Facility Location

Unit- II
Facility Location
Where should a plant or service facility be located?
• Need to produce close to supplier as well as customer due to
time-based competition, trade agreements and shipping costs

• Need to locate near the appropriate labor pool to take advantage of low wage
and high technical skills

Profit-oriented organization Make decision on profit potential

Balance between cost and
Non-profit organization
level of customer service
Why Facility Location…….????

Strategic Decision : Facility Location decisions

are part of the company’s strategy. Infrequent
but expensive.

Reasons for the importance:

• Facility Location requires large investment
that can not be recovered.
• Facility Location decisions affect the
competitive capacity of the company.
Location Decisions
Long-term decisions
Difficult to reverse
Affect fixed & variable costs
Transportation costs (25% of price)
Other costs: taxes, wages, rent
Objective: maximize benefit of location to firm
Importance of Facility Location :
 All areas of the company are affected by Facility Location:
Operations, but also Business Development, Human Resources,
Finance, etc.
 The facility location decisions affect not only costs but the
company’s income:
e. g., For a service business, market proximity is critical to
determine the capacity to attract customers.
 For a manufacturing business, facility location affects product
delivery time and level of customer service, which affects sales.
Regarding costs, facility location affects a great variety of them:
Land costs.
Labor costs.
Raw materials.
Transportation and distribution
McDonalds in India

Problems
Indian diversity.
Religion/Cultural constraints.
Environmental and animal activists opposed the entry
of fast food (like KFC and McDonald’s).
The Idea than this type of junk food destroy the
ecological balance and cause several behavioral
disorders because of the fatty and unhealthy foods.
Perception that McDonald’s was a food for rich people.
 Poor transportation and storage infrastructure.
Lower-quality agricultural products.
LOCATION McDonald’s opened its first
outlets in Mumbai and Delhi due to:
These 2 cities have metropolitan culture and wide Western
exposure.
There live the most of the Indian’s rich and upper middle
class inhabitants who were aware of McDonald’s food.
There were the 2 distribution centers of McDonalds. Due to
logistics play a critical role in McDonald’s location strategy,
the first outlets were opened only within a 500Km radius of
its main distribution centers.
McDonald’s also made some partnerships in order to opened
outlets besides the petroleum stations, railway stations and
drive-through in Delhi and along national highways.
Causes that originate Location decision problems
An expanding market
 Itwill require the addition of more capacity at a certain
geographic point, either in an existent facility or in a new
one.
Introduction of new products or services.
A contracting demand, or changes in the location of the
demand
 It may require the shut down and/or relocation of
operations.
The exhaustion of raw materials in a certain area
 Example: Extraction companies.
Obsolescence of a manufacturing facility due to the
appearance of new technologies
 It means the creation of a new modern plant somewhere
else.
Causes that originate Location decision problems
The pressure of the competence
To increase the level of service, it can force the
company to increase capacity of certain plants
or relocate some of them.
Change in other resources: like labor
conditions or subcontracted components, or
change in the political or economic environment
in a certain region.
Mergers and acquisitions
Some facilities may appear as redundant, or bad
located with respect to others.
Factors should be considered while deciding
a location :
Market Related Issues :
 Market for products & services
 Raw material availability
 Number & proximity of suppliers
 Availability of skilled labour
 Quality of infrastructure
 Nature of competition
Cost Related issues :
 Costs of inputs
 Transportation costs
 Taxes & other tariff issues
 Cost of manufacture/Service
 Currency & exchange rate fluctuation
Regulatory & Policy issues :
 Government & economics stability
 Quality of legal & other institution
 Trading blocks & trading agreements
(good quality governance, availability of free markets,
public finance, free access to markets)
Other issues :
 Culture
 Climate
 Quality of life
 Facility Location
Factors Affecting Location Decisions
• Proximity to customers

• Proximity to suppliers

• Business climate

• Total costs

• Infrastructure

• Government barriers

• Trade blocks
Location Planning Methods :
Centre of Gravity Method
Location Factor Rating
Break Even Analysis
Brown & Gibson Method
Transportation Methods
 Facility Location
Plant Location Methods
• Median Model :total TC between new & existing facilities is
minimum

• Center of Gravity Method: locating a single facility that

considers the existing facility, distance between
them and the volume of goods to be shipped

Service Location Method

Have multiple sites to maintain close contact with customers

Location decision is closely tied to the market selection decision
 Facility Location
Center of Gravity Method

A company needs to locate an intermediate holding facility

between its plant and major distributors. Locations and
amounts of product are as follows:

Location Amount
Plant (325, 75) 1500
Distributor A (25, 240) 450
Distributor B (350, 400) 350
Distributor C (400, 150) 250
Distributor D (450, 350) 450
 Facility Location

500
A
400 B
D
Plant : (325,75)
300 Dist A: (25,450)
Dist B: (350,400)
200 Dist C: (400,150)
C Dist D: (450,350)
100
Plant

0
0 100 200 300 400 500 600
 Facility Location
Location Amount Cy 
 d iyVi
Plant (325, 75) 1500 Vi
Distributor A (25, 240) 450
Cx 
 d ixVi
Distributor B (350, 400) 350
Distributor C (400, 150) 250 Vi
Distributor D (450, 350) 450

Location of Intermediate holding facility

325 * 1500  25 * 450  350 * 350  400 * 250  450 * 450

Cx   307.9
1500  450  350  250  450

75 *1500  240 * 450  400 * 350  150 * 250  350 * 450

Cy   185.16
1500  450  350  250  450
 Facility Location

500
A
400 B
D
Plant : (325,75)
300 Dist A: (25,450)
Dist B: (350,400)
200 Dist C: (400,150)
C Dist D: (450,350)
100
Plant Facility : (308,185)
0
0 100 200 300 400 500 600
 Facility Location
Center of Gravity Method
Find the best location by the method of centre of gravity,
following information is given:

No. of containers

Store Location shipped per month

Chicago (30, 120) 2,000

Pittsburgh (90, 110) 1,000

New York (130, 130) 1,000

Atlanta (60, 40) 2,000

Locational Cost-Profit-Volume Analysis

24
 Cost-Profit-Volume Analysis

Cost-Profit-Volume (Break-even)Analysis
 A technique for evaluating location choices in
economic terms
 Steps:
1. Determine the fixed and variable costs for each alternative
2. Plot the total-cost lines for all alternatives on the same
graph
3. Determine the location that will have the lowest total cost
(or highest profit) for the expected level of output

25
Locational Cost-Profit-Volume Analysis
Assumptions
1. Fixed costs are constant for the range of probable output
2. Variable costs are linear for the range of output
3. The required level of output can be closely estimated
4. Only one product is involved

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Location Cost-Profit-Volume Analysis
For a cost analysis, compute the total cost for each
alternative location:

Total Cost  FC  v  Q
where
FC  Fixed cost
v  Variable cost per unit
Q  Quantity or volume of output

27
Break-even analysis example
C&A Electronic is considering two possible sites for its
new DVD plant. The annual fixed and variable costs for
each site are:

Location Fixed costs Variable costs

Lexington $650,000 $50/unit
Wilmore $350,000 $65/unit

If annual demand for C&A’s DVD is expected to be

25,000 units, which is the best location?
TC(L) = FC +VC = 650000+ 50x 25000 = 19,00000
TC(W) = 3,50000+ 65x 25000 = 19, 75000
Break-even analysis example continued
1. Determine the fixed and variable costs for each
location

Let Q be the demand of DVD for BEP,

TC(Lexington) = 650000 + 50Q
TC(Wilmore) = 350000 + 65Q
At BEP,
TC (L) = TC(W)
650000 + 50Q = 350000+ 65Q
Q = 20,000
Break-even analysis example continued
2. Identify the indifference points between each pair of
location alternatives
Let Q* be indifference demand,
TC(Lexington) = TC(Wilmire) at Q*
650000 + 50Q* = 350000 + 65Q*
Q* = 300000/15 = 20,000 units
Break-even analysis example continued

3. Identify the ranges of output for which each location

has the lowest total costs
At Q = 0,
TC(Lexington) = $650,000
TC(Wilmore) = $350,000
 Q < 20,000, Wilmore has the lowest total cost; Q >
20,000 Lexington has the lowest total costs
 TC= FC +V Q
TC = 350000+0
TC= 350000+65* 10000
TC= 350000+ 65* 20000
TC= 350000+65 * 30000
$4,000,000
Break-even analysis example continued
$3,500,000

$3,000,000
$2,500,000
Q<20000
Wilmore
Cost

$2,000,000 Choose Wilmore

Lexington
$1,500,000

$1,000,000
Q>20000
$500,000 choose Lexington
$0 Q
0 10000 20000 30000 40000 50000 60000
Break-even analysis example continued
4. Select the location that gives the lowest cost for the
design capacity of the new facility
If Q = 25,000
Q > Q* (20,000)  Lexington should be chosen as
the location for the new facility
Example: Cost-Profit-Volume Analysis

Fixed and variable costs for four potential plant

locations are shown below:

Fixed Cost Variable Cost

Location per Year per Unit
A $250,000 $11
B $100,000 $30
C $150,000 $20
D $200,000 $35

34
 Example: Cost-Profit-Volume Analysis
Comparison of total costs at a production volume of 10,000

Fixed Variable Total

Costs Costs Costs
A $250,000 $11(10,000) $360,000
B 100,000 30(10,000) 400,000
C 150,000 20(10,000) 350,000
D 200,000 35(10,000) 550,000

35
Example: Cost-Profit-Volume Analysis
Plot of total costs
$(000)
800 D
700
600 B
500 C
400 A
300
200
100
0
0 2 4 6 8 10 12 14 16

Annual Output (000)

36
 Example: Solution
$(000)
800
700
600 D B
500 C
400 A
300 A Superior
200 C Superior
100 B Superior
0
0 2 4 6 8 10 12 14 16

Annual Output (000)

37
Example: Cost-Profit-Volume Analysis
 Range approximations Total Cost of C  Total Cost of B
 B Superior (up to 4,999 units)
150,000  20Q  100,000  30Q
50,000  10Q
Q  5,000

 C Superior (>5,000 to 11,111 units)

Total Cost of A  Total Cost of C
250,000  11Q  150,000  20Q
100,000  9Q
Q  11,111 .11
 A superior (11,112 units and up)

 For A & B = 7895

38
Factor Rating Method

39
Factor Rating Method
 A general approach to evaluating locations that
includes quantitative and qualitative inputs
 Most widely used location technique
 Useful for service and industrial locations
 Rates locations using both
 tangible (quantitative) factors such as short-run and
long-run costs and
 intangible (qualitative) factors such as education
quality, labor skills.
40
Factor Rating
Procedure:
 Determine which factors are relevant
 Assign a weight to each factor that indicates its relative
importance compared with all other factors.
 Weights typically sum to 1.00
 Decide on a common scale for all factors (such as 1-100), and
set a minimum acceptable score if necessary
 Score each location alternative along each factor
 Multiply the factor weight by the score for each factor, and
sum the results for each location alternative
 Choose the alternative that has the highest composite score,
unless it fails to meet the minimum acceptable score

41
ILLUSTRATION
Let us assume that a new medical facility, Health-
care, is to be located in Delhi. The location factors,
factor rating and scores for two potential sites are
shown in the following table. Which is the best
location based on factor rating method?
Factor Rating

43
Example: Factor Rating
A photo-processing company intends to open a new branch
store. The following table contains information on two
potential locations. Which is better?
Scores
(Out of 100)
Factor Weight Alt 1 Alt 2
Proximity to
existing source .10 100 60
Traffic volume .05 80 80
Rental costs .40 70 90
Size .10 86 92
Layout .20 40 70
Operating Cost .15 80 90
1.00
44
Example: Factor Rating
A photo-processing company intends to open a new branch
store. The following table contains information on two
potential locations. Which is better?
Scores
(Out of 100) Weighted Scores
Factor Weight Alt 1 Alt 2 Alt 1 Alt 2

Proximity to
existing source .10 100 60 .10(100) = 10.0 .10(60) = 6.0

Traffic volume .05 80 80 .05(80) = 4.0 .05(80) = 4.0

Rental costs .40 70 90 .40(70) = 28.0 .40(90) = 36.0
Size .10 86 92 .10(86) = 8.6 .10(92) = 9.2
Layout .20 40 70 .20(40) = 8.0 .20(70) = 14.0
Operating Cost .15 80 90 .15(80) = 12.0 .15(90) = 13.5
1.00 70.6 82.7
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