CHAPTER 2 LOCATION (2)

Operational Management CHAPTER 2
BBC 2113 LOCATION STRATEGY

1 Learning Outcome
Identify the strategic importance of location
decision
Discuss the factors affecting location decisions
Understand the methods of evaluating
locations alternatives:

Break-even-Analysis
Factor Rating Technique Concept
Centre of Gravity Technique Concept

Explain service location strategy
Understand Geographic Information System

2

Location Strategy Location Strategy(Cont.)

Identify some of the main reasons organizations need Identify some of the main reasons organizations need to
to make location decisions. make location decisions(Cont.)

❑ Existing organizations may need to make location ❑ Some firms face location decisions through depletion
decisions for a variety of reasons. of basic inputs.
❑ For example: logging operations are often forced to
❑ Firms such as banks, fast-food chains, supermarkets, relocate due to the temporary exhaustion of trees at
and retail stores view locations as part of marketing a given location.
strategy, and they look for locations that will help them ❑ Fishing operations can be affected by seasons as
to expand their markets. well as government limits on the amount of fish.
❑ Mining and petroleum operations face the same sort
❑ Conversely, when a chain decides to close some of its of situation, although usually with a longer time
stores, the question becomes which ones to keep. horizon.

❑ When an organization experiences a growth in ❑ For other firms, a shift in markets causes them to
demand for its products or services that cannot be consider relocation, or the costs of doing business at a
satisfied by expansion at an existing location, the particular location reach a point where other locations
addition of a new location to complement an existing begin to look more attractive
system is often a realistic alternative.
4
3

Location Strategy(Cont.) Location Strategy(Cont.)

To maximize the Explain why location decisions are important.
benefit of location ❑ Location decisions for many types of

to the firm businesses are made infrequently, but they
tend to have a significant impact on the
5 organization.
❑ The decisions, the usual objectives managers
have when making location choices, and some
of the options available to them.

6

Location and Costs Industrial Location Decisions

Location decisions based on high or ❑ Cost Focus
low cost require careful consideration ❑ Revenue varies little
► Once in place, location-related between locations

costs are fixed in place and difficult ❑ Location is a major cost
to reduce factor
► Determining optimal facility ❑ Affects shipping &
location is a good investment production costs (e.g.,
labour)
7 ❑ Costs vary greatly
between locations 

8

Service Location Decisions In General – Location
Decisions
❑ Revenue Focus
❑ Costs vary little between ❑ Long-term decisions
market areas ❑ Difficult to reverse
❑ Affect fixed & variable costs
❑ Location is a major revenue
factor ❑ Transportation cost- As much as 25% of
❑ Affects amount of product price
customer contact
❑ Affects volume of ❑ Other costs: Taxes, wages, rent etc.
business
❑ Objective: Maximize benefit of location to firm =
9 Cost or Revenue = $’s! for either Manufacturing
or service

10

The Strategic Importance of The Strategic Importance of
Location Location(Cont.)

► One of the most important decisions a firm The objective of location strategy is
makes to maximize the benefit of location

► Increasingly global in nature to the firm
► Location also has an impact on the overall risk
Therefore: Need to look:
and profit 1. Expanding existing facilities
► Significant impact on fixed and variable costs 2. Maintain existing and add sites
► Decisions made relatively infrequently 3. Closing existing and relocating
► Long-term decisions
► Once committed to a location, many resource 12

and cost issues are difficult to change

11

Location Decision Sequence Location Decisions

An OM has to be carefully assessed Country Decision Key Success Factors
factors that need to be considered in
selecting the best location:- 1. Political risks, government
rules, attitudes, incentives
Sequence in Location Decision:
❑ National Decision 2. Cultural and economic
issues
❑ To choose a country to operate
❑ Regional or Community Decision 3. Location of markets

❑ Once decision made, then next 4. Labor talent, attitudes,
step to choose the region productivity, costs

❑ Site Decision 5. Availability of supplies,
❑ To choose a site within communications, energy
community. Need to consider
as many factor as possible 6. Exchange rates and
currency risks

13 14

Location Decisions(Cont.) Location Decisions(Cont.)

Region/ Key Success Factors Site Decision Key Success Factors
Community
1. Corporate desires 1. Site size and cost
Decision 2. Attractiveness of region
3. Labor availability and costs 2. Air, rail, highway, and waterway
MN 4. Costs and availability of utilities systems
WI 5. Environmental regulations
6. Government incentives and fiscal 3. Zoning restrictions
MI
policies 4. Proximity of services/ supplies
IL IN OH 7. Proximity to raw materials and needed

customers 5. Environmental impact issues
8. Land/construction costs

15 16

Location Decisions Sequence Factors Affecting National
Decision
in Malaysia
► Government Rules, attitudes, political risk and
Country Region/Community incentives

Site ► Culture & economy
► Market location
► Labor availability, attitudes, productivity, and cost
► Availability of supplies, communications, energy
► Exchange rates and currency risks

17 18

Factors Region Location Factors Region Location
Decisions Decisions(Cont.)

► Corporate desires ► Labor Productivity
► Attractiveness of region (culture,
► Wages rates are not the only cost
taxes, climate, etc.) ► Lower productivity may increase total cost
► Labor, availability, costs, attitudes
Labor cost per day
towards unions = Cost per unit
► Costs and availability of utilities
► Environmental regulations of state Productivity (units per day)

and town Example of Cost per unit: Mexico
► Government incentives South Carolina $25
► Proximity to raw materials & 20 units = $1.25 per unit
$70
customers = $1.17 per unit
► Land/construction costs
60 units

19 20

Factors Region Location Factors Region Location
Decisions(Cont.) Decisions(Cont.)

► Exchange rates and currency risks ► Political risk, values, and culture
► Can have a significant impact on costs
► Rates change over time ► National, state, local governments attitudes
toward private and intellectual property,
► Costs zoning, pollution, employment stability may
► Tangible - easily measured costs such as be in flux
utilities, labor, materials, taxes
► Intangible - less easy to quantify and include ► Worker attitudes towards turnover, unions,
education, public transportation, community, absenteeism
quality-of-life
► Globally cultures have different attitudes
21 towards punctuality, legal, and ethical issues

22

Factors Affecting Site Decision Six (6) Factors to be Considered in
Making Location Decision
► Site size and cost
1) Proximity to markets or Customers
► Air, rail, highway, and ► Very important to services
waterway systems ► JIT systems or high transportation costs may
make it important to manufacturers
► Zoning restrictions
2) Proximity to suppliers
► Nearness of ► Perishable goods, high transportation costs,
services/supplies needed bulky products

► Environmental impact 3) Proximity to competitors
issues ► Often driven by resources such as natural,
information, capital, talent
23 ► Found in both manufacturing and service
industries

24

Six (6) Factors to be Considered in Location Decision Example
Making Location Decision
► BMW decided to build its first major
4) Labour Supply manufacturing plant outside Germany in
► Firms that require a lot of labour normally choose a location Spartanburg, South Carolina
that has high availability of labour, particular skilled labour
► The purpose to reduce costs of hiring and training ► BMW cars have been officially sold in the United
States since 1956 and manufactured in the United
5) Availability of Facilities States since 1994
► Like telecommunication and transportation are crucial in
selecting location 26
► E.g.: Internet connection, telephones and facsimile to stay
connected with suppliers, customers and the government
► Accessibility to land and air or sea transportation modes

6) Government Incentives
► Incentives, such as subsidies or tax inducement, are provided
by the government in some area
► The purpose to attract firms to base their facilities in that area

25

Methods of Evaluating Objective of Break-Even Analysis
Locations Alternatives
❑ To determine the quantity to be
Three (3) methods an organization produced, so that the firms can break
can use to evaluate location even
alternatives :
1) Break-Even Analysis ❑ By calculating the break-even quantity,
2) Factor Rating Technique the firms will know at which point it can
3) Centre of Gravity Technique start making profit

27 28

1) Locations Using 1) Locations Using Break-Even
Break-Even Analysis Analysis(Cont.)

❑ Break-even analysis is a form of analysis that ❑ To select best location, a firm need to
focuses on Costs and Revenue. consider three (3) types of costs:
❑ Fixed Costs (FC)
❑ At Break-even Point (BEP), a firm does not ❑ Variable Costs (VC)
make any profit or loss (Zero Profit) = At BEP ❑ Selling Price (SP)
total costs and total revenue are equal
Break-even Pont (BEP)= Fixed Cost
❑ The faster the firm can break even, the better
to gain profit Selling Price-Variables Cost per unit

29 ❑ Selling price-Variable cost per unit =
Contribution margin

30

Example 1: Location Solution

Break-Even Analysis BEP for Sungai Petani = 4,800 = 400 units
20-8
Aromaju Sdn. Bhd. is considering opening a new
facility to produce its new products. The company BEP for Kulim = 7,500 = 500 units
has found three alternatives with the following cost 20-5
structure:
BEP for Alor Setar = 6,300 = 450 units
LOCATION FIXED COST (RM) VARIABLE COST 20-6
PER UNIT (RM)
DECISION:
SUNGAI PETANI 4,800 8 The company should choose Sungai Petani
because it has the lowest BEP. This location can
PENDANG 7,500 5 generate profit faster compared to other locations

ALOR SETAR 6,300 6 32

If the company plans to sell its products for RM 20

per unit, which location is the best to be selected

based on the break-even point analysis?

31

2) Locations Using Factor Rating 2) Locations Using Factor
Technique
Rating Technique (Cont.)
❑ Factor Rating Technique is a location evaluation
technique that considers quantitively and qualitative ❑ Factor Rating
factors in choosing a location ⚫ Popular because a wide variety of factors can be included in
the analysis
❑ This factors are called tangible and intangible factors
❑ Tangible: are the cost factors which can be ❑ Procedure:
measured in monetary value 1. Determine which factors are relevant called key success
❑ E.g.: Labour, transportation and raw material cost factors
❑ Intangible: Factors that area hard to be measured in 2. Assign a weight to each factor that indicates its relative
monetary value importance compared with all other factors.
❑ E.g.: Labour availability, proximity to market and ⚫ Weights typically sum to 1.00
facilities availability 3. Decide on a common scale for all factors, and set a minimum
acceptable score if necessary
33 4. Score each location alternative
5. Multiply the factor weight by the score for each factor, and
sum the results for each location alternative
6. Choose the alternative that has the highest composite score,
unless it fails to meet the minimum acceptable score

34

Example: Factor Rating Example: Factor Rating

Technique Technique

❑ A photos processing company intends to open a new ❑ A photos processing company intends to open a new
branch store. The following table contains information on branch store. The following table contains information on
two (2) potential locations. Based on the Factor Rating two (2) potential locations. Base on the Factor Rating
Technique, which locations is better? Technique, which locations is better?

35 36

Example: Factor Rating 3) Locations Using Centre of Gravity
Technique Technique

DECISION: ❑ The Centre of gravity technique is a mathematical
The company should choose Location 2 because it has the technique used to obtain a location of a
highest factor rating technique with 82.7.This location can distribution Centre that will minimize distribution
generate profit faster compared to other locations costs

37 ❑ This technique takes into account the location :
❑ Markets
❑ The volume of shipments to these markets
❑ The transportation or shipping costs

❑ The Centre of gravity technique makes the
assumption that the cost is proportional to the
distance and shipment volume

38

Objective of Centre of Gravity Objective of Break-Even Analysis(Cont.)
Technique •

❑ To minimize the weighted distance between a 40
warehouse and its retail outlets, where the distance
is measured by the number of containers shipped

❑ The steps in the Centre of gravity technique:
1. Placing an exact location by its coordinates on
a grid. The scale of the grid is determined to
get an accurate location. The best way is by
placing a grid over map
2. Determining the coordinates for every places.
The Centre of gravity technique is determined
by these equations:

39

Example: Centre of Gravity Technique Example 1: Centre of Gravity Technique
(Cont.)
State University is attempting to locate the
best site for a new student centre and CAMPUS STUDENT COORDINATES DAILY STUDENT
athletic complex. The university CONCENTRATION (10,12.5) POPULATION
administration would like to know the best (15,27) 700
location relative to the four main Meranti Dorm (20,7)
concentrations of student housing and Complex (22,20) 900
classroom activities on campus. The
coordinates of the housing and classroom Melati Housing 1150
areas, as well as the daily student Complex
population are: 430
Akasia Classroom
41 Complex

Millennium
Classroom Complex

42

Solution 1 Solution 1

CAMPUS STUDENT CAMPUS STUDENT 10 x 700 = 7,000 12.5 x 700 = 8750
CONCENTRATION CONCENTRATION
15 x 900 = 13,500 27 x 900 = 24300
Meranti Dorm 10 x 700 = 7000 12.5 x 700 = 8750 Meranti Dorm
Complex 27 x 900 = 24300 Complex 20 x 1150 = 23,000 7 x 1150 = 8050
7 x 1150 = 8050
Melati Housing 15 x 900 = 13500 20 x 430 = 8600 Melati Housing 22 x 430 = 9,460 20 x 430 = 8600
Complex Complex
52,960 49,700
Akasia Classroom 20 x 1150 = 23000 Akasia Classroom 52,960 49,700
Complex Complex 700 + 900 + 1,150 + 430 700 + 900 + 1,150 + 430
= 16.65 = 15.63
Millennium 22 x 430 = 9460 MILLENNIUM
Classroom Complex
Classroom Complex
TOTAL

Divided by Total
Population

43 The new coordinates for the student Centre and athletic complex are
(16.65, 15.63)

44

Example 2 Solution 2 (Cont.)

d1x = 30
d1y = 120
Q1 = 2,000

45 46

Solution 2 (Cont.) Solution 2 (Cont.)

x-coordinate = (30)(2000) + (90)(1000) + (130)(1000) + (60)(2000) The best Options is Pittsburgh as it is near to the Center of
Gravity
2000 + 1000 + 1000 + 2000
48
= 66.7

y-coordinate = (120)(2000) + (110)(1000) + (130)(1000) + (40)(2000)

2000 + 1000 + 1000 + 2000

= 93.3

47

Transportation Model Transportation Model (Cont.)

► Transportation model addresses the concept
of moving a thing from one place to another,
without change (Point A to Point B)

► Finds amount to be shipped from several
points of supply to several points of demand

► Solution will minimize total production and
shipping costs

► A special class of linear programming
problems

49 50

What is a Transportation Model Aim of Transportation Model

To find out optimum transportation ► The transportation problem is a special
schedule keeping in mind cost of type of Linear Programming Problem
(LPP) where the objective is to minimize
transportation to be minimize the cost of distributing a product from a
number of sources or origins to a number
51 of destinations

► Because of its special structure the usual
simplex method is not suitable for solving
transportation problems. These problems
require special method of solution.

52

Transportation Model Transportation Model (Cont.)

❑ Solution Methods: 1. Stepping-stone modified distribution
1. Stepping-Stone ❑ The Stepping-stone Method is used to check the
2. Modified Distribution (MODI)
3. Excel’s Solver optimality of the initial feasible solution
determined by using any of the method Viz
53 (Summary).
❑ Thus, the stepping-stone method is a procedure for
finding the potential of any non-basic variables
(empty cells) in terms of the objective function.
❑ Through Stepping-stone method, we determine
that what effect on the transportation cost would be
in case one unit is assigned to the empty cell. With
the help of this method, we come to know whether
the solution is optimal or not.

54

Transportation Model (Cont.) Transportation Model (Cont.)

1. Stepping-stone modified distribution 1. Stepping-stone modified distribution (Cont.)
❑ Example:
Now we need to find the most feasible distribution plan.We will use the intuitive approach,
❑ The following table highlights which looks at cost first. Looking at our table, we will start with the lowest cost and reallocate
the model in terms of supply units to that cell. This will repeat until we've allocated all units.
and demand between 2. Identify the lowest cost cell.
warehouse and factory. 3. Allocate units to that cell, crossing out the row or column that's exhausted.
4. Find cells with the next lowest cost.
❑ Rows A, B, and C show the cost 5. Repeat steps 2 and 3 until units are allocated.
to ship one unit from that factory • In our example, the lowest cost is Factory A, Warehouse 4 ($1). Factory A supplies 150,
to Warehouses 1, 2, 3, or 4.
but demand is 200. We can only supply a maximum of 150 to this cell. Since we satisfied
❑ The last row and last column the supply, we can reduce the demand down to what's left: 200 - 150 = 50.
each display supply and
demand. Let's say each factory is 55 56
supplying each warehouse with
X number of widgets.

Transportation Model (Cont.) Transportation Model (Cont.)

2. Modified Distribution Method (MODI) 2. Modified Distribution Method (MODI)(Cont.)
❑ Modified distribution method reduces the
❑ The Modified Distribution
number of steps involved in the evaluation of
Method or MODI is an efficient method of empty cells, thereby minimizes the complexity
and gives a straightforward computational
checking the optimality of the initial feasible scheme through which the opportunity cost of
each empty cell can be determined.
solution.
58
❑ The Modified distribution method is an

improvement over the steppingstone method

since; it can be applied more efficiently when

a large number of sources and destinations

are involved, which becomes quite difficult or

tedious in case of steppingstone method.

57

Transportation Model (Cont.) Transportation Model (Cont.)

2. Modified Distribution Method (MODI) 2. Modified Distribution Method (MODI)
❑ Example: ❑ Example (Cont.)

59 60

Transportation Model Transportation Model (Cont.)
(Cont.)
2. Modified Distribution Method (MODI)
2. Modified Distribution Method (MODI) ❑ Example (Cont.)
❑ Example (Cont.)

61 62

Transportation Model (Cont.) Service Location Strategy

3. Excel’s Solver ❑ A location strategy is a plan for obtaining the
❑ Example: optimal location for a company by identifying
company needs and objectives, and searching for
63 locations with offerings that are compatible with
these needs and objectives.

❑ Unlike manufacturing, service is governed by
different considerations in making location
decision

❑ Manufacturing focuses on minimizing costs, while
service focuses on maximizing revenues

64

Factor to Considered By Service Factor to Considered By Service
Organization to Generate Higher Organization to Generate Higher

Revenues: Revenues(Cont):

1. Demographic Data of Population: Age, Income, 3. Customers’ Access
Education ❑ Good transportation and parking facilities can

❑ Since service organization are customer focused, it is ease the customers’ accessibility to the service
important to study the demographic profile of the location
population in the area ❑ Safety of the customers is only a key
consideration, prior to making location decision
❑ E.g.: A private university offering education services may ❑ Focusing on these customer-related factors may
consider the income of the population before selecting increase traffic volume
the area
66
2. Near Competitors

❑ Some services organizations prefer to be near their
competitors to benefit from higher traffic volume of
customers

❑ E.g.: Laundry services are normally located near each
other to benefit from concentration of potential customers

65

Factor to Considered By Service Factor to Considered By Service
Organization to Generate Higher Organization to Generate Higher

Revenues(Cont): Revenues(Cont):

3. Customers’ Access(Cont.) 3. Customers’ Access(Cont.)
❑ Other components of volume and revenue for ❑ Service organization use different methods in

service organization include: selecting the best location
❑ The techniques used in the service sector include
a) Service and image compatibility with the
demographics of the customer drawing area correlation analysis, traffic counts, demographic
analysis, purchasing power analysis and
b) Quality of the competition geographic information system
c) Uniqueness of the firm’s and competitor’s locations
d) Operating policies of the firm’ 68
e) Quality of management

67

Comparison Between Manufacturing and Service Geographic Information System
Organizations with Regards to Location Decision
❑ Geographic Information System (GIS) is a tool used by an
Focus Manufacturing Ser vice organization for making better decision about location

Cost Revenue ❑ GIS is a computerized data management system used to
capture, store, manage, retrieve, analyse and display spatial
Technique a) Linear Programming a) Regression Models information
Assumption
(Transportation Method) b) Factor Rating Method ❑ Data captured and used in a GIS is commonly represented on
paper or other hard-copy maps
b) Factor Rating Method c) Traffic Counts
❑ GIS stores and display information that can be linked to a
c) Location Break-even d) Demographic Analysis geographical location

Analysis e) Purchasing Power ❑ It enabled organization to combine data, such as age, income
and traffic flow with geography, thus facilitating them in
Analysis getting the best new location

f) Centre of Gravity Method ❑ E.g: Airline industry to identify airports with better ground
services, restaurants to identify target markets according to
g) Geographic Information demographic profile and many more

System 70

a) Location is a major a) Location is a major

determinant of cost determinant of revenue

b) Most major costs can be b) High customer-contact

identified explicitly for issues are critical

each site c) Costs are relatively

c) Low customer contact constant for a given area,

allows focus on thus the revenue function

identifiable costs is critical

d) Intangible costs can be

evaluated 69

Geographic Information System

71 72