The ABC rule for ERP systems: would you take to the road in a 100-year-old car?

The ABC analysis of inventory comes from the Pareto principle, which states that 80% of effects come from 20% of causes. The Pareto principle is more than 100 years old and for decades, ERP systems have applied the ABC rule to categorization codes for articles. While these concepts are extremely valuable, splitting items in A, B, and C classes is relatively arbitrary, and spend volume should not be the only metric applied to the importance of an item.

The ABC rule for ERP systems: would you take to the road in a 100-year-old car?

The Pareto rule in the electronic component procurement

Let’s have a look at a classic electronic spend distribution from an electronic board manufacturer:

classic electronic spend distribution from an electronic board manufacturer

90% of the spend is comprised in by 5% of the articles; and 75% of the articles account for only 1% of the spend.

While those numbers may change from one OEM-ODM-EMS to another one or from one industry to industry, the distribution will probably remain roughly the same.

We can now arbitrarily split these articles into 3 classes:

Class A articles comprise 80% of global spend but only 2% of the articles. Class B is 15% of the spend and 8% of the articles. Class C, 5% and 90%.

The ABC rule limit

Now, let’s face it! The lowest cost item in class A is 122 times lower than the highest. 122 times within the same class! In class B, the lowest is 10 times less than the highest, and it’s even worse for class C items where the lowest spend item is 3,778,521 times lower than the highest.

Should we really consider such articles to be the same? To calculate reorder frequency? Safety lead-times? To filter push requests?

Reordering frequency example

In many ERPs, articles are split into reordering frequency classes: the highest spend articles being reordered every week, the lowest spend articles being reordered every three months.

I see huge system limitations:

  • spend value is the only criteria to calculate reordering frequency — we should take into account higher shortage risks with frequent reorders — ;
  • at both ends of the same class, articles have very different spend and should not have the same reordering frequency;
  • since reordering frequency classes are only updated once a month or once a quarter, you will always find articles in the wrong class because of demand changes.

I would highly advise you to contact your ERP administrators. Many ERPs have now embedded advanced and dynamic calculation models for greater efficiency and convenience.

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