Operations Management Location Strategies Chapter 8

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.

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?? Students should be asked to suggest why the “hub” concept provides the advantages noted. They should also be asked to consider the limitations of the hub concept.

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.

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). It is helpful to begin this discussion by asking students how and under what conditions location impacts costs and revenues. Once they have begun to consider these issues, then the decision for industrial or service organizations can be explored.

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.

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. This and the following slide suggest organizations which need to be physically close to their markets

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. This and the following slide suggest organizations which need to be physically close to their markets

Location Decision Sequence Region/Community Country Site Stress that the location decision process is basically another process in which one attempts to continuously narrow the range of alternatives considered.

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. Students, especially those from other countries, should be able to contribute significantly to a discussion of factors affecting one’s choice of country.

Labor Costs - Figure 8.2

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

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. Discussion of this slide might include comments on the impact of information technology on the priorities attached to the factors listed.

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. What impact does the increasing rate of environmental change have on a firm’s site choice? For example, would one build a single site, or a collection of sites which might be tied together by technology? Does one have to choose a site near desired services, or can these services often be secured through technology? .

Location Decision Example - BMW In 1992, BMW decided to build its first major manufacturing plant outside Germany in Spartanburg, South Carolina. BMW’s decisions

Country Decision - BMW Market location. Labor. Other. 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).

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.

Location Evaluation Methods Factor-rating method. Locational break-even analysis. Center of gravity method. Transportation model. This slide can be used to frame a discussion of methods to evaluate location decisions.

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. This technique might be viewed as an extension of the Critical Success Factors methodology where the factors are weighted and rated.

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. One way to derive an example of this technique is to ask students to identify the factors which caused them to select your particular college or university, and work through the appropriate analysis.

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).

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.

Factor Rating Example Factor weight A B C Cost 0.3 Proximity to trans. 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

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

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. Basically breakeven where costs depend upon location.

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? An example

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: 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 B is Best An example

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? An example

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 An example

Locational Crossover Chart 200,000 Akron 150,000 Chicago Bowling Green Akron lowest cost Bowling Green lowest cost Chicago lowest cost $ 100,000 50,000 Graphical solution to the example 500 1000 1500 2000 2500 3000 Volume

Locational Crossover Chart 200,000 Revenue Akron 150,000 Chicago Bowling Green Akron lowest cost Bowling Green lowest cost Chicago lowest cost $ 100,000 50,000 Graphical solution to the example 500 1000 1500 2000 2500 3000 Volume

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. An example

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). This is a good point at which to raise the issue of choosing a decision methodology. Point out to students that the Center of Gravity method is helpful in a limited number of situations (where geography and transportation costs are important?)- where the critical factor methodology is more general. (but the critical factor method is more qualitative)

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.

Center of Gravity Method Equations X Coordinate dix = x coordinate of location i Wi = Volume of goods moved to or from location i diy = y coordinate of location i Y Coordinate

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. Chicago (30,120) New York (130,130) Pittsburgh (90,110) Atlanta (60,40) 120 60 Location Volume Chicago 200 Pittsburgh 100 New York 100 Atlanta 200

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

Center of Gravity Example Chicago (30,120) New York (130,130) Pittsburgh (90,110) Atlanta (60,40) 120 60 Location Volume Chicago 2000 Pittsburgh 1000 New York 1000 Atlanta 2000 X Center of gravity = (66.7, 93.3)

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. Again, this method, while quantitative, is unable to handle many of the important factors.

Transportation Model Example Atlanta Chicago St. Louis London 800 500 1000 Supply is in green Demand is in red 300 200 900 300 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 Atlanta $1

Transportation Model Example Atlanta 300 Chicago 500 900 Atlanta 800 Chicago 300 St. Louis London 1000 St. Louis 200 Supply Demand $40 $10 $20 $8 $35 $1 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).

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

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. This slide makes the distinction between an industrial and a service organization. Students may be asked to cite examples for each of the qualities listed.

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. Assumptions Location is major determinate of revenue. High customer contact issues dominate. Costs are relatively constant for a given area. Industrial Location Techniques Linear and Integer Programming (Transportation method). Factor rating. Breakeven and crossover analysis. Center of gravity. Assumptions Location is major determinate of cost. Costs can be identified for each site. Low customer contact allows focus on costs. Intangible costs can be objectively evaluated.

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). Given the significant impact of the World Wide Web, this slide should be discussed in detail.

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.