The MRO Inventory Dilemma

What Causes Excess MRO Inventory?

The answer to this question is complex, since there are numerous reasons and practices that put companies in this position. Some of the key causes are:

Blind reliance on equipment manufacturer’s spares stocking recommendations

During the new equipment acquisition process, it is not unusual for a company to ask the supplier for spare parts to support them for an initial period. Typically, these spare parts are purchased along with the production equipment, with little analysis of whether they will be needed, or if they are the right parts. As a result, many of these spare parts turn out to be excess, or become dormant.

Lack of due diligence in proactively provisioning the spare parts needed to support new equipment

Provisioning is a term used to describe a formalized process for identifying the range and depth of spare parts needed to support new production equipment. While there are some exceptions, most companies do not perform a rigorous analysis to determine what spare parts are needed. The primary reason for this lack of analysis is the pressing workload to get a machine (or plant) up and operational, and a lack of available resources to conduct the detailed analysis required to adequately provision the equipment. Additionally, even a cursory analysis of other plants’ experiences with the same or similar equipment is seldom done.

Not screening in inventory other plants to identify excess stock that can be redistributed

In our experience, we have also seen numerous cases where inventory needed to support the new equipment is already in the network and, in many cases, is in an excess position. Typically, this is a systemic problem because plants do not have visibility into other site’s inventories and, even if the visibility exists, there is no process for allocating and transferring inventory from plants that have surplus stock.

Adoption of a “just in case” inventory mindset

In this situation, when a detailed review of spare parts is done, the plant manager or maintenance manager determine whether they need to buy additional critical spare parts to minimize the risk of a production line shutdown. This decision is typically not based on any detailed analysis of failure data or lead time considerations but based on intuition or risk aversion.

Inadequate analysis of inventory characteristics

Typically, once an item becomes part of the inventory, no rigorous analysis is done to understand its inventory characteristics, i.e. usage patterns, reorder point, lead times, etc., as usage patterns or lead times change. As a result, companies may be maintaining too much inventory or not writing off material that has become obsolete.

Optimizing MRO Inventory

Manufacturing organizations can proactively and effectively manage their MRO inventory by implementing a twopronged approach designed to:

1. Reduce the levels of current inventory
2. Optimize their investment in capital spares

Reduce Current Inventory Levels

A great starting point for optimizing MRO inventory is to develop a program that reduces current inventory to an agreed optimal stock level or dollar amount. To do this, plant material managers must first understand the current inventory profile and tailor solutions to address the various categories of inventory. First, the inventory must be segmented into groups that require different supply planning and management strategies (see table 1). In this example, inventory is categorized based on consumption rate as dormant, slow moving, fast moving and extremely fast moving. Once the inventory is segmented, the following strategies can be implemented to significantly reduce the current inventory levels.

Establish a Central Warehouse for Common and Critical Spares

With a clear segmentation of inventory, it is easier to identify obsolete inventory, excess stock, and critical spare parts. High-value inventory used at multiple sites can be pooled within a region. These items can be stored at a designated facility or at a third-party warehouse. Such pooling will allow sites to maintain a minimum amount of inventory on-site and obtain inventory as needed from the pool.

It is important to develop policies and procedures to document material requisitioning, replenishment processes, and inventory ownership. A successful implementation of this strategy will require completion of other initiatives, such as SAP data cleanup and inventory transfer capabilities.

Slow-moving, critical items, such as safety stock can be moved to a central warehouse. The central warehouse can supply the stock to other locations, as and when the need arises.

In case of regionally dispersed sites, it is worth having regional distribution centers. Managers at the central warehouse for a region can manage the replenishment requirements. A key benefit of this approach is that a central warehouse forces managers to search and locate existing inventory before ordering new stock.

Modify Existing ERP System/CMS for Improved Inventory Visibility

Manufacturing organizations must modify or update their ERP/CMS to provide inventory visibility and an easy method for inventory transfer. An ERP-based virtual warehouse can store all the information related to MRO inventory. All sites can search and retrieve inventory data from the virtual warehouse in real time.

The transfer of inventory ownership from the warehouse to the site and the replenishment process can be managed through the centralized virtual warehouse. Once a transfer request is acknowledged, all aspects of the transaction can be updated in real time, and the history can be tracked. The success of a virtual warehouse depends on the commitment to invest in the required IT resources.

Initiate Inventory Buyback Agreements with Suppliers

Manufacturing companies can enter into inventory buyback agreements with key suppliers to reduce their current inventory. Distributors are usually willing to buy back usable materials in original packaging. OEMs might take back materials that can be resold with some repackaging or refurbishing. OEMs can also be engaged to help market scrap or surplus inventory. Besides reducing the cost of carrying surplus inventory, manufacturing organizations can receive cash or credit in exchange. Suppliers typically charge 20 to 25 percent buyback or restocking fees in such transactions.

Implement Vendor Managed Inventory (VMI) Programs

Vendor Managed Inventory (VMI) is an effective way to reduce inventory carrying costs and improve cash flow. In a VMI model, the supplier is responsible for maintaining the required inventory levels for selected items at the manufacturer’s location or at their facility. The ownership of the inventory lies with the supplier, until it is requisitioned by the customer.

VMI model allows the company to minimize the material it holds in inventory and pay only for the material it uses. VMI requires tight integration of the manufacturer’s and the supplier’s systems to provide the supplier visibility into the manufacturer’s inventory usage data and replenishment plans. In successful VMI programs, manufacturers work proactively and closely with suppliers to ensure that adequate inventory is available at all times.

Optimize Capital Spares Investment

While the strategies discussed so far are helpful in reducing existing inventory levels, long-term success requires that the organization buys the correct inventory when purchasing new capital equipment. The following strategies can be deployed to optimize capital spares investment, while minimizing the risk of equipment downtime.

Manage Capital Spares Identification Process Proactively

The maintenance, engineering and purchasing departments, as well as the equipment manufacturer, should formalize a process that results in an in-depth analysis of the reliability of the equipment to be purchased to identify critical spare parts, and those likely to be used routinely in maintenance activities. By using the equipment “Bill of Material” (BOM), Mean Time Between Failure (MTBF) data and the equipment maintenance plan data, a detailed analysis can be done to identify the items and quantity of material that must be stocked.

This analysis must include failure predictions, item criticality, lead times and any historical data that can be gleaned from experience with the same or similar equipment in other plants.

Final recommendations should be screened across the enterprise to identify if the recommended items are already in stock and if they can be reallocated from other sites to fulfill their requirements. This process minimizes upfront investment in spare parts.

Require OEMs to Identify COTS Items

During the equipment acquisition process, best-in-class companies require OEMs to identify “commercially available off-the-shelf” (COTS) items and list them in the final agreement. Identification of these parts allows the company to screen its inventories to see if the material is already in stock and can be reallocated for these requirements. It also allows these items to be purchased from appropriate commercial channels, typically at a much lower cost.

OEMs will resist this request as aftermarket spares are a high-margin business, so due diligence and strong negotiation skills are required during the contracting process to avoid future conflicts.

Negotiate with OEMs to Hold Consignment for Equipment Rollout

Another strategy to optimize capital spares investment involves the implementation of a consignment program. OEMs can stock spares expected to be used during the initial maintenance support period of the equipment for the buyers. In this model, the spares are paid for only when used. This process reduces the initial investment in spares and shifts the responsibility and risk of maintaining the spares to the OEM. After the agreed support period, critical items as well as those items that are used during the support period must be identified, before the ownership and responsibility is transferred from the OEM to the company.

It is important to negotiate liability terms to address the risks of OEMs not carrying the spare parts when required. This process can improve cash flow and reduce the cost of carrying inventory. The company might have to pay a premium for the parts as the OEM bears the cost of stocking the spare parts, but this premium is far less than the amount invested in spares that will never be used.

Contract OEMs to Provide Maintenance and Spares Support

Buyers can negotiate with the OEM to enter into a maintenance and spares support agreement. The OEM must be able to provide full maintenance support for an interim period of one to two years. In such arrangements, the OEM is fully responsible for all maintenance and spares support.

The OEM must agree to meet equipment uptime goals. The negotiations must focus on cost of service, indemnification and liability requirements. Due diligence must be conducted to define and implement transition requirements six months prior to transition date.

With this approach, the risk shifts from the manufacturing company to the OEM. The initial investment in spares is also minimal. The investment in post-transition spares is based on the actual use of items and critical spares, which minimizes the need to buy unnecessary spare parts.

Conclusion

With a proactive, systematic and structured approach, manufacturing companies can drive significant cost reduction and savings by optimizing their MRO inventory. Some of these inventory optimization strategies can bring immediate savings and improved cash flow, while others can deliver long-term sustainable value. Strong, collaborative relationships with stakeholders, such as OEMs, labor unions and plant managers are critical to the success of these strategies. By making the right investment in people, processes and systems, manufacturing companies can optimize their MRO inventory and drive significant bottom-line savings.