Author: Michael V. Brown, New Standard Institute
Copyright © 1999 by New Standard Institute, Inc. (http://www.newstandardinstitute.com)
In their book "Re-engineering the Corporation," Michael Hammer and James Champy relate a story that parallels a commonly found problem in maintenance storeroom management. A commercial airline had a plane, which was grounded due to a technical problem. A mechanic in a city in another part of the country was the only person qualified to correct the problem. The mechanic's supervisor refused to send the mechanic on the next flight out because that would create an overtime charge against the supervisor's budget. Instead, the supervisor sent the mechanic the next day, during normal working hours. As a result, the plane sat on the ground for a day, losing thousands of dollars in revenue to save a few hundred dollars in overtime pay.
Just like the supervisor cited in the story, maintenance storerooms often operate in a vacuum within the company. Cost responsibility, which should be controlled by the storeroom manager, is often placed under the jurisdiction of another department or accounting cost center. For example, the cost of shipping parts to the plant site are usually accumulated in a general account, apart from the stores inventory account. As a result, the storekeeper is not held responsible for last minute purchases, which may require expensive air freight. The higher shipping cost is wrongly assumed to be a necessary cost of doing business, rather than the result of sloppy inventory control.
The two main contributors to high stores inventory dollar value are the reorder point and the reorder quantity. The reorder point is governed by the lead time of the part and the average usage. A safety stock may be added to more important items to compensate for fluctuations in usage or lead time. On average, half the safety stock will still be on the shelf once the replacement parts are received.
Reorder quantities should be based on economic decisions concerning the cost of holding a part and the cost of placing an order. As with safety stock, about half the reorder quantity will be held in stock.
Any company hoping to reduce the cost of inventory should first reevaluate both reorder quantity and safety stock. Unfortunately, some popular management improvement programs designed to reduce stores inventory have ended up costing more than the holding costs and ordering costs saved.
Many companies have decided to eliminate some or all items from storeroom control and have instead made contracts with local vendors to provide the parts on demand. These programs tend to reduce storeroom inventory, and hence inventory carrying costs. This approach does not mean the parts are delivered immediately, but rather within an hour or so.
The costs which are not accounted for in this arrangement are the costs associated with downtime and the time maintenance employees spend waiting for the parts. Production and personnel waiting for a simple five dollar bearing to arrive can end up costing a few hundred dollars.
The parameters used to determine the best order quantity for a part also embody some costs wrongly considered to be outside the control of the storeroom. One of these is the administrative costs associated with each purchase order. These costs can range from $30 to $150 from company to company.
The annual cost of purchasing and receiving an item is determined by the formula shown below.
The annual purchasing costs can be reduced if fewer orders are placed. This is accomplished by increasing the order quantity for each order.
The down side of placing larger orders is that the overall inventory value will increase. Many companies are also reviewing the high costs associated with carrying parts in a storeroom. Holding or carrying costs for storeroom inventories can be as high as 20 percent of the inventory value per year. The cost to carry a part in a storeroom includes clerks' salaries, building costs (such as rent or depreciation), and inventory tax. Obsolescence, shrinkage, and scrap also claim some of the storeroom inventory. As old equipment in the plant is removed, spare parts in the storeroom become unnecessary. Other parts may be simply stolen from the storeroom or scrapped due to damage. The "cost of money" is also a major portion of carrying costs. Every dollar spent on items in storage could have been put in the bank or invested in some other way.
These costs begin to accumulate the day the part is put on the shelf. Average annual carrying costs for an item can be calculated by the following relationship:
Assume the following example:
The total expense, which should be charged against the storeroom operation to hold this item for the year is $340. However, this allocation to stores operation may never be performed by accounting. The purchasing department will cover their costs as a separate entity. This myopic view of the storeroom operation runs counter to efforts to reduce total operation costs.
The $340 figure for this part may not be the lowest cost, which can be achieved. It will take nine purchase orders, at a cost of $30 each, to meet the needs of the facility. Perhaps more items could have been purchased on each order to reduce the annual cost of purchasing. On the other hand, a higher order quantity would lead to a higher carrying cost because the average inventory would be higher. A happy medium must be achieved.
The graph below shows the relationship between purchasing costs, carrying costs, and the order quantity for the item in question.
The purchasing costs in a year can become very high if only a few parts are ordered at a time. The annual cost of purchasing drops off considerably when the order quantity is high. This fact, when considered alone, would suggest that it is best to purchase the highest quantity you can afford so costs will be lower. Unfortunately, the carrying costs will also accumulate as time progresses and will become a major factor by the end of the year. The graph shows that, if the order quantity is high, the annual carrying costs are high. The total cost curve, which combines the purchasing costs and carrying costs, provides a more complete relationship when comparing different order quantities.
The lowest total cost indicated on the curve corresponds to an order quantity, called the economic order quantity (EOQ). This is the order quantity where purchasing costs and holding costs add up to the lowest total cost. A conclusion can be drawn that the EOQ is the best order quantity for all future purchases of this item.
Coincidentally, the purchasing costs and carrying costs are equal at the EOQ. An equation for the EOQ can be derived by setting the equation for the purchasing costs equal to the equation for carrying costs, and solving for L (or EOQ), the order quantity.
For our example:
The result indicates that each order should be placed for 13 items. The curve shows that the total cost will go up if more or less than the EOQ of 13 items is ordered. The curve implies that any increase or decrease in order quantity will result in higher charges against the operation of the storeroom.
Many storekeepers complain that they must keep a high safety stock to compensate for variations in vendor lead time. However, lead time for the delivery of a stores item is made up of much more than just the vendor involvement with the order. Often, the biggest contributor to lead time is the bureaucracy at the company doing the ordering. Here are some common lead time problems that should be eliminated:
1. Time to notice the part is below the reorder point.
Storekeepers who rely exclusively on cycle counts for inventory control may not find out about the depletion for a week or more. Implementing a perpetual inventory system is one solution. A perpetual inventory system begins with the requirement that all parts removed from the storeroom must be signed out. The quantity signed out is removed from the current book inventory. The part is placed on order when the inventory reaches the predetermined minimum. Once the items are received from the vendor they are placed on the shelf and the book inventory is updated.
Even with a perpetual inventory system some delay will still remain. If the part reaches the reorder point in the evening or over the weekend, the order may not be placed until the next working day. Even if the depletion occurs during normal working hours of the storeroom, a perpetual inventory system, in its purest sense, may not catch it until the data is entered into an inventory record or onto the computer. The storekeeper should print a daily edit list of the items at or below the reorder point
Companies that use bar coding systems or ones which enter stores withdrawals at the time of the withdrawal tend to shorten the time required to react when the reorder point is reached.
2. Time required to prepare and distribute a purchase request.
The preparation of a purchase request (as opposed to a purchase order) is required by some company management. This may be coupled with other purchase requests to make a complete order to a vendor. Often (and unnecessarily) this requires further approvals beyond the initial approval given to a part when it was first placed in the storeroom. Eliminating the additional approval process altogether is the best solution. Another solution is to set up an E-mail approval system on the computer network. The purchase request can be listed on the network and a call to the persons who should approve the purchase can be made on the system. A hard copy or computer document of the purchase request can be sent immediately to purchasing.
3. Time for purchasing to place the order.
In an effort to avoid numerous, small purchase orders, a purchasing agent or a storekeeper will often wait to order a part until a full purchase order is developed. It is not uncommon for orders to wait for two or three weeks before being placed with the vendor. Although this reduces the problem of numerous small purchase orders, it can cost the company in longer lead times and higher inventory levels.
To combat this delay, set up a negotiated blanket order system for commonly used items in the storeroom, like pipe fittings and power transmission equipment. Blanket order purchases could be handled by the storekeeper. Purchases to blanket vendors could be accomplished using a pre-designed fax data sheet. The invoice could be compared to the faxed data sheet to assure proper prices were charged.
Electronic Data Interchange (EDI) is also used by storekeepers in place of a fax. EDI is a computer modem link directly to a vendor's inventory system or through a service system. Orders can be placed by the storekeeper or sent automatically through the storeroom inventory computer system. The latter option may require some human intervention to prevent the computer from making a number of small purchases for items, which reach the reorder point.
4. Receiving time.
Once the vendor delivers the part to the facility it must be inspected and received. Receiving takes different forms at various facilities. The receiving function may not be part of the storeroom responsibility at some facilities. This usually adds a day or two to getting the part on the shelf. The solution is to have the part delivered to the storeroom as soon as it leaves the truck. Ideally, the storeroom should be located next to the receiving area.
Some items require testing before they can be placed on the shelf. Measurement of critical dimensions, chemical alloy tests, hardness tests and electrical tests must be performed to ensure the item is fit for use. These tests can extend the receiving time. One solution is to require certified test results from the vendor at the time of delivery. A small sample of parts can be tested by company employees to keep the vendor honest.
5.Time to stock and post the receipt.
All too often an unfortunate situation occurs, when a part needed in an emergency is not on the shelf but is discovered too late sitting in a receiving area at the site. Stocking and posting received items should not take more than an hour at most facilities, unless a further inspection process is required.
Some computerized inventory management systems track all the components, which make up the lead time. If the overall time is increasing, these programs can pinpoint where the additional time is occurring.