Basic Location Strategies

Basic Location Strategies

An economic activity can remain operational if the relationship between the costs of its inputs and the revenue from the sale of its outputs is positive. It is at least able to breakeven. Otherwise, it needs to be subsidized, implying a transfer of wealth from another sector. A location can impact the price of both inputs and outputs, so the choice of a location can be important to ensure its profitability. In the above example, two location criteria are considered along a continuum between a location with low land costs (X) and a location (market) with a high number of customers (Y). Two location strategies can be considered:

  • Cost minimization mainly considers location problems where revenues (sales) are generally constant and where costs vary. This approach focuses on reducing input costs such as rent, which is particularly the case for manufacturing and resources that tend to service large markets. Thus, a manufacturer is likely to have similar sales, wherever its location, but its production costs are likely to vary depending on its location. The goal is consequently to find an optimal location (X) that minimizes costs and maximizes profits. Such a location can be “bounded” (between X and A), implying that a certain geographical area, due to its lower costs, would incur profits for an activity wherever its location within this area. There is a potential positive feedback effect as a low cost location enables to increase profits, which can be passed down the supply chain and likely improve the market share, demand and revenue.
  • Revenue maximization deals with constant costs, but varying revenues. This approach focuses on maximizing outputs, which is particularly the case for retail activities whose inputs tend to be constant (such as labor), but whose revenues (sales) can increase at locations that are more accessible to potential customers. There is an optimal location (Y) ensuring the highest access to customers, which can be bounded (between B and Y).

Both strategies can be reconciled in a profit maximization perspective where costs and revenue vary according to the location. In the above case, the profits from land costs derived from a location are compared with the profits from customer revenues from the same location. Each requires to be above a breakeven line. Under such a perspective, the optimal location could be different (O).