EXCESS INVENTORY AND
DISPOSAL
A.
Introduction
Inventory is the net
result of demand plans, planning parameters and supply plans flowing into the
inventory management process and shipments going out the bottom.
What is Excess
Inventory? Excess
Stock/Inventory is defined as any quantity of inventory either held or on
order, which exceeds known or anticipated forward demand to such a degree that
disposal action should be considered. (2)
B. Causes Of Excess
Inventory:
The path to high quality results is not a
secret or magic and it works every time -- set expectations, measure results,
find root causes when expectations are not met, Pareto them and then take corrective
action. Apply these steps to the inventory management process and the
"quality" improves every time. (1)
“There are multiple drivers that cause excess
inventory problems, and this cycle had different issues. For example, in the
past, fear of a production line being shut down because of lack of inventory
caused managers to keep excess inventory in warehouses and double and triple
order strategic parts in periods of higher demand. Just-in-time delivery
schedules, in-plant stores, and other innovative practices have reduced those
fears and inventory stockpiling has been minimized.” Tom Brunell (3)
Excess inventory can pile up for many
reasons. If your inventory is not spinning, consider these most frequent and
major root causes, which are in the most significant contribution sequence to
excess inventory (1):
Root Cause #1: Plans Not Integrated
The plans are not the same and usually they
are not integrated. We are likely bringing in too much of the wrong material
and not enough of the right material -- and we don't even know it until the
excess inventory accumulates on the balance sheet.
Fortunately, the corrective action is neither
technically difficult nor expensive to implement. The solution does require
significant behavioral changes and strong leadership from the executive
management ranks. The proven tool is an effective Sales and Operations Planning
(SOP) process
Root Cause #2: Poor Demand Planning
Forecasts will never be accurate. But they
should be reasonable. The supply plans that drive inventory input to the
balance sheet are almost always based on anticipated demand, i.e. forecast. The
best forecast of demand is a customer order. Second best is an inquiry from a
specific customer who is close to making a decision. Because of lead times, we
often have to make a "buy" or "not buy" decision. The only choice is to make an educated guess!
The quality of the demand plans becomes a critical input to the inventory
management process and a significant factor in the result.
Here are a just a few of the key questions
that must be continuously answered -- Is the new customer order part of or in
addition to the forecast? Does the total demand plan pass the sanity checks?
Who is accountable for the "quality" of the demand plan?
The solution is to treat demand planning as a process and apply the
quality management principles to the process. Set Zero Defect expectations.
Make demand-planning part of your Six Sigma initiative. Measure demand quality;
assign accountability for demand quality and tie performance to compensation.
Root Cause #3: Large lot Sizes
How many times have you heard this comment,
"If you are going to make 1000, might as well go ahead and make 3000 ...
the other 2000 are practically free!" "Bigger is better" is one
of the most embedded paradigms in industry! While larger lot sizes may be
justified in a few cases, they always result in more inventory than gets used.
When the demand drops, the 4-week supply quickly becomes a 6-month supply. The
risk of excess inventory goes up exponentially as lot sizes increase.
The solution is to declare war on all excuses
for making or buying any more today than you think you will use in the same
day. Measure the current average lot sizes and plot the progress of reducing
them without cost increases.
Root Cause #4: Excessive Time Fences
The time fence is the longest cumulative
lead-time for all items required to acquire the product. The time fence is a
function of supply lead times
The solution is to declare war on long lead
times to minimize the risk impact. Reduce time fences at least 50%. Establish a
starting point and measure progress. In most situations, supplier lead times
account for 80% of the time fence. Make lead times an equal consideration to
purchase price when selecting suppliers. Tie supplier manager's compensation to
time fence reduction.
Root Cause #5: Too Many Items and Options
A customer recently discovered that they had
over 5000 accessories, all with assigned part numbers that they used with the
product. These were items such as cables, holsters, connectors, adapters, etc.
Most of these accessories didn't cost much, but the supply lead times were not
always short either.
This same problem frequently occurs with
spare parts. After planners have been repeatedly chastised for not being able
to deliver, they load the shelves with every flavor and color. The result is excess
inventory.
The solution to this excessive item
and option problem is to start by documenting a set of rationalization rules.
This is a set of criteria for determining what will and will not be preplanned
(i.e. forecasted) and made available for short delivery lead times. It doesn't
take long to draft a recommendation. It does take courage, conviction and
leadership to enforce the rules daily.
Where to Start? There are likely more potential root causes
of excess inventory. These five causes are only the most frequent and the
biggest culprits. Determine which ones are most significant in your situation
and focus on overcoming them.
C. Inventory Reduction:
Organizations today must be fast and nimble
enough to react quickly to changes in (customer) demand/changing needs and do
it with little inventory. (R.
Michael Donovan)
I. Executives are often concerned with inventory
levels:
In a survey conducted by R. Michael Donovan
& Co., Inc., 82 percent of the senior executives who responded said that
excessive levels were a major concern for them. Some saw inventories as just a
vehicle that absorbs massive amounts of cash while others understood that high
inventories were also an indication of other serious problems.
Also, the monies unnecessarily tied up in inventory could be better
spent elsewhere such as: new product development, expanded marketing and sales,
modernization, reengineering, expansion, acquisitions, debt reduction among
others. Yet, well-intentioned efforts to reduce inventory, more often than not,
get only temporary results. Without effective business process changes, the
organization can easily slip back to old ways with inventories (and costs) just
climbing up again.
II. Why
should the managers get involved?
In some cases, inventory is so bloated that a
high percentage of it will become obsolete before it is used. Worse, too much
inventory is a certain indicator that more serious and costly process and
system problems exist, which is very likely deeply rooted in the organization.
Some of these problems include poor forecasting, inadequate product
specifications, ineffective production scheduling, low quality, bottlenecks,
long cycle times, product and process problems, high costs, poor vendors and
wrong performance metrics to name a few.
III. Tap
the “Hidden Cash Reserve”
Most experts agree that top-heavy inventories
are a giant cash vacuum that needs to be turned off in order to free up cash.
So, how can this be accomplished? One of the major impediments to inventory
reduction is the mistaken notion that just improved inventory management is all
that is required to get the job done. The real culprits are the inefficient
business processes that cause excessive inventories to exist in the first
place. Here are six suggestions:
1. Do
not always blame inventory
Certainly some aspects of excessive inventory
investment are the result of Inventory Control, but often their behavior is
motivated by management’s certain negative reaction to material shortages
versus periodic and less severe response to excesses. For the most part,
inventory excesses can only be significantly reduced or eliminated when the
cross-functional business processes that cause the need for excessive inventory
buffers to exist are fixed. It is futile to think inventories can be isolated
and singularly managed. Inventories are invariably the result of how well many
cross-functional business processes really work.
2.
Reengineer Order-to-Delivery
Major reductions (20% to 50% or more) in all
forms of inventory and increased service usually require the reengineering of
the order-to-delivery cycle to develop a process to do it faster, better,
cheaper. When you fix the processes that caused the excess inventory buffers to
exist in the first place, you will very likely shorten cycle time, decrease
costs, increase quality, and improve customer service.
3.
Improve Supply Chain Management
By streamlining the entire supply chain, an
organization can reduce inventory, improve time to customer, compress cycle
times, free up more cash, decrease costs, and improve efficiency and
effectiveness.
4. Use
Effective Performance Metrics
It’s surprising that many organizations actually reward behavior that
tends to bloat inventory levels everywhere.
5.
Utilize “Pull” Based on Demand
Many organizations base inventory-stocking
levels on inaccurate long-term sales forecasts. The high cost of these “bad
numbers” if they aimlessly drive operations, as they often do, depresses
overall performance. One result is that organizations that use a total “push”
inventory system will end up with high inventories.
6.
Reduce Cycle Times
Cycle time reduction almost always means
reduced costs, reduced inventory levels, increased customer service.
To minimize inventory excesses and improve
customer responsiveness, more and more organizations today are building
flexibility into their operations -- flexibility in how they operate in order
to quickly respond to changing customer demand. Today, the VALUE that a
manufacturer offers its customers is very important. Value includes short lead
times, quality materials, on-time delivery and good customer service.
D. Challenges
for Inventory Reduction:
I. Pressure
to reduce inventory (4) (Extract from Statement of General George T.
BABBITT, USAF)
As the Cold War
ended, the US Military began to downsize. Both the Congress and OSD strongly
encouraged the Services to eliminate excess inventory. But the downsizing was
not well managed and has led to some problems.
Part of the
problem was accounting policy. Progress in reducing inventory was measured in
dollars. But DoD inventory was not valued at original cost. Instead it was valued
at replacement cost. Each year, inventories of old spare parts were increased
in value to reflect their latest acquisition price (the normal commercial
practice is to deflate, not inflate, the value of long term assets). Many
supply managers who faithfully disposed of unneeded inventory were surprised at
the end of the year to see their total inventory value increase. As a result,
they were subject to great pressure to further reduce inventory levels.
Efforts to
reduce inventory appeared to be failing. So, restrictions on new procurement
were added in the budget process. On the surface the logic was sound. If the US
Military had excess inventory, then restrict new buys until the excesses are
used up. Unfortunately, the excess spare parts were usually for older systems
that were no longer needed. The funding requirements submitted in the budget
were intended to support new weapons and modernized subsystems. The old spares
were not usable. The new spares were needed but funding restrictions prevented
purchase of these parts for several years.
Pressure to reduce inventory and
to restrict new procurement, although well intended, seriously impacted spare
and repair parts availability. Pressure to reduce inventory has slackened. DoD
has agreed to review inventory valuation policy.
J. Economic Retention Models
1. Concept
The economic retention model may be defined as
a model that computes an economic tradeoff between the costs of retaining items
versus the risk of having to procure the items in the future. (5)
The object of
the economic retention model (ERM) is to calculate the maximum retention levels
that can be economically justified to meet future peacetime requirements. The model is applicable to both reparable and
non-reparable items. ERM has mathematical models and calculations working
behind to assist in making retention determinations with respect to excess
inventories. If any item is in an excess position it is desirable to dispose of
stock that is in need of repair (an unserviceable) rather than dispose of stock
that could be used immediately (a serviceable).
Hence, there must be some level determined for which unserviceable items
will be disposed and a different level for serviceable items. (6)
To go one
step further, the user level may have stock it wishes to return to the
wholesale level (a depot). However, if
the wholesale level is in an excess position it may not want to receive
additional stock from the user. The
quantity above that the depot will not accept returned stock would be referred
to as the economic return level (return stock to the wholesale level from the
user level). This is a part of the
retention decision; however, instead of retaining or disposing of stock the
decision is to return stock to a depot (wholesale level) or dispose of stock at
the retail level. (6)
The
basic question to be answered is: IF
ASSETS ARE ABOVE THE Approved Force Acquisition Objective (AFAO), SHOULD THE
STOCK BE RETAINED OR DISPOSED? IF THE
STOCK IS TO BE RETAINED: HOW LONG? The answer to these questions concerns three
areas: non-reparable,
reparable-serviceable, and reparable-unserviceable. At the same time each area has a retention
level (assets above this level can be disposed), and a return level (items
below this level are considered for return to a depot).
Then again, ERS
is the stock above the AAO that is more economical to retain for future
peacetime use than to dispose of and use new procurement or repair to satisfy
future needs. To warrant economic retention, an item shall have a reasonably
predictable demand rate. (6)
By the way, Contingency retention stock is
the quantity of an item over the AAO and economic retention stock for which
there is no predictable demand or quantifiable requirement, and that normally
would be allocated a potential reutilization stock, except for a decision to
retain the assets for specific contingencies. (5)
The
ERM is based on economic factors and is an economic decision only. The ERM is implemented if supply is in an
excess position, that is, above the AFAO.
It is not crucial to the decision to know if the item is an essential
part of a weapon system since there is a surplus of stock. The concern is of keeping or disposing of
stock. The decision is basically time
related and is concerned with the cost of keeping an item in stock over a
period of time. If demand is sufficient
to get stock below the AFAO then regular buy policies will decide future buy or
no-buy situations.
Now
suppose that assets are above the AFAO.
Suppose further that the stock is held for t years before it is
used. Then it can be said that the value
of the item is recovered in t years.
However, for those t years the items must be held in inventory; hence,
the value of the item is diluted by the holding cost for t years.
Since
assets are above the AFAO it is possible that the field users may have stock,
which they wish to return to the depot, that is, they may be in an excess
position as well. Should the wholesale
level accept these returns? As in the
retention question, there is an economic level above which the depot should not
accept the returns. The same criteria
apply as with retention buy keep the asset or dispose of it. Disposal is accomplished at the installation
and no transportation costs are involved with retention. If the item is to be returned to the depot it
will have to be transported there by some means. Hence, there is the additional transportation
aspect that must be accounted for in the computation of a return level. Thus, the return of assets will take place if
the value of the item, minus the storage cost, minus the transportation cost,
is greater than the disposal value.
The judgment as
to retain or dispose of stock is an economic decision. Such a verdict will best be resolved by using
pertinent, reasonable costs for the various functions involved. How can costs for the function be
obtained? Can such costs be updated in
the future with continued use of the ERM computation? There are a total of six costs that must be
obtained independent of individual item parameters. They are:
interest, storage, obsolescence, inventory losses, transportation, and
disposal.
In addition to
the above costs, for each item for which an economic retention value is
computed, individual item data are required.
These data will be obtained from the national stock number master data
record (NSNMDR). Care should be taken when deriving the cost parameters to be
used in the computation
2. Economic
Retention Model in DoD (7)
Wholesale Retention
Except for
ammunition, principal and secondary items shall be stratified applicably
Approved Acquisition Objective (AAO) stock, Economic Retention Stock (ERS), Contingency
Retention Stock (CRS), and potential reutilization stock.
To ensure that
retention stocks correspond with current and future force levels, the DoD
Components annually shall review and validate their methodologies for making
economic and contingency retention decisions.
Personnel
involved in wholesale materiel management functions should be evaluated on
their performance in eliminating wasteful retention practices and achieving
cost savings in the retention of stock. In particular, item managers and
distribution system managers should be evaluated on the timely handling of
disposals.
Procedures
The methodology
used to set the maximum level of ERS for an item, that is, its economic
retention level, should be based on an economic analysis that balances the
costs of retention and the costs of disposal. The DoD Components should
consider in the economic analysis the costs of retaining item stocks, the
potential long term demand for the item, potential repurchase costs, and, for
items essential to the operation of a weapon system, the expected life of the
system and the number of systems in use. The analysis may be accomplished on an
item-by-item basis or for logical commodity groupings or for specific end item
applications.
For
weapon-system items, economic retention levels shall be reduced in proportion
to any reduction in the number of systems in use.
The Components’ annual review of
economic retention methodologies should focus on:
Ø
Better analyses supporting retention decisions
through the use of forecasting models that take into account potential future
upward or downward trends in demand and/or the uncertainties of predicting
future long term demand based on historical data.
Ø
Improved estimates for costs used in retention
decision-making.
The DoD Components shall identify
CRS according to these categories:
Ø
Military contingency: assets
needed to meet military contingencies for U.S. Forces.
Ø
Potential security assistance:
assets held in expectation of foreign military demand under U.S. security
assistance.
Ø
General contingency: assets based
on potential usefulness, for extreme reprocurement problems, or other special
considerations involving nonmilitary contingencies, such as civil emergencies
or natural disaster relief.
Items unique to
a weapon system that is being withdrawn from use should be reviewed for
possible contingency retention. Stocks on items with potential security
assistance contingency retention shall be held based on historical demand and
anticipated sales from foreign customers. Stocks on items with no contingency
retention may be held for up to 1 year after the phase out of the weapon
system, with a written determination by the Commander of the applicable IMM
that holding the stocks is in the interest of the Department of Defense, or up to
2 years, with a determination by the Head of the Agency responsible for
maintaining the stocks that they are required in the interest of national
security.
Since the
orientation of contingency retention is different from economic retention, the
Components’ annual review should focus on an item-by-item verification that the
reason for contingency retention still exists and the coding of the reason for
contingency retention is correct. The DoD Components shall establish goals for
validating or eliminating their item contingency retention stocks. Stocks held
for potential security assistance shall be disposed of after two years without
demand.
IMMs shall make
final decisions, normally within 60 days, on assets categorized as potential
reutilization stock. When a disposal release order is issued, the depot should
transfer the assets to the Defense Reutilization and Marketing Office (DRMO),
normally within 45 days. ICPs shall follow-up quarterly on disposal release
orders to ensure that depots have transferred the applicable items to the DRMO.
Retail Retention
To guard against
variable demand and the associated unnecessary costs of returning and later
reordering materiel, retail supply activities may have retention levels for the
demand-based items.
Procedures
The DoD Components may retain item assets at a
retail supply activity up to the sum of the approved war reserve level, the
requisitioning objective, and a maximum of 24 months' worth at anticipated
issue or wear-out rates.
Reporting and Return of Retail Assets Above Local
Retention Levels
All serviceable
assets or economically repairable assets above a Component’s retention limit at
a retail supply activity shall be reported to the wholesale manager for a
determination as to disposition. To guide the wholesale manager in making an
economically viable decision on disposition, the DoD Components shall establish
criteria such as cost-to-process, cost-to-hold, and cost-to-ship. Based on that
criterion, the wholesale manager shall advise the holding Component to do the
following:
Ø
Return the reported assets to wholesale stocks;
Ø
Laterally redistribute the reported assets;
Ø
Temporarily retain the assets in-place; or,
Ø
Assume local disposition, as the reported assets
are not returnable.
As an
alternative to procurement to satisfy operational requirements within the
budget year, wholesale managers shall accept returned assets and provide a
financial credit to the owning Component.
If serviceable
assets of consumable and reparable items or unserviceable-but-economically-repairable
assets of reparable items exceed the local retention levels at a retail supply
activity, the holding Component shall report as soon as practicable, but at
least quarterly, those assets to the wholesale manager.
Logistics and Acquisition Professional, Industrial Engineer
ugurerdemir1975@hotmail.com
See also:
Warehouse Site Selection Models
http://warehousesiteselection.blogspot.com/
Risk Allocation and Motivation Functions of Contracts
http://contractriskallocationandmotivation.blogspot.com/
- http://www.rdgarwood.com/archive/hot49.asp
- http://www.iolt.org.uk/sig/scimglossary.htm
- http://www.avnetmarshall.com/html/resources/publications/gsc/editorial.html
- http://www.house.gov/hasc/testimony/106thcongress/99-10-07babbitt.htm
- http://www.usapa.belvoir.army.mil/pdffiles/r710_1.pdf
- http://stlouis.wlmp.com/ads/docs/fielded/ums/lcdjbm06.doc (An extract of the yet to be published
AMSAA IRO Technical Report titled Economic Retention Level, dated June
1991)
- http://superreg.lmi.org/supreg/chap4wkg.htm
