Originally published: 07.01.08 by Robert Wilkos
Peaden Air Conditioning practices lean inventory management for stellar results —you can too.
With decades of industry experience, I’ve run the gamut on stocking inventories with different types of hvac companies. Although special circumstances may require a large stocking inventory, I’ve never been a fan of such for an hvac service/retrofit business.
Why? No matter what we stocked with good reason, something different was needed. In addition, often those stocking decisions eventually were followed by somewhat dormant stock where dust increases were measurablefrom one periodic inventory check to the next.
Other issues relative to inventory were also troublesome—damaged goods, pilferage/theft, temporarily missing in action and the labor required to perform the monthly inventory check during high-volume months. In addition to these factors, mix in consignment orders; pre-season orders; bulk purchases for cost-saving measures; and stocking of rarely sought, but hard-to-find-when-you-need-it parts or products and inventory control can soon become a misnomer despite having acceptable inventory processes and procedures in place.
Back in the mid- to late-’90s at Peaden, we handled inventory as many others still do. We were a service/replacement company with annual revenues around $2 million and we stocked an assortment of parts, supplies and equipment and systems, but our control was somewhat haphazard. The hvac equipment and systems were stored openly while the parts were caged under lock and key. If someone left with the key and you needed a part, you had to wait until the person with the key returned.
We managed as best we could under these circumstances and thought we did a decent job at inventory management so there was no reason or push to change. There was never any conversation about the number of inventory turns or the associated cash savings of operating with less warehouse space and inventory.
Demand Flow For A Service/Retrofit Contracting Business?
During this same period, we visited several Nordyne manufacturing plants seeking information prior to entering into a private-label partnership with Nordyne and Remsco, a local independent distributor. While touring Nordyne’s facilities, something caught my eye. There didn’t seem to be an abundance of raw materials in stock and I learned that they operated with lean inventory levels based on demand-flow technology. They relied significantly on their vendors to provide them what they needed, when they needed it and at a fair price…with minimal interruptions! This made sense from a manufacturing perspective because they had the luxury of time to plan what they needed to produce weeks, if not months, in advance. Equally impressive were Nordyne’s quality processes that we later modified and applied to our service/retrofit business to create enthusiastic Peaden fans.
At the same time, Trane built a manufacturing plant in our backyard, which we frequently toured because we were a Trane dealer. Their plant, located in Lynn Haven, Fla., is a well-run manufacturing facility and one of the cleanest you will ever visit. They, too, carried minimal inventory. However, in Trane’s scenario, vendors set up satellite branches outside Trane’s back door. To create a simple visualization, let’s say Trane’s production line was running low on screws. Trane’s production supervisor would call out the back door to the guy at the screw company and tell him he needed more screws. Within short order, the screws would arrive and Trane’s production line kept humming along. Granted this is a very simple analogy, but not too far from reality.
This inventory-management concept became more intriguing and we began to investigate the possibility of arranging something similar at a contractor/distributor level. If manufacturers could manage inventory in this manner, maybe we could too. After all, isn’t the primary role of a distributor to distribute?
Peaden is a sizeable contractor for our region and every distributor and sales rep within hundreds of miles has approached us to inquire how they could earn more of our business. They would soon get the opportunity.
We mapped out all the wholesale businesses in the region. There were seven within a 10-mile radius plus another dozen or two within 100 miles. We met individually with our key local distributors to discuss our thoughts and exchange ideas. These contractor-distributor relationships would be vital to lowering our inventory totals, increasing our inventory turns, establishing timely delivery and maintaining our stocked level of products and goods necessary to feed a busy and growing service/retrofit business. If these key distributors would slightly modify their inventory to warehouse what we normally use and deliver orders when we needed them, we would purchase from them exclusively — definitely a plus for them. Without question, we would need to modify our purchasing and stocking habits, but we would reap the bottom-line benefits for years to come.
As a cohesive management team, we have worked together to address numerous issues for almost 15 years and, regarding this subject, we were willing to make changes. With the vendors mapped, we made a list of potential issues including, but certainly not limited to: timely deliveries from distributors; after-hours and weekend parts and supply needs; emergency needs from major hurricane damage; unapplied labor; tech time in parts houses; min/max inventory levels; emergency orders; re-stocking; non-stocking items, back orders; price increases; rent expense for more space/more inventory versus managing with less space/less inventory; monthly inventory checks; truck stock; customer satisfaction; timely job completions; and the list goes on.
In 1998, we committed to take a unique approach to hvac inventory. We outgrew our office and warehouse space (3,500 square feet) years before and eagerly sought a new location and a building with more room. We purchased land and drafted the design for our new offices and warehouse with a total of 7,000 square feet (4,000 square feet for office). Since rent is a constant overhead expense, we decided to implement this lean inventory concept and save on the additional space expense for many years to follow. Our new warehouse space of 3,000 square feet was double what we were leaving, but was designed to be used in a much different manner. It would house the usual items and stock—duct machine, worktables and benches, pallets of refrigerant, service parts, maintenance supplies, installation materials, copper tubing, filters and files, etc., but no havc equipment or systems would be stocked. As sensible as it now seems, it could’ve been our worst nightmare. Ten years later, this process works like a Swiss watch.
Here’s a common example that occurs at Peaden on a daily basis — a high SEER system is sold today and the installation is scheduled for next Tuesday. The day prior to the installation the system is ordered for delivery on that same day. The install crew arrives at our office the next morning, picks up their job orders and away they go. This system is never entered into inventory because it’s been specifically ordered for a certain job. In some cases, the system isn’t in our warehouse
for more than an hour before the equipment is on its way to its new and final home. In the event a problem occurs, such as a dented/scratched unit or one piece of the system is not available, we still have time to fix the issue (same or other vendor) and meet the job schedule as planned. With no equipment in stock, our entire inventory is comprised of products, materials and supplies that will be turned over within weeks if not days. Our key vendors play a significant role with regard to re-stocking because we only maintain about three days worth of fast-moving items. If we should run out, we would be dead in the water.
Since we moved into our present facility in October 1999, we have grown our revenues from approximately $2.8 million to $7 million without ever stocking one single unit or system. Our monthly inventory total has risen from approximately $50,000 to $100,000, but this gain relates directly to the increase of truck stock as our number of fleet vehicles increased to parallel our increasing work load and revenues.
Due to our highly visible and convenient location, we have a multitude of walk-in customers. Some consumers are attracted by our advertising and the rest are existing ones. They enter the building into our showroom with many systems on display and, to this day, they do not realize that every new hvac system is custom ordered.
We have benefited in many ways — reduced inventory levels; reduced rent expense; less damaged goods; less pilferage/ theft; better (and easier) inventory control; less labor to perform monthly inventory checks; real cash savings; high inventory turns and great relationships with vendors. Several distributor reps have been involved with this process so long that they know more about the internal thinking and workings of our management staff than some of our employees do. We’ve dissected any problems that occurred and resolved the issues for the long haul. Our staff and the employees of our distributors are so accustomed to this process that any new issue is very rare.
In retrospect, the key was communication. Everyone in the loop had something to gain. However, this Just- In-Time inventory process would only work well and last long if it was win-win-win for all involved — our distributors, our customers and us. To date, the original key vendors are still our key vendors, even though most of the reps and volume mix has changed. We know for a fact that any vendor located outside of the inner distributor circle described above cannot service our account to the degree that we need. We have come to expect same-day or next-morning deliveries. One particular vendor may make as many as a half-dozen deliveries on a busy summer day. I wouldn’t dispute that we may pay a little more for certain stock items than if we extensively shopped the price. However, our primary focus from Day 1 was customer service. To us, it’s well worth it to pay a fraction more so we can continue to grow this business without the pressure of needing more stock (and the space to house it) and unnecessarily tying up cash that we can put to better use. In actuality, we have reduced our original warehouse space of 3,000 square feet to less than 2,500 square feet because of our greater need for more office space.
You don’t have to be an inventory management specialist to quickly realize the benefits of handling inventory in a similar fashion. Inventory is a necessity, but you can create a stocking program that better suits your operations, business and cash flow. If the industry average is 12 inventory turns per year, which I think is high, ours is more than 18 times. This is an unusually high number…and the higher, the better! By managing inventory as we do, we can anticipate cash savings and better cash flow. Since there is a time value of money, we win on both ends and it goes directly to our bottom line.
Ideally, you want to turnover your inventory every month so you should have approximately 1/12 of your annual material costs available on a monthly basis. Here’s a good rule of thumb : $1 of inventory costs you 24 cents on your income statement — 10 cents for interest expense and 14 cents for labor costs managing inventory plus the infrastructure costs (warehouse, lighting, racks, software, etc.).
Although we took an unusual path to achieve our inventory success, we have come to believe in the importance of Just-In-Time inventory management and would no longer think of doing it any other way. The benefits are just too good to go back. While we still perform a monthly inventory of our warehouse and 50-plus vehicles to maintain good inventory management, especially with regard to pilferage and shortages, our total time to do so has been reduced by 75%. Now inventory is done with a smile and there is no dust to measure.
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