Are you effectively managing your inventory?
When asked, most companies will say yes – and they genuinely believe they are. However, if you’re not managing your inventory in the most efficient ways possible, you could be leaving dollars on the table.
Today, we’ll discuss ABC inventory management and how it can help you not only make inventory oversight more manageable, but help you focus on the most profitable products to increase your bottom line.
What is Inventory Management?
Before we dive into the specifics, let’s take a moment to ensure we’re all on the same page when it comes to defining inventory management.
In simple terms, inventory management is a system used for sourcing, storing, and selling both finished products and the raw materials used to make those products.
In practical business terms, this essentially means ensuring you have the right materials, the right products, in the right locations and that they are acquired (for materials) and sold (for products) for a fair price.
As you can see, without proper inventory management, you could be losing money instead of making it. No one wants that.
What is ABC Inventory Management?
So, now that we’ve talked about what inventory management is in broad terms, let’s dive deeper and talk about ABC inventory management.
ABC inventory management (which is sometimes referred to as selective inventory control) centers on the idea that not all products are created equally. Because of this, there should be a focus on your products that generate the most revenue.
This doesn’t mean only focusing on your best products from a sales perspective, but rather across the board – from sales, to production, to marketing, and beyond.
This seems totally logical, right? Who wouldn’t want to focus on their most profitable products?
You’d be surprised to learn that many companies don’t.
How Can ABC Inventory Management Help You?
Have you ever heard of the Pareto Principle?
If you haven’t, it’s only because you probably know it better as the old “80/20 Rule.”
ABC inventory management operates on this same principle – 20% of your activity generally creates 80% of your profit. Therefore, it makes sense to focus on the 20% of things that most dramatically move the needle in your business.
Following this guideline can improve your business in a multitude of ways.
-
Allows for Inventory Optimization
When you follow the ABC inventory control paradigm, it’s much easier to make sure you have the proper amount of product and materials on hand.
There’s nothing worse than not being able to fulfill customer orders because you don’t have the right amount of inventory – unless you’re just wasting money sitting on truckloads of product that will never sell.
ABC inventory control protocols can eliminate both of these issues.
-
Better Resource Management
Utilizing these principles allows you to know which products you’re focusing on at any given moment. As such, it’s easier to always guarantee your resource levels are in line with your needs. This not only refers to materials or human resources – it can also mean time management as well.
-
Determine Strategic Pricing
When you’re sure a product is one of your top-sellers and in high demand because you’re using ABC inventory management principles, it’s easier to figure out issues when it comes to pricing. Knowing your high demand products, and that you’re pushing them with customers may mean you can actually charge more. This eliminates some of the guesswork for pricing.
-
Better Forecasting
Understanding where a product is in its life cycle makes it infinitely easier to predict what kind of revenue it will generate, how much inventory you need, and how to better price it. Utilizing ABC principles helps make this possible, meaning you can forecast for the future with greater accuracy and insight rather than just relying on old data and gut feelings.
-
Better Customer Experience
ABC inventory management doesn’t just apply to products – you can apply it to your customers as well. After all, doesn’t it make sense to focus most of your customer service efforts on customers who provide the most value to your business?
That doesn’t mean ignore your new or lower value customers, but again – the 80/20 rule applies here.
Of course, there are also a few challenges with the ABC inventory control approach, including:
- It requires a time investment to set up and maintain
- It doesn’t always work well with other inventory strategies you might be using
- It can neglect products that are trending in a positive direction
These are all valid issues, but the benefits of what an ABC inventory control system brings to the table outweigh the potential pain points in the vast majority of cases.
How Does it Work?
Without taking a super deep dive into the details, here’s how an ABC inventory management system generally works.
Products are broken down into three groups: A, B, and C. Of course, you can call these whatever you like – personally, I like Alfred, Brad, and Constance, but your mileage may vary.
Anyway, the names are less important than the criteria for each product silo. Key indicators are often annual consumption, inventory value, and cost significance in a standard ABC structure.
Then we break down products like this:
- Group A: High value items (generally 70%), with small numbers (10%)
- Group B: Moderate in value (20%) and numbers (20%)
- Group C: Small value (10%), high numbers (70%)
One of the great things about ABC inventory management is you can set your metrics however you like. It doesn’t have to be solely based on profitability.
So, now that we’ve discussed that in the abstract, let’s give you an example with an actual product.
Running an ABC analysis basically starts with looking at product sales over time.
When doing this at our fictitious widget company, we learn that widget A accounts for 80% of our purchases from new customers and 30% of total sales. Because it moves a high number of products, this is an item for column A on our breakdown sheet.
Now that we know this, the next step is to devote the bulk of our efforts to this product. We can figure out how to spin it off into other products (can we make widget A in another configuration? A different color? A different material?).
And since we know this product moves, we can ensure we’re spending more marketing dollars to promote it to even more potential customers.
We can also make sure it’s the centerpiece of our widget lineup. It gets the hero spot on our website. It’s the centerpiece of our catalog. We might even design our company branding around it.
In a perfect world, all of this focus on your top products will lead to an increase in revenue, new customers, and so on. Focusing on your most profitable products simply makes sense from a business perspective.
How Does it Make Your Buyer’s Life Easier?
One of the great things about ABC inventory management is that it’s really great for helping your buyers operate more efficiently.
The average buyer is managing a wide range of products – and receives a veritable mountain of information they have to sift through each and every day.
To say this can be overwhelming is an understatement.
Things only get worse as the week wears on and these things pile up while our buyer handles all the other aspects of his job.
Our hypothetical buyer then may spend hours (and hours) going through products looking for a winner that can move the needle.
However, with ABC inventory management principles, we can help our buyer really narrow down the pool. Instead of looking for the proverbial needle in the haystack, he can prioritize based on knowing the top items.. Rather than focus on 300 products, he can instead narrow it down to a handful of top sellers. Those are the things that are going to bring the best potential return, so it makes sense to focus on those first.
This allows your buyers to prioritize things rather than take a scattershot approach based on all the different products they handle. Your buyer becomes more efficient under the ABC inventory management system because he has exactly that – a system – that allows him to take a huge amount of information and distill it down to the things that matter most.
That not only makes your buyers happier employees, it makes your department more efficient. That’s a double win.
Final Thoughts
There are a lot of different ways to manage inventory, and ABC inventory management is but one of them.
That being said, this system offers a lot of positives for your business.
- It’s fairly easy to implement
- Easy to understand
- Highly customizable to meet your specific needs
- And it offers up a lot of insight into your products – allowing you to focus on the things that are working and forecast more accurately.
While there’s no “one size fits all” answer when it comes to managing inventory, ABC inventory management works really well for small businesses and large corporations alike.
Want to learn more about inventory management? Then be sure to subscribe to our blog so you don’t miss our latest posts.
