Five Levers for Optimising Spare Parts Inventory

As organisations grow they tend to amass spare parts for their operations, which can tie up large amounts of cash and incur significant costs as the result of write-offs, duplication and insurance. Companies often overlook opportunities to optimise their inventories – sometimes through fear of risk to the business if spares are unavailable, and other times through mistakes in software, processes or accounting practices. Here are the five levers that optimise spare parts inventory:

1. Segment data to find the first inefficiencies.

The first step is to assess and understand your spare parts inventory.

An effective technique is the 12-box analysis, which provides a bi-dimensional look at spare parts. As illustrated below in Figure 1, this analysis typically segments spare parts based on stock usage value on the left axis (high value = A; medium value = B; low value = C) and frequency of use on the top axis (fast, medium, slow and very slow).

Spare parts used within a designated amount of time, such as the past five years, fall into one of the 12 boxes on the diagram, allowing further analysis of each box to identify and quantify inefficiencies, understand root causes of inefficiency and target areas for improvement. Inventory that has not moved during the analysis period (“non-movers”) typically is analysed separately.

Figure 1: Example of a 12-box analysis for spare-parts inventory
REL Consultancy fig1
For example, when applied at a large energy company, this exercise revealed that more than 80% of the company’s total spare-part stock keeping units were used only rarely (“very slow movers”) or hadn’t moved in five years. Together, these segments accounted for 37% of the dollar amount of net inventory and US$66m in write-offs and depreciation.

Often, a 12-box analysis will highlight undifferentiated stocking strategies as the key causes of inefficiency, in which systematically cautious planners and maintenance staff order too much stock from fear of disruption to the business. The next two levers address these issues.

2. Use statistical models to set different stocking rules.

To optimise spare parts inventory, a company will typically need to tailor stocking and replenishment to part-specific factors such as demand, lifecycle status or criticality. The 12-box analysis can be useful for guiding development of differentiated stocking rules based on these characteristics.

The first step uses standard statistical models, such as normal and Poisson distributions, to calculate target stock levels. This approach sets inventory levels using agreed-upon data rather than conservative estimates, which are often based on fear of not having parts available when needed. Based on our experience, applying normal distributions across all categories can reduce the level of inventory held by 15%-25% without increasing risk to operations. Then, by applying more advanced stocking policies to the different boxes (as per Figure 2 below), savings could be increased to around 25% to 30%.

Figure 2: Examples of 12-box stocking strategies
REL Consultantcy Fig2
Figure 2 provides an example of how a company might apply differentiated stocking strategies for specific segments:

  • Kanban, a system of inventory replenishment using cards as a signal, for high value, fast-moving (“core”) items.
  • Materials requirements planning (MRP), a planned ordering of spares based on lead times, for high-value but slow-moving (“volatile”) items.
  • Re-order point, or replenishment of spares based on a fixed inventory level, for other core (medium value, medium movement) items.
  • 2-Bin, similar to Kanban except using an empty container to signal replenishment, for low-value, medium- to fast-moving (“non-core”) items.

It is important to review such strategies regularly to ensure they remain appropriate.

3. Apply demand-management and forecasting basics.

Understandably, maintenance and planning staff do not want a plant to stop operating because a particular part was unavailable. But this “fear factor” can lead to other problems, including excess inventory, unused spares, and excessive write-off costs.

Using basic demand-management and forecasting rules and processes can go a long way toward optimising demand and timing for spare parts. Figure 3 below outlines a typical demand forecasting and planning process. This starts by defining demand specifications for spare parts and moves on to check requirements for operations planning. From there, it considers maintenance planning before developing forecasts for the inventory.

Figure 3: The demand forecasting and planning process
REL Consultancy Fig3
Once the company has proper demand-management processes in place, it can take advantage of more advanced forecasting techniques to optimise spare parts inventory. These techniques link stocking policies to mean time to repair, mean time to failure, and Weibull analysis.

4. Consider other supply-management concepts, but only after taking the steps above.

After taking the above steps, it may be prudent to look at other supply-management concepts, such as consignment and vendor-managed inventory or capitalisation.

Consignment and vendor-managed inventory are popular and well-established concepts for direct production materials, but they can also be applied to global spare parts inventory. These are most relevant for low- to medium-value, standard, or frequently used items such as standard electrical components, seals, valves, and tubing. Typically, this may include 30% to 40% of spare items but only about 5% of total inventory value.

These concepts may also be applicable for specialty items when equipment suppliers have global supply contracts, such as for certain types of production machinery such as computer numerical control (CNC) machining centres or automated production lines. They may be more difficult to apply, though, with major specialty equipment for which there are only few suppliers in the marketplace and those suppliers aim to sell spares as part of the purchasing contract.

Another possibility at this stage is capitalisation of spare parts; that is, treating them as fixed assets on the balance sheet rather than inventory, which is reflected in working capital. While this can have a very significant impact on reported inventory levels, companies should use caution in pursuing this direction as it hides the resulting inventories and can lead to cost inefficiencies and expensive, redundant and obsolete items.

Again, while these may be attractive quick fixes, they will be most likely produce benefits only after implementing other optimisation strategies.

5. Sustain results by embedding monitoring and continuous improvement into regular processes.

Once an organisation has taken action to optimise its spare parts inventory strategies, it will need a way to measure performance and sustain improvements. The three critical elements for sustaining and improving performance across an organisation are key performance indicators (KPIs), governance and continuous improvement processes. The key is making sure all three elements are properly aligned.

Figure 4 below illustrates an example of a KPI structure for inventory management. It contains a hierarchy of measures that are both managerial and operational.

Figure 4: Example of inventory-management KPI structure
REL Consultancy Fig4

These KPIs are then aggregated, monitored, tracked and controlled at a group level. For this to happen, the underlying operational and reporting processes must be standardised and consistent across operations, with clear definitions of roles and accountability.

Of course, KPIs and governance structures are meaningless if they do not drive corrective actions. An inventory-management dashboard can be an essential tool for continuous improvement, enabling regular monitoring and producing information to be used for problem solving, root-cause analysis, and improvement actions.

Strategic Insights

Focusing on spare parts stock presents working capital opportunities, but to capitalise, companies must invest the same discipline in planning that they apply to operational inventory- from practices and policies to measurement. This discipline starts with replacing a “just-in-case” mindset with one that relies on proven inventory management techniques. Complementing these techniques should be a focus on continuous improvement that includes integrating systematic processes and measures for tracking and managing spare parts inventory into regular business operations.

Our experience has shown that world-class organisations integrate these activities into their lean management and continuous improvement programs to make inventory optimisation an ongoing part of business operations.

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