I think, you are asking about creation of Functional Location & its hierarchy.
Generally, Functional Locations will be created as per the physical existence.
Under one plant, if you have multiple Production lines, then each line can be created as Functional Location.
Sometimes, Functional Location will be created based on Equipment type. For example, Boiler Area or Generators Area or Parking Area. Here, multiple generators will be grouped & will be created as Generator Area. All generators surrounding to that will be assigned under that.
Also, Cost Centers (Department wise if each department separate cost center or Line wise as mentioned above if cost center created as per production line) can decide the Functional Location structure.
Generally, it will combination of both. Also accommodate your Business Requirement.
Check the below link.
http://help.sap.com/saphelp_crm60/helpdata/en/01/d5438b4ab311d189740000e8322d00/content.htm