Surplus Maintenance, Repair and Operations (MRO) inventory, defined as stock-on-hand in excess of maximum levels, is an unfortunate reality at many asset-intensive organizations. Surplus inventory is undesirable because it increases holding cost and also ties up scarce resources – capital, warehouse space and manpower – at the expense of items that are more urgently needed by the organization. It is not uncommon for surplus inventory to make up a significant fraction of total inventory at many organizations and, since it increases cost but not inventory performance, it represents a logical target for inventory-reduction initiatives.
Within the Oniqua Analytics Solution (OAS) application, surplus inventory can easily be identified by implementing Control Segments and/or Work Queues with appropriate business rules. Once so identified, the organization must decide on the best way to address it. The two standard options are to write off the surplus inventory or to run it down through natural attrition. In the case of the former, a write-off cost is incurred and this has to be balanced against the benefit of immediately eliminating the surplus-inventory holding cost. In the case of the latter, the write-off cost is avoided but the holding cost is eliminated over an extended period of time instead of immediately.
However, surplus inventory is really only a symptom of deeper underlying inventory management problems. Why does surplus inventory occur if the inventory is managed within strict Min/Max levels? One common cause is the return of items that have been purchased for planned maintenance (PM) and/or special projects but not used. In an ideal world, PMs and projects would have accurate Bills of Materials (BOMs) that enable the planner to identify and purchase only the items that are required, nothing more and nothing less. In reality, BOMs are frequently inaccurate, incomplete or missing thereby forcing the planner to exercise judgement in deciding which items to purchase. This uncertainty creates a tradeoff between the conflicting objectives of ensuring that all the required items are available on the one hand and minimizing the return of unused items on the other. In such a situation, it is not difficult in principle to establish an objective framework to guide the buy/no-buy decision by quantifying the expected costs of the two alternatives. To do so, we first define and estimate the following parameters for each item that is potentially required for the PM/project:
P = probability that the item will be required
S = stock-out cost if the item is not purchased but required
W = write-off cost if the item is returned and written off
R = rundown cost if the item is returned and ran down
= holding cost of the surplus inventory over the rundown period
Then, if the item is purchased, the expected cost to the organization, taking into account the possibility that it will not be required, is C1 = (1-P)*MIN(W,R) where it is assumed that, in the event that the item is returned, the organization selects the disposal option that corresponds to the lesser of W or R. Conversely, if the item is not purchased, the expected cost to the organization, taking into account the possibility that it will be required, is C2 = P*S. Then if C1 < C2, the planner should purchase the item and conversely, if C1 > C2, the planner should not purchase the item.
While this analytical framework is simple and provides an objective buy/no-buy decision, it is unlikely to be utilized at most organizations where the dominant dynamic in the decision-making process is the asymmetric incentives and consequences between the buy/no-buy alternatives. Stocking out of an item that is required is treated as an extremely bad outcome while returning an unused item less so. As such, the planner is strongly incentivized towards purchasing the part as long as there is even a slight possibility that it will be required i.e. 0 < P << 1. While it is in the planner’s rational self-interest to do so in view of the consequences, this type of decision-making process is sub-optimal for the organization as it results in increased expected costs in the long run i.e. the item is purchased even if C1 > C2.
To improve the decision-making process, organizations need to change the asymmetric nature of the attendant incentives and consequences. One way to do so is to introduce equally severe consequences for returning unused items. Alternatively, management may opt to change the perception and consequences around stock-outs such that the entrenched behavior of avoiding stock-outs at all cost is moderated.
Organizations must address the root causes of surplus inventory otherwise more will keep appearing even as it is being written off and/or run down. Ensuring that BOMs are complete and accurate removes the uncertainty around the material requirements for PMs/projects and the subsequent return of unused items. In the absence of reliable BOMs, organizations can still manage their surplus inventory by using an objective framework to optimally balance the cost of the surplus against the cost of stock-outs. To make such a framework effective, however, requires a culture change in the prevailing decision-making process.
Learn more about how Intelligent MRO management can help you significantly reduce operational costs and eradicate waste, while improving uptime and service levels