6 Keys to Setting Inventory Priority Levels
A logical inventory hierarchy streamlines the inventory management process.
Unless your business builds or sells just one SKU, you understand that inventory items are not all managed equally. High priced, long lead time items tend to be monitored closely while low value items might be managed by simply refilling kanban bins periodically. How do you know which items to prioritize, and how do you create the right inventory levels for your business?
Dollar value is part (but not all) of the story. With the help of inventory management software and a thoughtful review of your products, suppliers, and customers, you can develop an inventory prioritization strategy that helps your business succeed.
“The more inventory a company has, the less likely they will have what they need.” – Taiichi Ohno
The A-B-Cs of inventory prioritization
The best-known inventory prioritization method is called ABC analysis. As the name implies, ABC analysis is used to divide inventory into one of three categories based on value, turnover rate, and the significance of each item to overall business objectives.
Once items are classified, rules are established to determine inventory audit frequency, warehouse locations, barcode labeling methods, and other variables that drive resource allocation. In general, the three categories are defined as:
- Category A: Items that are in high demand or contribute significantly to revenue. For manufacturing operations, this category might also include sole-source or long lead time items that are difficult to replace.
- Category B: The mid-level category usually includes items with lesser value that still experience frequent inventory turns and warrant significant monitoring to ensure successful order fulfillment.
- Category C: This tier typically includes low value, low demand parts, commodity items, packing materials, and off-the-shelf items like screws, washers, and spacers that don’t warrant constant review.
6 keys to setting inventory priority levels
ABC analysis can be a great starting point for establishing an inventory prioritization framework. Depending on the nature of your business, you may want to expand upon this foundation by creating more (or fewer) categories and establishing tailored criteria. This deeper dive should include:
1. Business context
Each industry and individual business has a unique set of variables that feeds into inventory prioritization. For example, fast food restaurants emphasize the availability of high-volume, perishable ingredients, while computer manufacturers might focus on long lead-time processors and displays. As part of the initial planning process, it helps to review all supply chain risks and their potential impact on customer order fulfillment.
Business goals and priorities also come into play when items are related to a new product launch or marketing initiative and must be prioritized to ensure their quality and availability. Other strategic decisions can cause items to be de-prioritized based on phase outs or obsolescence. These factors should be tracked so that categorization adjustments can be made accordingly.
2. Assessing part value
If inventory value is not defined by price tag alone, how do you create a system to assign item value consistently? According to the 80/20 rule, 80% of results come from 20% of causes. As applied to inventory management, 80% of profits come from 20% of the products sold. Establishing inventory categories and defining top tier items requires you to research insightful metrics such as:
- Annual demand for each item
- Profit margin associated with the item
- Expected lead time and lead time variation
- Shelf life (for chemicals and perishables)
- Criticality to operations
Weighing these factors, and others that are specific to your business, leads to part “values” that go well beyond the purchase or sales price. You can define the relative weight of each factor based on the nature of your product and potential impact (financial or otherwise) of a shortage. Keeping these targets in mind will help you categorize items appropriately and create a formula that can be applied consistently.
3. Reviewing turnover ratios
Turnover should be reviewed as part of a robust inventory prioritization process. The turnover ratio indicates how quickly inventory is sold and replenished while providing deeper insight into the efficiency of the inventory management process. Items with high turnover ratios have lower holding costs, reduced risk of obsolescence, and a level of demand that signifies their influence on order fulfillment and revenue.
Slow moving items could be essential for specific customer preferences, so a low turnover ratio does not automatically translate to a lower priority level. A nuanced approach to priority level setting considers multiple inputs to determine the requisite level of control.
4. Establishing ideal inventory quantities
The amount of inventory kept on hand should be evaluated both before and after setting the priority levels. For example, a long lead item that is usually consumed as soon as it arrives might merit a category “A” prioritization. The resulting inventory management rules might call for low inventory and purchase order quantities to minimize carrying costs and prevent obsolescence.
Inventory management practices like just-in-time (JIT) also impact inventory prioritization strategies. Using JIT, stock and purchase order quantities are minimized to reduce waste, rework, and holding costs. Since excessive safety stock is not an option to mitigate risk, parts with inconsistent supplier and delivery performance always require more monitoring.
“To be competitive, we have to look for every opportunity to improve efficiencies and productivity while increasing quality.” – Cynthia Fanning
5. Inventory management software
Even retail stores and E-commerce businesses with a small number of product offerings can create, track, and analyze inventory prioritization systems much more effectively using inventory management software. Real-time inventory and price information, sales order data, and supplier performance reports provide a foundation to set inventory priority levels, while helping you monitor and analyze inventory KPIs for each category, including:
- Inventory turns per year
- Supplier on time delivery (OTD)
- Order fill rates
- Carrying costs
- Forecast accuracy
Embracing the latest inventory management technology also helps you identify trends and patterns proactively to prevent bottlenecks, stockouts, or excess inventory conditions that impact customer satisfaction and the bottom line.
6. Assigning meaning to each level
Setting inventory priority levels is only half of a two-step process. For each level, you will need to define the activities required to support monitoring and maintenance. For example, category A inventory should be subject to more frequent inventory audits and cycle counts, while Category C might be counted only once per year. Labeling high priority items with barcodes or RFID tags improves the accuracy and efficiency of physical counts.
The placement of each item in the warehouse should also be established based on priority level. Important items should be located in secure areas that are easily accessible for shipping, receiving, and order fulfillment operations, while lower priority items can be placed on high shelves and other less accessible areas. Many larger companies utilize dynamic slotting practices to adjust warehouse locations in real-time.
Overcoming inventory prioritization challenges
Inventory priority level setting is unique for each company, so subjectivity can become an issue during the categorization process. Lack of clarity and consensus can also make it difficult to define appropriate inventory control parameters for each level. Utilizing data-driven algorithms and cross-functional teams to plan and oversee the process are wise mitigation strategies.
Maintaining accurate inventory prioritization assignments is another common challenge. Factors like seasonal demand, material shortages, and unpredictable market shifts can render prioritization formulas obsolete quickly. Continuous (or automated) review and adjustment of parameters can prevent these changes from negatively impacting inventory management efficiency.
Setting inventory priority levels: Final thoughts
In many ways, inventory prioritization activities mirror our own lives and households. Personal items like car keys, wallets, and favored jewelry are never far from sight, while our closets often feature a hodge-podge of long forgotten items we will eventually dispose of. Without consciously applying priority levels, we pay more attention to the most important items while giving little notice to things we assign less personal value to.
Applying this thought process to inventory management requires some additional planning and technology. The cloud-based, mobile-friendly Agiliron product suite seamlessly integrates inventory management, mobile point of sale (POS), warehouse management, and full featured customer relationship management (CRM) solutions to help you manage, analyze, and act on all important data sources from one place.
Businesses of all types and sizes can improve their efficiency and customer service by setting useful inventory priority levels. Getting started can be the most difficult step, but we are here to help. Contact us today and let our solution experts help you find the inventory management strategy that fits your unique situation.
