E1: 41: ABC Analysis (R4164) (Doc ID 625468.1)

Last updated on MARCH 26, 2024

Applies to:

JD Edwards EnterpriseOne Inventory Management - Version XE and later
Information in this document applies to any platform.

Purpose

Overview

ABC analysis is a very useful and relatively simple method for classifying and analyzing inventory. The method of analysis is based on observations first publicized by Vilfredo Pareto in Italy in the 19th century. Pareto observed that roughly 90% of the wealth in Italy, at that time, was held by 10% of the population. This imbalance has since been discovered in many other situations in life, both natural and man-made. It is sometimes referred to as the 90-10 rule, the 80-20 rule, or as Pareto's Law.

With respect to inventory, Pareto's Law has shown, with uncanny consistency that close to 80% of the value of total inventory is represented by 20% of the items. Although many deviations are possible, a rule of thumb is to identify the top 20% of the items as "A," the next 30% as "B," and the bottom 50% as "C."

EnterpriseOne Inventory Management system allows the user to identify A, B, and C items using three different sets of criteria. Total sales, gross margin, and on-hand inventory value all exhibits the traits expressed in Pareto's Law.

There are many ways in which the ABC classification may be used to help manage inventories. The common theme of the classification is the concept of degree of control. It is common sense that managers should be more concerned with the costly few as opposed to the trivial many.

Some of the ways that ABC classifications can be used include:

Cycle-counting frequency - More valuable A items should be counted more frequently than B or C items.
Engineering Priorities - The identification of A and B items help guide engineering when it seeks cost-reduction improvements on certain items. Efforts are better spent on items with high cost or usage than on items with very low value or usage.
Purchasing priorities - Purchasing activities should concentrate on high cost and high usage raw materials in much the same way that engineering priorities are determined, with the focus on A items for sourcing and negotiating.
Security - ABC analysis may be used as an indicator of which items should be more closely secured in locked storerooms to protect against loss, spoilage, or pilferage.
Replenishment systems - It is often more economical to control C items with simple replenishment systems. More sophisticated systems are generally employed for A and B items.
Investment decisions - Because A items represent a larger investment in inventory, more care should be taken when making decisions about order quantity and buffer stocks, than with B and C items.