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 prioritise 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 prioritising 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.
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.
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 categorise your products into X, Y and Z:
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).
XYZ analysis offers a more sophisticated inventory categorisation 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 optimisation tool like EazyStock can automate the process to make it less daunting. EazyStock categorises your inventory based on multi-dimensional criteria such as demand, sales frequency, number of picks and annual consumption value. The system automatically analyses and re-classifies your inventory daily, so products are always managed according to the most relevant inventory policy.
Download our eGuide for more information on how to combine ABC and XYZ analysis and increase the effectiveness of your inventory classification techniques.