CHAPTER FIVE

Facility Location

1.1. The Need for Location Decisions

Location decisions arise for a variety of reasons:
 As part of a marketing strategy to expand markets
 Addition of new facilities
 Growth in demand that cannot be satisfied by expanding existing facilities
 Depletion of basic inputs/resources (e.g. mining & fishing)
 Cost advantage
1.2. The Nature of Location Decisions

Facility location is determining the best geographic location for a company’s facility.
Facility location decisions are particularly important for two reasons.
 First, they require long-term commitments in buildings and facilities, which
means that mistakes can be difficult to correct.
 Second, these decisions require sizable financial investment and can have a
large impact on operating costs and revenues.
The location decision often depends on the type of business. For industrial location decisions, the
strategy is usually minimizing costs, although innovation and creativity may also be critical. For
retail and professional service organizations, the strategy focuses on maximizing revenue.
Warehouse location strategy, however, may be driven by a combination of cost and speed of
delivery. A poor choice of location might result in excessive transportation costs, a shortage of
qualified labor, loss of competitive advantage, inadequate supplies of raw materials, or some
similar condition that is detrimental to operations. For service, a poor location could result in
lack of customers and/or high operating costs. For both manufacturing and services, location
decisions can have a significant impact on competitive advantage. Businesses therefore have to
think long and hard about where to locate a new facility.

In most cases, there is no one best location for a facility. Rather, there are a number of
acceptable locations.

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 One location may satisfy some factors whereas another location may be better for others.
If a new location is being considered in order to provide more capacity, the company
needs to consider options such as expanding the current facility if the current location is
satisfactory.

1.3. Factors affecting location decisions

Many factors influence location decisions. However, it often happens that one or a few factors
are so important that they dominate the decision. For example, in manufacturing, the potentially
dominating factors usually include availability of an abundant energy and water supply and
proximity to raw materials. In service organizations, possible dominating factors are market
related and include traffic patterns, convenience, and competitors’ locations, as well as proximity
to the market. This section presents you a brief description of some of these important factors.
The main factors that affect location decisions are presented as follows:

i. Global- international: is the highest level in the location decision hierarchy. Decision
makers who are considering expanding in to a new country must consider
macroeconomic, demographic, and political issues of long-term significance. They must
consider international trade issues, such as

 International trade issues (currency exchange risk, balance of trade, quotas, tariffs etc.)
 market access issues (such as free trade agreement, consumer sentiment towards
imported goods)
 labor issues (availability, wages, skill and training, and regulations)
 Political concerns (stability of current regime, risk of asset nationalization, local owner
ship laws etc.)
 Cultural issues (compatibility of business practices and products with local culture)
 Legal issues (environmental regulations, accounting &reporting requirements etc)

ii. Regional considerations: ones the decision has been made to locate a facility in a
particular country, decision makers must choose a region based on regional issues like:

 Supply issues (availability of material inputs): select the region endowed with abundant
or sufficient inputs.

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  proximity to market: select the region which is near to the major market if product is
perishable, fragile, if the product needs large transportation space, transportation cost is
expensive, and if further processing increases the volume, bulk, fragility and perish
ability.
 proximity to material: a possible reason to select regions which is near resources
includes: when further processing reduces the bulk (e.g. sugar processing), perish ability
(e.g., freezing, canning, pasteurizing etc)
 Transportation facility: transformation facilities are essential for the economic operations
of production systems. Operations manager must study the characteristics of the new
materials and finished products in regard to their transportation (water, railroad, road,
pipelines, and airline transport) need and search for the location (region) that provides
facilities of transportation with a reasonable cost.
 Climate: select the region with favorable climate which is important in order to acquire
and maintain productive work forces. Certain industries such as agricultural business
require specific climatic conditions.

iii. Community considerations: choice of community depends on the following factors:

 Community attitudes: in order to ensure the long term existences in that community, it is
mandatory to win the interest, enthusiasms, and cooperation of the society. Otherwise,
poor relation with community will result in putting the survival of the organization under
question mark. So select the community with positive attitudes towards the company.
 Community government and financial incentives: it is important to assess the current
situation and attempt to predict the future situations in regard to the policies of local
government. In general stable, competent, honest, and cooperative government officials
are great asset to a newly located company. Local government may be evaluated in terms
of financial incentives they offer, taxation polices, peace and securities etc.
 Community facilities: is concerned with the availability of schools, churches, medical
facilities, residential housings, recreational opportunities, highways etc.

iv. Site considerations: after identifying the community in the already selected region, the
final step in location selection decision is to screen out the best site out of the possible
ones. The followings are the basic factors that influence site selection.

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  Size and cost of the site: while selecting exact site, consider the size of the site and its
cost (building and construction costs). Generally, the size of the site must be large enough
to satisfy requirements such as employees parking requirement & future expansion plans
and the cost of the land must be reasonable.
 Drainage and soil condition: poor drainage leads to accumulations of water around the
plant which may be harmful for some organization. Similarly, if the load bearing capacity
of the soil is low, it will be difficult to establish sound building foundations.
 Land development cost: cost related to excavation, grading, filling, construction of road,
sidings, etc must also be taken in to consideration while selecting the site.
 Utilities: selection of site is influenced by cost of acquiring and using utilities like
electricity, natural gas, water as well as disposal facilities. For example all enterprises
need safe and pure water. Some organizations like breweries need water even with some
extra ordinary quality. So select the site which is better furnished with utilities.
 Access concerns: select the site which is easily accessible for customers, suppliers,
utilities and other concerned bodies.
Evaluating Location Alternatives:

There are a number of techniques that are helpful in evaluating location alternatives: factor rating
method, Centre of gravity method, Locational cost-profit-volume analysis and transportation
model.
1. Factor Rating Method:
A typical location decision involves both qualitative and quantitative inputs, which tend to vary
from situation depending on the needs of each organization. Factor rating is a general approach
that is useful for evaluating a given alternative and comparing alternatives. The process of
selecting a new facility location involves a series of following steps:
Determine which factors are relevant (e.g., location of market, water supply, parking,
revenue potential)
Assign a weight to each factor that indicates its relative importance compared with
all other factors. Typically, weights sum to 1.00.
Decide on a common scale for all factors (e.g., 0 to 100)
Score each location alternative

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 Multiply the factor weight by the score for each factor, and sum the results for each
location alternative
Choose the alternative that has the highest composite score
Example: Assume that a small manufacturing firm has recently decided to expand its
operations to include several new lines which it hopes to produce in a separate location
because of space limitations in its existing plant. The following rating sheet illustrates
relevant factors and factor weightings for two alternative locations.

Weighted score (out of Weighted score

100)
Factor/criteria Weigh Site A Site B Site A Site B
t
Proximity to the 0.1 100 60 0.1*100=1 0.1*60=6
existing store 0
Traffic volume 0.05 80 80 0.05*80=4 0.05*80=4
Rental cost 0.40 70 90 0.40*70=2 0.40*90=36
8
Size 0.10 86 92 0.10*86=8. 0.10*96=9.2
6
Layout 0.20 40 70 020*40=8 020*70=14
Operating cost 0.15 80 90 0.18*80=1 0.18*90=13.
2 5
TOTAL 1.00 70.6 82.7
As the weighted score of the two alternatives indicate, alternative A=70.6 and alternative B=
82.7. Therefore, based on factor rating method, alternative B is selected which has the higher
weighted score value.

2. Location Cost-Volume Analysis/ Break Even Analysis

Break-Even Analysis - is a technique used to compute the amount of goods that must be sold just
to cover costs. The break-even point is precisely the quantity of goods a company needs to sell to

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break even. Break-even analysis is the use of cost-volume analysis to make an economic
comparison of location alternatives. Whatever is sold above that point will bring a profit. At the
break-even point, total cost and total revenue are equal and the equation will use those to solve
for Q, which is the break-even quantity:

PQ = F+VQ where, Q = F/ P - V
Step 1: For Each Location, determine Fixed and Variable Costs. Fixed costs are incurred
regardless of how many units are produced and include items such as overhead, taxes, and
insurance. Variable costs are costs that vary directly with the number of units produced and
include items such as materials and labour. Total cost is the sum of fixed and variable costs.
Step 2: Plot the Total Costs for each Location on one Graph. To plot any straight line we
need two points. One point is Q = 0, which is the y intercept. Another point can be selected
arbitrarily, but it is best to use the expected volume of sales in the future.
Step 3: Identify ranges of output for which each location has the lowest total cost.
Step 4: Solve Algebraically for the Break-Even Points over the Identified Ranges. Select the
location that gives the lowest cost for the range of output required by the new facility
Example: Fixed and variable costs for three potential plant locations are shown below: If the
selling price is = Br. 120 Expected volume = 2,000 units

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Figure 5.1 From the figure 2 we can understand that up to 1,000 units the best alternative is
Hawassa; while from 1,000 to 2,500 units the best alternative is Diredawa and beyond 2, 500 is
Addis.

3. The Centre of Gravity Method:

The center of gravity method is a method to determine the location of a distribution center that
will minimize distribution costs. It treats distribution cost as a linear function of the distance and
the quantity shipped. The center of gravity method takes into account the locations of plants and
markets, the volume of goods moved, and transportation costs in arriving at the best location for
a single intermediate warehouse. The center of gravity is defined to be the location that
minimizes the weighted distance between the warehouse and its supply and distribution points,
where the distance is weighted by the number of tones supplied or consumed. The first step in
this procedure is to place the locations on a coordinate system. The origin of the coordinate
system and scale used are arbitrary, just as long as the relative distances are correctly

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represented. This can be easily done by placing a grid over an ordinary map. The center of
gravity is determined by the formula.

dixVi diyVi
Cx= Cy=
Vi Vi

Where, Cx is X Coordinate of the centre of gravity

CY is Y Coordinate of the centre of gravity

Dix is X Coordinate of the ith location

Diy is Y Coordinates of the ith location

Vi is volume of goods transported to the i th location

Example: A small manufacturing facility is being planned that will feed parts to three
heavy manufacturing facilities. The locations of current plants with their coordinates and
volume requirements are given in the following table.

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