Integral Logistics Management — Operations Management and Supply Chain Management Within and Across Companies

11.2.2 The ABC Classification and the Pareto Chart

Intended learning outcomes: Explain the principle of the ABC classification, shown as a Pareto chart. Describe the ABC classification for each ABC category.

Up to now we have stressed the “importance” of an item in relationship to all items as a whole. Turnover, which generally refers to past usage, can yield the importance of an item. However, forecasts rather than turnover may also yield this information.

In all types and sizes of organizations, it can be observed that a small number of products make up the largest portion of the turnover.

ABC classification divides a set of items into three classes, specifically A, B, and C.[note 1103].

Figure illustrates the principle of this classification and possible limits for a change of class (break points) in the form of a Pareto chart:

Fig.       The principle of the ABC classification, shown as a Pareto chart.

  • In the example, A items, that is the A class, is composed of 20% of the items, which account for 75% of total turnover.
  • B items, that is, the B class, is made up of 30 to 40% of the items, which comprise approximately 15% of total turnover.
  • C items, that is, the remaining items, which make up a large part of the product range, here 40 to 50% of the items, only account for about 10% of total turnover.

The precise shape of the Pareto curve and the break points between classes will vary among firms, but the point that a small percentage of items make up most of the importance (or value) remains generally true. Prioritizing inventory items according to the ABC classifi­cation allows targeted implementation of appropriate materials management measures.

  • It is much more important to reduce inventory for A items than for C items. In addition, since A items are more limited in number, close follow-up is much easier. They are ordered in frequent small batches. Purchase orders are placed only after intensive evaluation. Production orders are closely reviewed and expedited with high priority. All these measures increase ordering costs and administrative costs.
  • It is important that C items are always available. Under no circumstances should an item that costs only a few cents be allowed to delay the delivery of a machine that may have a value of hundreds of thousands of dollars. Management releases procurement orders early, with ample margins as to quantity and time. This increases storage costs only slightly, since the items are inexpensive ones. Ordering costs for C items can be kept low, since large quantities are ordered at one time. It may sometimes even be possible to trigger orders automatically, without the intervention of a planner, by using an IT-supported system.
  • Generally, management handles B items between the above two extremes.

The ABC classification thus provides the foundation for various param­eters in materials management. Since goods have different importance, depending on their type, most organizations have separate ABC classifications for each item type, as outlined in Section 1.2.2 (final products, subassemblies, individual parts, raw materials, and so on). This is especially important when the value added is high. In that case, a sole ABC classification for the entirety of the item range would tend to classify all final products as A items and all purchased items as C items. However, this would defeat the objective of the ABC approach.

The ABC category is the identification of the set or group of items grouped together for an ABC classification.

Therefore, first all items are assigned to an ABC category. Then, the ABC classification is completed in two stages, as outlined in Figure

Fig.       The ABC classification for each ABC category.

Course section 11.2: Subsections and their intended learning outcomes