ABC Analysis & Its Role in Inventory Optimization

Poovika Prakash

22nd Jul, 2020

To understand the different inventory control measures and their value addition to the businesses, its first essential to understand the scope of the word ‘Inventory’. Theoretically, inventory would be the finished goods that the company holds for sale to its customers in the future. Inventory Control, on the other hand, is the systematic control and regulation of the purchase, storage, and usage of materials to maintain an even flow of production and to avoid excessive investment in materials.  The literal meaning would be easy to grasp as compared to the small nuisances it sums up to be a part of. Hence inventory control has been given that much of prime importance as its manufacturing.

What is ABC Analysis of Inventory?

How often have we come across articles/blogs/literature which elaborate the plight of an operations manager struggling to have a good model in place as far as inventory control procedure is concerned? How often have we seen businesses treading on a downward slope because the inventory control processes were not good enough to land them ahead of the curve as far as operating profits are concerned. It is no surprise that the decision-making authority as far as inventory control is concerned is of critical importance for a business to gain a competitive advantage.

ABC analysis (aka Pareto’s law) is one of the most important and widely used inventory control technique. The process involves breaking down the stock items into three major classes according to their cost usage, so the company can focus on items with preeminent cost value since they account for a compelling percentage of the inventory costs.

ABC Analysis works by dividing items into 3 categories

Class A-items are goods with annual consumption value the highest i.e the top 80% of the annual consumption value of the company but account for only 20% of the total inventory items.

Class B-items are the interclass items with a medium consumption value; that 15 % of annual consumption value typically accounting for 30% of the total inventory items.

Class C-items are, on the contrary, items with the lowest consumption value; the lower 5% of the annual consumption value typically accounting for 50% of the total inventory items.

Classifying the inventory items aims to assist the inventory managers to focus more on class A items, as they keep the top-notch priority and calls for tight control. While class B has comparatively low priority, spans items with availability either low or out of stock, and veritably, they account for 20% of the total inventory cost. Class C items have the least priority, and it uses the simplest inventory control methods.

So, managing inventories by ABC requires segregating inventory items based on their relative importance, for instance, resource availability, fiscal value, lead time, manufacturing requirements, etc. Practitioners claim that ABC analysis can handle cyclic inventory effectively, for ‘A’ class inventory items, counted weekly for accurate monitoring of items, consecutively, has a greater impact on the inventory cost. Conversely, ‘B’ class items, having less impact on the inventory, perhaps counted monthly and ‘C’ class items counted once in three or six months as their consumption score is low with less impact on the inventory value.

How does the ABC technique help in warehouse management?

In a typical multi-warehouse, the nitty-gritty of controlling inventory increase the inventory cost if not controlled properly. ABC analysis cyclic counting has been an effective inventory counting technique across multi-warehouse where inventory managers assign the inventory into one of the three ABC analysis class.

Inventory Management –

ABC analysis can be a smart strategy in the ASRS (Automated storage and retrieval system) for increasing the overall efficiency in the warehouse. For disorganized storage, the categorization strategy in ABC ensures the fastest access to the items in the highest demand, for instance, storing the items with high priority in the front section of the ASRS.

Resource Management-

The analysis approach can be a part of a computerized resource management software like WMS (Warehouse Management System), subjected to access real-time data of the inventory items. Additionally, the analysis establishes a smart order routing, a quick initiation into a smooth transfer of goods across the multi-warehouse.

Picking Technologies –

 To select the right picking technology, this technique helps to identify and select among different picking technologies like Voice Picking technique ( Pick by Voice, Light – Directed Picking Technique ( Pick to Light ), Artificial Intelligence and vison based  Technique ( Pick by Vision ). To improve the travel time within the manually operated warehouse, where operators are picking by forklift or by hand, or in the automated warehouse that running automatically on conveyors, with cranes and robots handling different processes.

Supply Chain Management-

ABC analysis helps the various stakeholders of the supply chain in the following ways –

By this categorization, one can identify hot spots and separate them from the rest of the items, especially those that are numerous but not that profitable. Identification of inventory items that pose the biggest business risks due to theft or damage and pose the largest opportunities from sales is also possible from this analysis.

  • It helps warehouse managers and other supply chain professionals to prioritize their time.
  • It empowers warehouse managers to achieve close to 100% inventory accuracy.

Also, ABC Analysis can help in making Smarter Purchasing and Inventory Control Decisions as well. Warehouse owners and supply chain managers have limited time and resources, so they must allocate their energy in the most efficient way possible. ABC analysis helps them identify the areas of their business that require the most attention in purchasing and inventory control.

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