1. In any inventory some items will be more important to the organization than
others
If there is a stock out of items with a very high usage rate ( e.g. FMCG
products), customers will be disappointed
Inventory Planning
Material Classification
For high value items, keeping high inventory levels would not be cost effective
For low value items, higher levels of inventory would not affect the inventory
performance significantly while ensuring uninterrupted supply of these
materials to production or sales
With different types of materials used in any production / distribution unit,
monitoring and controlling the inventory levels need scientific analysis

2. Inventory Planning
Methods of Classification
There are different ways of classifying material. Some of the major ones
include:
Type of requirement
Frequency of procurement
Standard or stock items
Physical or chemical nature
Cost
Type of requirement
One way of classifying materials is whether they
are used for direct (i.e.; go into the products being
manufactured) or used indirectly for supporting
the production process.
As an example, for a car manufacturer, the steering wheel assembly could be classified
as direct material. Oil, used to lubricate the factory conveyor belt would be classified as
indirect material.

3. Inventory Planning
Observation on Materials
In a computer,
A large proportion of the total costs is made up of small number of high value
components like CPU
A large number of components like mouse, connectors, cables, key board, etc
constitute a smaller proportion of the total cost

4. Inventory Planning
80:20 Rule, The Pareto Principle
The Pareto principle (also known as the 80-20 rule, the law of the vital few)
states that, for many events, roughly 80% of the results come from 20% of
the efforts
Based on these observations he
formulated the pareto principle

5. Inventory Planning
Observation on Materials
It takes 20% effort to complete the first 80% of a project, the remaining 20%
work takes 80% effort

6. Inventory Planning
Pareto Rule in Inventory
Typically,80% of an operations sales are accounted for by only 20%
of all stocked item types.
The relationship can be used to classify the different types of items
kept in an inventory by their usage value
ABC inventory control allows inventory managers to concentrate
their efforts on controlling the more significant items of stock

7. The pareto rule has been applied to this classification called ABC, with a slight
improvisation
Inventory Planning
ABC Classification

8. Inventory Planning
ABC Analysis
Let us refer to the table above
Class A items constitute approximately 10% of the number of items in inventory, and
their value typically ranges from 70-80% of the total value of inventory.
Class B ranges from between 11-20% of the items in inventory, and their value ranges
from between 10-20% of the total inventory value.
The last category, Class C make up 70-80% of the items in inventory, and their value is
only between 5-10% of the total inventory value.
By clearly identifying the high value of A class items this allows purchase managers to
focus their efforts on areas which will have the maximum impact to the organization

9. The graph shows how the Pareto Analysis or ABC Analysis can be depicted pictorially
Inventory Planning
ABC Analysis
On the X-axis we have the cumulative percentage of items. On the Y-axis we have the
cumulative percentage of use by value.
As can be seen from the graph, a few items contribute to a high percentage of usage by value
and there are many items which are the ‘C’ class items which contribute only to a small
percentage of usage by value.
The ABC analysis puts items into categories that show the amount of effort worth spending on
inventory control
20% of inventory items need 80% of the attention
while the remaining 80% of items need only
20% of the attention

10. Inventory Planning
Inventory Classification

11. Inventory Planning
Classify Items
The first step in ABC analysis is to classify all inventory items as either A,B,C
Calculate value for each
item:
Cost x Annual demand
Rank items according to
their annual value
(descending order)
Classify
10% as A items
20% as B items
70% as C Items
These classification will not be exact, but they have been found to be close to
the actual occurrence

12. Inventory Planning
‘A’ Class Items
The next step is to determine the level of inventory control for each
classification
Class ‘A’ Items require tight inventory control as they represent a large
percentage of the total value of inventory .These levels should be as low
as possible, with minimum safety stocks
They require accurate forecasts and detailed record keeping
They also need appropriate inventory control system and cost effective
procedure to determine order quantities
In addition, close attention should be given to purchasing policies and
procedures of class ‘A’ item

13. Inventory Planning
‘B’ & ‘C’ Class Items
‘B’ and ‘C’ items require less stringent inventory control
Since carrying cost are usually lower for ‘C’ Items, higher inventory levels
can sometimes be maintained with larger safety stocks
It may not be necessary to control ‘C’ items beyond simple observation

14. Inventory Planning
Monitoring

15. Inventory Planning
ABC Classification Example

16. Inventory Planning
Application of ABC Analysis

17. Inventory Planning
XYZ Classification
Many enterprises need to manage their inventory based on the
movement of goods or more precisely, the demand
For some items, it is easier to forecast demand than for some others
The XYZ analysis helps manage inventory based on the fluctuation of
demand for some product

18. Inventory Planning
XYZ Classification
Many enterprises need to manage their inventory based on the movement
of goods or more precisely the demand
X Classification
Material requirement is predictable and hence should be stocked in
adequate quantities
The requirement fluctuate only slightly around a constant level so that the
demand can be accurately

19. Y Classification
Inventory Planning
XYZ Classification

20. Inventory Planning
XYZ Classification
Completely irregular consumption
Z Classification
These materials are not used regularly
The usage can strongly fluctuate or occur sporadically
In these cases, you can often observe periods with no consumption at all
Forecast is extremely demanding and very difficult
It is useful to further subdivide the ‘Z’ materials into ‘Z1’ and ‘Z2’
materials, the letter being used even less regularly than ‘Z1’ Materials
This enables you to trigger detailed counteractive measures for
particularly critical materials

21. Inventory Planning
XYZ Classification

22. Inventory Planning
XYZ Classification

23. Inventory Planning
Other Classifications

24. Inventory Planning
Single Period Inventory Analysis
Purchase managers sometime face a special situation, That of one time
inventory purchases or purchases for a single period. This is referred to as
the “Newsboy Model”
Along with specialized equipment (Usually expensive),Spare parts are to be
purchased
Examples In Industry
The provision store or supermarket must decide how many loaves of bread to
order for each day
During the festival season, the sweet shop must decide how much of sweets
to make in such situations, a technique called marginal analysis is used

25. Material classification plays an important role in managing different
inventory items
The treatment required to monitor and control varies from item group
to item group and hence classification based on value or movement or
any other criteria helps in ensuring supply as per demand at
economical cost
The choice of classification (ABC OR XYZ) depends on the industry
segment
FMCG / Retail / Distribution industries may be use XYZ Classification
Electronics manufacturing units may be use ABC
Inventory Planning
Summary