What does that inventory really cost?

Nov. 1, 1998

What Does That Inventory Really Cost?

By Bill de Decker

November 1999

Bill de Decker is a Partner with Conklin & de Decker Associates, publishers of aircraft operating cost databases, MxManager® integrated maintenance management software, and consultants on cost analysis and fleet planning. He has over 35 years experience in fixed and rotary wing design, marketing, training, operation, and management. He also teaches a number of aviation management courses.

Everyone agrees that to maintain aircraft you need spare parts. Also, almost everyone agrees that to minimize down time caused by a lack of spares, you need to keep some spares in inventory. But, no one agrees about the optimum size for a spares inventory.

Consider this true tale about two Fortune 100 flight departments. Both have about the same number and type of aircraft, both fly trips all over the world, both fly about the same number of hours per year, and both have an excellent reputation with their users for availability and reliability. But, one has a spares inventory of over $10 million, while the other has an inventory of about $500,000!

One reaction is to say "they are both doing a good job, so who cares?"

From an operations level, this is true. But, from a maintenance management and financial point of view, there is a huge difference — a difference of almost $2.4 million per year. This difference, which is incurred every year, is a direct consequence of the cost of owning and managing the inventory. These costs, which are usually expressed as a percentage of the value of the spares inventory, can be divided into three categories:

Storage, distribution, security, record keeping, insurance and taxes; 5 to 13 percent per year.
Parts require secure storage with climate control. They need to be insured and, in many locations, there is a property tax levied on them. Someone needs to maintain the records, make sure they get to where they are needed, and ensure that parts that can be overhauled or repaired, are sent out and returned to inventory. As an example of how not to do this, consider the implications when the new maintenance manager at an FBO found several run out helicopter turbo shaft engines in a storage closet underneath stairs leading to a loft! Research shows that this part of the cost of carrying inventory ranges from 5 to 13 percent of the value of the inventory per year.

• Obsolescence, recertification, damage, spoilage and pilferage; 3 to 9 percent per year.
Parts that sit on the shelf do run out of calendar time and need to be recertified, or they need to be upgraded to a later "dash" number through the application of a service bulletin. Sometimes, rust or an accident damages the parts. And sometimes, parts develop "legs." We don't like to think about these things, but they do happen.

One graphic example of what happens to spares that sit on the shelf happened to one of our customers. Recently, they got rid of the last of a fleet of jets they had been using since 1973. This year, they sold the spares inventory they had been using for that aircraft and realized about $2.5 million from the sale. This sounds good, until you realize those spares were on the books for $13 million. In short, this cost element, which runs from 3 to 9 percent of the value of the inventory per year, is very real, even if you take good care of the inventory.

• Cost of money; 8 to 20 percent per year.
Each time spare parts are bought, they cost money. If the spare part is put on the aircraft, or resold to a customer, it helps the organization earn revenues and profits. Thus, the cost of the spare part is easy to justify. On the other hand, if the spare is put on the shelf, it earns no revenues or profits and, until the part is put on an aircraft or resold, ties up the money used to acquire it. This money either comes from earnings or it is borrowed. In either case, there is a cost associated with it. If the money is borrowed, the cost can be as low as 8 percent or as high as 14 percent per year. If the money comes out of earnings, the effective cost can be as high as 20 percent — if the money used to buy the part that sits in inventory was used instead to buy revenue producing equipment, it could earn a return of 20 percent or higher. Recall the example of the organization that sold the $13 million of surplus spares from their inventory for $2.5 million. Another way to look at this is that they lost over $10 million — money that could have been used to buy more aircraft to generate profits.

Adding all these expenses together shows that the annual cost of carrying inventory is 16 to 42 percent of the value of the inventory per year. For most organizations, the average is about 25 percent per year. In other words, for every $100,000 of spares inventory on the shelf, the annual costs are about $25,000.

A survey we did earlier this year for the Helicopter Association International showed that the average operator carried about $275,000 of inventory for each helicopter in their fleet. The implied carrying cost is $68,750 per year, which equals the typical profit per helicopter per year. Put another way, eliminating a substantial part of the inventory, would allow these operators to increase their profits significantly.

Another interesting item that came out of the survey was that for the average operator, the ratio of value of inventory to annual revenues was 20 percent. However, this percentage varied from 1 percent to over 65 percent. Just like the example of the two corporate operators at the beginning of this article, this suggests there is lots of room for decreasing the value of your inventory without impacting the quality of the maintenance, availability or reliability of the aircraft.

What are some of the ways to decrease inventory, or prevent it from building up in the first place? First, start tracking actual usage very carefully. This will show what is actually being used. You will find that about 10 to 20 percent of the line items in your inventory account for 80 to 90 percent of the activity. Those are the ones you want for your inventory. The others you probably don't. Second, find out who has the parts, what are their lead times and how fast can they get a part to you if you really need it. Remember, overnight, counter-to-counter, and exchange charges are probably a heck of a lot less than that 25 percent annual carrying cost, particularly for a part that is not used frequently. Third, analyze various maintenance tasks to determine how long you have from the time the need is identified till the time the part is actually required for installation. This will tell you how long you have to get the part from whoever has it, or whether you really need it in inventory. And lastly, strongly resist the urge to order two of any parts when only one is needed to fix the problem.

In the words of a friend of mine, a very successful corporate operator, "If we don't use a part within 120 days, I don't want it in our inventory." Wise words that will help you avoid a major cash and profit drain.