Asset intensive organizations often manage tens of thousands of items - spare parts, materials, equipment and supplies - to keep plants and facilities running. Procuring and storing this MRO inventory (indirect materials) is expensive, with large enterprises often maintaining tens of millions of dollars of inventory. A.T. Kearney's 2010 Indirect Procurement Study (http://www.atkearney.com) reports that indirect spending sometimes accounts for 50% of thirdparty spend in manufacturing organizations. Still, many organizations perceive direct materials to be more important, as reflected in relative perception (Figure 1) and procurement headcounts (Figure 2).
With this investment and activity, you'd think that organizations would focus more on managing their indirect/ MRO materials spend. In fact, most try, but lack the proper information and analytics. This article will focus on optimizing your MRO spend by providing the proper information and analytics to tell you:
- What to buy
- When and how much to buy
- Where to buy.
"What to Buy" - The Importance of Clean Data
MRO data is notoriously 'dirty,' with incomplete, inconsistent and incorrect descriptions. Plant users can't find what they need and order "new" parts, while procurement can't determine what they are spending money on.
The solution is description cleansing and standardization. Unstructured, free-form text needs to be converted into structured data using a cataloging methodology and 'data dictionary' developed specifically for MRO. Industry standards, such as the Standard Modifier DictionaryTM (SMDTM),2 do this by providing:
Figure 1 Source: MSC Industrial Supply Company - Strategic Opportunities for Indirect MRO Procurement
Nomenclature specific to industrial MRO, which is more complex than that needed for direct materials. This should include a hierarchical classification such as a noun (class), modifier (subclass), characteristics and valid values.
An unambiguous classification structure with a consistent and repeatable set of rules to characterize and catalog inventory. An item must be classified in only one place.
Classification guidelines, definitions, images and synonyms/aliases. These not only assist users to choose the correct classification, they also assist those who search the catalog.
Capability and rules to create short and long standardized descriptions for use in ERP/EAM systems.
Compatibility and cross-referencing with upper-level classification systems (such as the United Nations Standard Products and Services Code® (UNSPSC®), covered later in this article).
The cleansed and standardized descriptions support users who work in the plant or procurement by making clear what exists, what is being used and what is being bought. Clarity eliminates duplicates and wasted spend.
Some companies choose to cleanse and standardize the descriptions themselves using a standard such as the SMDTM, or outsource to companies that specialize in these activities.
When and How Much to Buy - The Importance of Correct Order Metrics
MRO inventories are unique in that there are pockets of items with consistently high demand, while others sit stagnant with occasional demand spikes. Stockrooms hold critical "must-have" insurance spares, as well as over-stocked and obsolete items that you'll likely never use. ERP and EAM systems do not dynamically monitor and adjust order points, order quantities and lead times. This information is typically entered once when an item is first added to inventory and then managed by exception - such as when a stockout causes downtime.
It is vital in controlling costs to make sure that you are not over-ordering parts because you have the wrong order quantities and lead times (while also making sure you are not under-ordering). Common planning tools don't take into account the sporadic nature of spares usage. To address this, many companies have implemented an MRO inventory "decision support" service to optimize order points, order quantities and lead times. A Web-based service, such as xIO Inventory Optimizer TM 3, tailored specific for MRO can be swiftly implemented and interacts seamlessly with your ERP or EAM system, thus improving material availability and achieving cash flow savings.
Where to Buy - Addressing the Categorization Conundrum
Companies often look to common categorization methodologies (such as UNSPSC®) to better understand where they are spending their funds in the hope that this will help them to improve performance and lower costs.
Since UNSPSC® categorization (and other similar approaches) have functioned reasonably well for direct materials, many assume that MRO/ indirect spend can be managed the same way. Unfortunately, the complexities of indirect spend in general, and MRO in particular, have proven difficult to manage via UNSPSC® and similar tools.
For example, choosing a UNSPSC® category for a standard washdown duty 25 HP Baldor VL5000A motor requires categorization at either a generic "Electric Motors" category, or one of a number subcategories that could equally well describe the motor depending on usage (e.g. Compressor Motor) or design (e.g. Single Phase Motor). However, there is no category for perhaps the most relevant characteristic (i.e. washdown duty motor). As a result, users are unable to effectively group spend into relevant buckets using a standardized coding approach alone.
A customized categorization approach is needed that provides for "actionable" categorization. Categories must be both commercially relevant and manageable in scope. In addition to existing coding information, the customized categorization approach must account for such characteristics as description, usage, manufacturer, supplier/distributor, purchase methodology and geography.
For some categories, standard coding will be sufficient. For others, supplier or manufacturer information may be enough to effectively define an actionable category. More commonly, however, a combination of factors will be needed to develop effective categorization. Continuing with the motors example, one category that might be relevant is: Integral Horsepower AC Washdown Duty Motors. This category might be best identified by combining UNSPSC® data (Motors and all underlying codes), Descriptions (parsing for information such as "wash" in the description), Manufacturer (e.g. Baldor) and Manufacturer part numbering schemes that indicate washdown duty design.
Area Spend Procurement Headcount (Corporate)
Total ~$3.0 Billion 101
Direct ~$1.2 Billion 60
Indirect (MRO/Technical) ~$2.8 Billion ($900 Million) 41 (11)
Figure 2 - This example of a leading food manufacturer shows headcount often diametrically opposed to spend and complexity levels of direct materials versus indirect materials.
Figure 3 - Before and After Diagram
What constitutes an "actionable" category? It is a grouping of goods and services that can be defined as a market. A category might be driven by a group of suppliers who provide similar goods/services (i.e. janitorial services) or a grouping of items that compete with one another (e.g. washdown motors), even though they can be obtained from a variety of sources (who also sell other goods/services and may not even consider each other competitors).
Effective categorization provides the foundation for a powerful sourcing program by enabling buyer specialization and the development of meaningful category sourcing strategies.
A recent project4 for a leading protein processing company (revenues of about $15 billion) led with the development of actionable categories and followed with sourcing strategy development and implementation. Within eighteen months of engagement, supplier fragmentation for four major category groupings was reduced from over five hundred suppliers to ten suppliers. In addition, $90 million spend was reduced by 28% or $25 million, and the company was positioned to self-manage category strategies going forward.
Actions You Can Take
Developing actionable spend categories depends on understanding what your organization is buying. The integrity and completeness of item master data is a critical input factor into the quality of categorization. It is recommended that item data cleansing, including an ongoing data management program, be implemented before or in concert with a categorization program. One approach that can drive quick benefits while retaining product quality is to do an initial (highlevel) categorization based on existing data, cleanse item master data and then complete the lower-level categorization once the cleansing process has been completed.
- What to buy - cleanse and standardize MRO item data
- When and how much to buy - optimize inventory levels
- Where to buy - analyze and reform your vendor spend.
Doing each of these has a direct impact on your bottom line by driving unnecessary costs out of your MRO inventory. The tools and processes covered in this article have been repeatedly demonstrated to bring not only a sustained impact on the bottom line, but positive ROI.
More information on this topic can be found at www.mroconnection.com.
- Source MSC Industrial Supply Company - Strategic Opportunities for Indirect MRO Procurement
- SMD is a registered trademark of IHS Inc.
- xIO Inventory Optimizer is a registered trademark of Xtivity Inc.
- Project performed by OptiSource Solutions
Will Templeton, Intermat Solutions Specialist, IHS Inc. Will is a senior sales engineer for IHS Inc., working with IHS Intermat Solutions for MRO data cleansing, cataloging and inventory optimization. Will has over 15 years experience dealing with data and data management issues. www.ihs.com
Niels Martin, Founder & Managing Director, OptiSource Solutions LLC. Niels is the Founder and Managing Director of OptiSource Solutions LLC, which develops and provides customized solutions and strategies in the Operations, Procurement and Sourcing arena. Niels has over 20 years of Technical Procurement and Operations experience. www.optisourcesolutions.com.