Factory Location

Selecting the most sensible location for a new food factory is a strategic decision, which may affect the technical and financial performance of the company for many years to come. It is not a straightforward task as it involves consideration of a number of constraints and both quantitative and qualitative factors. Some of these are listed in Table6.1; others are discussed in Chap.11. Simple comparative techniques can be used to identify the optimum location, for example, the analytical hierarchy process (AHP) devised by Saaty (1986). In this section, the principal factors affecting factory location are discussed.

6.2.1 Constraints

Before a possible site can receive serious consideration, it must satisfy the essential criteria listed in the first column of Table6.1. The first of these, compliance with the strategic mission of the company, can encompass a number of factors. For example, how would it interrelate with other manufacturing facilities operated by the company? In many instances, the rational for building a new factory is to enable one or more older, less productive sites to be closed down. In this case, the new factory must be able to satisfy both existing markets and, if appropriate, develop new ones. Company strategy will also dictate the development of new products. The factory must be capable of delivering on both.

The location of the factory must be such that it is possible to expedite regular deliveries of the necessary raw materials and other goods and resources used in the manufacturing process (e.g., packaging materials) and to distribute the finished products within the desired market. Some factors entering into this decision include:

1. Whether or not the raw materials are perishable. Clearly, fruits, vegetables, dairy products, and other perishables need to be transported to the factory as rapidly as possible in order to maintain quality. In this case, it is desirable to site the factory close to the suppliers. Preprocessing some raw materials following harvesting can be used to maintain quality and therefore extend the permissible storage time and/or distance between the growing site and the factory. Examples include drying of grain, chilling of milk prior to and during transportation to the dairy, production

Factory Location (Section 6.2)

Factory and Equipment Layout (Section 6.4 ) Plant Capacity (Section 6.3)

Lean Manufacturing (Section 6.5)

Warehousing (Section 6.6) FACTORY

DESIGN Fig. 6.1 Aspects of

Industrial and Operations Management to be considered in the factory design

of tomato paste from freshly picked tomatoes at the growing site, and freezing of freshly caught fish at sea in factory ships.

In the case of nonperishable raw materials, the distance between their source and the factory is obviously less critical than the cost of transportation and logistics (see below).

2. Shelf-life of products. In the case of short shelf-life products in particular, the distance (and hence time) between the factory and all envisaged markets is clearly a factor that needs to be taken into consideration. It is obviously less critical in the case of nonperishable goods.

3. Transportation infrastructure. This is another important factor that should be taken into account when selecting the factory site. In most cases, the principal requirement is the close proximity of major highways and/or rail networks. The absence of bottlenecks in the transportation infrastruc-ture is important, particularly if just-in-time (JIT) manufacinfrastruc-ture is employed or the finished products have a short shelf life. It is also necessary to consider the impact that the resulting truck traffic will have on the local environment in the vicinity of the proposed factory, particularly if it is zoned as a mixed industrial and residential area.

In today’s world, large quantities of fresh produce and processed foods are transported by air to distant markets. In these circumstances, proximity to local and international airports is an important consideration. Whether, in the light of global warming, this practice will continue on the same scale as today or will become prohibitively expensive due to the rising cost of fuel and the imposition of future carbon taxes remains to be seen.

In certain parts of the world (e.g., the Middle East), delivery of raw materials by sea is often essential. Examples include sheep and cattle from Australia and New Zealand for the manufacture of a variety of meat products and wheat for conversion into flour and subsequently baked goods. In these circumstances, regular and reliable shipping services and adequate raw materials storage are essential.

Other important factors that must be satisfied when deciding upon an acceptable location include the ready availability of skilled manpower, utilities, and essential services. Suitable provision must obviously be made to staff the new factory at all levels. It may be necessary to recruit senior management and technical specialists; alternatively, it may be possible to transfer existing staff to the new facility from elsewhere in the company. In either event, an attractive location will make this task easier. It is always desirable to hire production staff, fitters, office workers, etc., locally. The availability of a suitable pool of skilled manpower should therefore be confirmed before finalizing the location.

6.2.2 Quantitative Factors

Production costs may differ from one location to another and this should naturally be taken into account in choosing where to site the factory. It is therefore necessary to prepare estimates of the total production cost (CTP) in, e.g., $/y for each option that satisfies the constraints described above:

CTP¼ CMþ CGE (6.1)

Table 6.1 Factors affecting new factory location

Constraints Quantitative factors Qualitative factors

• Compliance with strategic mission

• Adequate and reliable supply of raw materials

• Quality of life of employees

• Access to good educational and research institutions

HereCMis the manufacturing cost andCGEthe general expenses. These costs can be divided into:

CM¼ Q  CVþ CFþ CO (6.2)

CGE¼ CAþ CDSþ CRD (6.3)

whereQ is the production rate (units/y), CVthe variable production costs ($/unit),CFthe fixed costs ($/y),COthe factory overhead charges ($/y),CAthe administrative costs ($/y),CDSthe distribution and selling costs ($/y), andCRDthe research and development costs ($/y).

Table 6.2 gives a further breakdown of these costs, which are largely self-explanatory. The breakdown is for guidance only as different companies may choose to allocate their costs somewhat differently. For example, many organizations prefer their managers to take direct responsibility for as much of the cost base as possible, thereby minimizing the charges allocated to the overheads over which individual managers have little control.

Table 6.2 Breakdown of operating costs (Adapted from Peters et al. (2003)) Variable production costs

• Raw materials (food ingredients, including water if appropriate, process aids, food additives), including delivery costs

• Packaging materials (primary, secondary, and tertiary)

• Production labor (operators, fitters, etc., attached to production departments)

• Direct supervisory and clerical labor (attached to production departments)

• Utilities proportional to production (electricity, water, steam, natural gas, oil, process water, etc.)

• Waste treatment

• Inventory and warehousing costs

• Product distribution costs

• Maintenance and repairs carried out by engineering department

• Operating supplies (cleaning chemicals, PPE, etc.)

• Quality assurance/quality control laboratory

• Patents and royalties (if applicable) Fixed costs

• Depreciation

• Local taxes

• Rent (if applicable)

• Insurance

• Financing charges (interest on capital) Overhead charges

• General upkeep of the factory and surroundings

• Payroll overhead

• Medical services

• Staff restaurant and recreation facilities

• Factory contribution to corporate overheads Administrative costs

• Contribution to corporate R&D facility

The capital cost of the factory is reflected in the annual depreciation charges for buildings and equipment. For tax calculation purposes, there are legal constraints on the depreciation method that can be used. In the USA, for example, the normal technique is modified accelerated cost recovery system (MACRS), which accelerates depreciation charges in the early years of the planning horizon.

However, for the purpose of comparing different options (e.g., factory locations), the simpler straight-line method is widely used.

The operating and transportation costs listed in Table6.2may well vary from one location to another. In particular, significant variations in wage rates, utility charges, local taxes, and insurance as well as transportation costs may well occur, especially if the sites being considered are in different countries. In order to evaluate this, a spreadsheet based on Table6.2should be constructed enabling each viable option to be compared. Construction of such a spreadsheet will require estimates of the rates of consumption of raw materials and utilities. The former is based on relatively simple material balances (see Chap.2). Estimation of utility consumption is more complex. The construction of accurate figures for steam, natural gas, electricity, etc., requires detailed knowledge of the perfor-mance of each unit operation in the manufacturing process. In wet processes, usage of wash water in addition to process water should also be taken into account. The calculation of wages, salaries, and payroll taxes must obviously be built on accurate estimates of manpower requirements. Past experience with similar operations is naturally useful here. However, the more formalized techniques based on job design described in Chap.4of Vonderembse and White (1991a) can be used to provide more accurate estimates of the requirements.

In order to determine the preferred location, it is strictly necessary to compare the profitability of each option over its operating life. The annual profit P ($/y) is defined as the difference between the sales revenue and the total product cost in any given year:

P ¼ Q  Cs CTP (6.4)

whereCs, selling price ($/unit). Note that production rates, revenue and costs, and hence profits can vary from year to year and also from one location to another. For example, higher manufacturing costs in one particular location could push the selling price higher and consequently reduce the market share. Moreover, long distances between the factory and viable demand centers may make significant inroads into such potential markets unrealistic.

The internal rate of return (IRR)i* is the most reliable measure commonly employed to determine the profitability of a particular venture as it takes into account the time value of money. It is equal to the maximum rate of interest at which money can be borrowed to finance the project without making a loss. Full details of this approach are given in texts on engineering economy, e.g., Blank and Tarquin (2002) and Thuesen and Fabrycky (2001). It can reveal important differences between options that would not be apparent if more simplistic methods (e.g., payback period or capital recovery period) are employed that do not take into account the time value of money. The trial-and-error approach (Bisect Method) involves discounting the capital investments and annual profits over the life of the project to the initial starting time using different interest rates i. The sum of the discounted capital investments equals the sum of the discounted revenues when i ¼ i*. This approach will provide useful quantitative data that can ultimately be employed in conjunction with other relevant information to make the optimal choice of location. Note that if the highest calculated value ofi* is less than a minimum acceptable value set by the company, the minimum attractive rate of return (MARR), the best option would normally be not to invest in the new factory.

There is always an element of risk in estimating profitability, particularly in the case of projects having a long service life since even the most carefully calculated estimates are subject to uncer-tainty resulting from unpredicted future events. This should always be born in mind when comparing different locations, particularly when they are sited in different countries. In such cases, political upheavals, civil unrest, currency fluctuations, and changes in taxation legislation can all impact the

calculations. Decision theory techniques, based on probability analysis, can be used to quantify risk;

for details see Blank and Tarquin (2002) and Thuesen and Fabrycky (2001) cited above.

Many jurisdictions (countries, states, counties, etc.) offer financial incentives to encourage companies to move to their area. These may include direct grants, low-cost loans, reduced property taxes, and sometimes lower and/or deferred corporation taxes. These factors may all affect the profitability of the venture and need to be taken into account when making the final decision on the location.

Finally, after-tax profits are important to every organization, and the rates of corporation tax applying in the jurisdiction in which the factory is located will certainly need to be taken into account.

If there are significant differences in these rates between possible candidate countries, this could have a major impact on the selection, as could any agreements that are in place to avoid double taxation.

6.2.3 Qualitative Factors

There will undoubtedly be a number of qualitative factors that may not directly affect the profitability of the venture but will have an impact on the selection of a suitable factory location. Most of these are quality-of-life issues that affect the ability of the company to attract and retain suitable staff.

Examples may include availability and cost of housing; recreational, entertainment and educational facilities; commercial services such as banks, shopping centers, and car dealerships; and the proximity to major highways, airports, and other transportation hubs. These factors can be assessed for each location as follows:

1. List all qualitative factorsi that are considered to be of importance and assign a relative weight Wi

to each.

2. Assign a scoreSi,jfor each of the factorsi and locations j under consideration.

3. Sum the values ofSi,jfor each location j. Divide each result by the highest value and rank the results from highest to lowest.

6.2.4 Summary

To summarize, choosing an appropriate location for a new factory involves the following steps. First, the essential criteria discussed in Sect. 6.2.1 should be satisfied for each potentially acceptable location. This may well eliminate a number of proposed options. Secondly, the IRR for each of the remaining possibilities should be estimated to assess the financial feasibility of the venture. Where appropriate, possible risks should be factored in. Finally, any qualitative factors that might sway the balance between the leading options should be considered.