ABC analysis is an inventory classification method that helps warehouses focus attention on the items that matter most financially. It is based on the Pareto principle, where a small fraction of stock keeping units often accounts for most of the annual consumption value. By separating items into A, B, and C classes, managers can set different control rules for ordering, counting, storage, and security.
This improves service levels while reducing wasted labor and excess stock.
Key Facts
- Annual usage value = annual demand x unit cost.
- A items are usually about 10% to 20% of SKUs and about 70% to 80% of inventory value.
- B items are usually about 20% to 30% of SKUs and about 15% to 25% of inventory value.
- C items are usually about 50% to 70% of SKUs and about 5% to 10% of inventory value.
- Cumulative value percentage = running annual usage value / total annual usage value x 100%.
- Reorder point = demand during lead time + safety stock.
Vocabulary
- ABC analysis
- ABC analysis is a method for grouping inventory items by their importance, usually measured by annual consumption value.
- Stock keeping unit
- A stock keeping unit, or SKU, is a unique item identifier used to track a specific product in inventory.
- Pareto principle
- The Pareto principle states that a small share of causes often produces a large share of results, such as a few items creating most inventory value.
- Cycle counting
- Cycle counting is a regular process of counting selected inventory items to check accuracy without shutting down the warehouse.
- Inventory turnover
- Inventory turnover measures how many times inventory is sold or used during a period, often calculated as cost of goods sold divided by average inventory.
Common Mistakes to Avoid
- Classifying items by unit price only, which is wrong because a cheap item with very high demand can have a large annual usage value.
- Using the same control policy for A, B, and C items, which is wrong because high-value A items need tighter monitoring than low-value C items.
- Forgetting to update ABC classes, which is wrong because demand, prices, and product importance change over time.
- Treating C items as unimportant, which is wrong because stockouts of low-value parts can still stop production or delay customer orders.
Practice Questions
- 1 A warehouse uses 2,000 units of Item X per year, and each unit costs $15. Calculate the annual usage value and decide whether it might be an A item if the warehouse defines A items as the highest-value group.
- 2 Five items have annual usage values of 30,000, 6,000, and $2,000. Find the total annual usage value and the cumulative value percentage after the first two items.
- 3 A small bolt has low unit cost but is required to assemble every product shipped by a factory. Explain why ABC analysis should not be the only rule used to decide storage priority and reorder control.