A business owner asked me: how can I manage my company’s inventories more efficiently?
The business owner imported soap, luggage, and cell phones, in short: assorted merchandise. He shipped in and kept hundreds of items in inventory, in which he had trouble keeping track. Sometimes he had too many items in storage or had too few which quickly ran out of stock.
I advised the businessman to try an ABC inventory system.
An ABC inventory system classifies items under three (3) categories founded on Pareto’s Law. (Pareto’s Law otherwise known as the 80-20 principle states that 80% of outcomes stem from 20% of inputs).
In the ABC inventory system, I recommended to the businessman the following classification:
Another way of putting it:
Sales is the product of price times quantity sold (P x Q) so items in a Group could either be selling at high volumes at low prices or at low volumes at high prices:
An enterprise realises higher total sales as prices & quantities increase, and vice-versa if prices & quantities decrease.
Operations managers would treat each group (A, B or C) differently.
Group A inventories should be accurate and real-time. Operations teams should count Group A items at least once a day and reconciled with book balances or with reports derived from the company’s database. Procurement quantities & inbound logistics schedules should be based on what’s on stock, in-transit, and demand outlooks. There should also be policies for safety stocks and customer orders management.
Group B item inventories should also be accurate but need not be reviewed as often as that for Group A. Managers may schedule counting & reconciling of items less frequently such as once a month. Replenishment may be based entirely on reorder points. Purchasing managers have more leeway to order bigger bulk quantities to avail of offered volume discounts.
Group C items are items which require the least frequent inventory monitoring though this does not exempt storage facility staff to keep an eye on them. Group C items include items which are at the sunsets of their product cycles and hence headed for discontinuance and eventually, the scrap heap.
Group C items, however, may be significant in that they usually constitute half or a lion’s share of stock-keeping units (SKUs) and may take up significant, if not sometimes the most, storage space. Operations managers should ideally buy Group C items only to match any confirmed customer orders and at the same time, keep stock levels low, if not wind down inventories.
The business owner took my advice and tried the ABC system.
After a few months, he reported that challenges remain but at least he was able to bring some formal control to his company’s inventories. Staff had more clarity on which items to count more frequently (Group A) versus those which they didn’t have to as often (Groups B & C). Staff also had a better idea which items needed more marketing (Group C). And the owner had a better handle of planning how much to buy & stock such that he could control his working capital.
Enterprise owners can vary the ABC to suit whatever needs they deem fit. There can be more than three (3) categories [e.g., ABCD] or even just two [AB]. Managers may use other criteria such as turnover (inbound & outbound quantities), total delivered cost of goods, or value of purchases, rather than the standard value of sales.
The point is to use what works best for one’s business.
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