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7
©iStockphoto/Thinkstock
Facility Location and Process Selection
Learning Objec�ves
A�er comple�ng this chapter, you should be able to:
Discuss loca�on as a strategic decision.
Discuss the quan�ta�ve and qualita�ve factors influencing
loca�on decisions.
Integrate qualita�ve and quan�ta�ve factors to make effec�ve
loca�on decisions.
Describe how loca�on influences other opera�ng decisions.
Describe the process selec�on decision and how it is influenced

by the volume of product demanded.
Define the different process types: line flow, batch flow,
flexible manufacturing system, manufacturing cell, job
shop, and project.
Construct a cost-volume-profit model of a firm, and understand
how to use the model to manage the firm.
Calculate the break-even point for cases involving both single-
and mul�ple-product breakeven.
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Fast-food restaurants, hotels, hospitals, and gas sta�ons
are o�en located on heavily traveled
roadways in order to provide customer convenience and
accessibility.
©age fotostock / SuperStock
7.1 Facility Location
The previous chapters in this book have provided an
understanding of what opera�ons are, why they are
important, how they can be used to create compe��ve
advantage, how they impact key business elements such as
cost and quality, and how they relate to suppliers. This
chapter provides some organiza�onal context for
the study of opera�ons.

The purpose of an organiza�on is to manufacture a good
or provide a service, and opera�ons play a key role. This
begins with designing the produc�on system,
which includes:
1. Designing a product, which was discussed in an earlier
chapter
2. Determining where and how the product will be created
(loca�on and process)
3. Se�ng the capacity of the organiza�on
There are other decisions involved in designing the system
that produces these goods and services, such as how to
lay out and organize the facility and design the
individual jobs that employees must perform. However,
these topics are beyond the scope of this text.
Facility loca�on is the placement of a facility with regard
to a company's customers, suppliers, and other facili�es
with which the company interacts. The loca�on
decision usually commits substan�al resources and cannot
be easily changed. Many of the principles and techniques
used in loca�ng a facility are the same
whether an organiza�on is selling fried chicken or
groceries, provides fire protec�on or health services,
stores electronic parts or food, or makes computer chips
or
paper. Managers making the decision should consider the
costs of opera�ng at a par�cular loca�on, including costs
to acquire the land and build the facility, as well
as costs for labor, taxes, and u�li�es. They should
consider the convenience of a par�cular loca�on for
customers as well as the cost to transport materials to the
facility and move finished product from the facility.
Managers should also consider access to banking,
educa�onal, and other ac�vi�es that are important to the

success of their organiza�on. Thus, many factors, both
quan�ta�ve and qualita�ve, influence the loca�on
decision. Quan�ta�ve factors are easily measurable, while
qualita�ve factors are more subjec�ve.
What o�en differs from one industry to another are the
weights assigned to these various factors. The size of the
weight assigned to a factor indicates its
importance. For example, a primary factor in loca�ng a
fire sta�on is its response �me to the buildings within
that fire district. Thus, response �me should be
assigned a large weight. When loca�ng a restaurant, easy
customer accessibility may be more important than the
cost to transport raw material (food and
beverages) to the facility. An organiza�on producing solar
cells may feel that it is very important to locate in an
area close to a university or research park that
specializes in key technology. Organiza�ons that produce
plywood, dimensional lumber, or paper need a readily
available supply of wood, so they usually locate
near �mber resources. Managers of labor-intensive
opera�ons may feel that low labor cost is the cri�cal
factor that determines the loca�on of their facility.
Location as a Strategic Decision
The loca�on decision usually involves commitment of a
large capital investment that cannot be moved. As a
result, loca�on should be viewed as a long-term,
strategic decision because it will have a major impact on
the organiza�on's ability to compete. The loca�on
decision should not be based solely on marke�ng
issues, produc�on factors, or transporta�on costs.
Successful managers integrate the relevant factors and
weigh them appropriately in order to make the best long-
term decision for the organiza�on.

This long-term commitment should fit with the
organiza�on's overall
strategy. In some cases, organiza�ons develop marke�ng
and opera�ng
strategies that have an impact on the loca�on decision. A
regional facility
strategy requires that each produc�on facility has a
defined marke�ng
area and each facility produces a complete line of
products for that area.
This is o�en done when customer convenience and access
are important,
or when outbound transporta�on costs are very high. Fast-
food
restaurants, instant oil change opera�ons, hospitals, and
branch banks are
examples of opera�ons located to provide maximum
customer
convenience and access. Many customer-oriented service
opera�ons are
located in this way. Bo�le making, corrugated box
produc�on, and
aluminum can making opera�ons are examples of facili�es
that are located
by region to keep outbound transporta�on costs low.
These finished
products have high shipping costs because they occupy a
lot of space—
shipping a can to the beverage company means shipping a
lot of empty
space. When these low-value finished products are shipped
long distances,
transporta�on costs increase the cost of the product,
making the company
less price compe��ve.

A product facility strategy means that one facility is
responsible for
producing one product or product line and shipping that
product throughout the country and the world. This
approach is appropriate when the produc�on process
is complex and hard to control, such as making ceramic
heat shields for spacecra�. It can be used when a firm
does not want to duplicate expensive equipment,
facili�es, and highly trained personnel. This approach is
also popular when there are advantages to specializa�on
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costs are not prohibi�ve. The produc�on of igniters for
jet aircra� engines, for example, would benefit from a
product facility strategy. This item is small, so
shipping costs are low. An igniter is high in value, so
shipping cost, as a percent of purchase price, is also
small.
Manufacturing Location Factors
There are differences in the loca�on decision for
manufacturers and service providers. Manufacturing firms
consider a variety of factors.
Quan�ta�ve factors for manufacturers include:

Labor costs
Material costs
Transporta�on
U�li�es, taxes, real estate costs, and construc�on costs
Government incen�ves
Qualita�ve factors include:
Labor climate
Quality of life
Proximity to customers and markets
Proximity to suppliers and resources
Service Location Factors
In service opera�ons, many of the factors iden�fied with
manufacturing are s�ll relevant. In most service
opera�ons, service providers would consider labor cost,
taxes, real estate costs, construc�on costs, and government
incen�ves as important elements in a loca�on decision.
On the other hand, material cost and
transporta�on costs would be relevant for only some
service providers, such as restaurants and retail opera�ons
that purchase, transport, and resell goods. U�lity
costs are not a significant factor for most service
opera�ons because consump�on is generally low compared
to manufacturing. The qualita�ve factors listed for
manufacturers are likely to be relevant for service
providers, with the excep�on of proximity to suppliers
and resources. This is because materials and component
parts are not always shipped from suppliers.
If a business has customers that u�lize a service facility
in person, being close to customers is very important. For
example, retail opera�ons require this proximity

to the customer, but a call center can be located
anywhere in the world. Customers o�en place a high
value on their �me, therefore, convenience is essen�al.
Transporta�on costs are important for warehousing and
distribu�on, but response �me—the �me elapsed between
a request for service to the delivery of that
service—may be even more important. If travel distance
and �me are short, total inventory in the system can be
kept very low. In some cases, the trip from
producers to the distribu�on center to the retail store can
be one day or less.
Loca�on of compe�tors may also be an important factor
for service opera�ons. In some services, such as
newspaper publishing, having compe�tors in the
immediate area o�en has a significant nega�ve impact on
sales. In others, service providers tend to cluster together.
In many cases, they adver�se together. Nearly
every medium-size town and large city has an "auto mile"
or "auto strip" where one of every car dealer is located.
The idea of such a loca�on is to create a cri�cal
mass, so customers can quickly and easily compare
products from different dealers. Fast-food restaurants will
o�en locate in similar clusters. These clusters are
caused to some extent by the need to deal with customer
choice. For example, in a large group of poten�al
customers, some will want pizza, some will want
burgers, and others will want chicken. Fast-food chains
locate their restaurants near high-volume ac�vi�es, such
as large shopping malls, sport centers, and
expressway exits in large urban areas.
The loca�on of emergency units, such as fire protec�on
and ambulance service, is determined by minimizing
response �me, providing minimum coverage, and
opera�ng from a mobile loca�on. Response is important

when �me is a cri�cal factor. The objec�ve is to locate
a facility so that the maximum response �me to
any point served by the emergency unit is minimized.
Minimum coverage implies that all customers have a
minimum level of coverage. For example, no house in the
city will be more than one mile from a fire sta�on
or an ambulance service. The number and placement of
facili�es required to provide minimum coverage can be
determined by grouping customers into appropriate
popula�on centers and examining candidate facility
loca�ons to see if the minimum coverage is provided.
This can be accomplished by lis�ng the popula�on
centers in the columns of a table and lis�ng the poten�al
facility loca�ons in the rows of the same table. Then,
each poten�al facility can be judged to determine if
the minimum coverage is achieved. In many cases, more
than one candidate facility may be required to provide
that coverage.
Government Incentives
Many states and local governments have been very
aggressive in their efforts to a�ract new businesses. One
incen�ve offered by state and local governments is a
significant reduc�on in property taxes. They have also
offered low-interest loans, provided free training to
workers, and subsidized wages for a specified period of
�me. In addi�on, many states and ci�es have established
agencies that can help private industry slice through
governmental red tape. In some cases, state and
local governments have put together parcels of land by
using their powers of eminent domain. Simply stated,
eminent domain means that an owner can be forced
to sell property to the government at fair market value if
it will be used for the good of all. Once obtained,

proper�es are sold to private industry for development.
Governments can acquire property more quickly and less
expensively than private industry can. As soon as word
gets out that private industry is interested in
developing an area, the land prices are sure to increase
significantly. With the power of eminent domain, the
government can avoid being delayed by owners of
key parcels.
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In some cases, businesses that have been in a state for
years are grumbling about the preferred treatment given to
newcomers, and some states are beginning to
wonder if the jobs created are worth the costs of the
incen�ves. Despite this, bidding wars among states for the
jobs these new developments bring are likely to
con�nue. The pressure on elected officials to create jobs
in the short term seems to mask the long-term impact that
this treatment may have on future revenues
and expenses of the state.
Highlight: Changing Loca�ons for Automo�ve Assembly
For many years, automobile assembly plants were located
in the Midwest, and new facili�es were built in this
region in order to provide good, low-cost access
to a large percentage of the North American popula�on.

As the popula�on has increased in the South and
Southwest, many automobile companies—especially
foreign producers—have located new assembly facili�es in
the South to take advantage of lower labor costs, lower
construc�on costs, cheaper land, and
government incen�ves. Alabama persuaded Mercedes-Benz
to build an assembly facility for making sport u�lity
vehicles. Honda opened a facility in Lincoln,
Alabama, that employs more than 2,000 people to make
its Odyssey minivan. Toyota has constructed an engine
assembly facility in Huntsville, Alabama.
Hyundai Motor Company of South Korea has built a final
assembly facility in the South.
These efforts have cost Alabama nearly $700 million in
incen�ves. Cri�cs argue that the state has not received
sufficient return on its investment. Also, these
investments have taken money away from schools and
services, and made it difficult for the state to provide tax
relief for its low-income residents. Proponents
argue that these efforts are "Alabama's new day." Other
companies are inves�ga�ng the poten�al that Alabama
has to offer.
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State and local governments offer incen�ves such as tax
breaks,

low-interest loans, and help cu�ng through red tape to
a�ract
and retain businesses and jobs.
©Photodisc/Thinkstock
7.2 Evaluating Locations
The factors that must be weighed when evalua�ng
loca�ons are grouped into three subsec�ons: (1)
managing the quan�ta�ve factors, including the impact of
loca�on on cost and the increasing
importance of government incen�ves; (2) describing the
qualita�ve factors and illustra�ng how these
can be analyzed as well as integrated with the
quan�ta�ve factors; and (3) discussing the effects of the
loca�on decision on other opera�ng factors.
Managing Quantitative Factors
Quan�ta�ve factors include the costs associated with
facility construc�on, produc�on, overhead, and
transporta�on to and from the facility. State and local
governments offer incen�ves to a�ract and retain
businesses and jobs. Such incen�ves include tax
abatement, low-interest loans, help in cu�ng through
red tape, low business taxes, and low rates for
unemployment insurance and worker's compensa�on.
Finally, the loca�on can affect sales volume and selling
price. The announcement of a new facility may
ini�ate price-cu�ng or other costly product promo�on
ac�vi�es by exis�ng compe�tors in the area.
Loca�on decision plays an important role in shaping the
cost func�on. The total-cost equa�on is:

TC = (VC)X + FC
where
TC = total cost
VC = variable cost per unit
X = the number of units produced
FC = fixed costs
Variable costs are affected by prevailing wage rates,
material costs, u�lity rates, and transporta�on costs for
incoming materials and outgoing finished products.
Fixed costs are affected by construc�on and land costs
and the cost of administra�on, all of which are likely to
be lower in rural areas. There also may be tax
incen�ves or other special considera�ons for a par�cular
site.
To prepare cost es�mates for a site, data are collected
and analyzed. To illustrate, Table 7.1 contains data for a
site in Indianapolis, Indiana, for a facility to build
computer control panels. These data can be used to
prepare a pro forma opera�ng budget.
Table 7.1: Data for site in Indianapolis, Indiana
Produc�on Costs
Type Rate Projected Usage
Labor Welding
Electrical
General assembly

$10.00/hr.
$12.00/hr.
$9.00/hr.
0.5 hrs./unit
0.3 hrs./unit
1.1 hrs./unit
Material Sheet metal
Threaded fasteners
Electrical wire
$.40/lb.
$2.00/100
$.06/lineal �.
100 lbs./unit
20/unit
70 lineal �./unit
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U�li�es Natural gas
Electricity
$4.00/1,000 cu. �.
$.06/kilowa� hr.

500 cu. �./unit
200 kilowa� hrs./unit
Transporta�on* In rail
In motor carrier
In motor carrier
Out motor carrier
$.03/lb. (sheet metal)
$.04/lb. (fasteners)
$.04/lb. (wire)
$20/unit (finished)
100 lbs./unit
5 lbs./unit
4 lbs./unit
1
Facility Overhead Ini�al Investment
Land acquisi�on costs
Building construc�on
Plan start-up costs
Ini�al employee training
$2,100,000
$175,000,000
Special Considera�ons Tax abatement
Low-interest loans
Supplementary training expenses
$25,000,000
*Rates are given from specific origin to a specific
des�na�on, so distance has been accounted for.

Table 7.1 contains projected labor, material, and u�lity
usage in addi�on to the rates. U�li�es may have both
fixed and variable components. Some u�lity costs are
variable and directly linked to producing a product, such
as the power required to run a drill press. In other cases,
u�lity costs cannot be linked to a product. An
example is the energy needed to heat a building. The
amount of heat required is not related to the number of
units produced. Table 7.1 shows variable u�lity
costs. The fixed component of u�li�es is included in
overhead expenses. Transporta�on costs are a func�on of
the quan�ty of materials shipped, the distance
traveled, and the type of carrier used.
Table 7.1 also lists as a lump sum an es�mate of facility
overhead expenses, such as supervisors, material handling,
and plant management staff. The value of the
investments in the facility and the value of any special
considera�ons are also listed as lump sums. The special
considera�ons figure is shown as a savings that
should be deducted from the ini�al investment.
Table 7.2 shows a pro forma opera�ng budget based on
producing 45,000 units per year at the site described in
Table 7.1. An opera�ng budget usually does not
include capital costs for facili�es. The costs of making
products at this facility can now be es�mated.
Considering only the variable costs, the unit variable cost
is
calculated as follows:
Unit variable cost
= $100.46/unit
The cost including a share of the annual facility overhead

is:
Cost with overhead
= $147.13/unit
*Throughout this text, to enlarge the size of the math
equa�ons, please right click on the equa�on and choose
"se�ngs" then "scale all math" to increase the
viewing percentage.
Table 7.2: Pro forma opera�ng budget for one year based
on es�mated sales of 45,000 units
Labor
Welding
Electric
Assembly
Total Labor costs
($10.00/hr.)(0.5 hrs./unit)(45,000 units)
($12.00/hr.)(0.3 hrs./unit)(45,000 units)
($9.00/hr.)(1.1 hrs./unit)(45,000 units)
$ 225,000
162,000
445,500
$ 832,500
Material
Sheet metal
Fasteners
Wire
Total material costs
($.40/lb.)(100 lbs./unit)(45,000 units)
($2.00/100)(20/unit)(45,000 units)

($.06/lin. �.)(70 lin. �./unit)(45,000 units)
$ 1,800,000
18,000
189,000
$ 2,007,000
U�li�es
Natural gas
Electricity
Total u�lity costs
($4.00/1,000 cu. �.)(500 cu. �./unit)(45,000 units)
($.06/kwh)(200 kwh/unit)(45,000 units)
$ 90,000
540,000
$ 630,000
Transporta�on
Sheet metal
Fasteners
Wire
Finished product
Total transporta�on costs
($.03/lb.)(100 lb./unit)(45,000 units)
($.04/lb.)(5 lb./unit)(45,000 units)
($.04/lb.)(4 lb./unit)(45,000 units)
($20.00/unit)(45,000)
$ 135,000
9,000
7,200
900,000
$ 1,051,200

Variable costs
Facility overhead*
Grand total
$ 4,520,700
2,100,000
$ 6,620,700
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*Some overhead costs can be variable, but to simplify the
discussion in this case, we will assume all overhead costs
are fixed.
Comparing Quantitative Factors
To make effec�ve loca�on decisions, management must
organize the poten�al costs and revenues for each site in
a way that allows them to be easily compared.
Begin by examining the cost data for the Indianapolis site
(detailed in Tables 7.1 and 7.2), and for an alterna�ve
site in Lexington, Kentucky. The new facility is
scheduled to produce 45,000 units per year. The costs for
both sites are summarized here. (The incen�ves are to be
subtracted from the ini�al investment.)
Indianapolis Lexington

Variable Costs $100.46/unit $95.77/unit
Annual Overhead Cost $2,100,000/year $1,900,000/year
Ini�al Investment $175,000,000 $168,000,000
Incen�ves $25,000,000 $10,500,000
Several assump�ons are made including: (1) revenue is
not affected by either choice; (2) sales volume per year,
selling price, unit variable costs, and fixed costs do
not change over the period in ques�on; and (3) the �me
value of money is ignored. The �me value of money is
the no�on that one dollar received today is worth
more than one dollar received at some future point. One
dollar received today can be invested and earn a posi�ve
return, thereby making its value greater than
one dollar.
Problem
Compare the costs of the Indianapolis and Lexington sites
over a five-year period, using the total-cost equa�on. (The
subscript I stands for Indianapolis and the
subscript L for Lexington.)
TC = (VC)X + FC
TCI = ($100.46/unit)(45,000 units/year)(5 years) +
($2,100,000/year)(5 years) + $175,000,000 – $25,000,000
= $22,603,500 + $10,500,000 + $150,000,000
= $183,103,500

TCL = ($95.77/unit)(45,000 units/year)(5 years) +
($1,900,000/year)(5 years) + $168,000,000 – $10,500,000
= $21,548,250 + $9,500,000 + $157,500,000
= $188,548,250
Over a 5-year period, Indianapolis has a lower total cost.
At what point in �me will the costs of these two sites
be equal? In this case, X will represent the number of
years un�l costs are equal. This informa�on may
be very useful for managers when choosing between the
alterna�ve sites.
TCI = TCL
(100.46)(45,000)X + 2,100,000X + 175,000,000 –
25,000,000 = (95.77)(45,000)X + 1,900,000X + 168,000,000
– 10,500,000
$4,520,700X + $2,100,000X + $150,000,000 = $4,309,650X
+ $1,900,000X + $157,500,000
$6,620,700X – $6,209,650X = $157,500,000 – $150,000,000
$411,050X = $7,500,000
X = 18.25 years
Check the answer by subs�tu�ng the �me X into the cost
equa�ons for Indianapolis and Lexington and seeing if the
costs are equal.
If the amount sold per year is allowed to vary, the point
of equal costs could be viewed in a different way. In the

model, the number of years could be a
constant, and the number of units sold per year could
become a variable. If the �me period is set at five years,
how many units must be sold each year if
costs are equal? Here, the variable X represents the
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TCI = TCL
(100.46)(X)5 + (2,100,000)5 + 175,000,000 – 25,000,000 =
(95.77)(X)5 + (1,900,000)5 + 168,000,000 – 10,500,000
X = 277,186 units/year
Including Qualitative Factors
Qualita�ve factors do not usually have measurable, direct
effects, but they do need to be carefully considered and
integrated into the decision by management. The
chapter 7 appendix contains a sample list of some of the
qualita�ve factors that could be considered such as labor
climate, cultural ac�vi�es, and weather.
To integrate qualita�ve factors into the loca�on decision,
managers should:
1. Decide which factors are relevant
2. Weigh each of the factors—some may be more important than

others
3. Evaluate each site so that ra�onal comparisons can be made
Unless a manager makes a judgment about the importance
of each factor, all the factors are assumed to have equal
weight. These weights are usually selected
prior to determining the rankings or raw scores so that
the scores do not bias the weights. The weights are
mul�plied by the scores to determine the weighted
scores. Then, the weighted scores are added together to
determine total scores.
Problem
A commi�ee has determined that the following factors are
relevant to the decision. Indianapolis and Lexington are
ranked on a scale of 1 to 10, with 10 being
most desirable. The rankings are subjec�ve es�mates.
Factor Weight Indianapolis Raw Score Lexington Raw Score
Recrea�onal ac�vi�es 20 8 7
University research facili�es 40 8 8
Union ac�vity 40 4 7
Banking services 80 7 6
Available labor pool 60 7 5
The rankings can eventually be added; 10 is considered
"good" in all cases, but a ten may not indicate more of
that factor. For example, a 10 in university
research ac�vi�es is desirable and indicates high levels of
research; a 10 in union ac�vity is also desirable, but may

indicate low levels of union ac�vity.
Mul�ply the weight by the raw score for both
Indianapolis and Lexington.
Indianapolis Lexington
Weight Raw Score Weighted Score Raw Score Weighted Score
Recrea�onal ac�vi�es 20 8 160 7 140
University research facili�es 40 8 320 8 320
Union ac�vi�es 40 4 160 7 280
Banking services 80 7 560 6 480
Available labor pool 60 7 420 5 300
Total 1,620 1,520
As long as the same weights are applied to each loca�on,
the weighted scores are comparable. The absolute value of
each score does not have meaning, but
comparing total scores is useful.
If Indianapolis is superior in profit and investment, then
the choice between the two loca�ons is easy because
Indianapolis also has a slight qualita�ve edge. If
Indianapolis is not superior in profit and investment, then
management should judge the impact of these qualita�ve
factors on the long-term success of the
organiza�on. Even though a mathema�cal model can be
used to analyze the data, the results must s�ll be
interpreted and a decision made.

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On-Site Versus Off-Site Expansion
Loca�on can have a significant impact on an
organiza�on's ability to compete. It can influence costs,
selling price, demand, educa�onal opportuni�es for
employees
and their families, and access to financial services. How
can the loca�on decision affect other factors in
produc�on?
Assume that demand for an organiza�on's product exceeds
present capacity. An organiza�on can consider two op�ons
to increase capacity: build addi�ons to the
exis�ng plant on-site, or design and build a new plant in
another loca�on. On-site expansion is more popular
because it usually involves less capital investment.
Many services, such as shipping, receiving, and
administra�on, may not need to be expanded. Only the
cri�cal opera�ons— that is, the bo�lenecks—require
capacity increases.
However, on-site expansion can create many problems,
especially if it is a repeated prac�ce. As more produc�on
space is added, material handling and storage
become more difficult because inventory space is o�en
converted to produc�on. As new product varia�ons are

added, the once simple product flow becomes
complicated or stymied because plant addi�ons o�en occur
over many years and no long-term planning for future
addi�ons is made. When on-site expansion is
used to increase capacity, intra-plant transporta�on and
communica�on can become strained.
Staying at the same site o�en postpones the introduc�on
of new product and process technologies. Old equipment
and old produc�on methods are used longer
than they should be. Future product innova�on,
produc�vity increases, quality improvements, and cost
reduc�ons can be nega�vely affected. On-site expansion
can
mean a growing number of workers, products, and
processes that must be managed. Such layering of
expanded responsibili�es creates complexi�es for managers
at all levels.
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Leverage means making the workforce more produc�ve
through the use of be�er tools and
equipment. One worker with a few simple tools may be
able to assemble an automobile,
but not at a compe��ve cost.
©Monty Rakusen/Cultura/Ge�y Images

7.3 Foundations of Process Selection
Process selec�on is determining the most appropriate
method of comple�ng a task. It is a series of decisions
that include technical or engineering issues and
volume or scale issues. The technical or engineering issues
include the basic methods used to produce a service or
good. For example, deciding to remove a gall
bladder using laparoscopic surgery versus tradi�onal
methods is a technical decision made by physicians. The
decision depends on the pa�ent's condi�on and is
o�en made at the �me of surgery. On the other hand,
determining the number of surgery rooms and the number
of surgeries to perform each day at the regional
medical center is a volume or scale decision that is
related to demand. In general, the technical aspects of
process selec�on are beyond the scope of this course, so
the focus will remain on volume or scale issues.
There is a strong rela�onship among process selec�on
and three cri�cal
elements in business: volume, cost, and profit. The volume
or scale decision
involves applying the appropriate mix of technology to
leverage the
organiza�on's workforce. Leverage means making a
workforce more produc�ve
through the use of be�er tools. For example, one person
working alone with a
few simple tools may be able to assemble an automobile,
but he or she cannot
build it at a cost that competes with organiza�ons
providing their employees
with sophis�cated tools and technology. The person
working alone, or even

with many others like him or her, cannot build enough
cars to sa�sfy demand
without significant automa�on and an organiza�on to
leverage their �me and
talent. More sophis�cated tools allow a workforce to
produce more with the
same commitment of �me and effort. This produc�vity
improvement lowers
the unit cost of the product and raises the capacity of the
workforce. Similarly,
a surgeon performing a surgery without the proper
equipment and an effec�ve
suppor�ng staff will not only be less produc�ve but
could also be dangerous to
the pa�ent.
This presents an interes�ng trade-off between efficiency
and costs in the
process selec�on decision. As more sophis�cated tools are
applied to the
produc�on process, produc�vity and capacity increase and
labor cost per unit
declines. As tools become more sophis�cated, the cost of
acquiring them o�en
increases, which translates into increased fixed costs.
Process Selection Relates to Product Design and Capacity
Product design, capacity, and process selec�on are
decisions that should be considered simultaneously. The
way the product is designed affects how many people
will buy it, and that affects the producer's capacity
planning decision. This, in turn, affects the process and
the costs to produce the product, which affects how
many people can afford to buy it. This logic can be
represented as a circle with customers at the center, as

illustrated in Figure 7.1.
Figure 7.1: Product design, process selec�on, and capacity
decisions are closely related
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Rela�ng Process Selec�on to Product Design
Decisions made when designing a product have an impact
on the process for making it. For example, if a bed is
made of brass, there is no need for woodworking
equipment in the manufacturing process. Process selec�on
and process technology, in turn, influence the product
design. Electronic funds transfers, music
downloads, and streaming video are examples of products
that are now feasible because of improvements in
informa�on and communica�on technology.
Rela�ng the design of the product to process selec�on
goes beyond the examples listed in the preceding
paragraph. The teamwork concept is changing how
organiza�ons approach product design and process
selec�on. In service organiza�ons, such as fire
departments, teams of managers from various disciplines
design
the services, which may include fire preven�on programs
for homes and businesses, fire safety for school-age

children, and firefigh�ng. While developing a product
design, the team examines various process selec�on
decisions, including the types of equipment and facili�es
needed, the techniques used in figh�ng fires, the
methods used to develop educa�on programs, and the type
and level of training needed by employees who deliver
these services.
Manufacturing firms combine design engineers with process
engineers (some�mes called manufacturing engineers) to
create a design team. This team, like the
team at the fire department, is responsible for providing
what is best for the customer. Because the design
engineers and the process engineers work together, the
lead �me required to bring a new product from an idea
to a reality is reduced. This effort, called concurrent
engineering, enables the organiza�on to par�cipate in
�me-based compe��on. By doing what is best for the
customer, the organiza�on hopes to be rewarded with
increased demand for its products and high profit
margins. These teams also improve communica�on, which
decreases the number of engineering change orders, avoids
unnecessary delays, and gets the product to
market more quickly, preven�ng mistakes that could
increase costs.
Process Selec�on and Capacity
Process selec�on is also related to the volume demanded
in the marketplace. If the market for the product is
es�mated at only 1,000 units per year, it may be
difficult to jus�fy expensive, specialized equipment that
produces 100 units per hour. Such equipment would be
required to operate only 10 hours each year. It is
unlikely that the cost of this specialized equipment could
be supported by the 1,000 units demanded unless a very

high price is charged for each unit.
Problem
Quick-as-a-Blink Prin�ng Center is growing rapidly, and
many of its customers are demanding that their documents
be professionally bound. Management has
made a decision to purchase a binding machine. The
op�ons are to purchase a manual binding machine that
requires con�nuous operator a�en�on or an
automa�c machine that requires only periodic operator
a�en�on. The following data are available for analysis.
Note that the costs of materials can be ignored
because we are assuming that the cost of the printed
documents and the binding material are the same
regardless of the machine used.
Machine Annual Fixed Costs Variable Labor Costs
Produc�on Rate
Manual $1,000 $18/hour 10 units/hour
Automa�c $9,000 $2/hour 100 units/hour
The total-cost equa�on is as follows:
TC =FC + (VC)(Xp)
where
TC = total cost
FC = fixed costs

Xp = number of units produced
Comparing Costs: What is the cost to produce 1,000 units
per year on each machine? From the following
calcula�ons, it is clear that the manual machine has
lower costs. Dividing the total cost by the volume
produced gives a unit cost that includes the variable cost
and a share of the fixed costs.
Manual:
TC =
= $2,800
Unit Cost =
= $2.80 per unit at a volume of 1,000
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Automa�c:
TC =
= $9,020
Unit Cost =
What happens if 10,000 books need to be bound? The

marginal labor cost of binding each addi�onal book on
the automa�c machine is only $.02 because the
labor cost is $2.00 per hour and the output is 100 units
per hour. On the manual machine, the marginal cost of
binding a book is $1.80.
Manual:
TC =
= $19,000
Unit Cost =
Automa�c:
TC =
= $9,200
Unit Cost =
The unit cost for binding 10,000 books with the automa�c
opera�on is significantly lower. As demand increases, the
automa�c process becomes more and
more appealing.
The Indifference Point: At what produc�on volume are the
costs of the manual and automa�c machines equal? The
variable X represents the volume
produced. To check the accuracy of the following
calcula�ons, subs�tute the computed value of X into the
total-cost equa�on for each machine to determine
if the two total costs are equal. Except for differences
caused by rounding, they should be:

Total cost manual = Total cost automa�c
(1,000) + (1.80)(X) = (9,000) + (0.02)(X)
Solve for X:
(1.80 - 0.02)(X) = 9,000 - 1,000
X
X = 4,494 units
The Power of Volume to Reduce Costs: This problem
illustrates how unit costs can be decreased by purchasing
high-speed equipment and producing large
numbers of parts. The following table lists the unit costs
for various volumes. Verify the unit cost for binding
100,000 books.
Volume Manual Automa�c
1,000 $2.80 $9.02
10,000 1.90 0.92
100,000 1.81 0.11
This example makes many simplifying assump�ons, such
as unlimited capacity, no increase in maintenance costs,
and no increase in the failure rate of the
machine as volume increases. These and other relevant
factors could be es�mated and considered in the analysis.
The impact of volume on unit cost is very
clear based on this example.
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The economies of scale principle states that there is a
most
efficient size for a facility and a most efficient size for
the firm.
©Stockbyte/Thinkstock
Shipping Goods by Container Ships: Economy of
Scale; Addicted to Cheap Shopping? Why the Real
Cost of Goods Keeps Going Down
7.4 Understanding Effects of Scale
Business leaders have long recognized the advantages that
can be gained by having high-volume
opera�ons. The tremendous increase in prosperity in the
United States and other developed
countries was driven by making large quan��es of the
same or similar products on the same
equipment, that is, the same fixed-cost base. This
approach, o�en called mass produc�on, is based
on the concept of economies of scale. Recall from Chapter
3 that the economies of scale principle
states that there is a most efficient size for a facility,
and a most efficient size for a firm. In prac�ce,
the principle has been used to jus�fy both building larger

facili�es for the produc�on of goods and
services and purchasing more automated equipment to
speed produc�on and lower costs.
An organiza�on can use both or either of these
approaches to leverage the �me and talents of the
people who create the large volume of services and goods
that customers demand. If organiza�ons
and society are to progress, investments in equipment and
facili�es (fixed costs) must be made to
increase the produc�vity of labor and management.
The cri�cal challenge when
achieving economies of scale is
pu�ng a large volume of
product across the same
equipment or fixed-cost base. In
the past, it was necessary that
different products produced on
a machine where very similar because equipment was not
flexible enough to cope with design
differences. With technological advances, it is possible to
achieve economies of scale by
making different products on the same equipment, and this
can be done without the extra
costs that are incurred when equipment is stopped and
changed over to make the new
product. Economies of scope is the term that describes this
situa�on. Economies of scope are
economies of scale across products. For example, Allen-
Bradley has a facility that can produce
a wide variety (100 different designs) of computer
motherboards in produc�on lot sizes as
small as one unit. The facility can produce them at a rate
and cost that rivals mass produc�on.

Cost-Volume-Profit Modeling
To understand scale, it is helpful to construct a simple
model. A model is an abstrac�on of the
key variables and rela�onships in a real problem, and is
used to simplify the problem and
increase understanding. The cost-volume-profit (C-V-P)
model uses es�mates of costs,
revenues, volume sold, and volume produced in order to
es�mate profit.
C-V-P Model Formula�on
The C-V-P model is formulated by determining total
revenue and costs, as shown in the following equa�ons:
TR = (SP)(Xs)
where
TR = total revenue
SP = selling price per unit
Xs = number of units sold
TC = FC + (VC)(Xp)
where
TC = total cost
Shipping Goods by
Container Ships:
Economy of Scale

From Title:
Addicted to Cheap Shopping? Why the Real Cost ...
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wID=100753&xtid=39028)
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FC = fixed cost
Xp = number of units produced
The profit (P) equa�on is total revenue minus total cost:
P = TR – TC
By subs�tu�ng the TR and TC equa�ons into the equa�on
for profit, the following mathema�cal model can be used
to calculate profits, given sales and produc�on
volumes. This is the cost-volume-profit model.

P = SP(Xs) – [FC + VC(Xp)]
This model can also be manipulated to determine the
volume required to earn targeted value for profit. In order
to do this, assume that the number of units sold
is equal to the number of units produced.
If X = Xs = Xp, then
P = SP(X) – [FC + VC(X)]
P = SP(X) – FC – VC(X)
P + FC = (S – VC) (X)
Solve for X as follows:
If C is defined as contribu�on per unit, then C = (SP –
VC). Thus, the equa�on becomes
The profit point is the number of units (X) that must be
produced and sold at the contribu�on per unit (C) in
order to cover the fixed costs (FC) and profit (P).
Figure 7.2 represents this model graphically and illustrates
the profit point. If the profit is set to zero, equa�on 7.1
is recognizable as the break-even formula. The
break-even point (BEP) is the volume that must be
produced and sold so that profit is zero.
Figure 7.2: Cost-volume-profit model
Problem
The mechanics of applying the C-V-P model are rela�vely
simple. To calculate the profit point, you must know the
selling price, variable costs, and fixed costs.

Management can determine the projected level of profit to
be used in the model. In this example, the fixed cost and
profit are for a one-month period.
SP = $8.00/unit
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FC = $25,000/month
P = $8,000/month
In this case, the number of units that must be produced
and sold to make $8,000 profit in one month is 9,429
units; that is the profit point.
X
= 9,429 units/month
Managers can use this number in many ways. Here are
two examples. First, if the organiza�on has a capacity of
only 5,600 units per month, then achieving an
$8,000 profit is not possible. Second, if the sales forecast
is for 9,000 units, then that profit level will not be
achieved because not enough units will be sold.

Changes can be made to the model for the purpose of
sensi�vity analysis and to answer what-if ques�ons. For
example, what if the variable costs increased
from $4.50 to $5.00 per unit? Under these circumstances,
the profit point becomes 11,000 units per month.
C-V-P Assump�ons
The C-V-P model, like any model, makes several
assump�ons. The assump�on that sales volume equals
produc�on volume has already been men�oned. The model
also assumes that total cost and total revenue are linear
func�ons of volume. The model is based on historical
data for costs and revenue. Any changes in these
rela�onships caused by changes in technology, demand, or
strategy may invalidate the use of this or any other
model. Users of models should understand these
assump�ons, or they may apply the model ineffec�vely
and thus obtain misleading results.
The Mul�ple-Product Case of the C-V-P Mode
The discussion of the C-V-P model has considered only
single-product firms. Many organiza�ons produce more
than one product, using the same set of fixed costs.
How can this firm be modeled? In this case, another set
of variables, product mix, is added to the revenue and
cost rela�onships. To solve the problem, a weighted
contribu�on based on the mix of each product is
calculated. Consider the following problem.
Problem
A company repairs small appliances. The table that
follows provides the average selling price, variable cost,
and contribu�on for each service. The product mix

and profit target are also listed. The fixed costs are
shared by all three products.
Coffeepot Mixer Blender
Product mix 45% 20% 35%
Selling price/unit $12 $16 $9
Variable cost/unit $6 $7 $4
Contribu�on/unit $6 $9 $5
Profit target = $20,000/yr.
Fixed costs = $30,000/yr.
The mix is the number of each product repaired divided
by the total number repaired. The weighted contribu�on is
calculated as:
where
WC = weighted contribu�on per unit
Mi = product mix as a percentage of total sales for
product i, where i = 1,. . ., n for n different products or
product lines
SPi = selling price for product i
VCi = variable cost for product i
Thus, the weighted contribu�on for the product mix
shown above is:

WC = 0.45($12/unit – $6/unit) + 0.2($16/unit – $7/unit) +
0.35($9/unit – $4/unit)
= $6.25/unit
In the mul�ple-product case, the weighted contribu�on per
unit subs�tutes for the contribu�on per unit in equa�on
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X =
=
= 8,000 units
Interpre�ng the Results: The variable X is measured as a
composite unit—a unit consis�ng of 45% coffeepot, 20%
mixer, and 35% blender.
One composite unit with a weighted contribu�on = $6.25
45% Coffeepot
20% Mixer
35% Blender
Product Mix No. Required
Coffeepot 0.45 3,600 units

Mixer 0.20 1,600
Blender 0.35 2,800
8,000 units
The number of units, 8,000, represents the total number of
coffeepots, mixers, and blenders that must be repaired to
make a $20,000 profit. The number of
coffeepots required is (0.45)(8,000 units), or 3,600 units.
What Happens to the Profit Point if the Mix Changes?: In
this model, the mix affects the profit point. If the
es�mated mix is different from the actual mix,
then the profit point will change. Assume the mix changes
to 50% coffeepots, 10% mixers, and 40% blenders, and
the total number of units repaired remains
8,000. How is profit affected?
Coffeepot Mixer Blender
Product Mix 50% 10% 40%
Selling price/unit $12 $16 $9
Variable cost/unit $6 $7 $4
Contribu�on/unit $6 $9 $5
Profit target (P) = unknown.
Fixed costs = $30,000/yr.
Equa�on 7.2 can be restated and used to calculate profit.

X
WC(X) = P + FC
P = WC(X) – FC
The fixed costs are $30,000, and the volume is given as
8,000 units. First, the weighted contribu�on is calculated
based on the new mix.
WC =
= 0.5($12/unit – $6/unit) + 0.1($16/unit – $7/unit) +
0.4($9/unit – $4/unit)
= $5.90/unit
Now profit can be calculated.
P = $5.90(8,000 units) – $30,000 = $17,200
The profit is only $17,200 dollars because demand shi�ed
away from mixers, which have a higher contribu�on per
unit, to the lower-contribu�on coffeepots
and blenders. Profit is not only a func�on of the volume
produced and sold, but also a func�on of the product
mix.
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An assembly line allows a company to make a fast-food
pizza quickly and with low labor
costs.
Newscast/ASSOCIATED PRESS/AP Images
7.5 Process Selection and Economies of Scale and Scope
From the perspec�ve of economies of scale or economies
of scope, process selec�on focuses on the volume of
product demanded in the market. Organiza�ons can
influence that volume by increasing adver�sing, providing
be�er service, and producing higher quality products.
Regardless of how that volume is generated, an
organiza�on needs to respond to higher demand with an
appropriate process.
When does an organiza�on have sufficient volume to
jus�fy specialized, high-speed equipment? Is a demand of
50,000 units per year sufficient? It is not possible to
give specific answers to these ques�ons because the
answers depend on what the organiza�on produces. For
example, if it produces space shu�les, then an annual
demand of 50,000 would certainly be large enough to
support specialized facili�es, and even 5,000 would be
considered a large volume. If, however, the
organiza�on is processing checks for a bank, 50,000 a
year is a very small number, and even 1 million per year
is not large.
In process selec�on, Hayes and Wheelwright (1979, p.133)
have suggested that product and process can be viewed
through two sides of a matrix. Figure 7.3
displays a series of process alterna�ves that can be
matched with iden�fiable product characteris�cs so that

efficient opera�ons can be achieved. High-volume
opera�ons are usually referred to as line flow processes.
One type of line flow is the con�nuous flow process. A
con�nuous flow does not usually iden�fy
individual units; rather, the product is mixed and flows
together in a con�nuous stream. Oil refining is a good
example of a con�nuous flow process. Processing
checks in a bank is another example. The term assembly
line is used to describe the high-volume assembly of
discrete products. A washing machine is a good
example of an assembly-line product and making a fast-
food pizza on a busy night is another. Con�nuous flow
and assembly lines are usually dedicated facili�es
that produce large volumes with li�le, if any, difference
in the products. Because the items produced within such a
facility are the same or very similar, the process
involves economies of scale. To increase volume, cut
costs, and achieve economies of scale, organiza�ons
tradi�onally move up the shaded diagonal in Figure 7.3
(see next page).
Batch is a term used to describe a produc�on process
that does not have
sufficient volume from a single product to fully use a
facility. In this case, the
facility produces several products to build sufficient
volume. When this
resource sharing exists, a transi�on �me, or changeover
�me, is usually
required to change the facility from being able to make
one product to being
able to make the next. For example, Merck, which
produces medica�ons, uses
batch produc�on. Merck has equipment that is designed to
mix ingredients and
form pills or capsules. O�en this equipment can produce

in a few weeks all the
capsules of a par�cular medica�on needed for an en�re
year. Because of shelf
life considera�ons and inventory costs, making even a
one-year supply in a
single batch creates too much inventory. So, companies
like Merck produce
different medicines in smaller batches using the same
equipment. In between
batches, the equipment must be thoroughly cleaned so the
next batch is not
contaminated. These changes take �me and cost money,
but are necessary to
maintain enough volume to support the large investment in
equipment.
As product volume declines, batching opera�ons may no
longer be possible.
Here, only a few units of a product are required, and
there may be no
assurance that the order will be repeated. The differences
between products
can be significant. In this situa�on, usually called job
shop produc�on, the
facility is general and flexible enough to meet a variety
of needs. To achieve
this flexibility, job shops generally have a much higher
unit cost than line flow or batch processes for the same
product. Fancy restaurants and hospital emergency
rooms are examples of job shops. Both types of
organiza�ons offer great product variety and cater to
individual customer demands.
At the bo�om of the volume scale in Figure 7.3 are
projects, which are usually one-of-a-kind opera�ons. Each
job is different from the rest. Most large construc�on

jobs are projects, and many service opera�ons can be
categorized as projects. Installing new computer hardware,
adding new computer so�ware, and
implemen�ng a new management planning and control
system could all qualify as projects. The rela�onship
between product and process, illustrated in Figure 7.3,
indicates that there is a one-to-one rela�onship between
product volume and the type of process. For example,
Figure 7.3 indicates that one-of-a-kind products
cannot be produced on an assembly line or in a
con�nuous flow shop. Figure 7.3, therefore, implies that
an organiza�on's op�ons are limited to product and
process matches on the diagonal. The diagram implies that
if an organiza�on wants to achieve the low cost obtained
in con�nuous flow or assembly-line
opera�ons, it must significantly limit product variety. An
organiza�on that wants to achieve the product variety
obtained in a job shop or projects must incur high
unit costs.
Figure 7.3: Matching process alterna�ves with product
characteris�cs
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However, with the advances in informa�on and
manufacturing technologies, organiza�ons have new process
alterna�ves that are flexible, allowing changes from

one product to another to be made quickly and with few
costs. With these technologies, the products produced
within a facility can be different, yet low in costs.
This is economies of scope, and it implies moving off the
shaded diagonal in Figure 7.3 toward the lower le�
corner of the diagram. This segment of the diagram
implies both low cost and high variety, which is called
mass customiza�on and is discussed in a later sec�on.
The following sec�ons describe the tradi�onal process
alterna�ves: con�nuous flow, assembly line, batch, job
shop, and project, as well as manufacturing cells and
flexible manufacturing systems.
Line Flow Processes
Con�nuous flow opera�ons and assembly lines have some
differences; yet both are high-volume, mass-produc�on
opera�ons characterized by a standardized
product with interchangeable parts. Because of this, the
process is the same for each unit, and the product has a
dominant product flow through the facility. With
li�le or no product varia�on, there is no reason to have
more than one path through the facility. Furthermore, the
equipment that processes the products should
be arranged "around" the product so that material-handling
and transporta�on costs are not excessive. This approach
is called a product layout.
In terms of the cost structure, a con�nuous flow process
or an assembly line has rela�vely high fixed costs and
rela�vely low variable costs. The high fixed costs
are, in part, a result of the substan�al investment in
specialized equipment.
There are some differences between a con�nuous flow

process and an assembly line. In a con�nuous flow
process, the product is o�en a commodity in which one
unit is not dis�nguishable from another. In this case, the
producer makes no a�empt to track each unit separately.
For example, in refining gasoline from crude oil,
one gallon of unleaded regular gasoline is like another.
Banks process checks one a�er another without changing
methods. The produc�on of fiberglass insula�on is
high-volume and fast-paced. It is not feasible to track and
iden�fy each piece produced. The emphasis is on
measuring inputs and comparing them to outputs.
The tradi�onal assembly-line process allows some
varia�ons among units. Op�ons are usually selected from
a list of possibili�es, and the minor adjustments
needed to cope with this varia�on can be made by
workers on the produc�on line. Adding green peppers to
the standard pizza is easy to do. Adding custom floor
mats to a car or a temperature probe to a microwave
oven is also easy to do. As technology improves,
assembly lines are becoming more flexible. The con�nuous
flow and assembly-line characteris�cs are summarized in
Table 7.3, along with the other process types.
Table 7.3: Characteris�cs of the process alterna�ves
Characteris�cs
Process Volume Product variety Product
flow
Facility
layout
Fixed costs Variable costs Equipment

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A woodcarving business that makes carvings to order is
one example of a job shop because
it handles a large number of different products produced
in small volumes, rather than
producing large quan��es of the same product.
iStockphoto/Thinkstock
Con�nuous flow High Standard Dominant Product High Low
Special
purpose
Assembly line High Standard with minor
modifica�on
Dominant Product High Low Special
purpose
Batch High Some varia�on Dominant Product High Low Some
flexibility
Flexible manufacturing
system
High Moderate variety Dominant Product High Low Flexible

Manufacturing cell High Moderate variety Dominant Product
Moderate Low to
moderate
Flexible
Job shop Low Major differences Random Process Low High
Flexible
Project One One-of-a-kind Not
applicable
Fixed
posi�on
Low to
moderate
High Flexible
Batch Flow
When quan��es are not sufficient to support dedicated
produc�on facili�es, several groups or batches are
produced using the same facility. These products are
usually similar in design and have similar processing
requirements. For example, glass containers come in a
variety of sizes but are designed and built similarly. A
key to understanding whether or not differences among
products are meaningful can be found when the equipment
is shut down to change from one product to
another. If the �me for these changes is not significant
and the sequence of opera�ons is similar, then it is like
a line flow process. However, if the changeover �me
is significant, then these products are usually built in
batches.

Because of the similar processing requirements in batch
opera�ons, one or a few product flows dominate. For
example, appliance manufacturers may produce
several different models of refrigerators on the same
assembly line. In cases where changeover �me is
significant, manufacturers may produce a batch—for
example, one week's produc�on of a par�cular model—
and then switch to another model. Although the models
show some differences from batch to batch, these
differences are not significant enough to change the
product-oriented layout of the facility. If a producer is
able to design the product and the process so that
different models can be produced one a�er the other with
zero or near zero changeover �me, then the process is
similar to an assembly line that is producing a
standard product. The disadvantages of batch produc�on
are that (1) changeover �me is nonproduc�ve, and (2)
extra inventory must be maintained to sa�sfy
demand for the products that are not being produced.
Job Shops
With limited product volume, batching opera�ons may not
be possible.
Here, only a few units of a product are required, and
there may be no
assurance that the order will be repeated. The differences
between
products can be significant. In this situa�on, usually
called job shop
produc�on, the facility is general and flexible enough to
meet a variety of
needs. To achieve this flexibility, job shops generally have
a much higher
unit cost than line flow or batch processes for the same

product. Fancy
restaurants and hospital emergency rooms are examples of
job shops.
Both types of organiza�ons offer great product variety,
and cater to
individual customer demands.
A job shop does not produce large quan��es of the same
or even similar
products, but is dominated by a large number of different
products
produced in small volumes. Because the products are
different, they do
not follow the same path through the facility. In fact, the
movement of
products between work centers is best characterized as
random. As a
result, it is not possible to organize machines by product
flow as in the
line flow processes or in batch opera�ons. It is necessary
to group
machines by process or type of opera�on because a job is
as likely to
require work at one work center as at any of the other
centers. When
similar equipment is grouped together it is called a process
layout. The
job shop is one of the process alterna�ves shown in Table
7.3.
Because the products are very different, specialized
equipment cannot be jus�fied. Job shops use flexible
equipment to meet the needs of the diverse product
group. A job shop produces different products on general-
purpose machines using skilled labor. The cost structure

has low fixed costs and high unit-variable costs.
Projects
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Direct Sales in Computers; Your Computer, Your
Way: Dell and the Direct Sales Model
In a project, cost structure is not the same as in other
processes because there is only a single unit. In one
sense, the cost for the project is all variable. Fixed costs
in the form of overhead begin to make sense when a firm
is engaged in more than one project and can spread
certain major equipment costs and overhead costs
across several different projects.
Product flow is not meaningful in projects because the
end product of most construc�on projects is designed to
remain sta�onary. The usual term that describes
the layout is fixed posi�on. A project-oriented opera�on
is very flexible, allowing extensive customizing of the
finished products. Projects are common in service
opera�ons, for example, Seibel Systems develops and
installs so�ware systems that control banking opera�ons.
These so�ware systems can monitor each
transac�on, keep a history on it, and assist in reconciling
the transac�on to the account. To design these systems,
so�ware companies draw the needed talent from

a pool of experts and form a project team. Because each
system is different, different groups may be used to
develop each system. These companies provide a
service and use project management to successfully
complete the work.
Manufacturing Cells and Flexible Manufacturing Systems
Manufacturing cells and flexible manufacturing systems
(FMS) are process op�ons that offer the poten�al to
produce low-cost products that meet varying customer
requirements. Manufacturing cells rely on group technology
to build a family of parts with similar design and
processing characteris�cs. Group technology is a set
of methods that enables firms to classify parts based on
size, shape, use, type of material, and method of
produc�on. A family of parts is a collec�on of parts with
similari�es in these characteris�cs. In this way, a
product-oriented layout (cell) can be designed that will
reduce material-handling costs, increase machine
u�liza�on, and shorten produc�on lead �mes. Because
the processing is similar, less �me is required to change
from one product within the family to another (see
Table 7.3).
An FMS is similar to a manufacturing cell because it
relies on group technology to build families of parts.
Also, like a manufacturing cell, an FMS produces low-cost
products with high variety. The major differences are that
an FMS o�en has more automa�on, robots, and computer
control than a manufacturing cell does, and it
usually operates without people tending the machines.
Flexible manufacturing systems grew from the need to
cope with demand for increasing product varia�ons. With
an FMS, an organiza�on can capture new markets

by accumula�ng produc�on requirements from several low-
volume products. Higher-volume opera�ons allow the
arrangement of a set of machines in one layout to
produce all the different products. The products, however,
must be similar enough to have the same or a similar
sequence of opera�ons, and the machines must
be flexible enough to handle the differences. This system
is feasible with computer technology and robo�cs that can
quickly be adapted to new products. A
manufacturing cell and an FMS enable organiza�ons to
increase the volume of product moving across a group of
machines and, thereby, reduce opera�ng costs.
Mass Customization
Mass customiza�on offers an alterna�ve to addressing
product variety. Firms that seek mass
customiza�on are able to design, produce, and quickly
deliver products that meet specific
customer needs at close to mass-produc�on prices. These
firms develop close rela�onships
with their customers, which depend on frequent
informa�on exchange.
From an opera�ons perspec�ve, mass customiza�on is the
low-cost, high-quality, large-volume
delivery of individually customized goods and services. Put
simply, mass customiza�on
combines the pursuit of economies of scale and scope,
quality improvement, and flexibility.
Economies of scale and scope imply achieving high-volume
opera�ons and low costs. When
pursuing flexibility, there are three a�ributes to consider:
1. Range/variety—The number of viable states for the
produc�on system and the degree of

difference in those states. From the perspec�ve of range, the
greatest variety is when a large
number of very different products can be produced
2. Mobility/responsiveness—The ability to change quickly from
producing one product to
producing another. High mobility minimizes the need for long
produc�on runs. How long
does it take for the service center to shi� from doing brake
work on a Ford to doing exhaust
work on a Chrysler?
3. Uniformity—The ability to a�ain similar performance across
the en�re range of outputs. Will
the quality on the brake job for the Ford be at the same high
level as the quality of the
exhaust system for the Chrysler?
Flexibility is the greatest when all three elements of
flexibility are at the highest level. That is,
the firm can produce a large number of products that are
very different, can change between them quickly, and can
maintain a high level of performance.
Flexibility is an important factor for the service industry.
Following are some examples of the product variety that
services face.
1. Hospitals and medical clinics a�empt to treat pa�ents with a
wide variety of needs.
2. With the deregula�on of financial markets, the differences
between banks and brokerage houses have blurred. Banks are
doing much more than taking deposits
and making loans.
3. Universi�es are a�emp�ng to cope with an expanding

number of majors, specialized degree programs, and
individualized study programs. When this expansion
occurs, universi�es must have faculty who have the capabili�es
to teach and conduct research across disciplines, else the
capabili�es of the faculty may not match
Direct Sales
in Computers
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Your Computer, Your Way: Dell and the Direct S...
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the changing needs of the organiza�ons that hire the graduates.
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Chapter Summary
Facility loca�on should not be based en�rely on produc�on
factors and transporta�on. Loca�on is a long-term strategic
decision that can have a major impact on
the organiza�on's ability to compete.
Loca�ng a facility can have strategic implica�ons. Some
organiza�ons employ a regional facility approach where one
facility is responsible for producing all the
products for that area of the country. Others employ the product
facility strategy where one plant produces one product or
product line and ships it throughout
the country.
Both quan�ta�ve and qualita�ve factors influence the loca�on
decision. These factors should be integrated if the decision-
making process is to work effec�vely.
Loca�on influences costs, selling price, demand, and access to
financial services.
Process defines the way that the products should be produced.
Process selec�on is closely related to the product design and
capacity decisions.
A cost-volume-profit model is one way of reviewing processing
op�ons. This model allows the organiza�on to examine the
risks associated with selec�ng a
processing op�on. Mass-produc�on alterna�ves involve
greater risk, but have the poten�al for greater return.
Process selec�on is a func�on of volume demanded. The

different process types include line flow, which includes
con�nuous flow and assembly line, batch, job
shop, and project as well as manufacturing cells and flexible
manufacturing systems. Each of these process types is
summarized in Table 7.3.
Mass customiza�on allows firms to achieve greater product
variety while keeping costs low and produc�on volumes high.
Case Studies
Tilley Video Disc, Inc.
William ("Call Me Billy") Tilley, founder, president, and
chairman of the board of Tilley Video Disc, Inc., has a
very pleasant problem. The market for digital video
discs (DVD) is expanding rapidly, and he has accepted an
a�rac�ve offer for his controlling interest in Tilley Video
Disc, Inc., while retaining his current management
responsibili�es. The deal is con�ngent on Billy's
development of a plan to expand produc�on from 10,000
to 50,000 units, and to lower produc�on costs. Evers,
Inc., the company that has made the offer, feels the
growth in sales will be drama�c if costs can be
significantly reduced.
Presently, produc�on of the video discs takes place in
one plant in Rimer, Oregon. The plant was formerly a
slaughterhouse and meatpacking facility. Billy has
quickly come to the conclusion that produc�on could be
maintained at this facility, but that significant on-site
expansion is not sound. The equipment in the facility
was purchased from a bankrupt company and has been
used for several years. It can best be characterized as
slow, general-purpose equipment. The following data
has been compiled from the exis�ng plant for the last 12
months:

Selling Price $6.50/unit
Variable costs $3.25/unit
Total Produc�on 9,824/year
Rejects 644/year
Sales 9,180/year
Es�mated capacity 10,000/year
Annual fixed costs $20,000
Evers' vice president of marke�ng thinks that the selling
price should be reduced to about $5.00 in order to
achieve the needed sales growth and to grab market
share in the highly compe��ve consumer market. As a
consultant to Billy Tilley, you are charged with
developing a plan that will allow the company to increase
capacity by 400% and reduce variable costs by 20%. You
should use the cost-volume-profit model in building your
plan. Use an annual profit of $80,000 as a target
profit. Provide a wri�en report that addresses the
following ques�ons:
1. Is it a good idea to keep the exis�ng facility?
2. What benefits may be derived from the new technology?
3. Should one facility be built, or should the plan have several
small facili�es similar to the present facility?
4. Why and how will the cost structure of the new facility differ
from that of the exis�ng one? Be specific. Use the C-V-P model
to help describe the differences.
Dailey Computer Service
Kathy Dailey, president of Dailey Computer Service, has
called you into her office to help plan the company's
future. Profits have been declining even though sales
have increased. During this �me, selling price and costs
have not changed. The company sells three services: a

payroll package; data entry services; and computer
forms. The following table shows the revenue and costs of
these services:
Payroll
Package
Data entry
(per 1,000)
Computer forms
(per 100)
Selling price $3,500 $25 $35
Variable cost $800 $16 $30
Fixed costs average $40,000 per month.
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Two Months Ago Last Month
Units Sales Units Sales
Payroll (packages) 7 $24,500 5 $17,500
Data entry (1,000) 2,500 62,500 2,200 55,000
Forms (100) 1,400 49,000 2,000 70,000
Total sales $136,000 $142,500

1. How did the firm manage to increase sales, hold the line on
price and costs, and make less money? Be specific; Dailey
wants numbers to back up your answer.
2. If Dailey Computer Service maintains the same sales mix as
last month, how can it achieve a profit of $10,000 next month?
Be specific.
3. From what you have discovered in this analysis, answer the
following ques�ons:
a. How should Dailey Computer Service approach marke�ng?
b. Should price changes be considered?
Discussion Ques�ons
Click on each ques�on to reveal the answer.
1. Why is facility loca�on important to an organiza�on?
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Facility loca�on is the placement of a facility with
respect to customers, suppliers, and other facili�es with
which it interacts. The facility loca�on decision is
cri�cal to an organiza�on's success because (1) the result
of the decision is to commit a significant amount of an
organiza�on's resources, (2) the costs of
reloca�on are high, (3) the loca�on can greatly influence
produc�on and transporta�on costs, (4) the loca�on
affects an organiza�on's ability to serve its
customers, and (5) the loca�on can be a key ingredient
in an organiza�on's strategy. The facility loca�on decision
is a long term, strategic decision, which can
have a major impact on the organiza�on's ability to
compete.

2. What factors are affected by the choice of loca�ons? Which
of these factors can be measured in dollars, and which cannot?
Facility loca�on decisions depend on marke�ng issues,
produc�on factors and environmental decisions. Many
organiza�ons require easy access to customers.
Some choose to locate near universi�es to take advantage
of research facili�es. Some need easy access to raw
materials. Some locate to take advantage of low
labor rates, material and/or transporta�on costs. The
quality of schools, cultural advantages and banking
services, along with others, can also play an
important role in the loca�on decision.
Many of these factors can be measured in dollars while
others cannot. Quan�ta�ve factors include costs associated
with building the facility, producing the
product, overhead, and transporta�on to and from the
facility. State and local governments offer incen�ves to
a�ract and retain businesses and jobs, and
these are quan�ta�ve, as well. Qualita�ve factors include
recrea�onal and cultural ac�vi�es, availability of labor,
educa�onal and research facili�es, and many
others listed in the appendix to this chapter.
3. How can qualita�ve and quan�ta�ve factors be integrated to
make a sound and logical loca�on decision?
Qualita�ve factors, whose direct impact on profits is not

measurable, need to be carefully considered and integrated
with quan�ta�ve factors. To integrate
these factors, managers should decide which qualita�ve
factors are relevant to the decision, weight each relevant
factor, and evaluate each site so that ra�onal
comparisons can be made. These scores can be summed
for each site and compared with the results from the
analysis of the quan�ta�ve factors. If one site is
the best in both qualita�ve and quan�ta�ve factors, then
it would seem to be the correct choice. If not, then
trade-offs need to be made among the sites.
4. What hidden factors are influenced by on-site loca�on, and
how are they influenced?
On-site expansion can create many problems, especially if
it is a repeated prac�ce. As more produc�on space is
added, material handling and storage become
more difficult because storage space is converted to
produc�on. As new product varia�ons are added, the once
simple product flow becomes complicated by
twists, turns, and back-tracking. On-site expansion can
strain intra-plant transporta�on and communica�on.
Staying at the same site o�en postpones the introduc�on
of new products and process technologies. Old equipment
and old produc�on methods are used
longer than they should be. Future product innova�on,
produc�vity increases, quality improvements, and cost
reduc�ons can be nega�vely affected. On-site
expansion can mean a growing number of workers,
products, and processes that need to be managed. Such
layering of expanded responsibili�es creates real

complexi�es for management at all levels.
5. Why are spa�al rela�onships important in the loca�on
decision?
In addi�on to factors like local labor costs and u�lity
costs, the loca�on decision should consider spa�al
rela�onships. Spa�al rela�onships are important
because convenient access by customers and/or the ability
to transport large quan��es of material easily and quickly
may be very important. In loca�ng a
health care facility, the distance which customers travel
should be considered because it is important to the
customer. When outbound transporta�on costs are
high, manufacturing and warehousing tend to locate close
to customers. A good example of this is aluminum can
producers. The cost to ship a can is very high
because the organiza�on is shipping a lot of air and very
li�le product. On the other hand, when inbound
transporta�on costs are high, facili�es tend to be
located close to suppliers.
6. What is process selec�on, and how can the organiza�on use
it to gain compe��ve advantage?
Process describes the way in which the product is made.
Process selec�on is a series of decisions that include
technical or engineering issues and volume or
scale issues. The technical issues include the basic
technology used to produce the good or service such as

con�nuous cas�ng to make slabs in the steel
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industry. It includes the sequence of steps, the equipment,
and the facili�es needed to perform the services or
produce the goods. Volume or scale decisions
involve using the proper amount of mechaniza�on to
leverage the organiza�on's workforce. Leverage means to
make the workforce more produc�ve through
the use of be�er tools. The purpose of leveraging is to
achieve the desired level of produc�on at an acceptable
level of cost. Process is strategically important
because it helps to define the product's costs and quality.
7. How is process selec�on related to product design and
capacity determina�on?
Product design, capacity, and process selec�on decisions
should be considered simultaneously rather than
independently. The market research that helps to
shape the product design also provides an es�mate of the
demand for the product at a price that customers are
willing to pay. The demand for that product
should be used to determine the capacity the organiza�on
will select. The amount of demand will help to determine
how the product will be produced. Large
volume products (and low product variety) tend to be
produced by line flow processes while low volume
products (and high product variety) are produced in
job shops.
The following example illustrates the rela�onships between
product and process design. If a fast food sandwich is
described as flame broiled, the process
should not include grills for frying. In turn, process
selec�on influences product design. A wrist watch

powered by light is an example where improvements in
technology ul�mately led to new product designs.
Process selec�on is constrained by the volume of the
product required. For example, if the market for a product
is es�mated at only 1,000 units per year, it
would be very difficult to jus�fy spending a great deal of
money on a machine that will produce 100 units per hour.
The machine will only need to operate ten
hours per year to meet demand.
8. Explain how the cost-volume-profit model of a firm is
derived. How is it useful to opera�ons managers in making the
process selec�on decision?
The cost-volume-profit (C-V-P) model uses es�mates of
costs, revenues, volume sold, and volume produced in
order to es�mate profit. The C-V-P model is
formulated by determining total revenue and costs. The
difference between revenue and costs is profit. The model
allows managers to calculate profit for any
sales or produc�on volume. It also can be used to
determine the volume required to be produced and sold to
achieve a given level of profit. It is useful for
opera�ons managers in making the process selec�on
decision because the cost structure (the amount of fixed
and variable costs) can be changed to represent
the different processes. Line flow processes have high
fixed and low unit variable costs while job shops have
low fixed and high unit variable costs. By trying
different alterna�ves, the impact of process selec�on on
profit can be determined.

9. What are line flow processes, and what characteris�cs help
to define them? Give examples.
High volume opera�ons are generally referred to as line
flow processes. Line flow processes are characterized by
standard products, a dominant product flow,
high fixed costs, low unit variable costs, and special
purpose equipment. One type of line flow is the
con�nuous flow process. A good example of a con�nuous
flow opera�on is an oil refinery. Another good example
is a paper mill. Assembly lines refer to opera�ons that
assemble a high volume of discrete products.
Automobiles are made on assembly lines.
10. What is batch flow, and what characteris�cs help to define
it? Provide examples.
Batch flow describes a produc�on process that does not
have sufficient volume from a single product to fully use
the facility. Several products are made on the
same equipment to provide sufficient volume. Changeover
�me is generally required to change the facility from one
product to the next. Thus, products are
made in batches. Batch opera�ons are characterized by
limited product variety, small differences between product
flows, high fixed costs but not as high as a
line flow process, moderate unit variable costs, and special
purpose machines which have some flexibility in order to
deal with product variety. The auto parts
manufacturer referred to in the text is a good example of

batch flow.
11. What is a job shop, and what characteris�cs help to define
it? Provide examples.
Job shops are characterized by the need to produce only a
few units of a given product with no guarantees that the
product will ever be made again.
Differences between products can be significant. A job
shop is characterized by product flows that vary
significantly, low fixed costs, and high unit variable
costs. The facility for such an opera�on must be general
and flexible. Hospital emergency rooms and five-star
restaurants are examples of job shops.
12. What is a project, and what characteris�cs help to define it?
Provide examples.
Projects are generally one-of-a-kind opera�ons in which
each job is different. Projects are characterized by low to
moderate fixed costs, high variable costs, and
tremendous flexibility. Construc�on work and installa�ons
of large computer hardware and so�ware systems are good
examples of projects.
13. How will flexibility help an organiza�on achieve a
compe��ve advantage?

In the future, flexibility in the produc�on process will
play an increasingly important role. Changing customer
demand and specialized design will give
producers that have flexibility a compe��ve edge because
they can provide a variety of products in a �mely fashion
and at low costs.
Problems
1. Darwal Developers specializes in analyzing facility loca�on
decisions. Presently, the company is looking at two loca�ons:
Orlando, Florida, and Olympia, Washington,
for which it has determined the following cost informa�on:
Orlando Olympia
Variable costs $14.70/unit $16.45/unit
Annual fixed costs $12,000,000 $11,000,000
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172020 Printhttpscontent.ashford.eduprintAUBUS644.1.docx

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172020 Printhttpscontent.ashford.eduprintAUBUS644.1.docx