Lecture 6 facility location
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Lecture 6 facility location Document Transcript

  • 1. Unit 2 Management of Conversion System Chapter 6: Facility locationLesson 18:- Location selectionLearning ObjectivesAfter reading this lesson you would be able to understand Location strategy and its importance Globalization – its reasons Global operations management Dominant factors in location selectionThis lecture describes in detail the factors leading to globalization and theensuing advantages and disadvantages. We would also focus on the variousfactors that are dominant in location decisions.So, we start with the first issue at hand and that is:-Locations strategy and its importanceDear students, as you all know, selection implies choice and choicepresumes the existence of various options available to a decision maker.Choosing where to locate new manufacturing facilities, service outlets, orbranch offices is a strategic decision. The location of a business’s facilitieshas a significant impact on the company’s operating costs, the prices itcharges for goods and services, and its ability to compete in the marketplace.Analyzing location patterns to discover a firm’s underlying strategy isfascinating. For example,Why does McDonald locate restaurants in a posh area?Why do competing new-car sales showrooms cluster near one another?McDonald’s target customers are those in high-income group. In contrast,managers of new-car showrooms deliberately locate near one another
  • 2. because customers prefer to do their comparison-shopping in one area. Ineach case, management’s location decision reflects a particular strategy.There are strategic impacts of location decisions. We will first consider themost important trend in location patterns- the globalization of operations.Meaning of GlobalizationThe term globalization describes businesses’ deployment of facilities andoperations around the world. Worldwide exports now account for more than30 percent of worldwide gross national product, up from 12 percent in 1962.Globalization also results in more exports to and imports from othercountries, often called offshore sales and imports. Globalization of servicesis also widespread. The value of world trade in services is roughly 20percent of total world trade. Banking, law, information services, airlines,education, consulting, and restaurant services are particularly activeglobally. For example, McDonald’s opened 220 restaurants in foreigncountries other than USA in just one year. Steel Authority of India (SAIL)hired Silver Spring, Maryland, consulting firm to design and implementquality systems for its five major steel plants.Friends, the question that emerges from the ongoing discussionforces us to analyze as to what globalization is all about.Many see it as a primarily economic phenomenon, involving theincreasing interaction, or integration, of national economic systemsthrough the growth in international trade, investment and capitalflows.However, one can also point to a rapid increase in cross-bordersocial, cultural and technological exchange as part of thephenomenon of globalisation.The sociologist, Anthony Giddens, defines globalisation as adecoupling of space and time, emphasising that with instantaneouscommunications, knowledge and culture can be shared around theworld simultaneously.Globalisation can also be defined as a process in which geographicdistance becomes a factor of diminishing importance in theestablishment and maintenance of cross border economic, politicaland socio-cultural relations
  • 3. Left critics of globalisation define the word quite differently, presentingit as worldwide drive toward a globalised economic system dominatedby supranational corporate trade and banking institutions that are notaccountable to democratic processes or national governments.Reasons for globalizationThere are four developments, which have spurred the trend towardglobalization. These are Improved transportation and communication technologies Opened financial systems Increased demand for imports Reduced import quotas and other trade barriers.Disadvantages of globalizationOperations in other countries can have disadvantages. A firm may have togive up proprietary technology if it turns over some of its componentmanufacturing to offshore suppliers or if suppliers need the firm’stechnology to achieve desired quality and cost goals. There may be politicalrisks. Each nation can exercise its sovereignty over the people and propertywithin its borders. The extreme case is nationalization, in which agovernment may take over a firm’s assts without paying compensation.Also, a firm may alienate customers back home if jobs are lost to offshoreoperations. Employee skills may be lower in foreign countries, requiringadditional training time. Korean firms moved much of their sports shoeproduction to low-wage Indonesia and China, but they still manufacturehiking shoes and in-line roller skate in Korea because of the greater skillsrequired.Dear friends, in view of the issues that we have just discussed, it becomesimperative to understand the intricacies involved in Managing globaloperations. I would now focus on these issues.Managing global operationsWhen a firm sets up facilities abroad it involve some added complexities inits operation. Global markets impose new standards on quality and time.Managers should not think about domestic markets first and then globalmarkets later, rather it could be think globally and act locally. Also, thy musthave a good understanding of their competitors. Some other importantchallenges of managing multinational operations include other languages
  • 4. and customs, different management style, unfamiliar laws and regulations,and different costs.Dear students, in general Managing global operations would focus on thefollowing key issues:-1. To acquire and properly utilize the following concepts and those related toGlobal Operations, Supply Chain, Logistics, etc.2. To associate global historical events to key drivers in Global Operationsfrom different perspectives3. To develop criteria for conceptualization and evaluation of differentGlobal Operations.4. To associate success and failure cases of Global Operations to Political,Social, Economical and Technological environments5. To envision trends in Global Operations6. To develop an understanding of the world vision regardless of theircountry of origin, residence or studies in a respectful way of perspectives ofpeople from different races, studies, preferences, religion, politic affiliation,place of origin, etc.Let us see what factors in general, affect the location decisionsFactors affecting location decisionsFacility location is the process of determining a geographic site for a firm’soperations. Managers of both service and manufacturing organizations mustweigh many factors when assessing the desirability of a particular site,including proximity to customers and suppliers, labour costs, andtransportation costs.Location factors can be divided into two categories: -Dominant factors, andSecondary factorsDominant factors are those derived from competitive priorities (cost,quality, time, and flexibility) and have a particularly strong impact on salesor costs. Secondary factors also are important, but management maydownplay or even ignore some of them if other factors are more important.
  • 5. Friends, let us consider the issue of why firms choose to locate newfactories and describes the main factors for their location choice. Whilelocation conditions are widely seen as the differences among locations thatexist for all industries, location factors refer to the specific importance that isattached to such differences by individual firms when choosing locations forspecific factors.Let us examine the key location factors:-Eleven location conditions can be distinguished: Transportation facilities Materials Markets Labor External Economies Energy Community Infrastructure Capital, Land Environment and Government policyLocation conditions are complex and each comprises a differentcharacteristic of a tangible (i.e. Freight rates, production costs) and non-tangible (i.e. reliability,Frequency security, quality) nature.By now, all of you must have realized that location conditions are hard tomeasure. Tangible cost based factors such as wages and products costs canbe quantified precisely into what makes locations better to compare. On theother hand non tangible features which refer to such characteristics asreliability, availability and security can only be measured along an ordinal oreven nominal scale. Other non tangible features like the percentage of
  • 6. employees that are unionized can be measured as well. Generally speakingcompanies prefer location with low taxes and low wages rather than suchwhere high taxes and wages are charged. But by taking these two factorsunder considerations low taxes are likely to imply low levels of communityservices and poor quality supplies of industrial land. While low wages mayimply low skills and low purchasing power. To sum this up non-tangiblefeatures are very important for business location decisions.Let us consider the effect of factors such as:Materials, markets and transportationFactories which produce products for different markets usually arethreatened by transportation costs. These costs include procurement costs,i.e. the costs considered for bringing raw materials or semi products to thecompany. On the other hand the finished products needs to be distributed tothe markets, which incurs distribution costs. Therefore locations near inputslower procurement costs and locations near markets lower distribution costs.Transportation costs comprise direct freight charges, while transfer costsrefer to both direct costs and indirect costs such as insurance costs and lossesresulting from damage in transit. Basically transportation costs aredetermined by physical characteristics like value of product and quantity ofgoods on the one hand and are determined also by freight rates on the other
  • 7. hand. Consequently, average transport costs decline significantly withdistance.All of us have a fair bit of idea about labor as an important constituent in theoverall scheme of things. Let us see how.LaborLabor costs comprise wages and non-wage benefits, like contributions tomedical plans, vacation time and pay, and pension schemes. Labor costsvary by industry, country, region, unionized and non-unionized sectors.Tremendous differences in labor costs can be seen between countries withhigh wages like developed countries on the on hand, and low developedcountries like China, India and so on, on the other hand. But even amonghigh developed countries labor costs can vary. So American and other strongcompanies are threatened by the highest manufacturing wages among thedeveloped countries while wages and labor costs in Canada or the UK aremuch lower. This is mainly because of strong influence of the unions in theUS and Europe compared to other countries.Even though there are large differences in wages and salaries amongcountries, Europe, and the US as labor expensive countries have prosperedand most of this has occured within recent decades. This fact leads us toanother important intangible characteristics of skilled labor. In a country
  • 8. with high taxes and wages you usually will find sophisticated infrastructureand educational system and therefore skilled workers. By focusing on China,India and the US we can recognize how low wages do not necessarily meanhigh competitiveness and high living standards. The main figure whichdetermines competitiveness is productivity.Another factor of immense importance that all of you must consider is:External economies of scaleExternal economies of scale can be described as urbanization and locationaleconomies of scale. It refers to advantages of a company by setting upoperations in a large city while the second one refers to the “settling down”among other companies of related Industries. In the case of urbanizationeconomies, firms derive from locating in larger cities rather than in smallerones in a search of having access to a large pool of labor, transport facilities,and as well to increase their markets for selling their products and haveaccess to a much wider range of business services.Location economies of scale in the manufacturing sector have evolved overtime and have mainly increased competition due to production facilities andlower production costs as a result of lower transportation and logisticalcosts. This led to manufacturing districts where many companies of relatedindustries are located more or less in the same area. The emergence of
  • 9. agglomeration like in the case of the Manufacturing belt in the United Statescan be explained like this: At the beginning of this century the great bulk ofmanufacturing was located in relatively small area in the Northeast of theUnited States. Even though wages were lower in the south of the UnitedStates and there were more mineral resources in West and Midwest,companies kept staying within the belt as a result of location economies ofscale. Each manufacturing facility stayed there because of havingadvantages of being near other manufacturers. However this did not onlytake place in the US but other countries as well such as Germany in the Ruhrarea or in Japan - Toyota city. As large corporations have realized thatinventories and warehouses have become a major cost factor, they have triedreducing inventory costs by launching "Just in Time" production system (theso called Kaban System).This high efficient production system was onemain factor in the Japanese car industry for being so successful. Just in timeensures to get spare parts from suppliers within just a few hours afterordering. To fulfill these criteria corporations have to be located in the samearea increasing their market and service for large corporations.Power or energy, as dear students all of us are aware is the commodity thatmakes the world go round.
  • 10. EnergyEnergy sources were a significant factor of location before the IndustrialRevolutions. Companies needed access to water energy, electricity for theiroperations. Now electricity and other energy sources like oil can betransformed and shipped very easily and cheaply and therefore Energy asbeing a main factor of location has decreased in its meaning.Friends, all of us are a part of the community and society in general. Thus,the factors given below also assume grave significance.Community infrastructure and amenityAll manufacturing activities require access to a community infrastructure,most notably economic overhead capital, such as roads, railways, portfacilities, power lines and service facilities and social overhead capital likeschools, universities and hospitals.These factors are also needed to be considered by location decisions asinfrastructure is enormously expensive to build and for most manufacturingactivities the existing stock of infrastructure provides physical restrictions onlocation possibilities. But on the other hand it is worth to mentioning thatexisting infrastructure does not cause" industry to occur.Another issue which we need to examine is the:Capital
  • 11. By looking at capital as a location condition, it is important to distinguishthe physiology of fixed capital in buildings and equipment from financialcapital. Fixed capital costs as building and construction costs vary fromregion to region. But on the other hand buildings can also be rented andexisting plants can be expanded. Financial capital is highly mobile and doesnot very much influence decisions. For example, large MultinationalCorporations such as Coca-Cola operate in many different countries and canraise capital where interest rates are lowest and conditions are most suitable.Capital becomes a main factor when it comes to venture capital. In that caseyoung, fast growing ( or not) high tech firms are concerned which usuallyhave not many fixed assets. These firms particularly need access to financialcapital and also skilled educated employees (i.e. Silicon Valley).Dear friends, let us now focus our attention to the conduct of operations ofMNCs and see how these have an important bearing on the decisions athand:-Multinational Companies or “MNC”A MNC is a company which has substantial direct investment in foreigncountries, not just an export business (International company). Beeing aMNC means that active management is required at any company andholding outlets in a passive financial portfolio. The main relation between a
  • 12. Multinational Corporation and an International company is that eachsubsidiary could be run as its own independent company. By definition ofthe United Nations a Multinational company is an enterprise:a. which comprises entities in two or more countries, regardless of the legalform and fields of activity of those entity.b. which operates under a system of decision making permitting differentpolicies and a common strategy through one or more decision makingcenters.c. In which the entities are so linked, by ownership or otherwise, that one ormore of them may be able to exercise a significant influence over theactivities of the others, and, in particular, to share knowledge, resources, andresponsibilities with others.Frinds, in this context I would request you all to answer the following basicquestion:-What motivates companies to expand their operations internationally?Let us probe deeply.Motivations for InternationalizationWe can classify these as follows:-Traditional Motivations
  • 13. One of the earliest reasons why companies moved abroad was the need tosecure key supplies, especially minerals, energy, and scarce raw materialresources.Another strong trigger of internationalization could be described as a marketseeking behavior. This motivation was particularly strong in companies forwhich their home markets have become too small and especially forcompanies who wanted to use economies of scale.Expenses for Research and Development for new High Tech products are sohigh and the life time so short that companies are forced to meet a salesquota of a certain amount and therefore their home markets have becomesmall.Another traditional and important trigger of internationalization was thedesire to access low cost factors of production as cheap labor or lower costcapital (perhaps through a government investment subsidy).Multinational Companies and national statesIt is generally argued that over the last few decades Multinational companieshave become extremely powerful and the influence of the home country inwhich MNC operates have decreased over time.
  • 14. MNC are very important for Host countries because they employee manypeople and increase GDP of the country. Therefore Host countries try toattract MNC by offering subsidies when they start their operations andproviding infrastructure and as well as tax allowances.‘MNC work in many countries and have really spread out their home". Thismeans they do not necessarily belong to one host country but they are athome everywhere where they have a headquarters.The power of MNC is rooted because of their technological and managerialexpertise and complexity, their financial resources, international marketingchannels and differentiated products, reinforced by powerful advertisingcampaigns.The power of the host country government is related to the size of thedomestic markets, resources and skilled labor pools, the availability ofinfrastructure and the political stability in the country.Dominant factors in manufacturingFactors dominating location decisions for new manufacturing plants can bebroadly classified in six groups. They are listed in the order of theirimportance as follows. 1. Favourable labour climate 2. Proximity to markets 3. Quality of life 4. Proximity to suppliers and resources
  • 15. 5. Proximity to the parent company’s facilities 6. Utilities, axes, and real estate costs Let us consider each of these factors one by one.Favorable labor climateA favorable labor climate may be the most important factor in locationdecisions for labour-intensive firms in industries such as textiles, furniture,and consumer electronics. Labour climate includes wage rates, trainingrequirements, attitudes toward work, worker productivity, and unionstrength. Many executives consider weak unions or al low probability ofunion organizing efforts as a distinct advantage.Proximity to marketsAfter determining where the demand for goods and services is greatest,management must select a location for the facility that will supply thatdemand. Locating near markets is particularly important when the finalgoods are bulky or heavy and outbound transportation rates are high. Forexample, manufacturers of products such as plastic pipe and heavy metals allemphasize proximity to their markets.Quality of lifeGood schools, recreational facilities, cultural events, and an attractivelifestyle contribute to quality of life. This factor is relatively unimportant onits own, but it can make the difference in location decisions.Proximity to suppliers and resourcesIn many companies, plants supply parts to other facilities or rely on otherfacilities for management and staff support. These require frequentcoordination and communication, which can become more difficult asdistance increases.Utilities, taxes, and real estate costsOther important factors that may emerge include utility costs (telephone,energy, and water), local and state taxes, financing incentives offered bylocal or state governments, relocation costs, and land costs.Other factorsThere are some other factors needed to be considered, including room forexpansion, construction costs, accessibility to multiple modes oftransportation, the cost of shuffling people and materials between plants,
  • 16. competition from other firms for the workforce, community attitudes, andmany others. For global operations, firms are emphasizing local employeeskills and education and the local infrastructure.Dominant factors in servicesThe factors considered for manufacturers are also applied to serviceproviders, wit one important addition – the impact of location on sales andcustomer satisfaction. Customers usually look about how close a servicefacility is, particularly if the process requires considerable customer contact.Proximity to customersLocation is a key factor in determining how conveniently customers cancarry on business with a firm. For example, few people would like to go toremotely located dry cleaner or supermarket if another is more convenient.Thus the influence of location on revenues tends to be the dominant factor.Transportation costs and proximity to marketsFor warehousing and distribution operations, transportation costs andproximity to markets are extremely important. With a warehouse nearby,many firms can hold inventory closer to the customer, thus reducing deliverytime and promoting sales.Location of competitorsOne complication in estimating the sales potential at different location is theimpact of competitors. Management must not only consider the currentlocation of competitors but also try to anticipate their reaction to the firm’snew location. Avoiding areas where competitors are already well establishedoften pays. However, in some industries, such as new-car sales showroomsand fast-food chains, locating near competitors is actually advantageous. Thestrategy is to create a critical mass, whereby several competing firmsclustered in one location attract more customers than the total number whowould shop at the same stores at scattered locations. Recognizing this effect,some firms use a follow –the leader strategy when selecting new sites.Site-specific factorsRetailers also must consider the level of retail activity, residential density,traffic flow, and site visibility. Retail activity in the area is important, asshoppers often decide on impulse to go shopping or to eat in a restaurant.Traffic flows and visibility are important because businesses’ customersarrive in cars. Visibility involves distance from the street and size of nearby
  • 17. buildings and signs. High residential density ensures nighttime and weekendbusiness when the population in the area fits the firm’s competitive prioritiesand target market segment.Well, I know you have been following very clearly and must haveunderstood the issues that were discussed. The best way, as usual is througha small case study or case-let, as it is commonly referred to. So, here we goagain.POM in practice 6.1*The Radisson Hotels International, with headquarters in Minneapolis,Minnesota, had become by 1995 one of the world’s fastest-growing upscalehotel companies. Its global expansion program was adding one new locationevery 10 days, on average. In 1991, it opened the four-star RadissonSlavjansksya Hotel in Moscow, which has become a very successfulhospitality oasis for Western business travelers. However, opening theSlavjanskaya forced Radisson to weather many storms and deal with everyconceivable managerial challenge.Multiple LanguagesThere is great diversity in the language of the hotel’s managers, employees,supplies, and customers. Most of the managers are expatriates, and most ofthe employees are Russians. The customer mix is American (55 percent),Western Europe (20 percent), Eastern European (15 percent), Asian (5percent), and Russian (5 percent)Different Norms and CustomsRussian standards of service quality were much lower than those expectedby management. To attain and maintain top service quality, employees hadto participate in intensive training. Employee attitudes toward work andethical norms also were different. For example, employees often missedwork because of sick leaves, maternal leaves, and vacations. Russian lawsallow 24-day vacations and sick leaves of up to four months with pay, whichcan be renewed by returning to work for only a few days. Securityrequirements were demanding, with theft being commonplace. Once theentire payroll was lost in a Russian bank. On another occasion, about 500 ofthe 600 champagne glasses were missing. The nearby train station was saidto be controlled by gangs who offered “protection” to the vendors. Some 70security guards were employed, many more than at a typical Radisson hotel.
  • 18. Workforce ManagementStaffing and training issues arose unexpectedly. For example, the Russianemployees were offended by being rotated through various jobs to gainwider experience, viewing rotation as a lack of confidence in their abilities.They believed that Americans were too quick to punish and too slow tounderstand cultural differences. An important hiring requirement was thatthe applicant had smiled sometime during the interview and had expressed awillingness to reject bribes. The notion of linking pay and bonuses withperformance was a radically new idea to Russian employees.Unfamiliar Laws and RegulationsCommunist-era “job-for-life” laws were still in effect, and firing anemployee was difficult. The housekeeping people were paid for 8 ½ hoursper day, regardless of the actual hours worked. Tax laws were extremelycomplicated and sometimes were changed retroactively. Russian employeeswere paid in rubles at a time when inflation was 18 percent per month.Unexpected Cost MixLabour productivity was low relative to a comparable Western hotel, butsalary rates were even lower. The net result was a savings because salariesaccounted for only 13.5 percent of total costs, in contrast to the 35 percent inthe United States. However, local suppliers were unreliable and procurementcosts were quite high. About 93 percent of all products were imported fromthe West – shipped to Helsinki or St. Petersburg and then trucked toMoscow. This importing process was slowed by problems with customs,Russian fuel, truck breakdowns, and the need for “expediting payments”.These uncertainties and delays created unusually large inventories. Theinfrastructure, including mail, telephone, banking, and city services, alsowas inadequate. For example, hot water came from city-run water heatingplants. Because this source wasn’t always reliable, Slavjanskaya had to payfor the construction of a second hot water pipe to guarantee both heat andhot water.*Source – Operations Management Strategy and Analysis (L. J. Krajewski,L. P. Ritzman) Prentice HallLet us consider another small case.
  • 19. POM in practice 6.2*Call centers are frequently mistaken for telemarketing operations, when infact they are not. Most are “inbound” facilities that take reservations andorders or provide customer service. The industry has boomed during the lastdecade as more firms decided to outsource such customer service processes.Texas leads the United States in the number of new centers over the pastdecade – its number of call centers doubled in the last decade. By oneestimate, 113 centers located there in the 1990s compared with 81 in Florida,the runner-up. In the past, the vast majority of call centers went to the state’slarge metropolitan areas, but now smaller cities such as Big Spring,McAllen, and Brownsville are getting in on the act.Two dominant factors favouring small Texan cities are their ample supply ofinexpensive labour and the incentives that thy are tossing in to land thecompanies. Before Denver-based StarTek opened a call center in Big Spring,a West Texas town of 23,000 where unemployment had been about 6percent, a job fair attracted 1,200 applicants. Employees started at $6.50 perhour, far less than what would be paid in a bigger city. To seal the deal, BigSprings gave StarTek $2.3 million in interest-free loans. Smaller cities aremore likely to get state funds for this type of economic development becausethe call centers are such an economic-development bonanza for them. Inlarger cities, companies usually do not qualify for incentives unless theymake a substantial capital investment-and many do not, choosing to leaseoffice space. The smaller cities need the jobs more. Call centers employseveral hundred people, bringing jobs and a level of technical training andgiving smaller cities a foot in the door to the new high-tech economy.Particularly if labour stays in short supply, call centers could be the first stepfor smaller cities to draw other burgeoning business, such as the distributioncenters for e-commerce companies.Other factors that favour Texas are the central time zone (making itconvenient to reach markets on both coasts), the availability of advancedtelecommunications structures (such as fiber-optic lines and digitalswitching systems), and the favourable regulatory climate. It is a one-party-consent state, meaning customers do not need to be notified if theirconversations are being recorded; getting permission slows down the callingprocess. And the state also does not levy excise or sales taxes on out-of-statelong distance calls, as some states do. Border cities also offer a supply ofbilingual workers – to take calls from Spanish-speaking customers. This
  • 20. advantage is particularly important as more companies expand their marketsinto Latin America.*Source– Operations Management Strategy and Analysis (L. J. Krajewski,L. P. Ritzman) Prentice HallWith that, we have come to the end of today’s discussions. I hope it hasbeen an enriching and satisfying experience.Points to ponder