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Is your warehouse full of widgets wigging you out?  Not to worry, this simple ABC guide will help you implement and maintain an effective inventory management system. It allows you to identify your most valuable items and react accordingly to avoid stock outs and reduce excess inventory. 

Analyze

A simple ABC analysis will quickly and effectively inform you which widgets have the most impact on your business. Not all widgets are created equal, and the idea here is to bucket your inventory according to expected demand or value. These buckets will allow us devote an appropriate amount of time and energy to each bucket or type.

Start by looking at your future demand plan in weekly buckets. If your firm uses monthly buckets, simply divide the monthly demand by the number of weeks in the month. Your demand horizon will depend largely on the amount of variance in it. If you are in a fairly stable demand environment with little weekly variance, then a short horizon will do while a more volatile environment will require more time. I suggest no less than 8 weeks and no more than 26.

From here, take the total demand in units per item and multiply it by each item’s inventory value to determine its extended demand value (EDV) and rank them from top to bottom. You will also want to calculate your average weekly forward demand (AWFD) over the length of your horizon at this point. (We will come back to this.)

As you move from top to bottom by EDV, calculate a cumulative value until you’ve reached 80% of your total EDV. These are your ‘A’ SKUs or the ‘important few’. Following from there, the next 15% are your ‘B’ SKUs and the last 5% are your ‘C’ SKU’s or the ‘insignificant many’. To these, it is usually necessary to add two more categories, ‘D’ for discontinued and ‘E’ for any widget that has insufficient data to develop a dependable forecast – for example, a newly introduced widget. It’s important to point out that these %’s are not hard and fast rules. If there is a reason to delineate ‘A’ from ‘B’ at 75% such as a significant drop in demand at that point, then you should do so. Tailoring these designations to your business will be important in the next step.

Build

Build an inventory strategy for each widget type. Before we get too far into this I want to point out that we are going to discuss these strategies in general terms. Exactly how we get to our plan will require collaboration with our friends in planning and procurement.

‘A’ widgets are your most valuable and they will require the most time and investment. We need these important few to be in stock!  To do that, you will need to keep enough on hand to cover your order lead time plus your review time. You will want to review these no less than every other week. Your strategy will also need to include a safety stock buffer dependent on the volatility of your demand and the reliability of your supplier. To get to a quantity we will use our AWFD calculated previously. If your order cycle time is 4 weeks, you review your inventory every other week and you decide to keep 2 weeks of safety stock then you will need 8 weeks of inventory on hand at any given time. Multiply the AWFD by 8 in this case and you have your inventory target.

Repeat for ‘B’ widgets but with a less frequent review period and zero safety stock.  ‘C’ SKUs can be managed effectively with a quarterly ‘set and forget’ review. ‘D’ widgets require no review while ‘E’ widgets should be treated as ‘A’ until they are proven otherwise.

Consistent Review And Communication

Now that you have set the framework for your inventory management system, you will need to set a schedule of consistent review and communication. Your ABC Analysis should be done monthly, changing designation and strategy accordingly. Lastly, you need a quarterly review with your Supply Chain peers, Sales, and Product Development to determine disposition on ‘D’ widgets, rationalize the existence of ‘C’ widgets and determine when ‘E’ widgets can be treated as demand dictates.