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Maintaining inventory through counting, placing orders, receiving stock and so on takes personnel time and costs money. When there are limits on these resources, the logical move is to try to use the available resources to control inventory in the best way. In other words, focus on the most important items in inventory.
In the 19th century, Villefredo Pareto, in a study of the distribution of wealth in Milan, found that 20% of the people controlled 80% of the wealth. This logic of the few having the greatest importance and the many having little importance has been broadened to include many situations and is termed the Pareto principle. This is true in our everyday lives (most of our decisions are relatively unimportant, but a few shape our future) and is certainly true in inventory systems (where a few items account for the bulk of our investment).
Any inventory system must specify when an order is to be placed for an item and how many units to order. Most inventory control situations involve so many items that it is not practical to model and give thorough treatment to each item. To get around this problem, the ABC classification scheme divides inventory items into three groupings: high dollar volume (A), moderate dollar volume (B) and low dollar volume (C). Dollar volume is a measure of importance; an item low in cost but high in volume can be more important than a high-cost item with low volume.
ABC Classification: If the annual usage of items in inventory is listed according to dollar volume, generally, the list shows that a small number of items account for a large dollar volume and that a large number of items account for a small dollar volume.
The ABC approach divides this list into three groupings by value: A constitutes roughly the top 15% of the items, B items the next 35%, and C items the last 50%. Segmentation may not occur always so neatly. The observation, though, is to try to separate the important from the unimportant. Where the lines actually break depends on the particular inventory under question and on how much personnel time is available.
The purpose of classifying items into groups is to establish the appropriate degree of control over each item. On a periodic basis, for example, class A items may be more clearly controlled with weekly ordering, B items may be ordered biweekly, and C items may be ordered monthly or bimonthly. Note that the unit cost of items is not related to their classification. An A item may have a high dollar volume through a combination of either low cost and high usage or high cost and low usage. Similarly, C items may have a low dollar volume because of either low demand or low cost. In an automobile service station, for example, gasoline would be an A item with daily or weekly replenishment; tires, oil, batteries, grease and transmission fluid may be B items and ordered every two to four weeks; and C items would consist of valve stems, windshield wiper blades, radiator caps, hoses, fan belts, oil and gas additives, car wax, and so on. C items may be ordered every two or three months or even be allowed to run out before reordering because the penalty for stock out is not serious.
Sometimes an item may be critical to a system if its absence creates a sizeable loss. In this case, regardless of the item’s classification, sufficiently large stocks should be kept on hand to prevent run out. One way to ensure closer control is to designate this item an A or B, forcing it into the category even if its dollar volume does not warrant such inclusion.
ABC analysis provides a mechanism for identifying items which will have a significant impact on overall inventory cost whilst also providing a mechanism for identifying different categories of stock that will require different management and controls When carrying out an ABC analysis, inventory items are valued (item cost multiplied by quantity issued/consumed in period) with the results then ranked. The results are then grouped typically into three bands. These bands are called ABC codes.
ABC codes
“A class” inventory will typically contain items that account for 80% of total value, or 20% of total items.
“B class” inventory will have around 15% of total value, or 30% of total items.
“C class” inventory will account for the remaining 5%, or 50% of total items.
ABC Analysis is similar to Praetor the “A class” group will typically account for a large proportion of the overall value but a small percentage of the overall volume of inventory.
The ABC classification process is an analysis of a range of objects, such as finished products, items lying in inventory or customers into three categories. It’s a system of categorization, with similarities to Pareto analysis, and the method usually categorizes inventory into three classes with each class having a different management control associated:
A – outstandingly important; B – of average importance; C – relatively unimportant as a basis for a control scheme.
Each category can and sometimes should be handled in a different way, with more attention being devoted to category A, less to B, and still less to C.
Popularly known as the “80/20” rule ABC concept is applied to inventory management as a rule of-thumb. It says that about 80% of the Rupee value, consumption wise, of an inventory remains in about 20% of the items.
This rule , in general , applies well and is frequently used by inventory managers to put their efforts where greatest benefits , in terms of cost reduction as well as maintaining a smooth availability of stock, are attained.
The ABC concept is derived from the Pareto’s 80/20 rule curve. It is also known as the 80-20 concept. Here, Rupee / Dollar value of each individual inventory item is calculated on annual consumption basis.
Thus, applied in the context of inventory, it’s a determination of the relative ratios between the number of items and the currency value of the items purchased / consumed on a repetitive basis.
10-20% of the items (‘A’ class) account for 70-80% of the consumption
the next 15-25% (‘B’ class) account for 10-20% of the consumption and
the balance 65-75% (‘C’ class) account for 5-10% of the consumption
‘A’ class items are closely monitored because of the value involved (70-80% !).
High value (A), Low value (C), intermediary value (B)
20% of the items account for 80% of total inventory consumption value (Qty consumed X unit rate)
Specific items on which efforts can be concentrated profitably
Provides a sound basis on which to allocate funds and time
A,B & C , all have a purchasing / storage policy – “A”, most critically reviewed , “B” little less while
“C” still less with greater results.
ABC Analysis is the basis for material management processes and helps define how stock is managed. It can form the basis of various activity including leading plans on alternative stocking arrangements (consignment stock), reorder calculations and can help determine at what intervals inventory checks are carried out (for example A class items may be required to be checked more frequently than c class stores
Inventory Control Application: The ABC classification system is to grouping items according to annual issue value, (in terms of money), in an attempt to identify the small number of items that will account for most of the issue value and that are the most important ones to control for effective inventory management. The emphasis is on putting effort where it will have the most effect.
High value (A), Low value (C) , intermediary value (B)
A Items: These Items are seen to be of high Rupee consumption volume. “A” items usually include 10-20% of all inventory items, and account for 50-60% of the total Rupee consumption volume.
B Items: “B” items are those that are 30-40% of all inventory items, and account for 30-40% of the total Rupee consumption volume of the inventory. These are important, but not critical, and don’t pose sourcing difficulties.
C Items: “C” items account for 40-50% of all inventory items, but only 5-10% of the total Rupee consumption volume. Characteristically, these are standard, low-cost and readily available items.
ABC classifications allow the inventory manager to assign priorities for inventory control. Strict control needs to be kept on A and B items, with preferably low safety stock level. Taking a lenient view, the C class items can be maintained with looser control and with high safety stock level. The ABC concept puts emphasis on the fact that every item of inventory is critical and has the potential of affecting, adversely, production, or sales to a customer or operations. The categorization helps in better control on A and B items.
In addition to other management procedures, ABC classifications can be used to design cycle counting schemes. For example, A items may be counted 3 times per year, B items 1 to 2 times, and C items only once, or not at all.
Suggested policy guidelines for A , B & C classes of items
| A items (High cons. Val) | B items (Moderate cons. Val) | C item (Low cons. Val) |
| Very strict cons. Control | Moderate control | Loose control |
| No or very low safety stock | Low safety stock | High safety stock |
| Phased delivery (Weekly) | Once in three months | Once in 6 months |
| Weekly control report | Monthly control report | Quarterly report |
| Maximum follow up | Periodic follow up | Exceptional |
| As many sources as possible | Two or more reliable | Two reliable |
| Accurate forecasts | Estimates on past data | Rough estimate |
| Central purchasing /storage | Combination purchasing | Decentralised |
| Max. efforts to control LT | Moderate | Min. clerical efforts |
| To be handled by Sr. officers | Middle level | Can be delegated |
How to do ABC Analysis / Classification
ABC analysis is a basic supply chain technique, often carried out by inventory controllers/materials managers, and is the starting point in Inventory control.
ABC classification is a system of categorization, with similarities to Pareto analysis and the method usually categorizes inventory into three classes with each class having a different management control associated.
Although different criteria may be applied to each category the typical method of “scoring” an inventory item is that of annual consumption value of said item (Qty consumed X Cost of item) with the result then ranked and then scored (A, B or C).
Classification may be specific to the industry but typically follows a 70%, 90%, 100% banding in that A class items represent 70% of the value, B class items fall between 70% and 90% of the annual value with C class the remaining.
In practical terms the complex high cost materials typically fall into the A class items, with the consumable, low cost (and typically fast moving) classed as C class.
How to carry out the actual analysis?
Carrying out ABC analysis is a bit tricky affair. What ultimately is done is to segregate all the inventory items into three categories viz. A, B & C.
ABC analysis can be done for any given data that has money value as the prime factor. For example classification of pending suppliers’ bills, items of an MRO or any type of inventory, expenditure over a period of time, customers with respect to sale value etc.
Procedural steps:
First of all, collect all the data of the inventory and calculate the consumption or sale value. For a
Stores, maintaining inventory, this shall be Quantity issued X unit rate of an item, say x1. Similarly, get the values for all the remaining items, say, x2,x3,x4….x100 in the following way :
| SI. No | Item | Unit Rate | Consumption (Qty) issue |
| 1 | X1 | 10 | 10 |
| 2 | X2 | 12 | 10 |
| 3 | X3 | 15 | 12 |
| 4 | X4 | 20 | 5 |
| 5 | X5 | 30 | 2 |
| 6 | X6 | 5 | 100 |
| 7 | X7 | 4 | 80 |
| 8 | X8 | 16 | 12 |
| 9 | X9 | 13 | 22 |
| 10 | X10 | 35 | 6 |
Now, arrange all the consumption values in ascending or descending order of values. Let us assume we have listed in descending order (starting with highest consumption value item to lowest consumption value item)
Create next column and start adding the cumulative total of consumption value, starting from the top and finishing with the last item as given in the table below:
| Consumption Value | Value in ascending order | Cumulative Value | Item | Class |
| 100 | 60 | 560 | X5 | C |
| 120 | 100 | 1160 | X1 | C |
| 180 | 100 | 260 | X4 | C |
| 100 | 120 | 380 | X2 | C |
| 60 | 180 | 560 | X3 | C |
| 500 | 192 | 752 | X8 | C |
| 320 | 210 | 962 | X10 | B |
| 192 | 286 | 1248 | X9 | B |
| 286 | 320 | 1568 | X7 | A |
| 210 | 500 | 2068 | X6 | A |
From the last column it is clearly evident that the bottom 20 % of items (x6 & x7) consume together nearly 70% of value, upper 70% (x1, x2, x3, x4, x5, x8) items consume only 20% value and the remaining 10% items (x9) consume 10% value. Respectively, these are A,B and C classes of items
ABC Classification / Analysis of Inventory
The ABC classification process is an analysis of a range of objects, such as finished products, items lying in inventory or customers into three categories. It’s a system of categorization, with similarities to Pareto analysis, and the method usually categorizes inventory into three classes with each class having a different management control associated:
A – Outstandingly important; B – of average importance; C – relatively unimportant as a basis for a control scheme.
Each category can and sometimes should be handled in a different way, with more attention being devoted to category A, less to B, and still less to C.
Popularly known as the “80/20” rule ABC concept is applied to inventory management as a rule of-thumb. It says that about 80% of the Rupee value, consumption wise, of an inventory remains in about 20% of the items.
This rule, in general, applies well and is frequently used by inventory managers to put their efforts where greatest benefits, in terms of cost reduction as well as maintaining a smooth availability of stock, are attained.
The ABC concept is derived from the Pareto’s 80/20 rule curve. It is also known as the 80-20 concept. Here, Rupee / Dollar value of each individual inventory item is calculated on annual consumption basis.
Thus, applied in the context of inventory, it’s a determination of the relative ratios between the numbers of items and the currency value of the items purchased / consumed on a repetitive basis.
10-20% of the items (‘A’ class) account for 70-80% of the consumption
The next 15-25% (‘B’ class) account for 10-20% of the consumption and
The balance 65-75% (‘C’ class) account for 5-10% of the consumption
High value (A), Low value (C), intermediary value (B)
20% of the items account for 80% of total inventory consumption value (Qty consumed X unit rate)
Specific items on which efforts can be concentrated profitably
Provides a sound basis on which to allocate funds and time
A,B & C , all have a purchasing / storage policy – “A”, most critically reviewed , “B” little less while “C” still less with greater results.
ABC Analysis is the basis for material management processes and helps define how stock is managed. It can form the basis of various activity including leading plans on alternative stocking arrangements (consignment stock), reorder calculations and can help determine at what intervals inventory checks are carried out (for example A class items may be required to be checked more frequently than c class stores
Inventory Control Application: The ABC classification system is to grouping items according to
annual issue value, (in terms of money), in an attempt to identify the small number of items that will account for most of the issue value and that are the most important ones to control for effective inventory management. The emphasis is on putting effort where it will have the most effect.
A Items: These Items are seen to be of high Rupee consumption volume. “A” items usually include 10-20% of all inventory items, and account for 50-60% of the total Rupee consumption volume.
B Items: “B” items are those that are 30-40% of all inventory items, and account for 30-40% of the total Rupee consumption volume of the inventory. These are important, but not critical, and don’t pose sourcing difficulties
C Items: “C” items account for 40-50% of all inventory items, but only 5-10% of the total Rupee consumption volume. Characteristically, these are standard, low-cost and readily available items.
ABC classifications allow the inventory manager to assign priorities for inventory control. Strict control needs to be kept on A and B items, with preferably low safety stock level. Taking a lenient view, the C class items can be maintained with looser control and with high safety stock level. The
ABC concept puts emphasis on the fact that every item of inventory is critical and has the potential of affecting, adversely, production, or sales to a customer or operations. The categorization helps in better control on A and B items.
