into a sense of operational excellence when nothing could be further from the truth. When subject to critical analysis, the reasons for this become quite obvious. Let me explain.
Traditionally, one of two approaches has been applied: either undergo data analyses using a statistically-based software algorithm, or select a single criterion (such as obsolescence) and look for inventory that meets that criterion. Both of these approaches overlook one simple fact.
High levels of materials and spares inventory are a symptom of the broader issues with the way the inventory is controlled, supplied, accessed, purchased, and managed. Inventory levels are determined by a combination of supply chain management, internal policies and processes, and people’s behavior and training. These issues involve a wide range of personnel who come from engineering, maintenance, stores, inventory management, procurement, and even finance. Achieving true inventory optimization and lasting results requires an understanding of all the behaviors, context, and process factors that influence the inventory. Addressing high levels of materials and spares inventory through traditional inventory review and ‘optimization’ techniques does not address these issues as it rarely involves the range of personnel that influence the outcomes and does not improve the company systems and knowledge to address these issues in the future.
Neither software algorithms nor single criterion solutions address the full range of possibilities and so they cannot possibly provide true optimization. The short-lived gains they do achieve will, most likely, be reversed when the focus is taken off the immediate project and the operational processes and behaviors once again influence the inventory levels.
Achieving true inventory optimization requires a new, innovative approach that combines knowledge of parts usage, procurement, and supply chain issues with a review of behaviors and the management processes that drive them. This approach is known as the Inventory Process Optimization™ Method.
This second edition of Smart Inventory Solutions expands on the key material of the first edition to encompass and explain the Inventory Process Optimization™ Method. In doing so it also explores the supply chain, policy, process, people, and behavior issues that must be addressed for the achievement of true inventory optimization.
Inventory: The Forgotten Investment
Materials and inventory management is one of the most important disciplines in almost every company. Inventory can provide the capability to fulfill a customer need, repair a broken machine, assemble products for sale, or just keep production going. Yet, inventory management is widely perceived to be one of the most boring management topics there is. Mention inventory management to most people and almost immediately their eyes begin to glaze over. In fact, someone once suggested to me that the title of this book should be: Inventory: More Exciting Than It Sounds!
However, consider this: for manufacturing organizations, inventory can account for up to 50% (or more) of the current assets of the business (see Appendix A for a glossary of terms used in this book). This means that for most manufacturers, up to 50% of their assets that could convert to cash in the next 12 months are tied up in inventory. For retail and wholesale businesses, the figure is even higher. While materials and spares holdings typically do not reach these values in terms of percentage of assets, a large number of organizations have millions and even tens of millions of dollars tied up in this type of inventory. Some larger organizations with which I have worked even have hundreds of millions of dollars tied up in spares.
The problem is that, unlike cash, the money tied up in this type of inventory is not available for any other use. It cannot be used to fund the business or for further investment in other productive assets. With engineering spares, this problem is even more exaggerated as the inventory is not purchased with resale in mind. The funds spent on this type of inventory are essentially gone; there is little probability of a genuine return on investment. Unlike receivables, this inventory does not represent a defined future stream of income. (The exception to this issue of resale revenue is the combination of wholesalers and final suppliers of parts who do sell their inventory. However, the ideas and processes in this book do apply equally to them.)
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
