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This week, we’re talking about inventory optimization. Make sure to check out our previous blog entries to get the full story–How Material Master Data Drives Efficiency: Introduction and How Material Master Data Drives Efficiency: Procurement Strategies.
Why inventory optimization?
Imagine a piece of equipment suffers catastrophic failure. The maintenance staff identify the part that needs to be replaced, but when they try to find it, there aren’t any in stock. Suddenly the production line is halted indefinitely and you’re facing the expense of a catastrophic downtime.
The difference between an easy repair and a costly incident is your inventory. But it’s not so easy as making sure you stock plenty of each item. While you do have to make sure you have items stocked, it’s all about having the right amount according to several different factors. Because having too much is also a problem–it means overspending, more storage costs, and crowded storage rooms.
Returning to our example, imagine that the part you need is available in large quantities at a local supplier. You’re able to go there, get the needed part, and have the production line back up within the hour. In that case, maybe you want to have one in stock for the next time you need a repair, but there’s no need to keep more since it’s so readily available.
Now imagine that same incident, but the part is not readily available. Instead, it’s an OEM part that the manufacturer will take three weeks to ship–or longer, if they don’t have any in stock. Now your downtime extends and costs hundreds of thousands of dollars because you weren’t properly prepared. In that case, having the right number in stock is essential because it’s incredibly difficult to get one on demand.
When you’re ordering that replacement part for your piece of equipment, you’d probably be tempted to buy extras. If you need one part to fix something, then get two or three in case it fails more than once, right? But even that’s not so simple. Looking at transactional data, you might find that you last bought the part two years ago and used it once in the past year. Arguably, having one extra is the appropriate minimum.
As we’re getting at with the example, the biggest challenge organizations face is not having the data they need to make decisions about what should or shouldn’t be in stock. An educated inventory manager looks at activity: how many times an item was bought, how much was purchased, how many times it was used, what the availability of the supply chain is. If you can make decisions based on quality data, you can have a better inventory that reflects what you actually need–especially when you factor in the clashes from Maintenance wanting a surplus of items to avoid downtimes and Finance wanting fewer items to save costs.
Essentially, inventory optimization requires multiple strategies–one for MRO parts and one for OEM parts–and those strategies come down to data.
Inventory challenges
We talked about why inventory optimization is important, but what challenges are we dealing with while trying to have the correct inventory? When you’re not working with consistent, clean data across the board, staff are going to make decisions that don’t necessarily take previous actions into account. That can mean spending more, purchasing stock that already exists, and overstocking.
Multitude of suppliers
It might not sound like a problem to have multiple suppliers, but if purchases are being made from different suppliers, that means you’re getting different prices and likely overpaying. It also makes it difficult to leverage spend, since you’re giving up opportunities for better negotiation with one supplier when you spread your purchases over many. It’s also possible that you’re buying OEM and MRO parts that are essentially the same–spending extra for OEM parts in comparison.
Maverick purchases
When purchases are made from a variety of suppliers, that can also mean you may be paying a premium for items purchased from non-preferred suppliers.
Excess inventory
Ideally, you want to have exactly the right amount of inventory so you aren’t wasting storage space but always have what you need. Without proper (and correct!) data to understand what you need to have in stock and what you actually have, you likely have additional stock “just in case.”
There’s also the frequent issue of still stocking items that are no longer used in production. As that excess inventory continues to accumulate, valuable warehouse space is used up and inventory carrying costs increase.
Difficulty identifying and disposing of excess/obsolete inventory
Without a comprehensive data cleansing and governing process, your historical data is likely patchy and inaccurate. Inconsistent or unavailable historical data makes it much more difficult to set accurate minimum and maximum levels. Overall, a lack of good data leads to a lack of defined strategy.
The objective
If lacking clean, usable data leads to the issues above, what are the goals and strengths of usable data? How do you truly optimize your inventory?
Identify and reduce excess inventory
Using your historic data, you can identify items exceeding the required maximum quantity and develop excess inventory disposal strategies. Disposing of excess inventory allows you to capture cash or credit savings on dead stock.
Leverage spend
Knowing your maximum and minimum needs allows you to establish preferred supplier agreements and reduce MRO item pricing.
Optimize inventory stocking levels
Finally, with the usable historic data, you can adjust your minimum and maximum or reorder point (ROP)/reorder quantity (ROQ) levels for efficient asset utilization and reduced inventory. From there you can establish an inventory strategy going forward (conservative, moderate, aggressive).
Getting usable data
To get to a point where you have usable data that can help you optimize your inventory, you need certain item data. That includes on-hand item information and vendor purchase history information
On-hand item information
On-hand items are what you’d think–items you stock. To generate a comprehensive item analysis, you need the following data:
Internal part number
Part description (this may be divided into distinct fields: noun, modifier, description, notes)
Manufacturer name
Manufacturer part number
On-hand quantity
Part issue by date and quantity
Item location
Unit of measure (unit of issue)
Last price paid
Current reorder point
Current reorder quantity
Internal item category/sub-category settings
Vendor purchase history information
Purchase history is the information required to establish a purchasing profile for each individual item to be analyzed. The profile is based on itemized purchase information collected for a specified period (generally 12 to 24 months) and addresses the following areas:
Internal part number
Part description (this may be divided into distinct fields: noun, modifier, description, notes)
Manufacturer
Manufacturer part number
Unit cost
Quantity purchased
Extended cost
Box quantity
Unit of measure (unit of purchase)
Vendor part number
Vendor number
Vendor name
Invoice number
Invoice date
Purchase order number
Purchase order date
Item receipt date by purchase order number
Analyzing the data
Inventory optimization and spend analysis can reveal significant inventory and procurement related cost savings opportunities. This is because the data lets you break down your inventory and categorize what you have into actionable groups: required active, excess active, and inactive.
Required active items are items that have been purchased or issued at least once during the analysis period and do not have an on-hand quantity that exceeds the IMA recommended maximum inventory stocking level. In other words, you have the right amount of inventory for these items and can move forward maintaining the optimum stock level.
In contrast, excess active items are items that have been purchased or issued at least once during the analysis period and have an on-hand quantity that exceeds the IMA recommended maximum inventory stocking level. Which means you can act on this information to get rid of excess stock (and stop over-purchasing), ultimately saving money.
Finally the inactive items are the ones that have not been purchased or issued during the analysis period. This category can be further broken down into the following subcategories:
Slow-moving: items such as parts with long lead times which may affect plant efficiency, or recommended spare parts which are kept to satisfy risk aversion
Critical spares: items that are essential for the business to operate and stocking out would significantly impact production, quality, safety, and cost
Obsolete: items that are no longer used or required
Below is an example of a report IMA can generate to visualize the data and understand where savings lie:
Working with the data
Once you have clear data and have analyzed it, you can act on it. We already mentioned the inventory strategy options–conservative, moderate, or aggressive. Knowing what your inventory currently looks like will help you determine your approach going forward. With that in mind, you can plan how you will purchase, store, and get rid of excess inventory.
Planning
No matter which strategy you employ (conservative, moderate, or aggressive), you’ll want to start by ensuring no additional items are purchased until stock levels reach the adjusted minimum/reorder point. From there, you can continue to monitor and use your data to appropriately order what you need–and plan smart, bulk orders from the right vendors to get the best price.
Storage
As your stock decreases through holding off on excess purchases and removing unneeded inventory, you can reassess your storage necessities. You may be able to reduce your storage space, or reorganize it to better address your needs now that it is no longer occupied with unnecessary items. A storage area that’s easier to access can lead to additional savings in the form of time employees spend searching for items.
Removing excess
Now that you know what is obsolete and excess, you’ll likely want to get rid of these parts to clear up space. That can be done through methods like reallocation, supplier buy-backs, auctions, third-party liquidation, and e-commerce. Potentially, you’ll be able to recoup the costs spent on obsolete inventory as well as save the money wasted on having to store those parts.
How IMA can help
In this blog post, we’ve laid out a lot of the process to go from chaos to a functioning inventory. It may be overwhelming! There’s a lot to consider and even more to put in place. That’s why IMA exists–to make data collection, cleansing, and governance easy. Our services address a lot of the needs to get to an optimized inventory, and what we don’t do we can assist with or offer recommendations (for example, if you decide to reorganize your storerooms).
To learn more about how IMA can help you, contact us at info@imaltd.com!
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