An explanation of ABC XYZ inventory analysis and why it adds value
In previous posts, we’ve discussed the benefits of ABC classification models and how to use them to improve inventory control and management. ABC analysis can be a simple and effective way for inventory planning teams to prioritize their workload and save time spent managing inventory. However, it does have its limitations.
ABC classification’s one-dimensional evaluation criteria are mostly oversimplistic. They neglect other crucial inventory management factors by prioritizing items based on their value. These will influence the inventory you carry and where you focus your time.
This means you can segment items based on their forecastability, e.g. the likelihood that their demand will vary from their forecast.
To help overcome this issue, it’s possible to introduce ABC XYZ analysis or ABC XYZ classification.
XYZ analysis is a framework to classify products based on their variability of demand.
- X-items have regular demand, which means demand forecasts are reliable.
- Y-items don’t have steady demand, meaning there is substantial demand variability. Usually, demand variations are due to seasonality, product lifecycles, competitors, or the economy, making it harder to get accurate demand forecasts.
- Z-items have very irregular and difficult to predict demand. Without trends or predictable influential factors, getting accurate demand forecasts is almost impossible. We discuss how to forecast intermittent or lumpy demand in our blog post.
ABC XYZ classifications can inform inventory management processes to set optimal order schedules and service levels.
For example, companies can invest in X items – the stock they use, reducing investment in Y and Z items to avoid overstocking and potential obsolescence.
As X items have low demand variation and are easier to forecast, they should be ordered the most frequently. Due to influential factors, Y items should be ordered less frequently depending on demand variations. The demand volatility of Z items means they should be ordered the least often.
How to calculate ABC XYZ inventory analysis
You calculate an inventory item’s demand variability by finding the average demand for a product during a given period. It’s important to set an appropriate period for assessing demand volatility. For example, if you have items with seasonal demand, including 12 months of data makes sense.
Next, find the difference between the demand at each data point and the average. Now, square each difference and find the average. You can then use the square root of the average to find the demand variability.
In statistical terms, demand variability can be expressed as the coefficient of variation. To categorize your products into X, Y and Z:
- Identify the items you want to include in the analysis.
- Calculate the coefficient of variation for each item, e.g. (standard deviation/mean) * 100.
- Sort the items by increasing coefficient of variation and accumulate the figures.
- Set the boundaries for each category.
With your ABC and XYZ categories identified, you can produce a matrix like the one below and assign each group.
Adding another level of insight to your inventory classification process allows you to make more informed ordering and stocking decisions. For example, it makes sense to treat valuable AX items with constant demand differently from AZ items with erratic demand. If demand is steady and easy to predict (X items), you can have lower safety stock levels than for products with more volatile demand (Z items).
From ABC XYZ analysis to automation
XYZ analysis offers a more sophisticated inventory categorization framework, but doesn’t eliminate the need for time-consuming, manual calculations in spreadsheets. Manual spreadsheets also make it harder to keep your calculations up to date as sales volumes vary and products move between categories.
An inventory optimization tool like EazyStock can automate the process to make it less daunting. EazyStock categorizes your inventory based on multi-dimensional criteria such as demand, sales frequency, number of picks and annual consumption value. The system automatically analyzes and re-classifies your inventory daily, so products are always managed according to the most relevant inventory policy.
For more information on EazyStock or to book a demo click here.
FAQs about ABC XYZ inventory analysis
ABC and XYZ are part of the same classification analysis; XYZ adds extra elements. ABC classification is one-dimensional and can be oversimplistic, as it prioritizes items based solely on their value. This influences the inventory you carry and focuses your time. XYZ analysis helps classify products based on their demand variability.
- X-items have regular demand with reliable demand forecasts,
- Y-items don’t have steady demand, leading to substantial demand variability,
- Z-items have very irregular demand that is difficult to predict.
ABC XYZ analysis informs inventory management processes to set optimal order schedules and service levels.
First, calculate your ABC analysis (annual consumption value), then calculate demand variability:
- Identify the items you want to include in the analysis
- Calculate the coefficient of variation for each item, e.g., (standard deviation/mean) x 100
- Sort the items by increasing coefficient of variation and accumulate the figures
- Set the boundaries for each category
Create a 3×3 matrix with forecastability along the X-axis and value along the Y-axis.
- AZ – High sales value, sporadic demand – Top priority
- AY – High sales value, trends or seasonal demand – High priority
- AX – High sales value, constant demand – High risk/value
- BZ – Medium sales value, sporadic demand – Moderate
- BY – Medium sales value, trends or seasonal demand – Moderate
- BX – Medium sales value, constant demand – Moderate
- CZ – Low sales value, sporadic demand – Low cost
- CY – Low sales value, trends or seasonal demand – Low cost
- CX – Low sales value, constant demand – Low cost
XYZ analysis measures volatility by classifying inventory items based on their demand consistency over time, using the standard deviation divided by the mean. It classifies items into X (stable/low priority), Y (fluctuating/moderate priority), and Z (irregular/high priority).
ABC XYZ analysis should be carried out quarterly to ensure changes are picked up and acted on. Although the analysis should be redone when there are changes in demand, supplier prices, or supply. It’s also important to conduct more regular reviews of high-turnover or volatile items, or those with seasonal demand.
As manual reviews can be time-consuming, automated systems allow for continuous reclassification, allowing you to focus on actions instead.
AX items have high sales value and constant demand, making them the most important to the business. The best inventory strategy is to monitor these tightly and use automation to maximize availability while minimizing inventory investment.
CZ items are considered the most difficult to manage because they exhibit the most demand variability, making it extremely difficult to provide accurate forecasts, particularly when using manual forecasting methods. Inventory optimisation software uses advanced algorithms to improve forecasting accuracy of CZ items to ensure balanced stock levels.
Inaccurate forecasts increase the risk of imbalanced inventory levels, dead stock and stockouts. Excess stock leads to higher carrying costs and wasted capital, while stockouts lead to poor customer service and the risk of customers finding alternative suppliers.
ABC XYZ analysis provides more insight into inventory to facilitate data-driven ordering and stocking decisions. Using ABC XYZ analysis to inform stocking policies enables tailoring those policies to each item group. Instead of holding safety stock for all items, you can match safety stock levels to ABC XYZ profiles. For example, AX items require lower buffers than Z items, which have erratic, volatile demand.
With a better understanding of demand variability from XYZ analysis, companies can better anticipate needs and reduce unnecessary safety stock for items with unpredictable demand.
Optimizing resource allocation allows inventory management teams to focus efforts on high-impact items (AX, AY), reducing safety stock levels for less critical, slow-moving items.
- X items with constant, stable demand need low safety stock levels,
- Y items with fluctuating demand need moderate safety stock levels,
- Z items with irregular or erratic demand need high safety stock levels.
