Realizing Location Economies

We know from earlier chapters that countries differ along a whole range of dimensions, including the economic, political, legal, and cultural, and that these differences can either raise or lower the costs of doing business. We also know from the theory of international trade that because of differences in factor costs, certain countries have a comparative advantage in the production of certain products. For example, Japan excels in the production of automobiles and consumer electronics. The United States excels in the production of computer software, pharmaceuticals, biotechnology products, and financial services. Switzerland excels in the production of precision instruments and pharmaceuticals.⁶  What does all this mean for a firm that is trying to survive in a competitive global market? It means that, trade barriers and transportation costs permitting, the firm will benefit by basing each value creation activity it performs at that location where economic, political, and cultural conditions, including relative factor costs, are most conducive to the performance of that activity. Thus, if the best designers for a product live in France, a firm should base its design operations in France. If the most productive labor force for assembly operations is in Mexico, assembly operations should be based in Mexico. If the best marketers are in the United States, the marketing strategy should be formulated in the United States. And so on.

Firms that pursue such a strategy can realize what we refer to as location economies. We can define location economies as the economies that arise from performing a value creation activity in the optimal location for that activity, wherever in the world that might be (transportation costs and trade barriers permitting). Locating a value creation activity in the optimal location for that activity can have one or two effects. It can lower the costs of value creation and help the firm to achieve a low-cost position, and/or it can enable a firm to differentiate its product offering from that of competitors. Both of these considerations were at work in the case of Clear Vision, which was profiled in the Management Focus. Clear Vision moved its manufacturing operations out of the US, first to Hong Kong and then to mainland China, to take advantage of low labor costs, thereby lowering the costs of value creation. At the same time, Clear Vision shifted some of its design operations from the US to France and Italy. Clear Vision reasoned that skilled Italian and French designers could probably help the firm better differentiate its product. In other words, Clear Vision thinks the optimal location for performing manufacturing operations is China, whereas the optimal locations for performing design operations are France and Italy. The firm has configured its value chain accordingly. By doing so, Clear Vision hopes to simultaneously lower its cost structure and differentiate its product offering. In turn, differentiation should allow Clear Vision to charge a premium price for its product.