7 keys to facility location: Number 6 - Markets
By John T. Mentzer -- Supply Chain Management Review, 5/1/2008
It makes sense to locate where land, labor, and capital are cheap—but only up to a point. Why so? Because where those factors cost less is seldom where customers are located. The very cost factors that draw us to inexpensive locations draw us away from our customers. Yet the consequent increased costs of getting to market tend to pull back, drawing the product to be near the market. Exhibit 1 provides a sample list of these push-versus-pull forces.
| Exhibit 1: Forces that Push or Pull Facilities Toward Markets | |
|---|---|
| Push Toward Markets | Pull Away from Markets |
| Number of potential customers. | Higher cost of labor. |
| Income levels of customers. | Lack of available labor. |
| Demographic match between customers | Higher land costs. |
| and market. | Higher capital cost. |
| Level of competition. | Traffic congestion leading to logistics disruptions. |
| Substitutability of products. | |
| Economic factors (unemployment levels, economic activity, etc.) | |
Introduction
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The push-pull dilemma is very evident in the retail sector, where sellers want to place inventory as close to stores as possible with the ultimate goal of every-day delivery to each store. The market-based rationale for this is to never be out of anything in any store for more than one day. However, the counter-argument is to keep inventory at a central location (supplier-positioned) and to deliver once a week, for example. Although that response involves a higher customer service cost, the cost to deliver to the stores is minimized.
Several years ago, for example, a leading office supply retailer announced it was shifting from a once-per-week to a once-per-day store delivery schedule. The announcement was clearly motivated by management's frustration with in-store availability. But the announcement eventually had to be retracted upon analysis of the total system cost. It revealed that the annual cost of daily transportation and additional facilities would exceed $45 million. Upper management wanted higher availability in the stores, but did not have the financial wherewithal to add $45 million to supply chain costs—that is, to take $45 million off the bottom line if the new delivery schedule failed to boost sales.
So in such situations, how do supply chain managers decide which makes most sense: near-market locations or near-low-cost areas? The answer lies in the customer service and cost sensitivities of the product. Products where customer service is particularly sensitive—where customers are not willing to wait and will quickly buy competitive substitutes—mean that the cost of a stock-out can be a lost sale or perhaps even a lost customer. For example, one consumer goods company (let's call them Company A) found that every time the product of its competitor (Company B) was not in stock, an otherwise loyal Company B customer bought the Company A product. Eventually, however, that customer went back to the Company B product. Yet every time Company A's product was out of stock, its once-loyal customers bought the available Company B product and never bought Company A products again. These customers convinced themselves that Company B products were superior—even though the products were identical!
In a case like this—where lack of availability means a permanent loss of the customer—customer service cost is so sensitive that product must be stored near the markets to maintain customer service levels. But when a lost sale results only in the customer waiting until the product is back in stock, there is less urgency to maintain a high customer service levels and less need for market-positioned facilities.
Thus, there is a tendency to inventory customer-service sensitive products close to larger markets to ensure quick replenishment. Products that are expensive to store tend to be located at consolidated locations. This is an important force in drawing inventory away from market positions.
Questions managers should ask:
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Where are the markets for our products and how large is each market?
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What are the customer service costs (lost sale, lost customer, expediting costs, etc.) of a stock-out in each market?
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What are the costs to store product near each market?
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