What’s the value of ABC Inventory Management?

What if there was a system of Inventory classification that you could use to maximize the effectiveness of your efforts in just about any aspect of your business especially inventory management?

The good news is that such a system was developed a long time ago. Originally based upon an observation by Italian economist Vilfredo Pareto, and now known by many terms such as the Pareto Principle, 80/20 rule, ABC analysis and ABC Classifications.

As the diagram below shows, in a typical organization a small % of customers (A) often generate a large % of the sales eg 80%. By contrast, a large number of customers (C) often generate only a small % of sales eg as low as 5%.

The same logic applies to Inventory valuation where often a small % of the items represents a large % of the inventory valuation and a large % of the items represents a small % of the inventory valuation.

If one could easily identify the customers that generated the most sales and the items that represent the highest inventory investment, wouldn’t that help you to increase sales and reduce inventory?

The main idea here is that the real value of an ABC Inventory Management system is more than just a classification system. Rather, its true importance is that it will help you to understand how effective the major systems in your business really operate, ata practical level.

Consider This:

In terms of inventory management, the impact is obvious: the traditional methods of inventory management are grossly inefficient because with a little bit of analysis you will often find that:

While 20% of your Items represent up to 80% or so of your inventory valuation you are probably managing all your items the same way – eg using the same inventory replenishment technique

So you have to ask yourself the question “how should I manage the 20% of my items that accounts for approximately 80% of my inventory valuation, and how should I manage the 80% of items that represent only 20% of my inventory valuation”?

What would be the Quantifiable Benefits of better Inventory Management?

Lets assume you can reduce your inventory by 10% (a very realistic target with ABC inventory classification type techniques)

If your inventory valuation is $20million you could a achieve:

A once off saving of $2 million (10% of $20m) – straight into your Bank account

A saving each year of $200,000 (10% of $2m) – assuming a ‘holding cost’ of 10% again very conservative

Certainly worth spending your time and effort on – don't you think?

Imagine what your boss would say if you came up with these savings, that promotion would be a lot closer and your standing in the company would improve.

So how do you calculate and assign what’s known as ABC classification codes?

Its simple, and with a well-designed inventory spreadsheet it makes it even easier.

Firstly, calculate the 12 month dollar usage for all of your products (Note: there are other selection options). You can do this by multiplying your volume sold or used pa by the unit cost of that item.

Next, rank your items in descending order of annual dollar usage.

Then, calculate a cumulative % of the annual $ usage

Then, calculate a cumulative % of the number of items

From there:

Assign “A”to all items that comprise the top 80% of your inventory investment

Assign “B” to all items that comprise the next 15%.

Assign “C” to all items that are in the bottom 5% of your inventory investment

What do you do when you have assigned the ABC classification codes?

In inventory management, there are many usages that the ABC classification can be used for including:

 Applying different degree of control to each item according to their classification such as:

• Re-order frequency (“A” –daily/weekly, “C” - monthly)
• Cycle count frequency (“A” - weekly, “C” every 3 months)
• Safety stock levels (“A” lower, “C” higher)
• Re-order quantities (“A” weekly, “C” items monthly)

All these actions combined to reduce the total inventory $ invested and will free up your time by spending less time managing the “C” items and allowing you to spend more time on the “A” items –where the most $ savings are.

What are the Benefits to you?

Lets assume you achieving significant inventory $ savings by introducing a ABC Inventory Management system in your organization what will be different for you?

• Your boss will look up and listen
• You will stand out from the crowd as someone that has the company at heart and gets things done
• Your day-to-day working life easier by being better organized with a clearly defined logic to your inventory planning processes
• You will have more time to focus on what really matters (the “A” items)
• That job promotion will be looking a lot closer

Remember with New Skills your Future Starts Now

Conclusion

Businesses that ignore the ABC system of classification are not operating as systematically or at an efficiency level that is possible. There is a lot of money to be saved in reduced inventory levels and improving customer service though better inventory analysis and planning using an ABC Inventory Management system.