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
Country Region/Community

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

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 world’s 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 B C
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
You’re an analyst for AC Delco. You’re
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: Total Cost = TC = 30000 + 75x
B=Bowling Green: Total Cost = TC = 60000 + 45x
C=Chicago: Total Cost = TC = 110000 + 25x
For all: Total Revenue = TR = 120x

At x=2000 cases/year: B is
Best
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
 Locational Break-Even Analysis
Example
You’re an analyst for AC Delco. You’re
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: TC = 30000 + 75x
B=Bowling Green: TC = 60000 + 45x
C=Chicago: 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
k ron
A

150,000
Chicago
$

100,000 een
l in g Gr
Bow

50,000 Akron lowest Bowling Green Chicago

cost lowest cost lowest cost

0
0 500 1000 1500 2000 2500 3000
Volume

8-30
 Locational Crossover Chart
200,000

e
nu
k ron

ve
A

Re
150,000
Chicago
$

100,000
g Green
lin
Bow

50,000 Akron lowest Bowling Green Chicago

cost lowest cost lowest cost

0
0 500 1000 1500 2000 2500 3000
Volume
8-31
 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
dix = x coordinate of location i
 d ix Wi
Cx  i
 Wi
i
Wi = Volume of goods
Y Coordinate moved to or from location i
 d iy Wi
Cy  i
 Wi diy = y coordinate of location i
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
Pittsburgh (90,110)
Chicago 200
Pittsburgh 100
New York 100 60
Atlanta 200
Atlanta (60,40)

0
0 60 120
8-36
 Center of Gravity Example
Location Volume X-Coordinate Y-Coordinate
Chicago 200 30 120
Pittsburgh 100 90 110
New York 100 130 130
Atlanta 200 60 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
New York (130,130)
Location Volume
Chicago (30,120)
Chicago 2000 120
Pittsburgh 1000
Pittsburgh (90,110)
New York 1000 X
Atlanta 2000
60 Center of gravity = (66.7, 93.3)

Atlanta (60,40)

0
0 60 120

8-38
 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 Chicago
1000
500
Supply is in green London
300
Demand is in red St. Louis
200

900 Atlanta
300

From To Cost per unit flow

Chicago London $40
Chicago St. Louis $10
St. Louis Chicago $8
St. Louis Atlanta $20
Atlanta London $35
Chicago Chicago $1
St. Louis St. Louis $1
Atlanta 8-40 Atlanta $1
 Transportation Model Example
Supply Demand
$40 London 1000
800 Chicago $1
$10
$8 Chicago 500
300 St. Louis
$35 $1 St. Louis 200
900 Atlanta $20
$1
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 firm’s and competitor’s
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 Industrial Location
Techniques Techniques
 Regression models to determine importance  Linear and Integer Programming
of different factors. (Transportation method).
 Factor rating.  Factor rating.
 Traffic counts & demographic analysis of  Breakeven and crossover analysis.
drawing area.  Center of gravity.
 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 are relatively constant for a given area. costs.
 Intangible costs can be objectively
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