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Lecture 6 Location Strategy

 Long term Cost and Revenue Decision
 Determine fixed and variable costs
 Transportation cost can account as much as 25% of product selling price
• Raw material coming in and going out, Taxes, Wages, Raw material, Ill trained
labour, Poor ethic, Energy costs
The above are firmly in place, difficult to reduce, start at a disadvantage or advantage

Location Strategy = f(type of firm being considered)

Industrial plant Service Organisation
(Objective is to minimise costs) (Objective is to maximise profit)
Location Strategy is about maximising benefit from location of the firm.

Location Considerations
 Labour Productivity and Wage Rate
 Exchange rates
• Tangible Costs
Utilities, labour, material, taxes, depreciation, transportation costs, site
• Intangible costs
Quality of education, Public infrastructure, Community attitude, Attitude of
employees, Climate, Sport facilities…

Weighted Approach to Evaluation
1. Develop a list of relevant factors
2. Assign a weight to each factor to reflect its relative importance in the company’s
3. Develop a scale for each factor (1-10 or 1-100)
4. Have management score each location of each factor using the scale
5. Multiply the score by the weights for each factor, and total the score for each location

Prepared by: Dr D.K Hurreeram

August 04
Lecture 6 Location Strategy

6. Make a recommendation based on the maximum point score, considering the results of
quantitative approaches as well.

Factor Weight Scores out of 100 Weighted Scores


Labour 0.25 70 60 17.5 15

Total 1.00

Factors Weight
Labour costs
Wages, Unionisation, Changes in wages
Changes in unionisation
Availability and Productivity of Resources
Available workforce, Energy costs
Value added, Labour hours lost
State and Local Government Fiscal Policies
Expenditure v/s personal income growth
Tax effort, Changes in taxes
State business incentives
Debt growth v/s personal income growth
State Regulated Employment costs
Workers compensation insurance levels
Unemployment compensation benefits
Average workers’ compensated insurance cost
per case
Unemployment compensation
Other issues
Education, Cost of living
Transportation, Health care

Prepared by: Dr D.K Hurreeram

August 04
Lecture 6 Location Strategy

Locational Break Even Analysis

Use of cost-volume analysis to make an economic comparison of location alternatives.
1. Determine the fixed and variable cost for each location
2. Plot the costs for each location, with costs on the vertical axis of the graph and annual
volume on the horizontal axis
3. Select the location that has the lowest total cost for the expected production volume


The Transportation Technique

Objective is to determine the best pattern of shipments from several points of supply
(sources) to several points of demand (destinations) so as to minimise total production
and transportation costs.

There is given production capacity of goods at each source of supply and a given
requirement for the goods at each destination. (Network of demand and supply problem).

1) Determine the capacity at each factory, requirements at each warehouse, and cost of
shipping from each source to each destination.
2) Set up a transportation matrix with the above information.
3) Develop an initial solution – North West Corner Rule (initial solution)
a) Start in the upper left-hand cell and allocate units to shipping routes as follows:
i) Exhaust the supply (factory capacity) of each row before moving down to the
next row
ii) Exhaust the (warehouse) requirements of each column before moving to the
next column on the right
iii) Check that all supplies and demands are met
4) Use the Stepping-Stone Method to come up with the optimal solution as follows
a) Select any unused square to evaluate
b) Beginning at this square, trace a closed path back to the original square via
squares that are currently being used (only horizontal and vertical moves are
permissible). You may, however, step over either an empty or an occupied square.

Prepared by: Dr D.K Hurreeram

August 04
Lecture 6 Location Strategy

c) Beginning with a plus (+) sign at the unused square, place alternative minus and
plus signs on each corner square of the closed path just traced
d) Calculate an improvement index by adding the unit cost figures found in each
square containing a plus sign and then by subtracting the unit costs in each square
containing a minus sign
e) Repeat steps (a)-(d) until you have calculated an improvement index for all unused
squares. If all indices computed are greater or equal to zero, you have reached an
optimal solution. If not, it is possible to improve the current solution and decrease
total shipping costs. **
f) Improvement
The maximum quantity that may be shipped on the newly opened route is the
smallest number found in the squares containing minus signs.
5) If demand does not equal to supply, use dummy sources or dummy destinations. In
each case we assign cost coefficients of zero to each square on the dummy location
because in fact these units will not be shipped.
6) Check that the number of occupied squares in any solution (initial or later) must be
equal to the number of rows in the table plus the number of columns minus 1.
Solutions that do not meet this rule are called degenerate.
7) You may use the Modified Distribution Method (MODI) to compute improvement
indices for each unused square without drawing all of the closed paths.
a) Begin with the initial solution using the North West Corner Rule
b) Compute a value for each row as Ri
c) Compute a value for each column as Ki
d) Compute Cij, the cost of shipping from source i to destination j
i) To compute the value for each row and column, set Ri + Kj = Cij but only for
occupied cells.
ii) After you have written all equations, set R1 = 0
iii) Solve the system of equations for all R and K values
iv) Compute the improvement index for each unused square by the formula
• Index = Cij – Ri – Kj
v) Select the largest negative index and proceed to solve the problem as you did
using the stepping stone method.

Prepared by: Dr D.K Hurreeram

August 04