ABC Inventory Planning

ABC Inventory Planning

Let’s learn more about ABC Inventory Planning. 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 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

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

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 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.