The ABC classification, the tool for a healthy inventory!

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As an inventory planner/manager, you want to ensure that you maintain enough inventory in your warehouse to meet customer requirements (internal and external), but not have a surplus. That’s why inventory management is essential to track the flow of goods in and out of inventory. Each product is associated with various costs such as acquisition costs and/or warehousing fees, and the goal of the inventory planner is to reduce these costs by not running out of inventory.

Here is a reminder of what ABC analysis (inventory) is all about

ABC Analysis (Inventory)

ABC (activity-based costing), also known as ABC Analysis, ABC Classification, Pareto’s Law or 80/20 rule, is a method that classifies items or events into three classes (A, B and C) according to their degree of importance: A being the most important items and C the least important items. 

ABC (activity-based costing), also known as ABC Analysis, ABC Classification, Pareto’s Law or 80/20 rule, is a method that classifies items or events into three classes (A, B and C) according to their degree of importance.

Based on Pareto’s principle, which recommends that 20% of events occur 80% of the time, this method makes it possible to spread control efforts more evenly and to be more efficient. This method is mainly applied to inventory management. It allows us to classify items according to their value and thus establish an item control policy that gives more attention to the 20% of critical parts and less attention to the less important parts. There is a minimum of three product classes:

  • Class A: 20% of products; 80% of profits
  • Class B: 30% of products; 15% of profits
  • Class C: 50% of products; 5% of profits

This ranking tool can also be applied in companies at other levels, such as warehouse management and analysis of the causes of underperformance. This method is part of a production management approach. The expected results of the method, applied to inventory management, are better control of critical parts and a reduction in safety stocks.

The benefits of an ABC classification for your company

To help planners minimize their costs while optimizing their inventory, companies can benefit from using the ABC inventory analysis technique. Indeed, it allows them to optimize their inventory, improve their customer service levels and have a better management of the life cycle of their inventories. These improvements have a significant impact on the supply chain within the company.

Inventory Optimization

Inventory optimization is an important feature of ABC analysis because it allows inventory planners to organize high priority items based on actual customer needs. Based on demand fluctuations, inventory is adjusted to meet high demand for certain items but also to hold a limited inventory of slow-moving items.

Levels of service

Due to their level of demand, not all products can be treated in the same way or achieve the same levels of customer service. Depending on the product classification previously determined, service levels for different products will depend on several factors, such as the cost of the item, the quantity sold and the margin on the product. When talking about service levels, it is recommended not to keep large quantities of low-volume products because they are less sold and this causes clutter in the warehouse, as well as loss of revenue. Thus, ABC analysis allows planners to define the right service levels based on product classification, which improves overall supply chain performance while satisfying the real needs of your customers.

Graph demonstration about cost of service level

Ask yourself

Are you able to quantify the investment according to the level of service you establish?

Life cycle management

Each product goes through four phases during its lifecycle: launch, growth, maturity and decline. Once a product reaches maturity, it will decline sooner or later. Customer demand plays a key role in end-of-life management. With the ABC analysis concept, inventory planners can predict product demand in advance and manage inventory levels accordingly. With the right discipline, the ABC tool makes it much easier to identify mature and declining items. This allows for more proactive inventory management, allowing for level adjustments without accumulating a quantity of nonessential inventory, thus reducing the risk of obsolete items.

Digitization of the ABC methodology

The digitalization of supplies is a management approach that will have to be considered increasingly by companies. Indeed, in the near future, thanks to the addition of computer tools and business intelligence, it will be possible to adjust the ABC classification and Min/Max directly through digitization. It is by cross-referencing calculations of inventory levels, forecasts and actual sales that artificial intelligence will be able to cross-reference data and propose, or even adjust, the life cycle, stock levels and even generate replenishments directly.

As not everything is infallible, it will therefore be important for tomorrow’s managers to have a good knowledge of these metrics. A good configuration of the different systems will allow a better result, by selecting the right computer system for your company.

In 2020, high-performance IT systems are available to support you in your inventory management. In addition, they allow the optimization of your quantities needed to support your established customer service levels.

When are quantities optimal?

The exercise of a well-orchestrated ABC analysis allows companies to set up optimal quantities, per SKU, to be kept in inventory. This is referred to as “Min/Max”. Once you have established the ABC category, the desired level of service and the life cycle phase of your product, it is important to determine its optimal quantities.

At Conseil 2.0, we will help you in your ABC classification process. Feel free to leave a comment or contact us directly if you want to learn more.