Spare Parts Inventory Management: A Complete Guide to Sparesology

PART 1

The Spare Parts

Management System

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