I like the 80-20 Rule, others called it ABC Analysis, and I apply it at the Inventory Analysis. And How?
Lets look at the following scenarios: -
Item Ordered Frequency/Year Ordered Qty/Year Revenue
ABC : 2 / 5000 / $7500
PQR : 6 / 700 / $850
XYZ: 50 / 124 / $524
→ For ABC, its order frequency is low, but each ordered qty is huge, therefore, the total annual sales is high.
→ Item PQR is at the middle.
Questions are:-
- If we want to keep stock, which item we shall keep more stock? and Why?
- Which item will incur more inventory inaccuracy issue? and Why?
- Which item will suffer over shelf life most (assume that all items having same shelf life span)? and Why?
Q1. If we want to keep stock, which item we shall keep more stock? and Why?
a. About 1/3 of inventory executives I asked, they prefer to keep stock for Item ABC. Their arguments are:
- Item ABC contributed biggest revenue to the company. It is company’s most important product. Therefore more focus shall be given to the product and its buyers.
- Selling Item ABC is enough to survive the company, other products are not significant. Therefore, keeping stock for ABC is necessary.
b. About 2/3 of inventory executives I asked, they prefer to keep stock for Item XYZ. Reasons are:
- Even though Item ABC has contributed biggest revenue, but it happened 2 times only in the past. They doubted whether this will happen this year. Therefore, keeping more stock for Item ABC is very risky and it will incur more cash flow being tied up.
- Keeping stock for Item ABC will incur a lot of cost (inventory, space, management etc). It is very risky if customer didn’t buy it this year.
- Sales for Item ABC involves huge delivery quantity. Customer would not simply give an order without discussing with the supplier for their delivery capability. Therefore, supplier can formulate different delivery schedules to fulfill the order. Thus, no stock keeping is necessary.
- In contrast, Item XYZ is being purchased in low qty but very frequently. It means customers ask for it very frequently. Further more, to keep some stocks for Item XYZ would not tie up cash flow but can fulfill customer’s satisfaction. Therefore, why not keep some stock to satisfy the customers?
- Some executives even said — may be those customers who purchased Item XYZ is satisfied with the company’s service, therefore they purchased the Item ABC…
What do you think?
Q2. Which item will incur more inventory inaccuracy issue? and Why?
Most executives picked Item XYZ, because:
- higher frequency of movement will incur higher chances of errors if accumulated.
- goods movement for Item XYZ is much higher than the other 2 products. therefore its inaccuracy will be higher.
What do you think?
Q3. Which item will suffer over shelf life most (assume that all items having same shelf life span)? and Why?
I believe most of us will say: It is Item ABC. Because its moving frequency is low.
– Yes, mostly slow moving items will suffer over shelf life problem. Because items are kept at a place not being notice obviously and not being moved In/Out frequently. It will be neglected.
What do you think??
In fact, all above critical inventory management issues can be resolved if user utilizes the Pareto Analysis. How to do it?
For users who use the Chronos eStockCard inventory software, you would find out that the 80/20 rules has been applied in the Inventory Cycle Count practice — count by moving frequency.
After login to the system, go to Inventory > Cycle Count > Item Moving, you can click on the Info button beside it to find out how we group the Inventory items using 80/20 rules.
Operation data (IN and OUT) will be accumulated for 80/20 analysis. The more transaction data accumulated, the better the result will be achieved. User/readers can access to the software to experience this 80/20 application.