Table 2-1: Relevant Terms and Expressions
What is the Purpose of Having Inventory?
Before moving on to develop an understanding of how to manage and optimize inventory, it must first be recognized that inventory exists for a purpose. In fact there are three main reasons that companies invest in inventory:
1.To enable supply in a timely manner.
Companies invest in inventory to ensure that the item is available when needed. The investment is based on an assessment that without the inventory there will be a loss of profit due to missed sales. This is true even for spare parts where equipment downtime may ultimately result in a lost product sale — obviously not all customers are willing to wait for delivery.
2.To provide purchasing/manufacturing efficiencies.
Order quantities and batch sizes sometimes force companies to buy more than they need or want in the short term. In this case, they invest in the inventory in order to avoid the extra cost associated with small quantities or batches. (See also Chapter 6: Issues, Myths, and a Few Home Truths.)
3.As a temporary measure to accumulate stock prior to major events/projects.
The major event or project could be a marketing program or an engineering upgrade. In either case, an investment is made in inventory because there is only a small window of opportunity in which to use/move the parts and it is considered that the supply chain cannot provide the quantity of parts required in that window of opportunity.
In all three cases, the real driver for investing in inventory is to minimize the risk of other potential costs or losses. Therefore, it is essential to continue to think of inventory as an investment made with the purpose of minimizing risk.
Why Spares and Indirect Inventory Are Different
While the process and actions discussed in this book can be widely applied to many types of inventory, they are particularly effective on spare parts and indirect inventory. Indirect inventory can be defined as the stock of all the “bought in” materials that companies might use. This includes parts and components (in assembly operations), finished goods (for wholesalers), service parts, OEM spares, operating supplies, engineering spares, industrial supplies, and MRO (maintenance, repairs, and operations) parts. Conversely, ‘direct inventory’ is those materials that a company controls and manages along its own supply chain. This includes work in progress (WIP) and finished goods that are created by the manufacturer.
When most companies (or consultants!) work on improving the management of spares and indirect inventory, they typically fall back on the solutions that are applicable to direct inventory. These solutions are well known and proven for direct inventory. However, when it comes to indirect inventory they do have one fatal flaw — they are applied in a ‘one size fits all’ approach. This works perfectly well with direct inventory because large quantities follow the same supply path and have reasonably predictable usage, but this is not the case with spares and indirect inventory.
There are in fact six reasons why spares and indirect inventory are different and why the ‘one size fits all’ approach does not work.
1.The demand is less predictable.
With most types of inventory, demand forecasting receives a huge amount of attention. With stable and predictable supply chains, an accurate forecast is seen as being the best way to manage inventory. In these cases a forecast that is wrong by 10–20% can cause significant problems. However, with some spares and indirect inventory, the demand could vary by 100% and this would still be acceptable. Consider an engineering spare where the usage is twice what was expected or where there has been no demand, yet the item is kept in stock. Managing this order of magnitude difference in predictability requires a different approach to spares and indirect inventory management.
2.There is usually a large number of Stock Keeping Units (SKUs).
It is common for organizations that are managing spares and indirect inventory to have thousands or tens of thousands of SKUs. There are few manufacturing organizations that can claim to have that number of SKUs in their direct inventory.
3.The supply characteristics may be different for each and every SKU.
In addition to the large number of SKUs, another attribute of spares and indirect inventory is that the supply characteristics of each and every SKU may be different. The items will, almost certainly, come from a wide range of individual suppliers and rarely does an organization purchase sufficient quantities of a single item to be able to dictate the logistics of supply.
4.The value and volume of SKUs varies greatly.
Not only is there a large number of SKUs with different supply characteristics but also the value of individual items and the volume of individual items will vary significantly. With spares and indirect inventory, management must be able to economically order, receive, handle, and store components that cost a few dollars and components that cost thousands of dollars — all with the same system and approach. Some of those components will be supplied in ones or twos and some in the hundreds. Again there is significantly greater variation than with direct inventory.
5.Stockout costs can be disproportionately high.
When a company runs out of direct inventory, the cost of that stockout is generally limited to the profit margin from the sale that is lost. With spares and indirect inventory, stocking out of a two dollar component may result in thousands of dollars in lost production. This potential for significantly disproportionate costs for a stockout drives many companies to overstock spares and indirect inventory ‘just in case.’
6.In some circumstances a low stock turn may be acceptable.
A high stock turn rate is a goal for most inventory management. This figure can be used as an indicator of the efficiency of inventory management. However, with spares and indirect inventory, it is sometimes acceptable to have very low stock turn rates. In those cases, the low stock turn rate is usually a function of the unpredictable demand, the high stockout costs, and long lead times for supply. Companies should always seek to maximize their stock turns. But they also need to recognize that an acceptable stock turn for one type of inventory may not be acceptable for another.
The degree to which any one of these issues impacts an organization depends upon the organization’s individual circumstance. However, one thing is certain. With this number of issues to differentiate spares and indirect inventory from direct inventory, the solutions used for direct inventory management cannot be applied in a ‘one size fits all’ fashion to these types of materials.
An Introduction to the Materials and Inventory Management Cycle
Materials and inventory management involves much more than just reviewing the maximum holding level and checking items into and out of a storeroom. Materials and inventory management involves a cycle of activity that starts when the initial need for an item is recognized and then works through setting parameters, procurement/ordering, delivery, storing, issuing, and reordering. This Materials and Inventory Management (MIM) cycle is shown schematically in Figure 2-1.
Notice that each of the steps in Figure 2-1 has an arrow that feeds back into the step in which it originates. This arrow indicates