All the benefits of the ABC method to optimize your inventory management

What is the ABC method?

The ABC method is a classification and organization method products in a warehouse according to their importance to their business .

This is measured in terms of economic value, contribution to sales, benefits or turnover.

History of the method

The ABC method has its origins in the 80/20 rule or Pareto's law. This is based on the principle that a small portion of the whole (20%) contributes to a large portion of the results (80%).

Applied to inventory management, it implies that 20% of total stocked products would generate 80% of the company's profits.

Inspired by this principle, the ABC method involves prioritize high-value-added goods and higher turnover .

This method aims to optimize the organization of the warehouse, the inventory system and the allocation of resources, rather than organizing them according to weight or size, for example.

Prioritization criteria may, however vary according to the company's specific needs.

In accordance with the Pareto principle, the company's goods are segmented into 3 categories: A, B and C. A being the class of products deemed most important according to the chosen importance criteria.

Class A: high-value or high-turnover products

Within the framework of the ABC method, Class A categories are for the company.

They represent only 20% of the inventory, but they generate a major part of the company's profits. They are also affected by by the highest rotation.

As such, Category A products also require the company to concentrate resources in their management .

They need to be checked periodically and frequently. The company needs to be aware that, given their importance, any stock-outs or inventory problems in this product category can also potentially produce heavy losses for the company.

Similarly, their location in the warehouse must also be designed so as to fast access and streamlined order-picking processes .

Category A products must be placed in easily accessible areas, close to loading units or shipping area . This optimizes loading and unloading times for orders.

Class B: products of medium value or moderate turnover

Category B products have moderate size and rotation . They represent around 30% of the company's inventory and generate no more than 20% of profits.

They also require periodic monitoring and control, but less frequently than with A categories .

Their management should not exceed the workload devoted to A categories. In fact, as they are an intermediate category, their transfer to either category A or C should be considered.

In the warehouse, they are placed in easily accessible areas, once the best locations have been allocated to categories A .

Category B products are therefore placed in locations at an intermediate level compared with category A products.

Class C: low-value or slow-moving products

In the ABC model, category C products are the most numerous in the company's inventory . They account for more than 50% of total references. However, they are also the ones lowest impact on company revenues (just 5%) and rotation is slowest .

In other words, these are the least ordered items, which explains their slow turnover.

As a result, the resources devoted to their management must also be kept to a minimum. Their control should only be avoid worries about expiry or obsolescence.

The C categories are, moreover, stored in areas of lesser accessibility The plants are located at various distances from the shipping zone.

The company will even have to periodically assess whether these products are worth allocating resources to their storage. The costs involved must not outweigh the benefits generated.

The advantages of the ABC method

The ABC method offers the following advantages:

Optimize management of priority products

The ABC method makes it possible to manage inventory by priority by prioritizing products with a high contribution to the company's revenues.

This makes it possible to focus more effort on managing products offering the highest added value.

Reduce storage costs

The ABC method cuts storage costs limiting management costs for products that have little impact on the company's profitability .

Efficient resource allocation

Thanks to the defined order of priority, the company can better choose the products to which it can allocate its resources. The idea is to balance the resources allocated with the level of importance of each product reference.

Disadvantages

Despite its advantages, the ABC method also presents certain constraints and risks.

It requires regular analysis of the categories

The ABC method is dynamic, not static. It is based on regular, rigorous data analysis .

Product categorization must be revised and adjusted periodically to reflect company realities .

Without this, the ABC method and the prioritization efforts it implies would lose all their effectiveness.

As a result, the application of the ABC method requires rigorous monitoring and constant readjustment to be fully effective.

Risk underestimating certain products

As you can see, the ABC method is based on a system of prioritizing items to adapt inventory management according to their importance.

With this in mind, C categories are considered products with a low impact on the company's revenues. For this reason, we limit the efforts and resources allocated to their management.

Without an effective strategy, you run the risk of underestimating products with a certain impact.

5 methods for classifying products using the ABC method

We have seen that the ABC method consists of classify products according to a specific order of priority.

However, prioritization criteria can vary from one company to another, depending on the sector, the company's needs and the type of goods involved.

This means that there is no ideal universal classification system that can be transposed to all companies. All you have to do is choose the one that best suits the realities of your business.

There are 5 possible grading modes:

Classification by total value of products in stock

Product classification is done by taking into account the total value of products stocked for each part number . In other words, it's the unit cost multiplied by the number of units that is taken into account here.

In this case, category A includes products with the highest total cost, and category C the lowest.

This is a complex classification system, as it requires carry out continuous stock control and update A, B and C categories on an ongoing basis according to the flow of goods in and out of the warehouse.

Classification by unit value of each product

Unlike the previous classification method, this method involves taking into account the value of each product In other words, its price or cost per unit. The most important products are those that produce the greatest financial impact per unit.

Category A products are those with a higher unit value and a significant impact on the company's revenues.

Ranking by product rotation frequency

In this model, products are classified as category A, B or C. according to the frequency of their rotation in the warehouse.

The products that generate the most movements and orders are classified in category A, while those least in demand are in category C.

Ranking based on unit storage cost

Product storage generates costs. Classification by unit storage cost means that products are classified as follows in terms of storage costs.

Thus, products with the highest costs are classified in category A, and those with the lowest costs in category C.

This model is suitable for companies that stock products with very different storage costs.

Ranking of products by strategic importance

This is the most effective ranking method because it takes into account several criteria at once:

• Product value

• Rotation or demand level

• Added value

It combines the advantages of all previous ranking methods, using all these different criteria. It can be made even more effective by adding other relevant criteria, such as a product's profitability.

Category A products are those in greatest demand, with high turnover and high added value for the company.

How do I get started using the ABC method for inventory management?

Here is the 3-step guide to start applying the ABC method to your inventory management system:

Identify high-value products with sales data

Applying the ABC method requires collect and analyze inventory data . The very first thing to do is to gather the necessary data for each item in the stock:

• Quantity available

• Annual consumption

• Unit value

You can obtain this data by extracting it from your inventory management software.

Once this data collection has been completed, you can take the following steps:

• Calculate the annual value of each item . To do this, multiply the annual quantity consumed by the unit value.

• List items by annual value by placing those with a higher annual value at the top of the list. This will help you to identify high-value products at the top of the list.

Categorize items according to profitability and costs

Referring to the list of products drawn up in the previous step, you will can calculate the cumulative contribution of products by adding up the annual values of each item .

To better apply the Pareto principle, consider expressing this contribution in percentage terms:

• Category A products account for 80% of total inventory value, but only 20% of items in terms of units.

• Category B represents 15% of total value and 30% in number of units

• C categories account for only 5% of the total value but 50% of the items.

Set up indicators to monitor category performance

The ABC method is designed to optimize inventory management, optimizing costs and order processing . The categorization of articles should help achieve this objective.

That's why it's important to set up performance indicators which will enable us to evaluate the effectiveness of the classification method used. The KPIs chosen should reflect the specific objectives of each category:

• Categories A . The objectives are to minimize stock-outs, optimize costs and maximize product availability.

• Category B . The aim here is to balance cost and availability.

• Categories C . These are products of lesser importance to the company. The aim here is to reduce storage costs.

With these objectives in mind, you can monitor and analyze the following KPIs:

• Availability rate

• Inventory values by category

• Out-of-stock rate

• Storage costs by category

• Obsolescence rate

• Etc

Think about use inventory management software (ERP or WMS) to automate the calculation of indicators and analyze them periodically via the tool's dashboard.

Depending on the results, you can adjust your strategies and reallocate A, B and C categories as you go along.

In short, the ABC method optimizes inventory management by categorizing items according to their importance. The result is a better allocation of resources and a reduction in storage costs. The key, however, is to analyze the data carefully, categorize products accordingly, monitor the relevant KPIs and constantly adjust your strategies to ensure full efficiency. ABC method.