Inventory management is a critical task of tracking the flow of goods in and out of the inventory. As an inventory planner/manager you want to ensure that your warehouse is carrying enough stock to fulfill customer requirements but also not crowding the warehouse by overstocking it. Every product has various costs associated to it like holding costs, carrying costs and the aim of the inventory planner is to reduce these costs by not running low on stock. To help planners minimize these costs while optimizing their inventory, here is the ABC Analysis of Inventory technique and tool.
What is ABC Analysis of Inventory?
ABC analysis of inventory is a process of classifying the products based on the value of importance. This concept is derived from the Pareto principle of 80/20 rule which focuses on vital few from trivial many. Not all items in an inventory are of the same value, therefore these items are broken down into three categories A, B and C. Class A consists of most valuable items, although these items constitute only 10% of quantity they account for 70% – 80% of consumption value. Class B consists of items with moderate importance accounting for 10% – 20% of revenue. And class C consists of least valuable items that contribute to only 10% of revenue. This classification helps managers in prioritizing and monitoring items of high importance closely.
An organization can benefit by adapting the ABC analysis in inventory management. Here are some of them
1.End of life management:
Every product goes through four phases during its lifespan: launch, growth, maturity and decline. Once the product reaches the maturity stage it is bound to decline sooner or later. Customer demand plays a vital role in end of life management. With the concept of ABC analysis, inventory planners can forecast the demand for products beforehand and manage the stock levels accordingly. The maturity and decline period is different for different products, with decrease in demand the sales will fall and therefore it would be wise to reduce the inventory levels to minimize the carrying costs on the items and also avoid having obsolete stock.
2. Supplier negotiation:
It is obvious that the company would make most money by negotiating with suppliers of the class A category since 70% – 80% of the money is spent on them. An offer may look lucrative from afar but never accept the very first one. Make a counter offer in return. Wait for the supplier to revise his numbers. If the supplier is not willing to budge, you can still make the most of the deal by negotiating other features like providing post purchase services, reducing the down payment, free shipping etc. The negotiation needs to be a win-win approach, the supplier needs to make reasonable profit from the deal while helping your company get desired quality product and services.
3. Inventory optimization:
Optimizing inventory is a popular benefit of ABC analysis as it allows inventory planners to organize high priority items aligning to customer requirement. Depending on the demand fluctuations the inventory is stocked to cater to high demand items and also carrying low stock for undesirable items.
4. Strategic Pricing:
ABC analysis of inventory helps in setting the prices very strategically for products which bring more value to the company. The company will have to monitor those products which are highly desirable to customers and have an escalating demand. Based on that data, the company can increase the price of these items by a few extra dollars which will make a huge impact on the profit. Another strategic pricing option to consider is to consolidate suppliers or consider transferring business to a single supplier. Purchasing more goods from a single supplier will reduce carrying costs and complexity costs associated with them.
5. Resource Allocation:
Resource allocation with ABC analysis is a continuous process requiring periodic tracking of class A items. Since these items are of utmost value, the stock level must always align with the customer demand. In case a class A item is no longer desired by the customers or has fairly lower demand, the item needs to be moved to a lower classification B or C.
6. Customer Service Levels:
Not all products can be treated the same or achieve same customer service levels. The service levels for different products depends on multiple factors like the item cost, quantity sold and margin on the product. There is no point crowding your warehouse with low margin products which are sold once in a while. ABC analysis allows planners to set service levels based on the product classification, which improves the overall supply chain performance carrying less safety stock.
There you have it. Six target benefits to adapting ABC analysis of inventory method in your company. If you have employed this technique in your business, please share the advantages and benefits you enjoyed.
This is the guest post from aspiring graduate Pranali Pawar:
Pranali Pawar is a class of 2016 graduate who holds a Master’s degree in Supply Chain & Logistics Technology from University of Houston. Her passion for supply chain management stems from her love for learning, analyzing and solving complex process optimization challenges. Coming from a business family, she has always been intrigued by the impact of people and processes in supply chain and retail management. With her newfound interest for writing, Pranali aims at sharing and gaining knowledge by interacting with industry peers. She is driven to expand her network and build connections with industry professionals, experts and gain insight into their experiences