Despite these obvious financial issues, and the quantum of funds that are invested in this inventory, engineering materials and spares inventory management isn’t a serious business topic for many people. This inventory is something that trades people and engineers stress over, accountants count, or stores people store. Many people in business concern themselves only with strategy or sales or process management or IT solutions because these are seen as high profile and ‘sexy.’ At the other extreme, some people consider inventory only as a means to an end. The attitude is to stock more ‘just in case’ but the cash impact of this is not always fully appreciated. Inventory management, it seems, is considered by many to be an activity at too low a level to create genuine financial advantage because changes in this area don’t directly affect operating budgets or profit. By definition, the working capital tied up in this inventory is a cash expense that does not appear on the ‘Profit and Loss’ statement. Therefore, it gets little attention.
This is why engineering materials and spare parts really are the forgotten investment.
Inventory Process Optimization™
The Inventory Process Optimization™ Method aims to cast inventory in a different light. Taking a proactive approach to optimizing processes can provide significant financial advantage and enable companies to free up millions of dollars in cash. This is money that has been invested in inventory, but which either wasn’t needed in the first place or is no longer needed due to a change in the market or operating environment. These changes could include a change in the level of demand, a change in the ability to supply, or both. In either case, there is an opportunity to free up cash and make alternative investments.
This book addresses the range of issues faced when managing inventory and details an approach to inventory review and reduction that has been proven to work and deliver results. Using the processes presented in this book, one company recently achieved an $18M inventory reduction in a little over 14 months. This represented a 36% reduction in the total value of their inventory. Importantly, they generated a $24M improvement in cash flow which they then invested in business improvements projects. These benefits were achieved with no loss in operational integrity, no capital investment, and no significant use of external resources. There are few investments of time or money that can match that kind of return!
By following the process and actions set out in this book, you too can implement some smart inventory solutions and achieve true inventory optimization.
Management, Reduction, or Optimization?
In all fields of management, the language and terms that are used evolve and change over time. Sometimes these changes reflect a broadening in expectations, such as the evolution of ‘maintenance’ into ‘asset management.’ Sometimes it is an innocent confusion that results from widespread use. And sometimes, it is a deliberate obfuscation by people in order to gain advantage by making the simple look complex or vice versa.
In my experience the terms inventory management, inventory reduction, and inventory optimization are frequently interchanged and misrepresented. For the sake of clarity, the following are the ways in which these terms are used in this book. Understanding these terms in context will help take us on the first step towards understanding why process optimization is the real issue in improving inventory outcomes.
Materials Management
Think of Materials Management as the top level process for control of all materials. This includes the recognition of need, estimating requirements, purchasing, and logistics of supply. Some materials may be purchased for immediate use and so will not end up as inventory
Inventory
Inventory can be defined as: All materials and spare parts that are held for future use without knowing exactly where and/or when the item will be used. This definition is discussed further in Chapter 2.
Inventory Management
Inventory Management is the activity that ensures the availability of inventory items in order to be able to service internal and/or external customers. In an operational environment, the customer will be the maintenance and production departments; in a finished goods environment, the customer is the external customer. Inventory management involves the coordination of purchasing, manufacturing, and demand to ensure the required availability.
As inventory management aims to ensure availability, the focus, almost invariably, is on the minimization (or even elimination) of stockouts. That is, minimizing any occurrence where there is not sufficient stock to meet demand. The logic that drives this behavior is as follows: Running out of inventory has consequences and there always seems to be a need for blame. Being blamed for something is an unpleasant experience for most people and in extreme cases can be seen as ‘career limiting.’ Therefore, any stockout triggers an action, not only to restock but also typically to overstock, in order to avoid the negative consequences of the stockout. If the inventory is already overstocked, for whatever reason, there may not be a stockout to trigger a need to take action. Therefore, there is no signal that a problem exists. A company may be overstocked and never perceive that it has a problem. Hence, a specific program of activity is required to identify these items so that their stocking can be adjusted to more appropriate levels. The result of this approach is overstocked inventory.
From this description we can already see that the traditional approach to inventory management involves processes that drive behaviors that systematically overstock inventory. This is why so many companies are overstocked.
Right now, I know that the purists will be saying, ‘Wait a minute, we can put in signals to indicate overstocking such slow-moving stock indicators.’ However, the practical reality is that these flags are rarely acted upon until the overall value becomes too large to ignore!
Inventory Optimization
Inventory optimization is an analytical technique that uses historical data and theoretical formulae to calculate the required level of inventory for a desired level of availability. Inventory Optimization can be a very attractive approach because it is ‘fact based.’ However, this strength is also its weakness because quality data is so hard to achieve (more on this in Chapter 9).
Also, by its very definition, this approach must assume that all of your existing conditions and processes are fixed; otherwise, the calculations cannot be completed. This means that Inventory Optimization does not and, in fact, cannot address the process and behavior issues that actually drive your inventory outcomes. For these reasons, Inventory Optimization can never be a solution to your inventory problems. It can only ever be a tool that is used as part of a wider program of review and then it must be used with caution.
Inventory Reduction
Inventory reduction really is just a goal. It is not a technique or a process. For example, retailers many have an ‘Inventory Reduction Sale’ where they sell unwanted stock at low prices. With engineering materials and spares inventory, the goal might be to reduce the level of investment in inventory (that is, the working capital or cash that is tied up) without negatively impacting the operational results.
Inventory Process Optimization™
Inventory Process Optimization™ addresses all of the shortcomings from the above. By combining inventory management fundamentals with optimization techniques, and utilizing systems thinking (Chapter 4), double loop learning (Chapter 8), and hypothesis driven