the long run the building site could instead of using workers and spades
use a digger. This would allow a move on to a second average cost curve
and therefore lower potential average costs. This is how economies of
reduce average costs of production.
Internal and external economies of scale
We can break down economies of scale into two broad groups, these are Internal and External.
Purchasing
As firms grow, they increase the size of orders for raw materials or
components. This will then result in discounts being given, and the cost of
each individual component purchased will fall. This will therefore reduce
the average cost of production.
Technical
As businesses grow they are able to use the latest equipment and
incorporate new methods of production. This increases efficiency and
productivity, reducing average costs of output.
Financial
As firms grow they will have access to wider range of capital, such as
equity capital (share issues), this reduces the cost of borrowing for
investment. Also as the assets of the firm grow, businesses are able to
offer more security for borrowing, reducing the risk to the lender and
reducing the cost of borrowing.
Managerial
As businesses grow they are able to employ specialist managers. These
managers will know how to get the best value for each £ spent, whether it
is in production, marketing or purchasing. This will increase efficiency,
reduce the average costs of producing goods and selling the goods
produced.
Advertising
As firms grow each £ spent on advertising will have greater benefit for the
firm. Imagine a chain of local supermarkets; a TV advertisement is placed
to cover the region. If there were 10 stores in the chain, the cost of the
advert must be borne by each of the 10 stores, but if they have 20 stores,
then the cost of the advert would be spread across each of the 20 stores
and the benefit of the advert applies to each of the 20 stores.
External Economies of Scale
The largest firms often benefit from external economies of scale. These
include:
Diseconomies of scale
Firms can also suffer from diseconomies of scale. When diseconomies
occur, the average costs of production rise with output. Let's go back to
the example of the building site.
Maybe the foreman is capable of looking after 10 workers effectively and
ensuring that each digs 5m per hour, but if there were 15 workers
average output may start to fall. This happens because the supervisor
isn't able to supervise all the workers and ensure that each is working at
maximum capacity. Efficiency of production falls and there is increasing
average costs of output. We now have diseconomies of scale.
Like economies of scale, diseconomies can also be internal and external.
Traffic congestion
The firm grows, suppliers move in, the area becomes an industrial centre,
and the roads are clogged with cars, vans and Lorries. Deliveries are late;
drivers spend time stuck in traffic jams etc.
Breakdown of relationships
With suppliers and buyers. When a firm is small, there is often a direct
relationship between owner managers and customers or suppliers. As the
firm grows, these relationships are hard to maintain as the owner
manager finds his time is taken up with administration or problem solving.
Competition for labour
More firms mean increased demand for labour, making the best workers
harder to recruit and keep.
Increasing employment costs
More firms mean increased demand pushing up the price of labour -
wages.
Location of Business
Regional Location of Business
The main determinants of where businesses locate are:
access to markets
the cost, nature and availability of factors of production
social factors
historical reasons
It is the varying importance to businesses of these three, which in the long
run determines where businesses are located.
Access to Markets
For some businesses it is the availability of, and access to markets, that is
the prime consideration that determines the location of the business. This
is most obvious when we look at retailers of consumer goods. In this case
the business has to be near customers.
It used to be true that retailers had to be in the city centre if they wished
to access a mass market, but the increased availability of private
transport has led to a growth of out of town shopping centres. But this
location relationship between retailer and customer is being broken down
by the growth of e-commerce and mail order purchasing.
Manufacturers of components in many industries (supplier firms), need to
be located close to the users of their products. This has become
increasingly true with the increased use of just-in-time systems, where
being 'on the doorstep' is now the expected norm.
Access to markets can be limited because of trade restrictions, or the
existence of 'trading blocks', such as the EU. To overcome these
restrictions it is often necessary to set up a manufacturing base within the
trading block.
Type and quality of infrastructure also affect access to markets.
Infrastructure used to mean roads, rail, and shipping. But a more modern
definition includes electronic communication systems, training agencies,
financial services, as well as the three traditional components. For many
modern businesses, such as those that are E-commerce based, or the
rapidly growing call centre industry, quality infrastructure has a very
different meaning from that understood by road hauliers, and steel
manufacturers.
Sometimes existing access to markets can break down. External
diseconomies of scale force firms to reconsider their location - congestion,
and competition for workers pushing up wage rates, are just 2 examples
of factors that can force relocation.
Cost and nature of factors of production
When firms use bulky, difficult to handle raw materials, then location close
to the source of these raw materials can substantially reduce costs. This is
why the world’s major paper manufacturers are located close to where the
wood is logged and pulped.
The factor of production Labour can also be a deciding factor in
determining location. By labour we mean cost of labour, availability of
labour, and the skills of labour.
Highly skilled labour, such as that in the finance industry, can be located
around one major centre in the UK. For finance that is the City of London.
A business with a need for this type of skilled labour, must therefore
locate in this area.
The cost of labour is also a determining factor. International location has a
habit of following low cost labour to wherever it is available. Shipbuilding
moved from the Clyde, and the Tyne, to Japan in the 50's and then to
Korea in the 70's, and is now moving to Indonesia, call centres are moving
to India, and manufacturing of clothes to China and India.
The cost of Labour can be affected by the availability of government
grants, giving incentives to move to particular regions of a country, and
by government taxation policies. Availability of grants can reduce the cost
of all factors of production - but most especially labour and land.
The availability of land is also an important factor. Most large investments
are based on 'green field' sites. And local government, along with
development agencies, often work hard to ensure that planning
permission is available to allow large developments to proceed.
Social Reasons
Managers want to live in an environment that suits them and their
families. They want leisure facilities, good schools, and low crime. This is
why it can be difficult to attract businesses to depressed areas.
Alternatively managers can often retain a commitment to their existing
work force, even when it makes economic and business sense to relocate
a business.
Historical Reasons
For a good number of firms, the original reason for their location has long
since disappeared, but they still remain in the locality where they were
originally established. Around the country there are steel and tin plate
plants that had their historical origins in the availability of local raw
material—raw materials that were exhausted decades ago. But the plants
remain.
Regional location of business is then dependent upon the interaction of
several traditional factors. But at the same time it is worth noting the
changing nature of industry in the UK and the increased reliance upon and
availability of telephone, the internet and other communication networks
has, in recent years, made location decisions a great deal more flexible. .
International Location
The largest firms, though still influenced by the same factors that dictate
national location of business, do have the alternative of locating their
production facilities virtually anywhere in the world. As long as there is a
stable political background and an available work force, most countries
will offer the possibility of hosting a production base.
The main influences on international location beyond politics and labour
force factors are:
Maximising Economies of Scale
If firms are able to have a single plant supplying all their requirements for
a type of product or range of components, then the firm's average costs of
production can fall. So we see huge factories providing cakes to sell
throughout Europe, or producing injection moulded plastics for distribution
throughout the world.
Tax Advantages
Companies sometimes establish operations where taxation levels are
lower than their home base. This can allow Transfer Costing to take place.
Transfer Costing is a process by which firms are able to inflate their profits
in countries where taxation levels are relatively low, and decrease their
profits where taxation levels are relatively high.
Firms when locating in these less regulated countries may also attempt to
reduce costs by ‘cutting corners’. Practices or systems that would have
been unacceptable in economically developed countries may be the norm
in less developed nations.
EXAM QUESTION
FACEBOOK
Facebook began as a social networking site for university students in the
USA. Mark Zuckerberg started it up while at Harvard University, then
followed Bill Gates’ example in dropping out of Harvard to turn his idea
into a real business. Initially only US university students could use
Facebook; now nearly 28% of its 24 million subscribers are from outside
the USA, with Canada and the UK leading the way.
To fund the start-up in 2004 Zuckerberg raised $500,000 from a ‘business
angel’, an individual willing to provide high-risk venture capital. Now the
business is able to finance its growth from its cash flow. From the early
days of the business, the single most important driving force has been to
find technological solutions to cope with the crazy growth rate. However,
in addition to coping brilliantly with the pressures of growth, Facebook has
also tried to keep moving ahead. New facilities are offered regularly, most
designed in-house, but some designed by users. Facebook is unusual in
providing its computer programming information freely to anyone who
wants to use it to develop a new service.
Adapted from ‘The Facebook Phenomenon’ by Roger Hammond (Business
Review Sept 2007)
After negotiations with the Transport and General Workers Union (TGWU)
and having carried out a benchmarking exercise, a deal was agreed to
keep the factory open with half of the workforce losing their jobs. In
exchange, the company guaranteed the remaining workers a minimum of
five years’ work. The deal involves a £7.3 million package of savings and
changes to the layout of the plant.
Paul Kitchener, Burton’s chief executive said “We’ve developed an
alternative proposal for the Moreton factory that will see the creation of a
centre of excellence for our seasonal ranges. The factory is in need of
updating and we have decided to invest in it because of its suitable
location. We also propose to introduce Total Quality Management
(TQM).”