Book excerpt: Overcome operational biases if you want true inventory optimization

Successful inventory management, and the achievement of true inventory optimization, requires a focus on people, policies, procedures, and, with that, behaviors.

By Phillip Slater September 19, 2011

Inventory management requires much more than just knowing the numbers. Knowing the relevant formulae is the easy part. Successful inventory management, and the achievement of true inventory optimization, requires a focus on people, policies, procedures, and, with that, behaviors. The requirement for improving the management of this interaction is even stronger in a maintenance environment where operations rely on the timely supply of spare parts in order to minimize the impact of equipment failure and provide efficient maintenance activities.

Yet many companies struggle to get this mix right. In a two-part extract from the book “Smart Inventory Solutions,” Phillip Slater explains this interaction and the results than can be achieved by getting the mix right. In Part 1, Slater shows the huge impact that operational biases can have on spare inventory holdings and how addressing these biases helped one company reduce its spare parts inventory by a whopping 45%.

Sydney, Australia, is perfect for a picture postcard. The natural beauty of the harbor is complemented by the design brilliance of the opera house, and this is all framed by the majestic Sydney Harbor Bridge (which is affectionately referred to locally as the “coat hanger” because of its steel arch construction).

As you drive west from this famous scene, the landscape changes into a fairly generic hinterland reminiscent of the industry that surrounds almost every major city. Sydney’s industrial hinterland includes oil and gas refineries, steel mills, paper plants, and major manufacturing locations for global brand names producing everything from biscuits to chemicals, glass, pharmaceuticals, valves, and everything in between. As you can imagine, I have visited this region often for my consulting work.

One clear and cold spring morning, I parked my rental car in the car park of a typical western Sydney facility. This facility was a small part of a very large company with global operations. The CEO of that company had engaged me to help the organization achieve true inventory optimization; this stop was one of two dozen similar facilities that I was in the process of visiting.

My appointment was with the site’s manager of operations and maintenance—the most senior on-site engineer. On walking into reception, I signed in as a visitor and the receptionist told me that “they” were waiting for me in the training room in the next building. She asked if I would mind finding my own way there. At this point I sensed that this was not going to be a typical first meeting.

Finding the training room, I knocked on the door and entered. The room was a standard corporate training room with a projector screen and whiteboard at one end, a projector suspended from the ceiling in the middle, and under that a series of tables all joined together to form one long table. What was less typical was that my contact and all of his direct reports, all 10 of them, were seated on one side of the table, facing the door, with their arms crossed! It looked and felt like I had walked into a panel-style interrogation.

Of course, everyone was quite civil; Australians are friendly in that way. However, the attitude and position were clear—we don’t want you here, we don’t need you here, we don’t have any problems with our engineering spare parts. I asked why they were so certain of this and the answer was universal: They almost never had a stockout and, therefore, in their view, they didn’t have a problem. As you will see, they had fallen into the Service Factor Trap.

Theirs was a textbook example of the biases that represent one of the greatest hurdles in implementing a successful inventory review program. This group, which meant well, was demonstrating almost every possible bias.

  • Overconfidence bias: They were overconfident in the ability of their systems to provide true optimization.
  • Loss aversion bias: They believed that bringing in outside assistance was a loss of face on their part and showed a lack of confidence in them by the head office.
  • Framing bias: They framed their options by only looking at solutions relating to parts supply, and not inventory investment.
  • Anchoring bias: They anchored their beliefs in the idea that a stockout was the only measure that counted.
  • Status quo bias: They were concerned about any changes that would alter the status quo.

The only way to overcome these biases was to forge ahead with a review and training program so that they could discover for themselves what they needed to do. Here’s some of what we found when we just got on with it:

  • They did not actually measure stockouts, yet the team had stated that they were OK because they did not have any stockouts!
  • Only one person had any type of stores or inventory performance measure which was the stockout measure, which they did not measure or report!
  • No one was held responsible for the level of financial investment in inventory.
  • Their stock turn ratio was 1.1; this level was below the stock turn average of 1.25 across their sister facilities.
  • Although there was a main central store, there were seven official but uncontrolled other stores across the site.
  • There were no standard definitions to classify items or from which to set stocking policies.
  • In their own words, “not a lot of science” went into setting the reorder point and reorder quantity for new items. Even then, it was “set and forget, unless we run out.”
  • The stock control function of their corporate IT system was not turned on.
  • Obsolescence was only managed “if someone happens to notice.” Notifying the storeroom of newly obsolete items was officially the responsibility of any engineer uninstalling equipment, but it was not normally done.
  • Their storeroom personnel failed to receipt items consistently, if at all.
  • There were no storeroom performance indicators.
  • The central storeroom had poor housekeeping with items routinely stored in the aisle, making it difficult to move around.

For this group their operational biases had blinded them to this wide range of issues.

Once the training program started, the manager of operations and maintenance, to his credit, immediately asked me to present a workshop involving a wider group of personnel as well as their on-site executive committee. He had now realized that there were actually many issues to address and that the task was bigger than they initially thought. The subsequent inventory review identified:

  • Write-downs for the preceding 12 months that were approximately 9% of the inventory value (based on an existing accounting policy).
  • That 70% of their inventory dollar value was tied up in less than 5% of their inventory, meaning that they actually needed to focus on just 500 items to have a major impact.

Reviewing those 500 items identified:

  • A single reduction opportunity valued at $425,000 from just one item, where the stock level had not been adjusted following reduced usage.
  • A single item with $200,000 in stock that was already obsolete but that had a further $200,000 in additional orders already placed—we cancelled this order. (Yes! They had reordered and obsolete item!)
  • A single item where they had placed a $50,000 order “by accident.”
  • A further 45 individual opportunities to reduce inventory by more than $10,000 each (some worth as much as $70,000).
  • The team also estimated that 30% of the items removed from their central storeroom were not officially signed out. Therefore, they had no official record of their usage and their existing records were unreliable.

After working through an inventory review and training program, their spare parts holding value fell by 45%, over a period of 16 months. They then remained at that level for the next two years (see Figure 1). Accordingly, their stock turn went from 1.1 to 1.9 over the same period.

Although the inventory reduction is impressive enough, the fact that it remained low over the subsequent years demonstrates that there was no adverse operational effect from this reduction. In fact, it is safe to say that prior to this program they had in effect spent millions of dollars on items that they really didn’t need. They achieved this because they finally recognized and challenged their operational biases.

So what does this mean to you?

First, addressing together policy and procedures with the application of fundamental tools and processes for inventory review gets results. It just does. If you are serious about achieving true inventory optimization, then apply these basics to your organization. Don’t cherry-pick those that you like or agree with—stick with a program and results will follow.

Second, take action. Don’t be delayed or deflected by operational biases that lead to discussions and arguments that “everything is OK.” It isn’t. And you are not so unique that the basic tools and processes will not work for you. Every single place has at least one person who says “nothing needs to change,” yet I have yet to see one single application of the fundamentals that has not delivered significant benefits for the organization applying them.

Third, begin today. You have invested time and energy to learn about achieving true inventory optimization; why not get on with it? Even if you cannot get a full program going, start influencing the people who can collect information, produce a Pareto curve, review storeroom management, build a picture of the issues and hurdles you face, identify and quantify the potential benefits, ask questions, dispel myths, and challenge assumptions. Just start.

Next month, Slater again uses a case study to explain some of the issues faced and tools used to successfully implement new policies and procedures. Implementation is the weak link in most programs, and understanding the issues and processes is a vital part of achieving success.

Slater is a qualified mechanical engineer, an experienced operations manager, a seasoned management consultant, and a published author. Slater holds degrees from the University of NSW and Monash University. He has authored four operations management books, including “Smart Inventory Solutions (2nd Ed.)” and “The Optimization Trap.” He is in demand internationally as a consultant, conference speaker, and trainer and has been published more than 100 times in industry and trade magazines around the world. For more information, visit