No previous post, I described a way to scale inventories for an upcoming product. In this post, I will describe how the stock should be dimensioned for spare parts that have very low turnover.
Very low turnover spare parts are present in production and logistics systems, and are represented by items such as generators, transformers and electric motors, which have some characteristics in common, such as, for example, high acquisition costs, high response times for resupply and very low turns. Analogously to other decisions involving inventory management, what is sought is the reduction of inventory levels without affecting availability. As we will see below, it is common for the decision on the dimensioning of the stock to involve, basically, the maintenance of one part or none.
Figure 1 – Gas turbine used in thermoelectric plants. The response time for resupply of this part can reach almost two years
Source: Toshiba Corporation press release
Before entering the methodology, it is important to define the following variables:
CTR – Total cost of resupplying the part, referring to the order cost;
caq – Unit cost of acquisition of the part;
TR – Request response time, in years;
λ – Historical consumption rate, in pieces/year
i – Capital opportunity rate, % per year
cip – Cost of unavailability and penalty, is the cost incurred when there is a need for the replacement part, but it is not in stock.
After understanding what each of the variables means, it is now important to understand the real impact of keeping a part in stock compared to keeping no parts. When we think of the strategy of keeping zero in inventory, the total cost incurred is given by the following equation:
It is easy to understand the equation if we imagine a part that has a consumption of 1 per year, that is, λ = 1. In this case, once a year it would be necessary to order a replenishment (incurring the CTR cost) and also once per year would incur the cost of unavailability and penalty (CIP) given that there would be no part in stock at the time of need. We noticed that the smaller the λ, the lower the total cost of not holding inventory. This, in a way, is intuitive: If consumption is radically low, why keep a spare part in stock?
In the case of keeping a part in stock, before showing the total cost equation, it is important to understand the concept of the FTECE variable or fraction of expected time with stock. This measure shows what fraction of the year the item would be in stock. This variable is defined by the following formula:
If we imagine a part that has a replacement time of 4 months (1/3 of the year) and historical consumption is one part per year, we would have FTEC = 1/(1+1*1/3) = 75%, that is , 75% of the time in the year we would have the part available in stock. Thus, the equation for the total cost of keeping a part in stock is shown below:
The first bracket in the equation refers to the opportunity cost (or financial cost) of keeping a part in stock for a fraction of the year. The second bracket represents the resupply cost to replace the part. The third bracket represents the cost of unavailability and penalty if the part is requested in the fraction of the year when there is no part in stock.
With the two equations in hand, it is up to the area manager to define the values of each cost variable, the cost of capital, historical consumption and replacement time to calculate total costs. That way, she or he can choose which of the two strategies represents the lowest total cost.
It should also be noted that the use of traditional methodologies for defining stock is not suitable for parts with very low turnover, as they may point to stocks above what is necessary, which may not make absolute sense when we think about costs.
The best choice of how much to keep in stock for spare parts can allow big savings for companies. More information and practical examples on sizing spare parts can be found in an article on the ILOS website, via this link.
References:
WANKE, Peter. Inventory management in the supply chain: decisions and quantitative models. Publisher Atlas SA, 2000.
Henry Alvarenga
He has been working in consultancy for 7 years, with experience in more than 20 Demand Planning and S&OP projects, Logistics Network Design, Logistics Master Plan, Inventory Policies, Operations Strategy and Market Intelligence
