Introduction

ABC Classification, also known as ABC Analysis, is a scientific inventory control technique that classifies inventory items according to their annual consumption value. It helps organizations focus their attention and resources on the most valuable inventory items.

The principle behind ABC Classification is based on the Pareto Principle (80:20 Rule), which states that a small percentage of inventory items account for a large percentage of the total inventory value.

In simple words:

Not every inventory item deserves the same level of attention.

For example, a laptop manufacturer may purchase thousands of screws every month. Although screws are purchased in huge quantities, they contribute very little to the total inventory cost. On the other hand, processors and display panels are purchased in smaller quantities but account for a major portion of inventory investment.

Therefore, managers should devote greater attention to expensive items rather than low-cost items.

Meaning of ABC Classification

ABC Classification is an inventory management technique that categorizes inventory into three classes based on their annual consumption value.

Annual Consumption Value = Annual Usage × Unit Cost

The inventory items are then ranked from the highest annual consumption value to the lowest.

The Pareto Principle

ABC Analysis is based on the Pareto Principle.

It suggests:

• Around 20% of inventory items account for approximately 80% of inventory value.

• Around 30% of items account for about 15% of inventory value.

• Around 50% of items account for only 5% of inventory value.

These percentages are guidelines and may vary from organization to organization.

Category A Items

These are the most valuable inventory items.

Characteristics:

• Very high annual consumption value

• Small number of items

• Require close monitoring

• Frequent inventory review

• Accurate forecasting

• Strict purchasing procedures

• Low safety stock

Examples:

• Aircraft engines

• Computer processors

• Gold

• Industrial robots

• MRI machine components

Management Strategy

Managers should:

• Review inventory frequently.

• Maintain accurate records.

• Purchase carefully.

• Avoid overstocking.

• Avoid stockouts.

Category B Items

These items have moderate importance.

Characteristics:

• Medium inventory value

• Moderate monitoring

• Monthly inventory review

• Balanced purchasing policy

Examples:

• Electric motors

• Office furniture

• Pumps

• Industrial batteries

Management Strategy

Managers should:

• Review inventory periodically.

• Use moderate control.

• Maintain average safety stock.

Category C Items

These are low-value items.

Characteristics:

• Low annual consumption value

• Large number of items

• Simple inventory control

• Bulk purchasing is acceptable

• Less management attention

Examples:

• Pens

• Nuts and bolts

• Paper clips

• Packaging tape

• Cleaning cloths

Management Strategy

Managers should:

• Purchase in bulk.

• Reduce ordering frequency.

• Simplify record keeping.

Steps in Performing ABC Analysis

Step 1

Prepare a list of inventory items

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Step 2

Calculate annual usage

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Step 3

Determine unit cost

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Step 4

Calculate annual consumption value

Annual Consumption Value = Annual Usage × Unit Cost

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Step 5

Arrange items from highest value to lowest value

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Step 6

Calculate cumulative percentage

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Step 7

Classify into A, B and C categories