Operations Management

Location Strategies Chapter 8

8-1

Outline
Strategic Importance of Location.

Factors That Affect Location Decisions.

Methods of Evaluating Location Alternatives.

The Factor-Rating Method. Locational Break-Even Analysis. Center-of-Gravity Method. The Transportation Model.

Integer Programming.

Service Location Strategy.

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Federal Express
Invented overnight delivery.

Uses hub concept.

Enables service to more locations with fewer aircraft. Concentrates package flows to exploit transportation economies of scale. Enables sorting economies of scale.

Key issue: Where to locate hubs??

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Location Decisions
Long-term strategic decisions. Usually expensive & difficult to reverse. Affect fixed & variable costs.

Transportation cost is up to 25% of product price.

Other costs: Taxes, wages, rent etc.

Objective: Maximize benefit of location to firm.

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Industrial Location Decisions

Cost focus.

Revenue varies little between locations.

Production separate from consumption.

Location is major cost factor.

Costs vary greatly between locations.

Shipping costs. Production costs (e.g., labor).

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Service Location Decisions

Revenue focus.

Costs vary little between market areas.

Production/service together with consumption.

Location is a major revenue factor.

Affects amount of customer contact. Affects volume of business.

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Organizations That Locate Close to Markets/Customers

Government agencies.

Police & fire departments, post offices, public libraries.

Retail sales and Services.

Fast food restaurants, supermarkets, gas stations. Doctors, lawyers, barbers, banks, auto repair, etc.

When transporting finished goods is more expensive than transporting materials.

Bottling plants, breweries. Electricity production.

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Organizations That Locate Close to Suppliers or Materials

By necessity.

Mining, fishing, farming, etc.

When transporting materials is more expensive than transporting finished goods.

Perishable raw materials.

Seafood processing.

Heavy or bulky raw materials.

Steel producers.

Processing reduces bulk.

Lumber mills, paper production. 8-8

Location Decision Sequence

Country Region/Community

Site

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Factors Affecting Country Decision

Government rules, attitudes, stability, incentives. Labor availability, attitudes, productivity, cost.

Availability of supplies, communications, energy.

Culture & economy. Location of markets. Exchange rate.

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Labor Costs - Figure 8.2

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Ranking of the Business Environment in 20 Countries, 1997 - 2001

1 Netherlands 2 Britain 3 Canada 4 Singapore 5 U.S. 6 Denmark 7 Germany 8 France 9 Switzerland 10 Sweden
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11 Finland 12 Belgium 13 New Zealand 14 Hong Kong 15 Austria 16 Australia 17 Norway 18 Ireland 19 Italy 20 Chile

Factors Affecting Region/Community Decision

Labor availability, costs, attitudes towards unions. Proximity to customers & suppliers. Costs and availability of utilities. Land/construction costs. Government incentives (taxes). Environmental regulations. Corporate desires.

Attractiveness of region (culture, climate, etc.).

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Factors Affecting Site Decision

Access to air, rail, highway, and waterway systems. Proximity to needed services/supplies. Site size and cost. Zoning restrictions.

Environmental impact issues.

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Location Decision Example - BMW

In 1992, BMW decided to build its first major manufacturing plant outside Germany in Spartanburg, South Carolina.

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Country Decision - BMW

Market location.

U.S. is worlds largest luxury car market & is growing. U.S. has lower manufacturing labor costs.

Labor.

$17/hr. (U.S.) vs. $27 (Germany).

U.S. may have higher labor productivity.

11 holidays (U.S.) vs. 31 (Germany).

Other.

Lower shipping cost to major market ($2,500/car less). New plant & equipment increase productivity (lower cost/car $2,000-3000).
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Region/Community Decision - BMW

Labor.

Lower wages in South Carolina (SC).

About $17,000/yr in SC vs. $27,051/yr in U.S. (based on 1993).

Government incentives.
$135 million in state & local tax breaks. Free-trade zone from airport to plant.

No duties on imported components or on exported cars.

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Location Evaluation Methods

Factor-rating method. Locational break-even analysis. Center of gravity method. Transportation model.

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Factor-Rating Method
Most widely used location technique.

Useful for service & industrial locations.

Rates locations using factors.

Intangible (qualitative) factors.

Example: Education quality, labor skills.

Tangible (quantitative) factors.

Example: Short-run & long-run costs.

Based on weighted average.

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Steps in Factor Rating Method

1. List relevant factors & assign importance weight (0-1).
- Higher weight = More importance.

- Make weights sum to one.

1. 2.

Score each location using factor scale (1-10 or 1-100).

- Higher score = Better site.

Multiply scores by weights for each factor & sum. Focus on location(s) with highest total scores.

3.

Consider sensitivity to weights and scores.

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Factors Affecting Location

Labor costs and availability: wages, productivity, attitudes, age, distribution, unionization, skills, etc. Site costs: land cost, parking, drainage, expansion opportunities, etc.

Proximity to raw materials and suppliers.

Proximity to markets. State and local government fiscal policies (including incentives, taxes, unemployment compensation).
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Factors Affecting Location continued

Utilities availability and costs. Transportation availability (road, rail, air, water, pipeline). Quality-of-life issues (education, cost of living, health care, sports, cultural activities, housing, entertainment, religious facilities, etc.). Foreign exchange, including rates and stability. Government, including stability, honesty, attitudes toward new business, etc.
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Factor Rating Example

Three locations: A, B and C; Four factors. 1. Assign weights to each factor. 2. Score each location on each factor. 3. Multiply the weight and score and sum for each location.

Factor weight A Cost 0.3 Proximity to trans. 0.2 Taxes 0.1 Labor 0.4
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Factor Rating Example

Three locations: A, B and C; Four factors.

Factor weight A B C Cost 0.3 10 9 7 Proximity to trans. 0.2 7 3 10 Taxes 0.1 7 5 10 Labor 0.4 6 8 5 7.5 7 7.1
A is best; B and C are similar.
Note that if the labor score for A was 5, not 6, then all locations are similar.
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Locational Break-Even Analysis

Break-even/Crossover analysis for location.
Steps:

Determine fixed & variable costs for each location.

Find break-even point.

Plot cost for each location. Select location with lowest total cost for expected production volume.
Must be above break-even.

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Locational Break-Even Analysis Example

Youre an analyst for AC Delco. Youre considering a new manufacturing plant in Akron, Bowling Green, or Chicago. Fixed costs per year are $30k, $60k, & $110k respectively. Variable costs per case are $75, $45, & $25 respectively. The price per case is $120. What is the best location for an expected volume of 2,000 cases per year?
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Locational Break-Even Analysis Example

A=Akron: B=Bowling Green: C=Chicago: For all: Total Cost = TC = 30000 + 75x Total Cost = TC = 60000 + 45x Total Cost = TC = 110000 + 25x Total Revenue = TR = 120x
B is best

At x=2000 cases/year: A: Profit = 240,000 - (30,000 + 150,000) = 60,000 B: Profit = 240,000 - (60,000 + 90,000) = 90,000 C: Profit = 240,000 - (110,000 + 50,000) = 80,000
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Locational Break-Even Analysis Example

Youre an analyst for AC Delco. Youre considering a new manufacturing plant in Akron, Bowling Green, or Chicago. Fixed costs per year are $30k, $60k, & $110k respectively. Variable costs per case are $75, $45, & $25 respectively. The price per case is $120. Over what range of output is each location preferred?
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Locational Break-Even Analysis Example

A=Akron: B=Bowling Green: C=Chicago: TC = 30000 + 75x TC = 60000 + 45x TC = 110000 + 25x

A is best at x=0. A < B for x < 1000/yr and A < C for x < 1600/yr, so A is best over range 0<x<1000/yr. B < C for x < 2500/yr so, B is best over range 1000<x<2500/yr. C is best over range 2500/yr < x
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Locational Crossover Chart

200,000 150,000

$
100,000 50,000 0
Akron lowest cost Bowling Green lowest cost Chicago lowest cost

500

1000

1500

2000

2500

3000

Volume
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Locational Crossover Chart

200,000
150,000

$
100,000 50,000 0 0 500 1000 1500 2000 2500 3000

Akron lowest cost

Bowling Green lowest cost

Chicago lowest cost

Volume
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Locational Break-Even Analysis Example

A is unprofitable for low volumes. Use break-even analysis with A to find break-even point = 666.67/yr. A is best and profitable over range 666.67<x<1000/yr. B is best and profitable over range 1000<x<2500/yr.

C is best and profitable over range 2500/yr < x.

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Center of Gravity Method

Locates a single facility to serve many destinations (customers).
Used for services and distribution centers.

Requires:

Location of existing destinations (Markets, retailers etc.) Volume to be shipped. Shipping distance (or cost).

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Center of Gravity Method Steps

Given for each destination, i:

Volume (weight or amount) to ship = Qi. X and Y coordinates = (dix, diy).

Can use an arbitrary coordinate grid.

Center of gravity location = weighted average of X & Y coordinates.

Approximately minimizes transportation cost.

Location is not necessarily optimal, but is usually close.

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Center of Gravity Method Equations

X Coordinate = C x

dixQi
i

Q
i

dix = x coordinate of location i

Y Coordinate = C y

d Q Q
iy i i i

diy = y coordinate of location i

Qi = Volume of goods moved to or from location i

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Center of Gravity Example

Given 4 cities with volume demanded and (x,y) coordinates. Find location for one warehouse to minimize total distance to supply these cities.
New York (130,130)

Chicago (30,120)
120

Location Volume Chicago 200 Pittsburgh 100 New York 100 Atlanta 200

Pittsburgh (90,110)

60 Atlanta (60,40) 0 0 60 120

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Center of Gravity Example

Location Volume Chicago 200 Pittsburgh 100 New York 100 Atlanta 200 X-Coordinate 30 90 130 60 Y-Coordinate 120 110 130 40

X coordinate of warehouse: Cx=(200x30+100x90+100x130+200x60)/(200+100+100+200) = 66.7 Y coordinate of warehouse: Cy=(200x120+100x110+100x130+200x40)/(200+100+100+200) = 93.3

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Center of Gravity Example

Location Volume Chicago 2000 Pittsburgh 1000 New York 1000 Atlanta 2000
New York (130,130)

Chicago (30,120)
120 Pittsburgh (90,110)

X
60
Atlanta (60,40) 0 0 60

Center of gravity = (66.7, 93.3)

120

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Transportation Model
Finds amount to be shipped from several sources to several destinations.

Used primarily for industrial location.

Type of linear programming model.

Objective: Minimize total production & shipping costs. Constraints:

Production capacities at sources (factories). Demand requirements at destinations.

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Transportation Model Example

800 500 Chicago 1000

Supply is in green
Demand is in red
300 200

London St. Louis

900 Atlanta 300

From Chicago Chicago St. Louis St. Louis Atlanta Chicago St. Louis Atlanta

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To London St. Louis Chicago Atlanta London Chicago St. Louis Atlanta

Cost per unit flow $40 $10 $8 $20 $35 $1 $1 $1

Transportation Model Example

Supply
800 Chicago 300 St. Louis 900 Atlanta
$8

Demand
$40

London 1000 Chicago 500 St. Louis 200 Atlanta 300

xij = Flow from origin i to destination j. Objective is minimize cost for all flows. Constraints for supply at each origin (3) and demand at each destination (4).
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Integer Programming for Location

x1 = 1 if a warehouse is located at Boston; 0 otherwise. x2 = 1 if a warehouse is located at Hartford; 0 otherwise. x3 = 1 if a warehouse is located at Albany; 0 otherwise. Minimize the cost to locate warehouses: Minimize C1 x1 + C2 x2 + C3 x3

At most two warehouses can be opened: x1 + x2 + x3 2 Either Boston or Hartford should have a warehouse: x1 + x2 1
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Location for Service Organizations

Focus on Revenue and Volume of Business, which are determined by:
Purchasing power and demographics of customer drawing area.

Competition in the area (amount and quality).

Relative attractiveness of the firms and competitors locations.

Uniqueness of location and offerings.

Physical qualities of facilities and neighboring businesses. Operating policies and quality of management.
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Service vs. Industrial Location

Service Location Techniques
Regression models to determine importance of different factors. Factor rating. Traffic counts & demographic analysis of drawing area. Center of gravity.

Industrial Location Techniques

Linear and Integer Programming (Transportation method). Factor rating. Breakeven and crossover analysis. Center of gravity.

Location is major determinate of cost. Location is major determinate of revenue. Costs can be identified for each site. High customer contact issues dominate. Low customer contact allows focus on costs. Costs are relatively constant for a given Intangible costs can be objectively area. evaluated.
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Assumptions

Assumptions

Telemarketing and Internet Industries

Require neither face-to-face contact with customers (or employees) nor movement of material. Keys are:

Labor costs and productivity.

Information systems infrastructure (including training and management).

Government incentives (including taxes).
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Geographic Information Systems GIS

New tool to help in location analysis. Combines spatial (locational) data and attribute data (for example, demographics). Uses spatial analyses to identify best or satisfactory locations. Allows intuitive graphical display using maps.
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GIS

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