In supply chain, ABC analysis is an inventory categorization method which consists in dividing items into three categories, A, B and C: A being the most valuable items, C being the least valuable ones. This method aims to draw managers’ attention on the critical few (A-items) and not on the trivial many (C-items). The ABC approach states that, when reviewing inventory, a company should rate items from A to C, basing its ratings on the following rules:
A-items are goods which annual consumption value is the highest. The top 70-80% of the annual consumption value of the company typically accounts for only 10-20% of total inventory items.
C-items are, on the contrary, items with the lowest consumption value. The lower 5% of the annual consumption value typically accounts for 50% of total inventory items.
B-items are the interclass items, with a medium consumption value. Those 15-25% of annual consumption value typically accounts for 30% of total inventory items.
The annual consumption value is calculated with the formula: (Annual demand) x (item cost per unit).
Through this categorization, the supply manager can identify inventory hot spots, and separate them from the rest of the items, especially those that are numerous but not that profitable.
Important Points on “ABC” Analysis
Whenever the items can be substituted for each other they should preferably be considered as one item. More emphasis should be given to the value of consumption and not to the cost per unit of item. While classifying as A, B and C all the items consumed on the organization should be considered together instead of considering them like spares, raw material, semi-finished and finished items and then classifying as A, B, C. The period of consumption necessarily is one year.
Inventory management policies
Policies based on ABC analysis leverage the sales imbalance outlined by the Pareto principle. This implies that...
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