8-1 operations management location strategies chapter 8

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Operations Operations ManagementManagement

Location StrategiesLocation StrategiesChapter 8Chapter 8

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OutlineOutline 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.

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Federal ExpressFederal 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??

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Location DecisionsLocation 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.

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Industrial Location DecisionsIndustrial 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).

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Service Location DecisionsService 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.

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Organizations That Locate Close Organizations That Locate Close to Markets/Customersto 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.

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Organizations That Locate Close Organizations That Locate Close to Suppliers or Materialsto 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.

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Location Decision SequenceLocation Decision Sequence

Country Region/Community

Site

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Factors Affecting Country DecisionFactors 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.

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Labor Costs - Figure 8.2Labor Costs - Figure 8.2

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Ranking of the Business Environment Ranking of the Business Environment in 20 Countries, 1997 - 2001in 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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Factors Affecting Factors Affecting Region/Community DecisionRegion/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.

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Factors Affecting Site DecisionFactors 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.

.

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Location Decision Example - BMWLocation Decision Example - BMW

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

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Country Decision - BMWCountry 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).

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Region/Community Decision - BMWRegion/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.

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Location Evaluation MethodsLocation Evaluation Methods

Factor-rating method.

Locational break-even analysis.

Center of gravity method.

Transportation model.

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Factor-Rating MethodFactor-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.

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Steps in Factor Rating MethodSteps 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.

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Factors Affecting LocationFactors 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).

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Factors Affecting Location - Factors Affecting Location - continuedcontinued

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.

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Factor Rating ExampleFactor Rating ExampleThree 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 CCost 0.3Proximity to trans. 0.2Taxes 0.1Labor 0.4

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Factor Rating ExampleFactor Rating ExampleThree locations: A, B and C; Four factors.

Factor weight A B CCost 0.3 10 9 7Proximity to trans. 0.2 7 3 10Taxes 0.1 7 5 10Labor 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.

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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.

Locational Break-Even AnalysisLocational Break-Even Analysis

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Locational Break-Even Analysis Locational Break-Even Analysis ExampleExample

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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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

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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?

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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

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Locational Crossover ChartLocational Crossover Chart

0

50,000

100,000

150,000

200,000

0 500 1000 1500 2000 2500 3000

Volume

$

Akron

Chicago

Bowling Green

Akron lowest cost

Bowling Green lowest cost

Chicago lowest cost

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Locational Crossover ChartLocational Crossover Chart

0

50,000

100,000

150,000

200,000

0 500 1000 1500 2000 2500 3000

Volume

$

Akron

Reven

ue

Chicago

Bowling Green

Akron lowest cost

Bowling Green lowest cost

Chicago lowest cost

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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.

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Center of Gravity MethodCenter 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).

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Center of Gravity Method StepsCenter 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.

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Center of Gravity Method EquationsCenter of Gravity Method Equations

ddix ix = x coordinate of location i= x coordinate of location i

WWii == Volume of goods Volume of goods

moved to or from location i moved to or from location i

ddiy iy = y coordinate of location i= y coordinate of location i

X CoordinateX Coordinate

Y CoordinateY Coordinate

ii

iiix

x W

WdC

ii

iiiy

y W

WdC

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Center of Gravity ExampleCenter of Gravity Example

Location Volume

Chicago 200

Pittsburgh 100

New York 100

Atlanta 200

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)

0 12060

60

120

0

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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

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Location Volume

Chicago 2000

Pittsburgh 1000

New York 1000

Atlanta 2000

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

Pittsburgh (90,110)

Atlanta (60,40)

0 12060

60

120

0

X

Center of gravity = (66.7, 93.3)

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Transportation ModelTransportation 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.

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Transportation Model ExampleTransportation Model Example

Atlanta

Chicago

St. Louis

London

From To Cost per unit flowChicago London $40Chicago St. Louis $10St. Louis Chicago $8St. Louis Atlanta $20Atlanta London $35Chicago Chicago $1St. Louis St. Louis $1Atlanta Atlanta $1

Supply is in green

Demand is in red

800500

300200

900300

1000

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Transportation Model ExampleTransportation Model Example

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).

Atlanta 300

Chicago 500

900 Atlanta

800 Chicago

300 St. Louis

London 1000

St. Louis 200

Supply Demand$40

$10

$20

$8

$35

$1

$1

$1

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Integer Programming for LocationInteger Programming for Locationx1 = 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

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Location for Service OrganizationsLocation 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.

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Service vs. Industrial LocationService 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 LocationTechniques

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.

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Telemarketing and Internet Telemarketing and Internet IndustriesIndustries

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).

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Geographic Information Systems - Geographic Information Systems - GISGIS

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.

8-1 operations management location strategies chapter 8

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