ABC analysis

In materials management, the ABC analysis (or Selective Inventory Control) is an inventory categorization technique. ABC analysis divides an inventory into three categories- "A items" with very tight control and accurate records, "B items" with less tightly controlled and good records, and "C items" with the simplest controls possible and minimal records.

The ABC analysis provides a mechanism for identifying items that will have a significant impact on overall inventory cost,^[1] while also providing a mechanism for identifying different categories of stock that will require different management and controls.

The ABC analysis suggests that inventories of an organization are not of equal value. ^[2] Thus, the inventory is grouped into three categories (A, B, and C) in order of their estimated importance.

'A' items are very important for an organization. Because of the high value of these 'A' items, frequent value analysis is required. In addition to that, an organization needs to choose an appropriate order pattern (e.g. ‘Just- in- time’) to avoid excess capacity. 'B' items are important, but of course less important than 'A' items and more important than 'C' items. Therefore, 'B' items are intergroup items. 'C' items are marginally important.

ABC analysis categories

There are no fixed threshold for each class, different proportion can be applied based on objective and criteria. ABC Analysis is similar to the Pareto principle in that the 'A' items will typically account for a large proportion of the overall value but a small percentage of number of items.^[3]
Example of ABC class are

‘A’ items – 20% of the items accounts for 70% of the annual consumption value of the items.
‘B’ items - 30% of the items accounts for 25% of the annual consumption value of the items.
‘C’ items - 50% of the items accounts for 5% of the annual consumption value of the items.

Another recommended breakdown of ABC classes:^[4]

"A" approximately 10% of items or 66.6% of value
"B" approximately 20% of items or 23.3% of value
"C" approximately 70% of items or 10.1% of value

ABC analysis in ERP packages

Major ERP packages have built in function of ABC analysis. User can execute ABC analysis based on user defined criteria and system apply ABC code to items (parts).

Example of the application of weighed operation based on ABC class

Actual distribution of ABC class in the electronics manufacturing company with 4051 active parts.

Distribution of ABC class
ABC class	Number of items	Total amount required
A	10％	70％
B	20％	20％
C	70％	10％
Total	100％	100％

Using this distribution of ABC class and change total number of the parts to 14213.

Uniform purchase

When one applies equal purchasing policy to all 14213 components, example weekly delivery and re-order point (safety stock) of two-week supply assuming that there are no lot size constraints, the factory will have 16000 delivery in four weeks and average inventory will be 2.5-week supply.

Application of weighed purchasing condition
Uniform condition		Weighed condition
Items	Conditions	Items	Conditions
All items 14213	Re-order point=2 week supply Delivery frequency=weekly	A-class items　200	Re-order point=1 week supply Delivery frequency=weekly
		B-class items 400	Re-order point=2 week supply Delivery frequency=bi-weekly
		C-class items 3400	Re-order point=3 week supply Delivery frequency=every 4 weeks

Weighed purchase

In comparison, when weighed purchasing policy applied based on ABC class, example C class monthly (every four weeks) delivery with re-order point of three-week supply, B class bi-weekly delivery with re-order point of 2 weeks supply, A class weekly delivery with re-order point of 1 week supply, total number of delivery in 4 weeks will be (A 200x4=800)+(B 400x2=800)+(C 3400x1=3400)=5000 and average inventory will be (A 75%×1.5weeks)+(B 15%x3 weeks)+(C 10%×3.5 weeks)=1.925 week supply.

Comparison of "equal" and "weighed" purchase (4 weeks span)
ABC class	No of items	% of total value	Equal purchase		Weighed purchase		note
ABC class	No of items	% of total value	No of delivery in 4 weeks	average supply level	No of delivery in 4 weeks	average supply level	note
A	200	75%	800	2.5 weeks	800	1.5 weeks^a	same delivery frequency, safety stock reduced from 2.5 to 1.5 weeks^a, require tighter control with more man・hours.
B	400	15%	1600	2.5 weeks	800	3 weeks	increased safety stock level by 20%, delivery frequency reduced to half. Fewer man-hours required.
C	3400	10%	13600	2.5 weeks	3400	3.5 weeks	increased safety stock from 2.5 to 3.5-week supply, delivery frequency is one quarter. Drastically reduced man・hour requirement.
Total	4000	100%	16000	2.5 weeks	5000	1.925 weeks	average inventory value reduced by 23%, delivery frequency reduced by 69%. Overall reduction of man・hour requirement

^a) A class item can be applied much tighter control like JIT daily delivery. If daily delivery with one day stock is applied, delivery frequency will be 4000 and average inventory level of A class item will be 1.5 days supply and total inventory level will be 1.025 week supply. reduction of inventory by 59%. Total delivery frequency also reduced to half from 16000 to 8200.

Result

By applying weighed control based on ABC classification, required man-hours and inventory level are drastically reduced.

Alternate way of finding ABC analysis:-

The ABC concept is based on Pareto's law.^[5] If too much inventory is kept, the ABC analysis can be performed on a sample. After obtaining the random sample the following steps are carried out for the ABC analysis.

Step 1: Compute the annual usage value for every item in the sample by multiplying the annual requirements by the cost per unit.
Step 2: Arrange the items in descending order of the usage value calculated above.
Step 3: Make a cumulative total of the number of items and the usage value.
Step 4: Convert the cumulative total of the number of items and usage values into a percentage of their grand totals.
Step 5: Draw a graph connecting cumulative % items and cumulative % usage value. The graph is divided approximately into three segments, where the curve sharply changes its shape. This indicates the three segments A, B and C.

References

↑ Manufacturing planning and control systems for supply chain management By Thomas E. Vollmann
↑ Lun, Lai, Cheng (2010) Shipping and Logistics Management, p. 158
↑ Purchasing and Supply Chain Management By Kenneth Lysons, Brian Farrington
↑ Best Practice in Inventory Management, by Tony Wild (2nd Ed., p. 40)
↑ Pareto's law in this example is that a few high usage value items constitute a major part of the capital invested in inventories whereas a large number of items having low usage value constitute an insignificant part of the capital.

External links

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