Focus management attention on the important things

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Inventory optimization is critical in order to keep costs under control within the Supply Chain. It is efficient to focus management attention on items that cost most to the business.

The Pareto principle states that 80% of the overall value is based on only 20% of total items. In other words, demand is not evenly distributed between items: top sellers vastly outperform the rest.

The ABC approach states that, when reviewing inventory, a company should rate items from A to C, basing its ratings on the following rules:

• A-items are goods which annual consumption value is the highest. The top 70-80% of the annual consumption value of the company typically accounts for only 10-20% of total inventory items.
• C-items are, on the contrary, items with the lowest consumption value. The lower 5% of the annual consumption value typically accounts for 50% of total inventory items.
• B-items are the interclass items, with a medium consumption value. Those 15-25% of annual consumption value typically accounts for 30% of total inventory items.

Through this categorization, you can identify inventory hot spots, and separate them from the rest of the items, especially those that are numerous but not that profitable.

What are the implications for your inventory policy?

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Each item should receive a weighted treatment corresponding to its class in ABC Analysis.

• A-items should have tight inventory control, more secured storage areas and better sales forecasts. Reorders should should be frequent, with weekly or even daily reorder. Avoiding stock-outs on A-items is a priority.
• Reordering C-items is made less frequently. A typically inventory policy for C-items consist of having only 1 unit on hand, and of reordering only when an actual purchase is made. This approach leads to stock-out situation after each purchase which can be an acceptable situation, as the C-items present both low demand and higher risk of excessive inventory costs. For C-items, the question is not so much how many units do we store? but rather do we even keep this item in store?
• B-items benefit from an intermediate status between A and C. An important aspect of class B is the monitoring of potential evolution toward class A or, in the contrary, toward the class C.

Splitting items in A, B and C classes is relatively arbitrary. This grouping only represents a rather straightforward interpretation of the Pareto principle. In practice, you can use several metrics to do an ABC Analysis. A very popular one is sales volume but also the impact of a stock-out on the business of the client should also influence the inventory strategy.

Double ABC

Run ABC Analysis based on two dimensions.

Visualize and analyze new item categories, defined based on two dimensions. See exactly how many articles belong to each of the nine classes, and analyze the most important KPIs for your inventory. Improve your decision-making process, and level-up the choice of inventory policies.

Combine ABC Analysis with other tools

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Achieve better results with our recommendations.