As an inventory planner/manager, you want to ensure that your warehouse maintains enough inventory to meet customer (internal and external) requirements, but without having a surplus. That’s why inventory management is essential to track the flow of goods coming in and out of stock. Each product is associated with various costs such as acquisition costs and/or storage fees, and the goal of the inventory planner is to reduce these costs without running out of stock.
A Reminder of What ABC Inventory Analysis Is
ABC Analysis
ABC (Activity-Based Costing), also known as ABC analysis, ABC classification, the Pareto Principle, or the 80/20 Method, is a technique used to classify items or events into three categories (A, B, and C) based on their level of importance: A being the most important items, and C being the least important.
Based on the Pareto Principle, which suggests that 20% of events occur 80% of the time, this method allows for better allocation of control efforts and improved efficiency. It is mainly applied to inventory management. Thanks to this method, items are classified by value, allowing the establishment of an inventory control policy that gives more attention to the critical 20% of items and less attention to the less important ones. There are typically at least three product categories:
- Class A: : 20% of the products; 80% of the profits
- Class B : 30% of the products; 15% of the profits
- Class C : 50% of the products; 5% of the profits
This classification tool can also be applied at other levels within companies, such as warehouse management and performance analysis. It is part of a broader production management approach. The expected results of the method, when applied to inventory management, are better control of critical parts and a reduction in safety stock.
The Benefits of ABC Classification for Your Business
To help planners minimize costs while optimizing inventory, companies benefit greatly from using the ABC inventory classification technique. It allows them to optimize their inventory , improve their customer service levels and better manage the lifecycle of their inventories. These improvements have a significant impact on the company's supply chain.
Inventory Optimization
Inventory optimization is one of the benefits of ABC analysis because it allows inventory planners to organize high-priority items based on actual customer needs. Depending on demand fluctuations, inventory is adjusted to meet high demand for certain items while maintaining a limited stock of low-movement items.
ABC analysis also enables a more suitable restructuring of warehouses. Product placement is determined based on its classification, which helps reduce frequent movements, maximize productivity, and ensure good inventory turnover. For example, a Class A product would be placed near the loading docks, while a Class C product would be farther away.
Service Levels
Given their level of demand, not all products can be treated the same way or achieve the same customer service levels. According to the product classification determined earlier, service levels for different products will depend on several factors, such as the item’s cost, quantity sold, and product margin. When discussing service levels, it is recommended not to keep large quantities of low-volume products, as they sell less frequently and cause warehouse congestion and lost revenue. ABC analysis allows planners to define the appropriate service levels based on product classification, improving overall supply chain performance while meeting actual customer needs.
Moreover, data collected through ABC analysis can be used to compare additional inventory costs between two service levels. For example, increasing a service level from 90% to 98% (an 8% increase) might cost $55,000. However, increasing from 98% to 99% (just a 1% increase) might cost $75,000. In this context, the company must decide—based on its optimal investment point—whether it's worth investing in a higher service level. Sometimes, it’s better to invest that money in other projects.
Reflective Question
Are you able to quantify the investment according to the service level you establish?
Lifecycle Management
Every product goes through four phases during its lifespan: launch, growth, maturity, and decline. Once a product reaches the maturity stage, it is bound to decline sooner or later. Customer demand plays a crucial role in managing the end-of-life phase. Thanks to the concept of ABC analysis, inventory planners can anticipate product demand in advance and manage stock levels accordingly. With proper diligence, the ABC tool allows for much easier identification of items in the maturity and decline phases. This enables proactive inventory management, allowing for stock level adjustments without accumulating unnecessary inventory, thus reducing the risk of obsolete items.
Digitalization of the ABC Method
Digitalization of procurement is a management method that companies will increasingly need to consider. In the near future, thanks to the addition of IT tools and business intelligence, it will be possible to adjust ABC classification and Min/Max levels directly through digital systems.
By cross-referencing inventory levels, forecasts, and actual sales, artificial intelligence will be able to analyze the data and propose—or even automatically adjust—the product lifecycle phase, stock levels, and even trigger live replenishments. As no system is foolproof, it will be important for tomorrow’s managers to have a solid grasp of the parameters involved. Proper configuration of various systems will deliver better results—of course, by carefully selecting the IT system that fits your company’s needs.
As of 2020 Powerful IT systems are already available to support your inventory management efforts. Moreover, they enable the optimization of the quantities needed to support your established customer service levels.
What About Optimal Quantities?
A well-orchestrated ABC analysis allows companies to set optimal quantities per SKU to keep in stock—commonly referred to as "Min/Max" levels. Once you've established the ABC category, the desired service level, and the product lifecycle stage, it becomes essential to determine these optimal quantities..
At Conseil 2.0 We support you in your ABC classification efforts. Feel free to leave a comment or contact us directly if you want to learn more.
