Facility Location

Selection
IDS 355
SUMMER 2020
 Learning Objectives

 Why Locations?
 Facility Selection Criteria
 Facility Location Planning
 A tool for Determining Location
 Strategic Considerations
 Strategic Location Concerns
 Distance Modeling: Euclidean and Metropolitan Models
 Geographic Information Systems
Locations

 Every business operation must have physical facilities somewhere

 Manufacturers have factories
 Brick-and-mortar retailers have stores
 Even Internet-based businesses need places for their employees to work – although
those places might be globally dispersed home offices!
 Physical facilities provide:
 Space to perform work
 Storage of inventory, data, and other assets
 A contact point for customers and suppliers
 But, different operations have different needs

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Facility Selection Criteria

 Businesses will establish new facilities in order to:

 Commence operation
 Replace older facilities
 Expand capacity
 Be closer to customers, suppliers, or resources
 Intensify competition
 The decisions about where to set up new facilities require understanding the factors important to the particular
business, such as:
 Proximity to customers and ease of access
 Nearby resources and other businesses (competitors, partners, and complementary ones)
 Potential for employees to work together
 Available space
 Labor pool
 Transportation and other infrastructure
 Legislative environment

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 Facility Location Planning

 Competitive positioning: prime location can be barrier to entry.

 Demand management: diverse set of market generators.
 Flexibility: plan for future economic changes and portfolio effect.
 Expansion strategy: contiguous, regional followed by “fill-in,” or
concentrated.

10-5
 Regression Model for Motel Location

 Competitive Factors: Room rate, hotels within one mile, competitive

room rate
 Demand Generators: College, Hospital beds within one mile, Annual
tourists
 Area Demographics: Family income, residential population
 Market Awareness: State population per inn, Distance to nearest inn
 Physical Attributes: Sign visibility, Distance to downtown, Accessibility

Y= 39 + (-5.41)STATE + (5.86)PRICE + (-3.09)INCOME + (1.75) COLLEGE

10-6
Facility Selection Criteria (cont’d)

 Let’s consider the needs of three archetypal operations:

 An auto manufacturer
 A restaurant
 A credit card company
 For these three business models:
 What are the most important selection criteria?
 What criteria are not particularly important?
 Are any criteria important to all three?

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Strategic Considerations
 Competitive Clustering (Among Competitors)
(e.g. Auto Dealers, Motels)
 Saturation Marketing (Same Firm)
(e.g. An Bon Pain, Ice Cream Vendors)
 Marketing Intermediaries
(e.g. Credit Cards, HMO)
 Substitute Communication for Travel
(e.g. telecommuting, e-Commerce)
 Separation of Front from Back Office
(e.g. ATM, shoe repair)
 Impact of the Internet on Service Location
(e.g. Amazon.com, eBay, FedEx)

10-8
Strategic Location Concerns

 Access to customers
 Complementary operations
 Separation of facilities
 Saturation marketing
 Area coverage
 Competitive clustering
 Expansion strategies

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Access to Customers

 Besides proximity, customers also want convenient access

 Important internal factors:
 Operating hours
 Merchandise location, customer flow design
 Stairs/escalators/elevators
 Walking distance
 Important external factors:
 Parking availability
 Public transportation stops
 Traffic flows & road layout
 Safety of surrounding environment

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Complementary Operations

 The surrounding environment can be important, especially for entertainment or

recreation operations, such as:
 Hotels near tourist attractions
 Restaurants near theaters
 Bars near sporting venues
 Typical structure:
 One operation or feature draws in customer traffic
 Other operations arise to serve those customers
 Can become a standard operating model, like convenience stores or fast food
restaurants paired with gas stations

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Separation of Facilities

 Operations can be separated into:

 Front office: Where customers interact with the business
 Back office: Where customers do not interact with the business
 Having more front office locations is convenient to customers but tends to cause low
utilization of back office resources
 Basic question: Do front and back office operations need to be located together?
 Sometimes, one back office can support multiple front offices: Banks and ATMs
 Or not: One kitchen per restaurant
 Portions of back office operations may be separated in different ways: inventory
stored on-site but product repairs handled at one large site covering many stores

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Saturation Marketing

 Establishing a dense network of front office operations can:

 Create a substantial barrier to new market entrants
 Reduce travel costs for all customers
 Provide economies of scale for deliveries and management
 Increase capture of impulse buyers
 On the other hand:
 Locations may add costs without raising aggregate sales
 Individual franchise owners will likely lose business

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Area Coverage

 Goal of providing service to all or most customers in an area

 Commercial motives:
 Make market unattractive for new entrants
 Perpetuate natural monopolies
 Non-commercial motives:
 Public education
 Public transportation
 Other non-profit goals emphasizing inclusion

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Competitive Clustering

 In competitive clustering, multiple competing stores are located near each other
and compete for the same customers
 Motivating causes:
 High customer traffic (smaller slice of much bigger pie)
 Aggressive competitor location strategy
 Prime location justifies high-risk, high-reward strategy
 Access to suppliers or other business partners provides economies of scale to all
operations in the cluster
 Sometimes, competitive clustering is sustainable and even creates a competitive
advantage for the businesses involved

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Expansion Strategies

 Standard expansion strategies involving adding new facilities:

 Low risk: Initially limited scale followed by more if successful
 More new facilities in a new market = more risk
 First-mover rewards may justify taking the extra risk!
 Businesses typically reduce risk by expanding to markets with similar product
preferences, identified by:
 Demographics
 Sales of comparable products
 Notable real-world expansion strategy examples:
 Starbucks: Expand to other urban centers first
 Wal-Mart: Expand to other rural communities first

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Distance Modeling
 Many service operations need to be close to their customers
 Delivery services
 In-store purchases
 Especially true for services handling many small orders
 Distance raises operating costs or the real price to customers
 Travel time
 Fuel
 Vehicle miles
 Can these costs be measured?

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Distance Modeling (cont’d)
 What should be measured is the actual travel cost:
 For delivery services: possible but usually approximated:
 Variable fuel and vehicle costs
 Traffic conditions can change labor costs
 Impractical to measure directly for customer visits:
 Different travel modes: walking, bicycling, public transportation, driving
 Time has a different value to different customers at different times
 Instead, distance is often used to measure travel costs even though:
 Distance models only approximate travel behavior
 The direct route may not be the fastest or even available
 Combining multiple stops in one trip changes cost functions
 When selecting from a set of potential locations, the best one has the smallest sum of distances

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Euclidean (Straight-Line) Distance Model

  
Straight-line distance is accurate if travel actually is direct for customers or
delivery. Otherwise, it can be an acceptable approximation if:
 Distances are long compared to any road constraints
 Demand is aggregated over large zones
 Formula:
 Customer located at coordinates (xc, yc)
 Service operation located at coordinates (xs, ys)
 Distance =
 Weighting may be applied as a multiplier to model multiple customers

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Example: Euclidean Distance

 Suppose you have aggregated customer demand as:

 You are considering two potential new facilities: Demand
Zone Location Weight
 One at (1, 0)
A (4, 1) 20
 One at (0, 1) B (-1, -5) 15
 Which facility has the shortest sum of distances? C (-3, 1) 25
 Find the Euclidean distance for each zone D (-1, 5) 30
 Multiply that distance by its weight
 Add all four weighted distances

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Metropolitan Distance Model

  The metropolitan distance model assumes all travel happens either:

 Parallel to the x-axis (east-west)
 Parallel to the y-axis (north-south)
 This simulates travel in rectangular road grids, approximating the road layout in many
urban environments
 Formula:
 Customer located at coordinates (xc, yc)
 Service operation located at coordinates (xs, ys)
 Distance = ||+ ||
 Weighting multipliers again may be used to model multiple customers

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Example: Metropolitan Distance Model

 Using the previous aggregated customer demand:

 Again, we compare two potential new facilities: Demand
Zone Location Weight
 One at (1, 0)
A (4, 1) 20
 One at (0, 1) B (-1, -5) 15
 Which facility has the shortest sum of distances? C (-3, 1) 25
 Find the metropolitan distance for each zone D (-1, 5) 30
 Multiply that distance by its weight
 Add all four weighted distances

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Geographic Information Systems

 Geographic information systems (GIS) correlate various demographic and other

data with their spatial distribution
 Useful for facility location decisions by estimating:
 Proximity to customers
 Relative value of customer groups
 Trends with a spatial component
 On the following slides, we’ll assume a GIS has given us data:
 About customers from four geographic zones
 Relative to three grocery store locations

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GIS Data
Annual Grocery
Spending per
# of Customers Household
Zone
A 12,000 $8,000
B 15,000 $6,000
C 8,000 $14,000
D 10,000 $11,000

Zone Average Average Average Store Size (sq. ft.)

Travel Time Travel Time Travel Time
to Store X to Store Y to Store Z X 2500
A 10m 14m 20m Y 3500
B 15m 18m 12m Z 4500
C 8m 16m 22m
D 16m 14m 10m

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Huff Model

 The Huff model predicts retail sales based on these assumptions:

 Customers prefer closer stores
 Larger stores draw more customers, since size is correlated with:
 Product selection
 Lower prices
 Ease of access
 Gravity model, where stores “exert attractive force” on customers by proximity
and store size

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Attraction

  Each store j has an attraction A to zone i calculated as:

 Where:
 is the attractive force from store j to customers in zone i
 is the size of store j
 is the average travel time between store j and customers in zone i
 indicates customer propensity to travel
 Low values increase attraction, high values decrease it
 In our examples, we’ll assume = 2

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Example: Attraction

 What is the attraction of store Z on zone A?

 Using Excel, calculate attractions from each store to each zone

 Attraction is used to calculate the probability that a given customer will visit a
given store

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Visit Probability

  
The probability Pi, j that a random customer from zone i will visit store j is
determined by:
 The attraction of j to zone i
 Relative to the other stores attracting customers from zone i
 Formula: , where:
Aij
 is the attraction of store j to zone i Pij = n

 is the sum of attractions of all stores to zone i å Aij

j=1

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Example: Visit Probability

 What is the probability that a random customer from zone A will visit store Z?
 Using Excel, calculate visit probabilities from each store to each zone

 Visit probabilities are used to estimate store sales

 Assumption: Each customer’s spending is uniformly distributed over all of that
customer’s store visits

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Store Sales

  For any {zone, store} pair, store sales are calculated as a function of:
 Number of customers
 Spending per customer
 Visit probability for that {zone, store} pair
 Formula: , where:
 = the expected sales at store j from customers in zone i
 = the number of customers in zone i
 = the relevant product budget of customers in zone i
 = the visit probability between zone i and store j

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Example: Store Sales

 What store sales are expected at store Z from zone A customers?

 Using Excel, calculate expected store sales for each {zone, store} pair

 Aggregate sales are found by adding the expected sales over all zones included in
the model
 Comparing aggregate sales allows calculating market share over an entire set of
zones
 Discuss: How to find market share if all customers are from one zone?

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Market Share

  
Market share Mj is the fraction of sales obtained by store j over all zones included
in the model
 Formula: , where:
 = expected sales at store j from all zones
 = expected sales at all stores

 Shortcut: Expected sales at all stores is the sum of all relevant spending over all
customers

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Example: Market Share

 What is the market share of store Z over the four zones?

 Using Excel, calculate expected store sales for each {zone, store} pair

 Although we have considered an existing set of stores, the Huff model offers a
framework for:
 Estimating sales and market share of potential new locations
 Estimating the impact of new market entrants
 Extrapolating demographic trends to estimate future sales

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