Facility Location

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Facility Location

Adapted from:Facilities Planning, Tompkins, White, Bozer, Frazelle, Tanchoco,

Trevino, Wiley, New York, 1996

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Importance of Location

• Up to 25% of the product’s selling cost

• Once a company commits to a location, many costs are fixed and difficult to change

• Energy

• Labor

• Location depends on the type of business

• Manufacturing – minimizing cost

• Retail and professional services – maximizing revenue

• Warehouse – cost and speed of delivery

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In General - Location Decisions

• Long-term decisions

• Difficult to reverse

• Affect fixed & variable costs

• Transportation cost

• As much as 25% of product price

• Other costs: Taxes, wages, rent etc.

• Objective: Maximize benefit of location to firm

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Location Options

• Expand the existing facility instead of moving

• Maintain current sites while adding another facility

• Closing the existing facility and moving to another

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Factors The Affect Location Decisions

Country Decisions

• Government rules, attitudes, stability, incentives

• Cultural and economic issues

• Location of markets

• Labor availability, attitudes, productivity, costs

• Availability of supplies, communications, energy

• Exchange rates

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Factors The Affect Location Decisions

Region/Community Decisions

• Corporate desires

• Attractiveness of region (culture, taxes, climate, etc…)

• Labor availability, costs, attitudes towards unions

• Cost and availability of utilities

• Environmental regulations of state and town

• Government incentives

• Proximity to raw materials and customers

• Land/construction costs

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Factors The Affect Location Decisions

Site Decisions

• Site size and cost

• Air, rail, waterway systems

• Zoning restrictions

• Nearness of services/supplies needed

• 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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Location Decision Example – BMW Country Decision Factors

Market location

• U.S. is world’s largest luxury car market

• Growing (baby boomers)

Labor

• Lower manufacturing labor costs

– $17/hr. (U.S.) vs. $27 (Germany)

• 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)

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Location Decision Example – BMW Region/Community Decision Factors

Labor

• Lower wages in South Carolina (SC)

– About $17,000/yr (SC) vs. $27,051/yr (US)

• Based on 1993 metropolitan averages for all workers

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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Organizations That Need To Be Close to Markets

Government agencies

• Police & fire departments

• Post Office

Retail Sales and Service

• Fast food restaurants, supermarkets, gas stations

• Drug stores, shopping malls

• Bakeries

Services

• Doctors, lawyers, accountants, barbers

• Banks, auto repair, motels

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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

11 Finland

12 Belgium

13 New Zealand

14 Hong Kong

15 Austria

16 Australia

17 Norway

18 Ireland

19 Italy

20 Chile

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Labor Productivity

• Low wage rates often heavily influence location choices

• What about productivity?

• Example:

• Company Q pays $70 per day with 60 units produced per day in Texas. The Mexican plant pays $25 per day with a productivity of 20 units per day:

• Labor cost per day/Productivity (units per day) = Cost per unit

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Labor Productivity - Example:

• Company Q pays $70 per day with 60 units produced per day in Texas. The Mexican plant pays $25 per day with a productivity of 20 units per day:

• Labor cost per day/Productivity (units per day) = Cost per unit

• Case 1: Texas Plant

• $70 per day/60 units per day = $70/60 = $1.17 per unit

• Case 2: Mexican Plant

• $25 per day/20 units per day = $25/20 = $1.25 per unit

• Lesson: Employees with poor training, poor education, or poor work habits may not be a good buy even at low wages.

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Costs: Tangible Vs. Intangible

• Tangible costs – those that are readily identifiable and precisely measured

– Utilities

– Labor

– Material

– Taxes

– Depreciation

– Other costs that accounting can easily identify

• Intangible costs – not easily quantifiable

– Quality of education

– Public transportation facilities

– Community attitudes toward the industry and the company

– Quality and attitude of prospective employees

– Climate

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Proximity To Markets

• Service organizations (drug stores, restaurants, post offices) find proximity to market is the primary location factor

• Manufacturing – useful to be close to customers when transporting finished goods is expensive or difficult

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Proximity To Suppliers

Firms locate near their raw materials and suppliers because:

• Perishability

• Transportation costs

• Bulk

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Proximity To Competitors

Clustering – the location of competing companies near each other, often because of a critical mass of information, talent, ventire capital, or natural resources

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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

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Factors Affecting Location Selection

• Labor costs (including wages, unionization, productivity)

• Labor availability (including attitudes, age, distribution, and skills)

• Proximity to raw materials and suppliers

• Proximity to markets

• State and local government fiscal policies (including incentives, taxes, unemployment compensation)

• Utilities (including gas, electric, water, and their costs)

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Factors Affecting Location Selection - continued

• Site costs (including land, expansion, parking, drainage)

• Transportation availability (including rail, air, water, and interstate roads)

• Quality-of-life issues (including all levels of education, cost of living, health care, sports, cultural activities, transportation, housing, entertainment, religious facilities)

• Foreign exchange Including rates and stability

• Quality of government (including stability, honesty, attitudes toward new business - whether overseas or local)

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Steps in Factor Rating Method

• State relevant factors in terms of “max” or “min”

• Assign weights to each factor (should add to 100%)

• Assign rating to each factor (1-5) (1=poor, 5=excellent)

• Multiply scores by weights for each factor & total

• Calculate percent of total

• Compare top 2 alternatives (using percent as a basis of comparison)

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Steps in Factor Rating Method

Alternative A Alternative B

Factor Weight Rating Score Rating Score

Min. Operating Cost

20 4 80 3 60

Max. Flexibility 30 3 90 2 60

Max. Space utilization

10 3 30 5 50

Min. Payback period

40 1 40 4 160

Total 240 330

Percent 240/330 = .7272

330/330 = 1.00

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Locational Break-Even Analysis

• Method of cost-volume analysis used for industrial locations

• Steps

– Determine fixed & variable costs for each location

– Plot total 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

• 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?

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Locational Break-Even Analysis Example

Akron:

• Total cost = $30,000 + $75(2000) = $180,000

Bowling Green:

• Total Cost = $60,000 + $45(2000) = $150,000

Chicago:

• Total Cost = $110,000 + $25(2000) = $160,000

• With an expected volume of 2000 units per year, Bowling Green provides the lowest cost location. The expected profit is:

• Total Revenue – Total Cost = $120(2000) - $150,000 = $90,000 per year

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Locational Break-Even Analysis Example

The crossover point for Akron and Bowling Green:

30,000 + 75(x) = 60,000 + 45(x)

30(x) = 30,000

X = 1,000

And the crossover point or Bowling Green and Chicago:

60,000 + 45(x) = 110,000 + 25(x)

20(x) = 50,000

X = 2,500

Thus, for a volume o less than 1,000, Akron would be preferred, and for a volume greater than 2,500, Chicago would yield the greatest profit.

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Locational Break-Even Analysis Example

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Center of Gravity Method

• Finds location of single distribution center serving several destinations

• Used primarily for services

• Considers

– Location of existing destinations

• Example: Markets, retailers etc.

– Volume to be shipped

– Shipping distance (or cost)

• Shipping cost/unit/mile is constant

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Center of Gravity Method Steps

• Place existing locations on a coordinate grid

– Grid has arbitrary origin & scale

– Maintains relative distances

• Calculate X & Y coordinates for ‘center of gravity’

– Gives location of distribution center

– Minimizes transportation cost

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Center of Gravity Method Steps

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Center of Gravity Method - Example

• Consider the case of Ryan’s discount Department stores, a chain o four large K-Mart type outlets. The firm’s store locations are in Chicago, Pittsburgh, New York, and Atlanta; they are currently being supplied out of an old and inadequate warehouse in Pittsburgh, the site of the chain’s first store.

Store Location Number of containers shipped pre month

Chicago 2000

Pittsburgh 1000

New York 1000

Atlanta 2000

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Center of Gravity Method - Example

30

60

90

120

30 60 90 120 150

Chicago (30,120)New York (130,130)

Pittsburgh (90,110)

Atlanta (60,40)

Center of gravity (66.7, 93.3)

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Center of Gravity Method - Example

X-coordinate of the center of gravity:

= (30)(2000) + (90)(1000) + (130)(1000) + (60)(2000)

2000 + 1000 + 1000 + 2000

= 400,000/6000 =66.7

Y-coordinate of the center of gravity:

= (120)(2000) + (110)(1000) + (130)(1000) + (40)(2000)

2000 + 1000 + 1000 + 2000

= 560,000/6000 =93.3

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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 capacity at source (factory)

• Demand requirement at destination

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Components of Volume and Revenue for a Service Firm

1. Purchasing power of customer drawing area

2. Service and image compatibility with demographics of the customer drawing area

3. Competition in the area

4. Quality of the competition

5. Uniqueness of the firm’s and competitor’s locations

6. Physical qualities of facilities and neighboring businesses

7. Operating policies of the firm

8. Quality of management

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Location Strategies – Service vs. Industrial Service/Retail/Professional Revenue Focus

• Volume/revenue

– Drawing area, purchasing power

– Competition; advertising/pricing

• Physical quality

– Parking/access; security/ lighting; appearance/image

• Cost determinants

– Rent

– Management caliber

– Operations policies (hours, wage rates)

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Location Strategies – Service vs. Industrial Industrial Revenue Focus

• Tangible costs

– Transportation cost of raw materials

– Shipment cost of finished goods

– Energy and utility cost; labor; raw material; taxes, etc.

• Intangible and future costs

– Attitude toward union

– Quality of life

– Education expenditures by state

– Quality of state and local government

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Location Strategies – Service vs. Industrial Service/Retail/Professional Techniques

• Correlation analysis to determine importance of factors for a particular type of operation

• Traffic counts

• Demographic analysis of drawing area

• Purchasing power analysis of drawing area

Assumptions

• Location is a major determinate of revenue

• Issues manifesting from high customer contact dominate

• Costs are relatively constant for a given area; therefore, revenue function is critical

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Location Strategies – Service vs. Industrial Industrial Techniques

• Linear Programming (Transportation method)

• Weighted approach to intangibles

• Breakeven analysis

• Crossover charts

Assumptions

• Location is a major determinate of cost

• Most major costs can be identified explicitly for each site

• Low customer contact allows focus on costs

• Intangible costs can be objectively evaluated

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Major Methods of Solving Location Problems

• Weighted methods which:

– Assign weights and points to various factors

– Determine tangible costs

– Investigate intangible costs

• Center of Gravity Method

– Find best distribution center location

• Location breakeven methods

– Special case of breakeven analysis

• Transportation method

– A specialized linear programming method

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Telemarketing and Internet Industries

• Require neither face-to-face contact with customers (or employees) nor movement of material

• Presents a whole new perspective on the location problem

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Telemarketing and Internet Industries

• Require neither face-to-face contact with customers (or employees) nor movement of material

• Presents a whole new perspective on the location problem