Effect of Plant Location Decisions on Raw Material Input Prices

Posted by D. Daniel Sokol

Diana M. Burton (Ecosystem Science and Management, Agricultural Economics, Texas A&M University) and H. Alan Love (Information & Operations Management, Agricultural Economics Texas A&M University) write on the 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. To determine the likely 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. Using an econometric representation of game-theoretic Nash equilibria relating input prices to processor competition in local procurement areas, an empirical model is developed to ex ante forecast the likely impact of entry on input price. The methods developed are applicable to a wide variety of industries where historic data are available.