ABC Inventory Analysis and Inventory Costs Reduction

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Introduction

ABC analysis is one of the most effective tools used in materials management. It involves the characterization of the inventory into three different classes based on the unit costs and the quantity of stock held within a given period (Heizer & Render, 2011). These classes can be described as

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  • Class A: This class is made up of the most valuable items. They make up 10%-20% of the total inventory items and account for 70%-80% of the total inventory costs.
  • Class B: This class is made up of moderately expensive items. These materials account for 20%-30% of the total inventory costs.
  • Class C: The items in this class account for 5% -10% of the total inventory cost. However, this class has the largest number of items in the inventory record. Typically, 50-60% of all the inventory items fall in this class.

Inventory Control Using ABC Method

The ABC inventory control technique was used to analyze 25 items in one of the production lines of a given company. The total inventory cost for this line was about 2.5 million. Table 1 below shows the classifications of the different items based on the ABC analysis.

Class Item number Total number of items % of items in category Value in each category % value for each category
A 20,18,12,9,14 5 20% 2048250 81%
B 21, 4, 16, 15, 22, 25 6 24% 349750 14%
17, 23, 24, 5, 13, 11, 2, 7, 10, 19, 3, 6, 1 8 14 56% 120075 5%
Totals 25 100 100%

Table 1: classifications of items.

From table 1, it can be seen that category A items are only 20% of the total inventory but account for 81% of the total inventory costs, category B contributes 14% of the inventory costs while category C contribute only 5%. Also, 56% of the total inventory items are classified in Class C.

Strategies for Reducing Inventory Costs

Class a Items

These items have the greatest impact on the inventory. The following strategies can be used to minimize their costs:

  • Ensure tight inventory control: These items require adequate control such that the minimum and maximum inventory levels are identified and maintained. This reduces the total inventory costs.
  • Reorders: Reorders for items in class A should be done frequently to avoid situations where the company runs out of stock. This is because these items play a significant role in the production process.
  • Requirement: The exact quantity of these materials should be ordered all the time. This reduces costs associated with poor inventory techniques. Excess materials may deteriorate reducing the quality of the final product. Increased inventory also results in to increase in storage, insurance, inspection, and material handling costs.
  • Cycle counting: Materials in class A require regular counting so as to maintain proper records and avoid inventory errors. These materials should be counted more frequently as compared to those in classes B and C.
  • Investigate potential stocking alternatives: Studies to identify other stocking arrangements, as well as means of reducing transport and warehousing cost, should be done to these materials to reduce the overall cost.
  • Use the Just in time (JIT) principle. JIT technique can be used to control material ordering in this class. Only the quantity required at a given period should be purchased. This minimizes materials wastage and warehousing costs.
  • Frequent reviews: It is necessary that frequent reviews are carried out on these materials. Demand requirement and order quantities should be evaluated and any changes recorded and implemented as these materials play an important role in the production process. Such reviews enable the management to track changes in the stock requirement and adjust them saving on inventory costs.
  • Reduced lead times: since these items are ordered frequently, ways of reducing lead times should be determined. This prevents delay in delivery of materials which results in production schedule disruptions.

Class B Items

These inventory items are lying between classes A and C. It is imperative that they are monitored closely to ensure that they don’t evolve to class (A) items or move towards class (C). The main inventory controls to reduce costs include;

  • Cycle counting: The materials should be counted less frequently as compared to class (A) items.
  • Requirements: These materials should be ordered in exact quantity to avoid waste and expensive storage. Ordering excess materials may result in quality deterioration and increased materials handling costs.
  • Control: Moderate control should be exercised on these materials. This ensures that the right quantity is supplied within a given time. The exact quantity must be determined and ordered all the time.

Class C Items

These items have very low value but makeup 50-60% of the total inventory items. The main strategies in reducing inventory costs include:

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  • Less frequent reorders: The reorders for these materials should not be frequent as this would increase the cost of transportation and other handling costs.
  • Order large quantities: These materials should be ordered in large quantities and the orders should be based on estimates.
  • Priority: These materials should be given less priority and less control as they don’t significantly affect the inventory.
  • Obsolete items: Stock in this class should be checked to identify obsolete items which may not be required. These materials can be eliminated from the production process.

References

Heizer, J., & Render, B. (2011).Operations Management Flexible Version with Lecture Guide & Activities Manual Package. New Jersey: Prentice Hall.

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