1. ABC inventory analysis is a method used to classify a business’s stock items into three categories – A, B and C, based on their value to the business.
2. A items are the most important in terms of the value they bring a company, whilst C items are the least valuable.
3. ABC inventory analysis is important as it helps managers focus their time on their most valuable / important products and adapt their inventory control policies accordingly.
THREE CLASSIFICATIONS
1. In a warehouse different stocked items (or SKU’s) will all have different values, in terms of how much money they make the business.
2. One way to differentiate products based on their value is to segment them into categories (A, B, and C).
3. As there are many ways to define ‘value’, this classification can be based on many criteria, including annual sales revenue, average profit margin, annual sales volume or annual consumption value.
4. A classification items are very important and sometimes business critical. These typically have a high value or are sold in large volumes.
5. B classification items are important, but less important than ‘A’ items and more important than ‘C’ items. These are typically mid-range in inventory value and demand.
6. C classification items are marginally important. Typically, they have a low inventory value.
80/20 RULE
1. This rule of thumb can also be applied to inventory consumption, where 80% of a business’s annual sales value comes from 20% of its items e.g category A items. Categories B and C then make up the remaining 20%.
2. How the 20% is split between category B and C items will vary, based on a business’s product portfolio.
3. The graph below shows how ABC analysis conforms with the Pareto Principle. You can see that 20% of the annual sales volume comes from a small number of A category items, while a large number of B, C and D items make up the remaining 20%.
APPLICATIONS AND ADVANTAGES OF ABC INVENTORY ANALYSIS
1. ABC analysis is a simple framework to work out which items in your warehouse are the most important, and, should therefore consume most of your time in terms of stock control and management.
2. Focus on your category A items. This could include reviewing and updating their demand forecast more frequently to guarantee stock availability or interacting more regularly with suppliers to improve lead times.
3. ABC analysis can also help you work out appropriate inventory rules for each category. It makes sense to set different service levels, safety stock levels and re-ordering parameters for each category. You can then prioritise the management of the policies based on their category classification.
4. For example, you may want to focus on improving the service levels of your A class products, over your Bs and Cs by increasing your safety stock levels. Avoiding stockouts on A items should be a priority.
DISADVANTAGES
1. ABC analysis arguably over-simplifies the classification of goods. Especially if the classification is done based on ‘gut feel’ and not hard data.
2. The ABC classes are also very one-dimensional as they only take into account one variable, such as sales value.
3. Factors such as demand variability or the effect of risk-of-runout are arguably equally as important to consider when categorising your most important inventory.
4. With only three categories, ABC analysis lacks granularity. With 100’s, sometimes 1000’s of items in one segment, it’s a big generalisation to suggest that all SKUs have the same characteristics and should be treated equally.
5. ABC analysis lacks dynamism. In a marketplace where trends come and go and product sales can be erratic, items can move from category C to A very quickly.
6. Without constant analysis and reclassification, your ABC classification groups can quickly become out of date. Treating A products as C products and visa versa can be very harmful to a business, leading to out of date inventory policies and consequently stockouts or excess inventory.
7. With the risk of your ABC categorisation getting out-of-date quickly, it can be time-consuming to constantly re-evaluate your As, Bs and Cs and look for signs of movement between the groups.
8. Inventory management teams could face spending more time on classifying their goods than acting on the implications of the results.
FACTOR IN DEMAND INTO ABC ANALYSIS
1. Taking ABC analysis to the next level, it’s possible to cross-analyse the annual consumption value of your items with their demand variability.
2. This allows you to classify products based on their value and their forecastability e.g how likely demand will vary from the forecast.
3. For example, some products will have a regular demand, whilst others will have intermittent demand. Having this level of insight helps you to make informed decisions about which products to stock and what safety stock levels to set. In its simplest form this is known as XYZ analysis.
AUTOMATING ABC ANALYSIS
1. There is a way to overcome the shortfalls above and use ABC analysis effectively. The answer lies in utilising software to analyse and categorise your inventory, carrying out multi-dimensional item categorisation that considers a range of variables including:
- Demand volume – number of units sold
- Sales frequency – what % of historical periods have a sale
- No of picks – number of times picked over the year
- Value of annual usage – sales volume x unit cost
XYZ ANALYSIS
1. ABC classification is, for many situations, over simplistic, due to the evaluation criteria being one-dimensional.
2. By only prioritising items based on their value, you’re missing many other important factors that should influence what inventory you carry and where you focus your time in terms of stock management.
3. To help overcome this issue, it’s possible to introduce ABC XYZ analysis (sometimes abbreviated to XYZ analysis).
4. XYZ analysis is a framework to classify products based on their variability of demand.
- X-items = regular demand
- Y-items = strong variability in demand\
- Z-items = very irregular and difficult to predict demand
5. This means you can segment items based on their forecastability e.g the likelihood that their demand will vary from their forecast.
CALCULATE ABC XYZ INVENTORY ANALYSIS
1. The variability of demand for an inventory item can be expressed as the coefficient of variation. To categorise your products into X, Y and Z you therefore need to:
2. Identify the items you want to include in the analysis.
3. Calculate the coefficient of variation for each item e.g (standard deviation / mean) * 100.
4. Sort the items by increasing coefficient of variation and accumulate the figures.
5. Set the boundaries for each category.
6. It’s important to make sure that you set an appropriate time span for assessing demand volatility. For example, if you have items with seasonal demand, it makes sense to include 12 months of data. With your ABC and XYZ categories identified, you can produce a matrix similar to the one below and assign each group.
7. Adding another level of insights to your inventory classification process allows you to make more informed ordering and stocking decisions.
8. For example, it makes sense to treat AX items that are valuable and have a constant demand differently to AZ items with erratic demand. If demand is steady and easy to predict (X items), your safety stock levels can be much lower than products where demand is much more volatile (Z items).
Source:
https://www.eazystock.com/uk/blog-uk/abc-analysis-inventory-management/
https://www.eazystock.com/uk/blog-uk/abc-xyz-analysis-for-inventory-and-how-can-it-add-value/
