ABC-analysis

Defeat your assortment demons and go beyond the 80:20 rule

Defeat your assortment demons

5 Steps to help you redefine your approach to inventory

It is no secret that for many businesses, 80% of the turnover is generated by just 20% of the assortment. Given that such a large proportion of the assortment seemingly offers such little value to the business, you would be forgiven for focusing all of your attention on the best performing lines. However, inventory decisions should not be taken lightly and businesses should strive to manage their entire assortment as effectively as possible.

How can you maximize the performance of your assortment while minimizing unnecessary costs? This article highlights 5 top tips to help boost the profitability of your assortment, minimize risk and help you manage your inventory more effectively.

Striking the balance

Unless you have a complete understanding of your assortment, how can you be sure that you are making the right inventory decision? After all, while a slow moving line may seem like a costly waste of space in your DC, for certain customers, these items could well be the main reason they buy from your business. Equally , if an item offers only a minimal return in terms of customer benefit or profit, is it worth investing time and money ensuring this item is always available?

Although overall availability is seen as one of the key performance indicators when it comes to inventory management, supply chain managers have to draw a line somewhere. Through finding the balance between investment in inventory and service levels, businesses can exploit the laws of Pareto principle in order to adopt a more proactive approach to managing the entire assortment.

The right criteria for the right classification

Should a slow moving item really be managed the same way as a fast moving line? When you consider that every item will have a unique demand pattern and margin, applying the same inventory strategy across the entire assortment is neither profitable nor logical.

This is where inventory classification comes in: through categorizing items depending on their strategic importance to your business, you can begin to adopt a more tailored approach to manage each category. This in turn enables you to focus resources on the areas which require the most attention.

For many businesses, a well-structured ABC analysis can provide the insight required to categorize items effectively. While the process on conducting an ABC analysis allows you to gain a greater understanding of the assortment, it is essential that the parameters of the analysis are well aligned with the business’ overall objectives. Furthermore, it is also important that it is clear who has the final say on what parameters should be used and that these are well communicated with the business’ decision makers. After all if your business is focused on customer satisfaction, categorizing items by margin alone will do little to help the business achieve its goals.

How you define the boundaries within your assortment will depend heavily on what KPIs are most important to your business. Essentially, there are two main objectives which determine the KPIs: on one hand the focus can be on the profit margins of an item or the turnover. Alternatively however, the financial elements can be put to one side and customer satisfaction in the form of order lines or transactions can be used as the foundation on which to build KPIs. However, in addition to this, the following questions must also be raised when determining which category each item falls into:

  • What items should be included? Which items should not be grouped?
  • What are the basic criteria for ABC analysis?
  • Dynamic or static? How often should ABC be recalculated?

How much do you really know about your assortment? Do you know which items offer the greatest return or which are most important to your customers? Equally, do you know which items are costing you money? This article highlights 5 top tips to help boost the profitability of your assortment, minimize risk and help you manage your inventory more effectively.

Acting on insights

Once the boundaries of an ABC analysis have been defined and agreed upon, your assortment can be categorized into different groups depending on strategic importance. From service levels to stocking decision, the insights provided by the ABC analysis should be used as a driving force to shape your assortment and optimize the performance of all your items.

Here are 5 steps you can adopt today to help reduce inventory levels, increase availability and ultimately help ensure your business achieves its overall corporate goals.

Step 1: Differentiate your service level

In the context of assortment management, a service level is the target % of all ordered pieces of an item that can be delivered from stock at the first requested delivery date. Given that A-line items are those which are most important to the business, whereas C-line items are likely to be slowing moving items which offer a much lower return, there is little point in setting the same service level targets.

For A-line items, the service level target should be the highest of the three categories. On the other hand, considering that B and C class items are likely to have a lower overall impact on your business’ strategic goals, setting an excessively high service level target could result in unnecessarily costs yet deliver only a small return. As a consequence, it is essential that service levels are considered carefully in order to ensure that they are both realistic and relevant to the goals of the business.

Step 2: Determine the right stock levels

Once you have defined the desired service level for each classification, you can continue to re-assess your inventory policy. Given that the level of insurance inventory will differ depending on the importance of each item, it is enviable that A-line items are likely to have a greater requirement for safety stock as going out of stock could cost the business dearly.

However, this is not simply a case of investing heavily in safety stock for your best performing lines while ignoring C-line items. While insights from a well-structured ABC analysis can be used to guide a differentiated approach to service levels, there are still a number of factors that have to be taken into account. For instance, could certain items have a political impact on the business which require special attention? Or are there already contractual or customer obligations in place?

Through carefully considering the inventory requirements of each category, your business can optimize stock levels in order to ensure that, where required, demand is covered with safety stock while cutting excess stock across the rest of the assortment.

Step 3: Make more informed stocking decisions

In addition to optimizing inventory levels, the insights from conducting an ABC analysis may identify further opportunities to refine the assortment. For instance, some C line items may actually not be worth stocking at all as they simply do not offer a significant enough margin to justify holding on stock. Alternatively, there may be a number of items which are currently non-stocked which would actually be better to keep stocked at all times. This is particularly true for items where there is either a lengthy lead time or low level of supplier reliability.

Through utilizing the insights from an ABC analysis to decide whether or not to change the stocking status on an item, you can boost customer satisfaction by ensuring the most important items are readily available. Equally, through using such insights to refine your assortment, you can remove items which do not contribute towards achieving the overall business goals. This in turn can help free up working capital which can then be reinvested elsewhere in the business.

Step 4: Optimize here, optimize there

With clear insight into which items have the biggest impact on your ability to achieve your strategic goals, you can prioritize areas which require the most attention. Whether this means taking time to re-negotiate lead time or order quantity with suppliers or develop more effective means of managing such items, the outcomes of the ABC analysis will aid you when structurally improving the way you manage your inventory.

When you consider that your A-line items are likely to be the best performing lines, negotiating more favorable lead times, or even better prices, could have a major impact. Likewise, for items which you identify as slow movers, the opportunity may arise to negotiate a smaller order quantity which in turn will result in you holding less stock.

While on an article level, these relatively minor developments may only seem to have a small impact, across the entire assortment, these can soon add up. In turn, such action can help improve overall availability, reduce inventory cost and generally improve efficiency across the board. Through utilizing the ABC analysis, you can clearly see exactly where you need to prioritize time and resources in order to deliver the most value to the business.

Step 5: Monitor, report, review

Given that the previous 4 steps could have large potential impact on the performance of your business, it is important to monitor the effectiveness of inventory decisions in order to ensure you are moving in the right direction.

While overall stock value or overall availability could be used to compare year on year performance, unless you dig a little deeper, you will not be able to identify exactly which aspects of your assortment are performing well and which require more attention. Given that the service levels for each category are likely to be driven by very specific objectives, categorizing items according to ABC classifications is a powerful way to monitor the evolution of your assortment.

Through reviewing each category that arises as a result of the ABC analysis, you can gain a much clearer picture of how your assortment is performing. Consequently, this provides you with time to investigate potential problem areas and respond accordingly. Furthermore, these categories provide a solid basis on which to report such developments to other areas of the business.

Published by Slimstock, market leader in forecasting, demand planning, and inventory optimization

Since 1993, Slimstock has been synonymous with better demand forecasting, effective inventory optimization, clearer inventory analysis and continuous improvement of inventory reliability. Our customer base consists of over 650 companies worldwide, across a diverse range of industries, covering large, medium and small enterprises.

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