ABC analysis is a technique for inventory control that classifies items into A, B, and C categories based on annual consumption value. A items account for the majority of total consumption value while C items account for the least. VED analysis classifies items as vital, essential, or desirable based on their criticality. Combining ABC and VED analysis provides a 9-box framework to prioritize control and service levels for different inventory items based on consumption value and criticality.

1. By R. Mekala, Ashwin Hariharan

2. Methods of inventory control Important methods of inventory control include A – B – C analysis Periodic revision of classification VED analysis A – B – C analysis A – B – C analysis is a basic technique of materials management. The applicability of this technique extends over almost all aspects of materials management such as purchasing, receiving and inspection of materials. This technique can be used in any aspects of business or individual problem to control the cost.

3. The origin of ABC analysis is PARETO’S 80 – 20 rule. This rule says that 80 % of country’s economy is controlled by 20% of the people. If we apply this rule to verify its correctness, the results say that it is correct. Example: List out all the expenses we do over a period of time and arrange them in the order from highest to lowest. Find the total of expenses and workout percentage of each with respect to the total. We see that only 20 % of items consume 80% of our expenses.

4. We have 24 hours in a day. List out the times you have spent on each activity and arrange them in descending order, workout the percentage, we find 20% of items covers 80% of time. The principle of management by exception is a better term under which we can classify ABC analysis. Controls applied selectively to contribute to a better management, in most cases avoiding wastages of precious management time and, importantly avoiding the confusion resulting from excessive controls.

5. The degree and characteristics of controls to be exercised by the management should depend upon: The necessity of control, The relative necessity of the material to be placed under control, The particular characteristics of the material.

6. Materials may be divided into three categories or three classes for selective management control. More grades than this may not give fruitful results. These three grades in which materials are classified is known as A – class materials, B – class materials, C – class materials. In reality A, B, C stands for three different classes. But many a time this classification is known as A lways B est C ontrol. ABC analysis is based on the relative importance of materials. Therefore there are various bases for ABC classification. They are:

7. Material price Material’s credibility Availability status of materials Materials physical characteristics such as size and weight, Frequency of materials usage, etc Depending on the situation and importance of above characteristics, classification is made. Conventionally, however, the basis for ABC analysis is ‘Annual consumption value’ of the material. One should understand clearly, that annual consumption value does not refer to the unit price of the material and it refers to the annual consumption value.

8. Example: Consider the firm using a component whose unit cost is Rs. 1000/- . It uses three units in a year. Hence the annual consumption value is Rs. 3000/-. Consider another item the firm is using is a bolt, whose unit price is Re. 1/-. The quantity used in a year is 10,000 units. Hence the annual consumption value is Rs. 10,000/-. Here the bolt is considered to be high consumption value item. It has been found in many industries that a small number of items account for a large proportion of the annual turnover of the inventory.

9. These items should attract materials managers’ attention immediately. Such items are known as ‘A’ class items. It is also observed in industries that a very large number of items of inventory accounts for a small portion of the annual turnover or annual consumption value of the materials. There are many items contributing very little to the ultimate problem of managing the working capital investment. Naturally, materials manager should turn his attention to those items only after he has taken care of high annual turnover items (A class items). Such items are classified as ‘C’ class items. Class B items belong to in-between categories; neither their total consumption value high nor their total numbers is high.

10. Procedure for ABC analysis: List all the materials used in the company Work out their annual consumption value Arrange all of the items in the descending order of their annual consumption value Add all consumption costs and get the total annual inventory cost Write the cumulative consumption value and find the percentage of this cumulated consumption value to total inventory value Write a was line at 70% and 90% All the items which fall under 70% are ‘A’ class items , items that falls between 70% and 90% are ‘B’ class items and other, which are between 90% and 100% are ‘C’ class items

11. The following steps are involved in implementing the ABC analysis: 1. Classify the items of inventories, determining the expected use in units and the price per unit for each item. 2. Determine the total value of each item by multiplying the expected units by its units price 3. Rank the items in accordance with the total value, giving first rank to the item with highest total value and so on. 4. Compute the ratios (percentage) of number of units of each item to total units of all items and the ratio of total value of each item to total value of all items. 5. Combine items on the basis of their relative value to form three categories: -A, B and C.

12. VED ANALYSIS In addition to the intrinsic or market value of materials, which is invested in the materials, there is sometimes a nuisance value to the materials. In ABC analysis, we have seen that annual consumption value; quantity of materials consumed and unit cost plays a vital role. This is to say that ABC analysis deals with the annual consumption value of the item due to their presence and not any other aspect such as the criticality of the material or the nuisance value.

13. The nuisance Value is the cost associated with materials due to their absence. Some of the materials are important by their absence. In case they are not available, the whole production system may come to standstill and involve high cost of loss of production. The investment in these materials may be small but for non – availability of the item the costs or losses the company going to involve will be very high. These are critical items, which are required in adequate quantity.

14. The materials may be classified depending upon their criticality that is on functional basis. The degree of criticality can be stated as whether the material is vital to the process of production, or essential to the process of production or desirable for the process of production. This classification is known as VED analysis, V stands for vital , E stands for essential and D stands for desirable items.

15. In addition to the conventional ABC analysis, VED analysis also plays an important role in materials management. VED ranking may be done on the basis of the shortage costs of materials, which can be either quantified or qualitatively expressed.

16. COMBINATION OF ABC &VED ANALYSIS We can combine both and classify the materials depending on both the consumption value and the criticality; it will give us a fruitful result. This can be done in nine ways

17. V E D A AV AE AD B BV BE BD C CV CE CD

18. V E D A 90% 80% 70% B 95% 85% 75% C 99% 90% 80%

19. This type of classification helps the management to decide the materials policy and what the service levels are expected to see that no difficulty is faced. An item belongs to both A and V class is costlier, at the same time higher criticality, the management should see that it is available at any time the need arises and the stock levels to be controlled properly to see that inventory carrying cost are kepy under control.

20. Reference: Productions & operations management – P.Rama murthy page number 282-288 Productions & operations management – R. Pannerselvam page number 223- 228 http://en.wikipedia.org/wiki/ABC_analysis

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