Holding inventory in squirrel storesAllowing this nutty practice can cost your company severely

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Overview

Inventory management is no oxymoron. Large international MROs have acknowledged the financial and organisational impact and value of proper control of inventory and yet, so many of the large organisations have only managed to succeed in the effective control of what is visible and in the direct control of the four walls of the warehouse. This practice of only controlling the known stock in many instances is already well managed, with very little benefit to be derived from further optimisation. But what about the spares that are not reflected on the balance sheet? Those requested and bought, but never used, and not in the formal control of the warehouse?

By walking around the operation and looking into cabinets and open spaces, you are more likely than not to find parts lying in “informal” locations, not controlled and not reflected on the inventory management systems. Without assuming poor discipline and malicious intent to circumvent the controls and processes of the operation, have you considered “why?” and “what is the impact?”

What about your site? Do you have informal stores? Why?

Large international MROs have acknowledged the financial and organisational impact and value of proper control of inventory.

What is a squirrel store?

The “squirrel store” is a term used to describe an unoffi cial storage of spare parts and indirect inventory kept by users such as engineering, maintenance or plant operations at their place of work and not in the formalised warehouse or store.

These parts are those “bought in” for occasional use or to maintain equipment and do not form a part of those elements which are bought and converted as a part of the normal supply chain.

As a result, units across the organisation hold on to more parts than needed to perform the task at hand. These additional and unused spares are not returned to the main store or warehouse, and as a result are hoarded for potential future use; hence the term “squirrel store”.

The “squirrel store” is a term used to describe an unoffi cial storage of spare parts and indirect inventory.

Holding inventory In squirrel stores Allowing this nutty practice can cost your company severely 2

Outside of the engineering and maintenance fraternity, the perception is that the users are ill disciplined, the supply chain is ineffective or there is little control of the processes. That may all be true, but why? Why do some of the world’s most successful MROs still face this challenge?

TrustTrust is most likely the single biggest reason for this phenomenon. The faith of the users in the supply of the correct parts at the correct time, when desperately needed to maintain or repair a critical piece of equipment, is often tarnished by the reputation of supply chains and procurement departments lack of reliable and consistent performance. The costs pressures to keep working capital (including spares) to a minimum, leads to instances where required parts are not in store and are only bought when required. This lack of availability is then further compounded by typically long lead times associated with these critical spares. This directly impacts the engineering and maintenance staff who are then blamed for the plant outage.

This impact on their work reduces the trust in the system that the correct parts will be available at the right time. By keeping a private stash of critical parts, it is often the belief that part availability will be guaranteed for “just in case”.

Ineffective Supply Chain practisesSince the demand patterns of MRO spares are much more irregular, historical demand patterns are often not a good indication of safety stock target levels. MRO operations often use ERP/MRP systems and calculations designed for the demand planning of direct stock – very different logic to slow moving spares planning.

In addition, the classification of the spares and the master data linked to the items in the ERP system are often not done to support the effective replenishment of the parts, but populated with standard lead times and reorder points just to “get the job done” prior to go-live and then never revisited.

Replenishment cycles, order processes and early warnings linked with effective contract management and guaranteed supplier lead times (low lead time variation) are often not applied to 100% of parts used, resulting in a fragmented and irregular approach to parts supply.

Policy and controlMore often than not the existence of squirrel stores are either not acknowledged or ignored by management. The result of this is that the processes and controls required to manage, limit or prevent this practise are not well defined or controlled.

Organisations often do not have policies governing the storage of spares not in use and do not insist on the return of unused parts to stores.

Due to the high focus on meeting the Key Performance Indicators (KPIs) of the engineering and maintenance teams, paying attention to areas which might cost the organisation significant amounts is often not a priority. As a matter of fact, keeping a private stash of parts is often believed to support the perpetrator in achieving his targets.

Why do squirrel stores exist?

Organisations often do not have policies governing the storage of spares not in use and do not insist in the return of unused parts to stores.

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Holding inventory In squirrel stores Allowing this nutty practice can cost your company severely 4

It is crucial to understand the financial and risk impact of inventory practices before turning a blind eye to squirrel stores. Clearly there would be a significant risk and cost to the business if it were to stock out of critical spares, but it is the counter risk posed by stashing away of these assets off balance sheet that is often not considered.

The largest challenge posed by squirrel stores is the lack of visibility by business of parts available in each store. Without knowing which parts are in stock and where they are in stock, squirrel stores can spiral inventory holdings out of control, increasing obsolescence, inviting theft, increasing downtime and impacting working capital. Risk of increased obsolescence and theft Inventory that has reached the end of its life cycle or has diminished in value is considered obsolete. Businesses endeavour to either discard or sell obsolete inventory at highly discounted prices as quickly as possible to avoid high levels of redundant stock and to allow space for new inventory to enter the business. The absence of formal stock registers in squirrel stores gives engineering and maintenance staff (as well as the business) limited visibility of which parts are available in their “stash.” Without visibility of how much AND where these parts are situated, discounting or discarding the parts as and when they become obsolete becomes a major challenge, not to mention the added financial burden of accounting for parts that should have already been used, or not even purchased in the first place. Additioanlly, the lack of visibility invites opportunity for theft, as the business has no sight of where and how many parts are kept in each squirrel store. The business runs the the risk of losing parts to theft which could have otherwise been used to generate cash for the business.

Risk of increased downtime Contrary to the notion of the user being able to achieve his targets by keeping a private stash of parts, squirrel stores can in fact increase the risk of user downtime. Increased downtime occurs as a result of “unofficial” parts being kept/ ”stashed” by users away from the team in situations when a particular part is required. Without visibility of available parts, the team experiences downtime looking for the part and eventually ordering in and waiting for the part to be delivered from the warehouse. Team productivity suffers as a result of time wasted looking for parts and KPI targets are thus impacted. This also results in an increase in “official” part holdings by the team to avoid future stock outs which in turn impacts further inventory expenditure. Working capital In the face of the credit crunch, companies have done everything possible to free up working capital. This has proved to be an effective means by which significant cash can be delivered to the business in a relatively short period of time. The spare parts held in the squirrel stores over and above the inventory already held in the warehouse contribute a significant increment to existing working capital.

Working capital tied up in “unofficial” parts depletes business asset efficiency and liquidity measures by increasing the asset base. The longer the parts remain unused in the squirrel stores the greater the risk becomes of the parts becoming obsolete and hence the business no longer being able to convert these parts to cash. Without sight of what parts are kept in squirrel stores, it is highly likely that businesses are missing opportunities to cycle these parts through the business and free up working capital.

Impeded Planning Cycles Users stashing parts in squirrel stores for “just in case” purposes skew the demand patterns on parts usage. This creates high demand variability showing higher or lower levels of demand for parts than the actual demand at the time. This renders demand data useless because it is not an accurate reflection of true demand. As a result, a lack of confidence in demand accuracy makes demand analysis a futile effort. Further to that, an inaccurate historic demand record complicates the parts planning cycle. Planners are unable to conduct analysis to determine forecast accuracy and demand error.

Demand Variability With variability introduced into the demand supply pattern by the presence of squirrel stores, the re order and safety stock levels are negatively impacted. Re order and safety stock levels drastically increase to account for the variability in demand patterns. With certain/more predictable demand and lead times, re order points and safety stock levels are more easily determined and managed.

What is the organisational impact of squirrel stores?

Increased uninsured stock on hand Multiple inventory locations or stock silos lead to higher inventory levels, including hidden or off balance sheet inventory. Without visibility of available parts in each squirrel store, insuring stock on hand becomes a challenge for the business. The business thus incurs a major risk of inventory losses on uninsured inventory kept out of sight within squirrel stores.

Increased Costs & Spending From a fi nancial perspective, those parts stashed in the squirrel stores must be paid for. Cash is diverted away from other more useful business purposes and tied up in unbudgeted inventory. Operating budgets are exceeded before their time, as more parts are taken than what has been forecasted. This impacts the team’s ability to manage costs and meet opex targets. The business is also exposed to the risk of paying for parts that might not be used.

Limitations on cross use Stashing stock in squirrel stores closer to site brings about the benefi t for the user of not having to wait for replenishment from the warehouse. However, often among the multiple squirrel stores out in the fi eld, users within each store have no visibility of what parts are available in their “neighbouring” squirrel stores. This presents limitations on cross use between sites. Businesses miss the opportunity to combat demand variation, unbudgeted inventory increases and obsolescence within squirrel stores by not creating visibility among the squirrel stores for available parts. Every squirrel store will continue to pick and stash parts that they need regardless of what might be available at their “neighbour” squirrel store.

Without visibility of available parts in each squirrel store, insuring stock on hand becomes a challenge for the business.

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Offi cial Store Squirrel Store 1 Squirrel Store 2 Squirrel Store 3

Week 1 Demand 1 2 2 10

Week 2 Demand 1 0 1 0

Week 3 Demand 1 2 0 0

Week 4 Demand 1 0 0 0

Week 5 Demand 1 2 2 0

Week 6 Demand 1 0 0 0

Week 7 Demand 1 2 5 0

Week 8 Demand 1 0 0 0

Week 9 Demand 1 2 0 0

Week 10 Demand 1 0 0 0

Holding inventory In squirrel stores Allowing this nutty practice can cost your company severely 6

Before anything can be put in place to reduce the inventory in the organisation it is important to know what inventory is owned at any given point in time. This includes the location and quantity of all spare parts not fi tted to equipment – irrespective of the classifi cation of the items (spares, consumables, etc.)

Based on the severe organisational impact, it is important to start this by conducting a proper diagnostic across the organisation. This will highlight the areas and the severity of the phenomenon in the business, as well as the potential drivers in the organisation.

The outcome of the diagnostic, combined with a desired future state design will lead to the solution that best suits the organisation. This may include a change in policies, procedures, controls, systems, physical changes in store locations or layout, supplier negotiations, etc. putting rules in place to reduce the risk of receiving a qualifi ed audit.

The most important part of the solution, however, is to make the inventory accurate and level the responsibility of all in the value chain.

ContactIlse Du Toitidutoit@deloitte.co.za

Clinton Houstonclhouston@deloitte.co.za

What options are available?

Before anything can be put in place to reduce the inventory in the organisation it is important to know what inventory is owned at any given point in time.

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