Unit 2

Management of Conversion System

Chapter 6: Facility location
Lesson 18:- Location selection

Learning Objectives

After reading this lesson you would be able to understand

Location strategy and its importance
Globalization – its reasons
Global operations management
Dominant factors in location selection

This lecture describes in detail the factors leading to globalization and the
ensuing advantages and disadvantages. We would also focus on the various
factors that are dominant in location decisions.

So, we start with the first issue at hand and that is:-
Locations strategy and its importance

Dear students, as you all know, selection implies choice and choice
presumes the existence of various options available to a decision maker.
Choosing where to locate new manufacturing facilities, service outlets, or
branch offices is a strategic decision. The location of a business’s facilities
has a significant impact on the company’s operating costs, the prices it
charges for goods and services, and its ability to compete in the marketplace.
Analyzing location patterns to discover a firm’s underlying strategy is
fascinating. 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
because customers prefer to do their comparison-shopping in one area. In
each case, management’s location decision reflects a particular strategy.
There are strategic impacts of location decisions. We will first consider the
most important trend in location patterns- the globalization of operations.

Meaning of Globalization

The term globalization describes businesses’ deployment of facilities and

operations around the world. Worldwide exports now account for more than
30 percent of worldwide gross national product, up from 12 percent in 1962.
Globalization also results in more exports to and imports from other
countries, often called offshore sales and imports. Globalization of services
is also widespread. The value of world trade in services is roughly 20
percent of total world trade. Banking, law, information services, airlines,
education, consulting, and restaurant services are particularly active
globally. For example, McDonald’s opened 220 restaurants in foreign
countries other than USA in just one year. Steel Authority of India (SAIL)
hired Silver Spring, Maryland, consulting firm to design and implement
quality systems for its five major steel plants.

Friends, the question that emerges from the ongoing discussion

forces us to analyze as to what globalization is all about.

Many see it as a primarily economic phenomenon, involving the

increasing interaction, or integration, of national economic systems
through the growth in international trade, investment and capital
flows.

However, one can also point to a rapid increase in cross-border

social, cultural and technological exchange as part of the
phenomenon of globalisation.

The sociologist, Anthony Giddens, defines globalisation as a

decoupling of space and time, emphasising that with instantaneous
communications, knowledge and culture can be shared around the
world simultaneously.
Globalisation can also be defined as a process in which geographic
distance becomes a factor of diminishing importance in the
establishment and maintenance of cross border economic, political
and socio-cultural relations
Left critics of globalisation define the word quite differently, presenting
it as worldwide drive toward a globalised economic system dominated
by supranational corporate trade and banking institutions that are not
accountable to democratic processes or national governments.

Reasons for globalization

There are four developments, which have spurred the trend toward
globalization. These are
Improved transportation and communication technologies
Opened financial systems
Increased demand for imports
Reduced import quotas and other trade barriers.

Disadvantages of globalization
Operations in other countries can have disadvantages. A firm may have to
give up proprietary technology if it turns over some of its component
manufacturing to offshore suppliers or if suppliers need the firm’s
technology to achieve desired quality and cost goals. There may be political
risks. Each nation can exercise its sovereignty over the people and property
within its borders. The extreme case is nationalization, in which a
government may take over a firm’s assts without paying compensation.
Also, a firm may alienate customers back home if jobs are lost to offshore
operations. Employee skills may be lower in foreign countries, requiring
additional training time. Korean firms moved much of their sports shoe
production to low-wage Indonesia and China, but they still manufacture
hiking shoes and in-line roller skate in Korea because of the greater skills
required.
Dear friends, in view of the issues that we have just discussed, it becomes
imperative to understand the intricacies involved in Managing global
operations. I would now focus on these issues.

Managing global operations

When a firm sets up facilities abroad it involve some added complexities in
its operation. Global markets impose new standards on quality and time.
Managers should not think about domestic markets first and then global
markets later, rather it could be think globally and act locally. Also, thy must
have a good understanding of their competitors. Some other important
challenges of managing multinational operations include other languages
and customs, different management style, unfamiliar laws and regulations,
and different costs.
Dear students, in general Managing global operations would focus on the
following key issues:-

1. To acquire and properly utilize the following concepts and those related to
Global Operations, Supply Chain, Logistics, etc.

2. To associate global historical events to key drivers in Global Operations

from different perspectives

3. To develop criteria for conceptualization and evaluation of different

Global Operations.

4. To associate success and failure cases of Global Operations to Political,

Social, Economical and Technological environments

5. To envision trends in Global Operations

6. To develop an understanding of the world vision regardless of their

country of origin, residence or studies in a respectful way of perspectives of
people from different races, studies, preferences, religion, politic affiliation,
place of origin, etc.

Let us see what factors in general, affect the location decisions

Factors affecting location decisions

Facility location is the process of determining a geographic site for a firm’s
operations. Managers of both service and manufacturing organizations must
weigh many factors when assessing the desirability of a particular site,
including proximity to customers and suppliers, labour costs, and
transportation costs.

Location factors can be divided into two categories: -

Dominant factors, and
Secondary factors
Dominant factors are those derived from competitive priorities (cost,
quality, time, and flexibility) and have a particularly strong impact on sales
or costs. Secondary factors also are important, but management may
downplay or even ignore some of them if other factors are more important.
 Friends, let us consider the issue of why firms choose to locate new
factories and describes the main factors for their location choice. While
location conditions are widely seen as the differences among locations that
exist for all industries, location factors refer to the specific importance that is
attached to such differences by individual firms when choosing locations for
specific 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 policy

Location conditions are complex and each comprises a different

characteristic 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 to

measure. Tangible cost based factors such as wages and products costs can

be quantified precisely into what makes locations better to compare. On the

other hand non tangible features which refer to such characteristics as

reliability, availability and security can only be measured along an ordinal or

even nominal scale. Other non tangible features like the percentage of
employees that are unionized can be measured as well. Generally speaking

companies prefer location with low taxes and low wages rather than such

where high taxes and wages are charged. But by taking these two factors

under considerations low taxes are likely to imply low levels of community

services and poor quality supplies of industrial land. While low wages may

imply low skills and low purchasing power. To sum this up non-tangible

features are very important for business location decisions.

Let us consider the effect of factors such as:

Materials, markets and transportation

Factories which produce products for different markets usually are

threatened by transportation costs. These costs include procurement costs,

i.e. the costs considered for bringing raw materials or semi products to the

company. On the other hand the finished products needs to be distributed to

the markets, which incurs distribution costs. Therefore locations near inputs

lower procurement costs and locations near markets lower distribution costs.

Transportation costs comprise direct freight charges, while transfer costs

refer to both direct costs and indirect costs such as insurance costs and losses

resulting from damage in transit. Basically transportation costs are

determined by physical characteristics like value of product and quantity of

goods on the one hand and are determined also by freight rates on the other
hand. Consequently, average transport costs decline significantly with

distance.

All of us have a fair bit of idea about labor as an important constituent in the

overall scheme of things. Let us see how.

Labor

Labor costs comprise wages and non-wage benefits, like contributions to

medical plans, vacation time and pay, and pension schemes. Labor costs

vary by industry, country, region, unionized and non-unionized sectors.

Tremendous differences in labor costs can be seen between countries with

high wages like developed countries on the on hand, and low developed

countries like China, India and so on, on the other hand. But even among

high developed countries labor costs can vary. So American and other strong

companies are threatened by the highest manufacturing wages among the

developed countries while wages and labor costs in Canada or the UK are

much lower. This is mainly because of strong influence of the unions in the

US and Europe compared to other countries.

Even though there are large differences in wages and salaries among

countries, Europe, and the US as labor expensive countries have prospered

and most of this has occured within recent decades. This fact leads us to

another important intangible characteristics of skilled labor. In a country

with high taxes and wages you usually will find sophisticated infrastructure

and educational system and therefore skilled workers. By focusing on China,

India and the US we can recognize how low wages do not necessarily mean

high competitiveness and high living standards. The main figure which

determines competitiveness is productivity.

Another factor of immense importance that all of you must consider is:

External economies of scale

External economies of scale can be described as urbanization and locational

economies of scale. It refers to advantages of a company by setting up

operations in a large city while the second one refers to the “settling down”

among other companies of related Industries. In the case of urbanization

economies, firms derive from locating in larger cities rather than in smaller

ones 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 have

access to a much wider range of business services.

Location economies of scale in the manufacturing sector have evolved over

time and have mainly increased competition due to production facilities and

lower production costs as a result of lower transportation and logistical

costs. This led to manufacturing districts where many companies of related

industries are located more or less in the same area. The emergence of
agglomeration like in the case of the Manufacturing belt in the United States

can be explained like this: At the beginning of this century the great bulk of

manufacturing was located in relatively small area in the Northeast of the

United States. Even though wages were lower in the south of the United

States and there were more mineral resources in West and Midwest,

companies kept staying within the belt as a result of location economies of

scale. Each manufacturing facility stayed there because of having

advantages of being near other manufacturers. However this did not only

take place in the US but other countries as well such as Germany in the Ruhr

area or in Japan - Toyota city. As large corporations have realized that

inventories and warehouses have become a major cost factor, they have tried

reducing inventory costs by launching "Just in Time" production system (the

so called Kaban System).This high efficient production system was one

main factor in the Japanese car industry for being so successful. Just in time

ensures to get spare parts from suppliers within just a few hours after

ordering. To fulfill these criteria corporations have to be located in the same

area increasing their market and service for large corporations.

Power or energy, as dear students all of us are aware is the commodity that

makes the world go round.

Energy

Energy sources were a significant factor of location before the Industrial

Revolutions. Companies needed access to water energy, electricity for their

operations. Now electricity and other energy sources like oil can be

transformed and shipped very easily and cheaply and therefore Energy as

being 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 amenity

All manufacturing activities require access to a community infrastructure,

most notably economic overhead capital, such as roads, railways, port

facilities, power lines and service facilities and social overhead capital like

schools, universities and hospitals.

These factors are also needed to be considered by location decisions as

infrastructure is enormously expensive to build and for most manufacturing

activities the existing stock of infrastructure provides physical restrictions on

location possibilities. But on the other hand it is worth to mentioning that

existing infrastructure does not cause" industry to occur.

Another issue which we need to examine is the:

Capital
By looking at capital as a location condition, it is important to distinguish

the physiology of fixed capital in buildings and equipment from financial

capital. Fixed capital costs as building and construction costs vary from

region to region. But on the other hand buildings can also be rented and

existing plants can be expanded. Financial capital is highly mobile and does

not very much influence decisions. For example, large Multinational

Corporations such as Coca-Cola operate in many different countries and can

raise capital where interest rates are lowest and conditions are most suitable.

Capital becomes a main factor when it comes to venture capital. In that case

young, fast growing ( or not) high tech firms are concerned which usually

have not many fixed assets. These firms particularly need access to financial

capital and also skilled educated employees (i.e. Silicon Valley).

Dear friends, let us now focus our attention to the conduct of operations of

MNCs and see how these have an important bearing on the decisions at

hand:-

Multinational Companies or “MNC”

A MNC is a company which has substantial direct investment in foreign

countries, not just an export business (International company). Beeing a

MNC means that active management is required at any company and

holding outlets in a passive financial portfolio. The main relation between a

Multinational Corporation and an International company is that each

subsidiary could be run as its own independent company. By definition of

the United Nations a Multinational company is an enterprise:

a. which comprises entities in two or more countries, regardless of the legal

form and fields of activity of those entity.

b. which operates under a system of decision making permitting different

policies and a common strategy through one or more decision making

centers.

c. In which the entities are so linked, by ownership or otherwise, that one or

more of them may be able to exercise a significant influence over the

activities of the others, and, in particular, to share knowledge, resources, and

responsibilities with others.

Frinds, in this context I would request you all to answer the following basic

question:-

What motivates companies to expand their operations internationally?

Let us probe deeply.

Motivations for Internationalization

We can classify these as follows:-

Traditional Motivations
One of the earliest reasons why companies moved abroad was the need to

secure key supplies, especially minerals, energy, and scarce raw material

resources.

Another strong trigger of internationalization could be described as a market

seeking behavior. This motivation was particularly strong in companies for

which their home markets have become too small and especially for

companies who wanted to use economies of scale.

Expenses for Research and Development for new High Tech products are so

high and the life time so short that companies are forced to meet a sales

quota of a certain amount and therefore their home markets have become

small.

Another traditional and important trigger of internationalization was the

desire to access low cost factors of production as cheap labor or lower cost

capital (perhaps through a government investment subsidy).

Multinational Companies and national states

It is generally argued that over the last few decades Multinational companies

have become extremely powerful and the influence of the home country in

which MNC operates have decreased over time.

MNC are very important for Host countries because they employee many

people and increase GDP of the country. Therefore Host countries try to

attract MNC by offering subsidies when they start their operations and

providing infrastructure and as well as tax allowances.

‘MNC work in many countries and have really spread out their home". This

means they do not necessarily belong to one host country but they are at

home everywhere where they have a headquarters.

The power of MNC is rooted because of their technological and managerial

expertise and complexity, their financial resources, international marketing

channels and differentiated products, reinforced by powerful advertising

campaigns.

The power of the host country government is related to the size of the

domestic markets, resources and skilled labor pools, the availability of

infrastructure and the political stability in the country.

Dominant factors in manufacturing

Factors dominating location decisions for new manufacturing plants can be
broadly classified in six groups. They are listed in the order of their
importance as follows.
1. Favourable labour climate
2. Proximity to markets
3. Quality of life
4. Proximity to suppliers and resources
 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 climate

A favorable labor climate may be the most important factor in location
decisions for labour-intensive firms in industries such as textiles, furniture,
and consumer electronics. Labour climate includes wage rates, training
requirements, attitudes toward work, worker productivity, and union
strength. Many executives consider weak unions or al low probability of
union organizing efforts as a distinct advantage.

Proximity to markets
After determining where the demand for goods and services is greatest,
management must select a location for the facility that will supply that
demand. Locating near markets is particularly important when the final
goods are bulky or heavy and outbound transportation rates are high. For
example, manufacturers of products such as plastic pipe and heavy metals all
emphasize proximity to their markets.

Quality of life
Good schools, recreational facilities, cultural events, and an attractive
lifestyle contribute to quality of life. This factor is relatively unimportant on
its own, but it can make the difference in location decisions.

Proximity to suppliers and resources

In many companies, plants supply parts to other facilities or rely on other
facilities for management and staff support. These require frequent
coordination and communication, which can become more difficult as
distance increases.

Utilities, taxes, and real estate costs

Other important factors that may emerge include utility costs (telephone,
energy, and water), local and state taxes, financing incentives offered by
local or state governments, relocation costs, and land costs.

Other factors
There are some other factors needed to be considered, including room for
expansion, construction costs, accessibility to multiple modes of
transportation, the cost of shuffling people and materials between plants,
competition from other firms for the workforce, community attitudes, and
many others. For global operations, firms are emphasizing local employee
skills and education and the local infrastructure.

Dominant factors in services

The factors considered for manufacturers are also applied to service
providers, wit one important addition – the impact of location on sales and
customer satisfaction. Customers usually look about how close a service
facility is, particularly if the process requires considerable customer contact.

Proximity to customers
Location is a key factor in determining how conveniently customers can
carry on business with a firm. For example, few people would like to go to
remotely 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 markets

For warehousing and distribution operations, transportation costs and
proximity to markets are extremely important. With a warehouse nearby,
many firms can hold inventory closer to the customer, thus reducing delivery
time and promoting sales.

Location of competitors
One complication in estimating the sales potential at different location is the
impact of competitors. Management must not only consider the current
location of competitors but also try to anticipate their reaction to the firm’s
new location. Avoiding areas where competitors are already well established
often pays. However, in some industries, such as new-car sales showrooms
and fast-food chains, locating near competitors is actually advantageous. The
strategy is to create a critical mass, whereby several competing firms
clustered in one location attract more customers than the total number who
would 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 factors
Retailers also must consider the level of retail activity, residential density,
traffic flow, and site visibility. Retail activity in the area is important, as
shoppers often decide on impulse to go shopping or to eat in a restaurant.
Traffic flows and visibility are important because businesses’ customers
arrive in cars. Visibility involves distance from the street and size of nearby
buildings and signs. High residential density ensures nighttime and weekend
business when the population in the area fits the firm’s competitive priorities
and target market segment.

Well, I know you have been following very clearly and must have
understood the issues that were discussed. The best way, as usual is through
a small case study or case-let, as it is commonly referred to. So, here we go
again.

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 upscale
hotel companies. Its global expansion program was adding one new location
every 10 days, on average. In 1991, it opened the four-star Radisson
Slavjansksya Hotel in Moscow, which has become a very successful
hospitality oasis for Western business travelers. However, opening the
Slavjanskaya forced Radisson to weather many storms and deal with every
conceivable managerial challenge.

Multiple Languages
There is great diversity in the language of the hotel’s managers, employees,
supplies, and customers. Most of the managers are expatriates, and most of
the employees are Russians. The customer mix is American (55 percent),
Western Europe (20 percent), Eastern European (15 percent), Asian (5
percent), and Russian (5 percent)

Different Norms and Customs

Russian standards of service quality were much lower than those expected
by management. To attain and maintain top service quality, employees had
to participate in intensive training. Employee attitudes toward work and
ethical norms also were different. For example, employees often missed
work because of sick leaves, maternal leaves, and vacations. Russian laws
allow 24-day vacations and sick leaves of up to four months with pay, which
can be renewed by returning to work for only a few days. Security
requirements were demanding, with theft being commonplace. Once the
entire payroll was lost in a Russian bank. On another occasion, about 500 of
the 600 champagne glasses were missing. The nearby train station was said
to be controlled by gangs who offered “protection” to the vendors. Some 70
security guards were employed, many more than at a typical Radisson hotel.
Workforce Management
Staffing and training issues arose unexpectedly. For example, the Russian
employees were offended by being rotated through various jobs to gain
wider experience, viewing rotation as a lack of confidence in their abilities.
They believed that Americans were too quick to punish and too slow to
understand cultural differences. An important hiring requirement was that
the applicant had smiled sometime during the interview and had expressed a
willingness to reject bribes. The notion of linking pay and bonuses with
performance was a radically new idea to Russian employees.

Unfamiliar Laws and Regulations

Communist-era “job-for-life” laws were still in effect, and firing an
employee was difficult. The housekeeping people were paid for 8 ½ hours
per day, regardless of the actual hours worked. Tax laws were extremely
complicated and sometimes were changed retroactively. Russian employees
were paid in rubles at a time when inflation was 18 percent per month.

Unexpected Cost Mix

Labour productivity was low relative to a comparable Western hotel, but
salary rates were even lower. The net result was a savings because salaries
accounted for only 13.5 percent of total costs, in contrast to the 35 percent in
the United States. However, local suppliers were unreliable and procurement
costs were quite high. About 93 percent of all products were imported from
the West – shipped to Helsinki or St. Petersburg and then trucked to
Moscow. 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. The
infrastructure, including mail, telephone, banking, and city services, also
was inadequate. For example, hot water came from city-run water heating
plants. Because this source wasn’t always reliable, Slavjanskaya had to pay
for the construction of a second hot water pipe to guarantee both heat and
hot water.

*Source – Operations Management Strategy and Analysis (L. J. Krajewski,

L. P. Ritzman) Prentice Hall
Let us consider another small case.
POM in practice 6.2*
Call centers are frequently mistaken for telemarketing operations, when in
fact they are not. Most are “inbound” facilities that take reservations and
orders or provide customer service. The industry has boomed during the last
decade as more firms decided to outsource such customer service processes.
Texas leads the United States in the number of new centers over the past
decade – its number of call centers doubled in the last decade. By one
estimate, 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’s
large 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 of
inexpensive labour and the incentives that thy are tossing in to land the
companies. Before Denver-based StarTek opened a call center in Big Spring,
a West Texas town of 23,000 where unemployment had been about 6
percent, a job fair attracted 1,200 applicants. Employees started at $6.50 per
hour, far less than what would be paid in a bigger city. To seal the deal, Big
Springs gave StarTek $2.3 million in interest-free loans. Smaller cities are
more likely to get state funds for this type of economic development because
the call centers are such an economic-development bonanza for them. In
larger cities, companies usually do not qualify for incentives unless they
make a substantial capital investment-and many do not, choosing to lease
office space. The smaller cities need the jobs more. Call centers employ
several hundred people, bringing jobs and a level of technical training and
giving 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 step
for smaller cities to draw other burgeoning business, such as the distribution
centers for e-commerce companies.

Other factors that favour Texas are the central time zone (making it
convenient to reach markets on both coasts), the availability of advanced
telecommunications structures (such as fiber-optic lines and digital
switching systems), and the favourable regulatory climate. It is a one-party-
consent state, meaning customers do not need to be notified if their
conversations are being recorded; getting permission slows down the calling
process. And the state also does not levy excise or sales taxes on out-of-state
long distance calls, as some states do. Border cities also offer a supply of
bilingual workers – to take calls from Spanish-speaking customers. This
advantage is particularly important as more companies expand their markets
into Latin America.

*Source– Operations Management Strategy and Analysis (L. J. Krajewski,

L. P. Ritzman) Prentice Hall

With that, we have come to the end of today’s discussions. I hope it has
been an enriching and satisfying experience.

Points to ponder