Looking for Cash? Look at Inventory

Inventory is expensive. It sucks up, and locks up, cash. How can utility managers save inventory money? Here are some possibilities from experts in inventory management.

The world—including the U.S.—has been in an economic contraction for months. In February 2009, the Institute for Supply Management‘s Non-Manufacturing Index registered at 42.9%, indicating business contraction (anything lower than 50% is a contraction). Revenues are down in most business sectors, including the electric utility sector, and major companies have cut dividends or postponed capital projects to conserve money.

For electric utilities, the need to keep generation plants up and running with minimal down time typically leads to a buildup of inventory with little regard for cost. As the economic downturn continues and acute financial pressures become more prevalent, keeping plants up and running becomes more of a focus, augmenting the already existing problem of having too much inventory on hand. Inventory management at power plants is generally viewed tactically versus strategically: How do I make sure I have what I want versus how do I make sure I have what I need?

Plant managers can ask several questions that will help them better evaluate and improve their inventory management practices to release cash. These ideas are proven and are based on work we’ve done for a number of utilities. We walk through an overall framework of how to look at inventory management and discuss questions that can be asked across this framework. Ultimately, we believe that improving inventory management can help utilities release cash into other areas of their business—particularly during an era of decreasing revenues—while maintaining or improving service levels.

Defining Inventory Management

For more context on questions to ask, we have summarized inventory management into three broad groups: procuring inventory, holding or using inventory, and discarding inventory.

Procuring refers to identifying inventory demand, sourcing and ordering inventory, and shipping inventory to the warehouse.

Holding refers to having the right processes and systems in place to store and find the right amount of inventory.

Discarding refers to selling off scrap and surplus items, selling and writing off obsolete items, and repairing failed items in lieu of buying new, which represents cost avoidance rather than revenues gained through a sale.

An Inventory-Management Checklist

Using this taxonomy, we propose the following questions.

How Do I Procure Inventory?

  • Is demand tied to ordering? We’ve normally found that storeroom personnel are not closely aligned with planners in the generation plants. This leads to excessive or wasted orders that ultimately pile up as inventory.
  • Is ordering optimized? The first aspect of order optimization includes segmenting items purchased and sourcing based on a clearly defined segment strategy. Typically, 15% to 20% of items are used for maintenance, repair, and operations and are supplied by hundreds of vendors. Because most of these items are commoditized, they can be competitively bid and vendors can be consolidated to gain volume discounts on pricing.
Another aspect of order optimization is making sure reorder points, economic order quantity, and lead times are actually tied to demand. This reduces the chances of purchasing and stocking inventory that is not yet needed by the generation plants.

Finally, a large number of utilities have failed to standardize items (of similar technology and function) both within and across plants. That has ultimately led to a proliferation of like items and difficulty in sharing across plants, resulting in a buildup of inventory in excess of what is really needed.

  • How much do I spend on shipping? Expedited shipments, while necessary, tend to get overused. This typically occurs when storeroom and plant personnel are not aligned and demand and ordering are not in sync. In addition to storeroom and plant personnel working more closely together, we recommend the storeroom personnel talk to their largest vendors and identify ways to “fill up” their trucks to reduce the number of incoming shipments.

How Do I Hold or Use Inventory?

  • Am I holding the right amounts of strategic inventory, or am I holding a significant amount of just-in-case inventory? Utilities should evaluate the criticality of part, lead time, and supplier market dynamics versus just-in-case inventory. Excess just-in-case inventory ties up cash unnecessarily and can be sold for cash.
  • What systems and processes do I use to store and find inventory? Simple technologies such as bar coding can help track and manage inventory better. Without the right processes and systems in place, errors in ordering are likely to occur, leading to increased costs from reordering and associated expedited shipping to meet time commitments. Additional cost increases may occur as a result of returns and potentially extended asset downtime. Furthermore, data and systems inaccuracies make it more difficult to obtain the right product information—descriptions, lead times, and manufacturer names—to competitively bid items to multiple vendors for better pricing.
  • Can I elevate the position of my storeroom personnel to minimize mundane tasks? The storeroom personnel at utilities are often highly paid union employees. By giving the day-to-day management of certain nonspecialized items to vendors, utilities can free up storeroom personnel from mundane tasks, such as credit-card ordering, to higher value-added tasks such as planning and forecasting. This will enable storeroom personnel to be better aligned with plant planners, improving ordering accuracy and reducing just-in-case inventory.

How Do I Discard Inventory?

  • How do I treat scrap and surplus items? In many instances, scrap items are considered junk and utilities do not have an organized process in place for collecting scrap and selling it to a scrap vendor or through a bid process, depending on the kind of scrap. Additionally, surplus items typically remain in warehouses rather than being shared with other plants, returned to vendors (which at times is avoided because of high restocking fees demanded by vendors), or robustly marketed and sold for cash.
  • How do I treat obsolete items? Many plants keep obsolete items on their shelves because they are reluctant to take a hit on their budgets by writing off the items. Obsolete items can be aggressively marketed and sold for cash to reduce the budget hit. There are a number of options available, depending on the specific situation of each utility, to address the impact on budgets. Utilities hanging on to obsolete items are holding on to items that could potentially free up cash.
  • How can I salvage failed items and not have to discard them all? Some failed items can be fixed through a repair or rebuild program and may be worth repairing if the cost of repair is significantly less than the cost of buying new. Utilities need to determine—based on lead time, cost of repair, and quality of repair—whether an item should be repaired or discarded. Credit for cost savings can be given to individual plants as incentives.

Inventory Strategy May Meet with Resistance

Solving inventory-management problems can help many utilities free up cash for reinvestment in other business areas. But we recognize that answering these questions may not always lead to smooth sailing. Indeed, some actions may generate push-back from stakeholders within regulatory communities, unions, budgeting, and plant operations. However, especially in our current market situation, we believe optimizing inventory management is a quick way to bring positive cash impact with minimal investment.

Our clients have generated significant value from inventory management. During a recent inventory optimization initiative with one of our clients, a major utility with over $50 million spent on inventory, we identified $4 million to $8 million in savings that can be ploughed back into plant operations.

—Daniel Osafo and Tushar Narsana are consultants with Bridge Strategy Group, a Chicago-based consulting company with a substantial energy practice.