Location Planning and Analysis

1. Selecting a Facility Location

Of all the pieces of the planning puzzle, facility location is one of the most strategic and critical. Once you build a new manufacturing facility, you have made a substantial investment of time, resources, and capital that can’t be changed for a long time. Selecting the wrong location can be disastrous. Some of the key factors that influence facility location are the following:

• Proximity to Raw Materials: The availability of raw materials, particularly ones that are perishable (materials that will go bad if not used in a certain amount of time, such as food products), are crucial to smooth operations. For materials that are not perishable, proximity still cuts transportation and inventory costs.
• Proximity to Markets: Equally important is closeness to the markets, whether sending goods to a distributor or establishing locations to deliver services. Companies want to locate near markets that they want to serve as part of their competitive strategy. For a manufacturer, this may just mean being near a transportation hub, but for the service industry, there will be deeper analysis of the demographics, spending habits, traffic patterns, and other attributes of the community where they open a facility.
• Labor Factors: Primary considerations include labor availability, wage rates, productivity, attitudes towards work, and the impact unions have in the region.
• Quality of Life Factors: The quality of life in a community will influence the decision, since this will affect the willingness of current staff to relocate, not to mention the quality of life for the executives making the decision. Access to education, shopping, recreation, and transportation are some of the key factors that affect quality of life. If they are relocating, managers must take culture shock into account, the feeling of disorientation and discomfort people feel when suddenly in a different culture.
• Other factors include utilities, taxes, and environmental regulation. Some states and local economies have incentives to companies relocating to their area.

EXAMPLE

Fast food restaurants thrive if they are close to an interstate exit, so naturally, many exits feature a long row of options. These will usually be differentiated by the offerings: one burger place, one taco place, one fried chicken place, a coffee shop, an ice cream shop, etc.

When identifying a site, it is important to consider seeing if the company plans on growing at this location. If so, the firm must consider whether or not a location is suitable for expansion.

term to know

Culture Shock

The feeling of disorientation and discomfort people feel when suddenly in a different culture.

2. Cost Analysis

2a. CVP Analysis

A company considering all the factors above will likely find no perfect location. One way to reach a conclusion is to do a cost analysis. There are three specific analytical techniques available to aid in evaluating location alternatives:

The cost-volume-profit (CVP) analysis is used frequently in business to determine the return on major investments. The CVP can be represented either numerically or graphically. Determining a location is only one application of a CVP analysis.

hint

You can use this spreadsheet to see the examples and test the formulas without having to pull out a calculator.
CVP Worksheet 1.xlsx

For selecting a location, the CVP involves these steps:

1. Determine fixed costs and variable costs. Fixed costs are the costs that are the same regardless of how well the business performs—the rent or lease, property taxes, salaries for some staff, depreciation, and insurance. Variable costs are those that do change depending on how successful the business is, generally increasing as productivity increases. These include raw materials, hourly labor, utilities, and transportation, among other factors. The variable costs can be estimated as a per unit cost.
2. For each location alternative, determine the contribution margin per unit—that is, the selling price per unit minus the variable cost per unit. You can then calculate the total contribution as the unit contribution margin times units sold.
3. Calculate net operating income, which is the total contribution margin minus fixed costs.
4. Perform a break-even analysis, finding the minimum number of sales needed to cover costs.
5. Determine the margin of safety, which determines how much sales can drop before the company reaches the break-even point.

1. Fixed costs are constant.
2. Variable costs are linear—that is, increasing steadily based on production.
3. Required level of output can be closely estimated.
4. There is only one product involved.

Gordon is trying to decide between two potential locations. He performs a cost analysis like this:

1. He determines the variable cost per e-bike made is $800. The bikes sell for $1,200 each. He determines that the fixed costs at location A are $200,000 a year, with a sales volume of 1,500 bikes. The fixed costs at location B are $300,000 a year, with estimated sales volume of 1,800 bikes a year. The difference is due to location B having a retail space where Gordon could sell bikes directly to consumers.
2. At either site, the variable costs and sales price are the same, so the contribution margin per bike is the same at $400 per bike.
3. Due to the difference in anticipated sales, the total contribution margin for location A is $600,000 (400*1500), and the total contribution margin for location B is $720,000 (400*1800).
4. The net operating income for location A is thus $400,000 ($600,000 contribution margin– $200,000 fixed costs), and the operating income for location B is $420,000 ($720,000 – $300,000).
5. To break even at location A (covering all costs without any profit), Gordon would have to sell 500 bikes. To break even at Location B, he would have to sell 750 bikes. (Do you remember how to arrive at these figures?)
6. The margin of safety for Location A is 1,000 bikes, and the margin of safety at location B is 1,050 bikes.

Location B has a narrower safety margin but has a higher potential. Through the CVP analysis, Gordon determines that the difference in cost at location B is not as much of a higher risk as he first thought, due to the additional sales.

terms to know

Cost-Volume-Profit (CVP) Analysis

A formula used in business to determine the return on major investments.

Fixed Costs

Costs that are the same regardless of how well the business performs.

Variable Costs

Costs that change depending on how successful the business is, generally increasing as productivity increases.

Contribution Margin

The profit margin per unit times the number of units sold.

Net Operating Income

The total contribution margin minus fixed costs.

Break-Even Analysis

Finding the minimum number of sales needed to cover costs.

Margin of Safety

How much sales can drop before the company reaches the break-even point.

2b. Factor Rating

The factor rating method involves qualitative and quantitative inputs and evaluates alternatives based on comparison after establishing a composite value for each alternative. Factor rating consists of six steps:

1. Determine relevant and important factors. These may be measured numerically, like the cost for the facilities, but may be less measurable, like the quality of life.
2. Assign a weight (importance) to each factor, with all weights totaling 1.00. For example, a company may decide the bottom line is most important, while another would rather have a happy workforce and rates the quality of life as most important.
3. Determine a common scale for all factors, usually 0 to 100. That is, for each location and each factor, a number will be assigned either based on measurable values or perceptions.
4. For each location, “grade” each factor, then multiply the score by the weight; add up scores for each alternative.
5. The alternative with the highest score is considered the best option.

Let’s look at how Gordon might use the factor rating method when comparing two locations.

1. Gordon identifies market potential, operating costs, labor availability and cost, and accessibility and transportation as key factors to his decision. Because both locations are in the same city, Gordon does not weigh factors like local incentives and quality of life, since they will be the same at both locations.
2. Gordon assigns weights to each factor; these show how important each factor is to his decision. The numbers are decimals and add up to one.
   1. Market Potential: 0.40
   2. Operating Costs: 0.25
   3. Labor Availability and Costs: 0.15
   4. Accessibility and Transportation: 0.20
3. Gordon now rates how each location scores for each factor on a scale of 1–10.
   1. Location A:
      1. Market Potential: 8
      2. Operating Costs: 7
      3. Labor Availability and Costs: 6
      4. Accessibility and Transportation: 5
   2. Location B:
      1. Market Potential: 9
      2. Operating Costs: 5
      3. Labor Availability and Costs: 8
      4. Accessibility and Transportation: 10
4. Gordon can now assign scores to each location by multiplying the weight for each factor by the rating for each location and adding up the total. Location A scores 6.85, and Location B scores 8.05. This makes the decision clearer than the CVP analysis by weighing factors other than costs and profits.

term to know

Factor Rating

A rating method for business decisions involving qualitative and quantitative inputs, which evaluates alternatives based on comparison after establishing a composite value for each alternative.

3. Facilities Relocation

A company that has outgrown its facilities can expand their existing facility, add new ones and keep their existing facilities open, move to another location and shut down the old location, or keep things the way they are and not do anything.

Why would a company choose to move to a completely different state, or even a different country? Two factors that make relocation appealing are:

Advances in technology: Technology has made it possible for some companies to relocate to a more desirable location, such as a bank that is no longer dependent on proximity to other businesses to be successful relocating from a cramped downtown office to a more spacious suburban location. In addition, companies may choose to move to a place where they can use renewable energy, such as a location with wind turbines or solar power, especially those businesses that use extensive power, such as data centers.

Trade agreements or incentive programs: Companies may move to another country to cut costs in labor, transportation, and taxes, or to better serve a global market. They may also move within the country, as many states and municipalities offer incentive programs to businesses.

4. Multiple Plant Manufacturing Strategies

When a company has several facilities, there are different ways for it to organize their operations. These ways include: assigning different product lines to different plants, assigning different market areas to different plants, or assigning different processes to different plants. These strategies carry their own cost and managerial implications, but they also carry a certain competitive advantage.

There are four different strategies for operating multiple plants:

4a. Product Plant Strategy

Products or product lines are produced in separate plants, and each plant is usually responsible for supplying the entire domestic market with their specific products. This is a decentralized approach, as each plant focuses on a narrow set of requirements that includes specialization of labor, materials, and equipment along product lines. Specialization involved in this strategy usually results in economies of scale and, compared to multipurpose plants, lower operating costs. The plant locations may either be widely scattered or placed relatively close to one another.

EXAMPLE

A large, diversified company might make beauty and hygiene products, snack foods, and over-the-counter medicines, among other goods. One facility for such varied product lines is unrealistic, and such businesses often have different facilities dedicated to each product line, which may even be in different cities. (Proctor & Gamble had, until 2016, almost 200 brands that included everything from diapers to potato chips to batteries but has since focused entirely on home goods and sold off their other companies).

4b. Market Area Plant Strategy

Here, plants are designed to serve a particular geographic segment of a market. The individual plants can produce either most, or all, of the company’s products and supply a limited geographical area. This strategy's operating costs are often higher than product plants but reduce the amount of shipping costs. It can also bring the added benefits of faster delivery and response times to local needs and allow variations to serve differences in regions. It requires a centralized coordination of decisions to add or delete plants, or to expand or downsize current plants because of changing market conditions.

EXAMPLE

Large soda-bottlers like Coca-Cola have several facilities throughout the country that bottle their products separately. Since the product is relatively inexpensive to make but expensive to store and ship, this is preferable to having products shipped all over the country from a central location.

4c. Process Plant Strategy

Here, different plants concentrate on different aspects of a process. This strategy is most useful when products have numerous components; separating the production of components results in less confusion than if all the production were done in the same location. A major issue with this strategy is the coordination of production throughout the system, and it requires highly informed, centralized administration to be an effective operation. It can bring about additional shipping costs, but a key benefit is that individual plants are highly specialized and generate volumes that bring economies of scale.

EXAMPLE

Automobiles usually have different plants focused on different parts of the process, which may be in different regions or even different countries. One plant may make the bodies of the cars, for example, while another focuses on the interiors, and a third on the electronic systems that every modern car must have. There may even be a fourth plant to put all the parts together before sending the cars to the lots where they will be sold.

4d. General-Purpose Plant Strategy

If a company follows this strategy, their plants are flexible and have the ability to handle a range of products. This allows for a quick response to products and market changes but requires that the product lines be similar enough that they can quickly adapt to a different product line. A benefit to this approach is the increase in learning opportunities that happens when similar operations are being done in different plants. Solutions to problems and improvements made at one plant can be shared with the other.

EXAMPLE

A publishing company may have different facilities dedicated to hardcover books, paperbacks, and magazines, with very different output in terms of materials and quality, but each capable of taking on any task if the company’s needs change.