New Approach to Inventory Management

[sudhir_khetarpal]

Time to look beyond “ABC Categorization of Inventory”

There are 4 main reasons why one keeps stock –

1.       Demand

2.       Lead Time

3.       Packaging Units

4.        Fluctuations in Demand

Most of the Inventory management models will take care into account Demand & Lead Time. The most commonly used and most accepted method of Inventory categorization is “ABC Analysis”.  Typical Categorization in “ABC Analysis”-

1.       "A class" inventory will typically contain items that account for 80% of total value, or 20% of total items.

2.       "B class" inventory will have around 15% of total value, or 30% of total items.

3.       "C class" inventory will account for the remaining 5%, or 50% of total items.

As we can see, it takes into account Demand & Lead Time but not the Fluctuations in Demand. It was fine in the earlier days when most of the categorization was done without the aid of sophisticated software and tools.

Most of the current ERP applications also use the same method but with provisions for Minimum Order Quantity etc they take care of Packaging Units requirement as well. The most neglected would be Fluctuations in demand both in terms of Inventory models & ERP capabilities. This would typically lead to incorrect inventories leading to higher cost of Inventory or loss of sales. Take for example –

Product A
	Jan’ 09	Feb’ 09	Mar’ 09	Apr’ 09	May’ 09	Jun’09
Demand	10	10	10	10	10	10

 

Product B
	Jan’ 09	Feb’ 09	Mar’ 09	Apr’ 09	May’ 09	Jun’09
Demand			30		30

Product C
	Jan’ 09	Feb’ 09	Mar’ 09	Apr’ 09	May’ 09	Jun’09
Demand				60

 

The three products would be categorized same as per ABC Analysis as they would have same average demand but product A with such a stable demand would not need high level of Inventory unlike Product B & Product C. There is great probability that in case of Product A we would be carrying high inventory than required and in other two cases lower inventory.

 Now a day with sophisticated tools & software at our disposals there is a need to look at alternative models of Inventory classification.

References

1. ^ Manufacturing planning and control systems for supply chain management By Thomas E. Vollmann
2. ^ http://www.supplychainmechanic.com/?p=46 How to carry out an ABC analysis of inventory
3. ^ Oracle E-Business Suite Manufacturing & Supply Chain Management By Bastin Gerald, Nigel King, Dan Natchek
4. ^ Purchasing and Supply Chain Management By Kenneth Lysons, Brian Farrington