The lure usually held out to manufacturers to locate offshore in foreign countries has been the relatively cheap labor available in some areas. Although rapidly increasing wages in many foreign countries have changed this situation in recent years, this argument still can be made for many foreign areas.
For a particular manufacturer, the important question is: Is a net advantage available in a foreign location? There are several important reasons why there may not be. Wage levels themselves are not the important parameter; rather, labor costs will determine the advantage or disadvantage. Wages can be high and labor costs can be simultaneously low. The equating factor is productivity. The American worker is paid a relatively large wage rate but with a large capital investment per worker the production effort multiplies his or her efforts through special tools, mechanization, and automation.
Of course, the temptation is to assume that we can couple the advantage of lower wages with high productivity by using the same levels of mechanization and Managerial practice abroad. The difference in basic production economies in these two contrasting situations must be noted. Because labor is inexpensive relative to capital in some foreign locations, we say find it wise to use relatively labor and less expensive machinery in these situations. The resulting productivity and final labor costs thus would be more in line with those usually achieved in the foreign environment. The most economic manufacturing methods and techniques are not necessarily those with the greatest possible mechanization but are those that, for a given situation, strike a balance between the costs of labor and capital costs.
There are many costs in addition to labor to consider. If there is a net labor cost advantage, will it be counterbalanced by higher costs of materials, fuel and power, equipment, credit, transportation, and so on?
Studies of production costs in the United States and abroad, involving companies with both domestic and foreign operations have indicated considerable variability in the relative advantage or disadvantage of foreign locations. Apparently, there are some products, industries, or companies that are favored by the structure of foreign costs; however, these same conditions are unfavorable to others. Products in industries that have a relatively high labor content seemed to have lower costs abroad. On the other hand, industries whose cost structures are dominated by materials, energy, and capital have higher costs abroad.
Whereas industrial plant location is often oriented toward dominant factors, such as raw material sources or even the personal preferences of owners, warehouse location is definitely distribution oriented. Although the particular site choice will be affected by subjective factors, such as those included in the multi attribute model, the focus of interest in the warehouse location problem is on minimizing distribution costs. One cost why warehouse location is interesting is that the problem occurs more frequently than plant location and can be evaluated by objective criteria.
Earlier efforts in logistics and distribution management attempted to define the most appropriate customer zones for existing warehouses. These graphical approaches centered on the determination of lines of constant delivery costs. Since the 1950s, however, there have been a variety of attempts to deal wit warehouse location as a variable to be determined using mathematical programming, heuristic and simulation approaches, and branch and bound methods.
The general nature of the problem is to determine warehouse location within the constraints of demand in customer zones in such a way that distribution cost is minimized for a given customer service level. Warehouse capacity is determined as a part of the solution. Customer service is defined in terms of delivery days thus limiting the number of warehouses that can service a given zone. Distribution costs are the sum of transportation costs, customer service costs, and warehouse operating costs. The warehouse operating costs break down into costs that vary with volume fixed costs of leasing or depreciation, and fixed payroll and fixed indirect costs.
First, let us dispose of the possibility of calculating the distribution costs of all ware house customer zone combinations and simply selecting the combination that has the minimum cost property.
Consider the following characteristics of a medium-sized manufacturing firm that distributes only in the United States:
1. 5000 customers or demand centers
2. 100 potential warehouse locations
3. 5 producing plants
4. 16 products
5. 4 shipping classes
6. 100 transportation rate variables involving direction of shipment, product, geographical area, minimum costs, rate breaks, and so forth.
One single evaluation can be made by making an assignment of customers to warehouses for each of the product lines and then using a computer to search for the minimum freight rates for that assignment. This would determine the total cost of that particular warehouse location alternative. Each other assignment would be evaluated in the same way until all were complete and the least cost alternative found. Although this seems feasible, the company described above has over 12 million alternate distribution systems. Even if the evaluation of each alternative could be performed in just three seconds, the evaluation of all alternatives would take over one year of computer time at 24 hours per day.