Tuesday, December 8, 2009

Parts Proliferation and Inventory Or, Give Me a Lever Long Enough and a Fulcrum On Which to Place It, and I Shall Move the World


Introduction

Archimedes of Syracuse (287 BC – 212 BC) was an ancient Greek mathematician, physicist, engineer, inventor, and astronomer. He is regarded as one of the leading scientists and mathematicians of history. Among many achievements, Archimedes is credited with saying about the lever, “Give me a place to stand on, and I will move the world.” If Archimedes were a modern day motor vehicle service-parts inventory manager, I wonder what lever he would use to move inventory levels, operating costs, and service levels.

It might well be parts proliferation or, more specifically, working with product engineering to reuse existing parts rather than releasing new or superseded parts into the catalog when new and modified vehicles are introduced. In this week’s blog we look at the impact of parts proliferation on:
  • Inventory levels
  • Operating costs
  • Service levels
  • The entire supply chain
In next week’s blog we will provide several best practice OEM case studies on what these companies are doing to reduce parts proliferation.

Summary

Inventory Managers, if Archimedes were alive today, reducing parts proliferation would be the lever he would be using to reduce inventory, reduce operating costs, and improve service throughout the extended supply chain. Reducing the number of parts released for new vehicles, from industry laggard to best-in-class can:
  • Reduce your parts inventory by up to 30%
  • Reduce your operating costs by $50 million over the duration of each vehicle’s life
  • Improve and sustain your system fill at over 98%
Parts Proliferation and Inventory Levels

The graph below shows the relationship between the number of new parts introduced per new model and total service-parts inventory for nine relevant comparable motor vehicle OEMs. In 2009, we asked North American Service-Parts (NASPC) OEMs for the average number of new parts that are released when a new model is introduced. This is an average over the past few years and you can see on the X-axis that the count ranges from less than 500 part numbers for OEM #5 to nearly 9,000 for OEM #3. This is an enormous range.

The Y-axis shows OEMs’ average service parts inventory level in 2008, measured in months of supply (MOS). Obviously, OEM #8 with about 2.5 MOS is in a better position than OEM #7 at 7.0 MOS.

The dark blue trend line on this chart tells an interesting story. It is a linear regression for eight of the OEMs. OEM #7 is a bit of an outlier in terms of inventory, fill, and business model and is excluded from the trend line calculation. The line is upward sloping as you move to the right. This makes sense; more parts getting added to the catalog each year means more inventory, because the OEM is spreading demand over more parts, resulting in more slower-moving parts and fewer faster-moving parts.

Beyond the common sense direction of the trend line, let’s consider the slope of the blue line. Suppose you have $1 billion in annual parts sales. If you are near OEM #5, #8 or #9, you are holding about $135 million of inventory assuming a 50% gross margin. But, if your are OEM #6 or #3 you are holding $220 million for this same billion dollars in sales. This is an incremental $85 million of inventory. The simple calculation suggests that this is a 60% plus penalty in inventory. However, as practical matter there are other factors also impacting this result. For this reason I have banded the trend line in light blue to indicate there is a range of impact. Let’s convert all of this Archimedean math to a simple statement: Reducing the number of parts released for new vehicles to the best-in-class level can reduce your parts inventory by a very significant amount – 30% is not out of the question.

Parts Proliferation and Operating Costs

By the way, Archimedes, our inventory manager, is also responsible for reducing operating costs. Beyond inventory benefits, reducing parts proliferation also eliminates operating costs. In fact, three motor vehicle service-parts OEMs from both North America and Europe have independently estimated over the past several years that there is between a $7,000 and $10,000 savings associated with not creating each new part. These cost savings include engineering set-up costs and end-of-life scrap costs (but not inventory holding costs). These OEMs use this $7,000 to $10,000 value as an input into new part and parts change approval processes.

In our graph above, at one extreme OEM #3 creates about 8,500 new parts per new vehicle launched while OEM #9, at the other end of the spectrum, creates only 1,000 new parts. This is a difference of 7,500 parts per new vehicle introduction and, at $8,500 (mid-point of the range) per part, this represents a potential cost savings of nearly $64 million. To summarize, Archimedes can save a poor performing OEM more than $50 million in operating costs over the duration of each vehicle’s life if he can move the organization to reuse parts at the level of a best performing OEM.

Parts Proliferation and Service Levels

Okay, Archimedes, our 21st century inventory manager, has shown us the value of reducing inventory and operating costs by holding the line on new parts. But, what about service? To illustrate this issue, we look at data from motor vehicle service parts OEMs in Europe.

OEM X is a volume automaker selling and servicing in Europe. OEM X has provided system fill to its European dealers (i.e., from Poland to the United Kingdom) at over 98% for about five years running, while consistently improving inventory turns. In fact, their reported performance was so good (unbelievably good) that our European Aftersales Conference (EAC) participants asked us to audit their metrics and processes to understand how OEM X could achieve such outstanding results.

In short, we found OEM X does many things well, including supplier management, to drive high fill. However, they are unique in one specific area: low parts proliferation. The chart above is a comparison of OEM X to another volume automaker selling parts in the United Kingdom (the UK is representative of other markets). It shows the cumulative count of parts that are required to satisfy total line demand. What we see is that only 24,000 part numbers are required by OEM X to fulfill 98% of demand. In contrast, a comparable OEM requires 31,000 part numbers to cover this same 98% demand level. In other words, because of parts proliferation controls, OEM X has to effectively manage about 25% fewer parts than its peers to cover most customer needs. As a consequence, OEM X consistently achieves one of the highest system fill and inventory turns performance levels across the Continent. According to Archimedes, limiting parts proliferation is a key lever to increasing service.

Impact on the Entire Supply Chain

The effects of parts proliferation on inventory, operating costs, and service impact all supply chain partners (suppliers, distributors, and dealers); not just OEMs. By reducing part count-related complexity, suppliers have lower manufacturing costs. Both direct activities (e.g., number of machine set-ups) and indirect activities (e.g., material handling and bill of material maintenance) are reduced. With demand concentrated on fewer parts, both dealers and distributors need to hold less inventory to achieve a target fill. Alternatively, they can invest in the same inventory and achieve higher off-the-shelf fill. Also, beyond the obvious benefits to customers, there are second order effects from higher off-the-shelf fill, such as lower premium transportation costs resulting from fewer emergency orders placed by dealers on behalf of customers.

Archimedes’ parts proliferation lever not only moves the OEM world, it also moves the supplier, distributor, and dealer world.

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