Business (9609) | Location and scale

Operations Management (A Level) Study Notes: Chapter 9.1 Location and Scale

Hello future business leaders! This chapter is all about two of the most critical decisions a firm makes: where to put the business (Location) and how big it should be (Scale). Get these right, and you minimize costs and maximize efficiency. Get them wrong, and your profits suffer! Let's dive in.

9.1.1 Location Decisions: Finding the Perfect Spot

Choosing a location is perhaps the most strategic, long-term decision an operations manager faces. Unlike changing a marketing plan, moving a factory is incredibly costly and disruptive. The location choice directly affects the business’s costs, revenues, and efficiency.

Factors Determining Location and Relocation

When a business decides where to set up (or where to move, which is relocation), they weigh a variety of factors. These factors can be categorized as cost-focused or revenue-focused.

1. Market/Customer Proximity:

• For services (like retail shops or restaurants) or products that are expensive to transport (like bottled water), being close to the final consumers is vital.
• For services requiring immediate presence (e.g., emergency plumbing), quick access to the service area is key.

2. Raw Material/Supply Proximity:

• If raw materials are heavy, bulky, or perishable (e.g., sugar beets for a sugar factory, fresh fish for a canning plant), locating the factory close to the source saves huge transport costs.

3. Labour Considerations:

• Availability: Does the area have enough workers with the necessary skills (e.g., IT specialists, engineers)?
• Cost: Wages vary dramatically between regions and countries. Low labour costs often pull manufacturing to developing countries.

4. Infrastructure:

• Access to reliable transport (roads, ports, airports) is essential for receiving inputs and shipping outputs.
• Reliable utilities (electricity, water, internet) are non-negotiable for modern businesses.

5. Government and Financial Incentives:

• Governments often offer tax breaks, subsidies, or grants to encourage businesses to locate in areas with high unemployment (e.g., enterprise zones).

6. Site Costs and Constraints:

• The cost of land or renting premises (e.g., a London office vs. a rural warehouse).
• Planning regulations and environmental laws.

Local, National, and International Location Decisions

The scale of the decision affects which factors are most important:

Local Location Decisions (e.g., choosing a street in a city)

These focus heavily on convenience and visibility.

• For a bank or retail store: Foot traffic, security, rental costs, and local parking are paramount.
• For a warehouse: Access to main roads and low rent outside the expensive city centre.

National Location Decisions (e.g., choosing a region in a country)

These involve comparing regions within the same country.

• Focus on differences in regional wage rates, availability of grants/subsidies, and the density of specific skills (e.g., Silicon Valley vs. Detroit).

International Location Decisions (e.g., choosing a country)

This is the most complex decision, involving massive risk and potential reward.

• Political Stability: Is the government reliable? What is the risk of conflict or nationalisation?
• Legal Framework: Differences in labour laws, consumer protection, and intellectual property rights.
• Exchange Rates and Tariffs: Will volatile currency movements wipe out cost savings? Are there high import/export duties?
• Cultural Factors: Does the local culture support the firm’s operational style?

Offshoring, Reshoring, and Globalisation

Globalisation, driven by cheaper transport and better IT, has made international location decisions common. This has led to two key trends:

1. Offshoring

This is the process where a business moves some of its operations (production, call centres, or even R&D) to another country, often to take advantage of lower costs.

• Reasons: Cheaper labour, access to massive foreign markets (e.g., China, India), lower taxes.
• Impact: Lower unit costs, increased competitiveness, but often faces issues like logistical delays, quality control challenges, and communication barriers.

2. Reshoring

This is the movement of operations back to the domestic country after they were previously moved abroad (offshored).

• Reasons for Reshoring:
  1. Rising wages in previously low-cost countries (making the initial move less profitable).
  2. Concerns over quality control or ethical issues (e.g., poor working conditions).
  3. Need for shorter lead times and closer control over the supply chain (especially after global disruptions).
  4. Improvements in automation/technology at home, reducing the reliance on cheap foreign labour.
• Impact: Increased domestic employment, tighter quality control, but likely higher production costs.

Key Takeaway for Location Decisions: Location is a high-stakes, long-term strategic choice. Businesses must balance cost reduction (cheap labour, materials) with quality, logistics, and political stability.

9.1.2 Scale of Operations: How Big is Best?

The scale of operations refers to the maximum capacity of production based on the size of the business. An optimal scale minimizes the average cost per unit.

Factors that Influence the Scale of a Business

A business doesn't just choose a size randomly. Its scale is influenced by:

• Size of the Market: A niche market (e.g., handcrafted luxury watches) supports a smaller scale than a mass market (e.g., smartphones).
• Availability of Capital: Large-scale operations (like car manufacturing plants) require huge investment. Small firms may lack the necessary funds for growth.
• Optimum Production Method: If a product uses job production (unique items), the scale will naturally be smaller than if it uses flow production (continuous stream).
• The Owner's Objectives: Some owners prefer to remain small to maintain control or work-life balance, even if they could technically grow larger.

Economies of Scale (EoS)

Economies of Scale occur when the average cost (unit cost) of production falls as the business increases the scale of its output. This makes larger firms more cost-competitive.

The link to unit cost is crucial. As output increases, fixed costs (like rent or management salaries) are spread over more units:

\[ \text{Average Unit Cost} = \frac{\text{Total Costs}}{\text{Output}} \]

Causes and Examples of Internal Economies of Scale

These savings come from within the firm itself, due to its size:

1. Technical Economies:

• Large firms can afford specialised machinery (e.g., advanced robotic assembly lines) that small firms cannot, leading to higher efficiency and output per hour.
• Large machines are often physically more efficient (The container ship analogy: transporting 10,000 containers costs far less per container than transporting 100).

2. Purchasing (Bulk Buying) Economies:

• Buying raw materials in bulk leads to substantial discounts (e.g., a massive supermarket chain buys milk cheaper than a small corner shop).

3. Financial Economies:

• Large, established companies are seen as lower risk by banks, allowing them to secure loans at lower interest rates.
• They can raise capital more cheaply (e.g., issuing shares).

4. Managerial Economies:

• Large firms can afford to hire specialist managers for specific functions (e.g., a Chief Marketing Officer, a HR Director). These specialists improve efficiency in their respective areas, which a single General Manager in a small firm cannot match.

5. Marketing Economies:

• The cost of a major national advertisement campaign is fixed, regardless of the size of the firm. A large firm producing millions of units spreads the cost of the advert over more units, lowering the unit marketing cost.

Diseconomies of Scale (DoS)

Diseconomies of Scale occur when a business grows too large, resulting in the average cost (unit cost) of production starting to rise.

Don't worry if this seems tricky! Think of it like a huge family gathering: up to a certain size, it's fun and easy. But when 500 people turn up, things get messy, communication fails, and the cost per person goes up because you need security guards and professional caterers!

Causes of Internal Diseconomies of Scale:

• Communication Problems: As the hierarchy grows, messages take longer to travel and can become distorted. Decision-making slows down.
• Poor Coordination and Control: It becomes difficult for top management to monitor and coordinate thousands of staff across multiple locations. Waste and inefficiency increase.
• Lack of Motivation/Alienation: Workers feel disconnected and less valued in a massive organisation, leading to lower productivity and potentially higher labour turnover.
• Increased Bureaucracy: More rules, paperwork, and procedures slow down operations, adding to administrative costs.

External Economies of Scale

These are savings enjoyed by all businesses in a particular industry or region, regardless of the size of the individual firm. They occur because the industry or area itself is growing.

• Skilled Labour Pool: If many similar firms locate in one area (e.g., banks in a financial district), local colleges start offering courses in those skills, creating a ready supply of trained workers for all firms.
• Improved Infrastructure: As an industry expands regionally, governments or suppliers invest in better roads, shared utility services, or specialized research facilities, benefiting everyone.
• Ancillary/Service Industries: Specialist support firms (e.g., maintenance companies for textile machinery, or specialist logistics firms) set up nearby, offering cheap, specific services.

The Link between Scale and Unit Costs

The relationship between scale (output) and unit cost is usually represented by the long-run average cost (LRAC) curve, which is often U-shaped:

• Downward Slope: As output increases, the business benefits from Economies of Scale, and the unit cost falls.
• Minimum Point: This represents the Optimum Scale of Production, where unit costs are at their lowest.
• Upward Slope: If the business grows beyond the optimum point, Diseconomies of Scale start to dominate, and the unit cost rises.