Are the Benefits From Inventory Savings Real?

Last month I wrote about the cost of delaying action when improvement opportunities are identified. My point was that many people only consider the accrual of benefits AFTER they have taken action and not the opportunity cost of not taking or delaying action (e.g. if I can be $100 better off by doing X then it is effectively costing me $100 if I don’t do X). And by the way, if you delay action you can never catch up!

This item resulted in quite a bit of feedback so I thought that this month I would close the loop on that discussion by sharing the feedback and comments with everyone. Essentially the comments I received come down to one concern: Are the benefits from inventory savings real? Here is a summarized version of my responses.

It is right to be cautious about the generic measures we use for estimating the value of holding inventory and we should take the generic values used for both the costs and savings as indicative. That is, the value and opportunity will be different for different companies and circumstance, so we need to consider the specifics. The following are some issues to consider when identifying the specifics for your situation.

1. The cost of money. The financial term is the Weighted Average Cost of Capital (or WACC – pronounced ‘wack’). This value takes into account the various funding sources for a company, such as loans, shareholder funds, bonds etc. It is often compared to (and even guided by) the opportunity costs of investing the funds elsewhere. In an economic sense these costs are real. As a result the value is usually much higher than the prime interest rate most people think about (usually equating the cost of money to the cost of their mortgage). Maybe your CFO could tell you what your company’s WACC is, as each situation is specific.

2. Fixed costs. It is correct to say that if you don’t eliminate fixed costs you don’t save anything in that area, you just spread the cost across a smaller number of items. However, we can be very effective in reducing these costs. For example, I have clients who have eliminated external warehousing, put off building new warehousing, been able to ‘repurpose’ space to save other costs (e.g. turn spares warehousing into general warehousing and so eliminate costs in general warehousing), been able to reduce the space they use and so reduce heating/cooling costs, repurposed forklifts and so on. Again each situation is specific but make no mistake, these savings are real.

3. Variable costs. One cost that many companies incur is the cost of conducting stocktakes. By reducing the volume of items to count you can reduce this cost. If the labor used is internal this might save overtime or you can redirect the staff to achieve other things and save costs elsewhere. If you bring in labor for the stock take there is a direct saving. Improved spare parts and warehouse management can also save money by reducing the time technical staff spend looking for spares. Again each situation is specific.

4. The ‘obsolescence time bomb’. I talk to companies about this ‘time bomb’ in their inventory because the stock they now carry may not show up as slow moving today (depending upon how they measure this) but still may result in significant obsolescence and write downs in the future. Most people see obsolescence as a ‘future and past’ issue. That is, it happens in the future based on actions in the past. But it really is a ‘today’ issue because today’s decisions direct our future results. By addressing the holding levels today many companies can minimize the impact of future obsolescence. This is a real saving in the cash spent today. For example, we sometimes buy large quantities of items believing that the purchase provides the lowest purchase cost. However, if we do not use the items, we do not get the advantage of the ‘economic purchase’ and so money has gone out the window. The ‘time bomb’ goes off when we finally realize (or admit) that something is now obsolete because we no longer need it.

One of my favorite quotes is from Albert Einstein who once said ‘The important thing is to not stop questioning’ and I encourage everyone to keep asking questions.

Satellite Based Inventory Management

Ever had problems locating an inventory item that you just knew was being held somewhere in your system but weren’t sure where?

Yesterday I was with a company that had this very problem with a large, engineered component. The maintenance team needed this particular component and they knew that it was being stored at another site but the stores and warehouse management team at that site couldn’t locate it. Based on memory and driven by frustration one of the maintenance guys used Google Earth to zoom in on the store’s yard and identify the item in the south east corner! He then sent the screen shot and directions, along with a store request, to the store supervisor! Forget RFID we now have satellite based inventory management!

Stock Turn Measurement and Problems

This 2Minute Tutorial explains the calculation of stock turns and presents 4 common problems with both calculation and interpreting the stock turn ratio.

Reviewing critical spare parts

Maintenance and reliability engineers will happily (well, not happily) undertake a review of spare parts that are not classified as critical, yet they will shy away from reviewing items that are classified as critical. The argument is: ‘the item is critical and so we must stock it’. Thus the classification drives the review action rather than a cost benefit or stocking analysis. But what if the classification was wrong, or the item was significantly overstocked, or the supply arrangements had changed? Surely these are factors that can be reviewed and have nothing to do with the part’s criticality?

It doesn’t make sense to limit your review action based on the idea of criticality alone. This will drive you to review parts that are critical but not defined as such and not review parts that are defined as critical but which may no longer be critical. Classifying an item as critical tells us that we need to have ready access to the item when it is required, it doesn’t tell us what the alternatives are or how many we need to carry. Nor does it tell us whether we need to actually own the items prior to needing them. Don’t shy away from reviewing critical items. They may be just as overstocked as any other item, or there just might be a viable alternative to holding the item at all.