Effect of Plant Location Decisions on Raw Material Input Prices

Abstract

In processing industries, plant location decisions are costly and have consequences for firm profitability. When raw materials are heavy or perishable, transportation costs limit shipping distances and processors must compete locally for raw material inputs. Adding a new processing plant in the procurement area will increase raw material demand, likely raising input price and decreasing profit for all processors in the area. Important to the entry decision is the expected magnitude of input price change. To determine the expected profitability of a new plant, a processor must forecast the effect entry will have on local post-entry raw material price. This requires anticipating how entry will affect market structure and intensify competition for raw materials. Through time and space, various numbers of processors can be observed competing for input supply within their procurement areas. These cross-sectional time-series variations potentially allow estimation of the relationship between number of processors competing for an input in a procurement area and the input price in that area. The probable effect on raw material price of a processor entering a procurement area can be inferred by contrasting procurement areas with n firms with those containing n+1 firms while controlling for differences between the procurement areas other than input price. The unique contribution of this study is development of a game-theoretic based empirical model that incorporates unique features typical of processing industries to forecast the magnitude of a raw material price response to processor entry. The method developed is widely applicable.