This article is part 1 of a 3 part series on ABC Inventory Analysis.
Part 1 introduces the concept of ABC classification.
Part 2 provides a step-by-step walk through of how to conduct ABC Analysis.
Part 3 shares a few tips on properly conducting ABC analysis.
For Lean Manufacturing, Start With the ABC’s
ABC classification is a simple and powerful inventory management tool that plays a vital role in inventory control and material flow planning. ABC inventory classification empowers lean manufacturers to improve the efficiency of the inventory replenishment schedule. ABC classification groups inventory items based on each item’s total annual cost. It is a straightforward task, and if you want to implement Kanban, it’s an essential prerequisite.
Risk analysis and schedule optimization are essential to maximizing plant profitability, so you may be unintentionally subscribing to versions of the ABC system already. The objective is to gather information by analyzing demand, costs and risks so that better decisions about allocating capital can be made. Each item in the inventory is assigned to a class:
Class A Inventory: High total annual spend items
Class B Inventory: Medium total annual spend items
Class C Inventory: Low total annual spend items
Classification enables you to accurately plan your safety stock, better gauge your lead-time targets and optimize the resources that you spend to prevent production downtime.
8-Step ABC Analysis Guide.
Here’s why it works. ABC inventory classification exploits the Pareto principle of economics.
The Pareto principle (also called the 80/20 rule) is the economic observation that in most systems, 20% of causes yield 80% of results. While some studies have shown that this principle tends to be even more extreme in many modern systems, the concept is that in nearly any system, the “vital few” of parts of the system are responsible for the great majority of its results, while the “trivial many” are responsible for a small fraction of results.
In inventory management, the 80/20 rule translates to the majority of your inventory value (i.e. 80%) coming from a minority of inventory items (i.e. 20%). However, the Pareto principle also applies to waste. That is, for most original equipment manufacturers (OEMs), the minority of inventory value is going to be responsible for the majority of management and waste. Original equipment manufacturers utilize ABC classification to discover the high value items they should actively manage and the low value items they shouldn’t.
Ultimately, inventory control plans based on ABC classification, reduce the parts that you are required to carry and lower inventory investment and control costs while not jeopardizing downstream demands even when there are upstream supply failures.
Classification reveals a predictable rhythm for parts demand.
The system has an innate requirement for observation that clarifies patterns in the value stream. For example, low-cost items present a lower risk and require less stringent decision-making. The low cost also makes ordering at higher counts possible. Ordering in higher quantities allows for fewer total orders and thus less time spent planning parts replenishment and more time on actual production. Procuring items whose cost is higher, however, takes more time and effort. A greater level of discernment must be used to assess need and observe patterns to determine the feasibility and necessity of restocking the more expensive parts. Taking care to pay attention to these items helps ensure that inventory funds are spent in the most economical way possible.
Falcon’s lean inventory consultants recommend that taking these concepts into account will, in turn, improve the accuracy of purchase quantities for determining target lead times.
Download the FREE ABC Inventory Analysis Guide.
Defining the ABCs
Class A Inventory Items
Class A inventory items are the 20% of your inventory that account for 80% of your yearly investment.
- Class A inventory items cost the most to use. This may be due either to the high unit cost of the item or the high volume usage of an inventory item with a low unit cost.
- Class A inventory items present a high risk. The crucial nature and expense of these items necessitates substantial investments in human capital. In fact, inventory managers must spend most of their time and attention on A item replenishment. Inappropriate stock levels can have extensive consequences.
- Class A inventory items are replenished on a short sawtooth curve. Because of the costs involved with A items, fewer are kept on hand and orders are made more frequently. Therefore, minimum lead time, as well as standard cost, requires vigorous negotiations to ensure that production continues. Additionally, closely monitoring minimum order quantities (MOQ) and standard packaging quantities (SPG) is essential since each of these can increase the order quantity and upset the optimal stream.
- Typical target lead time: three to 10 days. They comprise the bulk of the on-hand value. These items, while lower in quantity, make up about 60-70% of the on-hand value of inventory.
Class B Inventory Items
Class B inventory items account for about 15-30% of the inventory items. These have a lower impact on inventory spending, usually about 15% total, annually.
- They typically require standard costs at predictable intervals. These items are regularly required for production and should be reordered routinely, but not as frequently as A items.
- They are important enough to monitor but do not require the same level of control as A items.
- They should be kept on hand in moderate quantities. Generally, keeping low inventory is the aim, and it’s also important to limit the number of transactions where you can.
- Typical target lead time: five to 15 days. B’s contribute to about 15-25% of the inventory value.
Class C Inventory Items
Class C inventory items tend to make up roughly 50% to 70% of inventory stock keeping units (SKUs) but only account for approximately 5% of total annual spend.
- Class C items tend to cost very little but are consumed in high volume. Examples include fasteners, springs, retainer rings, stampings, literature etc. However, it is important to note that C items can also be more expensive items that are rarely used. An example of a high-cost C item would be a $700 sub-assembly used only 5 times a year.
- Class C item inventory replenishment should be as automated as possible. C items should not demand attention and effort from material and procurement managers. Spending time managing C items means neglecting the much more critical A and B items. The enormous number of C items that most OEMs need on hand would quickly burn through labor hours if close tracking was maintained. Consider, that even spending merely 30 seconds per month managing each of 15,000 C items equates to 125 labor hours.
- Procurement managers should focus on reducing transactional activities associated with acquiring C inventory items. The tedious tasks associated with ordering and receiving parts orders – making the order, inspecting it upon arrival and delivering it to the necessary department – can end up costing significantly more than the direct acquisition cost of C items.
- While C inventory items tend to only account for 5% of total annual spend, unfortunately, they often represent up to 20% of on-hand inventory dollars due to the common tactic of overstocking C items to avoid shutdowns caused by stock outs.
Falcon specializes in designing, implementing, and managing a broad-range of inventory solutions to reduce lead time, cut costs, slash stock, boost cash flow, and improve productivity.
The Falcon team is here to address any questions or concerns you may have about properly conducting ABC inventory analysis. It’s what we do. If you’d like a FREE consultation call 1-800-438-0332 and ask to speak to a Strategic Coordinator.
In part 2 of this 3 part series on ABC Inventory Analysis we cover a step-by-step walk through of how to properly conduct an ABC inventory analysis.