Operations Management / Supply Chain Management

Module 10.01 Key Concepts: Managing Inventory and ABC Inventory Analysis and Control

We will cover item inventory management in a subsequent section but will deal with some practical inventory management processes here.

ABC Inventory Control is useful in the establishment of the importance of an item and then establishing relevant control criteria for how much should be ordered at a time, how often should an order be placed, and how often should an item be counted in the Cycle Counting process used in Warehouse Management.  ABC Analysis divides inventory into three classes, usually based on annual dollar volume.

  • Class A – high annual dollar volume
  • Class B – medium annual dollar volume
  • Class C – low annual dollar volume
It is used to establish policies that focus on the few critical parts and not the many trivial ones.

ABC Inventory Control is based on the basic premise (attributable to Pareto Analysis) that 20% of the items will account for 80% of the total $ usage (A Items); 30% of the items will account for 15% of the total $ usage (B Items); and the remaining 50% of the items will account for 5% of the total $ usage (C Items).   Now, these are just theoretical examples that will differ with real life situations.  However, the general premise seems to hold true quite often.

An example of ABC Inventory Analysis is presented in the text for ten different items.  The annual usage in units and the item cost are shown in the first table.  This information is used to calculate the total annual $ usage for each.  In the second table the items are sorted in descending order of total annual $ usage.  Cumulative usage is easily calculated down through the table.  From this information and the simplified Pareto type classification scheme, the items can be classified as A, B, or C.

ABC Analysis can rely on other criteria than annual dollar volume such as high shortage or holding cost, anticipated engineering changes, delivery problems, or quality problems.  The process is useful to provide more emphasis on supplier development for A items, tighter physical inventory control for A items and more care in forecasting A items.

In general, from an inventory management perspective, a company might keep large amount of “C” items on hand because the value of items is usually not worth the extra control to keep inventory accurate.  On the other hand, high degrees of control should be used for “A” items.   This is intuitively obvious from an inventory accuracy perspective.  “A” Items are fast moving and thus require many transactions.  Each transaction provides an opportunity for an error.  “C” Items on the other hand are slow moving with infrequent transactions.

Inventory Record Accuracy is critical to any organization.  To ensure accurate inventory data, incoming and outgoing record keeping must be accurate and stockrooms should be secure.  It is also important to make precise decisions about ordering, scheduling, and shipping.  Annual inventories can be used to evaluate inventory accuracy and correct data records.  However, there is a better process that can be used to improve processes and reduce the generation of inventory errors long-term.  This is the process of Cycle Counting.

Cycle Counting is a process where items are counted and records updated on a periodic basis.  It is often used in conjunction with ABC analysis.  “A” Items are counted frequently and “B” and “C” Items are counted less frequently respectively (see example below).  Cycle Counting has several advantages over and annual inventory process.  Cycle Counting eliminates shutdowns and interruptions and eliminates annual inventory adjustments that are often plagued with errors.  Cycle Counting relies on trained personnel to audit inventory accuracy and drives for the identification of the causes of errors to so that they can be corrected.  Of course the process also maintains accurate inventory records.

Inventory is just as important to Service Businesses as Product Producing Businesses.   Inventory can be a critical component of profitability. Inventory losses may come from shrinkage or pilferage.  Inventory accuracy can be facilitated in Service Businesses by good personnel selection, training, and discipline; tight control of incoming shipments; and effective control of all goods leaving facility.