Of all the areas that can be improved to gain long-term profitability, concentrating on reducing slow-moving items and effectively eliminating dead items will produce the greatest results.
One of the key functions of the parts department is to carry inventory. But an equally important function is to satisfy customer demand and create sales.
To do that, the parts department need the correct parts in stock — most of the time — and unrestricted access to additional inventory as needed.
Few people will argue that the business of parts is capital intensive, and as with any capital intensive business, investment control is an essential ingredient of success. Moreover, reducing inventory, even a little, can boost profits and cash flow.
Let's face it, the prospect of freed up working capital can be a powerful persuader. Therefore, one plausible option — whether knee-jerk or pondered — might be to drastically reduce the inventory or cap the spending on inventory.
Should this happen, the value and role of the parts department could well be reduced. Not only will it compromise the ability to meet customer demand and increase sales in the short term, but it can undermine the ability of the parts department to compete in the long term.
Why? The 80/20 rule known as “Pareto's Principle” named after the nineteenth century economist Vilfredo Pareto applies. Twenty percent of the parts in inventory account for 80% of the parts sales and parts department revenues, and 80% of inventory account for 20% of sales. Restrictions on inventory — if not carefully planned — will surely affect this productive 20%.
Preferable to a willy-nilly attempt at controlling inventory investment, which puts sales and ultimately profits in jeopardy, is an integrated approach that links inventory to the selling function.
When inventory is right, customers buy, employees remain productive, cash flows, and the parts business grows. Consequently, consideration must be given to how well the parts inventory fulfills three critical related services provided to customers:
Level of service — Having what the customer wants
Availability — Having it when the customer wants it
Product range — Filling the customer's total needs
Counter to taking a conservative and restrictive attitude to inventory investment, one may conclude that a reasonable approach for supporting these services, and increasing sales, is to increase the present inventory. It could give rise to the notion that more inventory would mean more business, thus increasing cash flow. While this idea is rooted in fact, it can be a problem if inventory planning becomes driven by the conviction that, “If more sales and more satisfied customers are desired, more inventory is needed.”
The economics of inventory and sales would seem to indicate that the most profitable strategy is to carry every part customers might ever want and carry large quantities.
But a larger inventory requires greater cash flow. Hence, the operating reality is that the cash flow spiral eventually gets in the way. A shortage of cash leads to a shortage of inventory which leads to lost sales, resulting in less profits, further contributing to the shortage of cash.
It would be gratifying to provide every part from your inventory.
Unfortunately, you cannot have everything to fill every need. It is not economically feasible nor profitable. A more practical method is an integrated management strategy that will attain an inventory level consistent with customer service, sales, and profit goals. Such a strategy will allow the parts department to meet existing demands and generate additional sales without adding the burden of excessive inventory.
To implement an integrated strategy dealers and parts managers alike should rethink how they view inventory. For some, this may be difficult. Rethinking requires that management moves away from “the way it's always been done.”
There are three elements to an integrated strategy which I adapted from my second book, “Beyond the Numbers: Managing the Assets of an Automobile Parts Business.” They are:
- Total planning
- Incremental gains
- Modification of inventory profile
Separating inventory planning from sales planning can be disastrous.
Yet, this is a common practice in many parts departments. Often, a sales increase is planned without considering the implications to inventory. I'm not referring to the sale of any specific item or items. Not that planning isn't important to such an event. What I am referring to involves the bigger picture — the parts department as a whole. Rarely, if ever are goals established for inventory control devices such as turnover, level of service, and fill rate when planning sales. Yet, sales correspond directly to these inventory measurement mechanisms.
Parts departments may look for a sales increase without thought to inventory and performance levels, only to fall flat on their faces because turns may have increased but the level of service decreased dramatically.
The reason is found in how inventory management is viewed. When it is seen strictly as a function of controlling the inventory, it generally is not involved in the sales planning. Therein lies the flaw. Inventory management relates directly to sales performance and, therefore, must be included.
One may then logically conclude that when planning sales, to achieve a 20% increase, the inventory value must also increase by 20%. If not, how can the additional sales be sustained? This is not necessarily true. Sales gains can be made without proportionately increasing inventory value. However, such sales gains can be accomplished only with a total inventory and sales planning process — a process that includes inventory planning in the sales planning and vice versa.
If, for example, a 25% increase in wholesale sales is planned, the parts manager may perceive a deficiency in inventory. The present level of stock may not support such an aggressive sales move. The options considered may be to simply increase the inventory as needed, guaranteeing sufficient stock to meet anticipated sales demand. This can strain cash flow.
One option is to increase the inventory slowly. This would not be so burdensome. However, if sales rapidly outpace any planned inventory expansion acquisition costs may increase or lost customers might ensue.
A third option could offer the best of both worlds. The parts manager continuously examines the entire inventory, looking for ways to decrease existing levels by paying particular attention to excess stock, slow movers, and obsolescence. In doing so, the freed up capital could offset any additional investment in inventory, whether immediate or otherwise. This is one way that a substantial sales increase can be considered while leaving inventory dollars fairly constant, thus, averting potential cash flow problems.
During the planning process the tendency may arise to move ahead too quickly. Avoid this. For example, knowing that inventory turnover helps cash flow, the assumption generally follows that high turnover will significantly increase cash flow. Consistent with this rationale, a decision might be made to drastically cut back on days' supply. On the surface, it may seem that the action barely affects customer service; but an increase in order activity, creating an increase in acquisition costs, may go unnoticed.
The key here, whenever possible, is a plan that includes small changes instead of radical ones. Parts departments and the dealerships would be better served with a plan that holds total inventory costs at a constant level or that has a minimal increase for a predetermined period — assuming no sharp rise in sales during that time. Service level would not be jeopardized, and incremental increases in sales could be accommodated.
Modification of inventory profile
As mentioned, the 80/20 marketing rule — where 20% of the stocked inventory accounts for 80% of the revenues, and 80% of the stocked inventory accounts for 20% of the revenues — should shape the typical inventory profile for the parts department. The 20% comprises the fast-moving items. The 80% comprises slow-movers.
Modification of this profile mandates an obsessive approach to inventory control and management. This includes keeping obsolescence within acceptable limits and concentrating on reducing excess stock, particularly among the slow-moving but still active 80% of the inventory. This is not only an element of integrated strategy, it's also a function of the total planning illustrated earlier.
Modifying the inventory profile allows the parts manager to support sales increases and keep customer satisfaction high, while also holding the inventory costs somewhat constant. Of all the areas that can be improved to gain long-term profitability, concentrating on reducing slow-moving items and effectively eliminating dead items will produce the greatest results.
If dealerships are to reap long term success from their parts departments, parts managers must remain cognizant of three important issues.
First, availability is still important to customer service. Second, parts sales and inventory management are related functions. Third, to minimize inventory investment, and improve both sales and cash flow, an integrated strategy is needed.
Gary Naples provides parts consulting services and training for dealerships and manufacturers. Based in Wilkes-Barre, PA, he's written two books on parts management published by the Society of Automotive Engineers.