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The ABC Classification is an analytical method to classify objects (Customers, Products, or Employees) based on a particular measure (Revenue or Profit). For instance, manufacturers can classify customers into three classes: A, B & C according to their sales revenue.
Following the Pareto principle, ABC classification subsequently focuses on the dynamic items contributing significantly to revenue. The goods should be considered necessary from a manufacturing, inventory management, revenue, and sales generation perspective.
Methodology for ABC Classification:
The ABC classification structure helps categorize which items in the warehouse are vital. Consequently, these items should utilize critical attention, management, and control. Under this method, the administration segregates the items into three categories: A, B & C, where A is the leading item, and C is the least valuable.
- A Items represent 10% of the total inventory. However, they are 70% of the total annual value.
- B items represent 20% of the total inventory. However, they are 20% of the total annual value.
- C items represent 70% of the total inventory. However, they are only 10% of the total annual value.
Prioritizing Inventory by ABC Classification Method:
- Item A:
Items categorized under A are goods that record the uppermost value in annual consumption. Interestingly, the top 70 to 80 percent of the company’s yearly consumption value derives from around 10% to 20% of the total inventory items. Therefore, prioritizing these items is crucial.
- Item B:
These items have a moderate consumption value. They amount to about 30 percent of the total inventory & account for about 15 to 20 percent of annual consumption value.
- Item C:
The items in this category have the ordinary consumption value & account for less than 5 percent of the annual consumption value derived from about 50% of the total inventory items.
Note: Formula for calculating annual consumption value (Annual demand) x (Item cost per unit).
How to Calculate ABC Classification?
To calculate ABC classification, follow the below steps:
Step 01: Data Collection & Preparation
02: Ranking by Quantity Sold
03: Prioritizing by Value of Sales
04: Segmenting by Frequency of Sales
05: Integration & Classification
Advantages of ABC Classification:
ABC classification offers several benefits:
- End-of-Life Management: Every product has a duration, so it’s sure to decline eventually. ABC analysis can help estimate product demand earlier and manage stock levels accordingly.
- Supplier Negotiation: ABC analysis can assist in negotiating with suppliers of the class A category since 70% – 80% of the funds consumption is on them.
- Supplier Relationship: Focus negotiation efforts on Class A items to maximize profitability. Negotiate not only on price but also on additional benefits like delivery services.
- Inventory Optimization: ABC analysis lets inventory planners systematize high-priority items to customer requirements.
- Strategic Pricing: Management will be able to regulate the prices strategically for products carrying more value to the company.
- Resource Allocation: Ensures that the company’s stock level is in line with customer demand.
- Customer Service: Allows planners to plant service levels based on product classification.
In conclusion, professionalizing ABC analysis in inventory management is indisputably a game-changer for any business. By categorizing items based on their value, volume & frequency of sales, the company gains invaluable insights that can revolutionize its supply chain strategies. Considerably, the benefits are diverse, from prioritizing premium stocks to optimizing resource allocation.
Additionally, with handy tools like SCMDOJO’s Inventory Optimization tool, the process becomes more accessible and productive. Embrace this powerful technique and watch as it leads to reduced costs, enhanced efficiency, and a thriving and more profitable supply chain. Start taking the initial step towards more competent inventory management today. Happy analyzing!!!
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