The Unintended Consequences of Implementing 1.5 Month’s Supply on Parts Inventory

If you’re like most Parts Managers, at some point you’ve found yourself in a pickle with a mandate from upper management to cut physical parts inventory, or hit 1.5 Months Supply.

If upper management is focused on only one of these two numbers, it creates unintended consequences that cost the dealer substantially in the end.  But there is a way to reduce the total parts inventory value or hit 1.5 Months Supply of parts inventory without creating a bigger problem.

In this video, our resident parts expect talks about what actually happens when Parts Managers get this mandate, and also how to reduce the total parts inventory value without creating more problems than intended.

 

TRANSCRIPT:

Crystal N.: This is the time of year that dealers start to review and implement procedures moving forward for 2020, one of those being implementing 1.5 months supply in their parts inventory. Can you tell me a little bit about the unintended consequences that might come along with this, Shawn?

Shawn Larkin: When they implement 1.5 months supply, that’s actually industry guide across the board for parts inventory control. It is only one measurement, but typically, it’s a measurement known from dealer principles all the way down, even to parts managers.

Shawn Larkin: The problem is, that when you implement 1.5, generally speaking, a parts manager trying to hit 1.5 because he has more than that, he only has a few options to get rid of the parts inventory, or at least slim down the parts inventory to 1.5. But, before I get talking about that, let me really explain about what that number is and how it’s calculated.

Shawn Larkin: 1.5 months supply basically means having 45 days supply of parts inventory on hand. How we’re able to figure out how much that is and what the value should be, is we take last month’s financial statement, look at the total part sales, minus the gross profit we made, and that amount, once we do that, is called cost-of-sales. That’s the amount of parts, physically, that were sold in the parts firm.

Shawn Larkin: Here’s an example. This is not exact math, but if we sold $600,000 of parts, we’d have $100,000 of profit. We go $600,000 minus $100,000, it gives us $500,000. That $500,000 is cost-of-sales. If we do that by 1.5, that means $750,000 is what our inventory needs to be to hit 1.5.

Shawn Larkin: If a parts manager has a million dollars of parts, and he needs to get to 750, he has to figure out how to get from one million to 750. It’s a huge drop. What happens now is, a parts manager goes back to his desk and thinks of all the different ways that he can get rid of the parts inventory.

Shawn Larkin: The problem is that he’s already returning through his OEM, or at least he should be, returning all the parts he needs to or can through his OEM return program. What are, now, his other options? Of course, if you’re doing program orders, these large, every six months, doing these program orders, that’s the first thing to get cut. Right? So that we’re not ordering a supply that’s three, four, five, six months worth in inventory. That’s a no-brainer. That’s one of the ways to do it.

Shawn Larkin: But realistically, it doesn’t actually move the needle any. For a parts manager. What actually happens…from upstairs, they’re thinking, okay, so we’re going to get this number in line. We’re going to move from a million to 750, and the parts manager just makes it happen. What happens is, the parts manager is actually sitting at his desk, and he doesn’t have a way to make it happen. He’s already doing all he can. I’m going to talk about the ways to do it.

Shawn Larkin: What happens is, the unintended consequences of going or just using 1.5 as the only measurement of parts inventory and not really having a robust plan on how to implement it, what actually happens is, many parts managers are backed up against the wall. What other things can they do? They order parts. Right? They’re ordering special order parts for customers. They can’t cut that off. They can’t really tighten that up, although I’m going to talk about here in a minute. Or, the other parts that they’re ordering is at the parts inventory. So, guess what they have to cut?

Crystal N.: [crosstalk 00:03:42]. Obviously.

Shawn Larkin: What happens is, that’s actually the spinoff. Parts managers will then, depending on their background and their training, some of them will use their gut and just start picking off parts as they look at a stock order, right, start picking them off, parts that they usually don’t stock anymore.

Crystal N.: There’s an actual methodology of how you should be doing that. Correct?

Shawn Larkin: There absolutely needs to be and should be a methodology behind how you control inventory. If you don’t have that, and now you have this mandate to now trim your inventory, you’re using your gut, but now you’re using your gut even more.

Crystal N.: Yeah. It probably isn’t ever a good idea.

Shawn Larkin: Well, not at all, because here’s the spinoff, the fact is, when you cut off active inventory, yes, it makes sense that you can cut your days supply. I see some dealers that are running 45 day supply, 42, 40 day supply. Basically, the rule of thumb is running 30 days supply of active inventory, which makes sense.

Crystal N.: Right.

Shawn Larkin: How does a dealer have, if he’s only ordering, on average, back to parts, 30 day supply, but he has two months supply, and he needs to get to 1.5, why is there such a spread from 30 days, which he wants to stock, to two months? It’s all the difference, are all the parts he shouldn’t have. Right? But he doesn’t have a way to get rid of them.

Shawn Larkin: What happens now is, he’s trimming down his active parts. Now, it does make sense. The game plan would be to get down to 30 day supply, right? If you have more than that, then that is part of the game plan, by trimming that, going from whatever you’re at to 30 and keeping at 30. You don’t want any less than that for active parts.

Shawn Larkin: But, what happens is, now they start not ordering active parts inventory that they should have. They’ll come out with some phasing criteria, or use their gut, or phasing criteria that is either exotic that they just make up to try to choke that inventory from showing up on their stock order in ordering it, or what they’ll do is use ones that don’t have a proven statistic behind it to know what effect it does.

Shawn Larkin: I can tell you that nearly overnight, effectively 30 days, by making a couple of button presses, you can choke your inventory. I call it choke, because effectively, that’s what you’re doing. You can reduce your inventory 25-30% right away.

Crystal N.: That should make a huge difference when we’re talking about large numbers, like the $750,000, etc. Right?

Shawn Larkin: It makes a big difference, whether we’re talking about a small dealer inventory that has only $150,000 or we’re talking about a very large inventory, but what happens is, now when your fill rate or off-the-shelf level of service, whatever you want to call it, to supply your customers with the parts they need, drops dramatically. I have seen dealers who, their off the shelf fill rate is in the high 40s. Basically, they were doing exactly that. They were choking off the active parts because they had a mandate and a ceiling on their inventory.

Shawn Larkin: I’m not saying that having a ceiling on your inventory is a problem. I mean, it makes sense to have it, but it’s a measurement, but what’s actually inside of that inventory that makes that number. What happens now is, they’re trimming up the active parts that don’t sell frequently. So, they were active, but now they’re just not frequent enough. They have to do something, so they cut those first. Right? A part that they sell every single month, they’re obviously going to keep that.

Crystal N.: And month over month, those parts are going to change. Right?

Shawn Larkin: I mean, it could change day by day, right, or even transaction by transaction. But realistically, the bulk of the inventory gets reviewed across the board in its aging analysis and is really monthly, but what happens now is, about 25% to a third of a dealer’s inventory are those parts that sell bi-monthly to every third month, but that’s a huge portion of the inventory, that, actually feeds the shop and your customer. It doesn’t mean that they’re bad parts. That’s a huge population.

Shawn Larkin: When you cut that out, what happens now is, you think about the process to bring in a customer into the shop. Right? Because for most dealers, the shop is their biggest customer, right? What happens now is, the customer… I mean, for the customer, it’s a big process, and they hate it just to begin with. I mean, it’s just inconvenient. But internally, at the dealership, someone takes their call. Somebody looks it up, books an appointment. The customer comes in. Then an advisor handles it. If you have a porter, the porter is moving the car, and then the technician is handling it, driving in and out of the shop. Now they go to parts and don’t have the part, then they’re sending the vehicle outside.

Crystal N.: A lot of hands in the mix.

Shawn Larkin: There’s a lot of hands. It’s a lot of time, which means a lot of dollars.

Crystal N.: Totally.

Shawn Larkin: But then, think about it. They don’t have the part, or they don’t have all the parts to complete it. Guess what happens again? Parts department special orders the part, and we do the whole process all over again.

Crystal N.: Yeah, and that’s where the problem begins. Right?

Shawn Larkin: That’s the spinoff of the problem. What really happens is, you get paid by the customer once to finish the job, but you’ve handled the customer twice. That whole process. The same, likewise, happens. It’s just different when it’s wholesale or retail, or they just go elsewhere. These are hidden expenses, cause opportunities that you can’t measure, but what you’re measuring is, now we’re at 1.5 months supply. But I’ll tell you that the parts of sell bi-monthly or every third month, that’s 25% to a third of your inventory value in itself.

Crystal N.: That’s a lot.

Shawn Larkin: It’s active parts. It’s a lot. When your parts manager gets his back up against the wall, that’s the stuff that’s going first. Okay, so let me talk about, how should you fix it? The real problem for dealers, it’s not their active inventory, unless you’re going crazy with ordering these program orders or ordering a huge supply, and you don’t have a handle on day supply. If there’s not a strategy behind that, I mean, you could end up with problems. But generally speaking, that’s not the problem. Your problem is not active parts.

Shawn Larkin: Your real problem is your idle and obsolete parts inventory. Often, you’ll hear parts managers define an inventory, whether it’s good or bad, by whether or not… or how much he has of 12 months in older parts.

Crystal N.: But they’re not actually looking at the parts that are less than 12 months, right? What happens to those parts that are 9 months, or 10 months, or even say sometimes 6 months and see no movement? What happens to those parts?

Shawn Larkin: You’re exactly right. What happens is, the definition of, how much do I have in 12 months and older, is only a small window of what your parts inventory is like. What happens now is, of course, a parts manager gets rid of the oldest parts in inventory. Whatever oldest parts he has in inventory, at least that are eligible for return, that whole group means that’s where he’s applying all his return allowance.

Shawn Larkin: The question is, let’s say all his parts are all at 12 months older. There’s only a couple parts that are 13-14 months old, but they need to be written off that aren’t. Let’s just assume that. What happens, then, with the parts which are special order, unsold or return special-order parts now, which are on day 61?

Shawn Larkin: They have to sit there the entire duration until they become the oldest. Right? Only defining that your parts inventory is good or bad by looking at the value or the percentage of inventory that’s 12 months and older is only any number to look at. Right?

Crystal N.: Right, so what a dealer should actually be looking at for those parts, in specific, is different.

Shawn Larkin: It’s really about getting a handle on the inventory you shouldn’t have. For some, they can’t define this. Right? Or they don’t have any visibility into what this means, but really, what we need to do to implement properly so we don’t create the unintended consequences that you were talking about, really, what we need to do is a couple of things. This is a slow process. It doesn’t happen overnight. Let me just try to rattle them all off, the things that you need to do without affecting active inventory.

Shawn Larkin: First, I would say it’s to make sure that you actually have a proper methodology. We talk about that in various articles we have on our website.

Crystal N.: Lots.

Shawn Larkin: A lot, exactly. We have to have a proper methodology that actually you know the percentages of the probabilities and the risks associated with ordering a part, based off its prior sell history. Right?

Crystal N.: Not just going off your gut and just, “Well, I sold lots of them, but now it’s kind of trickled down, but I think I’ll sell more, so I’ll just order some more in.” That doesn’t work.

Shawn Larkin: Exactly. A way to know whether a guy has been trained, or knows enough to implement technical criteria and how he controls inventory, can be dialed in and filtered through his entire parts inventory on excel. If I have my inventory on Excel, and I can’t filter it to show you what I call active and what I call nonactive, idle and obsolete, if you can’t do that on Excel, it means you’re winging it. That’s what it is, right?

Shawn Larkin: Now, maybe you have the experience, but years of experience doesn’t necessarily always mean that you have the odds working for you because you don’t know what they are.

Crystal N.: No, and things change. Right? New procedures come into play. When you take that all into consideration, you have to take that back to your parts inventory and implement that properly.

Shawn Larkin: Exactly, and through your DMS. The first step is just knowing that we actually have a strategy or a methodology to handle inventory from the get-go. I mean, that’s number one by far, but that’s a little more complicated topic for another video, but we do have articles on our website specific on that.

Shawn Larkin: Then the next thing, so how do I get to 1.5 months supply, then, would be to look at your program orders and just stop ordering them. I’m not saying that that is the right thing to do, but if you have no other choice, then that is a thing to do. Because generally, you’re ordering these parts because you sell lots of them, anyway, but now you’re not getting the discount.

Crystal N.: Now, I know, Shawn, some dealers get themselves into a situation where they work for a specific brand where they are required to order a certain amount of parts or specific parts, I should say. What about those dealers? How do they handle it then?

Shawn Larkin: Well, you know what? That is a topic in itself. Let me spare that for another conversation. I’ll spend an hour on that, alone, in how to handle it and what you do. I mean, that gets pretty deep.

Crystal N.: Okay.

Shawn Larkin: Here’s the thing. You’re talking about manufacturer programs. You’ve got to think about why those are in place to begin with. They’re in place as to help your inventory, but anyone who’s selling you anything, who’s interest do they have first?

Crystal N.: Theirs.

Shawn Larkin: That’s something to consider. That’s why that becomes a whole conversation, itself.

Crystal N.: It’s a recommendation.

Shawn Larkin: Well, yeah. I mean, that’s the way you need to look at it, as a recommendation, not as the Bible.

Crystal N.: This is set in stone. This is what you need.

Shawn Larkin: You never want to do that. I’ll spare you for another conversation about that.

Shawn Larkin: Then the next thing is making sure that your day supply. What is your day supply, very specifically, and how do you ensure that that’s exactly what you’re following? Is it 30 day supply? I don’t recommend anything less than that for active inventory, because you start running out. That means you’re running to other dealers, picking them up. I mean, the list goes on and on. But basically, not having the part of active inventory is the worst.

Shawn Larkin: That’s the next thing, getting your day supply to 30, at least on your active inventory. As for the idle inventory, you’re not ordering them, unless a special order for a customer. Anyway, there is no day supply that you set on it, although it’s a blanket across your database, or should be.

Shawn Larkin: Okay, so then the next thing would be to implement, if you don’t already, a special order process where everybody, retail, internal, that’s a conversation, too, in itself, internal, prepay for the parts, whether it’s retail counter.

Crystal N.: Which is difficult, isn’t it? Because there’s a lot of pushback with that.

Shawn Larkin: Yeah. Well, there is. You know where a majority of the pushback is?

Crystal N.: It’s people ordering it.

Shawn Larkin: Yeah, it’s our own people. Our own people are the biggest pushback, but we wrote an article on that. You can Google it: Top Six Ways Dealers Can Get A Handle On Idle and Obsolete Parts Inventory. We list all these. Anyway, prepaid parts, implementing prepaid parts on the retail shop and internal and over the counter is a way to get a handle on it, because that’s where the problem starts.

Crystal N.: Then there’s security, right? It’s like you know the part is coming in. The part is already paid for. So, worst-case scenario, if it doesn’t get picked up, it doesn’t get used. It was misordered, whatever. It’s still paid for, so you have that security.

Shawn Larkin: Yeah. I mean, you de-risk the probability that the dealership owns the part. That’s where the problems come. There is a small… but depending if you’re running a proper methodology on your parts inventory, ordering them correctly, there’s a small percentage that actually fall off in a year that were active and now become idle and obsolete. It’s very small, but in comparison to the real problem is, these special orders, unsold and return special-order parts, and it’s easy to say that, “Well, we don’t have many.”

Shawn Larkin: But I can tell you that generally speaking, kind of a rule of thumb is, the value of parts that you have 10 months and older, you have approximately equal value that are nine months and less, that are idle. Well, they’re not obsolete, but they’re idle parts that you shouldn’t have. Kind of a rule of thumb if you have 10 months and older parts, and you have $100,000, effectively, you could almost bank on that you actually have $200,000 if you were to look at those unsold and return special-order parts, which are not aged out yet. Just because there’s no name on them doesn’t mean they’re not a problem.

Crystal N.: Doesn’t mean they belong there.

Shawn Larkin: We special ordered it. We hate special order parts, right? Until they sell, we love them, obviously, but when we go ahead, and the customer cancels or picks it up and returns it, we rip the name off it. It doesn’t mean they’re not a problem anymore. In fact, it’s a bigger problem.

Crystal N.: No.

Shawn Larkin: Right?

Crystal N.: Yeah, yeah.

Shawn Larkin: That’s the other thing, implementing prepaid is an absolute must. Then the other bit would be trying to get your special order bin in check so that there are no parts in your special order bin older than 30 days old, the next step, because if you let it sit, the longer we wait, the longer the problem gets.

Crystal N.: The worse the problem is. It just magnifies it.

Shawn Larkin: Yeah. The probability of the customer coming back gets worse by the day. The absolute worst-case scenario is not having anything older than 30 days old. 60 days, I mean, is a way to do it, but that’s too loose, in my opinion, so then the next strategy to implement would be to have pre-booking customers, retail customers, at least for the shop, pre-booking them before they leave on that initial visit, before they leave, pre-booking them. This includes warranty, too, pre-booking them their next appointment when the part actually lands. That’s important so that you’re getting a commitment from the customer to actually come back, rather than the part comes in a few days. Now you’re working with the customer over the phone.

Crystal N.: Trying to get ahold of them, yeah.

Shawn Larkin: Right. You want to do it right off the hop. This is very slow. There’s a lot of implementation of process.

Crystal N.: And it’s not just one person, either. It takes everybody to participate together, because everybody, as you’ve said, it’s that whole process in the beginning that you explained. Everybody kind of ties into another, and each position can help implement this, but it takes everybody to work together to implement it as a team, basically, right?

Shawn Larkin: Yeah.

Crystal N.: To kind of clean this up.

Shawn Larkin: It’s a coordinated effort, but the thing is that overnight, or even in 30 days, provided you can implement all this stuff and take some time just to implement this stuff and start checking them off, it’s slow. It’s slow to do that, but if you want immediate effect, I mean, you already know the answer. How can we have an impact on our inventory overnight to get to our number? The obvious answer is, well, that’s easy. Just stop ordering active parts, but I’ll tell you the cost of that is much bigger than trying to implement proper procedures in policy, try to get it under control. Here’s what I’ll leave you with. The real problem is not your active parts inventory. Of course, we all know that.

Shawn Larkin: The real problem is your idle inventory, and that’s what is ballooning. That’s what you can only get rid of so much. That’s the stuff that creates the problem. The looser your processes and policies are on idle parts inventory like you don’t have a prepaid process, you don’t have a methodology on inventory control, you’re not pre-booking customers. I mean, what happens is, it starts to get a bit sloppy. Which means that your idle parts inventory starts to balloon more than, of course, what you can get rid of back to the manufacturer. That just means that when you start to implement 1.5 months supply, the amount of active inventory you would have to scale back just to meet that number is even more, so the effect is even worse.

Crystal N.: Especially this time of year. I think dealers are really aware of what that number is. We’re coming to year-end. Dealers really know what they’re looking at, and what has been moving and what is not moving. That’s a big number for some dealers. Some, maybe not so much, but I think that this time of year is when, like I said in the beginning when they’re starting to implement and review and just looking at that number and making sure that they’re following these steps and starting that implementation now, so moving forward, then they have a plan in place, and they can start building, because if they don’t start, then it just keeps compounding.

Shawn Larkin: Yeah. I mean, there’s a bigger story. What happens is, if it’s month after month, year after year, the parts manager can’t get an in check because he really knows that I can only scale back active inventory so much. The problem is, what we would see is, we just keep trying to find a silver bullet, and replacing parts managers or finding parts managers or key leaves, he’s just like, “I can’t get this done,” because he can’t get it done, but what we’re really missing is, if you got the right guy, you just got to start with training and implement some processes. Yes, some of them are tough? Pre-paid’s are tough, not because it’s hard to implement, but you get a lot of push-back internally. How do we handle it? How does the DMS handle it? It’s all not hard. It’s all just in your head.

Crystal N.: Well, you and I, we’ve worked together for quite a while, and one thing that we’ve always been really firm and mutual on is to hire attitude. If they come with the right attitude, you can train them any skill you want, basically. Really making sure with your people in your department that everybody comes with that attitude, that we’re going to work at this together, and we’re going to make this better.

Shawn Larkin: Exactly. I mean, if you got the right guy, the right attitude, right morals, and ethics.

Crystal N.: Regardless of if he has 30 years, or 10 years experience, or five months’ experience. All those people, if they have the right attitude, then this is fixable, totally.

Shawn Larkin: Exactly. Let me wrap this up with this one last line. What dealers really need to do is, 1.5 is not a bad number. That supply is not a bad number. What happens is, how we get to it does matter. If you want to take the easy way out, it just costs you much more dollars. I mean, you can’t even count what the costs are, but it’s incredible.

Crystal N.: Yes, absolutely.

Shawn Larkin: It’s not about the easy way out. It’s about, okay, so how do we come up with a plan? I list off a ton of stuff. Go to our website. Look at the blog section. There’s a ton of articles on how to achieve that, and the list goes on, but…

Crystal N.: Absolutely.

Shawn Larkin: … I would say that’s all we have to add to these for this conversation. I could go on for another three hours but maybe don’t.

Crystal N.: Yeah. I think that we do this on a regular basis, though.

Shawn Larkin: Exactly. Very good.

Crystal N.: Okay.

Shawn Larkin: I appreciate it.

Crystal N.: Okay, thanks for your time.

Shawn Larkin: Thanks.

Crystal N.: Okay.

Shawn Larkin: Bye.

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