Christian Ketels: Location, location, location
Location is again high on the agenda of business leaders worldwide. General Motors reviews which sites to keep in Europe, pitching Germany’s Rüsselsheim against Sweden’s Trollhättan. CNN’s Lou Dobbs runs a series identifying US executives who “Export America” by moving jobs abroad. These stories are consistent with one world view: all jobs are inevitably moving to low-cost locations, especially China. And, yes, China surpassed America as a recipient of foreign direct investment (FDI) in 2004.
But a closer look at the evidence suggests that the situation is more complex. Two-thirds of all FDI still goes to advanced economies. China’s lead in global FDI inflows owes more to a dramatic drop in investment into America than to an increase in FDI into China. International companies still have much larger activities in advanced economies than in developing/transition economies. Many companies that have moved operations to China and other low-wage countries for cost reasons alone find the experience disappointing. Finally, we also see companies from China and India going the other way, buying up companies in developed countries to gain direct access to new markets and technologies.
What is happening? Companies clearly have more choices than ever before when deciding where to place operations or where to source products and services. The business environment has been improving in many countries and the legal framework for foreign investment continues to improve worldwide. Competition among locations is rising, and this is good news for executives pondering where to put a new plant or office. At the same time, companies are being increasingly scrutinized for the location decisions they make. On the one hand, financial markets have to be convinced that corporate leaders fully exploit the potential of new locations, while executives also have to deal with pressure groups, politicians and non-governmental organizations and their criticism about jobs losses at home and the setting up of “sweatshops” abroad.
Companies don’t make location choices lightly. Most companies take decisions about where to put which type of activity at the most senior management level. They spend a lot of time and money learning about new investment locations. An increasing number view location choice as being not only about increasing operational efficiency but also about strengthening strategic uniqueness. Some businesses have made location a permanent agenda item, not an infrequent topic once new plants have to be placed. There are three levels of analysis: drawing up a location short list; picking the one that fits your company, and making the optimization of locations a continuing task.
Drawing up the short list
Finding locations that qualify for the type of activity a company needs to place can be a challenging task. Although there is abundant information on a country’s general business context – for example, the general macroeconomic climate, the political, social, and legal conditions, the tax rules – it tends to be much harder to find information about more concrete microeconomic factors. The Business Competitiveness Index (BCI), written by Michael Porter, my colleague at Harvard Business School, and based on his work on company strategy and country competitiveness, addresses this gap by reporting the results of a survey of about 8,700 business leaders on the quality of the business environments and the sophistication of companies in more than 100 countries.
America, after trading places with Finland again, topped the 2004 BCI country ranking: Overall, America provides the best conditions for high productivity. Finland and Germany are ranked second and third, followed by a group of another four advanced economies (Sweden, Switzerland, Britain and Denmark) with a very similar overall level of business competitiveness. The first medium-income country is Malaysia, at 23, ahead of many more prosperous economies such as Italy, Spain, and Greece. The highest-ranked low-income country is India, at 29, with an impressive evaluation even though it is likely to be biased upwards by the conditions in the country’s most developed regions.
Indonesia, Japan, Romania, and Hong Kong registered the biggest improvement in competitiveness from 2003 to 2004. For Indonesia this absolute gain resulted in a jump of 18 places, for Japan just five places; while many low- and medium-income economies offer conditions that are very similar, differences tend to be larger among the most advanced economies. Italy, Vietnam and Latvia lost the most ground. In Italy’s case, there was a dramatic loss of confidence, while Vietnam and Latvia dropped back after strong improvements in recent years.
The BCI indicates the level of productivity that is sustainable in an economy on average. By transferring its own skills and knowledge the company might, of course, be able to do much better. But the BCI survey makes it plain to executives that they will have to work out a clear strategy if, for example, they are to achieve productivity levels in China that are more impressive than its current BCI ranking of 45.
Two-thirds of the multinational companies interviewed annually for the World Investment Report about their motivation for investing abroad cite the need to reduce costs. Clearly, they are not merely concerned about costs – otherwise sub-Saharan Africa would be the prime target for investment – but about costs relative to the level of productivity that can be reached. Again, the BCI can help. Some countries have improved their competitiveness much more than overall prosperity and wage levels have risen. Comparing a country’s BCI rank with its wage costs or, as a first indicator, its income per head, can help companies to identify locations that are relatively low-cost, that is, provide a better ratio of conditions for productivity versus operating costs.
Countries that the BCI suggests might be in this position include Malaysia, China, India, Indonesia, Jordan, Morocco, and Tunisia. They all report a level of prosperity in the country significantly below the conditions they provide for productivity. Among high-income countries, Finland, Britain, New Zealand, and Singapore fall into this category as well. Sweden and Germany also report a gap between prosperity and competitiveness but in these cases prosperity seems to suffer from such structural conditions as tax and labour market inflexibility, rather than low wages.
Locate to fit
Many like to draw an analogy between business and sports: both reward exceptional performance and your actions are the key determinant of how well you do. But while the analogy is often instructive, it can also confuse. In sport, there is only one winner. Therefore, it might be natural think that there is a single “best” location But business is different; choosing the race – and the location – that plays to your strengths is a large part of winning.
The decision of BMW and Porsche to locate big new plants in Leipzig, in eastern Germany in the former German Democratic Republic, is a good example. They made these commitments when many other car companies were moving to the central and eastern European countries that joined the European Union in May 2004, especially the Czech Republic and Slovakia. A key factor in both cases was that the German location matched both marques’ luxury positioning.
Although there is no location that is best for everyone, there will be one that best fits the demands of an individual company given the activity it needs to perform, be it research and development, production, assembly or sales, and, at least as important, its strategic positioning. Consistent location choices can only be made after a company has set its strategy; what customers it wishes to serve, and how. Location is a big part of the “how”. Locations differ in the qualities they provide in terms of customers, employee skills, suppliers, infrastructure, research assets, and so on, and thus have an important influence on the type of unique value companies located there can provide to their customers.
America, for example, does very well in such areas as technology, top-level talent, advanced capital markets, clusters, and the intensity of competition. It provides much less favourable conditions in such areas as basic human resources, and physical and administrative infrastructure. Comparing it with China, a country with lower rankings on virtually all indicators measured in the BCI, is particularly interesting. Relative to its overall quality, China is strong in clusters, technology and the intensity of competition, while lagging in capital markets, top-level talent, incentives, and physical infrastructure.
Therefore, for any activity, it becomes a question of which particular qualities your company requires relative to costs.
Investment begins at home
Moving your entire company – or even important parts of your value chain – to new locations is an infrequent event for most companies. But more and more executives have started to address location, not just in the context of relocations, but as part of their ongoing improvements to company operations.
Company success is driven not just by what you do, but by the context in which you operate: that is why location is so important. Therefore, investing in the quality of your home environment might be as profitable as buying a new machine or providing a new training programme.
New behaviour is often a reaction to external pressure. For such companies as Dow Chemical, the lack of economic dynamism and effective regional policy at its Leipzig location threatened to undermine the long-term sustainability of its multi-billion dollar investments. Dow Chemical executive Bart Groot brought together an alliance of business people to work with government agencies to improve the quality and attractiveness of the region. US Steel was drawn into similar efforts after investing in a new market. The giant steelmaker realized that the value of its investment in Slovakia depended on higher standards of corporate governance, not only within its own operation but also among its suppliers in the region. So, it embarked on a public campaign to push such reforms among current and prospective business partners.
While globalization has quite clearly changed the role of physical distance, it has not made location less important. In fact, the opposite seems closer to the truth: location has become one of the important choices companies make.
Christian Ketels
Christian HM Ketels is a faculty member at Harvard Business School and principal associate at Professor Michael E Porter’s Institute for Strategy and Competitiveness. He is currently a senior research fellow at the Institute of International Business (IIB) at the Stockholm School of Economics and is executive director of the foundation “Clusters and Competitiveness,” a not-for-profit organization located in Barcelona.
