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A Perfect Storm for an MRO Stockroom Crisis

A Perfect Storm for an MRO Stockroom Crisis

by Joel Levitt

There is a multi-headed monster of a crisis barreling toward us.

A Perfect Storm for an MRO Stockroom Crisis

This crisis in the sourcing, stocking and justifying of maintenance, repairs and operations (MRO) spares has been developing since the 1990s and will likely get worse before it gets better. The core of the crisis and the reasons for it are distinct. These distinct contributors form the perfect storm of trouble for any maintenance department, especially ones that have implemented lean principles. The solution is surprisingly in the domain of asset management.

Organizations are increasingly having trouble gaining access to spares for critical assets (note that you do not have to own the spare, just have access to it when you need it). The core of this crisis is the fundamental misunderstanding of the role of spares inventory in general and of critical spares in particular, and tremendous changes in the parts supply chain.

Organizations are increasingly having trouble gaining access to spares for critical assets.

Before Addressing Spares, Let’s Define AIM

The AIM of an organization is defined as the publicly published mission, vision and values. The AIM is the ultimate truth for any organization; it is the reason for the organization’s being.

Metrics

Metrics, also known as performance indicators (Pi, Uptime® Elements), are numbers and ratios that tell the story of what is going on in the organization. Ideally, metrics are used to manage action within the organization. Choosing the right metric is important because the wrong one will drive the wrong actions. There are many right actions on a functional or departmental level that are wrong when looked at from the perspective of the organization’s AIM.

For example, if you are trying to encourage customer engagement, you might measure complaints. You might interpret increased complaints as proof of increased engagement. After all, complaints do measure engagement, so what is the problem?

While greater complaints = greater engagement might be true, greater complaints might be considered deleterious to the AIM (i.e., mission, vision, values) of the organization. The problem is the metrics might drive the wrong behavior.

Let’s say your organization’s AIM states that it is a “low-cost, high quality producer with great customer relationships committed to people, planet and profit.” While people now know your reason for being, the greater complaints = greater engagement tends to contradict that AIM.

Getting back to storerooms, what do metrics that are contradictions to the AIM look like? Where is the misunderstanding of the role of the spares inventory?

Let’s say you carry a $3,000,000 inventory and you are ordered to dispose of any inventory items held for more than two years to free up space, reduce cost of ownership and free up funds. There is $275,000 of spares in this category.

Disposal of the $275,000 will free up space, reduce the cost of ownership (marginally) and might even free up some funds (5 to 10 cents on the dollar anyone?).

The other side of the argument is the impact on the AIM in being a “low-cost, high quality producer.” If a disposed part is needed for a maintenance incident, then the cost of the metric to dispose of the inventory might be 50 or 100 times greater than any savings or money generated from the disposal.

Another metric might be turns, which is annual purchases divided by inventory value. Higher turns mean the inventory is sitting on the shelf for a shorter time. It is said to be turning faster. This is particularly important in retail because the more turns for the same inventory, the greater the profit. Since you don’t make money until the item turns, it is a direct drag if it isn’t sold.

There are categories of maintenance stock that can be evaluated by turns. In fact, all items used more than once a month can be subjected to turns calculations. Considerable savings can be gained from an analysis of these categories.

Unfortunately, as many as 50 to 75 percent of the SKUs turn less often than once a month. Many items might turn only once a year or less often.

Optimizing slow moving items to improve turns creates a situation where you’ll save a few dollars until you need an item, but then you might induce production losses costing millions.

This situation is driven by actions that make sense to a function or department, but do not make sense to the organization’s reason for being or its AIM.

The misunderstanding is that many departments consider MRO spares inventory as an inventory asset. Inventory assets should be minimized because they soak up working capital and provide no direct value to the value stream producing the product. Logically, from this point of view, reducing this non-value-added inventory is the right thing to do.

More Accurate Point of View

The MRO spares inventory should be considered as a portfolio of insurance policies. Each policy (i.e., critical spare part) has a premium (i.e., cost of ownership) and a benefit (i.e., reducing duration of downtime).

The MRO spares inventory should be considered as a portfolio of insurance policies. Each policy has a premium and a benefit.

Typically, no one would look at their insurance policies and decide to discontinue coverage if they didn’t use a policy for two years. What people should do is decide if they still have the particular risks and if coverage is worth the premium they pay. This is one way of managing risk.

The Second Half of the Problem: Changes in Getting Parts

When did the supply chain for parts change? Surprisingly, one of the best new tools drives most of the changes to the supply chain. These changes were enabled by advances in computer and data analytics used to optimize value chains.

There are four factors that caused the change. All of these new realities contribute to the present day supply crisis:

  1. Optimization of the finished good inventory by the original equipment manufacturers (OEM) of the spares;
  2. Changes and optimization to the stocking policy by the end user;
  3. Disintermediation due to the Internet and other changes to distributors;
  4. Nature of spares themselves.

Factors one and two are driven by the same desire. Optimizing company assets requires you to look at stocking rules and what is stocked. If you are a retailer, the OEM parts stock is a retail inventory and if something does not sell for a year or more, it does not belong on the shelf. Good business practices dictate getting rid of parts that do not sell or are not used.

Everyone along the MRO supply chain, from the OEM and the distributor to the dealer and user, has been saving money by optimizing their inventory using computer analytics.

The dwindling resources available for the MRO inventory by users of the parts has already been noted. The arithmetic, metrics, rules and techniques of inventory optimization is the same for an OEM, distributer, or end user. The difference is that the retail and wholesale ends of the supply chain profit from inventory optimization (even if it does upset their customers).

Since the end user is buying insurance against downtime, optimization can have contradictory effects. All the financial benefits of years of optimization can be and will be offset by a single breakdown in a critical asset or process. It is that simple. All the savings of not buying home insurance for 10 or even 20 years are wiped out by a single event or by multiple, smaller events.

Note that none of this information supports having triple coverage for a loss (i.e., too many parts) or having coverage for a car you already got rid of (i.e., parts for critical assets you retired). Finally, this in no way supports policies that are not reviewed to see if they are still good and useful (i.e., damaged, broken, corroded parts). These are all legitimate surpluses to be disposed of.

Distributors and Dealers

In years past, distributors sometimes served as the intermediate inventory and, if it was profitable enough, kept sufficient parts for their customers even if the OEM did not. Two changes happened.

One change is described by the fancy word, disintermediation. Because of the Internet, it is easier for customers to locate and buy direct from the OEM. With advances in order entry software and low-cost logistics, like parts banks, it is economical and profitable for OEMs to sell direct to customers.

One fact of life for OEMs is that most of their profit comes from their parts and service business and little comes from the actual sale of the machine or component. The parts business is serious business for OEMs. Disintermediation puts more parts profit into the OEM’s pocket in a very competitive world.

That leaves distributors and dealers in some industries with lower volume and lower profit. In part, their lower profits drove the need to optimize their own inventories. Now, with their business threatened, they cannot justify stocking some of the more exotic parts.

Parts Are Parts, Aren’t They?

For a myriad of reasons, such as accelerating technology, a need for increased efficiency, higher quality tolerances and the fickle nature of specifiers and buyers, the lifecycle of equipment is shorter. Shorter lifecycles mean the opportunity to profit from the part is shorter.

With more variations and shorter lifecycles, it is becoming more expensive and difficult for an OEM to stock everything for all their equipment series, especially the older ones.

Your firm is also part of the problem if, when buying new equipment, you don’t review the parts you already stock and try to buy equipment that uses at least the same lines. Much of the problem locally is that designers are attracted to the newest, best and greatest. This attitude requires more SKUs and makes metrics, such as inventory value, balloon and turns crash.

Asset Management to the Rescue

According to the new ISO standard 55000, asset management is defined as managing the value from the asset and managing the risks associated with producing that value.

What is the value? The value is whatever your organization’s AIM says it is. The AIM begets the assert management strategy. The strategy begets the plan. Your challenge is to build a decision process that weighs the risk and the value, and answers the question for the whole company and not solely for a single silo.

How low does the probability catastrophe have to go to justify the savings?

So the question, “How low does the probability catastrophe have to go to justify the savings?” is a business question that must be addressed! A management-wide approach to managing risk is a primary function of asset management. It is not for the finance silo or the operations silo to address. It is for management to address through strategies developed by working from the AIM.

Are You
Already a Hero?

You are if you:

Already are cutting the inventory level before you even get started.

View inflation in prices of parts over the last decade or two and can see that parts prices have inflated faster than wholesale prices, consumer prices, or most other inflation metrics.

Bravely hold the line on maintenance inventory, equivalent to a five to 10 percent decrease in inventory. You recognize that although it might not sound like a lot, it does accumulate over time, so a $1,000,000 inventory today would be equal to a $2,000,000 just 10 or so years ago.