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ОглавлениеThe Spare Parts Management System
| SPARESOLOGY® STRUCTURE |
| 1. The Spare Parts Management System |
| Understanding Spare Parts | Finance | Policies & Processes | Parts Identification | Best Practices |
| 2. Create & Stock |
| • Deciding What to Stock |
| • Spare Parts Standardization |
| • Capital Equipment |
| • First Time Buy |
| • Critical Spare Parts |
| • Setting the Re-Order Point |
| • Setting the Re-Order Quantity |
| 3. Operations |
| • Forecasting |
| • Inventory Optimization |
| • Managing Repairable Spares |
| • Storeroom Management |
| • Data Management and Cleansing |
| • Inventory Accuracy |
| • Conducting Stock Takes |
| • Bar Coding |
| • Integrating Maintenance and Spare Parts Management |
| • Bills of Material |
| • Spare Parts Procurement |
| 4. Obsolescence and Disposal |
| • Managing Obsolescence |
| • End of Life Management |
| • Last Time Buy |
| • Spare Parts Disposal |
1.1 Your Management Systems Either Are Designed or Evolve Randomly
It doesn’t really matter what part of your business that you work in; there will be a system for addressing the key things that need to be done. In production planning there will be a way that demand and capacity are identified, prioritized, and scheduled. In procurement there will be a way that purchase orders are assessed, vendors selected, and invoices matched. In spare parts management there will be a way that decisions are made on what to stock and how many to stock. We all know this to be true because these tasks are completed on an almost daily basis.
What is less certain is whether the system in use is the most effective and efficient way to get the job done. This is because the systems that are in place today either are deliberately designed or have evolved randomly. Of course, not all “designed systems” are perfect or even fully effective, but there is a reasonably good chance that a designed system will outperform a random system every day of the week. This raises the question of who would allow themselves to have a system that has evolved randomly?
Well, unfortunately, too many companies do. In fact, in our research,1 almost 50% of companies score their development of spare parts management policies as either “no defined, formal inventory policies” or “broad-based corporate-level policy.” With either response those companies are saying that they have no specific set of policies that have been designed for day-to-day application in helping them manage their spare parts inventory. Wow!
But it doesn’t stop there. When we dig down to ask about the development and implementation of a specific spare parts stocking policy, that is, a policy to guide the decisions first on whether or not to stock an item and then on how many to stock, the number of respondents that have nothing in place jumps to a massive 75%! Double wow!
Is it any wonder then that companies find themselves so massively overstocked with spare parts and MRO (maintenance, repair, and operations) inventory, while at the same time having low levels of trust, that they hold the items that they really need? Of course not, especially once we understand that their decision-making system has evolved randomly and so delivers random results.
So what about those companies that have actually taken the time and effort to design a system for spare parts decision making? In our research we segmented the respondents based on their scores in terms of spare parts inventory management results (top performers having steady or decreasing inventory levels, high stock turns, and a low number of stockouts). We found that 75% of the top quintile (in terms of results achieved) had designed and implemented a spare parts management policy. However, we also found that 86% of the bottom quintile had not.
The difference in performance between the top and bottom performers is quite stark in terms of key spare parts management metrics, and so is the approach that they have taken for developing their spare parts inventory management systems. The top performers overwhelmingly design their systems, whereas the bottom performers have allowed theirs to evolve randomly. (These research findings are discussed further in Section 1.18, “Best Practice Spare Parts Management Research.”)
Part 1 of this book discusses the need to mindfully and deliberately develop your spare parts inventory management system. As a background to this, we explore the differences between the typical inventory types such as raw materials, work in progress, finished goods, retail inventory, and spare parts. This understanding helps explain why some of the tools and techniques that are widely used in most supply chain management situations just don’t work with spare parts inventories that are held by companies to support their maintenance and operations activities. Speaking of maintenance, it is also important to understand spare parts in the context of the end users, which is most often the maintenance and reliability function. Another contextual issue is understanding the financial considerations of spare parts inventory management; after all, no matter how they are accounted for, spare parts do cost money.
Having laid that groundwork, we shift our focus to the nitty-gritty of establishing a spare parts inventory management system. This includes understanding the minimum requirements for a workable system, establishing an identification system and management policies, and finally understanding the aforementioned best practice.
1.2 What Are MRO and Spare Parts?
Libraries, bookstores, and the Internet are filled with books, blogs, magazines, training courses, information, and experts that can detail the chapter and verse relating to supply chain and inventory management. However, as you will soon see in this book, the standard theories and formula for inventory and supply chain management do not apply to MRO and spare parts. This is explained in detail in Section 1.3. However, before progressing further, it is important to be clear about the type of inventory that this book does address.
The key is to understand that all inventories are not the same, at least that their characteristics and dynamics are not the same. Figure 1.1 shows a simplified supply chain that could be applied to almost any goods but here follows a path for the items that become MRO and spare parts inventory. This figure shows a chain involving:
1. The initial raw materials extraction or development (say, mining or chemical processing).
2. Initial manufacturing or processing into a usable form.
3. Warehousing.
4. The next stage of manufacturing or processing that creates a finished product or component.
5. Wholesaling of that component.
6. Delivery to a company that uses that component.
7. Storage in that company’s inventory.
8. Issuing to an end user.
9. Application in the company’s plant and equipment.
During this process the item continually changes from being a raw material to a work in progress to finished goods (the three standard inventory types). For example, the product produced at Step 1 is the raw material for Step 2. During processing in Step 2, it is considered to be a work in progress. After Step 2, it may be stored in a warehouse (Step 3) before becoming the raw material for Step 4 and so on along the supply chain. Further, the supply chain is made up of both material movement and information flows, so the demand from Step 4 becomes the signal for supply to Step 2. Importantly, this information flow is usually the opposite of the product flow and is the basis for production planning along the supply chain.
For typical inventory, the component at Step 5 may be sold to (say) an industrial or retail customer, and it is at this point that MRO and spare parts differ from the standard supply chain. In Figure 1.1, Step 5 is where the item is ordered for a storeroom to support maintenance and operations. During Steps 7, 8, and 9, it is removed from the storeroom and applied to repair or support the operation of a piece of equipment. And this is the defining attribute of MRO and spare parts management: being used for equipment repairs and support, not in production as a component or raw material for the next “widget” in the supply chain.
Figure 1.1. A simplified supply chain
The following are the MRO, materials, and spare parts definitions that apply to the inventory addressed by this book:
• MRO—maintenance, repairs, and operations. When used in relation to materials and spare parts, this term is referring to the items that are used to fulfill the functions of maintenance, repairs, and operations support—that is, consumables such as materials and spare parts.
• MRO—maintenance, repair, and overhaul. This really has the same meaning as the above term.
• MRO—maintenance and repair organization. MRO is sometimes used to refer to the organizations that fulfill maintenance and repair functions, but it may also be used to define the components that the organizations use and/or supply.
• Materials. Typically, this term refers to items that are purchased that are not used for production—they are not used in producing the widget. Materials are not necessarily spare parts since they could be maintenance consumables (oil, grease, welding rods, etc.) or items purchased for fabrication (for example, steel).
• Spare parts. These are items held in inventory that are used to replace failed parts or components in the equipment that is being maintained. Spare parts could be anything from a drive belt or bearing to entire components such as a pump set.
Do these definitions matter? From the above you can see that they do actually matter—the terms MRO, materials, and spare parts are not fully interchangeable. Therefore, it is important that the members of your team use the terms in a consistent way, as this will avoid confusion in their communication. One way to help with this is to ensure that you have definitions of MRO, materials, and spare parts within your spare parts management policy documentation.
1.3 Why Spare Parts Are Different (from Other Inventory Types)
As a young maintenance engineer, I learned the hard way that spare parts don’t follow the usual rules of inventory management. When first in a position that included spare parts management among my responsibilities, I started by applying the rules of inventory management that were taught during my time completing a maintenance engineering degree. This just did not work, and the team and I had to determine the right way to manage our spare parts inventory in order to support our maintenance and operational goals.
In the previous section we demonstrated that the spare parts supply chain is different from other supply chains, if only at the very end. This difference is, however, very important, because it is at the end of the supply chain that companies plan and use the parts for their intended maintenance and operations support purpose.
Not only is the supply chain different, but many aspects of spare parts inventory management are different from the usual supply chain and inventory management orthodoxy. The classic supply chain theory (and training) is based on what can be called a “retail model,” that is, the model most often associated with retail management and fast-moving consumer goods. As a way of explaining this point, in each of the following examples a comparison is made between the approach required for spare parts management and the likely approach that would be applicable to a major retailer, such as Walmart.
If not properly understood, these differences can have a significant impact on inventory decision making and the quantum of funds that are tied up in a company’s spare parts inventory.
1. Stock items that you don’t want to use. The most obvious difference between retail and wholesale inventory management and spare parts inventory management is that with spare parts you will deliberately stock items that you don’t want to use. These are the insurance spares that companies hold, literally, just in case. Insurance spares are typically high-value, long-lead-time items, without which operations would cease. Holding these spares is akin to taking out an insurance policy; you don’t want to be in a position that you need to make a claim, but you don’t want to operate without the coverage.
Compare this with the way retailers or wholesalers would act. In these environments they don’t want items sitting on the shelves, unsold, for long periods; they want turnover. Retailers want items to come in and sell as quickly as possible. Items that don’t sell quickly are delisted and not restocked.
Not understanding this is one of the major mistakes made by novice spare parts inventory managers. When accountants (and it is typically accountants) suggest that the way to reduce spare parts inventory is to remove all items that haven’t moved for two to three years, they are applying the retail-wholesale logic that they were taught at university, without understanding the dynamics of spare parts inventory and why it is held.
2. Items of small value can be critically important. In retail and wholesale inventory management, items of small value are rarely that important, as they are unlikely to return any significant profit unless they are very high turnover. Sometimes they are used as a “loss leader” as a way to get people into the store.
Compare this with spare parts inventory, where a low-value item may be critical to keep your plant operating, and so ensuring the supply of that part might be the most important thing that the spare parts management team can do.
3. Stockout costs are disproportionately high. In retail and wholesale inventory management, the cost of not having an item available when requested (a stockout) could be limited to just the marginal profit that the company makes on that item. In some circumstances, it doesn’t even have that impact, as the buyer may back-order the item and be satisfied with receiving it later.
Compare that with the cost of downtime if you do not have a critical spare part available when required. Depending upon the type of plant operated, the cost of downtime could range from thousands to hundreds of thousands of dollars—per hour! This disproportionate value of downtime, versus the cost of the spare, is what leads many companies to spend way too much on their spare parts inventories, justifying the expense with the potential value of downtime.
4. Users are part of the process but are not (generally) accountable for their actions. In a retail and wholesale environment, the user (in this case the buyer) of an item has little or no input into determining the need for an item and certainly no input or accountability for the process that gets the item on the shelf.
Compare that with spare parts where the user (maintenance) is central to determining whether an item is required, how many of an item will be required, and when it might be required. It is the user’s input that feeds into the entire procurement and inventory management process, and yet maintenance is rarely held accountable for the decisions it makes or the quality of the information it provides.
5. Small market eliminates the “balance effect.” When a retailer stocks an item, it typically has a large “catchment area” of people who may come and buy that item. For retail chains the retailer even has the option of moving items that don’t sell in one area to an area where the items do sell. This large market has the effect of enabling the retailer to balance stock locations with the location of demand.
Compare that to an inventory of spare parts that is usually intended to support one machine or set of machines at one site. Few companies have a means for sharing parts, and so the demand for spare parts is limited to their own small in-house “market.” This means that if parts are bought and not used in the expected volume, there are few, if any, options for alternative use.
6. Huge forecast variations due to technical requirements. In almost all stages of the standard supply chain, the forecast variation will most likely be within 20–30%, at most. Forecast variations greater than this, and that occur repeatedly, will result in investigation and further refinement of the forecasting process.
Compare this to spare parts where the forecast variation could easily be 100%. This occurs when an item is bought and not used (an item that was expected to be used). Visit any storeroom, and it is common to see where multiple units of an item are purchased but only one is used. This could be a forecast variation of 80–90%, depending on how many were purchased.
7. Massive variations in the value and volume of items managed. Retailers and wholesalers can usually afford to have different people managing the decision making for different categories. There may be a person who is the buyer of shoes, one that does fruit, and so on.
This type of category management is common in industrial organizations but is much less granular. Usually the area of spare parts is one category, and that is often put together with other related categories. This means that there is one process for decision making and management of all different types of spare parts: small, large, cheap, expensive, imported, local. This makes it very difficult to develop the kind of specialist management insight that occurs in the retail and wholesale environment. This issue is discussed further in Section 3.10, “Spare Parts Procurement Issues.”
8. Stock sales usually realize little return. Of course, mistakes are made, no matter what system you are part of. In retail this could be a swift change in fashion, and in wholesale it may be the overstocking of components that are then quickly replaced by a newer model by the manufacturer. The great advantage of these industries is the ability to have a sale. This might result in the loss of all margin or even a loss on the purchase price, but it can move the stock and recover some value.
Compare that with spare parts management where obsolete and excess items often have no resale value. In many circumstances it is years before excess or obsolete items get recognized as such, and by then the vendor won’t take a return and no one else wants the old model. Sometimes people will say that they can just write off the item, but while this reduces the value on the books (see the section on financial concerns), it ignores the reality that cash was used to purchase the item and that cash has shown no return.
What all these issues mean is that the risks associated with purchasing spare parts is much greater than with items in a retail and wholesale environment. This, in turn, means that companies should take more care with their spare parts decision making, not less.
1.4 Five Common Supply Chain Techniques That You Should Not Use for Spare Parts Management
An important part of any strategy, including your spare parts inventory management strategy, is to know what not to do. By understanding which inventory management techniques you should not apply to your spare parts management (and why), you might just save your company a bundle of money (and yourself a lot of heartache).
As discussed previously, spare parts inventory is the inventory that you hold for equipment repairs and support, as opposed to the inventory that is used in production for conversion to finished goods. This distinction is important, because the characteristics that set spare parts inventory apart from other inventory types also help identify supply chain management techniques that should not be used for spare parts management, including:
1. Materials resource planning (MRP). MRP is a production planning technique that aims to coordinate assembly operations by ensuring that the required components are available in the right mix and at the right time in the assembly process flow. Spare parts are not used for production assembly, and so the MRP production planning concepts of dependent and independent demand don’t apply. The term MRP has also been co-opted by some ERP (enterprise resource planning) providers as a proxy for running a reorder report, but running a reorder report is not actually the same as MRP—it’s just a reorder report! Don’t waste your time and money learning about or trying to implement this technique if you are managing spare parts.
2. Just-in-time (JIT). JIT is a production management philosophy that aims to eliminate wasted time on a production line by coordinating materials movements. It is not a management technique for nonproduction items such as spare parts. Further, holding excess stocks so that supply can be provided in an almost instantaneous manner is not JIT because it lacks the signals and coordination of JIT. Work instead on improving spare parts planning and coordination.
3. Economic order quantity (EOQ). Applying an economic order quantity sounds very attractive—who wouldn’t want to purchase in the most cost-effective manner? The problem here is that there are too many variables in the actual EOQ calculation for the results to be reliable. For example, what if more than one item is on the purchase order? Does that split the order cost? Instead of trying to make the theoretical EOQ calculation work in the real world, apply the logic explained in Section 2.6 and don’t bother with the calculation.
4. Service level. Service level is a measure of the number of times that a request for an item is filled in the acceptable time frame. It is commonly applied in fast-moving consumer goods and other wholesale industries, with the term delivery in full on time (DIFOT) being used. Having a DIFOT of 95% would be a good target in those industries, but with spare parts, if you don’t have the right part available 5% of the time your production might stop, and then nobody will thank you for achieving a 95% service level.
5. ABC analysis. ABC is an analytical approach that divides your inventory into categories to identify which are most important and then sets agreed service levels on the availability of those items and may also set the level of control. This is a way of recognizing that all items in an inventory are not equal in terms of value to the organization and then trying to ensure that the inventory mix reflects the criteria of importance. Typically, ABC analysis is based on sales volume, gross profit, or value. With spare parts inventory we know that service levels are not appropriate, stock turn only works at an aggregate level, there is no profit margin as the spare parts are used in your own plant, and volume and value measures ignore criticality. Therefore, ABC analysis is just not appropriate; it’s better to ensure that you have appropriate categorization for guiding your decision making.
Putting aside all the technical reasons why these techniques don’t work, there is one very good reason why you should not try to apply these techniques: employee confidence. Attempts to apply these techniques will cost you time, effort, and money, and because they don’t work effectively with spare parts, they will also cost you the trust that your spare parts management system can deliver the parts required when needed. And that might just be the greatest cost of all.
1.5 The Number One Problem with Spare Parts Inventory Management
Engineering spare parts management is a big topic, and managing a spare parts inventory involves engaging with lots of participants from different parts of the business. This means that there is plenty of opportunity for things to go wrong. And that may be one of the complications that make this task more difficult than it superficially appears.
So what do you think is the biggest problem in engineering spare parts management? This is a question that I ask at the beginning of almost every workshop and training event. Given the range of personnel involved in spare parts inventory management, it is perhaps no surprise that I get a wide range of responses. Here is a list from one recent session:
• Satellite stores
• Rotable spares management
• Lead time variability
• Stockouts
• Engaging operations
• Determining criticality
• Availability
• Redundant stock
• Logistics
• Cannibalized spares
• Location mix-up
That’s quite a list!
These responses could be sorted into a number of different categories, such as structure (e.g., satellite stores), process (e.g., rotable spares management, logistics), and outcomes (e.g., stockouts, availability). There may even be other categories or ways to break down this list. However, despite these issues being quite universal, identifying and grouping them doesn’t really help us identify the number one problem with spare parts inventory management. To identify the number one problem, we need to look for a theme that is evident in each of these issues.
One theme that is evident in almost all these issues is uncertainty. For example, the typical reason that rotable spare parts management is an issue is that there is uncertainty about the spares usage requirements, the repair time, and the reliability of the repaired item—sometimes all three! We could say something similar about lead time variability (uncertain by definition), determining criticality, stockouts, availability, redundant stock, and location mix-ups.
Another possible theme is communication. One reason that many items on this list become an issue revolves around the communication (or lack of) that occurs. This is obvious with items such as engaging operations, logistics, and even cannibalized spares and location mix-ups.
While uncertainty and communication are clear issues with spare parts inventory management, in my opinion the number one problem is how people deal with that uncertainty and lack of communication. Uncertainty and poor communication represent information gaps, and almost universally the way that people fill those information gaps is by guessing.
Therefore, I think that the number one problem in spare parts inventory management is guesswork!
The Merriam-Webster Learner’s Dictionary defines guesswork as: The act or process of finding an answer by guessing.
Guessing is further defined as:
To form an opinion or give an answer about something when you do not know much or anything about it.
Many people reading this will be outraged. How dare I say that their work is based on giving an answer when they don’t know much about it! In fact, it is even worse than that because the answer that is based on guesswork is often cloaked in the guise of management science. It is this guise of management science that helps people pretend that they are not really guessing. But consider the following.
How often have you heard someone justify a position on inventory stocking levels by saying:
• It’s based on the formula, or
• It’s based on our historic data, or
• Our forecast shows . . .
Or something similar?
Often the statement is made as if the statement itself were a full justification. Each of these things may be true (and are based at some level on management science), but they also each involve some degree of guesswork. For example:
• Many people use the wrong formula for determining their stock level; they are guessing that they should use (say) a Gaussian function (most typical) when maybe the function should be Poisson based, or maybe neither.
• Many people have extensive historic data on their spare parts, but that data doesn’t actually reflect the real demand history—though these people are assuming (guessing) that it does. Their data usually reflects the movement of spares out of the storeroom, not the use of those spares on their equipment.
• By their nature, all forecasts are based on assumptions—which, in effect, make any forecast a guess. Even worse, many people don’t even try to determine the likely basis of future demand for the item; they merely extrapolate the past into the future without necessarily questioning if that is an appropriate approach to take. This is the basis of most software packages. The use of software makes it easy to abdicate responsibility for decision making.
• The granddaddy of all guesses is the ill-informed assumption that spare parts inventory management follows the same rules as other types of inventory management. This is the underlying assumption that is at the heart of statements, often made by accountants, that there should be a clear-out of any spare part that hasn’t moved in two years.
Someone once said that all management problems end up in the warehouse. By this they meant that the warehouse (or storeroom) becomes the place that provides the buffer for problems that are actually created elsewhere. These are problems with issues such as the setup of satellite stores, rotable spares management, lead time variability, stockouts, operations engagement, determination of criticality, spare parts availability, management of redundant stock, logistics, cannibalization of spares, and location mix-ups. These issues are “managed” by stocking more inventory than would be needed if the issues were properly addressed.
When considering engineering spare parts, used to support operations through returning failed equipment to a fully operational state, it is fundamental to establishing a reliability and maintenance system that you consider the likely cause of failure and from that the appropriate course of management. Having done that, it ought to be possible to at least state the basis of the future usage of a part—whether that is condition monitoring, time-based replacement, random failure, or some other approach.
By identifying the basis of the forecast, it can then be reviewed for reasonableness or even currency. Yet this connection is rarely made in practice, and the “guess” becomes the basis of the stock holding. The result is that the inventory ends up being overstocked.
The same can be said of the engagement of operations, the involvement of procurement, and the input from finance, where an unchallenged assumption (a guess) results in overstocking.
Why is this so? Well, one answer is that it is easy (or is that lazy?) to not work through all the available information and to use a guess that is disguised as know-how as the proxy for information. A better answer might be that as long as the spare parts warehouse is overstocked, everyone can get away with this approach because it is easier to spend the company’s money on excessive parts holdings than it is to work on developing a more accurate or reasonable stock-holding requirement. It is usually when you tighten up on the wasted expenditure on spare parts, that the failures of the rest of the management system really come to light. By removing the excessive stock, the other systems lose their buffer for relying on guesswork.
There is another old saying along the lines that identifying a problem is half the solution. In this case it might be that identifying (and admitting) that the basis of the estimate for the future use of a part might be really just a guess then helps lead to a better solution. So if the basis of a stocking decision is unknown, or is really just a guess, then be clear and honest about that. Then you can get on with filling in the real data gaps and solving the real problem.
1.6 The Big Picture—Putting Spare Parts Management in Context
Now that the characteristics that define MRO and spare parts inventory are understood, let’s put management of that inventory into the context of the big picture. To do this, consider the reason that spare parts are held—to support the maintenance requirements of your plant and equipment. Once this is understood, it makes sense that understanding the maintenance and operations support activities will help with spare parts planning, and this flows on to stocking levels. (This is discussed further in Section 3.3, “Reliability-Centered Spares.”) Therefore, it makes sense that in order to better understand spare parts management, you need to also understand the basics of maintenance management. The following is not intended to be an exhaustive explanation of maintenance activities but should be sufficient to put spare parts management into context with maintenance.
A Simple Model of Maintenance Activities
Figure 1.2 is a simple model of maintenance activities. At the center of the model is “operational results.” This is the goal for everyone in the company and is about driving your plant and equipment to achieve your production plans. It is not just about minimizing downtime. Surrounding the goal of operational results are four activities that are at the heart of maintenance—they support the achievement of the company’s operational results.
Figure 1.2 A simple model of maintenance activities
Technical
In Figure 1.2, “technical” refers to the technical and reliability engineering aspects of maintenance. Think of this as identifying the work that needs to be done and determining how the goals will be achieved—that is, which strategies and techniques will be applied. Key aspects of this include:
• Identifying which assets are to be maintained. This might also be broken down into the subassemblies and parts level.
• Identifying the potential failure modes of those assets, subassemblies, and parts. Understanding this helps to determine the maintenance management policy that will best address that failure mode and keep the plant running.
• Determining criticality, which helps determine the priority of tasks that are subsequently planned.
• Identifying the appropriate maintenance management policy, which means determining what approach to take for maintenance given the detail set out in the above points. Some options include:
Preventive maintenance. Specific tasks are completed based on a regular schedule in order to prevent potential failure. A simple example is replacing oil filters before they become too blocked to work effectively.
Predictive maintenance. This involves inspecting the condition of the equipment to decide when maintenance should be performed, typically when some performance threshold is reached. With the oil filter example, this might include checking the pressure drop across a filter in order to determine when it should be replaced.
Fixed-interval maintenance. As the name suggests, this requires that the maintenance tasks be performed at fixed time or operational intervals. For example, changing an oil filter every 6 months or 1,000 run hours.
Run to failure. This means accepting that the potential failure cannot be determined in advance. For example, a puncture in a tire is a run-to-failure maintenance activity because it is not possible to determine through inspection when the failure might occur. This is often overlooked as a genuine option.
Condition-based maintenance. Similar to predictive maintenance, condition-based maintenance involves regularly recording the condition of an item to understand the rate of degradation and then planning maintenance activities before the performance threshold is reached.
In terms of spare parts inventory management, understanding the maintenance management policy and the chosen technical aspects of the approach to maintenance will help inform spare parts management through understanding how the demand signal for spare parts is generated.
For example, with equipment that is subject to fixed-interval maintenance, the timing of parts requirements should be known well in advance of the need for those parts. Even with condition-based maintenance, the time between potential failure and functional failure may be able to be estimated, at least at a ballpark level, and therefore the time horizon for needing the spare parts is also able to be estimated.
Planning and Scheduling
This activity is about organizing the work. That is, who will do the work, when will it be done, how will it be done, and what tools and spares will be needed. This is the function that generates the job lists (sometimes called work orders) that instruct the maintenance team on what needs to be done and when. These job lists should also include details of the parts required (sometimes referred to as a bill of materials, or BOM).
Planning and scheduling is often the place that spare parts management breaks down, because there is an assumption that parts will be available rather than an actual check of parts availability. In a well-managed system, it is planning and scheduling that triggers the need to order parts when those parts can be supplied within the planning horizon. This means that those parts do not need to be held in inventory. (The planning horizon is the time between when the need for a part is identified and when the part is actually needed. See Section 2.2.) Conversely, if the planning horizon is shorter than the lead time, then you will need to hold the parts in inventory. Often major improvements in inventory holdings can be made by reviewing the planning and scheduling activity and the associated planning horizon.
Data and Cost Management
Data and cost management consists of collecting data and recording and reporting costs so that the effectiveness of the work can be determined—both the operational effectiveness and the cost effectiveness. Of course, the same information is also required to measure whether or not the activities are achieved within the available budget and cost constraints. The issues with data and cost management are:
• Alignment with asset register. Ensuring that the costs are collected in a way that reflects the asset breakdown used by maintenance.
• Cost allocation. Ensuring that the costs are correctly allocated.
• Work order records. Ensuring that these reflect the actual usage of parts.
Understanding data and cost management can help the spare parts inventory manager with checking the actual usage of items and from that help inform future plans.
Materials Management
The management of the materials and spare parts required to complete the work, including inventory management and procurement, is a very important but often underappreciated aspect of maintenance activity.
Materials and spare parts management is as critical to the entire process as each of the other steps. It actually doesn’t matter how well your costs are tracked, or how well you plan and schedule, or how appropriate your technical solutions are, since if you don’t have the right materials and spare parts, you cannot do the work. In fact, if you don’t have the material to do the work, nothing happens. The key issues to consider include:
• Direct purchasing.
• Supplier management.
• Cataloging.
• Reorder levels.
• Materials usage.
• Returns to store.
• Squirrel stores.
• Repairs management.
In an ideal world, the people responsible for spare parts inventory management would have at least a basic grasp of the maintenance aspects discussed above. This would help with integrating maintenance and spare parts activities in order to produce better results. Failing this, there needs to be even greater collaboration between the maintenance and spare parts functions so that there can be a more streamlined, efficient, and effective approach to managing the funds tied up in the spare parts inventory.
1.7 Maintenance Alone Won’t Solve Your Spare Parts Problems
Is it true that spare parts held as inventory for maintenance use are primarily captive to the sophistication and execution of the maintenance system that they support? Is maintenance and reliability execution really the driving force behind the spare parts holding levels? Would improvements in maintenance planning, scheduling, and condition monitoring make a significant difference in inventory levels?
There is a persistent belief among many in the maintenance community that these things are all true, that is, that the best way to reduce spare parts holdings is to improve maintenance practices. Visit any maintenance or reliability forum, attend a maintenance conference, or strike up the discussion at your local professional group meeting, and you will no doubt hear someone saying, “Our spare parts problems would be fixed if only we could improve our maintenance.”
Unfortunately, for many companies, this belief then results in little being done to improve spare parts management, while everyone waits for maintenance system changes to take effect. This, in turn, results in those companies spending maybe millions of dollars more than they need to on spare parts because they are not addressing the real reason that they hold too much inventory. While the preceding section of this book has discussed why it is important for spare parts managers to understand maintenance, it does not automatically follow that improvements in maintenance will drive major improvements in spare parts holding levels.
It’s Not Just About Supply and Demand
It is easy to see where the belief about supply and demand comes from. Spare parts are held as supply to satisfy maintenance demand. Therefore, if companies were better able to reliably predict demand, they could better match the supply and so hold only the inventory they need in the quantity that they need it. If only the machinations of people and process were so simple!
The belief that maintenance improvements will have a major impact on spare parts holdings is only true in this idealized and theoretical world. However, in the real world, spare parts management is subject to a wide range of forces that have little or nothing directly to do with maintenance. These forces include human behavior, different attitudes and management of risk, supply chain variability, procurement myths such as use of the EOQ formula, storeroom management, and administrative practices. In terms of the investment that companies hold as spare parts inventory, the maintenance system is not the main driver of spare parts holding values. The proof of this is as simple as checking the results that companies have achieved in reducing spare parts inventory and increasing parts availability while largely ignoring the maintenance system. (Visit PhillipSlater.com for some examples of this.)
The Reality of Maintenance and Spare Parts
This maintenance belief is only theoretically correct, because, theoretically, if the maintenance system can be made sufficiently sophisticated that it can reliably forecast spare parts needs, then a company could optimize its spare parts to suit its maintenance needs.
The reality, however, is that this maintenance-driven belief doesn’t work in practice for two reasons:
1. Most maintenance systems contain systemic flaws or shortcuts that make them incapable of providing the required data at the required quality.
2. Similarly, most spare parts management systems are as flawed as the maintenance systems they support.
Therefore, significant improvements in spare parts holdings can be achieved without doing anything to the maintenance systems, and this can lead to significant spare parts and procurement savings with no negative operational results.
Yes, you read that correctly. Most companies can optimize their spare parts inventory for the environment in which they operate without actually changing anything about the way they do maintenance or negatively impacting their service to maintenance.
This is because most spare parts decision making is ad hoc and emotionally based, there is little or no structure or system to the way stockholding decisions are made, and terms such as safety stock, reorder point (ROP), and min (as in max and min) are used interchangeably when they are not interchangeable. This all means that the actual stock levels become a matter of opinion that has no standard against which to compare. In addition, genuine periodic reviews of spare parts levels, so that they may be adjusted to current expectations, either are almost nonexistent or focus on single issues such as slow-moving stock. Furthermore, there is usually some form of behavioral “blame game” around stockouts that drives overstocking rather than continual improvement.
This Is Supported by Research
This situation is demonstrated in the results from a spare parts management quiz that SparePartsKnowHow.com has recently been running online. The quiz assesses a company’s approach to spare parts inventory management based on seven simple questions. At the time of this writing, the quiz has been taken more than 360 times, which is more than enough to remove any small sample bias. Here is what the quiz results show:
• 70% of companies say that they don’t consistently provide guidance on how to determine both the reorder point and reorder quantity. Only 30% say that they do this always.
• 68% of companies say that they don’t consistently provide guidance on whether or not to stock an item. Only 32% say that they do this always.
• 64% of companies say that they don’t review inventory holdings as part of a formal plan of continuous improvement. Only 36% say that they do this at least annually.
So if there is no standardized approach for deciding what to stock, no standardized approach for deciding how many to stock, and no review of the current validity of past decisions, is it any wonder that spare parts stock holdings are much higher than they ought to be? Some companies can be overstocked by more than 100%!
How a Spare Parts Review Can Actually Improve Maintenance
In a recent case,2 a company that reviewed its spare parts holdings, and introduced a decision-making policy and process, reduced its inventory holdings by an average of 42% across four locations, in three countries, in just six months. At the worst location (in terms of stocking), the inventory reduction exceeded 50% (which equates to being overstocked by more than 100%). At the same time, the anecdotal feedback was that the company improved its parts availability. This was because quality decision making that sets appropriate holding levels works both ways: it establishes the right inventory at the right time.
Could an overhaul of its maintenance systems have improved the availability and reliability of spare parts data and so help in getting the holding levels even lower? Of course. But it would take years to stabilize the maintenance system and collect reliable data. Is the maintenance improvement necessary in order to achieve a significant reduction in spares holdings while simultaneously improving spare parts availability? Absolutely not. In fact, establishing the method for determining stock holdings, and the subsequent interrogation of spare parts holdings, actually forces the maintenance team to think about its needs, and so the spare parts project actually improves maintenance!
The Elephant in Your Storeroom
Most people have heard about the bull in the china shop, but have you heard about the elephant in your storeroom? This is not a mythical five-ton mammal, feasting on your critical spares in the dark corners of your warehouse, but a reference to the perceptions of the players involved with the effective management of spare parts. To explain this, let’s revisit the story about six blind men examining an elephant.3
One day an elephant walks into a village. This was not “elephant country,” and while the people of the village were all educated and experienced in their own region, they had never heard of an elephant. The arrival of this curious beast excited the whole village, and a group of six blind men decided to find out for themselves just what this elephant was.
They made their way through the crowd, and each touched a different part of the elephant.
“Hey, the elephant is a like a tree,” cried the first blind man as he touched the elephant’s leg.
“No, it is more like a rope,” said the second blind man who touched the tail.
“I think that it is like a thick snake,” chimed in the third as he touched the trunk of the elephant.
“A snake? No, it’s flat like a banana leaf fan,” said the fourth man, who was touching the ear of the elephant.
“A banana leaf? Are you mad? It is more like a huge wall,” laughed the fifth man, feeling the side of the elephant.
“I don’t know what you are all feeling, but this elephant feels to me like a solid pole,” said the sixth man, who touched the tusk of the elephant.
They began to yell at each other and argue about the elephant, with each one of them insisting that he was right. A wise man was passing by, and disturbed by the raised voices, he stopped and asked them, “What are you blind men arguing about?”
Almost in unison they said, “We cannot agree about what the elephant is like.”
They each told the wise man what they could feel, and the wise man immediately recognized the problem. Calmly he explained to them, “All of you are right. The reason every one of you is telling it differently is because each of you has touched a different part of the elephant. So actually the elephant has all those features.”
Understanding this, the blind men stopped arguing and started listening. They listened as each of them described in detail what he could feel, and before too long, these men who had never seen an elephant understood exactly what it was.
What Does This Have to Do with Your Storeroom?
One feature of the modern corporation is the departmentalization of functions. Companies do this to both create operational efficiencies and manage the span of management control. Thus most organizations will have, among others, an operations group, maintenance department, storeroom and logistics, purchasing and procurement, and finance. But what happens when these functions overlap? This is the elephant in your storeroom, and its name is the maintenance materials and spare parts inventory.
Each of the different corporate functions mentioned has an influence on your materials and spare parts management outcomes. Yet each operates independently, often with little incentive to coordinate activities to improve the overall business results. This is classically called functional silos, with each group doing what it thinks is needed, based on what each sees. In effect, each functional group looks at the same activity and literally sees different things. (For more on silos go to Section 3.9, “Integrated Maintenance and Spare Parts Management.”)
The storekeepers see a bunch of SKUs (stock keeping units) that they have to receive, store, issue, count, care for, and requisition. They get yelled at by maintenance and operations for not having enough parts and by finance for having too many.
The maintenance department sees the inventory as one of the elements needed to efficiently repair the company’s machines and other assets. The maintenance people get yelled at by operations if the part is not available when it is needed and downtime results. So the maintenance people yell at stores to speed up the issue process and to make sure that everything is stocked. The people in stores yell at maintenance for not telling them how many of a part was really needed or that the part was needed at all.
The purchasing people see all the hard work they do to source the parts, locating obsolete parts and negotiating the best prices and terms. They are yelled at by maintenance for taking too long when buying parts for breakdowns. They are yelled at by finance to save more money, which then means that they get yelled at again by maintenance for buying cheap parts that do not last. They, in turn, yell at maintenance to give them more time and not have so many emergencies. They also provide maintenance with meaningful advice such as “Failing to plan is planning to fail.”
The folks in finance see money tied up that they believe could be used better elsewhere. They yell at stores, maintenance, and purchasing to cut costs, cut inventory levels, and stop spending so much money. They see fixing things as a pure expense. They get yelled at by everyone else for asking for too much to be achieved from too little.
With the elephant in your storeroom, it seems that everyone is yelling at everyone else!
But what if they could all see the whole elephant, if each group could understand the perspective of the others? What if they could understand what they were trying to achieve and the constraints within which they were working. Maybe then they could have a meaningful discussion about the management of this strange beast known as materials and spare parts inventory management. And maybe then they could work out a way to collectively improve the overall business results.
1.8 Spare Parts Management Requires Collaboration, Not Just Cooperation
Over the past few years there has been a growing awareness that effective and efficient spare parts inventory management requires the input of people from a number of different departments. Engineering spare parts inventories are influenced by engineering, maintenance, planners, stores and warehouse, finance, purchasing, operations, and suppliers. It is important that any project, training, or program aimed at spare parts inventory management engage with representatives from these groups.
But what does that really mean in practice?
Often when people are talking about this, they use the terms collaboration and cooperation as if they are interchangeable. They are not. It is easy to see why these two words are used in this way when a quick check of the Oxford Dictionary online definitions shows:
Collaboration: The action of working with someone to produce something.4
Cooperation: The action or process of working together to the same end.5
Not quite the same but not so different that the practical meaning is obvious.
A More Practical Approach
In an article titled “There’s a Difference Between Cooperation and Collaboration,” Ron Ashkenas provides a much better insight into the differences.6
According to Ashkenas, cooperation usually relates to well-meaning “cooperative” behaviors such as the sharing of information. Essentially this means keeping others informed about your intent but without alignment of goals.
On the other hand, collaboration involves “making tough decisions and trade-offs about what and what not do, in order to adjust workloads across areas with different priorities.” This requires the “ability and flexibility [for departments] to align their goals and resources with others in real time.”
These definitions show us what goes wrong when companies embark on a spare parts inventory management program without fully understanding the difference. Without the alignment of goals and performance measures, team members end up “confusing pleasant, cooperative behavior with collaboration,” says Ashkenas.
In my experience the absence of true collaboration means that there is little or no give-and-take between departments, and often the information sharing becomes “telling” rather than engaging. A classic example of this is when procurement’s goal of minimum unit cost conflicts with a stocking goal of not overordering, and so procurement buys more than is required. Another example is when little investment is made in maintenance planning and yet the storeroom is expected to know what is required.
A lack of true collaboration often results in people defending entrenched positions and then blaming others for any lack of progress or, worse still, any problems that arise.
Ashkenas goes on to say that “cross-functional collaboration is easy to talk about but hard to do. . . . if you are able to map out what’s needed and bring the needed parties into alignment you’ll not only make an impact on your organization but begin to develop some important collaborative skills.”
With spare parts inventory management, being efficient and effective means minimizing your inventory investment while maximizing your spare parts availability. This just cannot be achieved without the true collaboration of the entire team whose actions influence this result.
No review or study of spare parts inventory can be undertaken (or even commence) without first having at least a basic understanding of the financial considerations.
At first, this statement may appear to be redundant; after all, don’t people understand that spare parts cost money? Of course they do. The problem is that the impact and accounting of this expense is seen differently when viewed from different management silos. For those involved in accounting and finance, the spare parts investment is both a cash cost and a balance sheet item that must be minimized. For those involved in maintenance, spare parts are often viewed through a lens of “more is better” because the cost of downtime is so expensive. In most circumstances, the funds tied up in the spare parts inventory are of little consequence to maintenance personnel because the funds aren’t treated as a maintenance expense until they are actually used.
The problem is that in most businesses there is no single authority that sees the whole picture. The purpose, therefore, of this section is to take you through a simple explanation of how spare parts are accounted for in most organizations.
Five Key Financial Principles
Stripping back the financial considerations to their very basic principles, there are five points to understand.
1. Spare Parts Cost Money
Of course they do! Every time a company purchases a spare part, it pays another company for the part. It doesn’t matter which cost center or budget the cost is allocated to or whether it is allocated as capital or as an operating expense; the purchasing company has spent money buying the part.
In addition, in some parts of the world, companies are required to pay taxes on the value of the inventory that they hold. For example, in the USA, 11 states impose a property tax that includes spare parts inventories.7
2. Money Is Limited
While this principle is also seemingly self-evident (after all, who has an unlimited supply of money?), it is also often, somewhat conveniently, forgotten.
When a company chooses to purchase something, anything, the money that it spends on that purchase cannot be also spent on something else. This principle is true no matter if the purchase is a $1 spare part or a $100 million processing plant. This means that companies must choose how to spend their money, just as we have to choose how to spend our household budgets. This requirement to choose leads to the concept of opportunity cost.
Put simply, if money is spent on one thing, the purchaser forgoes the opportunity to spend that money on something else. Money is a limited resource. Therefore, if a company invests $1 million in spare parts, above and beyond the quantity of parts required to keep operating, then it forgoes the opportunity to invest that $1 million somewhere else. That might be:
• Buying more productive plant and equipment.
• Paying down debt.
• Returning to shareholders.
In financial terms this opportunity cost is determined by what is known as the weighted average cost of capital (WACC, pronounced “wack”). The WACC takes account of the sources of a company’s funds: borrowings, shareholder funds, bond issues, retained profits, to name a few. Effectively the WACC is the rate of return that a company requires in order to pay for all of its sources of funds.
In practical terms there are two major issues with applying the principle that money is limited. First, at an operational level, it only seems like funds are limited if there is a specific budget, and there is rarely a budget for spare parts inventory. Hence the funds spent on parts that become inventory are not measured against a target. Second, establishing an “inventory budget” that takes account of all the risks is very difficult (and most likely is the problem that a reader of this book is trying to solve). This is why people resort to simple metrics such as percent of replacement asset value; however, these metrics are misleading, as they fail to take account of individual circumstance. Even with these issues, it is still an important principle to bear in mind with any expenditure—money is limited.
3. Money Costs Money
Sometimes this principle is a little less obvious than the first two. Everyone understands that if you borrow money, there will be interest to pay. Similarly, if a company has debt (and most do), then the cost of the debt can be easily determined. However, there are some other dynamics at play here.
The discussion above, Principle 2, referred to the WACC. This is the way that companies determine the cost of money when they haven’t directly borrowed money for the purchase. This means that, at a minimum, money that is invested in spare parts inventory costs the company the equivalent of the WACC each and every year. Examples of the WACC at some well-known companies8 (at time of writing) include:
• Apple Inc.: 11.1%
• ExxonMobil: 7.8%
• BHP Billiton: 7.1%
• General Motors: 6.9%
• Samsung: 5.6%
• Volkswagen: 4.4%
Consider this: if Apple invests in a $100 spare part and does not use it for 5 years, then the opportunity cost of spending that $100 is 100 × 11.1% × 5 years = $55.50. This is more than half the original cost of the part! This cost doesn’t include the cost of storing and managing the inventory during that time. Which leads us to Principle 4.
4. Inventory Requires Management
Which would cost more to manage: an inventory consisting of 10,000 different types of parts (SKUs) with an average of 10 of each (a total of 100,000 items) or an inventory of 100,000 SKUs with an average of 1 each? Without even thinking about it, most people would most likely say the second scenario, 100,000 SKUs, because this scenario will require:
• More space, as each SKU will require a unique location.
• Greater utilities costs due to the larger space.
• More inward goods movements and with that more “put-away” activity.
• More outward goods movement and transactions, requiring more labor.
• More labor for stock takes and cycle counts.
• Greater allowances for obsolescence, as there are many more parts to become obsolete.
• More indirect labor for processing purchase orders and invoices
None of the above are absolute, as each situation will be different, but this list does demonstrate that the costs of managing inventory include
• Storage space (both the capital cost and opportunity cost).
• Utilities.
• Direct labor.
• Indirect labor.
Some of these costs will have a linear relationship with the quantity of inventory held. For example, fewer SKUs and a lower number of items will most likely require fewer purchase orders and less labor for stock takes.
Some of these items will more likely involve step changes in cost, as they must be “purchased” in discrete quantities. For example, if you have a 50,000 sq ft storeroom and can reduce the space needs to 30,000 sq ft, you will still have a 50,000 sq ft space. Therefore, reducing storage space requirements may only provide a significant benefit if it means paying less for space or relocating something else into the newly freed space. (Note that there may be other benefits from space reduction such as reducing “travel” times for parts put away and retrieval.)
Every situation is unique; however, the generally accepted rule of thumb is that the cost of managing and storing inventory is 10% of the inventory value per year.
5. Timing Is Important
There are two ways in which timing is important with respect to inventory. The first is that holding onto inventory, over time, costs the company through both the opportunity cost (as calculated through the WACC, as discussed in Principle 2) and the management cost (as discussed in Principle 4). By adding together these two costs, it is easy to calculate the annual cost of holding inventory. For example, and using the rule of thumb of 10% for inventory management cost, the annual cost of holding inventory at the companies mentioned previously is:
• Apple Inc.: 11.1% + 10% = 21.1%
• ExxonMobil: 7.8% + 10% = 17.8%
• BHP Billiton: 7.1% + 10% = 17.1%
• General Motors: 6.9% + 10% = 16.9%
• Samsung: 5.6% + 10% = 15.6%
• Volkswagen: 4.4% + 10% = 14.4%
Previously the financial cost to Apple for holding a spare valued at $100 for 5 years was identified as $5.50. If we now add in the cost of managing that spare at 10% per year, the management cost is $50 for 5 years. Therefore, the total cost of owning that spare part for 5 years is:
$55.50 + $50.00 = $105.50
This is more than the actual cost of buying the item.
From this you can see that if a company can organize its spare parts management to hold less inventory for a shorter period of time, it can significantly reduce its inventory costs. In this case, time really is money.
Another way in which timing is important relates to accounting accruals. One of the principles of financial accounting is that a company’s accounts must reflect the current value of its assets. In most companies the spare parts inventory is treated as an asset, which means that the accounts need to reflect the current value of this inventory.
There are two problems with this: First, over time spare parts lose value and if sold are not worth what the company originally paid. Second, some parts will become obsolete or become nonfunctional through poor storage practices (sometimes referred to as spoilage). This means that if a company pays, for example, $100 each for 100 parts purchased today, that investment of $10,000 is unlikely to be worth $10,000 in the future. To account for this, accountants use what is called an accrual. An accrual is the way that accountants try to represent the real current value of inventory over time. For example, if a spoilage rate of 5% is assumed (that means that the accountant assumes that 5% of items will become nonfunctional each year) and a value reduction (called depreciation) of 5% is assumed, then the accountants will enter into the accounts an accrual of 10% each year, based on the value of the inventory that year. This accrual reduces the reported value of the items and so is the accountants’ way of reflecting the real value of the inventory.
Accruals are recorded separately from the purchase value of the spare parts, which is why a spare part purchased 10 years ago for $100 can still be valued in the inventory list today at $100. The accrual is recorded elsewhere.
A further explanation of accruals is beyond the scope of this book; however, it is important to understand that accounting principles require that the cost of inventory over time is recognized in a company’s accounts. This is one reason that accountants are often the people pressing companies to reduce their spare parts inventory.
1.10 Follow the Money-Accounting for Spare Parts
Expenses Versus Capital
Before explaining the accounting for spare parts, it is important to explain the differences between the type of capital and expenses. When a company spends money on spare parts, it is using its available cash (this includes funds made available through credit and other means, not just literally cash). How this expenditure is treated by accountants depends on why the purchase is made and when the utility of the expenditure is realized.
Utility is the term used to describe the benefit that a company gains from its purchases. For example, if a company buys a machine and expects that it will operate for 10 years, then the utility is realized over 10 years. The accountants take account of this by reducing the reported value of the machine by 10% each year. This is called depreciation. If the company buys some spare parts and they are used immediately, then the utility is realized and depreciation is not necessary.
Expenditures where the utility is realized during the current fiscal reporting period are generally referred to as expenses. Expenditures where the utility is realized in more than one fiscal reporting period are generally referred to as capital. Put another way, capital is the money that a company spends on items that it does not expect to sell or use in the current fiscal reporting period. This is why spare parts inventory is treated as capital. There are two types of capital:
1 Fixed capital. This includes buildings and plant and equipment. Essentially these are the physical items used over time.
2 Working capital. This is the money invested to operate a business to act as a buffer between payment terms for purchases and the revenue from sales.
While expenses and capital both require the use of cash, these expenditures are treated differently by accountants, and that is why there is a series of reports that the inventory manager must understand.
Four Key Financial Reports
The four key financial reports to understand are:
1. Balance sheet, as seen in Figure 1.3.
2. Profit and loss statement, as seen in Figure 1.4.
3. Cash flow statement, as seen in Figure 1.5.
4. Operating statement, as seen in Figure 1.6.
Each of these is explained and represented in the accompanying pictograms.
The balance sheet takes account of a company’s assets and liabilities to determine the net worth at a particular point in time.
Figure 1.3. The balance sheet
The profit and loss statement (P&L) is sometimes called the statement of financial performance and compares a company’s revenue to its expenses to determine if a profit was made. The P&L applies over a period of time such as a month, quarter, or year. The P&L does not include capital expenses.
Figure 1.4. The profit and loss
The cash flow statement reports on the cash that comes in and goes out, including both capital and expenses. The cash flow report includes every dollar into or out of a company, no matter the source or destination. The cash flow report applies over a period of time.
Figure 1.5. Cash flow
The operating statement (otherwise known as the budget) reports the actual expenditure versus expected or planned expenditure over a period of time.
Figure 1.6. Operating statement
Follow the Money
Figures 1.7 and 1.8 show how companies account for the value of spare parts.
As you can see in Figure 1.7, when a spare part is purchased as part of an inventory, the value is recorded as both an asset on the balance sheet and a cash-out expense on the cash flow statement. At this stage the value is not recorded on the profit and loss or the operating statement. This is why additions to inventory don’t impact maintenance budgets.
In Figure 1.8, you can see that when the spare part is removed from the inventory for use by maintenance or engineering, the value is shifted from the balance sheet to the expense section of the profit and loss. At this stage the value is also added to the operating statement as a measure of expenditure against the budget for the machine on which it is used or relevant department.
Figure 1.7. Financial allocation with purchase of a spare part
Figure 1.8. Financial allocation with use of a spare part
Accounting in this way uses the balance sheet as a kind of buffer for the accounting of inventory so that the inventory does not get counted as an expense until it is actually used. This helps to smooth out the reported operating cost for a company by only accounting for the cost of the spares in the reporting period in which they are used.
Recalling that one of the principles of accounting is to reflect the actual value of a company, this buffer-type impact of the balance sheet does just that because the inventoried parts do have a value and that value is reflected in the balance sheet. To do otherwise would result in massive swings in expenses as a company might spend up big on spare parts in one year (say, for new plant and equipment) but then spend very little as it uses up those parts over time.
Some companies don’t use this buffering approach; instead they expense all spare parts when they are purchased. We can let the accountants and auditors argue whether this practice is in accordance with accounting principles, but it is important to note that both the buffering and expensing approaches do have their pros and cons. These are shown in Table 1.1.
Table 1.1. The pros and cons of the balance sheet and expensing approaches
| Approach | Pros | Cons |
| Balance sheet | Improves asset management by aligning the timing of expense with operational activity and enabling budgets to be constructed to align with maintenance expectations | Reduces accountability for cash spent on spares, as there is generally no inventory budget or other direct accountability |
| Expensing | Direct accountability for cash used for spare part purchases on a monthly basis | Misalignment of the timing of parts expenses with actual use results in misleading maintenance cost reporting |
| Monthly parts budget can constrain purchases of parts required, impacting operational output |
The impact of the balance sheet versus expensing approach is not to be taken lightly. While the balance sheet approach may require additional accounting input, it does enable a company to more accurately reflect the actual maintenance expenses, which is important for asset management. On the other hand, companies that use the expensing approach have been known to put off completing maintenance tasks because the spares budget has been spent for the month. This might seem like prudent fiscal management until you realize that the budget may have been spent on items that have not been used and that may not be used for months or even years. This is clearly not good practice.
1.11 The Key Elements of a Spare Parts Management System
Now that we have reviewed some of the issues and concerns relating to spare parts inventory management, we need to understand just what makes up a spare parts inventory management system. As a starting point, let’s look at what a spare parts inventory management system is not.
It is not software.
No matter whether you use a companywide enterprise resource planning program, such as SAP, PeopleSoft, or IFS, or whether you use a standalone inventory management program, these programs are not your spare parts inventory management system. These are tools that you use within your system, primarily for data collection and labor efficiency. Similarly, bar coding is not a spare parts inventory management system. Bar coding is also a tool used within your spare parts inventory management system. So just what is a system? An online search using Google9 provides the following definitions:
1. A set of things working together as parts of a mechanism or an interconnecting network, a complex whole.
2. A set of principles or procedures according to which something is done; an organized scheme or method.
Thinking about these definitions, we can see that an ERP and bar coding are both systems, but on their own they are not spare parts inventory management systems.
Definition of a Spare Parts Inventory Management System
Here is a practical definition of a spare parts inventory management system:
A set of principles, policies, procedures, guidelines, and tools that enable a company to identify procure, control, account for, and dispose of spare parts.
In effect, the spare parts inventory management system encompasses the entire life cycle of asset ownership from determining what to stock to disposing of a part at the end of its life. This is shown in Figure 1.9.
Figure 1.9. The spare parts management life cycle
Importantly, establishing a spare parts inventory management system does not commence with the spare parts themselves; it commences with getting organized. That is, it is first necessary to determine how the parts that are ultimately selected will be identified, the holding quantities determined, and the parts then stored. Without this your spare parts inventory is likely to be nothing more than a pile of junk in the corner—just like Figure 1.10.
Even with an idea as simple as getting organized, there is a scale of sophistication or maturity that needs to be considered. For example, a simple system of storage bins with a label that includes a part description and maximum holding quantity, where levels are checked weekly and top-up replacements reordered, might be perfectly adequate for a small manufacturer with a handful of machines, a few different types of parts, a small inventory investment, and minimal downtime consequence. However, that approach would not be suitable for a large, complex manufacturer or processing plant, with millions of dollars tied up in thousands of stock keeping units, with perhaps hundreds of cost centers and downtime costs measured in tens of thousands of dollars per hour. The system therefore needs to be fit for purpose, based on the circumstance and situation in which it is being applied. Some examples of this are provided in Table 1.2.
Figure 1.10. A pile of junk results from not having a spare parts system
Table 1.2. Examples of increasing sophistication in the attributes of spare parts inventory management systems
| Attribute | Basic | Sophisticated |
| Use of IT | None, visual management only | Fully integrated, bar coding, equipment BOMs, alternative SKUs, images of parts, electronic vendor catalogs |
| Reordering | Manual stock reviews and periodic reordering | Automated reordering of selected parts based on vendor matrix and preapproved agreements |
| Parts identification | User memory | Formal, simple, standardized approach to part descriptions and numbering |
| Storage | Whatever is available | Fit-for-purpose storage based on part maintenance requirements such as vibration isolation and humidity control |
| Determining holding levels | Best guess by maintenance team members | Fully documented and rigorous approach that differentiates among inventory types |
Establishing and determining parameters such as identification, storage, and control, before establishing the rest of the spare parts inventory management system, sets the constraints within which the system must operate. Failing to understand this leads to many companies having misalignments between aspects of their spare parts inventory management system that drive inefficiencies and suboptimal outcomes.
The following sections of this book explore the key elements of spare parts inventory management through the spare parts life cycle and under the umbrella of a spare parts inventory management system.
1.12 A Quick Word on Multiechelon Systems
For spare parts inventory that is held by a company for the operations and maintenance support at its own sites, the vast majority of storerooms operate independently. That is, most typically, one storeroom services one site, or when there are multiple storerooms at a single site, each storeroom operates independently of the others. This arrangement, where one location acts as the buffer between the vendor and the user, is known as a singleechelon system (see Figure 1.11). This arrangement occurs even with very large companies that have many locations.
Some companies, however, operate with a multilayered approach that is sometimes referred to as a hub-and-spoke strategy. This is where one company storeroom operates as a kind of distribution center for other company storerooms. In this case the vendor delivers to a central storeroom, and the company then distributes to its own storerooms, which then supply to the users. Just to complicate things, vendors may also deliver some items directly to individual sites and storerooms. This is known as a multiechelon system and is also shown in Figure 1.11.
Multiechelon systems provide a number of inventory management opportunities that can result in reduced inventory holding levels and reduced procurement costs:
1. Slow-moving spares. If the central storeroom holds slow-moving spares, it saves each site from independently investing in the same slow-moving items.
2 Bulk procurement. If a vendor provides significant price breaks for quantities larger than a single site would order, or if the vendor supplies only in quantities greater than a single site should stock, then a central warehouse can be used as a distribution hub. Of course, care must be taken to ensure that the economics of this makes sense.
3. Excess parts redistribution. When one site finds that it has excess parts, the parts can be more easily redistributed to other sites via the central location. Care must be taken to ensure that the central location does not become a dumping ground for unwanted spares.
4. Repair management. For repairable items of significant value, utilizing the central hub to manage the repair process can provide improved repairs management and, with added volume, reduced costs.
5. Improved response times. By holding spares that have a long supply lead time at a central location, a company can significantly cut the lead time for supply to its own sites and so hold less safety stock.
6. Shared safety stock. If executed correctly, a multiechelon system can enable companies to hold less safety stock across their entire network.
However, there are also issues to be managed:
1. Visibility. To work effectively, each location needs to be able to see how much stock is held at the central hub and preferably at all sites in the network.
