Location Decision in SMEs

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1 Location Decision in SMEs – Berdien Lommerts

Location Decision in SMEs

A model for the location decision of small- and medium sized

enterprises applied to Latexfalt bv., the Netherlands

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Location Decision in SMEs

A model for the location decision of small- and medium sized enterprises applied to Latexfalt bv, the Netherlands

Master Business Administration, specialization Small Business and Entrepreneurship Faculty of Economics and Business

University of Groningen, Netherlands

Master thesis

Author: Berdien Lommerts

Date: June 2008

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Summary

Firms make decisions in an environment characterized by uncertainty and a lack of information. Location decisions are often based on inaccurate information about potential locations. Decision makers seem to be guided by their subjective interpretation of reality (Meester and Pellenbarg, 2005). This threat is even bigger for small- and medium-sized enterprises (SMEs) where the entrepreneur is a key decision maker and often makes decision based on personal ideas and motives. This paper looks at the location decision process of manufacturing SMEs. The main research question is “how to structure the location decision process of a manufacturing small- or medium-sized enterprise?” Based on existing literature, the location decision model show in figure S.1 was constructed. Manufacturing SMEs can use this decision model to structure their location decision. The model consists of nine phases where external, internal and location factors are the key elements and criteria on which the location decision will be based. The model deals with specific characteristics of SMEs with regard to their large counter parts.

Figure S.1 Location decision process model for manufacturing SMEs.

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1. Introduction

Firms make decisions in an environment characterized by uncertainty and a lack of information. Location decisions are often based on inaccurate information about potential locations. Decision makers seem to be guided by their subjective interpretation of reality (Meester and Pellenbarg, 2005). This threat is even bigger for small- and medium-sized enterprises (SMEs) where the entrepreneur is a key decision maker and often makes decisions based on personal ideas and motives. This paper approaches the location decision of SMEs by looking at the different factors that influence the location decision and will look at the location decision process. A decision process model will be presented based on existing literature. The model will support the decision makers to structure the decision process and to collect information.

1.1 Why a location decision model for SMEs?

Small- and medium-sized enterprises (SMEs) focus on daily activities and are less aware of the feedback from the external environment (Van Rijt-Veltman et al., 2002). SMEs have a short term time-view and are less concerned with strategic issues, like location decisions (Van Noort and Reijmer, 1999). Gibcus et al. (2004) argue that ‘strategic decisions are crucial to the viability of firms and are defined as intentional choices or programmed responses about issues that materially affect the survival prospects, wellbeing and nature of the organization. They guide the organization into the future and shape its course.’ Many models on decision making focus on the decision making process in large firms. Gibcus et al. (Ibid.) highlight differences in the decision making process of small firms from large firms. Entrepreneurs and small firms do not have access to extensive information and need to deal with uncertainty. Secondly, large firms often develop decision-making routines that simplify the process of decision-making. Entrepreneurs do not develop these routines and act on the basis of opportunism and on the basis of biases and heuristics. Thirdly, entrepreneurs are often believed to have specific characteristics that influence the decision-making process.

The location is an essential factor in the functioning and future survival of the firm (Van Noort and Reijmer, 1999). SMEs have fewer resources available to make this capital-intensive decision (Van Rijt-Veltman et al. 2002) and the location choice is often not seen as a strategic choice. According to the behavioral location theory, the entrepreneur often makes a location decision based on incomplete and biased information with his or her own ambition and personal preferences in mind. The entrepreneur simplifies the complex location problem through thumb-rules and standard company procedures (Pen, 2002). These thumb-rules and standard procedures do not approach the complexity of the location decision in a full matter. In the location decision many factors play or can play an important role, and information about these factors need to be collected. To support the entrepreneur in the decision making this paper will provide a model for the location decision process of SMEs.

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costs. Because the (re)location decision is thought to be more stressful and complex for already operating manufacturing firms, this paper will look further at the location decision of these types of SMEs.

1.2 Problem Statement and Research Question

Studies on the decision making process focus mainly on large firms (Gibcus et al., 2004). Little information is known about the decision making in small firms, especially with regard to the location decision process. The location decision can be a stressful event for firms for reasons as uncertainty, unclear cause of relocation or the huge investment that have to be made. The different factors that are important in the location decision should be analyzed and evaluated by the firm and should be integrated in the decision process. The goal of this paper is to combine these factors into a location decision process model for a manufacturing small- or medium-sized enterprise (SME).

The research question of this paper is:

How to structure the location decision process of a manufacturing small- or medium-sized enterprise1?

Factors that influence the firms location decision can be divided in push, pull and keep factors. This subdivision is based on the characteristics of the present and possible alternative locations (Van Dijk and Pellenbarg, 1999), but does not take into account the influence of the firm or entrepreneur. The entrepreneur plays an important role in the decision making in SMEs and should be part of the location decision. Also the influence of the external environment on the location decision is note taken into account in the division between push, pull and keep factors. Lloyd and Dicken (1977) suggest another approach which is based on the decision power of actors and reflects to what extent the firm is able to control the situation and to what extent the firm has to accept external changes. They distinguish between: ‘firm internal factors’, ‘location factors’ and ‘firm external factor’. The classification of Lloyd and Dicken will be used to look at the factors that influence the location decision of SMEs, because it takes the decision power of actors on the location decision into account.

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The external location factors influence the location decision, but the factors cannot be influenced by the company itself. The SME will see the production environment as given and will adapt to the situation (Van Rijt-Veltman et al., 2002; Vaessen, 1993). The internal location factors also influence the location decision, but can be influenced by the company. The location factors are the absolute and relative characteristics of the location site (Van Dijk and Pellenbarg, 1999). These factors form together the location decision, which leads to the following question:

1) Which internal, external and location factors are part of the location decision of a manufacturing SME? In order to answer the question, different location theories will be described in chapter 2. Brouwer et al. (2004) links these location theories to the internal, external and location factors. In chapter 3 the different factors will be discussed in further detail.

The paper will integrate these factors into a decision process. So a fourth factor should be taken into account in the analysis: decision making process. The location decision is based on the three factors mentioned above, but how the firm deals with these factors, evaluates and analyses are part of the location decision process. The decision making within large firms differs from that in large firms. For example in SMEs the entrepreneur plays an important role and has a stark influence on the decision making process. Gibcus et al. (2004) gives several characteristics on which the decision process can be described. Pen (2004) further looks at the location decision process. The contribution of these authors will be further described in chapter 4 and will be integrated with the external, internal and location factors to make up a model for the location decision process of a manufacturing SME in chapter 5. The research model is given in figure 1.1.

2) How is the location decision process of a manufacturing SME?

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The location decision model that will provided can be used to structure the location decision process for manufacturing SMEs. It will support the evaluation of the different factors that influence the location decision and will take into account some specific characteristics of decision making in SMEs. The model will help to identify and collect information about the different factors that are important for the SME in their location decision. The model will give several strategies that can be used to approach the location problem. The strategies can be evaluated according to the information that was collected about the different factors.

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2. Location Theory

There are several theories with regard to the factors that influence the location decision. The meaning of location for an effective production differs according to the type of company, the country or area and the place in time. Four mainstream theories will be further explained to look at the different factors and explanations of the location decision:

- Classical Location Theory

(Least-Cost Theory, early 20th century- 1950s) - Neo-Classical Location Theory

(Demand or Locational Interdependence Approach, around 1950s) - Behavioral Location Theory

(Around 1960s-1980s)

- Institutional Theory (Geography of Enterprises) (Around 1960s)

2.1 Classical Location Theory

The classical location theory focuses on the minimization of transportation costs. Both Neo classical location theory and classical location theory assume a well-informed, rationally acting entrepreneur for whom the costs and benefits of a certain location are of great importance (Van Noort and Reijmer, 1999). Location theory concerns itself with the problems of where to locate production, why and where industries agglomerate and the location effects of economic growth. In all classical theories transport costs and the location of resources used as input in the production process and the market, play an important role. Launhardt, Von Thünen and Weber have underlined the importance of transportation costs (Greenhut, 1957; Oosterveld, 1971). They set the stage for what is called “the least-cost theory of plant location” (Greenwald, 1993). The many writers who followed Weber asserted that manufacturing locations were determined by the desire to locate at least-cost sites. Authors such as Palander, Schneider and Hoover were also interested in the size of the firm’s market area and concerned with variable demand over space (Greenwald, 1993; Oosterveld, 1971). Palander (1935) focuses on the reaction of entrepreneurs on local differences. Other authors as Engländer, Predöhl and Isard (1956) were interested in a substitution cost analysis.

2.2 Neo-Classical Location Theory

After World-War II the increasing awareness of the limits of the cost-only framework of the location theory stimulated an opposite view of plant location. This mainly had to do with the competitive assumption underlying the classical theory. The interest in the neo-classical location theory centered on locational interdependence and the market area (Greenhut 1956; Greenwald, 1991). Studies on the market area approach and locational interdependence of firms are closely related, but can be distinguished. The market area approach assumes fixed locations and is essentially an analysis on short-term. The locational interdependence school looks at movable locations (without cost) or planned future locations and is an analysis on the long-term (Greenhut, 1956).

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and outputs were viewed as perfectly mobile (Isard, 1956). The theory is mainly designed for manufacturing plant locations. Important proponents of this theory are Christaller, Hotelling, Fetter and Chamberlin. In the market area approach buyers are conceived as scattered over an area, where each seller seeks to control the largest market area. The actual location is determined by the type of interdependence existing between the seller and his rivals. Lösch looked at the maximum profit location where a given number of buyers can be served at the lowest total cost. In selecting a plant site, each firm seeks that place which offers the optimum sales output at a cost that cannot be matched elsewhere. (Greenhut, 1956; Greenhut, 1957)

The Neo-classical theory supplements the classical location theory with items to which attention should be paid and which were missing in the classical theory (Van Noort and Reijmer, 1999). Differences between the location choice of small and large firms are also addressed. When costs vary widely among locations, large firms tend to concentrate, ceteris paribus, in the particular city or district which is least in cost relative to the whole market area. The location of the large firm is accordingly made with particular emphasis on the least-cost site in relation to the whole market area. The location of the small firm is more flexible. Small firms seek smaller market segment and may locate at the least-cost position with regard to a particular segment of the entire market. The smaller firm chooses its site with greater freedom and is more ready to avoid locations near competitors. Small plants disperse relatively more than large firms and frequently locate in less industrialized areas. (Florence, 1962; Greenhut, 1956; Greenhut 1957)

There are many pros and cons for the classical and neo-classical location theory. The general critics are summarized by Jansen (1980): the classical and neo-classical location theory in that it focuses on the location problem of one isolated company and on one location. There is dominance on transportation costs and there is no division between free and bounded location factors. Also the factor ‘time’ is missing and the risks and uncertainties accompanied with location decisions. The last critic of Jansen concerns the simplification of the full-informed, rational and profit-maximizing decision maker. (Pen, 2002)

The (neo-) classical theory addresses the importance of location factors in the location decision. Factors as transportation cost, labor cost and market size, are according to the theory the main forces driving firm relocation (Brouwer et al., 2004). Among these location factors are accessibility and distance to suppliers and markets (Van Dijk and Pellenbarg, 1999).

2.3 Behavioral Location Theory

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decision makers create their own reality. Information collection and processing are essential and bounded-rationality plays an important role (Rooijackers and Wenseveen, 1983).

The result of the behavioral approach leads to an analysis of the decision making process. Essential elements in the analysis are uncertainty, risk-taking and personal perceptions. Three independent concepts play an important role in the behavioral theory: bounded rationality, incomplete adaptation to the environment and unresolved conflicts. The entrepreneur makes a decision based on incomplete and biased information with his or her own ambition and personal preferences in mind. The behavioral approach assumes that the entrepreneur simplifies the complex location problem through reach goals in an incremental way and to use thumb-rules and standard company procedures (Pen, 2002).

Besides the behavioral aspects, the importance of the organization also plays an important role. The theory is not only concerned with the cost factors like transport and labor, but also looks at the behavior of the entrepreneur with regard to its environment. The classical theory focused mainly on the processes within the organization and the location factors that influence the location decision. The behavioral theory looks at the processes in the environment that are relevant for the enterprise. Firm size is a key factor in the relocation decision. For large firms, moving costs and the organizational problems are considerable (Van Dijk and Pellenbarg, 1999). According to Brouwer et al. (2004), smaller firms are more willing to move because they have less demanding premise requirements and less capital investment to write off; they make a series of small locational adjustments and select the first minimum requirement site which they find, while large firms make infrequent large locational changes; small firms are much more affected by redevelopment and large firms have more flexibility in accommodating expansion.

The behavioral theory can be used to look at the internal factors that influence the location decision, for example the role of the entrepreneur. The behavioral theory seeks to understand actual behavior of entrepreneurs and focuses on the decision making process (Brouwer et al., 2004).

2.4 Institutional approach (Geography of Enterprises)

At the same time the behavioral theory was developed, another approach to location emerged: the institutional approach. The rising of collective and bureaucratic decision making, the increased autonomy of (large) enterprises, the growth of regional planning by (large) companies and the new role of the government as a “mediator and arbitrator” were the causes of this new approach. The idea is that the company location an expression is of the investment strategies of multinational companies and other large enterprises with multiple locations in a regional system or industrial district. Location factors play a small role in the formulation of the corporate strategy. The earlier models focused on the small- and medium-sized enterprises, but through the increasing contribution and importance of large and multinational firms on the economy lead to a focus on these larger firms. (Pen, 2002; Brouwer et al., 2004)

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with suppliers, government, labor unions and other institutions. The negotiation concerns key factors in the production process of the firm, such as prices, wages, taxes, subsidies and infrastructure (Brouwer et al., 2004). Although there is an increased attention to SMEs, the theory still focuses on the development and growth of companies who are regional clustered. Corporate innovations, social relations and institutions in local, regional and national networks between companies and organizations and the regional collective learning are important themes in this approach. (Pen, 2002)

2.5 Integration of Location Theories

As mentioned in the introduction, Lloyd and Dicken (1977) classified the factors that influence the location decision based on the decision power of actors and the extent to which the firm is able to control the situation or has to accept external changes (Van Dijk and Pellenbarg, 2000). Lloyd and Dicken distinguish between: internal, external and location factors. Brouwer et al. (2004) link these factors to the location theories, see figure 2.1. The (Neo) Classical theory focuses on the market situation and looks at location factors. Where the behavioral theory looks at information and abilities and looks at the internal factors influencing the location decision. The institutional theory addresses the influence of networks and external factors in the location decision.

Figure 2.1 Factors in the location decision linked to location theory Source: Brouwer et al. (2004), The Firm Relocation Decision:

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3. Location Decision Factors

According to Van Dijk and Pellenbarg (1999), the classification of location factors of Lloyd and Dicken is applicable when looking at the decision process of a firm’s location. Lloyd and Dicken (1977) categorize the factors influencing the location decision, which is based on the decision power of different actors and reflects to what extent the firm is able to control the situation and to what extent the firm has to accept external changes. The division is between firm location factors (absolute and relative characteristics of the location site), internal factors and firm external factors. In the previous chapter these factors were linked to existing location theories (figure 2.1). The internal factors, location characteristics and firm external factors may change over time and become less optimal for the firm at its present location.

3.1 Firm Internal Factors

The behavioral theory interprets firms as agents that have limited information, are rational-bounded and settle for sub-optimal outcomes. The theory looks at the internal factors, such as age and size, which are important in the location decision process (Brouwer et al., 2004). A firm can be described according to its business characteristics: product/service, labor, capital, production process and geographical range. The internal location factors are the factors that can be influenced by the firm. Van Dijk and Pellenbarg (2004) divide these factors into organizational structure, management, organizational goals, financial reserves and size and structures of fixed capital good investments. According to Van Rijt-Veltman et al. (2002), the firm internal factors depend on the size, strategy, organization, competition, innovation capability and other factors that can be influenced by the company. As pointed about by Brouwer et al. (2004), the behavioral theory focuses on the internal factors that influence the firms’ relocation. The behavioral location theory approaches the location decision on the basis of the behavior of the entrepreneurs and the motives involved and deals with the extent to which a certain location meets the requirements of an entrepreneur. The role of the entrepreneur should also be taken into account when looking at internal factors. Van Rijt-Veltman et al. (Ibid.) distinguish the firm internal factors in corporate environment and personal environment. The corporate environment are the factors that are influenced by the company (strategy, size, sector, HRM, production resources, financial resources, ICT). The personal environment is the factor that is influenced by the entrepreneur (individual aspirations, cultural beliefs, mental maps). This classification will be used, because it takes into account the role of the entrepreneur in the location decision.

3.1.1. Strategic Resources and Competitive Advantage

As mentioned by Van Rijt-Veltman the firm internal factors depend on competition, strategy and innovation capability. So resources are in turn also part of the internal factors. In order to look at the influence of these resources in the location decision, the key performances and key capabilities first need to be defined. Second, the relationship of the resources with the current location should be analyzed to see the impact of a relocation decision on these resources.

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underpinned by resources and capabilities that are scarce and imperfectly mobile. Well-functioning markets for the resources and capabilities are not present or cannot be present.

Besanko (2007) defines competitive advantage as

‘ the ability of a firm to outperform its industry, that is, to earn a higher rate of profit than the industry norm. To achieve a competitive advantage, a firm must create more value than its competitors. A firm’s ability to create superior value, depends on its stock of resources and its distinctive capabilities.’

Resources are the firm-specific assets and factors of production. Distinctive capabilities are activities that the firm does better than competitors. Not all resources possessed by a company are considered. Only those that are strategic resources, which are the basis of the company’s sustainable competitive advantage. To determine which resources are strategic, Rangone (1999) formulates five tests to measure which resources are strategic resources. With the strategic resources the company can exert a key performance, which are based on the industry’s key performances and on the core customer benefits the company wants to address. Rangone divide the key performances in: key production performances; key new product development performances and key marketing performances. The division in one of the three categories depends on the capability to which the performance is related.

The company’s endowment of the strategic resources forms the basis of the basic capabilities. The key performances are the link between basic capabilities and the strategic resources. Rangone formulates three basic capabilities, where a SME puts its strategic focus on one or more basic capabilities: innovation capability (a company’s ability to develop new products and processes and achieve superior technological and/or management performance); production capability (the ability to produce and deliver products to customers, while ensuring competitive priorities) and market management capability (The company’s ability to market and sell its products effectively and efficiently).

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Figure 3.2 Resource tree

Source: Rangone (1999), A Resource-Based Approach to Strategy Analysis in Small-Medium Sized Enterprises

The model of Rangone will be used in the location decision to determine the resources that are part of firms’ key performances and to see how these resources relate to the location. Rangone only considers the resources that are strategic. In the analysis all resources that contribute to the key performance and key capability will be analyzed to see the overall impact of the location decision on these resources that are part of the firm. When the firm relocates, resources can lose value and in turn affect the competitive advantage of the firm. For example, the innovation capability of the firm can rest on the resource of knowledge and in turn that knowledge is partly derived from the partnership with the local university. When the firm moves to another location 300 km from the university the interaction with the university can diminish, and the strategic value of the resource can be affected.

The following steps need to be carried out:

1) Define the company’s strategic intent and key performances. This step involves:

- Definition of the basic capabilities on which the firm relies: innovation, production and market management capability. The firm can focus on a single capability or pursue two or all three basic capabilities.

- Definition of the key performances to achieve that constitute the basic capabilities. The key performances are based on the industry’s key success factors and the core benefits the company wants to ensure to its customers.

2) Identify the company’s resources influencing key performances.

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18 Location Decision in SMEs – Berdien Lommerts 3) Assess which resources are bounded to the location.

The resources of the firm are identified, the next step is to identify which resources lose or will not lose value when the firm relocates. For each resource it should be assessed if the resource derives its value from the environment of the current location, if the resource can be easily transferred and what the influence of firm relocation has on the resource. The following schedule can be used:

Relationship with current location

Reallocation flexibility Influence of relocation on resource

Resource 1 Resource 2 Resource 3

Table 3.1 Resources and the location decision

3.1.2. The internal factors in the location decision of SMEs

In table 3.2 the internal factors that are part of the location decision for SMEs are summarized. Because the entrepreneur plays an important role, SMEs should not only look at the corporate environment, but also at the personal environment of the entrepreneur.

Internal factors Corporate environment • Strategy • Size of company • Geographical range • Sector/branch • Product/Service • HRM (Labor)

• Production (factors and process) • Financial factors (Capital) • Communication/ICT

• Strategic Resources and Competitive Advantage

Personal environment (of entrepreneur) • Personal aspirations

• Cultural beliefs • Mental maps

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3.2 Location Factors

The classical and neo-classical theory focus on the minimization of costs and the maximization of profit. Location factors, such as transportation cost, labor cost and market size, are according to the theory the main forces driving the location decision (Brouwer et al., 2004). Location factors vary from industry to industry. Location factors can be classifies as basic or secondary. The basic factor is the one most influential in determining a location. Another classification is between general and specific location factors. General factors are state or regional factors. Specific factors direct the location to a particular city or district. Each location decision can involve different combinations of factors.

The location factors concern for example the size of the current building, availability of space, accessibility, parking facilities etc. Van Dijk and Pellenbarg (1999) divide the location factors into:

- Variables that describe the present type of location.

- Variables that reflect to what extent firms think that potential changes might affect the suitability of the present location.

3.2.1 Variables that describe the present location

Hanemayer and Rekkers (1998) published for the Department of Economic Affairs of the Netherlands a report about location factors. The authors questioned 2.350 small and large firms in the Netherlands and asked them to score 25 location factors according to their importance and relevance for the well-functioning of the company. These 25 different location factors are grouped in 7 clusters, see table 3.3.

Building and site Accessibility

• Expansion/Growth possibilities • Price (rent or ground)

• Parking facilities • Quality of environment • Representation of building

• Representation of direct environment

• Load- and unload possibilities • Accessibility of public transportation • Accessibility to roads

Other transportation possibilities Supplying companies • Closeness of harbor

• Closeness of fairway

• Possibilities train transportation • Possibilities combined transportation

• Presence similar companies • Presence supplying companies • Closeness distribution center • Logistic service

Knowledge potential International orientation

• Closeness knowledge center • Closeness education institute • Availability of trained personnel

• Closeness of airport • Closeness of customs

• Presence of international companies Telecommunication

• Availability of telecommunication supply • Availability of telecommunication

services

Table 3.3 Clusters of location factors in the external environment of the company

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The research of Hanemayer and Rekkers (1998) shows that accessibility is the most important location factors mentioned by 75% of the companies: roads, parking space and the availability of qualified personnel are the three most mentioned location factors. Accessibility is followed by building and site, telecommunication, knowledge potential, supplying companies, international orientation and last the other transportation possibilities. The importance of location factors differ in time. The study of Hanemayer and Rekkers indicates that expansion possibilities forms a bottleneck, but has a high importance and low valuation. Other bottlenecks include accessibility of roads and parking space for visitors.

Van Rijt-Veltman et al. (2002) also look at the criteria for the location decision. They look at both starting SMEs and at moving SMEs. Starting SMEs choose in two out of three for the municipally of the entrepreneur. Twenty-five percent looks at other municipals. Besides the personal binding of the entrepreneur, accessibility also plays an important role for starting SMEs. Other criteria involve the size of the building, image of location, market area, expansion possibilities, closeness of other companies and availability of skilled labor. For moving SMEs in three out of four companies, moving to another municipally is not an option. Important motives for SMEs are improvement of accessibility, larger building and a better image of the environment of the new building. Moving companies pay more attention to expansion possibilities. The results are shown in table 3.4 and are in line with the result of Hanemayer and Rekkers (1998). Van Rijt-Veltman et al. do point out that the influence of the municipal is limited. The municipal does not slow down the moving process, but also does not stimulate. The municipal does have an indirect influence on the location decision of companies: the image and accessibility is under influence of the municipal.

Starting SME Moving SME Expanding SME

• Current home or work town • Accessibility • Market area • Size of building • Expansion possibilities • Accessibility • Size of building • Image • Home/work town • Expansion possibilities • No other alternative • Accessibility • Cost-profit analysis

Table 3.4 Location factors in order of importance

Source: Van Rijt-Veltman et al. (2002), Een warmer vestigingsklimaat voor het MKB?

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small business employs only a couple of people in key positions who have great significance for the business. For SMEs human capital is a stronger keep factor than for large firms.

3.2.2. Opinion about potential changes of the present location

These factors do not describe the characteristics of the current location, but indicates the type and magnitude of changes in the firm and/or location that may lead to a decision to relocate. Two factors play a role: potential location stress and the need for revitalization. The potential location stress looks at possible changes which might affect the suitability of the present location: growth of the number of employees, accessibility, increasing criminality, government policy with regard to the environment and spatial planning and the investment premiums and lower rents at another location. When firms indicate that revitalization is really necessary this may increase the likelihood of relocation, because it indicates that firm are not happy with the present location. (Van Dijk and Pellenbarg, 1999)

3.2.3. The location factors in the location decision of SMEs

The location factors can be divided into factors that describe the current location and the opinion about potential changes of the present location (Van Dijk and Pellenbarg, 1999). Table 3.5 summarizes the location factors that are part of the relocation decision for SMEs. Although the same location factors can be identified for both small and large firms, the importance and meaning of the factors in the location decision differ (Hanemaayer and Rekkers, 1998; Van Noort and Reijmer, 1999; Van Rijt-Veltman et al., 2002).

Location factors

Current Location (table 3.5) • Building and Site • Accessibility

• Other transport possibilities • Supplying companies • Knowledge potential • International orientation • Telecommunication

Opinion about changes in the current location • Potential location stress

• Need for revitalization

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3.3 Firm External Factors

The institutional theory starts from the assumption that economic activity is socially and institutionally situated which is shaped by institutions and value systems and not by firm behavior. Firm location behavior is the outcome of a firm’s negotiation with its networks and external environment (suppliers, government, labor unions etc.) (Brouwer et al., 2004). The institutional theory looks at the external factors that influence the location decision.

The business environment is the world outside the enterprise in so far as this has a relevant or determining influence on the functioning of the firm (Wissema, 1988). The environment is characterized by factors which influence the location of businesses. These external factors are of importance to the firm, but are not controlled by the firm (Van Rijt-Veltman et al., 2002). A common division of the environment is that of Lambooy, see figure 3.3. (Van Noort and Reijmer, 1999)

Figure 3.3 Internal and external environment - Market environment

The commercial relations which a business maintains with other parties in the market: relations with customers, banks, suppliers etc. Certain factors in the market or commercial environment influence the location decision, for example the supply market, labor market and competitors. - Physical environment

The physical environments consist of items as infrastructure, building and communication provision among others.

- Institutional environment

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Van Noort and Reijmer (1999) follow the classification of Lambooy for the external factors that are part of the location decision. The same classification of external factors is also followed by Van Rijt-Veltman et al. (2002). They argue that firms search for a location which meets the demands and requirements of the firm (the internal factors and location factors). This search process can be executed on three levels: national, regional and local. The authors distinguish the external factors in:

- Factors which are part of the commercial environment of the firm. - Factors which are part of the physical environment of the firm. - Factors which have an institutional character.

Van Rijt-Veltman et al. (2002) also argue that small- and medium-sized enterprises (SMEs) focus on daily activities and are less aware of the feedback from the external environment. Assessing the external factors in the location decision is therefore for SMEs very important. The difference between large firms and small firms is the influence of the firm on the environment. Vaessen (1993) distinguish 4 ways in which a firm can deal with the environment and its dynamic nature:

- Utilization: Firm uses the possibilities in the environment.

- Adaptation: Firm adapts to the shortcomings in the environment.

- Manipulation: Firm exercises influence on the policy of the government to improve the environment.

- Immunization: Firm makes itself immune or insensitive for the environment.

According to Vaessen (1993), large firms follow all the ways mentioned, but small firms will see the environment as given and will choose the way of adaptation to the environment.

3.3.1 The external factors in the location decision of SMEs

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Table 3.6 External factors of the location decision Source: Van Rijt-Veltman et al. (2002)

3.4 Which factors are part of the location decision of a manufacturing SME?

The first question can now be answered: Which internal, external and location factors are part of the location decision of a manufacturing SME? A summary is given in table 3.7. Although many factors can also be mentioned for large manufacturing firms. Several differences can be mentioned. First, the influence of the entrepreneur as part of the internal factors is taken into the analysis Van Rijt-Veltman et al., 2002). Second, the meaning of the location factors differs between large and small firms. Third, the way the small firms deal with its external environment is different. As mentioned by Vaessen (1993) and Van Rijt-Veltman et al. (2002), small firms deal with their external environment through adaptation. Large firms use different kind of ways to deal with their external environment: utilization, adaptation, manipulation and immunization.

Although the factors are treated in separate paragraphs, together they form the basis for the location decision and the criteria on which alternatives are evaluated. For example, when the company produces a product (internal factor) that requires a regular supply of raw materials from its suppliers (external factor: market environment), accessibility (location factor) is important.

External location factors

Market/Commercial environment • Market • Labor market • Competitors Physical environment • Geographic position • Issue of ground

• Supply of commercial properties • Image municipality

Institutional environment • Advice

• License/subsidy

• Presence of other organizations • Political climate

• Complementary companies • Real estate

• Supply competing municipals • Living environment • Infrastructure • City management/maintenance/renewal • Tax climate • Regional networks • Organization of municipality.

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Internal factors Location factors External factors

Corporate environment • Corporate strategy • Size of company • Geographical range • Sector/branch • Product/Service • HRM (Labor)

• Production (factors and process)

• Financial factors (Capital) • Communication/ICT • Strategic Resources and

Competitive Advantage Personal environment (of entrepreneur) • Personal aspirations • Cultural beliefs • Mental maps

Current Location (table 3.3) • Building and Site • Accessibility • Other transport possibilities • Supplying companies • Knowledge potential • International orientation • Telecommunication Opinion about changes in the current location

• Potential location stress • Need for revitalization

Market/Commercial environment • Market • Labor market • Competitors • Complementary companies • Real estate • Supply competing municipals Physical environment • Geographic position • Issue of ground • Supply of commercial properties • Image municipality • Living environment • Infrastructure • City management/ maintenance/renewal Institutional environment • Advice • License/subsidy • Presence of other organizations • Political climate • Tax climate • Regional networks • Cooperation between

public and private sector • Organization of

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4. Location Decision Process

The different factors influencing the location decision were given in the previous chapter. It is now time to look at the process that lead to the location decision thereby focusing on the decision process in SMEs. According to Pen (2002),

‘ the location choice is part of a strategic or long-term investment decision that is complex, uncertain, inherently subjective and conducted by individuals or groups of decision makers with multiple goals’. The location decision process is part of the strategic decision making process of the firm. But according to Van Noort and Reijmer (1999), SMEs have a short term time-view and are less concerned with strategic issues, like location decisions. According to Gibcus et al. (2004),

‘strategic decisions are crucial to the viability of firms and are defined as intentional choices or programmed responses about issues that materially affect the survival prospects, wellbeing and nature of the organization. They guide the organization into the future and shape its course.’

It follows that the location choice is complex, uncertain and subjective. Decision makers will influence the decision making process to advocate their own goals. The location decision is a strategic decision in that it will influence the survival, wellbeing and the future of the firm.

4.1 Decision makers in SMEs

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Variable Definition

Frequency of decision-making: The number of decisions that the entrepreneur has taken in the last three years.

Independence: The entrepreneur was influenced by other persons (like employees, family or business contacts) in his/her decision-making process.

Confidence: The entrepreneur was (very) convinced about his/her decision.

Ambition: The entrepreneur had at the moment of the interview new ideas or plans that possibly will lead to a new (radical) decision.

Information Search: The entrepreneur searched for information.

Consideration of other possibilities: The entrepreneur considered other possibilities or alternatives.

Risk taking propensity: The entrepreneur dealt with risks.

Problems/bottlenecks: The entrepreneur encountered problems or bottlenecks during his decision-making process.

Economic situation: The entrepreneur was influenced by the economic situation when making his decision.

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4.2 Location decision process

Because this paper concerns the decision making process that leads to a location decision, the location decision process should also be identified. The decision process is executed by the decision makers. Pen (2002) identified the most frequent used decision phases in the strategic decision making process:

1) Identification: Opportunities, problems and/or crises form the reason for the decision making process.

2) Diagnosis: Acknowledge and formulation of problem and start of the decision making process.

3) Search: Collecting of information and the processing of reactions. 4) Development: Development of solutions and alternatives.

5) Evaluation: Comparison of different solutions. 6) Strategy: Choosing optimal strategy.

7) Implementation: Final decision and execution of location strategy.

Pen further develops a decision model for the relocation of firms. He identifies the following phases: 1) Exploration; 2) Awareness; 3) Search; 4) Negotiate; 5) Evaluation; 6) Evaluating relocation strategy; 7) Choosing of strategy; 8) Building and moving to new location; 9) Evaluation and monitoring. Another model for the location decision process, but for manufacturing firms, is given by Lloyd and Dicken (1977). Their model is presented in Appendix A. A stimulus takes place which will press the firm to make a decision with regard to the location and to define the nature of the problem. This can be compared with the first phase of exploration of Pen: opportunities, problems and/or crises are in place that causes the firm to start the decision making process. When the difference between the expectation and the experience of the functioning of the firm is greater than the company is willing to bare, the firm will search for a satisfying solution. Or as in the model of Pen, the firm acknowledges and formulates its problem and becomes aware of the location problem. The firm will search for a suited solution. In this stage the firm will collect information about possible solutions. According to Lloyd and Dicken (1977), the first solution is to solve the problem is to use similar solutions that were used before. When the solution is not satisfying or does not resolve the problem, the firm can choose a trail-and-error strategy or imitating behavior of other decision makers with similar problems. Eventually there is a negotiation and evaluation of the consequences of the alternatives and solutions: the different location strategies will be evaluated. Because of the time problem, decision makers will in general not investigate all the alternatives forehand. When the strategy is evaluated, the decision makers need to choose a strategy. Lloyd and Dicken formulated general strategies for a manufacturing firm. The strategies are:

- Relocate entire unit.

- Retain existing location and open branch unit.

- Expand at existing site.

- Adjust in situ by input substitution. - Engage subcontractors.

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The firm then needs to execute this strategy and still needs to monitor and evaluate the strategy that will be chosen. When the firm decides to relocate, the locational requirements need to be specified. Information need to be collected about different locations and the firm needs to search for the best location. The firm evaluates locations according to the fulfillment of the locational requirements. The firm further evaluates and searches for the best location and finally chooses the location for the future operations. The building and moving process will be started with finally the physical relocation of the firm. After the relocation the firm still needs to monitor and evaluate the relocation and the firms’ environment. An underlying assumption of the model of Lloyd and Dicken is that the company has one location.

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5. Location Decision Model for SMEs

In this chapter the literature in the previous chapters will be integrated into the location decision process model. Pen (2002) investigated the different phases of the location decision process. He interviewed several firms that had made a location decision and identified the phases in their process. His division of location decision phases is also followed here, because it is a good way to structure the location decision process. Lloyd and Dicken (1977) looked at the factors that can influence and are part of the location decision: external, internal and location factors, which were described in chapter 3. They also provided different location strategies for a manufacturing firm. These elements are integrated in the location decision process model in figure 5.1. In the decision process, the external, internal and location factors play an important role. For example, in the exploration phase the location problem(s) need(s) to be identified. The problem can lie in one or more of these factors. Further, in the search phase these factors also play an important role when information need to be collected about the factors that play a role in the location decision. In the evaluation phase the location strategies of Lloyd and Dicken (1977) are evaluated based on the information about the external, internal and location factors.

The model deals with specific characteristics of SMEs with regard to their larger counterparts. First, the model deals with the differences in the decision process. As said earlier, SMEs have less information available in the decision making. The model provides a way to collect information about the different factors that play a role in the location decision. According to Gibcus et al. (2004), SMEs also develop thumb-rules and standard procedures. The location decision is not a standard decision and cannot be solved by thumb rules. For SMEs the model provides a solution for this way of decision making. Second, in the internal factors the role of the entrepreneur and its personal environment is taken into account. The entrepreneur plays an important role in the decision making in a SME and also in the location decision. Personal motivations and preferences can further play a role in the location decision. Third as concluded in 3.4, the meaning of the external, location and internal factors in the location decision differ between large firms and SMEs.

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The model is developed for a manufacturing SME, in that way that the alternatives that are evaluated in the fifth phase are developed for manufacturing firms. The different phases of the location decision process will be described.

5.1 Exploration

In the first phase the firm starts to explore the nature of the location problem. A stimulus leads the entrepreneur and decision makers to start the location decision process. The stimulus of the SME is the point where the location problems are influencing the operations and profitability of the firm. The firm needs to identify the cause of the problem which can lie in the internal factors of the firm (the location does not fulfill the internal requirements of the firm), the location factors (the characteristics of the location) and/or the external factors which can be divided into the institutional, market and physical environment. In Appendix B a summary of the most frequent causes of relocation among 1.098 Dutch firms investigated by Pen (2002) is given. The location problems in general concern the building, organization or environment.

5.2 Awareness

When the firm has formulated the nature and cause of the location problem, the firm and its decision makers become aware of the problem and will see the necessity to find a solution. The location decision is often not seen as a strategic decision by SMEs and it is therefore important that all decision makers are aware of the problem. The location decision should become part of the strategic plan of the firm, because the location decision influences the long term operations and profitability of the firm.

5.3 Search

The firm needs to collect information about the internal, external and location factors. The factors that play an important role in the location decision need to be identified. Table 3.7 can be used to identify these factors. As part of the internal factors, the strategic resources should also be identified. How to conduct this analysis is already shown in 3.1.1. The analysis of these factors will give further information of the factors influencing the location decision. Further information should be collected about the long term trends and developments of the location problems.

5.4 Negotiate

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5.5 Evaluation

In general, SMEs choose the strategy of adaptation to the environment (Vaessen, 1993) to resolve problems. But the moment can be reached where adaptation is not possible anymore. The SME needs to evaluate other alternatives and ways to solve the location problem. A decision has to be made if it is possible to maintain operations at the current location or if it needs to move to another location. Lloyd and Dicken (1977) formulate 5 possible location strategies/alternatives for manufacturing firms: Relocate entire unit; Retain existing location and open branch unit; Expand at existing site; Adjust in situ by input substitution; Engage subcontractors; Merge with or acquire another company. The first two strategies will result in a movement to another location which will lead to the search for alternative locations.

5.6 Evaluate location strategy

The decision makers should evaluate the alternatives based on the information about the location, internal and external factors. Second, the impact and feasibility of the alternatives should also be analyzed. The alternative should solve or find a way to manner the current problem for the long term. Also the alternative should benefit the functioning and profitability of the firm on the long term. Personal motives and goals of the entrepreneur and decision makers can influence this evaluation. Personal preferences can lead to a biased decision. All decision makers should carefully examine the underlying motives of every alternative and should collect information that support a given decision.

5.7 Choosing strategy

The firm should choose the location strategy based on the earlier evaluation. The decision makers should integrate the location strategy in their overall strategic plan of the firm. If the firm chooses to relocate than the locational requirements should be formulated. The formulation of the locational requirements forms the transition to the search phase of an alternative location. The search process can either be a “systematical search” or a “search on the basis of knowledge and experience”. The process ends with an evaluation of alternatives in terms of location requirements.

5.8 Execution of strategy

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5.9 Monitoring and evaluation

When the firm has executed its location strategy, the firm still needs to monitor and evaluate its strategy. New problems can arise and old problems can still exist. Monitoring will never stop, because the environment is dynamic and never stands still.

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6. Location Decision Model of Latexfalt bv.

The location decision model was presented in the previous chapter, the model will now be applied to Latexfalt bv. located in the Netherlands that will serve as an example for other firms who will apply the model in their location decision process. As said, the location decision process will be the same for the SMEs that follow the model, but the role of the external, internal and location factors in the location decision will be different for every SMEs. This mainly is the result of the complexity and diversity of the location problem. In that way, one can wonder if it is necessary to provide an illustration of the location decision model. In my opinion, it is useful to provide an example to other SMEs on how to conduct the analysis and to apply the model. The illustration will give more insight into how a SME can use the location decision model in their location decision. For Latexfalt it is shown that it is an useful tool to structure their location decision.

6.1 Latexfalt bv.

Latexfalt bv. is located in Koudekerk aan den Rijn (Zuid-Holland, Netherlands). The economic activity of the Netherlands in centered in the west part of the country, where Latexfalt is also situated. The company is situated on the border of industrial area Hoogewaard part of municipality Rijnswoude. Latexfalt produces bitumen for production of asphalt, hot and cold binders for surface dressing, colored bitumen emulsions (for example for colored bicycle paths), joint fillers and industrial floors. The company had a turnover in 2007 of an approximately € 30 million, a balance sheet total of € 10 million and 75 employees and can be classified as a medium-sized enterprise (European Commission, 2006).

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Latexfalt bv. is a merger of Vauatol, Cindu, NWM and Latexfalt and current shareholders are three big construction companies in the Netherlands: Heijmans, BAM and KWS .The initial name of the merged company was Vauafalt, but the company later decided to use the name Latexfalt. Each of the merged companies had 50 years of experience with bitumen and emulsions for construction and road applications before they were merged. The company is current located across the road where formerly the old Latexfalt factory was located. The firm operates at this location since 1996.

For the data collection the management team of Latexfalt bv. was interviewed. The interview list is presented in Appendix C. The management structure and background information is given in Appendix E. The management team of Latexfalt consists of:

- Bert Jan Lommerts General Manager

- Jan Struik Sales Manager

- Marco Alderlieste Manager Finance, IT and Planning & Logistics

-

Jan van Dam (contact person) Manager Production and Technical Support

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7. Decision process of Latexfalt bv.

The general decision process of Latexfalt will be analyzed according to the different variables mentioned by Gibcus et al. (2004): frequency of decision making, independence, confidence, ambition, information search, consideration of other possibilities, risk taking propensity, problems and bottlenecks and finally the economic situation. Also the individual decision makers will be analyzed according to these variables. The management team were asked to score the general decision making process and the other management team members on every dimension with a scale varying from very low/low/medium/high/very high. An evaluation of every dimension will be made how the general decision process of Latexfalt takes place and what the role of every decision maker is. In this way it becomes clear how the decision maker function in the general decision making and is expected to act in the location decision process.

The analysis serves as an illustration for other SMEs. By conducting the same analysis as Latexfalt, the characteristics of the overall decision making process become clear, as well as the characteristics of the decision makers. It then becomes clear to which aspects the decision makers should pay attention. For example, when the SME normally have a low amount of information search, they should be aware of this point in the location decision process. They need to intensify their information search and do not easily say that enough information is available. Also a low consideration of possibilities can lead to a “tunnel vision” where the optimal solution may not even be considered. The same can happen with a high ambition level.

7.1 Frequency of decision making:

High

The management team meets every two weeks. Strategic decision making is conducted by the management team, although it is mentioned that the decision making of operational and strategic decision is intertwined. It is therefore not surprisingly that the decision making focuses on both the long (strategic) and short (operational) term, but the focus in the management team resides more and more on strategic and long term decision making. Decisions on both operational and strategic front are often being made by the management team and are therefore viewed as high.

Each management team member is characterized as a decision maker that makes often decisions. Apparently this leads to a high frequency of decision making within Latexfalt.

7.2 Independence in decision making:

Low

Personal motives are viewed to sometimes play a role in the decision making of Latexfalt. The responsibility to the department can be a major influence. Other influences in the decision process are the internal factors, like the goals of the organization, which is found to always influence the decision making, and the commercial environment; customers, competitors and suppliers; also influence the decision process. The institutional relationship plays a less important role in the decision making.

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making. But although this high independence of the decision makers, the decision of the management team as a whole is characterized as low.

7.3 Confidence in the decision making:

High

In general can be said that all managers support and are convinced of the decisions being made in the management team. Sr. Lommerts addresses that although a consensus is reached, some management team member(s) maybe not be entirely convinced. But the management team is open for discussion and other opinions.

7.4 Ambition:

Very high

New ideas and possibilities are already identified and the ambition of Latexfalt can be qualified as very high. The long term strategy is aimed at broadening of the market, product and knowledge. Latexfalt is aiming at all three basic capabilities of competitive advantage identified by Rangone (1999). The risk of this strategy is that neither capability is fully developed and Latexfalt is not able to compete successfully with other firms. Although the ambition level is very high, it can negatively influence the competitive advantage of the firm.

The ambition level of the decision makers of Latexfalt are above average, new, radical and innovational ideas and possibilities are already developed in the minds of the decision makers. The ambition level of Sr. Lommerts and Sr. Struik are high, Sr. van Dam and Sr. Alderlieste have an average level of ambition.

7.5 Information search:

Medium

When needed both internal and external information sources will be used in the decision making. Examples of these sources are experts and advisors with (specific) knowledge. These experts are attained internally and externally. Documents and reports are also used, but in less amount. The management team looks for information when their own knowledge is not sufficient. Because the perceptions of the decision makers in SMEs is often characterized as biased and a great influence of own personal motives and goals, the management team of Latexfalt uses more information sources to come to a well-informed and unbiased decision when their own knowledge is not sufficient. The individual search of information in the decision making can also be characterized as above average. Sr. Lommerts is viewed to look for the most information in his decision making, followed by Sr. Alderlieste and Sr. Struik and Sr. van Dam.

Location Decision in SMEs

Location Decision in SMEs

A model for the location decision of small- and medium sized

enterprises applied to Latexfalt bv., the Netherlands

Location Decision in SMEs

Summary

Table of Contents

1.

Introduction

1.1 Why a location decision model for SMEs?

1.2 Problem Statement and Research Question

2. Location Theory

2.1 Classical Location Theory

2.2 Neo-Classical Location Theory

2.3 Behavioral Location Theory

2.4 Institutional approach (Geography of Enterprises)

2.5 Integration of Location Theories

3. Location Decision Factors

3.1 Firm Internal Factors

3.2 Location Factors

3.3 Firm External Factors

3.4 Which factors are part of the location decision of a manufacturing SME?

4. Location Decision Process

4.1 Decision makers in SMEs

4.2 Location decision process

5. Location Decision Model for SMEs

5.1 Exploration

5.2 Awareness

5.3 Search

5.4 Negotiate

5.5 Evaluation

5.6 Evaluate location strategy

5.7 Choosing strategy

5.8 Execution of strategy

5.9 Monitoring and evaluation

6. Location Decision Model of Latexfalt bv.

6.1 Latexfalt bv.

-

7. Decision process of Latexfalt bv.

7.1 Frequency of decision making:

High

7.2 Independence in decision making:

Low

7.3 Confidence in the decision making:

High

7.4 Ambition:

Very high

7.5 Information search:

Medium

7.6 Consideration of other possibilities:

Medium