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Issues in Facility Location

Free trade zones defined Trading blocs defined

409

Plant Location Methods

Factor-rating systems Transportation method of linear programming Centroid method Factor-rating system defined Transportation method defined Centroid method defined

415 418 420 421

Locating Service Facilities Conclusion Case: ApplichemThe Transportation Problem Case: The Plant Location Puzzle

technical note

TECHNICAL NOTE TEN

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ARCHER DANIELS MIDLAND (ADM) IS A MAJOR PROCESSOR OF AGRICULTURAL PRODUCTS. ADMS EUROPORT PLANT IN ROTTERDAM, THE NETHERLANDS, IS THE LARGEST GRAINPROCESSING FACILITY IN THE WORLD; IT CAN SHIP BY LAND, RAIL, RIVER , AND SEA.

Where should a plant or service facility be located? This is a top question on the strategic agendas of contemporary manufacturing and service rms, particularly in this age of global markets and global production. Dramatic changes in international trade agreements have made the world truly a global factory, allowing companies greater exibility in their location choices. In practice, however, the question of location is very much linked to two competitive imperatives: 1 2 The need to produce close to the customer due to time-based competition, trade agreements, and shipping costs. The need to locate near the appropriate labor pool to take advantage of low wage costs and/or high technical skills.

This technical note discusses these and other issues in facility location decisions. Examples cover different industries with a global perspective. We present typical techniques involved in facility location analysis and two cases on global location decisions.

I S S U E S I N FA C I L I T Y L O C AT I O N
The problem of facility location is faced by both new and existing businesses, and its solution is critical to a companys eventual success. An important element in designing a companys supply chain is the location of its facilities. For instance, 3M has moved a signicant part of its corporate activity, including R&D, to the more temperate climate of Austin, Texas. Toys R Us has opened a new location in Japan as a part of its global strategy. Disney chose Paris, France, for its European theme park, and BMW assembles the Z3 sports car in South Carolina. Manufacturing and service companies location decisions are guided by a variety of criteria dened by competitive imperatives. Criteria that inuence manufacturing plant and warehouse location planning are discussed next.
P r o x i m i t y t o C u s t o m e r s For example, Japans NatSteel Electronics has built its two largest plants in Mexico and Hungary to be closer to major markets in the United States and Europewhose buyers want their goods delivered yesterday. Such proximity also helps ensure that customer needs are incorporated into products being developed and built. B u s i n e s s C l i m a t e A favorable business climate can include the presence of similar-sized businesses, the presence of companies in the same industry, and, in the case of international locations, the presence of other foreign companies. Probusiness government
Glob
al

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legislation and local government intervention to facilitate businesses locating in an area via subsidies, tax abatements, and other support are also factors. T o t a l C o s t s The objective is to select a site with the lowest total cost. This includes regional costs, inbound distribution costs, and outbound distribution costs. Land, construction, labor, taxes, and energy costs make up the regional costs. In addition, there are hidden costs that are difcult to measure. These involve (1) excessive moving of preproduction material between locations before nal delivery to the customers and (2) loss of customer responsiveness arising from locating away from the main customer base. I n f r a s t r u c t u r e Adequate road, rail, air, and sea transportation are vital. Energy and telecommunications requirements also must be met. In addition, the local governments willingness to invest in upgrading infrastructure to the levels required may be an incentive to select a specic location. Q u a l i t y o f L a b o r The educational and skill levels of the labor pool must match the companys needs. Even more important are the willingness and ability to learn. S u p p l i e r s A high-quality and competitive supplier base makes a given location suitable. The proximity of important suppliers plants also supports lean production methods. O t h e r F a c i l i t i e s The location of other plants or distribution centers of the same company may inuence a new facilitys location in the network. Issues of product mix and capacity are strongly interconnected to the location decision in this context. Free trade zone
Glob
al

F r e e T r a d e Z o n e s A foreign trade zone or a free trade zone is typically a closed facility (under the supervision of the customs department) into which foreign goods can be brought without being subject to the normal customs requirements. There are about 170 such free trade zones in the United States today. Such specialized locations also exist in other countries. Manufacturers in free trade zones can use imported components in the nal product and delay payment of customs duties until the product is shipped into the host country. P o l i t i c a l R i s k The fast-changing geopolitical scenes in numerous nations present exciting, challenging opportunities. But the extended phase of transformation that many countries are undergoing makes the decision to locate in those areas extremely difcult. Political risks in both the country of location and the host country inuence location decisions. G o v e r n m e n t B a r r i e r s Barriers to enter and locate in many countries are being removed today through legislation. Yet many nonlegislative and cultural barriers should be considered in location planning.

Trading blocs

T r a d i n g B l o c s The world of trading blocs gained a new member with the ratication of the North American Free Trade Agreement (NAFTA). Such agreements inuence location decisions, both within and outside trading bloc countries. Firms typically locate, or relocate, within a bloc to take advantage of new market opportunities or lower total costs afforded by the trading agreement. Other companies (those outside the trading bloc countries) decide on locations within the bloc so as not to be disqualied from competing in the new market. Examples include the location of various Japanese auto manufacturing plants in Europe before 1992 as well as recent moves by many communications and nancial services companies into Mexico in a post-NAFTA environment. E n v i r o n m e n t a l R e g u l a t i o n The environmental regulations that impact a certain industry in a given location should be included in the location decision. Besides measurable cost implications, these regulations inuence the relationship with the local community.

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H o s t C o m m u n i t y The host communitys interest in having the plant in its midst is a necessary part of the evaluation process. Local educational facilities and the broader issue of quality of life are also important. C o m p e t i t i v e A d v a n t a g e An important decision for multinational companies is the nation in which to locate the home base for each distinct business. Porter suggests that a company can have different home bases for distinct businesses or segments. Competitive advantage is created at a home base where strategy is set, the core product and process technology are created, and a critical mass of production takes place. So a company should move its home base to a country that stimulates innovation and provides the best environment for global competitiveness.1 This concept can also be applied to domestic companies seeking to gain sustainable competitive advantage. It partly explains the southeastern states recent emergence as the preferred corporate destination within the United States (that is, their business climate fosters innovation and low-cost production).
al

P L A N T L O C AT I O N M E T H O D S
If the boss likes Bakerseld, I like Bakerseld. Exhibit TN10.1 summarizes the set of decisions that a company must make in choosing a plant location. Although the exhibit implies a step-by-step process, virtually all activities listed take place simultaneously.
EXHIBIT TN10.1
Decision Unit Major Decision Selected Decision Criteria

Operating division Planning division

Market region

Market potential Market share Operating cost

Operating division Traffic Tax Purchasing Industrial relations

Subregion

Transport costs (market raw materials) Taxes (state) Raw material costs Labor cost and availability

Operating division Traffic Purchasing Industrial relations Property

Community

Access to market/materials Materials cost Labor cost and availability Taxes (local) Availability of public services Availability of sites Community amenities

Operating division Engineering Property Tax Board of directors Final approval of site

Site

Access to transport network Site characteristics Taxes (property) Availability of public services Land and acquisition costs Construction costs

Authorizes contracts division to begin legal negotiaions with community (and owner) for land (site)

Community Site

SOURCE: T. M. CARROLL AND R. D. DEAN, A BAYESIAN APPROACH TO PLANT-LOCATION DECISIONS, DECISION SCIENCES 11, NO. 1 ( JANUARY 1980), P. 87. COPYRIGHT 1980 DECISION SCIENCES. REPRINTED BY PERMISSION OF DECISION SCIENCES INSTITUTE, LOCATED AT GEORGIA STATE UNIVERSITY, ATLANTA, GA.

Glob

Plant Search: Company XYZ

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As suggested by the preceding vote for Bakerseld, political decisions may occasionally override systematic analysis. Evaluation of alternative regions, subregions, and communities is commonly termed macro analysis. Evaluation of specic sites in the selected community is termed micro analysis. Techniques used to support macro analyses include factor-rating systems, linear programming, and centroid method. A detailed cost analysis would accompany each of these methods, and they must, of course, be related to business strategy.

FAC TO R- R AT I N G SYST E M S
Factor-rating systems Factor-rating systems are perhaps the most widely used of the general location techniques because they provide a mechanism to combine diverse factors in an easy-to-understand format. By way of example, a renery assigned the following range of point values to major factors affecting a set of possible sites:
RANGE Fuels in region Power availability and reliability Labor climate Living conditions Transportation Water supply Climate Supplies Tax policies and laws 0 to 330 0 to 200 0 to 100 0 to 100 0 to 50 0 to 10 0 to 50 0 to 60 0 to 20

Each site was then rated against each factor, and a point value was selected from its assigned range. The sums of assigned points for each site were then compared. The site with the most points was selected. A major problem with simple point-rating schemes is that they do not account for the wide range of costs that may occur within each factor. For example, there may be only a few hundred dollars difference between the best and worst locations on one factor and several thousands of dollars difference between the best and the worst on another. The rst factor may have the most points available to it but provide little help in making the location decision; the second may have few points available but potentially show a real difference in the value of locations. To deal with this problem, it has been suggested that points possible for each factor be derived using a weighting scale based on standard deviations of costs rather than simply total cost amounts. In this way, relative costs can be considered.

T R A N S P O RTAT I O N M E T H O D LINEAR PROGRAMMING

Transportation method
tive Op ac

OF

The transportation method is a special linear programming method. (Note that linear programming is developed in detail in Supplement A.) It gets its name from its application to problems involving transporting products from several sources to several destinations. The two common objectives of such problems are either (1) minimize the cost of shipping n units to m destinations or (2) maximize the prot of shipping n units to m destinations. EXAMPLE TN10.1: U.S. Pharmaceutical Company
Suppose the U.S. Pharmaceutical Company has four factories supplying the warehouses of four major customers and its management wants to determine the minimum-cost shipping schedule for its monthly output to these customers. Factory supply, warehouse demands, and shipping costs per case for these drugs are shown in Exhibit TN10.2.

tions M era

ge ana me

nt

Inter

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Data for U.S. Pharmaceutical Transportation Problem

SHIPPING COSTS PER CASE (IN DOLLARS) TO COLUMBUS $25 55 40 30 TO ST. LOUIS $35 30 50 40 TO DENVER $36 25 80 66 TO LOS ANGELES $60 25 90 75

EXHIBIT TN10.2

FACTORY Indianapolis Phoenix New York Atlanta

SUPPLY 15 6 14 11

WAREHOUSE Columbus St. Louis Denver Los Angeles

DEMAND 10 12 15 9

FROM Indianapolis Phoenix New York Atlanta

Transportation Matrix for U.S. Pharmaceutical Problem

From To Columbus
25

EXHIBIT TN10.3
Los Angeles
60 15

St. Louis
35

Denver
36

Factory supply

Indianapolis
55 30 25 25

Phoenix
40 50 80 90

New York
30 40 66 75

14

Atlanta Destination requirements

10 12 15 9 46

11 46

The transportation matrix for this example appears in Exhibit TN10.3, where supply availability at each factory is shown in the far right column and the warehouse demands are shown in the bottom row. The shipping costs are shown in the small boxes within the cells. For example, the cost to ship one unit from the Indianapolis factory to the customer warehouse in Columbus is $25.

SOLUTION
This problem can be solved by using Microsoft Excels Solver function. Exhibit TN10.4 shows how the problem can be set up in the spreadsheet. Cells B6 through E6 contain the requirement for each customer warehouse. Cells F2 through F5 contain the amount that can be supplied from each plant. Cells B2 through E5 are the cost of shipping one unit for each potential plant and warehouse combination. Cells for the solution of the problem are B9 through E12. These cells can initially be left blank when setting up the spreadsheet. Column cells F9 through F12 are the sum of each row indicating how much is actually being shipped from each factory in the candidate solution. Similarly, row cells B13 through E13 are sums of the amount being shipped to each customer in the candidate solution. The Excel Sum function can be used to calculate these values. The cost of the candidate solution is calculated in cells B16 through E19. Multiplying the amount shipped in the candidate solution by the cost per unit of shipping over that particular route makes this calculation. For example, multiplying B2 by B9 in cell B16 gives the cost of shipping between Indianapolis and Columbus for the candidate solution. The total cost shown in cell F20 is the sum of all these individual costs. To solve the problem the Excel Solver application needs to be accessed. The Solver is found by selecting Tools and then Solver from the Excel menu. A screen similar to what is shown below should appear. If you cannot nd Solver at that location, the required add-in might not have been added when

Tuto

rial

: Excel
ve Sol r

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EXHIBIT TN10.4 Excel Screen Showing the U.S. Pharmaceutical Problem

Exce

S Phar l: U

ceutica ma

s l.xl

Excel was initially installed on your computer. Solver can easily be added if you have your original Excel installation disk.

Solver parameters now need to be set. First set the target cell. This is the cell where the total cost associated with the solution is calculated. In our sample problem this is cell F20. Next we need to indicate

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FACILITY LOCATION that we are minimizing this cell. Selecting the Min button does this. The location of our solution is indicated in the Changing Cells. These cells are B9 through E12 in our example. Next we need to indicate the constraints for our problem. For our transportation problem we need to be sure that customer demand is met and that we do not exceed the capacity of our manufacturing plants. To ensure that demand is met, click on Add and highlight the range of cells where we have calculated the total amount being shipped to each customer. This range is B13 to E13 in our example. Next select = indicating that we want the amount shipped to equal demand. Finally, on the right side enter the range of cells where the actual customer demand is stated in our spreadsheet. This range is B6 to E6 in our example. The second set of constraints that ensures that the capacity of our manufacturing plants is not exceeded is entered similarly. The range of cells that indicated how much is being shipped from each factory is F9 to F12. These values need to be less than or equal to (<=) the capacity of each factory, which is in cells F2 to F5. To set up the Solver, a few options need to be set as well. Click on the Options button and the following screen should appear:

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413

Two options need to be set for solving transportation problems. First we need Assume Linear Model. This tells the Solver that there are no nonlinear calculations in our spreadsheet. This is important because the Solver can use a very efcient algorithm to calculate the optimal solution to this problem if this condition exists. Next the Assume Non-Negative box needs to be checked. This tells Solver that the values in our solution need to be greater than or equal to zero. In transportation problems shipping negative quantities does not make any sense. Click OK to return to the main Solver box, and then click Solve to actually solve the problem. Solver will notify you that it found a solution. Indicate that you want that solution saved. Finally, click OK to go back to the main spreadsheet. The solution should be in cells B9 to E12. The transportation method can be used to solve many different types of problems if it is applied innovatively. For example, it can be used to test the cost impact of different candidate locations on the entire productiondistribution network. To do this we might add a new row that contains the unit shipping cost from a factory in a new location, say, Dallas, to the existing set of customer warehouses, along with the total amount it could supply. We could then solve this particular matrix for minimum total cost. Next we would replace the factory located in Dallas in the same row of the matrix with a factory at a different location, Houston, and again solve for minimum total cost. Assuming the factories in Dallas and Houston would be identical in other important respects, the location resulting in the lowest total cost for the network would be selected. For additional information about using the Solver, see Supplement A, Linear Programming with the Excel Solver.

CENTROID METHOD
The centroid method is a technique for locating single facilities that considers the existing facilities, the distances between them, and the volumes of goods to be shipped. The technique is often used to locate intermediate or distribution warehouses. In its simplest form, this Centroid method

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EXHIBIT TN10.5
500

Grid Map for Centroid Example

400

Thousand Oaks (25, 450) Glendale (350, 400) LaHabra (450, 350) 300 * Centroid (308, 217) Anaheim (400, 150) 100 Long Beach (325, 75)

200

100 Plant Distributor

200

300

400

500

ge ana me

nt

Inter

tive Op ac

method assumes that inbound and outbound transportation costs are equal, and it does not include special shipping costs for less than full loads. Another major application of the centroid method today is the location of communication towers in urban areas. Examples include radio, TV, and cell phone towers. In this application the goal is to nd sites that are near clusters of customers, thus ensuring clear radio signals. The centroid method begins by placing the existing locations on a coordinate grid system. The choice of coordinate systems is entirely arbitrary. The purpose is to establish relative distances between locations. Using longitude and latitude coordinates might be helpful in international decisions. Exhibit TN10.5 shows an example of a grid layout. The centroid is found by calculating the X and Y coordinates that result in the minimal transportation cost. We use the formulas Cx = di xVi Vi Cy = diyVi Vi

tions M era

where Cx = X coordinate of the centroid Cy = Y coordinate of the centroid dix = X coordinate of the ith location di y = Y coordinate of the ith location Vi = Volume of goods moved to or from the ith location EXAMPLE TN10.2: HiOctane Refining Company
The HiOctane Rening Company needs to locate an intermediate holding facility between its rening plant in Long Beach and its major distributors. Exhibit TN10.5 shows the coordinate map. The amount of gasoline shipped to or from the plant and distributors appears in Exhibit TN10.6. In this example, for the Long Beach location (the rst location), d1x = 325, d1y = 75, and V1 = 1,500.

SOLUTION
Using the information in Exhibits TN10.5 and TN10.6, we can calculate the coordinates of the centroid: Cx = = (325 1,500) + (400 250) + (450 450) + (350 350) + (25 450) 1,500 + 250 + 450 + 350 + 450 923,750 = 307.9 3,000

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LOCATIONS Long Beach Anaheim LaHabra Glendale Thousand Oaks

PER

GALLONS OF GASOLINE MONTH (000,000) 1,500 250 450 350 450

EXHIBIT TN10.6 Shipping Volumes, Centroid Example

Cy = =

(75 1,500) + (150 250) + (350 450) + (400 350) + (450 450) 1,500 + 250 + 450 + 350 + 450 650,000 = 216.7 3,000

This gives management the X and Y coordinates of approximately 308 and 217, respectively, and provides an initial starting point to search for a new site. By examining the location of the calculated centroid on the grid map, we can see that it might be more cost-efcient to ship directly between the Long Beach plant and the Anaheim distributor than to ship via a warehouse near the centroid. Before a location decision is made, management would probably recalculate the centroid, changing the data to reect this (that is, decrease the gallons shipped from Long Beach by the amount Anaheim needs and remove Anaheim from the formula).

L O C AT I N G S E R V I C E FA C I L I T I E S
Because of the variety of service rms and the relatively low cost of establishing a service facility compared to one for manufacturing, new service facilities are far more common than new factories and warehouses. Indeed, there are few communities in which rapid population growth has not been paralleled by concurrent rapid growth in retail outlets, restaurants, municipal services, and entertainment facilities.
Serv i

ce

LESS THAN TWO MILES FROM TWIN CITIES INTERNATIONAL AIRPORT, WITH FOUR MAJOR HIGHWAYS INTERSECTING THE 78-ACRE PROPERTY, BLOOMINGTONS MALL OF AMERICA HAS
BECOME GLOBALLY RECOGNIZED AS THE LARGEST ENTERTAINMENT AND RETAIL COMPLEX IN THE

UNITED STATES. SERVING OVER 28 MILLION PEOPLE WITHIN ONE-DAY DRIVE AS WELL AS MANY MORE AS A DESTINATION, THE MALL EMPLOYS MORE THAN 12,000 PEOPLE AND TOTAL TRAFFIC IS BETWEEN 35 AND 42 MILLION VISITS YEARLY. VISITORS SPEND AN AVERAGE OF 3 HOURS IN THE MALL, WHICH IS THREE TIMES THE NATIONAL AVERAGE FOR SHOPPING MALLS.

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GEOGRAPHIC INFORMATION SYSTEMS (GIS), SHOWN HERE FROM MAPINFO, ARE USED BY RETAILERS, FINANCIAL SERVICES GROUPS, AND OTHERS IN THE SITE SELECTION PROCESS. MAPPING INFORMATION ON POTENTIAL SITES SUCH AS DEMOGRAPHICS, COMPETITORS, AND
SO ON ALLOWS INFORMATION TO BE SEEN IN A SINGLE, COMPREHENSIVE VIEW FOR MORE INFORMED DECISION MAKING.

Services typically have multiple sites to maintain close contact with customers. The location decision is closely tied to the market selection decision. If the target market is college-age groups, locations in retirement communitiesdespite desirability in terms of cost, resource availability, and so forthare not viable alternatives. Market needs also affect the number of sites to be built and the size and characteristics of the sites. Whereas manufacturing location decisions are often made by minimizing costs, many service location decision techniques maximize the prot potential of various sites. Next we present a multiple regression model that can be used to help select good sites. EXAMPLE TN10.3: Screening Location Sites at La Quinta Motor Inns
Selecting good sites is crucial to a hotel chains success. Of the four major marketing considerations (price, product, promotion, and location), location and product have been shown to be most important for multisite rms. As a result, hotel chain owners who can pick good sites quickly have a distinct competitive advantage. Exhibit TN10.7 shows the initial list of variables included in a study to help La Quinta Motor Inns screen potential locations for its new hotels.2 Data were collected on 57 existing La Quinta Inns. Analysis of the data identied the variables that correlated with operating prot in 1983 and 1986. (See Exhibit TN10.8.)

SOLUTION
A regression model (see Chapter 12) was constructed. Its nal form was Protability = 39.05 5.41 State population per inn (1,000) + 5.86 Price of the inn 3.91 Square root of the median income of the area (1,000) + 1.75 College students within four miles The model shows that protability is affected by market penetration, positively affected by price, negatively affected by higher incomes (the inns do better in lower-median-income areas), and positively affected by colleges nearby.

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CATEGORY Competitive

NAME INNRATE PRICE RATE RMS 1 RMSTOTAL ROOMSINN CIVILIAN COLLEGE HOSP1 HOSPTOTL HVYIND LGTIND MALLS MILBLKD MILITARY MILTOT OFC1 OFCTOTAL OFCCBD PASSENGR RETAIL TOURISTS TRAFFIC VAN EMPLYPCT INCOME POPULACE AGE NEAREST STATE URBAN ACCESS ARTERY DISTCBD SIGNVIS

DESCRIPTION Inn price Room rate for the inn Average competitive room rate Hotel rooms within 1 mile Hotel rooms within 3 miles Inn rooms Civilian personnel on base College enrollment Hospital beds within 1 mile Hospital beds within 4 miles Heavy industrial employment Light industrial acreage Shopping mall square footage Military base blocked Military personnel MILITARY + CIVILIAN Office space within 1 mile Office space within 4 miles Office space in Central Business District Airport passengers enplaned Scale ranking of retail activity Annual tourists Traffic count Airport van Unemployment percentage Average family income Residential population Years inn has been open Distance to nearest inn State population per inn Urban population per inn Accessibility Major traffic artery Distance to downtown Sign visibility

EXHIBIT TN10.7 Independent Variables Collected for the Initial Model-Building Stage

Demand generators

Demographic

Market awareness

Physical

VARIABLE ACCESS AGE COLLEGE DISTCBD EMPLYPCT INCOME MILTOT NEAREST OFCCBD POPULACE PRICE RATE STATE SIGNVIS TRAFFIC URBAN

1983 .20 .29

1986

EXHIBIT TN10.8 A Summary of the Variables That Correlated with Operating Margin in 1983 and 1986

.49 .25 .22

.22

.22 .23 .22

.51 .30 .30 .38 .32 .25 .32 .22 .26 .35 .58 .27 .33

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SUPPLY CHAIN DESIGN La Quinta implemented the model on a spreadsheet and routinely uses the spreadsheet to screen potential real estate acquisitions. The founder and president of La Quinta has accepted the models validity and no longer feels obligated to personally select the sites. This example shows that a specic model can be obtained from the requirements of service organizations and used to identify the most important features in site selection.

CONCLUSION
Facility location decisions are a key element in any rms overall strategic plan. Dramatic changes in the global geopolitical environment, coupled with rapid advances in technology, have placed a premium on making location decisions in a matter of weeks rather than months, as has been the case in the recent past. As a nal comment, much of the location action is in deciding where to locate support functions rather than factories or retail outlets. In these situations the need for special capabilities of the workforce is often far more important than other cost factors. For example, IBM Business Consulting Services stated that a dominant factor in deciding where to locate the software application group of its client, a U.S. investment bank, was the availability of a large pool of multilingual workers.

KEY TERMS
Free trade zones A closed facility (under the supervision of government customs ofcials) into which foreign goods can be brought without being subject to the payment of normal import duties. Trading bloc A group of countries that agrees on a set of special arrangements governing the trading of goods between member countries. Companies may locate in places affected by the agreement to take advantage of new market opportunities. Factor-rating system An approach for selecting a facility location by combining a diverse set of factors. Point scales are developed for each criterion. Each potential site is then evaluated on each criterion and the points are combined to calculate a rating for the site. Transportation method A special linear programming method that is useful for solving problems involving transporting products from several sources to several destinations. Centroid method A technique for locating single facilities that considers the existing facilities, the distances between them, and the volumes of goods to be shipped.

FORMUL
Centroid

REVIEW
Cx = di x Vi Vi Cy = di y Vi Vi

SOLVED PROBLEM
SOLVED PROBLEM 1
Cool Air, a manufacturer of automotive air conditioners, currently produces its XB-300 line at three different locations: Plant A, Plant B, and Plant C. Recently management decided to build all compressors, a major product component, in a separate dedicated facility, Plant D. Using the centroid method and the information displayed in Exhibits TN10.9 and TN10.10, determine the best location for Plant D. Assume a linear relationship between volumes shipped and shipping costs (no premium charges).

Solution
d1x = 150 d2x = 100 d3x = 275 Cx = d1 y = 75 d2 y = 300 d3 y = 380 V1 = 6,000 V2 = 8,200 V3 = 7,000

di x Vi (150 6,000) + (100 8,200) + (275 7,000) = = 172 Vi 6,000 + 8,200 + 7,000

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EXHIBIT TN10.9
400 Plant C (275, 380) Plant B (100, 300)

Plant Location Matrix

300

200

100 Plant A (150, 75)

100

200

300

400

PLANT A B C

COMPRESSORS REQUIRED PER YEAR 6,000 8,200 7,000

EXHIBIT TN10.10 Quantity of Compressors Required by Each Plant

Cy =

di y Vi (75 6,000) + (300 8,200) + (380 7,000) = = 262.7 Vi 21,200

Plant D[Cx, Cy] = D[172, 263]

REVIEW
1 2 3 4 5

AND

DISCUSSION QUESTIONS

What motivations typically cause rms to initiate a facilities location or relocation project? List ve major reasons why a new electronic components manufacturing rm should move into your city or town. How do facility location decisions differ for service facilities and manufacturing plants? What are the pros and cons of relocating a small or midsized manufacturing rm (that makes mature products) from the United States to Mexico in the post-NAFTA environment? If you could locate your new software development company anywhere in the world, which place would you choose, and why?

PROBLEMS
1 2 Refer to the information given in the solved problem. Suppose management decides to shift 2,000 units of production from Plant B to Plant A. Does this change the proposed location of Plant D, the compressor production facility? If so, where should Plant D be located? A small manufacturing facility is being planned that will feed parts to three heavy manufacturing facilities. The locations of the current plants with their coordinates and volume requirements are given in the following table:
PLANT LOCATION Peoria Decatur Joliet COORDINATES (x, y) 300, 320 375, 470 470, 180 VOLUME (PARTS PER YEAR) 4,000 6,000 3,000 1. Cx = 176.7 Cy = 241.5 2. Cx = 374. Cy = 357.

Use the centroid method to determine the best location for this new facility. Bindley Corporation has a one-year contract to supply motors for all washing machines produced by Rinso Ltd. Rinso manufactures the washers at four locations around the country: New York, Fort Worth, San Diego, and Minneapolis. Plans call for the following numbers of

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Total profit = $4,240,000. 0 50 0 0 0 70 or 0 50 0 0 50 20 0 0 60 10 0 70 0 50 10 10 0 70

New York Fort Worth San Diego Minneapolis

50,000 70,000 60,000 80,000

Bindley has three plants that can produce the motors. The plants and production capacities are
Boulder Macon Gary 100,000 100,000 150,000

Alternate optimal solutions.

Due to varying production and transportation costs, the prot Bindley earns on each 1,000 units depends on where they were produced and where they were shipped. The following table gives the accounting department estimates of the dollar prot per unit. (Shipment will be made in lots of 1,000.)
SHIPPED TO PRODUCED AT Boulder Macon Gary NEW YORK 7 20 8 FORT WORTH 11 17 18 SAN DIEGO 8 12 13 MINNEAPOLIS 13 10 16

4. See ISM.

Given prot maximization as a criterion, Bindley would like to determine how many motors should be produced at each plant and how many motors should be shipped from each plant to each destination. a. Develop a transportation grid for this problem. b. Find the optimal solution using Microsoft Excel. RentR Cars is a multisite car rental company in the city. It is trying out a new return the car to the location most convenient for you policy to improve customer service. But this means that the company has to constantly move cars around the city to maintain required levels of vehicle availability. The supply and demand for economy cars, and the total cost of moving these vehicles between sites, are shown below.
To A
9 8 8 0

From

D
$9

E
$8

F
$6

G
$5

Supply
50

B
5 3 3 10

40

C Demand
50 60 25 30 165

75 165

a. Find the solution that minimizes moving costs using Microsoft Excel. b. What would you have to do to the costs to assure that A always sends a car to D as part of the optimal solution?

CASE:

A P P L I C H E M T H E T R A N S P O RTAT I O N P RO B L E M
costs that currently exist. They recognize that this study may result in the signicant reduction of output or possibly the shutting down of one or more of the existing plants. Applichem makes a product called Release-ease. Plastics molding manufacturers use this chemical product. Plastic parts are made by injecting hot plastic into a mold made in the shape of the part. After the plastic has sufciently cooled, the fresh part is removed

Applichem management is faced with the difcult problem of allocating to its customers the capacity of manufacturing plants that are located around the world. Management has long recognized that the manufacturing plants differ greatly in efciency but has had little success in improving the operations of the inefcient plants. At this time, management has decided to focus on how best to use the capacity of its plants given the differences in manufacturing

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FACILITY LOCATION from the mold and the mold is then reused to make subsequent parts. Release-ease is a dry powder, applied as part of the manufacturing process, that makes it easy to remove the part from the mold. Applichem has made the product since the early 1950s, and demand has been consistent over time.Arecent study byApplichems market research team has indicated that demand for Release-ease should be fairly steady for the next ve years. Although Applichem does have some competition, particularly in the European markets, management feels that as long as they can provide a quality product at a competitive cost, customers should stick with Applichem. Releaseease sells at an average price of $1.00 per pound. The company owns plants capable of making Release-ease in the following cities: Gary, Indiana; Windsor, Ontario, Canada; Frankfurt, Germany; Mexico City, Mexico; Caracas, Venezuela; and Osaka, Japan. Although the plants are focused on meeting demand for the immediate surrounding regions, there is considerable exporting and importing of product for various reasons. The following table contains data on how demand has been met during the past year:
PRODUCT MADE AND SHIPPED DURING PAST YEAR (100,000 POUNDS) FROM/TO Mexico City Windsor, Ontario Caracas Frankfort Gary Osaka MEXICO 3.0 2.6 4.1 5.6 20.0 12.4 14.0 4.0 CANADA VENEZUELA 6.3 EUROPE UNITED STATES JAPAN 7.9

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In considering how best to use the capacity of its plants, Applichem management needs to consider the cost of shipping product from one customer region to another. Applichem now commonly ships product in bulk around the world, but it is expensive. The costs involved are not only the transportation costs but also import duties that are assessed by customs in some countries. Applichem is committed to meeting demand, though, and sometimes this is done even though prot might not be made on all orders. The following table details the demand in each country, the cost to transport product from each plant to each country, and the current import duty rate levied by each country. (These percentages do not reect current duties.) Import duty is calculated on the approximate production plus transportation cost of product brought into the country. (For example, if the production and shipping cost for 1,000 pounds of Release-ease shipped into Venezuela were $100, the import duty would be $100 .5 = $50.)
TRANSPORTATION COST (PER 1,000 LBS), IMPORT DUTIES, AND DEMANDS FOR RELEASE-EASE PLANT/COUNTRY Mexico City Windsor, Ontario Caracas Frankfurt Gary Osaka Total demand (100,000 lbs) Import duty MEXICO 0 11.00 7.00 10.00 10.00 14.00 3.0 0.0% CANADA 11.40 0 10.00 11.50 6.00 13.00 2.6 0.0% VENEZUELA 7.00 9.00 0 12.50 11.00 12.50 16.0 50.0% EUROPE 11.00 11.50 13.00 0 10.00 14.20 20.0 9.5% UNITED STATES 11.00 6.00 10.40 11.20 0 13.00 26.4 4.5% JAPAN 14.00 13.00 14.30 13.30 12.50 0 11.9 6.0%

Differences in the technologies used in the plants and in local raw material and labor costs created signicant differences in the cost to produce Release-ease in the various locations. These costs may change dramatically due to currency valuation and labor law changes in some of the countries. This is especially true in Mexico and Venezuela. The capacity of each plant also differs at each location, and management has no interest in increasing capacity anywhere at this time. The following table gives details on the costs to produce and capacity of each plant:
PLANT PRODUCTION COSTS AND CAPACITY PLANT Mexico City Windsor, Ontario Caracas Frankfurt Gary Osaka PRODUCTION COST (PER 1,000 LBS) 95.01 97.35 116.34 76.69 102.93 153.80 PLANT CAPACITY (100,000 LBS) 22.0 3.7 4.5 47.0 18.5 5.0

QUESTIONS Given all these data, set up a spreadsheet (Applichem.xls is a start) and answer the following questions for management: 1 Evaluate the cost associated with the way Appplich plichems plant capacity is currently being used. l: A 2 Determine the optimal use of Applichems plant capacity using the Solver in Excel. 3 What would you recommend that Applichem management do? Why?
.xls em

SOURCE: THIS CASE IS ROUGHLY BASED ON DATA CONTAINED IN APPLICHEM (A), HARVARD BUSINESS SCHOOL, 9-685-051.

CASE:

T H E P L A N T LO C AT I O N P U Z Z L E 3
manufacturing operations overseas to take advantage of lower labor costs, Eldora had stuck with a domestic manufacturing strategy, keeping its plant on the same campus as its corporate ofces in Boulder, Colorado. Ann felt that her strategy of keeping all the parts of the company in the same location, although unconventional, had

Ann Reardon made her way across the crowded tradeshow oor, deep in thought and oblivious to the noisy activity all around her. As CEO of the Eldora Company (EDC) for the previous 13 years, she had led her organization through a period of extraordinary success. While larger bicycle makers had moved their

Exce

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section 3

SUPPLY CHAIN DESIGN began to fall off, Eldora had been able to adjust its production run with minimal disruption. EDC had also beneted from its foray into the high-end market (bicycles retailing for between $400 and $700) 12 years earlier. One of Anns rst moves as CEO had been to enter into a joint venture with Rinaldi, a high-end Italian bicycle manufacturer that at the time was specializing in racing models. As part of the agreement, EDC had begun importing Rinaldi bikes under the brand name Summit and selling them through specialty bike dealers. Similarly, Rinaldi had begun marketing EDC bikes in Europe. That arrangement had had lasting rewards: Although racing bikes were no longer very popular, EDCs offerings had taken off. About 20 percent of EDCs sales were now made outside the United States (primarily in Europe and Canada) through this and other agreements. The relationships with Rinaldi and the specialty bike shops also helped keep EDC management aware of the latest industry trends over the years. Most recently, those trends had included a move toward more exotic frame materials like aluminum and carbon ber and more advanced components, including the new front-fork suspension systems. Ann examined another rivals brochure touting a soon-to-be-released high-end model with these advances. EDC engineers were clearly ahead of the curve. Her satisfaction was quickly tempered with thoughts of foreign sales performance. Between 1987 and 1991, EDCs foreign sales had grown at an annual rate of over 80 percent. But during the previous two years they had been at. Sean appeared at Anns side, jolting her out of her thoughts and into the reality of her surroundings. Dale just nished up the rst round of retailers meetings, he said. Wed like to get some lunch back over at the hotel and talk about our options. Dale Stewart was Eldoras marketing vice president. His views of what was best for the company often differed from Seans, but the two had an amiable working relationship and enjoyed frequent spirited verbal sparring matches. You wont let this go, will you, Ann said, throwing up her hands in a gesture of surrender. Fine, lets talk. But you know I wont make a decision until weve had a more formal round of discussions back in Boulder next month. Over sandwiches, Sean made his case. Our primary markets in North America and western Europe represent less than a quarter of the worldwide demand. Of the 200 million bicycles made in the world last year, 40 million were sold in China, 30 million in India, and 9 million in Japan. Historically, bikes sold in Asias developing markets were low-end products used as primary modes of transportation. But the economic picture is changing fast. Theres a growing middle class. Suddenly people have disposable income. Many consumers there are now seeking higher quality and trendier styles. Mountain bikes with suspension are in. And cross-bikes are still holding their own. In fact, the demand in these markets for the product categories we produce has been doubling annually, and the growth rates seem sustainable. If were going to compete in Asia, though, we need a local plant. My staff has evaluated many locations there. Weve looked at wage rates, proximity to markets, and materials costs, and we feel that China is our best bet. Wed like to open a plant there as soon as possible, and start building our position. Dale jumped in. Two of our largest competitors, one from China, one from Taiwan, have been lling the demand so far, he said. In 1990, 97 percent of the volume produced by these companies was for export. In 1994, they are projecting that 45 percent of their production will be for local markets. We cant compete with them from here. About 20 percent of our product cost is labor, and the hourly wages

contributed greatly to cooperation among various departments and, ultimately, to the companys growth: EDC had become the largest and most protable bicycle company in the United States. Yet her manufacturing vice president, Sean Andrews, was now urging her to build a plant in China. Look at the number of companies here, he had said that morning, as they helped several other EDC staffers stack brochures on the exhibit table and position the companys latest models around the perimeter of their area. Manufacturing heads rarely attended trade shows; in fact, this was Seans rst, but he had wanted to attend, and Ann had supported his interest. There are too many players in this market, he had said. Ive been saying this for two months now, and you know the forecasters numbers back me up. But if they werent enough to convince you, just look around. The industry is reaching the saturation point here in the States. We have to break into Asia. Leave it alone, Sean, Ann had replied. I know this is something youre pushing; youve said so in the past. But lets set up a time to talk about it in detail later. This isnt the time or the place. Now, three hours later, with the show in full swing, Ann understood why Sean had been compelled to speak up again. Having all their competitors in the same room at the same time was a powerful visual reminder of how the industry had changed. She thought about what Sean had said about the U.S. market. In 1992 EDCs sales and earnings had hit record levels. The company now produced almost 30 percent of the bicycles sold in the United States. U.S. massmarket bicycle sales were growing by only 2 percent per year, while the Asian market for those same bikes was nearly doubling annually. And Eldora could not competitively serve those markets from its U.S. manufacturing facility. Two of the largest bike manufacturers in the world, located in rapidly growing Asian markets, enjoyed a signicant labor and distribution cost advantage. She stopped at a mountain bike display set up by a fast-growing young bike company. Mountain bikes with front suspension were the latest trendthe added support and cushion allowed riders to better absorb the shocks inherent in off-road riding without slowing down or losing balance. Most of these bikes were still prohibitively expensive. But Eldora, too, had an entry in this product category, retailing for about $190, and Ann was proud of it. For years, the company had concentrated its efforts on inexpensive bicycles, which retailed through mass merchandisers for between $100 and $200. Eldoras prices were slightly higher than other low-end competitors, but large retailers were willing to pay the premium because EDC had consistently been able to offer many state-of-the-art styles and features with quick, timely deliveries that competitors building overseas couldnt match. One of the reasons the company had been so successful was that Boulder, Colorado, was a bicyclists mecca. Eldora employees at all levels shared a genuine love of bicycling and eagerly pursued knowledge of the industrys latest trends and styles. Someone was always suggesting a better way to position the hand brakes or a new toe grip that allowed for better traction and easier dismounts. And Eldora never had a shortage of people willing to test out the latest prototypes. Another reason was that all marketing staff, engineers, designers, and manufacturing personnel worked on one campus, within a 10-minute walk of one another. Ann had bet big on that strategy, and it had paid off. Communication was easy, and changes in styles, production plans, and the like could be made quickly and efciently. Mountain bikes, for example, had gone from 0 percent to more than 50 percent of the market volume since 1988, and Eldora had met the increased demand with ease. And when orders for cross-bikesa mountain/road bike hybrid that had enjoyed a spurt of popularity

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FACILITY LOCATION of the manufacturing workforce in these countries are between 5 percent and 15 percent of ours. It also costs us an additional 20 percent in transportation and duties to get our bicycles to these markets. He glanced at Sean quickly and continued. But heres where I disagree with Sean. I think we need a short-term solution. These companies have a big lead on us, and the more I think about it, the more I believe we need to put a direct sales operation in Asia rst. Dale, youre crazy, Sean said, pouring himself some ice water from the pitcher on the table. What good would an Asian sales operation do without a manufacturing plant? I know we source components in Asia now, but we could save another 10 percent of those parts if we were located there. Then we would really be bringing Eldora to Asia. If we want to compete there, we have to play from our greatest strengthquality. If we did it your way, you wouldnt be selling Eldora bikes. Youd just be selling some product with our label on it. You wouldnt get the quality. You wouldnt build the same kind of reputation we have here. It wouldnt really be Eldora. Over the long term, it couldnt work. Were building bicycles, not rocket ships, Dale countered. There are lots of companies in Asia that could provide us with a product very quickly if we gave them our designs and helped them with their production process. We could outsource production in the short term until we made more permanent arrangements. He turned to Ann. We could even outsource the product permanently, despite what Sean says. What do we know about building and running a plant in China? All I know is were losing potential share even as we sit here. The trading companies arent giving our products the attention they deserve, and they also arent giving us the information we need on the features that consumers in these markets want. A sales operation would help us learn the market even as were entering it. Setting up a plant rst would take too long. We need to be over there now, and opening a sales operation is the quickest way. Ann cut in. Dale has a good point, Sean, she said. Weve been successful here in large part because our entire operation is in Boulder, on one site. Weve had complete control over our own exible manufacturing operation, and thats been a key factor in our ability to meet rapid change in the local market. How would we address the challenges inherent in manufacturing in a facility halfway around the world? Would you consider moving there? And for how long? Also, think about our other options. If the biggest issue keeping us out of these markets right now is cost, then both of you are ignoring a few obvious alternatives. Right now, only our frame-building operation is automated. We could cut labor costs signicantly by

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automating more processes. And why are you so bent on China? Frankly, when I was there last month touring facilities, a lot of what I saw worried me. You know, that day I was supposed to tour a production facility, there was a power failure. Judging by the reactions of the personnel in the plant the next day, these outages are common. The roads to the facility are in very poor condition. And wastewater and cleaning solvents are regularly dumped untreated into the waterways. We could operate differently if we located there, but what impact would that have on costs? Taiwan has a better-developed infrastructure than China. What about making that our Asian base? And Ive heard that Singapore offers attractive tax arrangements to new manufacturing operations. Then theres Mexico. Its closer to home, and aside from distribution costs, the wage rates are similar to Asias and many of the other risks would be minimized. You both feel strongly about this, I know, but this isnt a decision we can make based on enthusiasm. Ann crumpled up her sandwich wrapper and drank the last of her soda. Lets get back over to the exhibits. Im attending the IT seminar at 1:30. Well schedule a formal meeting on this subject soon. I was going to say next month, but how about bumping it up two weeks? Walking back to the convention center with Dale and Sean, Ann realized that she wasnt just frustrated because she didnt know which course EDC should pursue. She was concerned that she really didnt know which aspects of the decision were important and which were irrelevant. Should she establish a division in China? If so, which functions should she start with? Manufacturing? Marketing? And what about engineering? Or should she consider a different location? Would Chinas low labor costs offset problems caused by a poor infrastructure? Growth had always been vitally important to Eldora, both in creating value to shareholders and in providing a work environment that could attract and retain the most talented people. Now it appeared that Ann would have to choose between continued growth and a domestic-only manufacturing strategy that had served her well. Ann knew the plant location decision she had made years earlier had been critical to the companys success, and she felt the companys next move would be just as crucial. QUESTIONS 1 What is the competitive environment facing EDC? 2 What are EDCs strengths in manufacturing? 3 Should EDC establish a manufacturing division in Asia? 4 What plan of action would you recommend to Ann Reardon?

SOURCE: REPRINTED BY PERMISSION OF HARVARD BUSINESS REVIEW. THE PLANT LOCATION PUZZLE, BY A. D. BARTNESS, MARCHAPRIL 1994. COPYRIGHT 1994 BY THE PRESIDENT AND FELLOWS OF HARVARD COLLEGE; ALL RIGHTS RESERVED.

SELECTED BIBLIOGRAPHY
Ballou, R. H. Business Logistics Management, 4th ed. Upper Saddle River, NJ: Prentice Hall, 1998. Drezner, Z., and H. Hamacher. Facility Location: Applications and Theory. Berlin: Springer Verlag, 2002. Pasto, D. J., and R. L. Francis. Facility Layout and Location: Analytical Approach. Upper Saddle River, NJ: Prentice Hall, 1998. Khumawala, B. M., and D. C. Whybark. The Use of Economic Logic in Facility Location. West Lafayette, IN: Institute for Research in the Behavioral, Economic, and Management Sciences, Krannert School, Purdue University, 1975. Sule, D. R. Manufacturing Facilities: Location, Planning and Design. Boston: PWS Publishing Company, 1994.

FOOTNOTES
1 M. E. Porter, The Competitive Advantage of Nation, Harvard Business Review, MarchApril 1990. 2 S. E. Kimes and J. A. Fitzsimmons, Selecting Protable Hotel Sites at La Quinta Motor Inn, Interfaces 20 (March
April 1990), pp. 1220.

3 This is a broad top-managementoriented strategy case designed to elicit debate.