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Study Notes

Business Location - Methods of Choosing a Location

Level:
AS, A-Level
Board:
AQA, Edexcel, OCR, IB

Last updated 22 Mar 2021

Making a decision on a business location involves weighting and balancing the important factors.

  • Are cost (supply) issues much more important than customers and revenues (demand)?
  • Is the decision strategically important (i.e. it could affect the achievement of corporate objectives) or is it a relatively minor decision?
  • Can quantitative methods be used to evaluate alternative location options (e.g. by using investment appraisal techniques?)
  • Do qualitative factors, including senior management preferences, outweigh the financial considerations?

For a significant decision on business location, it is considered good practice to undertake some investment appraisal. The decision may involve a substantial capital investment (e.g. buying land & buildings, fitting out retail or other outlets, installing IT and production facilities).

The main approaches would be:

  • Discounted cash flow – which evaluates a project's cash flows in terms of the business' required rates of return on investment (by calculating a net present value for each option)
  • Payback – Also focusing on cash flows; this would help estimate the period of time it takes to repay the investments in the business location
  • Average rate of return – an accounting calculation that looks at the estimated average accounting returns as a percentage of the investment

In reality, the final choice of business location is often made using non-financial criteria – particularly when it comes to choosing the location for the start-up of a business. An entrepreneur will often begin the business at home and then, when extra space and staff are required, select somewhere nearby.

Benefits of the right location

There is no such thing as the perfect business location. Every choice made involves some trade-off between supply (cost) and demand (revenue) factors.

However, a good location is one which delivers the following benefits:

  • Competitive unit costs – through a combination of a productive and efficiency labour supply, acceptable location overheads and cost-effective access to inputs (raw materials, components etc)
  • Optimal revenue opportunities – customer service is not inconvenienced through the choice of location
  • An acceptable rate of return on investment – all business projects compete for scare cash resources; a business location decision is no different
  • Sufficient production capacity to meet demand and future flexibility in capacity management decisions
  • Access to a labour force which enables the business to achieve the objectives of its workforce planning

Industrial inertia and relocation

This is another factor which affects the choice of location. A business, once established, will often decide to stay in its original location even if other factors suggest a new location would be beneficial. The term for this is "industrial inertia". Why does this happen?

A positive reason is that the existing location provides advantages from external economies of scale. Over a long period of time, a location or region that has become associated with a particular industry develops specialist skills and experience. The pool of potential recruits is like to contain many people with relevant training and experience. Specialist suppliers are likely to be nearby.

Another reason is the cost and disruption that can arise from relocation. A decision to relocate involves potentially significant costs including:

  • Recruiting and training staff in the new location
  • Duplicated property costs – e.g. remaining periods on the original lease + upfront payments on a new lease
  • Costs of physical transfer – moving production equipment, transferring stocks
A third reason is a more intangible and qualitative reason – simply the desire to "stay put where the business has established its roots". Ask an entrepreneur why she started the business on the outskirts of York and she might simply say "because it was near to home". Ask her 15 years later why the business is still there, the answer could easily be "because we've always been here"!

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