You have always heard the classic real estate line "location, location, location." Obviously we all want to have our plants, distribution centers, and research sites in the right place. Why is it that so many companies go about the process of finding the perfect location improperly? Let's look at some underlying causes and then outline what I think is the best solution.
Defining the Company's Goals
First, let's start with the compatibility of strategies, goals, and objectives within the organization. Ideally, all functions should be aligned using a sequence of balanced scorecards that all point to the goals of the corporation as set by the senior management and board of directors. We all know that, in reality, many companies have silos that have little or no linkage between their goals and those of the corporation or each other because these functions don't sell, produce, or operate anything - they are overhead departments. Most corporate goals revolve around sales growth and profits within certain customer service criteria. It is the "within certain customer service criteria" that causes the divergent departmental goals.
Typically, the real estate department is charged with managing all real estate functions for the company. This means that the real estate managers negotiate leases, find properties, buy land and/or buildings, etc. They are measured on their ability to obtain low land and lease prices as well as incentives. They almost always pick the low-cost location. While this is a noble goal, it is not necessarily in step with the overall goals of the company.
When it comes time to do a performance review, how do you think the real estate VP would fair if he just closed a deal on a 500,000-square-foot production facility where the rent was $7.50 per square foot, when he passed up a similarly sized building with a rental rate of $5.50? On the surface, it would seem he just cost the company $1 million annually. The math is correct, but it does not tell the whole story. In fact, the real estate person may have just made an exceptional deal at $7.50/square foot.
For "the rest of the story" we have to look at the other functional groups we are focusing on - the production operations and supply-chain departments. These groups have the responsibility to produce and deliver the company products at the lowest total cost within the aforementioned customer service criteria. Many companies believe that they can largely disregard transportation costs, and base their location decisions on tempting incentives from local government agencies. Thus, rather than leave the site selection decision-making process to their corporate real estate departments, more companies are bringing plant operations and real estate managers under one roof and building a companywide consensus on a strategy that takes all the goals and objectives of both groups into consideration.
Establishing Project Objectives and Timelines
The first step in the process is to research costs and set overall project objectives and timelines. The big drivers in choosing any location for plant operations should be production labor costs and inbound and outbound transportation costs. Only if there are big incentives can a company offset higher costs that recur every year. In addition, for a typical production or distribution operation, transportation costs are 2.5 to five times higher than the cost of actually running the facility, i.e., occupancy costs. Between 60 and 70 percent of a plant's operational costs is labor, not rent. Rent is only a very small piece of a plant's total cost.
When calculating transportation costs, most companies have traditionally focused on outbound costs because they are easier to calculate than their inbound costs. The company knows where their customers are, and which routes and transportation modes must be used to supply them. Inbound costs are more difficult to calculate because there's less information, and many times this cost is paid by the supplier and buried in the price of the raw material/component part. But many companies now are taking inbound transportation costs into consideration when they select sites for plants and warehouses. As supply chains spread around the globe, they become increasingly complex and difficult to manage. For many global companies, inbound transportation routes are changing, along with the identity of suppliers who come and go according to their performance. As a manufacturer, you will not be in the right place to minimize supply-chain costs if you do not consider both inbound and outbound transportation costs in your location modeling.
Putting the "Deals" in Perspective
Rather than factor in all these costs, which takes some time, many companies "jump to the end, and start by looking at deals" from developers and development agencies offering tax holidays, worker training, and so forth in locations they "think" are appropriate for plant operations. The problem with this kind of approach is that the individuals in the company's real estate department don't usually understand such factors as labor and transportation, as well as access to infrastructure. The real estate department is more likely to respond to a sales pitch that a particular location is only "a few miles from a major highway," without exploring whether that location has easy access to the highway interchange or if the local roads are extremely congested at peak hours.
Some senior executives ignore the expertise of their supply-chain departments and defer to outsiders who are motivated by subjective considerations. A company salesman may advise his chief executive, "We need to have direct air service to Chicago, so our plant must be very close to a major airport." The problem is that these criteria are not based on an understanding of the supply-chain cost structure and may only apply to a few select customers that are not a large portion of the company's volume.
In other words, there is no simple formula for choosing the right location. To help in this matter, we have launched a five-phase program that is designed to maximize the benefits to the company, while minimizing the risks of making a mistake in this deceptively complex and critical process. Let's discuss the five-phase process in step-by-step detail:
Phase 1: Outline a location strategy that is designed to support your business strategy and run the site location mathematical model. Start by assembling the team, articulating your basic requirements, and developing preliminary cost profiles to determine the relative importance of such factors as labor costs/quality, operating costs and environment, quality of life, etc. This portion of the process usually takes only one or two days to complete if the team stays focused, outlining the objectives; the length of time required to run the site location modeling is determined by the availability of the cost information, but the model only takes minutes to run once the proper data is gathered. There will typically be multiple iterations of the "model" due to the tweaking of the input data elements. While this phase is being completed, you can initiate Phase 2 and run it parallel to the data gathering.
To recap Phase 1, gather the team, work on getting the appropriate data, and set the goals for the decision-making process. It is only after this is complete that you can run the site location model to determine the mathematical low-cost location for the facility.
Step by step:
• Meet to gather the cross-functional team and outline the strategies, goals, and objectives of all parties.
• Determine the "other factors" that will be included in the analysis of each finalist location.
• Get the information for the site location model including costs for labor, transportation, and rent.
• Run the model to narrow the list of potential sites to a manageable number.
Phase 2: Make an initial screening of
locations that meet your requirements. Rate communities in a specific
geographic area on each key requirement: labor attributes, cost
structure, operating environment, etc. Use a scale of 1-10 for each
element. List the top four or five candidates and analyze their
benefits based on such variables as number of customers overall and
average distances to customers and expected delivery time. Use the
results of this and Phase 1 to narrow your list of possible locations.
This usually takes one to two weeks.
Step by step:
• Gather estimates for agreed upon "subjective" criteria outlined in the first strategy meeting for each location.
• Narrow the list to a manageable number of locations.
3: Create a "qualitative-cost matrix" for each location on your list,
showing the trade-offs. If, for example, the matrix shows "City 4"
rates 20 percent lower for quality (of labor force, operating
environment, etc.) than "City 5," but that "City 4" costs 10 percent
more, you now have a clear idea of the trade-offs between the two
cities. You use this matrix to create a shorter list of locations. This
process takes about two weeks.
Step by step:
• Put ratings into the matrix for all finalist locations.
• Add the results of the site location model on supply-chain costs.
4: Conduct field visits to the remaining locations on your list. Assess
them for potential site-building operations, incentive possibilities,
the labor market, and supply-chain infrastructure and costs. This is
the first time you should be in contact with the local economic
development offices. Distribute requests for proposals for construction
or leasing and analyze the proposals you receive. Present your analysis
and recommendations to senior management. This process takes two to
Step by step:
• Develop a request for proposal
that outlines the requirements of your site as it relates to building
purpose, size, ceiling height, sprinklers, special requirements for
power, refrigeration, rail access, etc. so everyone is working off of
the same data.
• Travel to multiple site locations for meetings with local brokers, developers, and economic development groups.
• Return and recap the results of your meetings.
Meet with the team to narrow down the list to the final two or three
locations identified for specific negotiations on incentives.
5: This phase prioritizes and finalizes the negotiation process
relative to the final two or three locations. This ensures the
preservation of viable alternatives to utilize during the negotiation
process. There has to be some level of competition to ensure the
maximum level of incentives for your project. There is a little "poker
playing" here, i.e., you may know where the "best" site is already, but
you never reveal this to the economic development groups or they will
lose interest in negotiating incentives.
After the final
incentive packages are presented, the location team meets to make the
final choice based on all the components - operational costs,
supply-chain costs, qualitative elements, and economic incentives.
While the negotiations are being conducted with the economic
development groups, you are also negotiating with landlords for leases
and/or purchase of a site. Again, you should develop a letter of intent
to give to the two or three finalist sites. You always need a backup in
case you cannot come to terms with a specific landlord or owner on your
first-choice location. Once you have your lease or land purchase
agreement in hand, you go back to the winning economic development
group to sign up for your incentives.
Step by step:
• Negotiate with landlords and/or owners for specific site locations.
• Request "final offers" from the top candidates' economic development groups.
• Get formal approval from your winning economic development group for your incentive package.
five-phase process should take your company from defining for itself
the key business success attributes, through translation to location
attributes and the vetting of potential markets and locations against
these, yielding an optimal place and site to do business. Attributes
and their weightings vary across business types, but this replicable
analytical process will provide a consistent roadmap and discipline to
ensure a successful outcome.