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ABC, XYZ Classification

ABC inventory classification is a framework that categorizes inventory items into three groups - A, B, and C - based on their value to the business. Category A items account for the most value while Category C items account for the least. This allows companies to prioritize managing the higher value Category A items above the lower value Category C items. While ABC analysis provides a simple way to prioritize workload, it has limitations of being static and one-dimensional. XYZ analysis can be introduced alongside ABC to further segment items based on variability of demand.

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AbhayVarunKesharwani
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333 views

ABC, XYZ Classification

ABC inventory classification is a framework that categorizes inventory items into three groups - A, B, and C - based on their value to the business. Category A items account for the most value while Category C items account for the least. This allows companies to prioritize managing the higher value Category A items above the lower value Category C items. While ABC analysis provides a simple way to prioritize workload, it has limitations of being static and one-dimensional. XYZ analysis can be introduced alongside ABC to further segment items based on variability of demand.

Uploaded by

AbhayVarunKesharwani
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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ABC classification

What is ABC inventory classification?


ABC inventory classification or ABC analysis is used by inventory management
teams to help identify the most important products in their portfolio and ensure they
focus on managing them above those less valuable. The ABC classification
framework is based on the theory that all inventory is not of equal value. Instead it
follows the Pareto Principle, where 20% of stock accounts for 80% of the value to the
business. Using ABC classification you can therefore split inventory into three
categories, A, B and C.

Category A: this is the smallest category and consists of the most important
stock items
Category B: will generally be slightly larger in terms of volumes of SKUs and
will usually be made up of products of less value
Category C: this will typically be the largest category where products will
contribute the least to your businesses bottom line.

Your inventory’s ‘value’ can be defined based on a number of criteria, such as


annual sales revenue, profitability or annual consumption value.

The graph below illustrates how 80% of a company’s sales revenue comes from
20% of their stock items.

 
ABC classification calculation – an example
Here is a working illustration of how to divide up your inventory, using annual
consumption value.

1. Use the formula ‘annual number of units sold x cost per unit’ to calculate the annual
consumption value of each item.

Annual number of units sold (per item) x cost per unit

2. List your products in descending order, based on their annual consumption value

AND

3. Total up the number of units sold and the annual consumption value
4. Calculate the cumulative percentage of items sold and cumulative percentage of the
annual consumption values

5. Determine the thresholds for splitting the data into A, B and C categories. The threshold
for determining the ABC split will be unique to your company and your product mix, but
typically it’s close to 80% / 15% / 5%.
How to put your data to good use
With the calculations complete, you can use your final data to review how you
currently manage the inventory in each category. If you find that you’re treating all
items the same, in terms of the stock you hold and the purchases you make –
regardless of their category – then you’re most likely to have inefficient inventory
policies. This means you’re probably over and under ordering on many product lines.

The good news is that there’s plenty of room for improvement! And this will bring
about reduced storage, delivery and management costs.

Good practice is to adapt your purchasing and inventory policies for each group. This
could include setting up sophisticated ordering processes for all A items, such as
checking every purchase order and spending more time discussing lead times with
suppliers to guarantee best value and timely deliveries.

In contrast, C items should take up much less of your time and could be ordered
automatically to save valuable human resource.

XYZ analysis
ABC analysis can be very beneficial as a simple way to prioritize your workload and
help reduce the hours spent ordering and managing inventory.

However, there are limitations of the model. For starters, ABC classification is
arguably over simplistic, due to the categories being static (unless regularly reviewed
to allow items to move between groupings) and the evaluation criteria being one-
dimensional.

To help overcome these issues it’s possible to introduce XYZ analysis.

XYZ analysis is a framework to classify products based on their variability of


demand.

X-items = regular demand

Y-items = strong variability in demand

Z-items = very irregular and difficult to predict demand

This means you can segment items based on their forecast ability e.g. the likelihood
that their demand will vary from their forecast.

Adding another level of insights to your inventory classification model allows you to
make more informed ordering and stocking decisions. For example, it makes sense
to treat AX items that are valuable and have a constant demand differently to AZ
items with erratic demand. If demand is steady and easy to predict (X items), your
safety stock levels can be much lower than products where demand is much more
volatile (Z items).

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