Inventory management: The storeroom strikes back

Last month we discussed how it’s easy for management to see the glaring cost of high inventory levels but not necessarily the more-subtle cost of lost maintenance efficiency, which ultimately affects even-more-costly plant capacity and reliability. One can see why management might become overly aggressive in cutting inventory cost.

But the maintenance force itself can be guilty of making the storeroom carry too much inventory through unnecessary and uneven use of spare parts. Stay with me on the math here.

Consider the case of a plant that uses a $10 filter each month. This company has a 20% inventory carrying cost and a $100 cost to process a purchase order. Over the course of six years (72 months), the company would spend $720 on the filters themselves. But the overall cost will depend on how often the company places a purchase order and how many filters it carries in inventory. For the lowest overall cost to the company, the economic order quantity (EOQ) is 35. How did we arrive at that number?

EOQ = SQRT (2QP/C), where Q is the annual quantity used, P is the purchasing cost, and C is the carrying cost (calculated as the carrying percentage multiplied by the cost of a single item).

EOQ = SQRT [(2 × 12 × $100)/(20% × $10)] = 35.

Rounding this EOQ up to 36 means the company should place 2 orders during the 6 years for 36 filters each. The filters still cost $720 for 6 years, but the carrying cost adds $216 (18 average filters in stock × $10 each × 20% × 6 years) and the purchasing cost adds $200 ($100 per order × 2 orders). So the lowest total company cost for six years would be $1,136, or $189 annually.

The quantity on hand (QOH) goes from 36 to 35 to 34, etc., as maintenance uses a filter each month. If the lead time to purchase the filters is one month, then as soon as QOH reaches one filter, the plant should purchase 36 filters, which will arrive just in time for the next use. The reorder point (ROP) is one filter.

But presume the maintenance force sometimes, but not always, gets three filters at a time and puts the two extra filters in the maintenance shop (or even by the equipment itself) for the next couple of filter changes. The storeroom sees that maintenance sometimes needs three filters at a time and raises the reorder point from one filter to four filters to ensure having three on hand.

ROP = four filters, so the average number of filters kept in inventory over the six years (with the EOQ of 36) increases from 18 filters to 21 filters. The extra three filters incur an extra annual carrying cost of $6 (3 filters × $10 each × 20% carrying cost).

Six dollars a year does not seem like much, but consider the hypothetical effect on a $10 million inventory value if similar uneven use is a common practice. The average filter inventory is 21 filters. The average value of the filter inventory is $210 (21 filters × $10 each). The filters are 1/47,619th of the total inventory ($210/$10 million). So logically, if every 1/47,619th of a $10-million inventory costs the company an extra $6 per year, the total extra cost would be $285,714 per year. The company would spend an extra $285,714 each year because maintenance has a bad habit of grabbing extra parts rather than leaving them until they’re needed.

Withdrawing storeroom parts when it’s unnecessary to do so might not be a widespread maintenance problem, but it is just one practice that can lead to higher inventories. Cumulatively, these practices can have significant adverse effects on inventory levels.

There is some science behind storeroom management. The more that maintenance and the storeroom understand each other, the better they can work together. Maintenance groups should welcome the storeroom into maintenance discussions. Avoid tempting management to set overly simplistic cost-reduction mandates. Working together is critical.