How an ABC Analysis Can Help You Leverage the Best-of-the-Best Inventory Control Practices

When it comes to inventory control, you’re often dealing with two schools of thought:

1. Just-in-case, in which you carry, for example, 2-3 months of inventory at a time that’s stored in a warehouse, then distributed.
   
2. Just-in-time, in which you order, receive and distribute just enough to supply your customers, without storing much inventory at all.
   

However, in addition to these two options, you really have a third: A hybrid approach in which you combine both. Ultimately, assembling the right mix of inventory control strategies will depend on your business’s unique needs.

That being said, one way you might consider approaching a hybrid inventory control system is by applying an “ABC analysis” to your products.

By separating your products into three, distinct groups, you’ll be able to:

• Leverage the efficiencies and cost-effectiveness of just-in-time inventory management, all while
  
• Maintaining the high level of customer service that just-in-case inventory build-up offers.
  

We’ll walk you through it in this article.

But, first, let’s quickly review the pros and cons of each model of inventory control to understand which one to apply to each group. (If you want more detail, you can also do a deep dive on JIC vs. JIT.)

The Pros and Cons of Just-in-Case

Under JIC inventory management, your company elects to store a few months of inventory in a warehouse, leveraging sales forecasts to predict the stock and quantities your customers will need.

This philosophy, also known as traditional inventory build-up and stocking, falls under the “push” category of inventory management, in which stock is ready and waiting to be “pushed” to customers.  

Pros:

• Assuming your forecasting is reasonably accurate, you likely have stock ready to ship as soon as your customer places an order, so there’s no delay, enabling you to deliver a high level of customer service.
  
• If there’s a small disruption in your supply chain, you may have enough inventory on hand to fulfill orders while you fix any issue by, for example, changing suppliers.
  
• With enough back stock, you’ll also have the time you need to negotiate or wait for favorable pricing before placing an order for any additional supplies.
  

Cons:

• However, if you over-forecast demand, you could get stuck with unsold inventory, which can cause cash flow problems.
  
• Or, if you under-forecast demand and you don’t have existing agreements locked in for speedy manufacture or delivery, you could find yourself out of stock on high-demand items.
  
• Additionally, you’ll have to pay storage and warehousing costs for your inventory, which will begin to add up.
  

The Pros and Cons of Just-in-Time

When you operate under JIT inventory management principles, you stock very little, if anything. Instead, when a customer places an order, you, in turn, get the items necessary to fulfill the order from your suppliers.

As a “pull” system of inventory management, your customer’s requests “pull” the items through your system.

Pros:

• Because you’re not purchasing months of inventory in anticipation of customer demand, you can reduce the problem of dead stock.
  
• With very little on hand, you’ll have significantly better cash flow, since it won’t be tied up inventory.
  
• You’ll have fewer storage and warehousing expenses, reducing your inventory holding costs.
  

Cons:

• If you’re not able to source items quickly to fulfill orders, your shipments to your customers might be slower than a company who employs JIC strategies.
  
• Because you don’t have any back stock, a small disruption in your supply chain could have huge effects on your business and your customers’ satisfaction levels.
  
• Because you’re generally working on a short timeline, you may end up paying more for a product, since you don’t have time to wait for more favorable prices.
  

Some companies decide to go either/or on these models. However, others favor a hybrid approach, which can help you take advantage of the pros from each, while reducing the downside from the cons.

If you’d like to investigate a hybrid approach, the best place to start is with an analysis of your products.

Leveraging an ABC Analysis to Get the Best of Both Worlds

When you’re investigating the right inventory control system for your business, an ABC analysis can help you clarify your decision-making process.

At the heart of the ABC analysis lies the Pareto principle, also known as the 80/20 rule.

The Pareto Principle – The idea that roughly 80% of the effects come from 20% of the causes. Vilfredo Pareto created this rule after observing that 80% of Italy’s wealth was owned by 20% of the population.

When it comes to inventory management, an ABC analysis leverages the Pareto principle to argue that ~80% of the value of your inventory likely comes from ~20% of your products.

So, with this in mind, it’s possible to analyze your stock and place it into three categories:

A – Your big sellers, the money-makers that you can’t afford to be out of inventory on. Although A-level products may represent only about 20% of your stock, they likely account for 70-80% of the value of your inventory.

B – B-level products are the next ~40% of your stock that likely accounts for about 15% of the value of your inventory. These are items in less demand that you fulfill less often than those in category A, but with some frequency.

C – This is the final 40% of your stock that represents around 5% of the value of your inventory. These items don’t move very often, perhaps because they’re seasonal or specialty items that don’t attract many orders.

Now, if we’re looking at a hybrid approach to manage this inventory, we might consider something like the following:

A-Level Products: 70-80% of Inventory Value

• Preferred Method: Just-in-Case
  
• Allows you to fulfill orders on your top movers quickly, easily and predictably.
  
• Reduces possibility for dead stock, since you’re only stocking items you’re pretty sure will sell frequently and consistently throughout the year.
  

B-Level Products: 15-20% of Inventory Value

• Preferred Method: Hybrid
  
• Depending on your particular business, you may lean more toward Just-in-Case or Just-in-Time for this category.
  
• That being said, you may consider stocking the top few items in this category and relying on Just-in-Time for the rest. That way, you’ll keep warehousing costs low but still fulfill frequently-ordered items easily.
  

C-Level Products: 5-10% of Inventory Value

• Preferred Method: Just-in-Time
  
• Prevents you from having to stock items that you know won’t be ordered often, reducing warehouse costs.
  
• If there’s any disruption in your supply chain that causes delays, it will be limited to smaller, less frequent orders.
  

By helping you divide your inventory into three classes, based on inventory value and volume, you can easily see how an ABC Analysis can help you get the best of both worlds while avoiding some of the downsides.

Making the Right Decision for Your Business

In this article, we’ve offered some broad-stroke guidelines for inventory control and management. However, after working with hundreds of companies in varied industries, we realize that every company has individual requirements and unique customer expectations to fulfill.

That being said, we hope these ideas will get you started thinking about new methods to deal with your inventory, while freeing up cash, reducing overhead and keeping your customers well-supplied.

If you’d like help running a more formal ABC Analysis for your business, we’d be happy to help. We assist a number of our customers with inventory control and management, and we’d love to talk with you. Simply reach out to us, and we’ll help connect you with the logistics, inventory and supply solutions that are right for your business.

Contact Our Inventory Control Experts