inventory optimization 2009 results...inventory management operations in the electric and gas...

Inventory Optimization in theInventory Optimization in the Electric & Gas Utility Industryy y2009 Survey Results

Utility Materials Management Benchmarking ConsortiumUtility Purchasing Managers Group

October 2009 UMMBC

ContentsContentsIntroduction

Changing Market and Financial ConditionsChanging Market and Financial Conditions

The Impact of Global Supply and Demand

A Growing Focus on Inventory Optimization

Inventory Performance MetricsInventory Performance Metrics

Inventory Optimization Practices

Practice Impact on Performance

Survey InsightsSurvey Insights

Contacts

Appendix A: UMMBC Survey Questions

Appendix B: UPMG Utilities Survey QuestionsAppendix B: UPMG Utilities Survey Questions

Appendix C: UPMG Supplier Survey Questions

Copyright © 2009 by ScottMadden. All rights reserved. 1

IntroductionIntroductionReport Overview

This report summarizes the results of three recent surveys conducted by ScottMadden Inc regarding inventory optimizationThis report summarizes the results of three recent surveys conducted by ScottMadden, Inc., regarding inventory optimization practices and performance within the electric and gas utility industry

— The first was a 16-question survey examining inventory optimization practices and their impact on performance. This survey was conducted on behalf of the Utility Materials Management Benchmarking Consortium (UMMBC)

— The second was a five-question survey examining the impact of global supply and demand on utility inventory practices and strategies. This survey was conducted under the auspices of the Utility Purchasing Managers Group (UPMG)

— The third was a five-question survey examining the impact of global supply and demand on the inventory practices of major suppliers to the utility industry. This survey was also conducted under the auspices of the UPMG

The results from all three surveys are consolidated in this report. Graph and table footnotes are used to indicate the source of each finding/observation

The Survey Organizers

ScottMadden, Inc., is a general management consulting firm serving the electric utility , , g g g g yindustry since 1983. ScottMadden helped launch the Utility Materials Management Benchmarking Consortium in 2007 and is currently the consortium coordinator

The UMMBC is a group of industry leaders who are collaborating to develop information needed to critically examine and improve ongoing warehouse and UMMBCinventory management operations in the electric and gas utility industry. Membership is open to all utilities

The UPMG is a professional organization initiated in 1924 and dedicated to the sharing and development of best practices with a special emphasis on the strategic contribution of supply chain management to the utility industry

UMMBC

Copyright © 2009 by ScottMadden. All rights reserved.

contribution of supply chain management to the utility industry

2

IntroductionIntroductionUMMBC Utility Inventory Optimization Survey

The UMMBC conducts an annual survey on a topic of interest to its members The topic selected for 2009 was “inventoryThe UMMBC conducts an annual survey on a topic of interest to its members. The topic selected for 2009 was inventory optimization”

In May of this year, a web-based survey was distributed to the current 28 members of the UMMBC. A copy of the survey questionnaire is presented in Appendix A

In June, ScottMadden reached an agreement with the UPMG to extend the reach of the survey by distributing it to all UPMG member utilities registered to attend the 78th annual meeting to be held in Washington, D.C. in September

At the end of July, the survey was closed. 41 utilities responded representing 46 different business units. Responses from one business unit (e.g., Distribution) were treated as separate from those of another business unit (e.g., Fossil Generation)from the same company The distribution of respondents is shown in the figures below:from the same company. The distribution of respondents is shown in the figures below:

Survey Respondents by Type of Organization Survey Respondents by Business Unit

Investor owned utility

Federal utility

Public power utility (e.g., municipal)

76%

2%

15%

Generation -Fossil

Generation -Gas Turbine

Generation - Nuclear

9%

2%

9%

0% 10% 20% 30% 40% 50% 60% 70% 80%

Public power utility (e.g., municipal)

Transmission company

Independent power company/cogeneration company

4%

2%

0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

Transmission

Distribution

Other

7%

41%

33%


0% 10% 20% 30% 40% 50% 60% 70% 80% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

3

IntroductionIntroductionUPMG Global Trends Utilities Survey

In preparation for the UPMG September conference ScottMadden designed a set of questions regarding the impact of globalIn preparation for the UPMG September conference, ScottMadden designed a set of questions regarding the impact of global markets on inventory decisions within leading utilities

In August, this survey was distributed to the UPMG utility benchmarking group. The survey was closed at the end of August. 12 companies responded

UPMG Global Trends Suppliers Survey

Also in preparation for the UPMG September conference, ScottMadden designed a set of questions regarding the impact of global markets on inventory decisions within leading utility suppliers

In August, this survey was distributed to the UPMG utility benchmarking group . The survey was closed at the end of August. g , y y g g p y g21 companies responded


IntroductionIntroductionDefining “Inventory Optimization”

The term “inventory optimization” has come to mean many things to many people For our purposes we will borrow theThe term inventory optimization has come to mean many things to many people. For our purposes we will borrow the definition adopted by Southern Company1

“Inventory Optimization” is about having: The right materials, . . . . . . . . . . . . . . . . [Eng. specs; work orders; BOMs]

I th i ht bIn the right numbers, . . . . . . . . . . . [Inventory levels, service levels]

At the right location, . . . . . . . [Which warehouse; where in the warehouse]

At the right time, and . [Demand forecasting, lead times, need date control]

At the right cost . . . [Purchasing]

Responsibilities

Delivering this promise requires the participation of many dedicated employees throughout the company

At the right cost . . . [Purchasing]

Inventory Optimization Decision Rights

System Owner/User

h l

Purchasing

Whi h li

Materials Mgmt.Warehousing

d

Materials Mgmt.Inventory Mgmt.

hA suggested allocation of responsibilities is shown in the table on the right

• What materials do we need?

• How much do we need?

• When do we

• Which suppliers will we use?

• How much should we pay?

• How do we ensure supply?

• How do we receive and issue efficiently?

• Where will it be stored in the warehouse?

• How much should we keep on hand?

• In which warehouse should it be

need it?

• Where will we use it?

• What is our risk tolerance?

ensure supply?

• What are the expected lead time(s)?

• Who will deliver it? When?

warehouse?

• Is the shelf count accurate?

• Is it maintained adequately?

should it be stored?

• From where should each request be drawn?


1Southern Company, Generation Playbook, Chapter 13

5

it? When?

Changing Market and Financial ConditionsChanging Market and Financial ConditionsWhat a Difference A Year Can Make

The past 24 months have been tumultuous at best Utilities along with the rest of the world have been subjected toThe past 24 months have been tumultuous at best. Utilities, along with the rest of the world have been subjected to unprecedented changes in market and financial conditions. Many of these have significant potential impact on utility inventory strategies and direction

In parallel with these changes, utility materials management practices have been evolving and maturing. Management is beginning to pay more attention to the $14.3 billion currently invested in operating inventory across the utility industry2

An Unprecedented Market Reversal

The “Great Recession of 2008-9” has had a number of significant impacts on global market conditions. We have gone from:

— Global demand exceeding supply to global T i i Li C t ti C tsupply exceeding demand

— Rapid escalation in materials and services prices to declining prices for materials and services

— Critical supply shortages with utilities booking 260

280

300

320

000

= 10

0)

Upper Forecast

Towers & Poles

TransmissionLines

Proxy Transmission LineConstruction Costs

Transmission Line Construction Costs

Critical supply shortages with utilities booking advance production space to suppliers banging on the doors

— Transportation costs rapidly accelerating with capacity shortage in all modes to declining transportation costs coupled with significant

201

188

160

180

200

220

240at

ive

Perc

enta

ge C

hang

e (1

Q20

Median Forecast

Lower Forecast

Substation

transportation costs coupled with significant 3PL consolidation

— A concerted push to globalize supply to a returned focus on domestic suppliers 100

120

140

160

1Q20

00

3Q20

00

1Q20

01

3Q20

01

1Q20

02

3Q20

02

1Q20

03

3Q20

03

1Q20

04

3Q20

04

1Q20

05

3Q20

05

1Q20

06

3Q20

06

1Q20

07

3Q20

07

1Q20

08

3Q20

08

1Q20

09

3Q20

09

1Q20

10

3Q20

10

1Q20

11

3Q20

11

1Q20

12

3Q20

12

1Q20

13

3Q20

13

Cum

ula

TODAY

Source:


2FERC Form 1, Account 154: “Total Plant Materials and Operating Supplies”

Source:

6

Changing Market and Financial Conditions (Cont’d)Changing Market and Financial Conditions (Cont d)An Unprecedented Financial Reversal

The turnaround in global market conditions has occurred in parallel with a significant change in the financial fortunes of mostThe turnaround in global market conditions has occurred in parallel with a significant change in the financial fortunes of most electric and gas utilities. We have gone from:

— Demand for power rapidly growing to where power demand is declining for the first time in decades

— Utility revenues rising in all classes (residential, commercial, and industrial) to utility revenues declining – especially in the industrial and commercial categories

— Most PUCs granting reasonable rate increases to PUCs reluctant to grant rateincreases during the worst recession sincethe Great Depression

A focus on extensive new infrastructure— A focus on extensive new infrastructure build-outs to utilities postponing or cancelling capital projects

— Credit being readily available and historically cheap to credit availability being limited

A 200% increase in annual CAPEX

limited

— A generation mix that was favoring low-cost coal to a generation portfolio favoring gas and renewables


The Impact of Global Supply and DemandThe Impact of Global Supply and DemandOver the past decade, U.S. utilities have increasingly purchased materials, equipment, and components from sources outside of the United States. This trend continued until 2008 when higher fuel costs, increasing lead times, and supply di ti d b k t d ti f tdisruptions drove many back to domestic manufacturers.

Impact of Global Supply and Demand Relationships

The table to the right shows the percentage of utilities claiming that key materials they purchase are

Top Five Materials/Equipment/Components, etc. Influenced by Global Supply and Demand Conditions

% Reporting

Medium-/high-voltage transformers 100%Wire and cable 83%influenced by global supply and demand relationships.

The affected materials are listed according to the percentage of companies referencing the category

All of the utilities surveyed report buying materialsthat are influenced by global supply and demand

Wire and cable 83%Switches and switchgear 50%Alloy, carbon, and structural steel 42%Electronics 33%Turbine parts and boiler tubing 33%

that are influenced by global supply and demandrelationships in some form or another

Influence of Global Demand and Supply on Determining Inventory Levels for These Items Source: ScottMadden, 2009 UPMG Utility Survey

Poles and pole line hardware 25%Oil- and petroleum-based products 16%Reactors 8%

0%

45%

0% No influence at all

Little meaningful influence

While recognizing that global supply and demand influences the availability and price of key components, most utilities report that these factors have little meaningful influence in determining internal inventory levels to maintain for these items

g y

55%influence

Significant influence

Determining influence

These results may reflect the fact that many of these items are purchased for capital projects and these decisions are often not handled by the materials management groups


Source: ScottMadden, 2009 UPMG Utility Survey

8

The Impact of Global Supply and Demand (Cont’d)The Impact of Global Supply and Demand (Cont d)We asked suppliers to utilities whether global supply and demand relationships had affected their production decisions and their decisions regarding internal inventories and lead times.

Impact of Global Supply and Demand Relationships

The figure to the right indicates that the majority of utility suppliers (58%) believe that global supply anddemand relationships have had a significant impact on

Impact of Global Supply and Demand on Utility Supplier Production

No influence at all 10%the production of products they sell to utilities

We also asked whether global supply and demandconductions had affected their lead times with respectto their utility customers. The results are shown in thetable below

No influence at all

Little meaningful influence

Significant influence

33%

47%

table below

Influence of Global Demand and Supply on Supplier Lead Times to Utilities Source: ScottMadden, 2009 UPMG Supplier Survey

0% 10% 20% 30% 40% 50%

The primary, determining factor 10%

Interestingly, only 35% of the suppliers believe that global supply and demand relationships have affected their lead times in providing materials to their utility customers

The results imply that the suppliers have worked hard to

Supplier Lead Times to Utilities

35%

Yes The results imply that the suppliers have worked hard to cushion utilities from lead time disruptions caused by global supply and demand fluctuations

65%

No


Source: ScottMadden, 2009 UPMG Supplier Survey

9

The Impact of Global Supply and Demand (Cont’d)The Impact of Global Supply and Demand (Cont d)We also asked suppliers to utilities whether global supply and demand relationships had affected the volume of materials (raw materials and finished goods) they maintain on hand to support their production of materials for sale to electric and

tilitigas utilities.

Raw Materials Inventories

Slightly more than half of the suppliers felt that global supplyand demand fluctuations did not affect the volume of

Impact of Global Supply and Demand on Supplier Raw Materials Inventories

raw materials they maintained on hand for production

Finished Goods Inventories

48%

52%

YesNo

In the case of finished good inventory, the percentageswere reversed. Slightly more than half claimed that globalsupply and demand fluctuations did, in fact, affect thevolumes of finished good inventories they maintainedon hand for electric and gas utilities


Impact of Global Supply and Demand

As mentioned earlier, it would appear that utility suppliershave cushioned their utility customers from global supplyand demand fluctuations by changing the volume of finished goods inventories they maintain on hand

48% Yes

on Supplier Finished Goods Inventories

52%

YesNo



10

The Impact of Global Supply and Demand (Cont’d)The Impact of Global Supply and Demand (Cont d)Lessons Learned by Utilities. Given the ups and downs of global markets over the past several years, we asked the utility respondents to offer any “lessons learned” from the global roller coaster. Presented below are a selection of common themes:common themes:

Lead times:

— “Tight demand for steel, aluminum, and copper resulted in increased lead times on key T&D materials”

— “Tight global demand can spark a ‘hoarding’ mindset in certain material categories”

Relationships:

— “When supply is constrained, having long-term, collaborative supplier relationships will positively influence availability”

— “Maintain ongoing dialog with supplier and consistently monitor their financial health and production capacity”

“Plan ahead communicate often Global conditions can strain even the most established alliance relationships”— Plan ahead, communicate often. Global conditions can strain even the most established alliance relationships

Demand planning:

— “In the face of high global demand, it is imperative that project/construction planning be accurate and occur well in advance of the need date for materials”

“Pl i i iti l t f l l t t i ”— “Planning is critical to successful supply strategies”

— “Good planning with good forecasts given to the supplier allow us to make long-term commitments with our suppliers”

— “Utilities need to formalize internal forecasting processes to develop future needs so as to allow for the leveraging of volumes over time to secure needed capacity”

Inventory impact:

— “Global demand for raw materials affects our supplier’s performance which impacts our inventory levels and availability”

— “Longer supplier lead times have resulted in higher inventory levels”


The Impact of Global Supply and Demand (Cont’d)The Impact of Global Supply and Demand (Cont d)Advice from Utility Suppliers. We also asked the utility suppliers what advice they would give to electric and gas utilities with respect to global supply and demand fluctuations. Presented below are a selection of common themes:

Lead times:

— “Always allow for more lead time than is quoted by the vendor”

Relationships:

— “For strategic materials, partner with one supplier and know their chief supply chain officer. He should be on your alliance team”

— “Pick financially strong/stable partners and stay one step removed from global sourcing challenges”

— “The distribution business is designed to insulate the utility from supply chain disruptions by maintaining local inventories Use local distribution to offset the impact of global supply and demand fluctuations”inventories. Use local distribution to offset the impact of global supply and demand fluctuations

Demand planning:

— “Keep your supply base informed of your future plans as we want to provide top-notch service but cannot ramp up to meet significant demand increases overnight”

“P idi l f t (i 10% 10% t i ) i ifi tl h l li l t i l d— “Providing a general forecast (i.e., +10% or -10% to prior year) significantly helps suppliers plan material and capacity”

Use of global suppliers:

— “Resist the temptation to go with opportunistic imports”

— “Home country interests will be served first. Don’t be left at the alter by a mail order bride”

Inventory impact:

— “Look for longer lead times, need for greater on-hand inventory, and higher prices due to the increase in demand for materials”


A Growing Focus on Inventory Optimization MROA Growing Focus on Inventory OptimizationUtility Inventory Levels

Since 2002 utility inventory levels have continued to rise each year In fact inventory levels appear to be growing at anSince 2002, utility inventory levels have continued to rise each year. In fact, inventory levels appear to be growing at an accelerated rate

— From 2001 through 2005, FERC 154 inventory levels grew at an average rate of 3.5% per year

— From 2005 through 2008, they grew at an average rate of 10.6% per year

We believe multiple factors have contributed to recent growth, among which are:

— The rising cost of materials and supplies

— Increased annual capital project expenditures which rose 200% from 2004 to 2008

L li l d ti16,000,000

FERC 154 Inventory ‐ All Reporting Utilities in U.S.

10.6%

— Longer supplier lead times

— Fear of supply disruption which resulted in higher safety stock levels

— Recently cancelled projects which returned materials back into inventory

6,000,000

8,000,000

10,000,000

12,000,000

14,000,000 3.5%

materials back into inventory

— Greater diversity in the generation portfolio ofmany utilities which diversifies MRO inventory

We also believe there are factors which are working tocontrol or reduce inventories, among which are:

Source: FERC Form 1, Account 154: Total Plant Materials and Operating Supplies

0

2,000,000

4,000,000

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

control or reduce inventories, among which are:

— The credit crunch of 2009 forced many utilities to examine alternate ways to free up working capital

— Declining utility revenues have also encouraged utility executives to find ways to reduce cash expenditures

— Increased use of domestic suppliers with reduced lead times which may reduce inventory requirements

A growing recognition that inventory management practices within the utility industry are lagging the commercial


— A growing recognition that inventory management practices within the utility industry are lagging the commercial sector and can deliver improved inventory effectiveness and efficiency

13

A Growing Focus on Inventory Optimization (Cont’d) MROA Growing Focus on Inventory Optimization (Cont d)The Executive Suite Starts Paying Attention

Only a few years ago it seemed that few utilities executives were focused on inventory or how to optimize it This is no longerOnly a few years ago, it seemed that few utilities executives were focused on inventory or how to optimize it. This is no longer the case

When asked, “How important is inventory optimization to your company’s executive management?” 67% of respondents to the primary survey indicated that inventory optimization is either important or critical to their company’s executive management

None of the respondents indicated that it is “not on the radar screen.” This is a remarkable change in focus

Q: How important is inventory optimization to your company’s executive management?

9% 24% 41% 26%

67% Say Important or Critical

Today

0% 20% 40% 60% 80% 100%

e) Not on the radar screen - Nobody cares

Today

d) Not particularly important - We can't seem to get anyone's attention

c) Somewhat important - Blows hot and cold; just good operating practice

b) Important - A great deal of attention paid to this

a) Critical - Key strategic initiative

Source: ScottMadden 2009 UMMBC Survey


Source: ScottMadden, 2009 UMMBC Survey

14

A Growing Focus on Inventory Optimization (Cont’d) MROA Growing Focus on Inventory Optimization (Cont d)What is Driving the New Interest?

Unfortunately we did not add questions to this year’s UMMBC survey to explore what is driving this change in focusUnfortunately, we did not add questions to this year s UMMBC survey to explore what is driving this change in focus. However, recent survey results from Aberdeen Research for U.S. companies as a whole shine some light on this issue. The responses are shown in the figure below:

Q: What are the primary factors contributing to the need to optimize inventory levels?

Corporate need to improve return on invested capital 38% 29%

Very Influential Critical

Market pressure to reduce order-to-delivery lead times

Pressure to improve service levels

Shortage of working capital to support operations/expansions

36%

30%

25%

7%

15%

20%

0% 20% 40% 60% 80%

Increasing lead times, variability, and carrying costs 26% 10%

Percentage of Respondents (n=131)

S Ab d G M 2009

Not surprisingly, the leading factor is the need to “improve return on invested capital.” Since inventory balances must be offset by debt or equity on a company’s balance sheet, lowering inventory reduces invested capital and improves the return on capital assuming that revenues are not impacted

Source: Aberdeen Group, May 2009


Reduced inventory also frees up working capital for other capital projects or investments

15

A Growing Focus on Inventory Optimization (Cont’d) MROA Growing Focus on Inventory Optimization (Cont d)Where Should Management Attention be Focused?

The distribution of FERC 154 inventory by business unit is displayed in the figure below These results are for 256 utilityThe distribution of FERC 154 inventory by business unit is displayed in the figure below. These results are for 256 utility warehouses and were collected by ScottMadden in 2007. The distribution is believed to be largely the same today

As shown in the figure, Nuclear Generation holds the greatest dollar value of inventory. The next largest value is for T&D

Bottom line: If you want to reduce inventory values a focus on Nuclear Generation and T&D is a good place to start. As Willie Barton once said when asked why he robbed banks, “Because that’s where the money is”

Inventory Distribution by Business Unit

8%5%

0%19%

Fossil Generation

Gas Turbine GenerationHydro Generation

Nuclear Generation

67%T&D

Source: ScottMadden 2007 Utility Materials Management Benchmarking Report


Inventory Performance ManagementPERFORMANCE

Inventory Performance ManagementPerformance Metrics Studied

This year’s survey identified seven different metrics commonly used to assess the performance of a company’s inventoryThis year s survey identified seven different metrics commonly used to assess the performance of a company s inventory management process. These metrics and their definitions are presented in the figure below

Two of these metrics measure process efficiency, while the remaining five measure process effectiveness

Inventory Management Performance MeasuresInventory Efficiency y g

Type Metric Name DefinitionEfficiency Inventory Turns Ratio Cost of goods sold / average inventory value

Efficiency Days Inventory 365 / inventory turns ratio

Inventory efficiency measures the ability of the organization to meet its needs with as little inventory as possible

⎯ The Inventory Turns Ratio measures h ti i t i Efficiency Days Inventory 365 / inventory turns ratio

Effectiveness Line Fill Rate # of lines filled complete by date requested / # of lines requested

Effectiveness Order Fill Rate # of orders filled complete by date requested / # of total orders requested

Effectiveness Line Stockout Rate # of lines incomplete by date requested / #

how many times inventory is replenished in a given period

⎯ The Days Inventory measures the number of days of inventory issues that can be made with the inventory

Effectiveness Line Stockout Rate # of lines incomplete by date requested / # of total lines requested

Effectiveness Average StockoutDuration

Average # of days beyond request date to fulfill a line

Effectiveness Perfect Order Rate Order entry accuracy % * warehouse picking accuracy % * on-time delivery % * % of

on hand

Inventory Effectiveness

Inventory effectiveness measures how well the company meets the needs of its


accuracy % on time delivery % % of orders shipped without error/damage

the company meets the needs of its customers in terms of having the right items, in the right quantities, at the right time, and with no defects

Several effectiveness measures are l d ith diff t d f


commonly used with different degrees of compliance difficulty

17

Inventory Performance Management (Cont’d)PERFORMANCE

Inventory Performance Management (Cont d)Q: Which performance metrics do you use?

The figure below indicates which of the inventory performance measures are used by the responding utilitiesThe figure below indicates which of the inventory performance measures are used by the responding utilities

Inventory Turns Ratio and Line Fill Rate are the most commonly used metrics

There appears to be more of a tendency to assess process efficiency than to assess process effectiveness

S i i l thi d f d t l i t t f t i t i t t fSurprisingly, a third of respondents claim not to use any performance metrics to assess inventory management performance

Inventory Management Performance Measures Used

Inventory Turns Ratio

Line Fill Rate

Days Inventory

63%

37%

30%Days Inventory

Order Fill Rate

Line Stockout Rate

Average Stockout Duration

28%

22%

13%

= Efficiency Measure

= Effectiveness Measure

0% 10% 20% 30% 40% 50% 60% 70%


Perfect Order Rate 9%

Percent of Respondents Using Metric

Effectiveness Measure



18


Inventory Performance Management (Cont d)Inventory Turns Ratio (cost of goods sold / average annual inventory value)

Use of Computerized Inventory Software

Inventory Turns vary from a low of .09 for Hydro Generation to a high of 2.23 for T&D

Inventory Turns at non-utility companies typically average between 4.0 to 12.0 times

Inventory Turns within utilities are typically much slower since the inventory is not being processed for sale but rather represents inventory for maintenance and repairs operations (MRO inventory)

Inventory Management Software Used

Source: ScottMadden 2007 Utility Materials Management Benchmarking Report

Days Inventory (365 / inventory turns ratio)

Days Inventory is another way of measuring inventory throughput. It represents how many days of inventory is on hand based upon average issue volumes

T&D operations keep an average of 5.5 months of material on hand

Generation operations keep from 29 to 33 months of material on hand. This number is influenced by the

l f iti l i t i d


volume of critical spares maintainedSource: ScottMadden 2007 Utility Materials Management Benchmarking Report

19


Inventory Performance Management (Cont d)Line Fill Rate (# of lines filled complete by date requested / # of lines requested)

Line Fill Rate

Median byBusiness Unit Median byType of Company

Line Fill Rate is an effectiveness measure that indicates how well a company is doing at issuing the individual items found on a material request order

Median by Business Unit Median by Type of Company

Overall 96%

96%

T & D

Oth

97%

78%This is the most commonly used effectiveness measure among respondents

T&D business units perform better on this measure than other business units

Line Fill Rate Line Fill Rate0% 50% 100%

Investor Owned Utility96%

0% 50% 100%

Other 78%

Source: ScottMadden 2009 UMMBC Survey

Order Fill Rate (# of orders filled complete by date requested / # of total orders requested)

Order Fill Rate


A similar effectiveness measure is Order Fill Rate which reflects the percent of complete orders filled instead of the number of lines filled. Higher Order Fill Rates are more difficult to achieve than higher Line Fill Rates


Overall 88%T & D 93%

to achieve than higher Line Fill Rates

The survey results indicate that this measure is used less frequently than Line Fill Rate

Medians for this metric by business unit and t f d t h h i ti

Order Fill Rate Order Fill Rate0% 50% 100%

Investor Owned Utility 90%

0% 50% 100%

Other 90%


type of company do not show much variation Source: ScottMadden, 2009 UMMBC Survey

20


Inventory Performance Management (Cont d)Line Stockout Rate (# of lines incomplete by date requested / # of total lines requested)

Line Stockout Rate

Median byBusiness Unit Median byType of Company

Line Stockout Rates indicate how effective the materials management group is in meeting their customer expectations

T&D reports a stockout rate averaging 4%


Overall 4%

4%

Generation

T & D

12%

4%

Generation reports higher stockout rates averaging 12%

There is no difference between type of company Source: ScottMadden, 2009 UMMBC Survey

Line Stockout Rate Line Stockout Rate0% 5% 10%

Investor Owned Utility 4%

0% 5% 10%

T & D

company

Average Stockout Duration (average # of days beyond request date to fulfill a line)

Line Stockout Duration

Average Stockout Duration measures the duration of time beyond the material request date that it takes the materials management team to fulfill a line that was requested but not available when needed

Median by Type of Company

Overall 3T & D 3

Median by Business Unit

available when needed

This metric is only used by 13% of the companies responding

Again, T&D reports better fulfillment results th th b i it

Average Stockout Duration0 5 10

Investor Owned Utility3

0 5 10

Other 9



than other business units Source: ScottMadden, 2009 UMMBC Survey

21


Inventory Performance Management (Cont d)Perfect Order Rate (order entry accuracy % * warehouse picking accuracy % * on-time delivery % * % of orders shipped without error/damage)

Perfect Order Rate is the most comprehensive measure of inventory management effectiveness. It measures the percentage of orders that are considered “perfect.” A perfect order typically must meet all of the following criteria:

⎯ Accuracy of order (no errors)

⎯ Accuracy of pick (no errors) Perfect Order Rate

⎯ Timeliness of availability (by need date)

⎯ Quality of items (meet all specifications)

Only 9% of the respondents report using this metric T & D 96%

Overall 82%

Median by Type of CompanyMedian by Business Unit

metric

T&D business units report achieving a 96% Perfect Order Rate

Other business units report a lower achievement score of 49%

0% 50% 100%

Other 49%

0% 50% 100%

Investor Owned Utility

Transmission Company

68%

95%


achievement score of 49%

Transmission companies report better performance on this measure than do other types of business units

Perfect Order Rate Perfect Order Rate


Inventory Optimization PracticesInventory Optimization PracticesThis next section of the report focuses on the use of specific inventory management practices within the utility industry. The questions were divided into three categories. The subjects examined under each category are shown below

People & Organization

— Responsibility for inventory management

— Involvement of customer groups

Organizational level at which inventory is optimized

PEOPLE

— Organizational level at which inventory is optimized

Policy & Process

— Use of ABC category segregation

— Frequency at which ABC categories are refreshed PROCESS— Methods used to assign stocking level criteria

— Frequency at which stocking levels criteria are refreshed

— Methods used to determine safety stock levels

— Methods used to determine lead times

— Treatment of “critical spares” and their estimated impact

Tools & Technology

— Use of computerized inventory management software and which vendorsTECHNOLOGY

— Integration of work control software with inventory management software

— Level at which inventory is visible across the organization


Inventory Optimization Practices (Cont’d)PEOPLE

Inventory Optimization Practices (Cont d)Q: Who is responsible for inventory optimization at your company?

Parties Responsible for Inventory Optimization

Most respondents indicated that a dedicated individual or group located at the corporate or business unit level is responsible for inventory optimization

Only 16% of the respondents still manage inventory

a) Dedicated individual / group at corporate level

b) Dedicated individual / group at business unit level

33%

42%

levels at the warehouse level

0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

c) Dedicated individual / group at warehouse level

d) Other

16%

9%

Q: Do your inventory customers (e.g., system owners, maintenance/operations personnel, etc.) have a role in determining the following? (Check all that apply)


Internal Customer Roles in Determining Inventory Levels

determining the following? (Check all that apply)

76% of respondents indicated that customers have a role in determining inventory levels

The most common roles for customers are in d t i i j t d f t b SKU d i

Projected future usage by SKU

Service levels by SKU (e.g., Cat ID, Catelog Item, etc.)

No involvement

67%

57%

24%determining projected future usages by SKU and service levels by SKU

24% of the respondents indicated that their customers have “no involvement” in any of the activities listed

0% 10% 20% 30% 40% 50% 60% 70%

Supplier lead times

Other

4%

4%


0% 10% 20% 30% 40% 50% 60% 70%


24

Inventory Optimization Practices (Cont’d)PEOPLE

Inventory Optimization Practices (Cont d)Q: At what organizational level is inventory optimized?

Inventory management theory holds that the higher the

Levels at Which Inventory is Optimized

Inventory management theory holds that the higher the organizational level at which inventory is optimized, the lower the inventory levels required to achieve a given level of service

The survey results indicate that the most common level

a) Within one warehouse

b) Across multiple warehouses within one business unit

c) Across one operating company

20%

35%

13%for this responsibility within electric and gas utilities is within a single business unit, (e.g., fossil generation, etc.)

The next most common response was to optimize inventory at the operating company level


d) Across multiple operating companies

e) Other

28%

4%

inventory at the operating company level

In comparing performance based on the level of inventory optimization, we found that the higher the organizational level, the better the performance

0% 10% 20% 30% 40%



Inventory Optimization Practices (Cont’d)PROCESS

Inventory Optimization Practices (Cont d)Q: When setting inventory reorder points for specific CAT IDs (SKUs), which of the following factors do you take into consideration? (Check all that apply). Rank your responses in order of priority of importance to you

The responses to this question were tabulated and are presented in order of frequency cited in the table below

— The percentages shown after each factor show the percentage of companies using that factor

— The “priority” indicates how important the factor is in determining inventory levels

Usage history and supplier lead times are used by all of the respondents and are considered the top two in importance

Service level requirements (e.g., acceptable stock-out rates) are used by 92% of the respondents but ranked fifth in importance

Market supply and demand relationship were considered the least important factors in setting reorder points

Factors Considered in Setting Inventory Levels PriorityUsage history (100%) 1Supplier lead times (100%) 2Forecasts of future usage (75%) 3Supplier ability to supply as agreed (67%) 4Internal customer service level requirements (92%) 5Personal judgment of inventory analysts (83%) 6General min/max settings (92%) 7Domestic supply and demand relationships (50%) 8Global supply and demand relationships (25%) 9

Source: ScottMadden, 2009 UPMG Utility Survey


, y y

26


Inventory Optimization Practices (Cont d)Q: Which of the following lead time calculations are utilized?

Inventory optimization theory calls for the consideration of “total lead time” which is comprised of both “internal lead time” (timeInventory optimization theory calls for the consideration of total lead time which is comprised of both internal lead time (time from material request to purchase order) and “external lead time” (time from purchase order to material receipt)

The survey results indicate that only 18% of the respondents take both lead times into consideration when setting reorder points

The majority of respondents (65%) consider external lead times alone

4% of the respondents do not take either lead time into consideration

Lead Time Calculation Used to Set Reorder Points

2%

4%11% Internal Lead Time

External Lead Time

65%

18%External Lead Time

Both

None of the above65%

Other




Inventory Optimization Practices (Cont d)Q: Is inventory segregated on an "ABC" basis (i.e. based on frequency of usage) with each category

d diff tl ?

Percentage of Companies Using ABC Segregation

managed differently?

A common practice in managing inventory is to segregate the inventory into categories – typically A,B, and C. This can be done to facilitate physical counting and reporting (segregation by financial impact) or for

35%

a) Yesa) Yes

b) Nop g ( g g y p )

making inventory stocking decisions (segregation by usage pattern)

Surprisingly, only 65% of the respondents indicate they divide inventory into different categories based on usage l l

65%b) No

level

Q: If yes, how often is inventory reassessed and new ABC values applied?


70%68%

Frequency at Which ABC Values Are Reassessed

The frequency at which ABC levels are recalculated depends upon the degree of change in either their value or their usage patterns. Many retail distribution companies recalculate on a monthly or continuous basis

The majority of the utility companies responding report20%30%40%50%60%

18%

7%4%4%The majority of the utility companies responding report that they reassess and apply new ABC values on an annual basis

Neither the use of ABC segregation or the frequency of reassessing their values were correlated with inventory

0%10%

7%4%4%


g yperformance based upon available survey data


28


Inventory Optimization Practices (Cont d)Q: How do you assign inventory stocking level criteria (e.g., safety stock, reorder point, estimated lead time d d i d titi t )?

Percentage of Companies Using ABC Segregation

demand, economic order quantities, etc.)?

Stocking level criteria are the variables used to determine inventory levels. These criteria are designed into all inventory optimization software but may also be used manually to estimate required inventory levels

a) Manual calculations

b) System-generated / automated calculations

24%

0%

74%y q y

Survey results indicate that utilities are using a mix of system-based calculations and employee judgment to set inventory levels. The survey results also indicate that this approach yields the best performance results. U i l l l ti l i ld d th t

0% 20% 40% 60% 80%

c) A mix of both a) and b)

e) Other

74%

2%

Using manual calculations alone yielded the poorest performance results

None of the respondents rely on their inventory management software alone to set inventory levels


Frequency at Which Stocking Level Criteria are Reassessed

Q: How frequently are inventory stocking level criteria reassessed?

The frequency at which stocking level criteria are reassessed varied considerably between respondents

a) Every time a purchase is made

b) Once a quarter

18%

13%

The most common practice is to do this once each year

The survey results indicate that those who reassess more frequently (by transaction or quarterly) have better inventory optimization performance with respect to both

0% 10% 20% 30% 40% 50%

c) Once a year

d) Other

27%

42%As needed 13%

Varies 18%

Other response 11%


efficiency and effectiveness Source: ScottMadden, 2009 UMMBC Survey

0% 10% 20% 30% 40% 50%

29


Inventory Optimization Practices (Cont d)Q: How are safety stock levels determined?

The volume of required safety stock is a key factor influencing overall inventory levels It is determined by the customer’sThe volume of required safety stock is a key factor influencing overall inventory levels. It is determined by the customer stolerance for risk as well as the probability that things could go wrong. A customer’s tolerance for risk is measured by their desired “service level” which is the inverse of the “stock out rate” they can tolerate. The probability that things can go wrong is typically measured by the average demand forecast error rate

The figure below indicates how the responding utilities determine their internal levels of safety stock

The approach which yielded the best performance results was “statistical calculation based upon demand forecast, forecast error rates, and desired service level.” However, this approach is only used by 15% of the responding utilities

The approach correlated with the worst performance results was to allow “system owners or maintenance/operations personnel to assign based upon judgment and experience 24% of the respondents use this approachto assign based upon judgment and experience. 24% of the respondents use this approach

Methods Used to Determine Safety Stock Levels

11%

Statistical calculation based on demand forecast, forecast error rates and desired service level

15%

24%

28%

11%

System owners or maintenance/ operations personnel assign based on judgement and experience

Supply chain/materials management assigns based on judgement and experience

22%

j g p

Various Combination

Other



30


Inventory Optimization Practices (Cont d)Q: Are critical spares designated in your inventory management system and not considered for optimization?

Percentage of Respondents Designating Critical Spares

9%optimization?

Critical spares are systems or components which are held in reserve in the event they are needed as emergency replacements. There is at this time no common industry definition for this classification

27%

9%

a) Yesb) Noc) Othery

Since critical spares are held for strategic reasons and may never be used, they should not be considered during routine inventory optimization calculations

The results show 64% of the respondents designate

64%

The results show 64% of the respondents designate critical spares and back these out of their inventory optimization calculations

Q: If yes, what percentage of inventory dollar value do critical spares represent?


% Of Inventory Value Represented by Critical Spares

Critical spares can have a huge impact on total inventory value

Survey results indicate that critical spares represent more than a third of the value of on-hand inventory for 0 1

0.15

0.2

0.25

0.3

0.35

25% 25% 25% 25%23%

31%

15%

23%

30% 30%

10%

20%

10%

Generation

T & D

Othermore than a third of the value of on hand inventory for generation business units

Critical spares represent more than 10% of inventory values for most T&D business units

S i i l i f tiliti d t id tif iti l

0

0.05

0.18%

Other


Surprisingly, one in four utilities do not identify critical spares and do not know their dollar value Source: ScottMadden, 2009 UMMBC Survey

31

Inventory Optimization Practices (Cont’d)TECHNOLOGY

Inventory Optimization Practices (Cont d)Q: Do you utilize a computerized inventory management system?


2%

Nearly all (98%) of the respondents indicated their company uses a computerized inventory management system of some sort

In our experience, we have found that there is a great a) Yes

deal of variation between the capabilities of these systems. Some are simply inventory accounting and tracking software while others are full-featured inventory optimization software

98%

b) No

Q: If yes, what is the name and version of the system in use?



Only 5% of the respondents utilize home-grown inventory management software. 95% utilize applications provided by third parties

SAP and Indus Passport were the most frequently

Other

SAP

Indus Passport

33%

23%

15%

13%SAP and Indus Passport were the most frequently named suppliers from the list provided

A variety of other software solutions were named and are classified under the “Other” category

0% 5% 10% 15% 20% 25% 30% 35%

Oracle

PeopleSoft

In House

13%

13%

5%



0% 5% 10% 15% 20% 25% 30% 35%

32

Inventory Optimization Practices (Cont’d)TECHNOLOGY

Inventory Optimization Practices (Cont d)Q: Is your inventory management system integrated with your work order/asset management system?


9%

67% of respondents indicated some level of integration between their inventory management systems and their work order/asset management systems

No difference in inventory performance was noted

24%

9%

a) Yes

b) No

between those whose systems are integrated and those whose systems are not. The problem may lie in the definition of “integrated” 67%

c) Other

Q: How is inventory visible to users?

One of today’s leading practices is to increase the



“visibility of inventory,” allowing companies to view and act on inventory across a wider universe of warehouses

Our survey results indicate that one out of four utilities are able to view inventory on a warehouse-by-warehouse basis only

a) Warehouse by warehouse

b) Across all warehouses within one business unit

24%

15% Best

Worst

warehouse basis only

These companies scored worst in terms of inventory performance. Those who can view inventory across all warehouses in a business unit scored best in performance 0% 5% 10% 15% 20% 25% 30% 35%


d) Across multiple operating companies

28%

33%

Better

Better



33

Practice Impact on PerformancePractice Impact on PerformanceThe structure of this year’s survey allows us to examine the impact of inventory optimization practices on inventory management performance

To assess performance, we used one measure of efficiency and one measure of effectiveness

— For efficiency, we used Days Inventory3

— For effectiveness, we used Line Fill Rate

The relatively low percentage of companies that reported using Line Fill Rate (37%) reduced the number of responses that could be used for comparison. As a result, we were able to identify only the strongest relationships between practices and performance. We suspect that a larger survey would have identified additional relationships

The table on the right shows all of the practices

Impact of Inventory Management Practices on Inventory Efficiency and Effectiveness

Impact on Efficiency

Impact on Effectiveness

People & OrganizationThe table on the right shows all of the practicesexamined and their impact on both efficiency andeffectiveness

— Only five practices were clearlycorrelated with both improved efficiency and effectiveness

⎯ Who has responsibility for inventory management

⎯ The involvement of customer groups

⎯ The organizational level at which inventory is optimized

Policy & Process

⎯ Use of ABC category segregationefficiency and effectiveness

— For the remaining practices, there were either insufficient responses in a category to allow for comparisons or the differences in performance were negligible or inconsistent

⎯ Use of ABC category segregation

⎯ The frequency at which ABC categories are refreshed

⎯ The methods used to assign stocking level criteria

⎯ The frequency at which stocking levels criteria are refreshed

⎯ The methods used to determine safety stock levels

were negligible or inconsistent ⎯ The methods used to determine lead times

⎯ The treatment of “critical spares” and their estimated impact

Tools & Technology

⎯ The use of computerized inventory management software and which vendors

⎯ The integration of work control software with inventory management software


3Calculated using Inventory Turnover data when not provided directly

⎯ The level at which inventory is visible across the organization

Survey InsightsSurvey InsightsInsights from This Year’s Survey

Both market and financial environments for electric and gas utilities have turned upside down but utility inventory levels keepBoth market and financial environments for electric and gas utilities have turned upside down, but utility inventory levels keepmarching upward

The factors driving inventory growth appear to be winning over those that are focused on inventory control or reduction

The practice of performance measurement in support of inventory optimization within our industry is rudimentary. We won’t begin seriously improving until we begin seriously measuring our performance

The application of leading inventory management practices within the utility industry is mixed. A few utilities apply leading edge practices. The majority are lagging behind

The practices that are associated with improved efficiency and effectiveness include:p p y

— Optimizing inventory at a company-wide or higher level

— Setting stocking levels through a mix of inventory optimization software and judgment

— Reassessment and updating of stocking level criteria on a more frequent basis (transaction by transaction or quarterly)q y)

— Setting safety stock levels using statistical calculations based upon demand forecast, forecast error rates, and desired service level

— Establishing inventory visibility at a company-wide or higher level


ContactsContactsIf you have any questions regarding this survey, would like to learn more about the UMMBC, or would like to become a member please contact:

John H. Sequeira, Ph.D.Partner, Supply Chain PracticeScottMadden, Inc.2626 Glenwood Avenue, Suite 480Raleigh, NC 27608

Office Phone: 919-781-4191Mobile Phone: 704-560-5061Email: [email protected]

About the UMMBC

The UMMBC is a group of leading utilities who are collaborating to develop the information needed to critically examine and improve ongoing warehouse and inventory management operations in the electric and gas utility industry. The consortium is open to all utilities. There is no cost to join and most surveys are conducted and provided to participants at no cost. P i di ll S M dd ill h i l f f d i d i d d lPeriodically, ScottMadden will charge a nominal fee for report production to recover production and development costs


Appendix A: UMMBC Survey Questions Appendix A: UMMBC Survey Questions


Appendix A: UMMBC Survey Questions (Cont’d)Appendix A: UMMBC Survey Questions (Cont d)


Appendix B: UPMG Utility Survey QuestionsAppendix B: UPMG Utility Survey Questions1. When setting inventory reorder points for specific CAT IDs (SKUs) which of the following factors do you take into

consideration? (Check all that apply)

a) Usage history

b) Forecasts of future usage

c) Current min/max settings

d) Vendor lead times (time from order to receipt)) ( p )

e) Vendor ability to supply as agreed to (e.g., financial stability, production capability, etc.)

f) Internal customer service level requirements (e.g., stock-out tolerance)

g) Supply and demand relationships related to domestic producers

h) Supply and demand relationships related to global producersh) Supply and demand relationships related to global producers

i) System automatically resets reorder points

j) Personal judgment of inventory analyst(s)

k) Other (please specify)

2. Rank all of the above responses in order of priority (1 = Most Important; 2 – Next in Importance, etc.).

a) Assign each number only once

3. What are the top five materials (e.g., commodities, equipment, components, etc.) that you purchase that you believe are influenced the most by global demand and supply relationships?y g pp y p

a) Please provide examples


Appendix B: UPMG Utility Survey Questions (Cont’d)Appendix B: UPMG Utility Survey Questions (Cont d)4. To what degree has global demand versus supply for these items affected your decisions regarding internal inventory levels for

these items?

a) No influence at all

b) Little meaningful influence

c) Significant influence on inventory levels

d) The determining influence on inventory levels) g y

5. What lessons regarding global demand versus supply have you learned?

a) List as many as you wish


Appendix C: UPMG Utility Supplier Survey QuestionsAppendix C: UPMG Utility Supplier Survey Questions1. To what degree have global supply and demand fluctuations affected your production with respect to products you sell to

electric and gas utilities?

a) No influence at all

b) Little meaningful influence

c) Significant influence

d) The primary, determining factor) p y g

2. Have global supply and demand fluctuations affected the volume of raw materials inventory you maintain on hand?

a) If so, how?

3. Have global supply and demand fluctuations affected the volume of finished goods inventory you maintain on hand?

a) If so, how?

4. Have global supply and demand fluctuations affected your supply lead times to electric and gas utilities?

a) If so, how?

5. What advice would you give to electric and gas utilities with respect to global supply and demand fluctuations?

a) List as many as you wish


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