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.

8-2

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??

8-3

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.

8-4

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).

8-5

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.

8-6

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.
8-7

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

Region/Community

Country

Site

8-9

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.

8-10

Labor Costs - Figure 8.2

8-11

Ranking of the Business Environment

in 20 Countries, 1997 - 2001
11 Finland
12 Belgium
13 New Zealand
14 Hong Kong
15 Austria
16 Australia
17 Norway
18 Ireland
19 Italy
20 Chile

1 Netherlands
2 Britain
3 Canada
4 Singapore
5 U.S.
6 Denmark
7 Germany
8 France
9 Switzerland
10 Sweden
8-12

Factors Affecting
Region/Community Decision
Attractiveness of region (culture, taxes, climate, etc.).
Labor availability, costs, attitudes towards unions.
Environmental regulations of state and town.
Proximity to customers & suppliers.
Corporate desires.
Costs and availability of utilities.
Government incentives.
Land/construction costs.
8-13

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.

8-14

Location Decision Example - BMW

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

8-15

Country Decision - BMW

Market location.

U.S. is worlds largest luxury car market & is growing.

Labor.

U.S. has lower manufacturing labor costs.

$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 ($2,500/car less).

New plant & equipment would increase productivity
(lower cost/car $2,000-3000).
8-16

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.

8-17

Location Evaluation Methods

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

8-18

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.

8-19

Steps in Factor Rating Method

List relevant factors.
Assign importance weight to each factor (0-1).

Make weights sum to one.

Set a scale for scoring each factor (1-10 or 1-100).

Score each location using factor scale.
Multiply scores by weights for each factor & sum.
Select location with maximum total score.
Consider sensitivity to weights and scores.

8-20

Factors Affecting Location

Labor costs and availability, including wages,
productivity, attitudes, age, distribution,
unionization, and skills.
Site costs, including 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).
8-21

Factors Affecting Location continued

Utilities, including 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.

8-22

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
8-23

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.
8-24

Locational Break-Even Analysis

Cost-volume analysis used 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.

8-25

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?
8-26

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

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
8-27

B is
Best

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?
8-28

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
8-29

Locational Crossover Chart

200,000
ron
k
A

150,000

o
Chicag

100,000

reen
G
g
lin
Bow

50,000
0

Akron lowest
cost

Bowling Green
lowest cost

500

1500

1000

2000

Volume
8-30

Chicago
lowest cost

2500

3000

Locational Crossover Chart

Re
v

en
u

200,000
150,000

ron
k
A

o
Chicag

100,000

reen
G
g
lin
Bow

50,000

Akron lowest
cost

Bowling Green
lowest cost

500

1500

Chicago
lowest cost

0
0

1000

2000

Volume
8-31

2500

3000

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.
8-32

Center of Gravity Method

Finds location of single facility serving several
destinations.
Used for services and distribution centers.
Requires:

Location of existing destinations (Markets, retailers etc.)

Volume to be shipped.

Shipping distance (or cost).

8-33

Center of Gravity Method Steps

Find X and Y coordinates for all destinations.

Can use an arbitrary coordinate grid.

Calculate center of gravity location for

facility as weighted average of X & Y
coordinates.

Approximately minimizes transportation cost.

Location is not necessarily optimal, but is

usually close.
8-34

Center of Gravity Method Equations

X Coordinate
Cx

dix = x coordinate of location i

d ix Wi
i

Wi
i

Wi = Volume of goods
moved to or from location i

Y Coordinate
Cy

d iy Wi
i

Wi

diy = y coordinate of location i

8-35

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

8-36

60

120

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
8-37

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)

Center of gravity = (66.7, 93.3)

60
Atlanta (60,40)
0

60

8-38

120

Transportation Model
Finds amount to be shipped from several sources to
several destinations.
Used primarily for industrial locations.
Type of linear programming model.

Objective: Minimize total production & shipping costs.

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

8-39

Transportation Model Example

800
500

Chicago

1000
London

Supply is in green
Demand is in red

300
200

St. Louis
900 Atlanta
300

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

8-40

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

Demand

Supply

$40

800 Chicago
300 St. Louis
900 Atlanta

$8

London 1000
$1

$10

Chicago 500

$35
$1

$20

$1

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).
8-41

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
8-42

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.

8-43

Service vs. Industrial Location

Service Location
Techniques

Industrial Location
Techniques

Regression models to determine

importance of different factors.
Factor rating.
Traffic counts & demographic analysis of
drawing area.
Center of gravity.

Linear and Integer Programming

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

Assumptions

Assumptions

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.
8-44

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).

8-45

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.
8-46