Subject Area: Working Capital Management
It is easier for individuals to spend money on more inventory than it is to change processes, examine purchases, or better define maintenance needs
6. How 36% of Working Capital Spent on Spare Parts is Wasted
The Paradox of Spare Parts and Working Capital Management
Of course, nobody buys spare parts with the intent to waste money. However, examination of almost any spare parts inventory will identify items that are purchased in excess, obsolete, or just not needed to be held as inventory.
This is the paradox of spare parts management. We seem to do the right thing but still get the wrong result.
To understand this paradox we need to understand how companies spend their working capital on these unnecessary parts for their inventory:
• Sometimes it relates to people trying to do the right thing but not understanding the consequences
• Sometimes it’s due to plain ignorance of requirements
• Sometimes it is driven by the metrics used to measure performance
• Sometimes it results from the management processes and management system
One thing is certain: it is always something that can be controlled – when you know how.
Preventable Ways That Spare Parts Working Capital is Wasted
The key issue to understand is that, through appropriate education and control, much of the waste of funds can be prevented. Here are a few examples.
Capital Purchases: Often capital purchases include a ‘spare parts package’ and these are accepted with little or no examination by the purchaser. To address this requires greater attention being paid to the actual content of the parts package and being clear about the reason why an item should be purchased now and what the required quantity should be.
Risk Management: Well meaning staff can equate more stock with lower risk – a concept that is demonstrably not correct. Sometimes this extra inventory will be used over time but it does, never the less, tie up funds that don’t need to be spent now. When it results in parts that are never used, it is a complete waste of funds.
Procurement: Price breaks can be attractive, especially if procurement is driven by achieving ‘lowest unit cost’. Unfortunately, this sometimes results in buying more than could ever be used!
Internal Processes: Internal processes that delay procurement, delivery, put away, or issuance will always result in increased inventory holdings. Streamlining processes can produce significant reductions in inventory.
Communication: There are lots of examples of poor communication resulting in excess inventory but the big three are: advice on looming equipment/part obsolescence, poor integration between spare parts management and maintenance planning, the timing of advice on actual usage during shutdown/overhaul work.
Accountability: In many ways, accountability is the prime issue. For example, if project managers are not accountable for the parts they order, don’t use, and then have put into inventory, then what incentive is there for them to do the right thing with respect to inventory. If maintenance is not accountable for holding ‘just in case’ inventories, then why would they seek to minimize stock levels? If procurement is not accountable for ROQ’s that are set for their convenience, why would they seek to optimize?
All of these things can be controlled if you choose to do so.
A 36% Reduction – They Must Have Been Terrible to Begin With!
It would be easy to dismiss the idea that 36% of funds spent on spare parts inventory is wasted as reflecting companies that are unsophisticated or just plain hopeless to begin with. But that would be wrong.
The companies that have achieved this use high profile ERP and inventory optimization software. They are companies that work with highly technical and sophisticated equipment. Companies that have extensive management systems to guide safety, procurement, and finance. Companies that spend large sums on training and development of staff. Companies that are household names. Companies that believed that they were ‘doing the right thing’ with spare parts management.
The value of 36% is not chosen randomly or by way of hyperbole: this is the average reduction achieved by companies that apply the Inventory Cash Release® process to evaluate and review their inventory.
Some achieve much more – as much as 50% – and some less. However, over the past 14 years the process has delivered an average of 36% inventory reduction. Plus, because the process produces better trained staff and more relevant policies and procedures these savings have been ongoing for years. This equates to significant reductions in working capital and procurement savings.
The Real Spare Parts Inventory Problem
Someone once said that ‘all problems end up in inventory’ and that is certainly true with spare parts inventory. What this means is that it is easier for individuals to spend money on more inventory than it is to change processes, examine purchases, or better define maintenance needs. Rather than solve the problems in those areas or do the work required, it is easier to purchase more inventory.
This is the real spare parts working capital management problem being faced by senior managers and CFO’s:
Is it acceptable, in the long run, to knowingly waste 36% of the working capital spent on spare parts, or is it better to fix the training, policy, and process gaps that the wasted funds are trying to cover for?
This is a question that only senior management can answer and one that sets the tone for how the whole company is managed.
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Author: Phillip Slater