ABC-123 classification

Scale-Up Supply uses the ABC classification to provide a mechanism to assign targets and standardise management to a group of items while identifying an item's impact on inventory value, efficiency, and business targets. In this blog, we share the case of a trading company that improved its understanding of inventory status and target using the below steps.

1.  Item classification 

1. Set up the suitable classification

2. Understand the ABC-123 output

2. Inventory insight

1. Availability

2. Inventory turnover

3. Inventory value

3. Target setting 
   
   

Company Introduction

The trading company has about 2.000 SKUs in the assortment to serve its sales companies in Europe and Africa. Sales companies in different countries share various items, while each company also has its local customer requirements. All the sales companies are complaining about a delay in the order delivery, while the management is complaining about the high inventory value. Moreover, the warehouse needs to improve its efficiency. 

1. Item classification

With the ABC-123 tool, we dive immediately into the data by classifying the items. To do this, we need only the following data:

• Item code & description

• Item value

• Sales quantity over a period of time (6-24 months)

The classification can be customised based on the company. First, depending on the business and its goals, the classification can be made on volume, value, order lines, or variation in demand, depending on the business and the goals. Secondly, it can be that only four classes can be used (AB-12). And last, the parameters to define the classes can be updated. For this example, we use the following classification.

The tool groups the items and overviews the absolute and relative division. We can see that 31% of the items (A classified) are responsible for 80% of the sales quantity, while 17% of the items (1 classified) are responsible for 80% of the sales value. About 9% of the items are fast-moving and high-value (A1).

The tables show that the company has a relatively high share of fast-moving, low-value items (A3 classified). The biggest group is the slow-moving, low-value items, which is the case in most sales companies. The share of slow-moving, high-value items is the lowest, with only 2.5%

Next, the following tables show the division of the total sales quantity and average quantity per item. It gives us valuable insight into the total sales quantities per class. Moreover, the average item sales quantity will be helpful when improving the purchasing terms. 

Last, the following tables share information on the total sales value division and average sales value per item. The company had a turnover of 9.4 million euros, whereas 5.07 million was spent on A1 items. Although the high-value items category (C1) comprises only 2.5% of the items, the sales value is the highest per unit. The table on the right gives us an exciting insight into the average value per sold unit. 

2. Inventory insight

Now that the item assortment has been classified and understood, examining the inventory's health becomes interesting. To give us a first grasp, we examine three indicators: availability, inventory turnover, and inventory value. Inventory turnover can be shown in multiple ways; in this example, we used the average month on hand. 

Immediately, we recognise the complaints from the three sides of the business. 

• Availability of A1 items is low, while the average Month on Hand is relatively high.

• Most of the sales companies' complaints are likely due to the limited availability of the A1 items, as this is their bread and butter.

• As these items have a relatively high turnover, they must be available. Improving collaboration between the suppliers and the sales company is required. This could also lead to decreased inventory turnover, reducing the cash flow requirements. 

• Availability of fast-moving items with a low value (A3) is meagre

• Having low-value items in a warehouse handling them as efficiently as possible is necessary to make a profit out of them. A rupture will result in inefficient handling by putting pressure on the inbound and outbound departments.

• High inventory value of slow-moving items (C-items)

• Only 5% of sales turnover is made with 25% of the inventory value. Finding ways to decrease the inventory value for slow-moving items is necessary to improve the cashflow requirements. This can be done by, for example, lower minimum order quantities, improved forecasting, or short lead times.

3. Target settings

There is not one set of indicators for all companies, it depends on a lot of factors, internal and external, like customer expectations, supplier lead-time, purchasing power, business growth, and business requirements. Moreover, it is always recommended to balance customer satisfaction, inventory turnover, and cash flow requirements. In general, we will aim for the following goals:

Conclusion

As you can see, the ABC classification tool provided valuable insights into the trading company's inventory, highlighting the critical areas for improvement. By categorising items into A, B, and C classes, we identified that a small percentage of high-value items drives significant sales. In contrast, a large volume of low-value items affects efficiency and inventory turnover.

Key Findings:

1. Inventory Insights: Focus on high-value items (A1) for better availability and efficiency while addressing the handling of low-value items (A3) and reducing slow-moving inventory (C) to improve cash flow.

2. Actionable Targets: Align inventory strategies with business goals to balance customer satisfaction, turnover, and cash flow.

Using these insights, the company can optimise stock levels, enhance service, and improve operational efficiency.