ABC / XYZ Stratification
In this article, we discuss the purpose of ABC / XYZ stratification and what practical applications there are for it in your supply chain.
What is ABC / XYZ Stratification?
ABC / XYZ stratification is the act of classifying inventory based on level of priority and variability.
We use ABC / XYZ methodology to pinpoint the areas of our supply chain that require the most attention or that may provide the greatest opportunity for improvement.
ABC / XYZ can be broken down into the ABC portion and into the XYZ portion. You can use only ABC classification, only XYZ classification, or both. Because the ABC portion and the XYZ portion are not mutually exclusive, you can separate them and utilize whatever is best for your operation.
The first part of ABC / XYZ refers to your own classification of the important materials or products that you manage. A items are the most important, B items the next, and C items are of least importance.
ABC classification is usually denoted by either volume — number of pieces, cubic feet, liters, etc. produced or shipped — or dollars. The highest volume of material used would be the A items, so on and so forth.
Often, the top 20% of your inventory part numbers, SKUs, or products accounts for 80% of your volume. The next 30% of the products would account for 15% of your volume. The lowest 50% of the products would account for the remaining 5% of your volume.
The 80/20 rule is not a hard and fast rule, and if managing the A items in your operation means using a 90/10 rule, a 90/20 rule, or something similar, then use what works best for your supply chain.
The second part of ABC / XYZ refers to the level of variability in the demand for these materials or products. X items have very low variability in their demand. Y items have medium to high variability, and Z items either have extremely high variability, are new products with too little demand history for an accurate forecast, or are obsolete and have no demand.
Let me point out that many organizations say X items have extremely low variability and Y items have high variability, and they include seasonality into this variability. In all honesty, how you use ABC / XYZ stratification is up to you and your supply chain consultant or supply chain team, and what works best for your organization is the direction that you should go.
I prefer to call seasonality a low variability case since it is still predictable and would be included in any high-level forecast and any more detailed planning forecast, too. We could almost change the wording in this article to refer to XYZ classification as levels of predictability, not variability.
The point is that you know what the X items will be doing during your planning time fence, and you have time to react to the change in demand with your production and procurement strategy, not with your inventory management program.
Example: Stratifying by Pieces
Let’s say you make and sell widgets. You offer 100 different variants of these widgets, and, even though a widget is made from only 100 component parts, you have 500 different components that are used to make your 100 variants.
You can stratify your business using either pieces produced and sold or dollars produced and sold. Let’s look at pieces (PCS).
Of the 100 variants of your product, you have 20 variants that account for 80% of your annual volume. These are your A items.
You have an additional 30 variants that account for 15% of your sales. These are your B items.
Your remaining 50 variants account for the remaining 5% of your business, and these are your C items.
When making decisions to negotiate better component prices or to change your cycle counting process of your inventory or to modify your weekly production plan to limit setup time, you should focus this decision-making process on your A items. Because they account for the bulk of your sales volume, you will find the greatest opportunity in these items.
Now that we have classified your products by their volume, let’s classify them by the variability of their demand.
The products that have consistent demand with low variability are your X items. For example, you consistently sell 1,000 of one of your A items every week, and the demand increases a few times per year due to seasonality.
Products with medium to high variability would be your Y items. You may have one product where the last 6 weeks’ worth of demand looked like this:
That could be a Y item. The demand is not very stable, but it is also not sporadic or highly variable.
Finally, products with extremely high variability, products that are new and that have very little demand or history, or products that are obsolete might all be lumped into your Z classification.
If you have AZ items, then you should pay particularly close attention to these items as that means that they are high volume with either very high variability, very little demand history to develop a reasonable forecast, or are obsolete. Either way, your inventory levels of this product should be very closely monitored as the success of this product have a significant effect on your business.
You should have a run-out plan for this product, if it is obsolete. Have you agreed on the last available date with your customers? Do you have a final, firm order in place with them and an agreement on service or quality related issues?
For your AZ item that is new, has your Sales team provided their forecast for this product, and do you have sufficient component parts to support their expected demand? You likely have components of this product that are Z items, too, so closely monitoring their availability with your supplier and your supplier’s performance is critical to the initial success of this product.
Your AX items are your bread and butter. They are high volume and also easy to plan since the demand has such low variability. This means you can plan low safety stock levels for these items since you are easily able to prepare for changes in their demand with your procurement and/or production schedule.
Example: Stratifying by Dollars
Let’s classify your 500 component parts by dollars.
There is an electronic component in each of your widgets that causes it to do all kinds of wonderful things. Your cost is $25 each for these components. You have five variants.
You also have a galvanized screw, of which 24 are used in every widget that you make. The cost of this screw is $0.05 each. There is one variant.
If the total cost of your direct materials — the components that make your widgets — is $50, then the electronic component encompasses 50% of this cost. The total cost of your screw is $1.20 — $0.05 x 24 per widget. This screw is only 2.4% of your total direct material cost.
Depending on the demand for the widgets using each of the five electronic components, they could be A items. A low runner could potentially be a B item. Due to the level of investment into each electronic component, it is unlikely that any would be considered a C item. Once again, your variability in the supply and in the demand will determine the XYZ classification. Provided there are no quality issues with the component and the variant is a fairly steady runner, this could be an AX item that can be easily supported with your procurement and production plan.
The screw is so low cost that it is a C item. Because the demand is so stable — one in every widget you make, and we are assuming you have a level-loaded production plan — this might be an X item. Your supplier’s performance — both in terms of capacity and of quality — must be considered before making a final decision on the XYZ classification of the screw. If you constantly have quality issues related to bad galvanization, the supplier is constantly days or weeks late with shipment, or the ocean freight being used has a highly variable transit time, then you should consider to show this component as either a CY or a CZ component, depending on how variable the supply stream is. If everything is stable with the exception of once or twice per year, then this could be a CX item.
ABC / XYZ Stratification is an excellent methodology to use when deciding when and how to cycle count your inventory, how to prepare your detailed forecast, how your master scheduler should build your production plan, and where you should focus your continuous improvement efforts.
How you classify your products and components is ultimately your decision. If you have a high-end luxury product and a much lower end product, classifying your products by cost is possibly the best choice. If the cost is similar for all of the drink products that you manufacture but the volume is quite different, classifying by liters or gallons produced is likely the best choice.
In a future article, we will determine how to calculate the optimal safety stock level, depending on the ABC / XYZ classification, the service level that we want to achieve, and a few other factors.
In the mean time, if you have questions regarding this article or would like a Lean Six Sigma Black Belt and certified supply chain professional with experience stratifying inventory with ABC / XYZ methodology, then contact Titanium Consulting, LLC to arrange a consultation so that we can review your supply chain together and develop a plan to improve your operational efficiency.
Brad Couvillon, CPIM, CSCP
Lean Six Sigma Black Belt
Founder, Titanium Consulting, LLC