Senior executives, particularly those in the C-suite, have metrics driven by the P&L statement and balance sheet. When proposals connect to a positive impact on these financial statements, they are more likely to obtain executive support. Financial ratios can affect the share price, the executives' income, and, potentially, their job security. An example of a common financial metric for risk is quick ratio (or "acid test"):
Quick Ratio = (cash + marketable securities) / current liabilities
Reducing inventory and adding cash to the numerator improves the quick ratio. Similarly, using these funds to reduce liabilities in the denominator improves the ratio. The improvement makes an investment more attractive, raising the stock price and overall stockholder value. Since investors use this ratio to evaluate risk, an improvement will also reduce interest rates on the company's debt and improve profitability. Through optimization and less inventory, additional cash improves financial measures, stockholder value, and executive metrics. Improving your boss' metrics is often a good career move.
MRO Material Categories and Policies
Particularly in asset-intensive industries, replacement parts can represent a significant portion of operating costs; some utilities have reported expenses as high as 15 percent of revenue.
To provide clarity for this analysis, MRO replacement parts are bifurcated into two distinct usage patterns. Repetitive parts (like filters) wear, requiring regular replacement. Critical spare parts are stocked to control the risk of a lengthy interruption should a part fail in vital equipment required for production to operate, particularly those parts with a long lead time. This segmentation, repetitive and critical, helps reveal two corresponding and very different inventory management policies.
Repetitive Items Inventory Management
Min/Max Inventory Management: Items used repetitively have a demand history used in traditional min/max inventory management. The demand history, inventory carrying costs, and lead times drive a calculation for re-order point (min) and economic order quantity (EOQ). ERP and EAM systems have features that provide these calculations.
Vendor Managed Inventory: A core competence of a distributor includes inventory management with a high fill rate (otherwise, they do not last long due to cash flow and customer satisfaction issues). Vendor managed inventory (VMI) agreements with a local distributor offload the inventory and its management. The distributor's systems manage reorder point, EOQ, and the associated supply chain.
Critical Spare Parts Inventory Management
A combination of theory of constraints (TOC) and reliability centered maintenance (RCM) determines the critical equipment and associated critical spare parts for stocking. Many consider RCM too time-consuming to use to apply to every asset. Instead, they focus on the critical equipment identified by TOC or safety concerns.
With critical spares, using VMI is inherently risky. Keeping an item in inventory that has no demand goes against a distributor's systems, metrics, core competence, and culture. When one of these parts is sold, its people will celebrate getting rid of a "dog." When the next need for the part occurs, it will not be available.
Causes of Sub-Optimized Inventory
Asset management functions segment into three groupings, with the key metrics as shown with ARC's model for Asset Lifecycle Management (ALM). Conflicting metrics drive dysfunctional organizational behavior. This maxim applies to asset management.
For an upgrade, the project team key metrics focus on budget, schedule, and meeting specifications. Selecting parts from a catalog of existing MRO items takes additional time with no benefit to the engineers. It is often easier and faster to create a new part number. At handover, a massive information transfer occurs from engineering to operations with little incentive or methodology for engineering to avoid part number duplication. Neither the project nor operating teams rationalize duplicate numbers, resulting in a huge problem that worsens with time. Each upgrade adds to the "dirty data" and compounds the MRO inventory management problem.
Growing asset diversity, including new designs and technologies, compounds this part number duplication. In the new design, many of the old part numbers continue to exist, with a few new ones added for the improvements. Occasionally, all of the parts are assigned new numbers even though few are new. New technologies provide new types of equipment with an entire set of new part numbers. Together, these changes drive more SKUs for MRO inventory.
Duplication creates multiple instances of the same inventory. Also, after an upgrade, the spare parts associated with the removed equipment are no longer used but remain in stores. In reality, the parts could be used elsewhere in the plant if the duplication was identified, or sold while they still have value.
The dollar amount tied up in inventory continuously expands. As more cash becomes inventory, financial metrics for the corporate balance sheet erode and negatively affect shareholder value.
Data cleansing and inventory optimization provide an opportunity to reduce costs. Initial steps in MRO inventory optimization are:
Part Number Rationalization: Part number rationalization establishes a strong foundation for further improvements. Many organizations successfully outsource this rationalization. Well-defined and proven methodologies provide structure to each description and the associated part number assignments. With this structure, duplicates become much easier to identify. Part number rationalization also provides a standardized description format that technicians, dispatchers, planners, and even project engineers can interpret to identify the needed parts. The rationalized part numbers become a master parts catalog.
Business Process Management: Examine business processes (particularly handover) to avoid the creation of new, duplicate part numbers. For example, while designing a modification, the engineers should choose parts from the master parts catalog. Also, examine the ALM business processes for those authorized to add a new part number or edit an existing one, and provide visibility for these changes.
Data Cleansing: Optimize the re-order points and EOQs for each item in MRO inventory based on demand history.
Often, maintenance people focus on the equipment with much less attention given to materials management. The steps for MRO inventory optimization are:
Part Number Rationalization: Examine part numbers and apply a standardized part number assignment schema.
Identification and Disposal of Obsolete or Overstock Items: For duplicate items tagged for removal, use a two-tier hierarchy until the inventory is gone. Put a hold on buying additional parts and enter the replacement item in the "Alternate" field. This continuously uses excess inventory while reducing the size of the item list. For items with no application, sell the inventory back to the supplier or through eBay.
(Data Cleansing and Optimization Issues for MRO Inventory)
Prevention of New Duplicate Part Numbers: For the remaining rationalized part numbers, create an MRO parts catalog. Examine the business processes for creating a part number and assure that the preferred choice is in the catalog before creating a new SKU.
The benefits of MRO materials optimization include lower spending, reduced unit costs, less expedited delivery costs, and recovering obsolete inventory. Also, fewer stock-outs improve uptime. Optimization of this inventory should have a positive impact on the balance sheet and P&L statements - and your career.
Ralph Rio is the Research Director for ARC Advisory Group. His focus areas include Enterprise Asset Management, 3D Laser Scanning Systems, and Continuous Improvement Programs. Ralph has 35 years of experience with manufacturing applications, and he's been with ARC Advisory Group for 8 years. www.arcweb.com