Making inventory optimization as easy as ABC

Author: Zehra Melis Teksan

Inventory is a double-edged sword for supply chain companies: it can be used to carve out a competitive advantage by consistently satisfying demand or it can turn into a crippling cost that cuts into the bottom line.

Inventory optimization is the key to ensuring that manufacturers, distributors, and retailers can maintain just right amount of the right products in the right places at the right times – to maximize demand fulfillment and minimize stock-outs, stock surpluses, and overall inventory costs.

This, of course, is a highly complicated undertaking – as many supply chain companies have to handle wide and ever-changing product portfolios with literally thousands of different SKUs as well as constantly shifting demand and supply dynamics.

To effectively manage their inventory holdings, manufacturers, distributors, and retailers must not only have an integrated, automated planning and decision making optimization software system in place, but also must have the right inventory management strategies (whose logic is embedded into that software system). The right inventory management software system coupled with the right strategies will enable supply chain companies to make the best possible decisions on what and where and when to produce or buy.

Inventory classification

Let’s take a look at one example of this fusion of inventory management strategy and software.

One popular and effective inventory management strategy – particularly among manufacturers, distributors, and retailers with vast, diverse, and dynamic product portfolios of consumer goods including electronics, food and beverages, automobiles, pharmaceuticals, and other products such as chemicals and metals – is ABC analysis. In a nutshell, ABC analysis is a methodology of categorizing inventory based on the products’ consumption value.

“A” products are those with the highest consumption value – hot selling items that have a high turnover rate and generate the most sales revenue for the business. Companies need to be able to monitor and manage inventory of “A” products as closely and carefully as possible to ensure they are always able to produce and hold enough stock to satisfy demand.

“B” products (as you may have guessed) have a lower consumption value as they don’t sell as well as “A” products and thus generate less sales revenue for the business (although, it’s important to note, some “B” products can rise over time and become “A” products” or vice versa).

“C” products are those with the lowest consumption value. There is minimal market demand for these items (as they may be at the end of their product lifecycles) and thus companies may opt to keep little or no inventory of “C” products and manufacture them on a made-to-order basis upon customer request.

Automating and optimizing ABC analysis

The ABC analysis approach sounds simple in theory. But in reality – with “A”, “B”, and “C” classifications constantly changing over time and across various locations as market fundamentals shift and new products are introduced – it is extremely challenging for companies to assess and identify which products belong in which categories on an ongoing basis and manage their inventory levels of these products accordingly (so that they can consistently satisfy demand and slash inventory costs).

Using manual planning techniques and tools like Excel or even an ERP system, it is practically impossible for supply chain companies to get a complete, real-time picture of their demand, supply, and inventory conditions.

Many companies rely on hunches (based on sales, inventory, and other data along with their employees’ expertise) to drive decisions on which products to produce and hold in stock. But being able to accurately and dynamically classify the company’s portfolio products in the ABC framework and optimally manage production, inventory, and distribution planning and operations requires an automated, algorithmic software solution.

With such an advanced software solution, supply chain companies can:

• Automatically execute ABC analysis and categorize various products according the ABC methodology – whose logic is embedded into the solution – and dynamically reclassify products based on sales performance and demand forecasts.
• Utilize algorithms – including optimization, advanced analytics, and machine learning – to recommend optimal target inventory levels of “A”, “B”, and “C” products, taking into account historical sales and market data, demand plans and forecasts, supply capabilities, and product lifecycles.
• Integrate and synchronize production and inventory planning and decision making for “A”, “B”, and “C” products with demand and supply planning and decision making.
• Monitor and manage inventory levels of “A”, “B”, and “C” products in real-time and immediately alert planners if there’s a shortage or surplus of a particular product or if there is a production bottleneck that may cause a late delivery – so that they can make the best decisions and take the necessary actions to remedy these issues.
• Generate proposals on how to handle excess inventory or inventory shortages of “A”, “B”, and “C” products – taking into account demand forecasts, supply capabilities and constraints, and product lifecycles.

With an intelligent, integrated planning and decision making optimization software system (like ICRON), supply chain companies can automatically and optimally categorize their inventory according to the ABC strategy (or any another inventory management strategy whose logic is embedded into the system).

Such a system empowers supply chain companies to visualize their inventory levels in real time, harmonize their inventory holdings with demand and supply conditions, and optimize their inventory utilization.

If you would like to see ICRON in action, please contact us. If you have enjoyed this blog, you can find more content that you might enjoy here.