ABC Analysis: Focusing on the Critical Few

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In most stock-based businesses, the Pareto Principle, often known as the 80-20 rule, holds true for most aspects of inventory management. Roughly 80% of the value of a business’ inventory is usually tied up in about 20% of its product lines. This implies that managing the top 20% of a business’ inventory is critically important.

The ABC method is a method for categorising inventory and prioritising inventory control. It involves breaking down your business into several headline categories. These categories reflect the relative importance of an item to your business and, as a result, how much effort should go into inventory control and record keeping. ABC analysis can be deployed across a wide range of inventory, from manufactured products to spare parts.

An ABC analysis essentially involves dividing your business’ inventory into three categories:

  • Category A items which are business critical and require careful inventory control
  • Category B items which are of average importance and require some management
  • Category C items which are less important for your business and require relatively little inventory control.

Carefully Managing the Critical Few

A focus of most business’ inventory control is balancing the risk of stock outs against the cost of holding reserves of safety stock. Because category A inventory is critically important, managing this inventory well may involve a more conservative approach. Running short on category A inventory will typically have a severe impact on the business, so it may make sense to hold some safety stock.

On the other hand, if your business trades a large volume of category A inventory and has access to a reliable supply chain, you may wish to take a lean approach and keep inventory carrying costs to a minimum. Whatever approach you take, inventory control for category A inventory should be guided by risk and informed by real-time inventory data.

Extending Good Inventory Management

Once your business has the bulk of its category A inventory under control, it is worth considering how to extend good inventory management practices to category B. Although this inventory is less business sensitive and lower value, it is worth remembering that (at least cumulatively) category B inventory is important for your business to trade in the medium to long term. This inventory might not justify the same level of active intervention, but keeping track of how much category B stock you hold and where it is located is still useful. For a business that is looking to improve its margins, reducing the carrying cost of category B inventory is a smart next step.

Keeping Inventory Control Focused

Category C inventory rarely justifies active management, although it does not hurt to manage low value inventory better if the cost is only marginal. For example, a business that has invested in barcoding to improve inventory tracking and data entry would be unlikely to barcode category C inventory. The cost of printing, managing and scanning category C inventory as it is used may easily exceed the carrying costs saved or stock out risks avoided.

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Melanie - Unleashed Software

Article by Melanie Chan in collaboration with our team of Unleashed Software inventory and business specialists. Melanie has been writing about inventory management for the past three years. When not writing about inventory management, you can find her eating her way through Auckland.

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