In operations management there are many metrics that are used to measure operational performance. One of the most popular is OEE - Overall Equipment Effectiveness. OEE measures the productive operating capacity of plant and equipment, compared to the theoretical maximum capacity of that plant and equipment. That is, OEE measures the plant capacity that a company has invested in against the capacity that it is using productively. Losses from theoretical capacity are generated by any factor that reduces the output of the plant and equipment, including not being required to produce, unplanned downtime, planned downtime, reduced operating speeds, and reduced operating volumes. A world-class value for OEE is said to be 0.851. By itself OEE doesn't tell us about causes of losses but it is a good indicator of the effectiveness of production equipment investment and its management.
So, for example, if you buy too much equipment and some is left idle because it really is not required, you would have a low OEE. If your maintenance management of the equipment results in poor reliability and excessive downtime you will have a low OEE. If your planned stoppages (for change overs and so on) are too many or too long you will have a low OEE. Overall Equipment Effectiveness is a good, high-level, indicator of production capacity management.
In the above imaginary scenario the OEE of each of the plants would be less than 0.24, if they operated at full capacity, with no breakdowns or quality losses - which probably wouldn't happen. So, would continuing to operate all three plants at low capacity be a smart move or could better use be made of the capital that is tied up in one or more of those plants?
An investment in spare parts, to support your production capacity, is in many ways similar to the investment that is made in production capacity. Spare parts require an investment of capital with the expectation that the investment will be used productively. An indicator of the effectiveness of that spare parts investment is stock turns. This is a good high-level measure of the capacity management of the materials and spare parts inventory investment.
Similar to OEE, if you buy too much inventory and some is left idle because it is not really required, you will have a low stock turn. If your procurement management results in poor availability and thus drives excessive stock levels to cover the problems, you will have a low stock turn. If your parts usage planning is ineffective, you will have a low stock turn. If you buy items way before when they are really needed, you will have a low stock turn. If you don't pay attention to how much is stocked or how it is managed, you will have a low stock turn. Just like OEE and production capacity, the stock turn metric is a good, high-level, indicator of materials and spare parts management.
Measuring Your ‘Stock Turn'
The stock turn is the ratio of the value of the inventory issued in the past year (dollars per year) divided by the value of the inventory held (in dollars) at the point in time that the measure is taken2.
Stock turn = (value used in past 12 months) / (value held today)
For example, if a company holds $5M of inventory today and has issued $2.5M of that inventory in the past year, the stock turn ratio is 2.5/5.0 = 0.5. That is the company has ‘turned over' its inventory investment at the rate of one half per year.
Now, the first thing you might have noticed is that the stock turn is a ratio, not a percentage. This is because the units on the top and the bottom of the calculation are different. The top is dollars per year and the bottom is just dollars. Hence the value of the above example is 0.5, not 50%. I'll have more to say on the use of a stock turn percentage later.
What ‘Stock Turns' Tells Us
Just as OEE measures the effective use of the investment in production capacity, stock turns measures the effective use of the investment in spare parts capacity. It tells us if we have over-invested in the inventory and can, in conjunction with other measures, indicate whether we have the right mix of inventory. Note however, that while the stock turn metric tells us if we have ‘lazy inventory' we shouldn't try to use it to tell us about specific inventory items.
For example, in my experience the stock turn of 0.5 shown above is typical but quite low. By itself, this value indicates a plant that is overstocked. This may be further confirmed if the number of stock outs that the plant experiences is also low (something that is generally seen to be good). However, if the number of stock outs is high (which is bad) and the stock turn ratio is low, this indicates that there may be an investment in the wrong type of inventory. That is, that the money is tied up in stock that doesn't turn over and that they hold too little of the stock that is in demand.
Just as an OEE measure can be a catalyst for further investigation into plant investment and operational inefficiencies, the stock turn measure should be the catalyst for further investigation into spare parts investment and management operational inefficiencies.
So, what is a good stock turn?
An appropriate target for stock turns for your specific business type in your specific location will be influenced by a range of issues, some within your control and others outside of your control. An example of something outside of your control would be if you have spares that are imported from somewhere far away or you are in a very remote and isolated area. In these cases you are likely to need to hold more safety stock and therefore have a lower stock turn. An example of something that is within your control is if your management processes don't adequately control decision making on inventory stocking. Again this would lead to having a low stock turn.
Common Problems and Mistakes
There are a number of common problems and even mistakes that are made when using and interpreting stock turn measures.
1.Not including all inventory A stock turn ratio must be applied across the entire inventory. You cannot ‘cherry pick' elements of inventory. The reason for this is that some inventory items will naturally have a high ‘turn' and some will be low. The aim of the ratio is to measure the overall efficiency of the inventory investment.
In one recent case an inventory manager tried to justify the size of his inventory by pointing out that one section of inventory had a stock turn of 5 (very good in his circumstance) and that another section had a stock turn of 0.2 (very bad). The justification was that low stock turn spares caused the low stock turn and therefore nothing further could be done. This analysis, however, ignored a large component of inventory that could be managed to lower levels and it ignored the possibility of consignment stock for the fast movers.
In another example, it was argued that as the company had negotiated for many of their items to be held on consignment the low stock turn ratio of 0.43 was acceptable. However, when we added back the consignment stock with its full values for issues but without the value for what was held (a very generous way to calculate the ratio) we found that the overall stock turn ratio only increased to 0.56 - still a long way short of the ‘acceptable' level of 1.0.
1.Using the Wrong Data As the stock turn ratio shows the effectiveness of the investment in spare parts, it follows that the calculation should be based on the value used in the past 12 months. However, a mistake that is sometimes made is to base the calculation on the value purchased. Depending upon where a company is in the spare parts stocking cycle these two values (used versus purchased) could be significantly different and thus the stock turn calculated quite misleading.
2.Misinterpreting the Meaning Earlier in this article I mentioned that stock turn is a ratio not a percentage. This is one of the most confusing aspects of this calculation. Converting the ratio to a percentage is misleading as it is then interpreted to mean that a certain percentage of the inventory has moved when it has not. Using the initial example (above) with a stock turn of 0.5, it may be that 10% of the inventory (by value) has moved 5 times and the other 90% has never moved. This would only be known through further investigation. But we can be certain that the ratio does not definitively mean that 50% of items have moved.
3.Accepting Defeat Perhaps the most telling mistake that can be made with stock turns is trying to justify the current situation (isn't that the same with almost all metrics!). Companies that accept a low stock turn are in many ways accepting defeat in the battle to manage their working capital investment and will continue to waste money that is spent on spare parts that are not needed at that time. Improving stock turns is not just about eliminating slow and obsolete stock, it is about recognizing opportunities to better manage the existing stock. Here are some examples, from my files, of some of those type of opportunities:
• $2.0M in savings from completing a consignment deal - a genuine cash saving with ongoing benefits. • $1.4M in items (in one storeroom) were duplicated and overstocked and were then preferentially used before other items - a cash saving from not re-purchasing the other items until these were used. • $638k reduction achieved through improved maintenance planning and scheduling - saving wasted expenditure on items that they said would be used ‘one day' (whatever that means).
In each of these cases the company realized the full market value of the spares because they didn't re-purchase plus the change didn't impact their risk profile. Ultimately each opportunity improved their stock turn.
So, what should be done with the three production facilities with a low OEE? One choice is to do nothing and accept the status quo on the basis that the money has already be spent. But the rational business response could be to investigate closing one or more of the sites and improve the effectiveness of the investment in the remaining sites. This would, for example, allow for, and help justify, improved investment in reliability initiatives.
Similarly, the stock turn metric is the OEE of inventory management and implies ‘lazy inventory'. Is continuing the investment in ‘lazy inventory' a smart move, or could better use be made of the capital that is tied up in those lazy components?
References: 1: Maintenance Benchmarking and Best Practices, Ralph Peters, McGraw Hill 2006 2: Smart Inventory Solutions, Phillip Slater, Industrial Press 2010 3: Initiate Action analysis - www.InitiateAction.com
About The Author
Phillip Slater is a qualified mechanical engineer, an experienced operations manager, a seasoned management consultant, and a published author. Phillip holds degrees from the University of NSW and Monash University. He has authored four operations management books, including Smart Inventory Solutions and The Optimization Trap. He is in demand internationally as a consultant, conference speaker, and trainer and has been published more than 60 times in industry and trade magazines around the world.