ABC classification & ABC method
Advance your operations management by implementing ABC classification
What is ABC classification in operations management?
ABC classification is an effective way to identify critical goods within your organisations market offerings that generate the most value for your organisation. The goods should be classed as important from a manufacturing, inventory management, revenue, and sales generation perspective.
Products that are priority for manufacture runs and keeping in stock to meet sales demand are classified A. The next level of priority products are classified B and products that generate lower value for your organisation are classified C. This gives the whole supply chain awareness of critical products that should be available for sale to meet customer demand, lower performing items that can be delayed for production, or products that do not have to be always available for immediate despatch from stock.
What is the ABC method?
The ABC classification framework helps to identify which items in your warehouse are the most important. Therefore, these items should consume most critical attention, management, and control. Typically, the breakdown is as follows:
- A items represent 10% of total inventory lines but are 70% of the total annual value
- B items represent 20% of total inventory lines but are 20% of the total annual value
- C items represent 70% of total inventory lines but are only 10% of the total annual value
How is ABC classification calculated?
To calculate your ABC classification, you would need to look at historical sales data and forward forecasts to identify which 20% of your products generate 80% of your sales.
It’s recommended that you identify products that generate value NOT volume.
Example:
You may have an item that generates £100 profit per transaction and sell it infrequently yet have a second stock item that you sell in higher volume, but it only generates £1 profit per transaction.
At this point you can calculate the annual consumption value. This will then enable you to classify your products A, B or C.
Cost per unit x annual number of units sold = Annual consumption value
Why do we use ABC classification?
Not every organisation opts to use this classification for their product range. However, this can often lead to the organisation trying to ensure that they always have stock of their full product range, as ‘everything’ is classified as priority.
Any organisation that fails to plan and build in a classification system will not have effective control over its inventory management and therefore their cash flow. Classification enables focus on activity that surrounds critical stock lines and an increased level of effective stock management. This then reduces the impact of excess, end of life, or high volumes of phase-out products.
Some key benefits are:
- End of life management:
Every product has a lifespan, so it’s bound to decline eventually. ABC analysis can help forecast the demand for products beforehand and manage stock levels accordingly. - Supplier negotiation:
ABC analysis can help you to negotiate with suppliers of the class A category, since 70% - 80% of the money is spent on them. - Supplier relationship:
Suppliers of class A items need improved supplier relationship management to ensure collaborative relationships are achieved to protect supply routes.
- Inventory optimisation:
ABC analysis allows inventory planners to organise high priority items to customer requirements. - Strategic pricing:
You’ll be able to set your prices strategically for products which bring more value to the company - Resource allocation:
Ensures that your stock level is aligned with customer demand - Customer Service:
Allows planners to set service levels based on product classification
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