Location Analysis in Operations Management

Why loca­tion is impor­tant#

Loca­tion affects almost every cost and rev­enue line of a busi­ness. The effects of a good and a bad choice are sum­marised below.

For exam­ple, a retail store hid­den in a side lane may have good prod­ucts and still get few cus­tomers. The objec­tive, there­fore, is not sim­ply the cheap­est land. It is the best over­all busi­ness advan­tage: low total cost, easy access, smooth oper­a­tions, cus­tomer con­ve­nience and long-term ben­e­fit.

Lev­els of the loca­tion deci­sion#

Loca­tion is usu­ally decided in stages, mov­ing from the broad to the spe­cific:

1. Coun­try – rel­e­vant for multi­na­tional firms.
2. Region or state – influ­enced by mar­kets, raw mate­ri­als, incen­tives and labour.
3. Com­mu­nity or city – influ­enced by infra­struc­ture, ser­vices, atti­tudes and costs.
4. Site – the exact plot, judged on size, access, cost, zon­ing and util­i­ties.

Coun­try selec­tion in global deci­sions#

When the choice is between coun­tries, a firm stud­ies polit­i­cal sta­bil­ity, the tax sys­tem, labour cost and pro­duc­tiv­ity, trade rules and tar­iffs, infra­struc­ture, cur­rency risk and the legal envi­ron­ment. Cul­tural fit and close­ness to tar­get mar­kets also mat­ter.

Man­u­fac­tur­ing ver­sus ser­vice loca­tion#

The best loca­tion depends on the type of busi­ness. The con­trast between a cement fac­tory and a super­mar­ket shows this well. A cement plant wants to be near lime­stone, power sup­ply and trans­port routes because its raw mate­ri­als are heavy and costly to move. A super­mar­ket wants to be near homes, main roads and park­ing because cus­tomers must reach it eas­ily.

Fac­tors affect­ing the loca­tion deci­sion#

Raw mate­r­ial avail­abil­ity#

If raw mate­ri­als are heavy, bulky or per­ish­able, the firm usu­ally locates near the source. Sugar mills are placed near sug­ar­cane fields, paper mills near forests and cement plants near lime­stone deposits. This cuts trans­port cost and secures reg­u­lar sup­ply.

Near­ness to mar­ket#

Super­mar­kets, restau­rants, hos­pi­tals, banks and courier offices need to be close to cus­tomers. Firms mak­ing per­ish­able or quickly needed prod­ucts also pre­fer mar­ket loca­tions.

Trans­porta­tion#

A good site needs road, rail, port or air­port links. Trans­port affects raw-mate­r­ial move­ment, deliv­ery of fin­ished goods, employee travel and cus­tomer access. For many man­u­fac­tur­ers it is one of the strongest loca­tion fac­tors.

Labour avail­abil­ity#

The firm checks whether work­ers are avail­able, whether they are skilled, what the wage lev­els are and whether the labour sit­u­a­tion is sta­ble. A tex­tile unit, for instance, may choose an area with a pool of trained work­ers. Wage rates must be read together with pro­duc­tiv­ity: cheap labour with low out­put may not reduce cost per unit.

Power, water and infra­struc­ture#

Reli­able elec­tric­ity, water, inter­net, drainage, waste dis­posal and nearby sup­port ser­vices such as repair shops, banks and hos­pi­tals are essen­tial.

Land and build­ing cost#

Land price, rent, con­struc­tion cost and local taxes all raise fixed cost. An expen­sive site can still be worth­while when sales are high; a show­room in a prime city area may pay high rent because of strong cus­tomer traf­fic.

Gov­ern­ment pol­icy#

Gov­ern­ments influ­ence loca­tion through tax ben­e­fits, sub­si­dies, indus­trial zones and parks, pol­lu­tion rules and labour laws. Firms study these legal and pol­icy con­di­tions before choos­ing.

Safety and envi­ron­ment#

Hos­pi­tals need hygienic sur­round­ings, schools need safe neigh­bour­hoods and chem­i­cal fac­to­ries must sat­isfy envi­ron­men­tal rules. Com­mu­nity atti­tude towards the project also mat­ters.

Scope for future expan­sion#

A good site leaves room for more machines, more build­ings or more ser­vice coun­ters if demand rises. With no space to grow, the firm may have to relo­cate or split oper­a­tions later.

Loca­tional ori­en­ta­tion#

Dif­fer­ent busi­nesses are pulled towards dif­fer­ent anchors:

• Near raw mate­ri­als – when inputs are bulky, heavy, per­ish­able or expen­sive to trans­port.
• Near the mar­ket – when prod­ucts are per­ish­able, needed quickly or depend on cus­tomer con­tact.
• Near labour – when labour skill or cost mat­ters more than raw mate­ri­als.
• Near a trans­port hub – when fast dis­tri­b­u­tion is nec­es­sary.

Loca­tion choice is there­fore not ran­dom; it fol­lows from the nature of the busi­ness.

Steps in loca­tion analy­sis#

1. Iden­tify the loca­tion need. Why is a new site required? Is it a fac­tory, ware­house or store? Is it for expan­sion or a new busi­ness?
2. Define the impor­tant fac­tors. Decide what mat­ters most: cost, mar­ket, trans­port, labour or raw mate­ri­als, and how much each mat­ters.
3. Develop alter­na­tives. Short­list sev­eral fea­si­ble sites, for exam­ple Loca­tion A, B and C.
4. Com­pare the alter­na­tives. Study each site care­fully using qual­i­ta­tive judge­ment and quan­ti­ta­tive meth­ods.
5. Select the best loca­tion. Choose the site that gives the best total advan­tage, then con­firm with a detailed site visit.

Meth­ods of loca­tion analy­sis#

Fac­tor rat­ing method#

This is the most widely used method because it com­bines many fac­tors, includ­ing ones that can­not be mea­sured in rupees. The steps are:

1. List the rel­e­vant fac­tors.
2. Give each fac­tor a weight so that the weights add up to 1 (or 100).
3. Score each loca­tion on each fac­tor on a com­mon scale, say 1 to 10.
4. Mul­ti­ply each score by the fac­tor weight.
5. Add the weighted scores for each loca­tion and choose the high­est total.

$$\displaystyle \text{Weighted score of a site} = \sum_{i} w_i \times s_i$$

Worked exam­ple: fac­tor rat­ing

Sup­pose a com­pany is choos­ing between three sites and con­sid­ers four fac­tors: trans­port (weight 0.30), labour (0.20), mar­ket (0.25) and power (0.25). The weights total 1.00. Man­agers score each site out of 10.

For Loca­tion B: $0.30 \times 9 + 0.20 \times 7 + 0.25 \times 8 + 0.25 \times 7 = 2.70 + 1.40 + 2.00 + 1.75 = 7.85$. Loca­tion B has the high­est total, so it is selected. Note that B does not win on every fac­tor; C has bet­ter labour and A bet­ter power. The weights decide the result, which is why they must be set care­fully and agreed before scor­ing.

The method is use­ful because not all fac­tors are equally impor­tant: trans­port may mat­ter most for a fac­tory, acces­si­bil­ity for a hos­pi­tal and cus­tomer flow for a store. Its weak­ness is sub­jec­tiv­ity, since both weights and scores reflect judge­ment.

Cost-vol­ume analy­sis and break-even analy­sis#

This method com­pares loca­tions in eco­nomic terms. Each site has a fixed cost (land, build­ing, equip­ment, taxes) and a vari­able cost per unit (labour, mate­ri­als, trans­port, power). The total cost at vol­ume $Q$ is:

$$TC = FC + VC \times Q$$

A site with high fixed cost but low vari­able cost becomes cheaper as vol­ume rises; a site with low fixed cost but high vari­able cost suits small vol­umes. The vol­ume at which two sites have equal total cost is found by set­ting their cost equa­tions equal. Where rev­enue per unit is the same at every site, the cheap­est site at the expected vol­ume also gives the high­est profit.

Crossover chart#

A crossover chart plots the total cost line of each loca­tion on one graph. The point where two lines meet is the crossover point: at that vol­ume the two sites cost the same. Below it one site is bet­ter; above it the other is bet­ter. The chart makes the com­par­i­son easy to see.

Worked exam­ple: loca­tion break-even

Sup­pose a man­u­fac­turer has these hypo­thet­i­cal annual cost esti­mates and expects to make 25,000 units a year.

Step 1: total cost at 25,000 units.

• A: $30{,}00{,}000 + 150 \times 25{,}000 = 30{,}00{,}000 + 37{,}50{,}000$ = ₹67,50,000
• B: $12{,}00{,}000 + 250 \times 25{,}000 = 12{,}00{,}000 + 62{,}50{,}000$ = ₹74,50,000
• C: $20{,}00{,}000 + 200 \times 25{,}000 = 20{,}00{,}000 + 50{,}00{,}000$ = ₹70,00,000

Site A is cheap­est at the expected vol­ume.

Step 2: crossover points.

B and C: $12{,}00{,}000 + 250Q = 20{,}00{,}000 + 200Q$, so $50Q = 8{,}00{,}000$ and $Q = 16{,}000$ units.

A and C: $30{,}00{,}000 + 150Q = 20{,}00{,}000 + 200Q$, so $50Q = 10{,}00{,}000$ and $Q = 20{,}000$ units.

A and B: $30{,}00{,}000 + 150Q = 12{,}00{,}000 + 250Q$, so $100Q = 18{,}00{,}000$ and $Q = 18{,}000$ units.

Step 3: deci­sion ranges. Below 16,000 units B is cheap­est; between 16,000 and 20,000 units C is cheap­est; above 20,000 units A is cheap­est. At 18,000 units A and B tie, but C is lower than both there, so that crossover does not change the choice. With expected vol­ume of 25,000 units, choose Site A.

Other quan­ti­ta­tive meth­ods#

• Cen­tre-of-grav­ity method – finds a cen­tral point for a ware­house by weight­ing the map coor­di­nates of the places it serves by the quan­tity shipped to each.
• Trans­porta­tion model – a lin­ear pro­gram­ming method that chooses the site giv­ing the low­est total ship­ping cost across a net­work of plants and ware­houses.

Loca­tion of ware­houses and dis­tri­b­u­tion cen­tres#

A ware­house or dis­tri­b­u­tion cen­tre is placed mainly to improve deliv­ery speed, trans­port effi­ciency and cus­tomer ser­vice. The ideal site reduces over­all dis­tri­b­u­tion cost and lets the firm reach cus­tomers quickly. A courier com­pany, for exam­ple, may set up its hub near high­ways and an air­port.

Loca­tion ver­sus lay­out#

Stu­dents often con­fuse these two deci­sions.

A sim­ple retail illus­tra­tion#

Sup­pose some­one wants to open a super­mar­ket and com­pares three places. Place A has low rent but is far from cus­tomers. Place B has high rent but sits on a busy road with many cus­tomers. Place C has medium rent but poor park­ing and weak road access. None is best on every count, so the owner must weigh rent against foot­fall, access and park­ing, for exam­ple with a fac­tor rat­ing table. That weigh­ing process is loca­tion analy­sis.

Key terms#

Loca­tion analy­sis

The sys­tem­atic process of select­ing the best place for a busi­ness facil­ity.

Fac­tor rat­ing method

A method that scores each site on weighted fac­tors and picks the high­est total weighted score.

Fixed cost

A cost that does not change with out­put, such as rent or depre­ci­a­tion of a build­ing.

Vari­able cost

A cost per unit that rises with out­put, such as mate­ri­als, direct labour and freight.

Crossover point

The out­put level at which two loca­tions have equal total cost.

Crossover chart

A graph of the total cost lines of alter­na­tive sites, used in loca­tion break-even analy­sis.

Cen­tre-of-grav­ity method

A tech­nique that finds a dis­tri­b­u­tion point by weight­ing the coor­di­nates of des­ti­na­tions by the vol­ume shipped.

Loca­tional ori­en­ta­tion

The pull of a busi­ness towards raw mate­ri­als, mar­kets, labour or trans­port hubs.

Com­mon ques­tions#

Why is loca­tion called a strate­gic deci­sion?#

Because it com­mits large sums for many years, is hard to reverse and shapes costs, rev­enue and cus­tomer ser­vice for the life of the facil­ity.

How do the loca­tion pri­or­i­ties of a fac­tory and a retail store dif­fer?#

A fac­tory focuses on cost fac­tors such as raw mate­ri­als, trans­port, labour and power. A store focuses on rev­enue fac­tors such as cus­tomer access, vis­i­bil­ity, foot traf­fic and park­ing.

What is the main lim­i­ta­tion of the fac­tor rat­ing method?#

Its weights and scores are sub­jec­tive. Dif­fer­ent man­agers may reach dif­fer­ent answers, so the weights should be agreed before scor­ing and the result tested by chang­ing them slightly.

How do you find the crossover point between two sites?#

Write each total cost as $FC + VC \times Q$, set the two expres­sions equal and solve for $Q$. In the exam­ple above, sites B and C cross at 16,000 units.

Does the cheap­est site at the expected vol­ume always win?#

Not nec­es­sar­ily. Qual­i­ta­tive fac­tors such as qual­ity of life, com­mu­nity atti­tude, future expan­sion and risk are also weighed, which is why break-even results are often com­bined with fac­tor rat­ing.

Ref­er­ences#

1. Heizer, J., Ren­der, B. and Mun­son, C. Oper­a­tions Man­age­ment: Sus­tain­abil­ity and Sup­ply Chain Man­age­ment. Pear­son.
2. Steven­son, W. J. Oper­a­tions Man­age­ment. McGraw-Hill Edu­ca­tion.
3. Chary, S. N. Pro­duc­tion and Oper­a­tions Man­age­ment. McGraw-Hill Edu­ca­tion (India).
4. Pan­neer­sel­vam, R. Pro­duc­tion and Oper­a­tions Man­age­ment. PHI Learn­ing.
5. Kra­jew­ski, L. J., Mal­ho­tra, M. K. and Ritz­man, L. P. Oper­a­tions Man­age­ment: Processes and Sup­ply Chains. Pear­son.

Related read­ing#

• Capac­ity Plan­ning in Oper­a­tions Man­age­ment
• What is Plant Lay­out in Oper­a­tions Man­age­ment?
• Pro­duc­tion Sched­ul­ing in Oper­a­tions Man­age­ment