ABC inventory classification

The ABC inventory classification is a technique for segment the product references in the warehouse according to their importance into three categories (A, B and C), following a criterion (for example, its inventory value) and based on the Pareto principle or 80/20 rule, according to which a small percentage of the references will be responsible for most of the global objectives of the store (inventory value, turnover, profits, etc.). This classification helps to make decisions and prioritize warehouse resources towards the products that have the greatest impact on the global objectives (those in group A), instead of focusing efforts and resources equally on all products, which would be counterproductive with the minor items (group C).

The ABC analysis to classify the inventory is included in the set of good practices of the SCOR model.

The ABC analysis consists of applying the Pareto principle or 80/20 rule to segment entities (products, customers, suppliers, etc.). It is typically applied in the warehouse environment to classify inventory according to its importance. Although different criteria can be followed (according to each warehouse and types of merchandise they handle), a typical criterion is the inventory value of each reference, calculated as its annual demand multiplied by its unit cost. Then, they are ordered from highest to lowest and grouped according to the percentage they represent with respect to the total. Thus, the resulting typical percentages will be:

• Category A: Around 20% of the references represent approximately 80% of the inventory value (80/20 rule).
• Category B: Around 30% of the references represent approximately 15% of the inventory value.
• Category C: Around 50% of the references represent only 5% of the inventory value.

These percentages are indicative, and will vary in each case, depending on the business sector, warehouse characteristics, turnover levels, etc. The main thing is to understand that a small percentage of the SKUs represent the majority of the inventory value, forming category A, and to which we will have to apply stricter inventory controls and allocate more resources.

For example, category A products would be the ones indicated for the best areas of the warehouse and closest to the dispatch area, using automatic storage systems such as miniload or the automatic order preparation through Disban H automatic dispensers. While category C products could be stored in less optimal areas of the warehouse with storage systems focused on maximizing the use of space, such as elevated walkways.

The ABC analysis must be updated periodically, since, depending on market trends, product life cycles, etc., over time there will be references that promote to a higher category while others will decline to a lower category.

Although the concept of ABC inventory classification may seem simple, in practice it may be necessary to use multiple categorization criteria. For example, expiration dates, merchandise replacement times, importance of customers, etc. It may also be necessary to perform a more detailed analysis, such as the ABC/XYZ analysis.

The ABC analysis is typical in the classification of inventories, but it is also applicable in other areas. For example, the Pareto principle will also be fulfilled if we carry out a customer analysis, so that, in general, 20% of customers will represent 80% of our billing, forming category A of customers. In the same way, it can be applied to suppliers, employees, processes, etc. The ABC analysis is a tool that helps to differentiate the essential from the less important. It can be used to detect bottlenecks in the application of the theory of constraints or to identify what is not essential in the implementation of Lean management philosophies.

Once the ABC analysis on the inventory has been carried out and it has been classified into the three categories A, B and C, supply chain management decisions are made based on these categories. Then, different inventory control strategies will be established depending on the importance of the different merchandise. This is why ABC analysis applied to inventory is sometimes called selective inventory control.

In an ideal world, all the products we stock would have the same demand and the same profitability and, therefore, we would manage them equally. But in practice a small percentage of referrals are responsible for the bulk of sales and profits. Therefore, it is not logical that we dedicate the same level of resources to all references equally (financial, personal, stock levels, replenishment frequency, storage space, maintenance tasks, inventory count, etc.). So we will have to apply stricter inventory management and control strategies to category A, while simpler systems that require less time and warehouse personnel will be applied to category C.

Category A products are the most important for the business, typically 20% of the references representing 80% of the value. Therefore, resources must be allocated so that its inventory control is more exhaustive and with more frequent cycle counts.

Since stock problems of category A products will have a great impact on the business, efforts should be made to avoid out-of-stock situations and combat phantom inventory.

For order preparation, it is recommended that slotting favor category A references. In addition, it is especially advantageous to implement automated storage systems that speed up order preparation as much as possible. In the case of palletized loads, through automated warehouses and the Sherpa radio shuttle system, thus achieving maximum storage density while optimizing maintenance tasks. In the case of medium and light loads, the miniload system and Disban H automatic dispensing can be used, which allow high-speed automatic order preparation.

Category B products have a moderate importance, intermediate between category A and category C. Typically they will be around 30% of the references, constituting 15% of the value.

It is important to keep track of B products, since some will be close to promoting to category A, while others will be close to declining to category C.

Order preparation can be streamlined using the ATOX Technological Solutions light-guided system for pick-to-light operations. In combination with the transport by intelligent rollers, the movements of the picking operators are minimized, obtaining great performance even though the slotting of category B products is less advantageous because it favors A items.

Category C products are relatively unimportant. Typically they will represent around 50% of the references but constituting only 5% of the value. They are low-profit products. It will even be questionable if it is worth keeping stock of some of these references.

It doesn’t pay to spend a lot of resources on your inventory control, as storage costs and operating costs could easily outweigh the low profitability of these products.

In order to make the most of the warehouse, it is advisable to use ATOX storage systems designed to measure to optimize storage space, such as mezzanines and elevated aisles.

The origin of the ABC analysis, which derives from the Pareto principle, dates back to the 50s, and would be incorporated into the production systems of the time in Japan, expanding internationally in the following decades hand in hand with Western philosophies of quality control and Japanese production systems efficiency oriented.

Traditional markets were for a long time based on mass production, launching products with long life cycles. But in the last two decades the global market situation has changed drastically, due in large part to the evolution and modernization of logistics and the explosion of electronic commerce.

Currently, product life cycles are much shorter and variations in demand are more unpredictable. But this has also allowed new business models to emerge that were unfeasible just a few years ago.

Thus, the main e-commerce companies that lead online sales today offer hundreds of thousands and even millions of references. Many of them are part of the Long Tail and fall into category C according to a classic ABC analysis. In other words, analyzed individually, these products show low profitability. But taking into account the global objectives, they provide great business value since offering an extensive product catalog plays a key role in customer acquisition and loyalty. In fact, a good part of the sales of these companies correspond to references that are not usually found in stock in physical stores.

For example, there may be C products that, from an inventory value point of view, might even be considered unprofitable to keep in stock. But they can be accessories to high-value A-grade products, which consumers often buy together. In cases like these, having these category C products prevents customers from going to the competition to also buy product A.

But how do you manage to make stores with so many different references profitable, many of them with very little stock? One of the pillars in the new supply chains is the optimization of warehouses. Here it is necessary to optimize both the storage space and the performance of maintenance tasks. This is one of the reasons why ATOX Storage Systems designs and manufactures a wide range of metal shelving systems, which make it possible to make the most of storage space, and which are combined with the automations of ATOX Technological Solutions to streamline maintenance tasks and minimize warehouse operating costs.

For example, the elevated walkways designed and manufactured by ATOX tailored to each warehouse, they can be combined with sections of roller conveyors with descent spirals, which allows maximizing storage space at height without sacrificing agility in handling, favoring the profitability of high quality products. category C

There are many more examples where ATOX storage solutions contribute to the profitability of warehouses: live racking designed to measure for WIP inventories in manufacturing plants, clad-rack warehouses with stacker cranes for large distribution centers, Disban H automatic dispensers for automatic order preparation at very high speed, light-guided for picking optimization through operations pickt-to-light, etc.

The roller transport system works in coordination with the rest of the ATOX automations, drastically reducing the distances that picking operators have to travel, also acting as sorters for the automatic classification of merchandise.

In addition to storage and order preparation, e-commerce warehouses must allocate resources to reverse logistics as a fundamental part of their business model. Consider, for example, how in recent years online sales of clothing and footwear have proliferated, in which returns, which are expected to be frequent, are offered as a free service to the consumer. Optimizing the tasks of warehouse personnel is key here, with solutions such as ATOX light guidance (which, thanks to its versatility, also allows put-to-light operations) and intelligent roller conveyors that integrate sensors and diverters.

In the future, as the technologies that allow the application of internet of things supply chains effectively, we will have real-time inventory controls and traceability, and artificial intelligence and machine learning techniques will be applied to make much more sophisticated and accurate inventory classifications.