Meaningful Product Classification
By Jon and Matt Schreibfeder
Last month we discussed ranking products. That is, the process of classifying products so that you can identify those items that contribute most to your success. To fully evaluate inventory performance, we rank products by three criteria:
- Frequency of sale or use (i.e., the number of times the product is requested)
- Cost of goods sold
- Profitability (i.e., annual gross profit dollars)
We believe that frequency of usage should be the most important metric used for product ranking. While a stockout of a product that infrequently sells might disappoint a customer, it probably is not as critical as an item that is continually requested.
Typically, organizations will consider “A” items to be those that are responsible for 80% of activity, “B” items are responsible for the next 15%, “C” items are responsible for the next 4% and “D” items are responsible for the last 1%.
We have found that the typical ranking breakdown structure can create a wide range of values assigned to “A” items. Here is the ranking from one of our clients:
|Rank||Cost of Goods Sold||Requests||Profit$|
|A||$531,057 – $1,475||716 – 9||$106,211 – $295|
|B||$1,474 – $276||9 – 3||$294 – $55|
|C||$275 – $67||2||$54 – $13|
|D||$66 – $.01||1||$12 – $.01|
An “A” item might have been ordered 716 items in a year or only nine times. You probably want to pay a lot more attention to a product that is requested more than 700 times a year to one that was sold less than once a month.
Instead of hits (number of individual customer requests), we have found that a more useful method to measure frequency of usage is the number of months a product has had usage within the past 12 months. Classifying products in this way has several advantages over traditional ranking:
- There are now 12 classifications (i.e., 1 – 12 months) rather than four ranks (i.e., A – D). This method provides a more granular analysis.
- All of the products assigned to a classification have similar movement. That is, every product assigned to class 12 was sold in all 12 of the past 12 months. Products assigned to class 1 only had activity in one of the last 12 months.
Here is a breakdown of the months with usage for the “A” ranked items (based on customer requests) stocked by our client:
|Mo w/ Usage||Items|
Note that an “A” ranked item might have been requested in 12 or 1 of the last 12 months. Most of our clients want to pay more attention to the products with more activity. For example, they closely monitor stockouts of products that have had usage in 11 or 12 of the past 12 months. Chances are good that if you did not have one of these products available for immediate delivery, you would disappoint a customer. They will ask:
- Did the item experience unusual usage? Do we need to change the way we forecast future demand of the item?
- Was the lead time used to determine when to replenish stock of the item too short? Do we need to issue the next purchase order when a larger quantity of the product is still in stock?
- Is additional safety stock required to protect against future stockouts?
We believe that great customer service starts with focusing on the products used most often. Next month, we will start to evaluate the profitability of these items. In the meantime, please let us know if you have any inventory-related questions. We want you to achieve the goal of effective inventory management.