Leveraging ABC Classification - Part 1

Supply chain practitioners love to segment products. By far, the most common method of segmentation is the "ABC Classification". Based on the Pareto Principle, ABC Classification is a method for segmenting a product offering. The segmentation can be based on product volume, value, variability, or any number of other factors. It is such a ubiquitous concept that most Advanced Planning Software (e.g. SAP APO, JDA, Logility, etc.) offer extensive capability for calculating and storing ABC Classification. But despite its tried and tested nature, it can be tough for supply chain practitioners to extract tangible business benefit from the concept.

It doesn’t have to be that difficult. Below are some of the tangible benefits, how-to steps for getting started (or restarted), and some tips for maximizing impact.

When it works well…

Maybe your management team is skeptical. After all, they have seen this kind of segmentation a hundred times and it has rarely delivered any notable results. When well executed, ABC Classification can yield a number of significant benefits including:

l Improved forecast accuracy where it counts - Demand Planners can use it to focus forecasting effort and drive maximum value derived from interactions with sales & marketing.

l Lower inventory, same service levels - Inventory Planners can use it to stratify stock targets, resulting in more of the right inventory and less of the wrong inventory.

l Reduced waste and increased efficiency - Production Planners and Schedulers can use it to optimize production frequencies and lot sizes. This can create a positive feedback loop with inventory and forecasting.

l Lower fixed cost absorption and improved asset utilization - Plant managers can use it with their operations staff to optimize plant layout and critical asset placement for debottlenecking, improving throughput without changing headcount.

l Better negotiating position with key vendors - Procurement can even use it to maximize negotiating strength with suppliers

l Enables portfolio management – ABC Classification can help highlight the least valuable products in your portfolio. Identifying is the first step toward improved profitability through rationalization of outdated products and innovation of new products.

l Improves Planning Efficiency – This one is often seen as a bonus, but it is important to note that planner productivity can increase when ABC Classification is well implemented and broadly adopted.

How to…

 

There are many…many different ways to calculate an ABC classification. While the concept might be simple, its execution can be excruciatingly difficult. It can be helpful to have a model to start from to get the ball rolling, so here is a method you can use:

1.   Start with sales volume – Volume-based classification is both simple and easy to calculate, so it makes for a great starting point. Just load historical sales by product code into a spreadsheet, sort in descending order by the total volume and voilà, initial classification.

2.   Establish the percentages – Most of the time, people want more than just the top 80% and the bottom 20%. A more nuanced analysis is required. Experience suggests that the breakdown below provides a good starting point:

·         A = Top 70% - Not typically more than a few hundred codes

·         B = Next 15% - Similar number of codes to C Class

·         C = Next 10% - Similar number of codes to B Class

·         D = Next 4% - Usually 2x or more code than C class

·         E = Bottom 1% - Often thousands of codes

3.   Calculate the classes several different ways – Using sales volume, break down the classification by business unit, category, brand, product family, and producing site. This will help identify the optimal level in the product hierarchy at which to calculate ABC Classification. It will also answer questions that will come from functions about what class materials might be for them.

4.   Demonstrate its utility – Using individual codes, expand the dataset to include forecasted volume, inventory volume and value, production frequency, lot size, and gross margin. A picture of how to optimize the management of the code (or family of codes) will begin to develop.

5.   Commit to a result – Once you understand the potential for improvement, whether if relates to efficiency, capacity, profitability, or volume, connect it to a bottom line or top line improvement and commit.

Maximizing benefits...

With an understanding of the potential benefits and at least one method of implementation, here are some ways you can maximize the business impact ABC Classification can have on results:


1.  Keep it simple - Even if no one likes the way it's defined, ABC Classification should be easy to understand. Preferably within about 30 seconds...people just don't use tools they perceive to be overly complex.

2.   Set ownership in stone – Continuity is the key to a well utilized ABC Classification. This is most likely achieved when ownership and accountability lie within a single function. Ideally, supply chain.

3.   Develop expertise – Allow time to get familiar before making any significant changes to the calculation method. Maximum benefit comes when planners are familiar and comfortable with the method.

4.   Establish results, then upgrade – There may be significant pressure to make the method more “elegant”, but when it comes to ABC Classification, complexity kills results. Resist the temptation to add variables until benefits can be clearly tied to the method. Then tie any changes to specific improvements in outcomes.

Tying it all together…

ABC Classification can be tremendously impactful if it is properly implemented. A clear understanding of a simple approach will put you on a path to rapidly realizing real business benefits.

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