Ch.8 – The OM Blog by Heizer, Render, & Munson

OM in the News: Alabama Opens Its Wallet to Airbus

Following a year of secret negotiations, Airbus broke ground this month in Mobile, Alabama, for its new plant that will produce the popular A320 jet. Businessweek (April 22-28, 2013) provides the details of the final location decision and incentives: After looking at “just about every site in the US that had industrial capacity,” Airbus promised to bring an estimated $600 million in investment and 4,000 jobs to the state, no fewer than 1,000 permanent. Alabama, for its part, offered incentives totaling $158 million. They include $82 million in funds for capital investments in the plant and other expenses; and $51.9 million for a 40,000-sq.-ft. on-site training center where workers will be prepared, at state expense, for their new jobs. Faculty from the aerospace departments of colleges in the state will provide the training. The deal also includes tax breaks on manufacturing equipment and a state corporate income tax credit.

The State’s governor says Alabama taxpayers will recoup the investment more than 2-fold within 3 years.

Settling in Alabama, a right-to-work state, will mean lower labor costs for Airbus since plant employees won’t be unionized. Yet opening up shop in Alabama isn’t just about saving Airbus money. The facility won’t make entire airplanes—it will assemble pieces made overseas. Partially completed sections, from cockpit to tail, will be transported by barge from the company’s European factories to Alabama, where they’ll be put together. The cost of transporting the pieces means that even with lower labor costs, planes completed in the U.S. will cost more to manufacture than those made start to finish in Europe.

But having a presence in the U.S. is worth the cost and complications if it helps the company to sell more planes. “Being close to the customer always works—in any industry,” says one French industry analyst. “We believe, similar to other industries, including the auto industry, that if we create an industrial presence in the U.S. our market share will go up.”

Discussion questions:

1. Why did Airbus open a factory outside of Europe?

2. Were the incentives provided unusual or unreasonable?

OM in the News: Will Chip Makers Locate in India?

Dell sells in India, but does not make components there

India, home to many of the world’s leading software companies, wants to replicate that success by creating a homegrown industry for computer hardware. But unlike software, which requires little infrastructure, building electronics is a far more demanding business, writes The New York Times (April 16, 2013). Chip makers need vast quantities of clean water and reliable electricity. Computer and tablet assemblers also depend on economies of scale and easy access to cheap parts. When you are discussing multinational location decisions in Chapter 8, this article will highlight many of the factors that are considered in Figure 8.1.

“Nobody disputes India’s need to build up manufacturing. But the government needs to not mandate this, but create an ecosystem,” says the head of the U.S.-India Business Council. Another executive doubted that India could provide a new chip-making facility with the basic infrastructure it needed to even keep the lights on. Dot-matrix printers, outdated in most of the world, are one of the few electronic products that India manufactures. India’s import bill for semiconductors alone was $8.2 billion in 2012, and demand is growing at around 20% a year.

The big fish the government would like to land is a factory to produce microprocessors for computers. A computer processor typically accounts for 25% to 35% of the total cost of a PC or laptop. India hopes that such a plant, which could cost as much as $5 billion to build, would help spur a bigger high-tech manufacturing industry. Spurred by a new “Buy India” government requirement, Dell, the largest PC retailer in India, explored the possibility of setting up manufacturing facilities there. “They flew in their suppliers from China and Taiwan to see if they could set up facilities. They said no,” said an industry official. “Logistically it is a nightmare.”

Discussion questions:

1. Why do manufacturers hesitate to manufacture computers in India?

2. What are the key operations concerns?

OM in the News: Rethinking The Decision To Locate in Bangladesh

As we discuss in Chapter 8, there are many factors that go into global location decisions. For the past few years, Bangladesh had been one of the biggest beneficiaries of a major reordering of the world’s low-end manufacturing. Rising pay in China has forced companies to find less-costly production locales, especially for goods that require armies of laborers such as apparel, shoes and linens. Bangladesh’s exports of clothes have nearly doubled since 2008, creating thousands of jobs in a country with a long-struggling economy. But what many companies have found is that countries like Bangladesh—which seem like alternatives to China, including Cambodia, Vietnam and Indonesia—have their own obstacles, reports The Wall Street Journal (March 22, 2013). While salaries might be lower, political instability, poor infrastructure, recurring strikes and labor-law complexities can add their own costs.

Troubles in Bangladesh are beginning to spoil its reputation among foreign companies that had flooded into the country—and are highlighting risks to investors looking for new manufacturing bases cheaper than China. Violent protests have led to at least 60 deaths and widespread strikes. The protests come on the heels of two recent apparel factory fires which killed 119 garment workers. Thousands of trucks carrying goods to Chittagong port have been burned or damaged.

“Bangladesh was a good place to do business. But you have to read the political trends in the world,” says Tesco’s CEO. “We are already moving away from Bangladesh,” adds the VP of VF, the company that owns Wrangler, Timberland and Nautica. “How many eggs do you want in a basket that’s basically a powder keg?”

It seems that China’s deep supply chain network is hard to replicate quickly elsewhere. Nike recently said only eight of the 896 factories it worked with were in Bangladesh as it reduces its exposure to countries presenting reputational risks.

Discussion questions:

1. What advantages does China have for apparel makers over Bangladesh?

2. Discuss each of the location factors in Chapter 8 vis-à-vis Bangladesh.

Guest Post: Another Approach to Teaching the Center-of-Gravity Model

Our Guest Post today comes from Prof. Howard Weiss, at Temple University. Howard is the developer of the POM for Windows and Excel OM problem solving software that we provide free with our OM texts.

Your Heizer/Render textbook covers the Center-of-Gravity Method in Chapter 8. However, there is a related model that is not covered and is easy to explain to the students. Consider Example 3 in the text, on page 322, in which Quain’s Discount Department Stores is looking for a location to build a new warehouse. Suppose though that rather than seeking a “central” location, the warehouse must be built in one of the four cities that currently has a store – Chicago, Pittsburgh, New York or Atlanta.

This revised example can lead to the discussion of straight-line (Euclidean) distance as compared with city-block/taxi distance and can serve as a student reminder about the Pythagorean Theorem. The distance computations are tedious but not difficult. Of course, using POM for Windows (shown below)

or Excel OM (below) the students can easily identify that Pittsburgh is the city with the least total weighted movement from each of the other 3 cities with a total weighted movement of 318,692.

OM in the News: U.S. CEO to France: “How Stupid Do You Think We Are?”

“How stupid do you think we are?” With those choice words, writes The New York Times (Feb.21, 2013), Maurice Taylor, CEO of American tire manufacturer, Titan International, touched off a furor in France as he responded to a government plea to take over a Goodyear factory slated for closing in Amiens, France. “I have visited the factory,” said Taylor. “The French work force gets paid high wages but works only 3 hours. They have 1 hour for their breaks and lunch, talk for 3 and work for 3. I told this to the French unions to their faces and they told me, ‘That’s the French way!’ ”

Taylor’s assessment quickly struck a nerve in France, where concerns about declining competitiveness have led economists to ask whether the nation is at risk of becoming the next sick man of Europe. But Industrial Minister Montebourg released a letter calling the executive’s comments “extreme” and “insulting,” adding that they pointed to a “perfect ignorance” about France. French media outlets also minced no words. “Incendiary!” and “Scathing!” were just a few of the terms replayed in French newspapers. And the head of France’s main labor union wasted no time in weighing in, saying Mr. Taylor belonged in a “psychiatric ward.”

“Goodyear tried for over 4 years to save the Amiens jobs that are some of the highest-paid, but the French unions and the French government did nothing but talk,” said Taylor. “Titan is the one with the money and the talent to produce tires. What does the crazy union have? It has the French government.” He said his company would seek to produce cheaper tires in India or China, where he said Titan would pay the workers less than 1 euro an hour, and then sell the tires back to the French. He predicted that Michelin, the French tire maker, would not be able to compete with lower prices and would have to halt production in France within 5 years. “You can keep your so-called workers.”

Discussion questions:

1. How does France rank in the Global Competitiveness Index (see Table 8.1 and www.weforum.org)?

2. Relate this discussion to the major location decisions listed in Chapter 8.

OM in the News: The Continuing Use Of Incentives in Location Decisions

States and cities across the U.S., hungry to create jobs, are using increasingly controversial incentives to compete for some of the world’s most sophisticated manufacturers: passenger-jet makers. The trend, writes The Wall Street Journal (Dec.12, 2012), has accelerated since the recession, with states providing at least $1 billion in various incentives since 2008 to draw aerospace investments. That includes $450 million to attract Boeing to S. Carolina, $158 million from Alabama for rival Airbus, and $57 million from Virginia to draw engine-maker Rolls-Royce. But the escalation of local sweeteners also faces opposition from critics who say politicians are using public funds inefficiently to pick winners that market forces should be lifting.

Discussing the issue over lunch with my friend Michael yesterday, we agreed that these incentive packages don’t do much to help the overall economy. The benefit to one state is simply a loss to another. Michael, the retired CEO of 2 major multinationals, has made many location decisions in his career. In almost every case, the location selection hinged on a slew of other factors (qualified employees, distribution channels, right-to-work, among others). Incentives were the bonus that he fought for after finding the best site–never the #1 criterion.

But backers of incentives say aerospace factories are especially attractive because they lead to follow-on investment and other jobs at suppliers. Alabama Gov. Robert Bentley admits wooing Airbus “was an expensive project.” The funding will support training for many of the 1,000 new staff, new equipment and local infrastructure. For every new position at the Airbus facility, Bentley predicts 4 additional jobs at suppliers and service businesses will be created. Similarly, S. Carolina estimates the Boeing factory, employing more than 6,000 people, will create thousands more jobs in the local supply chain and generate $4.6 billion in annual economic benefits to the region.

Discussion questions:

1. Refer your students to the Chapter 8 OM in Action box regarding Mercedes decision to open a plant in Alabama. What do the auto and aerospace industries have in common?

2. What factors should OM managers focus on in decisions such as these?

OM in the News: China’s New Magacities and Industry Clustering

The subject of industry “clustering,” discussed in Chapter 8, Location Analysis, comes up in Businessweek’s article (Sept. 30-Oct. 6, 2012) about China’s new megacities and the specialties driving their economies. For example, almost unknown outside China, Changsha (population 3.1 million) is one of the second-tier cities emerging as engines of China’s next wave of growth. McKinsey projects that by 2025, 13 of the world’s 25 fastest-growing cities will be in mainland China, and that by 2025, that country’s top 225 cities will be responsible for 30% of global economic growth.

Last year, Changsha’s economy grew nearly twice the national rate and will continue the pace in coming years. Changsha has boosted its economy in part by turning itself into a TV filming center. Its Hunan TV is responsible for launching the wildly popular American Idol-like audition shows Chao Ji Nu Sheng (Super Girl) and Kuai Le Nan Sheng (Super Boy). Changsha is not just an entertainment center cluster, it’s also home to major construction-equipment makers like Zoomlion and Sany, which have benefited from the national building boom and are selling their excavators and truck cranes to India, Brazil, and Africa.

Just as Changsha has become an entertainment hub, many other second-tier cities are also thriving because they specialize. Chengdu is a high-tech manufacturing center: Intel recently moved its assembly and testing facility there from Shanghai, while Dell and Texas Instruments also have operations in the city. Wuxi, home of Suntech, is a leader of Chinese solar panel manufacturing; Xi’an, historically a base of the military-industrial complex, is a main center in the country’s efforts to develop an aerospace industry. The northeastern city of Shenyang has become an industrial center thanks to assembly plants operated by BMW, Boeing and other foreign investors.

Discussion questions:

1. Like China, Italy has many industry cluster cities. Name some of them and their specialities.

2. What are the OM advantages to clustering?

OM in the News: In the Race Between China and Mexico, Mexico Tries to Edge Ahead

The Wall Street Journal (Sept. 17, 2012) reports that China’s rising wages are giving a chance for Mexico to wrest back some of the business that chased cheap labor across the Pacific a decade ago. Mexico may already be a less-expensive place to make products for the U.S. market, as China’s average manufacturing wage topped Mexico’s this year, when accounting for differences in productivity. Mexican workers typically produce more per hour than Chinese workers, and the proximity to the U.S. means companies can ship faster and at a lower cost to American customers. Mexico’s average wage is $3.50 an hour. The average across China has climbed to $2.50 an hour, from 60 cents in 2000.

As global location and outsourcing decisions go, there will not be a wholesale rush back to Mexico. The drug war there scares away new business, and the country has built neither the skilled labor pool nor parts-supply chain to mount a serious challenge to China’s manufacturing prowess. But as Chinese wages continue to rise, Mexico looks the best-placed to benefit, as it is the least-expensive country outside the U.S. to manufacture for the U.S. market.

Customers who buy a Dell computer at a big-box retailer get a product made by Foxconn in China. But shoppers on the company’s website can customize their orders –and those computers are assembled and delivered from a massive Foxconn plant near Ciudad Juárez, which churns out 35,000 laptop and desktop computers a day, and can have a truck on the U.S. side in a few hours.

Here are a few World Economic Forum competitiveness rankings (out of 142) on the 2 countries: Overall– China 26, Mexico 58; labor market efficiency-36 vs. 114; available scientists– 33 vs. 86; infrastructure quality– 25 vs. 73. Mexico’s homicide rate is nearly 18 times that of China.

Discussion questions:

1. Why would businesses prefer to locate or outsource to Mexico?

2. Why would they prefer China?

OM in the News: The High-Tech Clusters– Silicon Valley, Boston, Bangalore, and Israel

In our discussion of how companies select a site in which to locate (in Chapter 8), we bring up clustering, which is basically locating near competitors so as to take advantage of major resources found in that area. The perfect example is how software and high-tech firms head to Silicon Valley, Boston’s Route 123, and Bangalore (India). Here the talents of bright graduates in scientific and technical areas and plenty of venture capital are keys to success. Today’s Wall Street Journal (Sept.10, 2012, pp. C5-C8) compellingly adds Israel to this list. Israel’s Minister of Finance ascribes much of its success to “government support of the robust venture capital industry, which is the accelerating spirit behind many start-up companies.”

Indeed the World Economic Forum’s Global Competitive Index just ranked Israel’s “availability of venture capital” 2nd in the world, “world-class capacity for innovation” 6th, and “high number of patents” 4th in world rank. The IMD World Competitiveness Yearbook lists Israel 1st for R&D expenditure (as % of GDP), 2nd for qualified engineers, 2nd for IT skills, 2nd for scientific research, 2nd for entrepreneurship, and 2nd for innovative capacity. The society, like the U.S., “puts entrepreneurs, successful or not, on pedestals, which allows them to attract the best minds to work with,” says one professor in Jerusalem. Included among the active sectors for innovators have been cleantech, agrotech, life sciences, communications technology, and security.

Here is the list of just some Israeli innovations: drip irrigation (1965), the Rummikub game (1977), voice mail (1984), multislice CD scanners and cardiac stents (1992), ICQ instant messaging, voice over internet VoIP), and the MS drug copaxone (all in 1995), USB flash drives and computer vision software for road navigation (1999), the pillcam (2001), and Intel mobile technology (2003). It follows that more than 50 Israeli firms are listed on NASDAQ–2nd only to the U.S.

Discussion questions:

1. Why do some countries have a much higher percent of scientists and engineers than other nations?

2. How does OM play a role in startup companies?

OM in the News: Airbus Over Alabama

When you are teaching global location analysis in Chapter 8, what better way to start a discussion than Airbus’ decision this week to open a new $600 million facility in Mobile, Alabama. The Wall Street Journal (July 3, 2012) reports that the European jet maker’s US facility will turn out 40- 50 A320 jetliners yearly by 2018, with about 1,000 full-time employees. (State officials say they expect each job to produce at least 4 more in the local economy). Airbus now assembles A320s at plants in Germany, France and China.

Even without the global politics of airline manufacturing, the economic incentives for Airbus to build more plants in France are difficult. With a headcount of 1,000, the new plant surpasses France’s various thresholds for taking on a welter of worker “protections” and the burden of union bureaucracies. But it’s worth noting that Airbus didn’t just pick the U.S. over France, Germany, or China. It chose Alabama over the rest of the U.S. Not least, it’s that Alabama is one of 23 right-to-work states, which means workers are free to decide if they want to join a union. That not only makes that labor market markedly freer than France, but also struggling states across the U.S.. Airbus, of course, isn’t the first foreign enterprise to notice Alabama. The state also hosts Mercedes, Toyota, and other auto production facilities.

Alabama is also offering Airbus over $100 million in tax breaks and other incentives such as job training and infrastructure improvements. Jets are sold worldwide in dollars and since Airbus’ planes are manufactured with most costs in Euros, US manufacturing will help hedge against currency gyrations. ( Here is a 3 minute WSJ video on the subject).

Discussion questions:

1. Why is Airbus starting production in the US?

2. How was Alabama able to lure the company?

OM in the News: South Carolina and the Auto Cluster

Here’s a pop quiz: Where did French tire-maker Michelin, just announce it will build a new global factory—China, Mexico or South Carolina? Answer: South Carolina.

What state is about to become the biggest manufacturer of tires in the U. S.? Answer: That would be South Carolina, too, with Michelin’s new plant (cost $950 million and employing 800 people). Other tire makers in the state are also expanding, reports The Wall Street Journal (April 20, 2012). The port of Charleston is adding capacity to handle cargo going in and out of the area.

“Ten years ago, everyone thought Mexico would be the place for expansion,” says the head of Michelin– North America. “But we can’t tolerate the level of instability there.” As for China, labor costs are rising quickly and there’s still concern about protecting intellectual property.”

A new survey of 106 big U.S. manufacturers picked up a similar sentiment. Thirty-seven percent of the companies said they plan to bring production back to the U.S. from China, or are actively considering it. Seventy percent said sourcing in China is more costly than it looks on paper.

In Chapter 8, we write about the unique vitality of manufacturing hubs or “clusters”—the co-location and interconnection of related industries and schools. Silicon Valley is a prime example. So too the tech corridor in upstate New York, aircraft design in Seattle, chemicals in West Virginia, and advanced engineering in Prince George County, Va., where Rolls-Royce and a group of universities recently tied up.

Michael Porter of Harvard, in a 1998 paper “Clusters and the New Economics of Competition,” wrote: “Paradoxically, the enduring competitive advantages in a global economy lie increasingly in local things—knowledge, relationships, and motivation that distant rivals cannot match.”

Discussion questions:

1. Name some cluster zones of business expertise outside the US.

2. Why did Michelin select S. Carolina for its original plant and for the new one reported here?

OM in the News: Where to Locate the Next McDonalds–in Your Hospital?

We all know that hospitals can be dangerous places to spend a few nights. Here are just a few statistics on annual deaths in US hospitals due to preventable errors (as cited from a variety of studies): 44,000-98,000 (Institute of Medicine, 1999); 195,000 (Health Grades, 2004); 180,000 Medicare patients (US Department of Health, 2008); and 99,000 (AHRQ, 2009). But what we would not expect as a reason for our demise to be hospital food. Maybe that is why a group of 1,900 doctors is starting a move to rid hospitals of our favorite fast food chain, McDonald’s, that has found a location strategy in a crowded market.

It turns out that 22 hospitals currently have contracts with the fast food industry leader, reports MarketWatch (April 10,2012), including the Cleveland Clinic and Children’s Memorial Hospital of Chicago. “Kids are being treated for diet-related conditions like diabetes on one floor in the hospital and given the wrong message by being offered the world’s most recognized junk food brand on another floor in the hospital,” says the former president of the American Diabetes Association “The practice earns McDonald’s an undeserved association with healthfulness among parents and children alike.”

A study in the Pediatrics demonstrated that allowing a McDonald’s to operate inside a hospital affects hospital guests’ consumption on the day of their visit, and boosts the perception of the “healthfulness” of McDonald’s food. To address this concern, the group just sent a letter to the 22 hospital administrators last week, noting: “It’s no surprise that McDonald’s sites stores in hospitals. For decades, McDonald’s has attempted to pose itself as part of the solution.”

In 2009, Dallas’ Parkland Health & Hospital System replaced a McDonald’s with a smaller chain offering healthier food. McDonald’s had been the only chain restaurant at the hospital for 20 years.

Discussion questions:

1. Do your students think locating McDonald’s in hospitals is an ethical issue?

2. Into what other types of facilities has the firm expanded?

Teaching Tip: Where Companies Locate and the Corruption Index

Today’s Wall Street Journal (Feb.10,2012) ran a very eye-catching 1/2 page ad, taken out by the Eurasian country, Georgia. Why would a multinational corporation locate in Georgia? “Because according to Transparency International we are one of the least corrupt countries in the world,” touts the ad.

And, indeed, as we discuss in Chapter 8, Location Strategies, corruption can create substantial economic inefficiency, as well as ethical and legal problems in the global arena. Transparency International’s annual corruption perceptions index (CPI) (www.transparency.org) is illustrated in Table 8.2 and excerpted here in today’s blog. This is an interesting topic to share with your students, and can lead to their tracking the success of other nations on this index, as well as on others (such as the World economic forum’s annual competitive index —see Table 8.1 and www.weforum.org).

The World Bank’s VP for Europe and Central Asia writes in the Journal: “Corruption is sometimes seen as as endemic, a product of traditional local culture, and, as such, inevitable. Georgia’s experience shows that the vicious cycle can be broken.” Georgia’s zero tolerance approach toward public-sector graft since its 2003 “Rose Revolution” places the country among some of the advanced European nations on the Transparency rankings. Georgia rose to 64th place out of 183 nations (from 68th last year) with a CPI score of 4.1. It is not quite in the league with the US, Canada, or New Zealand, but ahead of all four BRIC nations.

Video Tip: Where to Put the Next Red Lobster

Jay and I have developed two video case studies to accompany Chapter 8, Location Strategies. In the first, Where to Place the Hard Rock Cafe, we describe how Hard Rock makes its future location decisions. At that company, the Director of Development has significant personal authority, using his decades of experience and “feeling” about a city and a location in that town. Of course, he also employs demographics, but not nearly to the extent that Red Lobster and Olive Garden (both owned by Darden Restaurants) do.

In this 10 1/2 min. video, we see that Red Lobster uses trade area characteristics (like income, population density, racial makeup, average age, competition, nearby hotels, etc.), site characteristics (parking, signage, visibility, traffic flow, etc.), and real estate availability –all run through a geographic information system . The GIS (by MapInfo) provides interesting psychographic profiles for potential locations. What used to take Rob Reiner, the director of market development, 8 hours to analyze, now takes 5 minutes.

MapInfo (illustrated at the end of the chapter) segments the US into 72 “clusters” of customer profiles, based on income and buying behavior. One such cluster, called Equestrian Heights, is detailed in the case study. The software takes into account competition, projected sales volume, cannibalizing from existing stores, and sets a minimum distances between Red Lobsters.

A great guest speaker when showing the video would be a local or district Red Lobster or Olive Garden manager.

OM in the News: OM and the Christmas Rush at UPS

“Lots of people like a white Christmas, but the notion keeps United Parcel Service up all night”, writes the Wall Street Journal (Dec. 23, 2011). Which is why UPS picked Louisville and its mild climate for its sprawling global hub. The Worldport spans the length of 90 football fields and employs 6,000 graveyard shift workers to fulfill its next day service. And during this busy holiday season, even desk job employees jumped in to handle the overload as it travelled down 155 miles of conveyor belts.

About 125 jets –up from 85 the rest of the year–landed each night this season, all between 11pm and 3am. The packages had to be sorted and reloaded onto planes before sunrise to reach their final destinations. It’s all about operations management, just as it is for FedEx (which we describe in the Global Company Profile for Chapter 8, Location Strategy). If a flight is late and the package misses its delivery, freight operators generally have to eat the cost of the shipment. Each late delivery subtracts $5-$30 from UPS’ bottom line.

ups meteorologist — UPS meteorologist at the status board

A “hot status board”on the wall lists cities and regions where UPS positions spare planes and crews, prepared to “rescue volume”, that is, packages stuck somewhere because of weather or mechanical problems. More than a million such packages are indeed “rescued” every year at UPS. If they had been late, the loss would have been $20 million.

Discussion questions:

1. Why did UPS select Louisville as its Worldport hub?

2. Why is OM at the heart of UPS’ business?