Economics Notes - Location of Industry

Notes on basic economics concepts.

Economics Notes

Location of Industry

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What are the reasons for the location of a particular business or industry in a specific area? Was it just a snap decision or is there more of a science to the decision? This is the subject of location of industry.

Industries and Firms

An industry consists of firms that each have common characteristics in terms of the nature of their economic activity. The chemical industry, for example, is made up of hundreds of firms that have the common characteristic of being involved in either dealing with or manufacturing chemicals. These chemicals might be used for a wide variety of different processes, including agriculture, construction, medicines and a wide range of others - textiles, plastics, paper, cleaning and so on.

Individual firms might choose to set up their business in a variety of locations. In some cases, businesses with common characteristics are very widely spread. Take the example of solicitors or plumbers: there is a very large number of firms operating in this industry but their location tends to be spread fairly evenly across the country.

Other industries tend to have firms that might be clustered in a particular area. The chemical industry is one example: there are major groups of chemical firms located in and around the North East of England, especially on Teesside near Middlesbrough.

Percentage of gross value added derived from industry and services, 2000

Percentages
  Industry Services
United Kingdom excluding Extra Regio 26.7 72.2
North East 33.2 66.1
North West 30.6 68.6
Yorkshire & the Humber 30.9 67.8
 
East Midlands 34.7 63.7
West Midlands 33.2 65.6
 
East 24.9 73.7
London 16.4 83.6
South East 22.0 77.3
South West 28.0 69.9
 
England 26.1 73.0
Wales 32.8 65.7
Scotland 29.3 68.8
Northern Ireland 29.8 67.8
 

Source: Office for National Statistics.

The crucial factor in many cases will be locating where costs of production can be minimised. Planning laws and regulations might mean that it is not always possible to set up in the preferred location. The economist (and later sociologist) Alfred Weber (1868-1958) pioneered the work on location of industry way back in 1910. His theory was based on the principle that a business would seek to locate where costs could be minimised.

If there were two locations, a and b, where a represented a location where the cost of setting up was lower than b, then the firm would always go to a.

Weber was writing at a time when the industrial revolution resulted in a number of large industries being concentrated in certain parts of the UK - coal, steel, shipbuilding, textiles and so on. Whilst the factors that were relevant to firms in those industries are different for many firms in the 21st Century, some of the basic principles he laid down are still relevant.

There are a number of factors that will influence where a business will choose to locate. The following could all be considered as important but for some businesses, some of the factors will be more important than others.

Nearness to Power

Some firms require either a certain type of power/energy source or particular amounts to be able to operate effectively. This means that one consideration for location is somewhere that has relatively easy access to such sources. This might be particularly relevant for a business that uses large amounts of power in the production process. In simple terms, the location has to be in a position to be able to supply the amount of power that a business might need.

Cooling towers on the other side of a river

Chemical factory near Middlesborough

Some businesses need large amounts of power to be able to produce - this might be much more than is normally available from a domestic supply and so there has to be that source available if location is to be viable. The chemical industry is an example of production that uses large amounts of power. Copyright: Griszka Niewiadomski from stock.xchng, and A. Ashwin.

If we use the example of the chemical industry, the production process involved in this industry requires large amounts of gas and electricity. Providing the amount of electricity needed for such processes is not the same as the amount needed by the average house. For firms like BASF, ICI and Degussa, Teesside is able to provide that power. At the mouth of the River Tees is a nuclear power station at Hartlepool, which is able to supply the necessary power that these firms need.

Nearness to Market

Access to a market for the good or service produced is an important component for some firms. The market in this context is referring to the customers who buy the good or service produced. In some cases, this can be the general public at large; others might be far narrower. For example, some businesses sell their output to a small number of other businesses.

The importance of access to a market depends on the type of business and what it is involved in. For some businesses, being near to customers is essential. One obvious example is a snack bar or café . To survive, such businesses need to be somewhere where customers will regularly pass by.

Exterior shot of 'Amigo' snack shop

This snack food store is located on one of the main platforms at Reading station. It is ideally situated to take advantage of the flow of passengers going in and out of the station. If it was located down a quiet residential street, it would not be as successful.

In the case of our chemical firms, nearness to the market might not be quite as important as might be the case for online retailers such as Amazon, where other means of getting to the market are more important (good distribution and communication networks, for example). The importance of being near to the market might also be dictated by the nature of the product produced. Weber identified the importance of this in his original analysis. Weber noted that the ratio of the weight of raw materials to the finished product might be a factor influencing location. We refer to this as 'bulk reducing' or 'bulk increasing' industries.

Steel rods

The end product in the steel-making process might be heavy but is a lot less bulky than the raw materials that go to make it - this is a bulk reducing industry. Copyright: David Ritter, from stock.xchng.

A bulk reducing industry is one where the finished product is less bulky and easier to transport and distribute than the raw materials. Steel is a good example of this type of industry. Steel is made from a combination of coal, iron ore and fluxes which are processed before being combined in a blast furnace where molten steel is then processed into steel slabs, plate and so on. In such circumstances, the cost of transporting the raw materials may be high compared to that of the finished product. Tata Steel has a good animation showing the production process of steel.

A bulk increasing industry is one where the opposite occurs. In this case, the finished product might be more bulky than the raw materials. A good example here is the furniture industry. Completed items of furniture (not flat-packed obviously) tend to be far more bulky than the raw material used to make it.

Nearness to a Supply of Raw Materials

Some firms may rely on a source of raw materials for their business. If these raw materials are nearby, it is pretty much common sense that transport costs can be reduced if the firm is located nearby rather than far away. This might be particularly relevant for bulk reducing firms. In Weber's time, the steel industry tended to be located near to sources of coal (for coking) and supplies of iron ore. If the raw material is not available locally then it may be that a firm chooses to locate near a port, or other point of import, where they can access the raw materials efficiently and at lowest cost.

A Corus foundry in Holland

The steel industry traditionally located near to supplies of raw materials because it was more cost effective to transport the finished product rather than the raw materials. Copyright: Gerla Brakkee, from stock.xchng.

In other cases, the raw material might be less obvious. In certain parts of the UK, there tends to be a relative concentration of certain types of farming. In these cases it may be the quality of the land for arable use that might be important. In other cases it might be that certain types of land and area are more suitable for dairy farming. Even more obvious might be the proximity of many fish-processing plants located near to fishing ports or firms involved in quarrying.

Cows in a field outside a barn

A dairy farm relies on supplies of good quality grass to help boost productivity. In such cases, the soil and quality of the land might be determining factors for location. Copyright: Michael Swanson, from stock.xchng.

Nearness to a Supply of Labour

All businesses need labour to operate. In some cases, this labour has to have high levels of skill. Some areas have concentrations of industry in a region and have become known for having a pool of skilled labour available. In such cases, it can save a firm both time and cost locating near to the supply of labour. This can be extended if the local labour supply is relatively cheap. We have seen a number of firms in recent years relocating some of their operations to different countries to take advantage of the supplies of skilled and cheap labour that exist: for example, call centres in India and James Dyson's relocation of manufacturing capacity to Malaysia. The Economist Intelligence Unit reported that at the time of the decision by Dyson in 2002, labour costs for a UK worker stood at £9 per hour compared to just £3 in Malaysia. Moreover, UK office rents cost £114 per square metre per year whilst similar rents in Malaysia are priced at just £38 per square metre per year.

Arab construction workers

Relocating to foreign countries where labour is cheaper has become a high profile news story in recent years. Labour is one of the highest costs for any firm. If good quality labour is available at reasonable wage rates, firms are tempted to locate to exploit this supply of labour. Copyright: Dragon MasterGunner, from stock.xchng.

Certain parts of the country may be associated with certain types of labour. In the City of London, for example, there may be opportunities for firms in the financial industry to access supplies of highly skilled and experienced labour. There are, in addition, a number of specialist business schools in the City that are able to attract good quality teaching and research staff as well as recruiting good quality students. As a result, firms in the locality know that they have access to good quality labour.

Proximity of Other Businesses - External Economies of Scale

Where industry becomes concentrated in an area, there are generally a number of supporting or ancillary firms set up. In some cases, these firms supply specialised services or products to other firms in the industry. In and around fishing ports, for example, there might be specialist engine services, specialists in marine insurance, firms specialising in processing and distribution and so on. In such cases, any new firm seeking to enter the market might well gain benefits from the fact that the industry is concentrated in that area. In the City, there will be firms that have particular specialisms in different areas of finance, whose expertise can be a major reason for firms locating in the City. These benefits can result in lower average costs (costs per unit). This is called external economies of scale.

There might also be other specialist benefits. In our example of the chemical industry on Teesside, the emergency services are specially trained to deal with potential emergencies that might result from a chemical spill or explosion. In addition, there are specialist firms that deal with the problems of waste and processing of unwanted chemical residues. All of these might be of benefit to a new firm looking to set up in the area.

City of London logo carved into stone

The City has a huge reputation for the high quality of its financial services industry. Any firm in the industry setting up in this area will be able to reap the benefits of being associated with this reputation.

The Reputation of an Area

Certain areas of the country have a reputation for particular types of business - this might often be due to its industrial past. Staffordshire is associated with high quality pottery, Nottingham with fine lace, The City for its financial expertise and Sheffield for its steel - just some examples. Any firm linked with those industries setting up in these areas might well be able to trade on the back of the reputation of the area. If a firm that sells cutlery sets up in Sheffield, it may be able to associate its business with the reputation that Sheffield has built up in relation to steel; insurance companies setting up in the City may be able to gain some reputation purely by having a postcode that is linked to the City and so on.

As the structure of industry in the UK changes in favour of a more service-based economy, the importance of the concentration of industry which was a feature of the old traditional heavy industries that developed after the industrial revolution, is declining. Whilst this factor may be seen as being less important it can still be a factor that a firm might consider.

Transport and Communication Services

Firms that rely on good communications networks either for information transfer or distribution may well look to locate in areas where such facilities exist. This may include high quality road networks, access to trains, airports, ports and so on. Many new industrial estates have been built in out of town areas and major new trunk roads linking these estates with major road networks make locating in these areas worthwhile for some firms.

For other firms, speed of information may be the crucial factor in their business. Many city areas were the first to have access to high speed data networks, broadband, cable and satellite services and so on. For a firm in the City, having high speed data access is essential to the transaction of their business.

A close-up of the back of a server box

Data transfer is an important part of many businesses in the knowledge economy. Speed of transfer depends on having the right infrastructure in place - not everywhere in the country has access to super fast data transfer, which may affect decisions on location. Copyright: Andrew Brigmond, from stock.xchng.

In other examples, many hotel chains have located in particular areas often near to motorway exits around major cities or airports. Companies like Travelodge, Holiday Inn, Holiday Inn Express, Ibis and Premier Lodges have all appeared in clusters around these exits. They are hoping to take advantage of business travellers who use these main arterial routes.

Incentives

As the structure of industry changes, different regions of the country might experience different levels of economic growth. In some regions, the decline of old traditional industries like coal and steel has not been offset by a growth in new industries. Unemployment can be a problem in these areas.

EU flag fluttering in the breeze

The EU might play a role in location in offering various incentives to help promote economic growth and regeneration in poor regions of the EU. Copyright: Päivi Tiittanen, from stock.xchng.

As a result, various government and EU grants and incentives might be available to persuade firms to locate in these areas. The availability of low rent premises, faster planning permissions, employment subsidies (a sum of money given for every job created), reduced red tape, grants etc. can make a difference to a firm that decides to locate in that area. One of the problems, however, is that there might not be any other natural reasons for a firm to locate in these areas and when the incentives run out there might not be any reason for the firm to remain in the area.

Competition

Firms will be aware of the extent of the competition in an area when they are looking to locate their business. If there are several other similar businesses in the locality, it might influence their decision about location.

Orange and O2 shops next door to each other

Is this a good location decision or not? Being located near to competition can have its disadvantages but might also have some advantages.

Opportunities for Expansion

Many businesses might be looking for opportunities to expand in the future. Access to land, and the ease with which the business can expand if necessary, might therefore be something that a business will want to find out before making a location decision, or at least as part of a location decision. In some areas of the country, planning permission may be difficult to get - there may be restrictions on expansion into the countryside, various policies to encourage use of derelict land and so on. Whilst this may be of benefit to society as a whole, it is not necessarily the most cost-effective solution for a business.

In some areas of the country, land and rental prices can be significant factors in location decisions. In the south east of the UK, for example, average land prices for residential use have risen from £275,000 per hectare in 1983 to £2.49 million in 2002; in Inner and Outer London, the rise was even more dramatic with prices rising from £759,000 to £5.49 million per hectare. Compare this to Wales, where the price for a hectare in 1983 was £85,000 and rose to £980,000 by 2002. Source of data: Halifax. (http://www.hbosplc.com)

A recent report by real estate business DTZ noted that the West End of London was the most expensive place in the world to rent office space. They reported that the average cost per workstation area stood at £12,001. Hong Kong came in second at £10,170. (Source of data: Executive Offices Group) (http://www.executiveoffices.co.uk/virtual-offices/article.asp?item=18028843)

Development Agencies and Inward Investment

UK Regional policy in recent years has changed its emphasis. The UK's membership of the EU has been a part of this. The approach is to have a co-ordinated policy with the EU to help each region achieve its full economic potential but at the same time to allow decision-making to be devolved to the lowest level, where possible. This means that the regions themselves will take a lead in encouraging economic development and supporting businesses in their region.

Exterior shot of the Sage building in Gateshead

Gateshead in the north east of England - an area that has struggled to come to terms with changes in the structure of industry but an area that is rapidly taking on a different look as regeneration projects attempt to bring new business to the area. This is The Sage, a music and concert venue developed on the banks of the River Tyne on land that was once derelict. Copyright: Graham Soult, from stock.xchng.

To this end, there is now a network of regional development agencies (DAs) focusing their attention on improving the economy of particular regions. Examples of such DAs include the Welsh Development Agency, the South West of England Regional Development Agency, the South East England Development Agency and the East of England Development Agency. In Scotland, the Scottish Executive administers a grant scheme called Regional Selective Assistance (RSA), which seeks to encourage inward investment and job creation in so-called Assisted Areas in conjunction with the EU's regional aid mandate.

In October 2006, the map covering the Assisted Areas for the whole of the UK was amended and agreed by the EU. What this means is that regional assistance can be given to these areas under EU laws. It would be contrary to EU policy to provide economic aid to an area independently - this is really counter to the idea of a single market hence the need for EU agreement.

The new map for assisted areas in the UK is shown below:

A map showing the assisted areas in the UK, with the main highlighted areas being western Wales, Cornwall and the Highlands and Islands

Source: Crown Copyright.

The different tiers relate to the extent to which these regions are in need of help. Tier 1 regions have a GDP of less than 75% of the EU average, Tier 2 regions can have help provided it does not distort trading conditions in relation to the rest of the EU, by giving such regions a significant competitive advantage, for example. In England, the government now have what is called the Selective Finance for Investment in England as the body that oversees discretionary regional aid grant schemes.

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