Journal of Corporate Real Estate

Cost-reduction location strategies

Roel Spee Wim Douw
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Roel Spee Wim Douw, (2004),"Cost-reduction location strategies", Journal of Corporate Real Estate, Vol. 6 Iss 1 pp. 30 - 38
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 Journal of Corporate Real Estate Volume 6 Number 1
Downloaded by University of Sri Jayewardenepura At 21:33 03 September 2016 (PT)
Journal of Corporate Real Estate
Vol. 6 No. 1, 2003, pp. 30–38.
䉷Henry Stewart Publications,
1463–001X
Page 30
Cost-reduction location strategies
Roel Spee* and Wim Douw
Received (in revised form): 24th September, 2003
*IBM Business Consulting Services-Plant Location International (IBM-PLI), Woluwedal
22, 1932 Sint-Stevens-Woluwe, Belgium; Tel: ⫹32 2 416 5928; Fax: ⫹32 2 416
5451; e-mail: roel.spee@be.ibm.com
Roel Spee is an associate partner with IBM-PLI,
the key practice within IBM Business Con-
sulting Services (and previously PwC Consult-
ing) for global location strategies. Roel has 16
years of experience in advising corporate execu-
tives where to locate businesses around the
world. He has advised more than 200 com-
panies on these strategic location decisions. He
also advises economic development agencies
on how to improve their marketing strategies,
organisations, etc in order to attract new cor-
porate investment projects. Roel leads IBM-
PLI’s key practice for EMEA and Asia-Pacific,
and is responsible for global coordination with a
second key practice for the Americas. He is a
recognised speaker at industry events on site-
selection and location-strategy matters.
Wim Douw is a senior consultant with IBM-PLI,
with seven years’ experience in advising cor-
porate and agency clients on location strategies.
His experience includes location strategies for
companies in Europe and Asia-Pacific, as well
as advice to governmental agencies in Europe,
the Middle East, Africa and Asia-Pacific. He can
be contacted by telephone on ⫹32 2 416 5407;
and e-mail on wim.douw@be.ibm.com
ABSTRACT
Increasing competition in the market causes
continued pressures for many companies to
control or reduce costs. This has led to various
responses by companies to seek more efficient
operating models, in which the location where
activities are performed has become a key
determinant. The fast pace at which many
low-cost regions are developing into acceptable
business environments has offered enormous
opportunities for companies to change their
geographic network of operations. The result
is an ongoing shift of activities from well-
developed, but high- cost areas to low-cost
locations elsewhere in the world. This paper
describes the relocation trends in the last decade,
the drivers for cost reduction and the responses
of companies. A location evaluation approach
is described which helps to understand the cost
and quality of doing business in various
locations. Typically, there is a trade-off between
those two dimensions: low-cost locations offer
lower quality, whereas higher-quality locations
are more expensive. The challenge for com-
panies aiming at cost reduction is to identify
those locations where costs are low and quality
is at an acceptable level.
Keywords: relocation, location analysis,
business environment, cost reduction,
methodology, site selection
INTRODUCTION
Companies seeking opportunities for
cross-border investment are driven by a
variety of factors. The following
classification of these drivers has been
developed particularly for manufacturing
investments, but to a certain extent the

drivers apply to investments in services
activities as well. Each individual
company investing in new operations
abroad will probably recognise itself in
one of the following categories of foreign
direct investment (FDI):1
• Natural resource seeking FDI: to gain
privileged access to resources vis-à-vis
competitors (eg primary industries,
export processing, labour-intensive
processes)
Downloaded by University of Sri Jayewardenepura At 21:33 03 September 2016 (PT)
• Market-seeking FDI: to protect existing
markets, to counteract behaviour of
competitors, to preclude rivals or
potential rivals from gaining new
markets
• Efficiency-seeking FDI: as part of regional
or global product rationalisation and/or
to gain advantages of process specialisa-
tion
• Strategic asset-seeking FDI: to strengthen
global innovatory or production com-
petitiveness; to gain new product lines
or markets (this type of FDI is
dominated by merger and acquisition
activity)
• Trade and distribution-driven FDI: either
as entry to new markets or as part of
regional or global marketing strategy
(proximity to subcontractor or final cus-
tomer required).
Historically, most investments — par-
ticularly in the developed economies of
North America and Europe — were
predominantly driven by the above-
mentioned market and/or strategic asset-
seeking FDI. Well-developing companies
at some point in their growth stage made
the step to expanding their operations
into markets where they already had
strong sales (through exports) and which
required a presence in or close to those
markets. The typical process of setting up
sales and marketing, distribution and then
manufacturing operations in those markets
Spee and Douw
applies to many internationally operating
companies.
A combination of technology improve-
ments, strong economic growth, further
international expansions and globalisation,
increased merger and acquisition ac-
tivity and subsequent corporate restruc-
turing activity has resulted in very high
(re)location activity in the last decade.
The opening up of previously un-
developed areas or highly protected
markets, and the fast path of improve-
ments in those markets have given
international investment a further boost.
Countries and regions such as India,
China and Central and Eastern Europe
have attracted large numbers of invest-
ment projects in the past ten years; new
locations (Russia, South Africa, etc) are
continually being added to this list.
Besides the fact that these regions offer
a large potential market for many com-
panies (if not in the short term, because
of still low purchasing power, then at
least in the long term), a key attrac-
tion is the very low cost of the busi-
ness environment. Figure 1 gives an
indication of the huge cost differential
that exists between some of the leading
economies and a variety of low-cost
countries around the world.
In the most recent years, a variety of
factors and events have caused a major
change in the global investment pattern.
The economic slowdown, starting at the
end of 2000 or beginning of 2001, caused
a strong reduction of international invest-
ment activity. Although this was originally
focused on the ICT sector — telecom-
munications in particular — it began
a period of economic uncertainty in
other industries as well. The September
11th terrorist attacks and their im-
mediate economic implications (interna-
tional travel) as well as the subsequent war
against terrorism, led to continued hesita-
tion among companies for further invest-
Page 31
 Cost-reduction location strategies

Figure 1 Hourly 100

manufacturing 81
63 67
labour costs 2002 56
(in indices, based 33
22 26
on US$) 15 16 19 19
6 11 11 11
3 4

e
na

a
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ue

do
an
hi

at
iw
rk

nt

ap
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tn

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Af

rtu

m
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(R
ez

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er
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Source: IBM-PLI, 2003
Downloaded by University of Sri Jayewardenepura At 21:33 03 September 2016 (PT)

ment. Lack of consumer confidence and operations are outsourced to a service

continuing terrorism activity and military provider.
conflicts have caused the economy not to
recover until today, although isolated Outsourcing
positive signals could be noted over the Many companies had already started out-
past 6–12 months. sourcing non-core functions more than
All these events led to increased a decade ago. Initially this concentrated
competition in tightening markets, which strongly on distribution and manufactur-
caused many companies to review their ing or assembly activities, but over the
operations to become more efficient and years many services activities, such as call
seek opportunities to cut out costs where centres and various types of shared-serv-
possible. Especially for multinational com- ices centres, have also been outsourced.
panies who had, organically or through Various companies have also begun to
mergers and acquisitions, grown to mas- outsource R&D-related activities (for ex-
sive organisations with many operations ample, clinical trials or product testing).
and large numbers of staff, there was no Key advantages of outsourcing are a
escape from serious cost-cutting initia- stronger focus on core competences;
tives, in order to keep financial results reduction of internal headcount; higher
and shareholder satisfaction at acceptable flexibility in adapting to changes; and cost
levels. efficiencies. Since the service providers
are commonly able to achieve economies
of scale and efficiency improvements, this
COST-REDUCTION STRATEGIES leads to lower costs for the user of the
As far as corporate location implications outsourced activities. Costs also become
are concerned, solutions sought to reduce more predictable, since outsourcing allows
costs can be grouped in the follow- for upfront negotiations on the prices of
ing three categories: outsourcing con- services to be provided.
solidation of operations; and relocation of The outsourcing industry has become
operations to lower-cost locations. These very mature; key players — such as
initiatives also regularly occur in com- Flextronics and Solectron in electronics
bination: for example, relocating activities manufacturing, or Sykes, Sitel and Tele-
to a lower-cost environment where the tech in the call-centre industry — have

Page 32

developed into global operating com-
panies. From a location strategy point of
view this offers the flexibility to perform
tasks in various locations, depending on
the need to be close to markets (for
example, distribution activities), to have
access to resources (for example, IT
services), and to operate at low costs
(which applies for many of the outsourced
manufacturing and service activities).
Many service providers have moved
strategically to low-cost regions such as
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China, Mexico, India and Central Europe,
to be able to deliver their services at the
lowest cost possible. Because of fierce
competition in these markets, they are
continuously looking to reduce costs fur-
ther and consequently moving to the next
tier of low-cost locations. Various contract
manufacturers have already moved opera-
tions from Central Europe to Eastern
Europe or Asia for that reason.
Physical consolidation
This solution is frequently chosen by
companies who have experienced a
quick increase of similar operations in
one specific market, where those ac-
tivities need to take place physically in
that market. Front offices with cus-
tomer-facing activities such as sales and
marketing, dispatch services, or high-end
customer services make a good example.
These operations need to stay relatively
close to their market and are difficult to
relocate at large distances (internationally)
without high risks.
In those situations where many such
similar operations exist in one market,
companies seek opportunities to con-
solidate these into one or a few locations.
Although virtual consolidation has be-
come technically feasible, a physical
consolidation still offers additional cost
savings from a real estate perspective
(better use of less space) and a human
resources perspective (economies of scale
Spee and Douw
offer opportunities for headcount reduc-
tion).
In identifying where to consolidate
operations, a key factor to consider is that
key staff can be retained and new staff
with the right skills can be sufficiently
recruited. Frequently, these consolida-
tions are implemented in a very short
term, making the availability of property
another important driver for the location
selection. Most often, companies prefer to
consolidate operations in one of their
existing sites, rather than moving all
operations to one new (greenfield) loca-
tion.
The financial benefits of the consolida-
tion are obviously crucial to the deci-
sion whether and where to consolidate.
The operational costs in the various pos-
sible locations need to be considered first.
Main cost differences between locations
exist in wages and additional compen-
sation benefits, property costs, telecom-
munication costs, and (depending on the
geographical scope of the consolidation)
local taxes.
However, where consolidation takes
place, various existing sites will see
operations move to the newly selected
site, and some sites may even be closed.
This downsizing or closing of activities
leads to additional costs, which need to be
considered in the location evaluation as
well. Staff redundancy costs and lease
termination are some of the main costs to
consider. One should also be aware of
possible obligations to keep activities in a
specific location as a result of incentive
commitments made in previous years.
Moving away from such locations may
lead to repayment of incentives and
additional penalties.
Deciding where to consolidate opera-
tions is therefore not just a matter of
comparing individual locations according
to a set of criteria. The focus should be on
developing the most realistic scenarios for
Page 33
 Cost-reduction location strategies
the consolidation and preparing a full
financial business case for each scenario, in
which both the one-time costs (invest-
ment in the new locations and closure
or downsizing of other locations) and
the ongoing cost implications (increased
operational costs in the new locations, and
reduced costs in the other locations) need
to be considered. The results can be quite
different from case to case.
Relocation
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As indicated earlier, a wave of relocation
of activities started a decade ago when
low-cost locations in Asia and Eastern
Europe opened up their territories for
inward investment and companies quickly
discovered that a variety of operations
could be carried out in those locations at
an acceptable risk.
Meanwhile, a massive number of com-
panies have shifted activities to countries
such as India, China, Mexico, Poland,
Hungary, or the Czech Republic. Initially
mainly manufacturing and assembly ac-
tivities were relocated, but more recently
companies have learned that various
services activities can be successfully
transferred to some of the low-cost
locations too. India and the Philippines,
for example, have already attracted many
back-office operations of multinational
companies, such as data processing for call
centres.
Data from IBM-PLI’s Global Invest-
ment Locations database (GILD)2 show
that the developing world (which includes
most of the low-cost countries) is attract-
ing more manufacturing investments than
the developed world, while service ac-
tivities are also quickly increasing in the
developing countries (Figure 2).
COST–QUALITY TRADE-OFF
Although many emerging markets have
improved their business environment,
Page 34
moving to a low-cost location is not
completely without risk. Typically, lower-
cost locations still offer a lower quality of
business environment than the more
developed regions in this world. This
means that companies moving there will
have to compromise on the ease of doing
business and will have to accept some
degree of risk in the lower-cost locations.
At IBM-PLI, a location evaluation ap-
proach has been developed that allows
identification of the trade-off between the
cost and quality associated with operating
in a location. Figure 3 shows how loca-
tions can be benchmarked against each
other and plotted on a graph which shows
the sort of options that a company has.
The qualitative dimension summarises
to what extend the locations meet the key
qualitative (non-cost) location require-
ments for the activity in scope. Examples
of such requirements are: availability of
skills, flexibility of labour laws, quality of
infrastructure and political stability. In
recent years, security and safety fac-
tors (both business and personal) have
developed into key qualitative elements
considered by companies in their location
evaluations.
The second dimension relates to cost: it
summarises the financial attractiveness of
the locations. This attractiveness can be
quickly assessed by comparing the main
operational costs in the locations in scope.
Particularly for operations such as call
centres, shared service centres, or data
centers, which often operate as cost cen-
tres, a high- level comparison of the cost
drivers is sufficient to understand the main
differences between costs of doing busi-
ness in the selected locations. This should
always include labour costs as the key
cost driver for these operations, and may
additionally include property costs and
telecommunications costs, although these
are usually less crucial when defining a
relocation strategy.
 Spee and Douw

Manufacturing projects Figure 2

(by origin & destination, 2002) Cross-border
investment projects
To developed world between developing
1,200
countries (2002)
To developing world

1,000

800

600

400
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200

From developed world From developing world

Services projects
(by origin & destination, 2002)
To developed world
1,200
To developing world

1,000

800

600

400

200

From developed world From developing world

Source: IBM-PLI, Global Investment Location Database (GILD)

For activities involving other important
cost factors (such as utilities and logistics
costs) and operations running as a profit
centre (where taxes play a major role)
these factors must be assessed as well.
The advantage of the cost–quality
analysis is that it very clearly, and visually
recognisably shows the trade-off between
the two dimensions. High-quality loca-
tions are typically higher-cost locations,
whereas the lower-cost locations mostly
score more weakly from a qualitative
point of view. It is not common for
locations to offer a high-quality–low-cost
solution, although this does occasionally
happen (for example, Dublin until five
years ago for call centres).
The sorts of solutions that companies

Page 35
 Cost-reduction location strategies
Figure 3
Cost–quality map
Quality index
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Cost index
Existing locations
Greenfield locations
are looking for differ according to the
specific activity and its requirements. A
research and development centre, for ex-
ample, is likely to have a stronger focus
on the high-quality solutions and to ac-
cept the higher cost associated with those
locations.
In most cost-reduction strategies where
companies are considering relocating ac-
tivities to low-cost locations the objective
is to identify those locations that are
(very) low cost that offer an accept-
able quality of business environment. The
cost–quality analysis allows identification
of such solutions, both on the basis of
their overall position on the cost–quality
map and on the underlying key criteria,
which may reveal individual ‘showstop-
pers’ despite reasonable overall qualitative
rankings.
An important note is that this approach
has been developed with the sole ob-
jective of identifying quickly the best
Page 36
Ideal
strategic location options offering the kind
of business environment that a company
is seeking, given its specific requirements.
The approach is not appropriate to draw
a final conclusion on which location to
select. The key objective of the cost–
quality approach is to understand the
trade-offs between cost and quality in
the various location options, in order to
decide which locations best seem to fit
into the overall corporate strategy. Field
validation is then needed to assess the
dynamics and possible future risks in those
locations, before making a final deci-
sion where to (re)locate the operations in
scope.
LOCATION SELECTION
Selecting a location for establishing busi-
ness operations is not an easy task.
Frequently, the misconception exists that
by screening a number of data on possible
 Spee and Douw

1. Define Project Assumptions and Longlist of Location Options Figure 4 Typical

location selection
2. Analyse Longlist of Candidate Locations
approach
Identify Shortlist

3. Evaluate Short listed Locations

Select Preferred Location

4. Due Diligence and Negotiations

5. Implementation
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location options, one can identify the
location that best meets the purpose.
However, in trying to assess the risks and
impact that certain locations have on the
overall corporate performance, data from
the past do not tell one enough. The
dynamics in business environment can
only be understood by means of valida-
tion in the field. As an example: one can
only develop a sound judgment on the
characteristics and trends in a labour
market by talking to companies and
organisations that are working in that
specific labour market, and can describe
the pitfalls, forthcoming changes, cost
developments and so on. Statistics from
the past cannot provide that insight.
The disadvantage of this field work is that
it is time-consuming and can be quite
costly, depending on which locations are in
view. Companies prefer to perform such
evaluations only for a small number of
promising locations, and therefore seek an
approach to select a ‘shortlist’ of the most
promising options in an efficient way.
IBM-PLI has developed a location
selection approach which takes companies
efficiently through a robust process of
selecting a shortlist of locations and then
concentrates on the few remaining can-
didate locations in the required level of
detail (see Figure 4).
In the initial phases a ‘longlist’ of
locations is quickly reduced to a shortlist,
taking into account the key location
drivers for the contact centre. The
locations on the ‘longlist’ are screened via
desk research, using in-house databases,
statistics and own experience, and scored
on all relevant location criteria.
This screening approach is similar to
the cost–quality methodology described
above, where the objective is mainly
to deselect locations which meet the
strategic objectives of the company less
well and to identify the most promising
locations for further consideration. The
objective at this stage is not yet to select
one preferred location.
As said, this methodology allows iden-
tification of the trade-off between cost
and quality of locations on the longlist. It
helps to decide which cluster of locations
best meets a company’s objectives and
explains not only why certain locations
have been shortlisted, but also — some-
times equally important — why certain
locations are not considered any further as
viable options.
Selecting the preferred location
In order to select a preferred location it is
important to step away from the desk-
research approach (which is, by definition,

Page 37
 Cost-reduction location strategies
looking back in time) and try to
assess near-future trends and risks in the
shortlisted cities. This should be done
through fieldwork and includes inter-
views with similar operations, recruitment
agents and so on.
The most important factors to evaluate
in detail before making a final deci-
sion relate in many cases to people: the
availability, quality, flexibility and cost of
staff are the main drivers for locating
businesses at the right locations and need
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to be evaluated carefully for shortlisted
cities.
Today, competition for skills is a major
issue. Locations that were frequently
selected for specific operations in the
recent past (such as call centres in Dublin
and Amsterdam, or data-processing ac-
tivities in Bangalore) are coping with
shortage of labour, because too many
companies are looking for the same skills.
As a result, cost levels are increasing at a
higher speed than desirable, staff turn-
over increases and recruitment times get
longer.
CONCLUSION
Increasing competition and tightening
markets are forcing companies to reduce
operating costs in order to meet
shareholder demands for profitability.
Solutions are mainly found in outsourc-
ing, consolidation of operations, reloca-
tion of operations to lower-cost locations
or a combination of these. Preference for
any of these solutions very much depends
on the activity involved and the risk level
acceptable to the company.
In their efforts to find new low-cost
locations around the world, companies
Page 38
need to be aware of the specific trade-
offs in these locations. Typically, low-cost
locations offer a lower-quality business
environment, whereas the well-developed
business environments are usually higher
in cost. In location strategies driven by
cost reduction, the challenge is to identify
those locations where the costs of doing
business are low but at the same time the
quality of the business environment is
such that business can be done at accept-
able risk.
Lastly, the recent focus on costs has
clearly caused a shift in evaluating busi-
ness locations for future operations. Even
when the global economy is in an up-
swing again and companies may feel less
cost pressure, it is very likely that cost
factors will remain high on the priority list
of factors to be evaluated when making a
location decision.
REFERENCES
(1) Dunning, J. H. (1980) ‘Toward an
Eclectic Theory of International
Production: Some Empirical Tests’, Jnl.
Int. Business Studies, Vol. 11, No. 1,
pp. 9–31.
(2) GILD is a unique database that IBM-PLI
has developed to keep track of cross
border investment project
announcements around the world. It
focuses on projects for which there was
a choice where to locate business
(greenfield projects and major
expansions, but not mergers and
acquisitions). GILD registers location,
number of jobs, industry sector, activity,
and so on for each individual project
and allows historical, geographical and
sectoral trend analysis of location
preferences.
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