Alfred Weber Least Cost Theory Explained

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Alfred Weber Least Cost Theory Explained

The least cost theory by Alfred Weber takes a look at industrial location. It suggests that by choosing the correct location for an industry, its costs can be minimized. That allows the industry the opportunity to better maximize its profits.

The least cost theory looks at the three common categories of cost that typically have the largest influence on profits.

1. Transportation.
Weber suggests that industries must look for a site with the lowest possible costs for moving raw materials and then their finished products to market.

2. Labor.
When labor costs are high, profits are naturally reduced. Weber suggests that locating industries in regions where cheaper labor is available is the best way to maximize profits within this category.

3. Agglomeration.
Weber also suggests that industries should locate in clusters to maximize the assistance they can receive from one another. That reduces additional costs that various industries face and allows for the cross-promotion of products and ideas.

Every industry faces different challenges in these areas. Domestic companies face different challenges compared to international companies. Yet, at the same time, the theory suggests that a similar method of evaluation can help industries establish locations that minimize costs and maximize profits.

Why Many Industries Fail to Maximize Products

One of the key issues that is addressed in the least cost theory by Weber is the idea of weight gain. Certain industries are referred to as being “weight-gaining” or “bulk-gaining” industries because of the product they produce. After receiving raw materials at their location, they produce a product for the marketplace that is larger than the raw materials they received.

For the modern industry, there may be multiple weight-gaining issues that must be addressed for a single product that goes to market.

Take a bottle of Dr Pepper as an example. It was first introduced in the late 19th century as being “liquid sunshine,” but in reality, the formulation is a combination of raw ingredients that come together to create a liquid beverage. That liquid cannot be served to the general public after it has been created. It must be placed in containers that make the liquid accessible to others so it can be consumed.

That means cans, bottles, and pressurized containers. The plastics and metals add weight to the product that is shipped to the market. If a Dr Pepper bottler is creating their own cans and bottles, they will also experience bulk-gaining because raw aluminum is different than an aluminum can.

In the least cost theory, the added weight that comes from the extra bulk translates to a higher cost for getting it to the market. Industries that deal with this issue must place their industry closer to the final market phase because that will maximize their profits better than being closer to the raw materials.

The opposite, however, can also be true. Some products are lighter once they have been created for the market. Because the raw materials are heavier, the industry must locate itself closer to the source of the ingredients so it can maximize profits.

What Happens When Multiple Source Materials Are Required?

In Weber’s least cost theory, the goal is to examine the cost of every ingredient in the processing chain, from sourcing raw goods to placing a finished product onto a store shelf. When there are a variety of materials that are needed for production, Weber suggests that the production point should be moved closer to the heaviest raw material to balance out the industry’s transportation costs.

Agglomeration is an exception to this rule. When like-minded industries come together, it may be possible for the heaviest raw materials or heaviest finished products to have the lowest overall cost. That occurs because an industry can pay a portion of the transportation costs since other industries are involved in the same process.

For example: let’s say Dr Pepper and Miller Brewing have production facilities next to each other. Both need to purchase raw aluminum for their cans. By buying in bulk together, they can save $0.20 per pound on their order. They split the difference, which reduces their anticipated cost by $0.10 per pound.

The other exception to this rule is when energy supply is a major factor in the production chain. In the past, mills were often placed along rivers because the spinning wheel was required to make everything work. Energy-specific industries may benefit the most by being located as close to their primary energy source as possible instead of their raw materials source or their marketplace.

The Alfred Weber least cost theory suggests that by reducing costs on the most expensive budget line-item, it becomes possible to maximize profits over time. That is why it is such an effective strategy to use.