SUPPLY CHAIN DESIGN &

ANALYSIS

CHAPTER 7
FACILITY FIXED & VARIABLE COSTS
(READ EBOOK 1, CHAPTER 7)
The fixed costs are a one-time charge independent of the
volume: The cost of building the site; expanding the site;
adding equipment to the site like extra lines or equipment in
plants, additional racking or automation in warehouses;
paying taxes; or staffing the location.
The fixed costs could be considered a one-time capital
investment or an annual fixed operating cost.
• Capital investments are depreciated over time and you do
not necessarily need to justify the investment over a single
year.
• Fixed operating costs represent costs that are incurred
during the normal operation of the plant, line, or warehouse.
In essence, these are costs that are incurred each year (or
month) independent of how much volume is handled at the
facility.
Facility Fixed costs

There are reasons you may want to include fixed costs. These include the
following:
 The fixed costs vary significantly from location to location.
 Capacity is an important consideration and you want to model multiple
options. For example, you may staff a facility with one, two, or three shifts
and the shifts are best treated as fixed costs.
 We need to address capital investment decisions to expand or improve
existing locations or open new sites. When considering a capital
investment as a fixed cost, you want to be careful to make sure you put
the investment in the same time frame as other costs.
The variable costs are those that depend on the actual number
of units that are made at a facility or that pass through a
facility. To determine the total variable cost, you simply
multiply the total units made at a facility or that pass through a
facility by the variable cost.
For example, if the variable cost of production is $2, then
every unit adds $2 to the cost.
Note that different products may have different
characteristics, for example, different sizes, weights, or
manufacturing requirements. In this case, you may use a
simple conversion table to convert units to another measure
before applying the variable cost.
Facility variable costs
You may need to consider the following elements when determining
the variable costs:
• Labor Costs: This is the most obvious factor. If you don’t model
labor as a fixed cost, you need to determine the labor needed per
unit. Firms may have an estimate of this. Some firms may use
detailed Activity Based Costing methods to determine how much
labor cost is incurred for each unit produced or handled. In any
case, you need to include both direct and indirect labor.
Facility variable costs
You may need to consider the following elements when determining
the variable costs:
• Utility Costs: Depending on the type of firm, and more true for
manufacturing firms, the more product that moves through a
facility, the more electricity and water the facility uses.
• Material Costs: In manufacturing, you will need to purchase
additional material for each unit produced or consume packaging
material in a warehouse.
Regression to identify fixed and variable costs
When you have many different sites and there is complexity in
breaking out the variable costs, a regression analysis can be used.
In this case, the total cost of the site is the dependent variable, and
the total throughput of the site is the independent variable.
Using throughput can provide helpful insight. When the regression
runs, the slope of the line provides information on the variable
cost. The y-intercept of the regression can provide insight into your
overall fixed cost per facility.

You can add other independent variables as the situation requires,

such as product type or type of facility.
Regression to identify fixed and variable costs
When you have many different sites and there is complexity in
breaking out the variable costs, a regression analysis can be used.
Identify the fixed and variable cost of the facility?

Total facility cost 320 560 200 2000 1280 1040 800 1040 1520
Number of throughput
at facility 1000 2000 500 8000 5000 4000 3000 4000 6000
 MATH FORMULATION
The term Xi,w represents the facility i to be opened
with option w (which can be small, medium, or large
• Objective function: options for the size of facility)

The term transi,j The term facVari The term facFixi

represents the cost to represents the variable represents the fixed cost
send one unit of demand cost to run the facility i to run the facility i
from facility i to customer j

10
FULL MATH MODEL

All the demand must be served

The max and the min of the number

of facilities i of all options w (We
consider the fix cost of facility so we
should not open many facilities)

Only 1 option w is chosen for a

facility at one location.

A facility is never assigned more

demand than it can handle.

The facility i with option w must be

opened then it can serve the
customer j.

Binary variables
LESSON LEARNED
When adding fixed and variable costs to the facilities, the
optimization now has the incentive to pick facilities with the lowest
cost. When optimizing based on total costs, the optimization can
pick sites with low fixed and variable costs if the facility cost
savings are greater than the increase in transportation costs. So you
can now get locations and maps that do not seem to make sense if
you are expecting sites to be close to customers.
LESSON LEARNED
For fixed costs, you need to be careful to separate the ongoing fixed
costs (like keeping the lights on) from the one-time investments
(like building a new building). For the latter, the one-time
investments, you need to make sure you put the costs in the same
units of time as the other cost elements in your model or you will
not get realistic results.
 END OF
CHAPTER 7