abc analysis—manage what...

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ABC Analysis—Manage What MattersThe Pareto Principal, ABC Analysis, and How to Manage by Exceptiong y p

Bill Whiteside

Bill Whiteside

• Bill Whiteside is a principal in Demand Solutions Northeast, which markets and supports the Demand Solutions suite ofwhich markets and supports the Demand Solutions suite of forecasting and supply chain management software in the Northeast U.S. After purchasing the software and using it for 3 years while serving as director of marketing for a dairy products manufacturer, Bill made the ultimate product endorsement by quitting his job and founding Demand Solutions Northeast in 1990. Prior to working with Demand Solutions, his real‐world experience included 14 years of consumer goods marketing. Bill is a graduate of the University of Notre Dame and a member of APICS and the IBF.

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Big Data

kilobytemegabytegigabyteterabytepetabyteexabytezetabytezetabyteyottabyte

Time Management?

secondsminuteshourshoursdaysweeksmonthsyearsd ddecadesgenerationslifetimes

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Managing by Exception

ABC Analysis ABC Analysis 80/20 Rule 80/20 Rule Pareto PrinciplePareto Principle

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ABC Analysis ABC Analysis 80/20 Rule 80/20 Rule Pareto PrinciplePareto Principle

Who is this Pareto guy? When did he live? Did he lead an interesting life? Oth id ?Other ideas?

About this Pareto Guy

A fascinating story

Today is more about the principle than the man

It’s a story about the value of quantitative analysis

It’s a story about managing what matters

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About this Pareto Guy

A fascinating story

Today is more about the principle than the man

It’s a story about the value of quantitative analysis

It’s a story about managing what matters

It’ l b t Vilf d P t d h h dIt’s also about Vilfredo Pareto and how he managed what truly mattered in his life

Vilfredo Pareto

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Born July 15, 1848.

The Pareto Principle is little more than a footnote in most biographies

Vilfredo Pareto

in most biographies.

Much more widely celebrated as an economist and a sociologist.

Most controversial idea: “The circulation of elites” – Just as water seeks its own level, people will also settle in to the level of social status at which they belong.

His great-great-great grandfather was awarded the title of Marchese in 1729.

When his father died in 1882, Pareto refused the title on the grounds that since it was not earned, it was of

Vilfredo Pareto

on the grounds that since it was not earned, it was of no interest to him.

In 1893, Pareto was hired as a lecturer in economics at the University of Lausanne in Switzerland.

In Benito Mussolini’s autobiography, the Fascist dictator claimed to have attended one of Pareto’s lectures.

Most serious historians believe that Mussolini just flat out made that up.

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Pareto, an engineer by training, and an economist and sociologist

Birth of the Pareto Principle

and an economist and sociologist by avocation, noted that 80% of the land in Italy was owned by 20% of the population

This, however, was an insignificant chapter in Pareto’sinsignificant chapter in Pareto s vast output, and might have remained obscure …

A pioneer and a guiding light in quality management (as well as lean

f t i d Si Si )

Pareto’s Debt to Dr. Joseph Juran

manufacturing and Six Sigma)

Juran’s Quality Control Handbook (1951) is still a standard reference.

While writing “Maldistribution of Quality Losses” chapter, sought a simpler, more memorable tag.

Juran was the first to evoke “Pareto’s Principle.”

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Applied the 80-20 Principle much more b dl th P t

Pareto’s Debt to Dr. Joseph Juran

broadly than Pareto

Promoted “the vital view and the trivial many.”

Died in 2008 at the age of 103.

Pareto’s legacy benefited from Juran’smodesty.

Juran’s Mea Culpa

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A small, vital percentage of any A small, vital percentage of any population will account for thepopulation will account for the

The Pareto Principle

population will account for the population will account for the majority of observed results.majority of observed results.

a.k.a. The 80/20 Rule

a.k.a. The law of the vital few

20% of the U.S. population

The Pareto Principle in the Real World

0% o t e U S popu at oaccounts for 80% of total health care expenses

Source: U.S. Dept. of Health & Human Services Agency for Healthcare Research & Quality

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80% of all U.S. flight delays occur in 18% of our major airports

Source: downloaded FAA table

% f


80% of horse races are won by 20% of jockeys

Source: Flatstats.co.uk

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Collective experience from 1,000+ companies over 20+ yearsy

70-90% of most companies’ sales come from 10-20% of their products

70-90% of most companies’ sales come from 10-35% of their customers

70-90% of most companies’ total forecast error comes from 5-25% of their products


38% f th38% of the songs in iTunes account for 80% of my listening

Source: way too much time on my hands

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The Pareto Principle in Pareto’s World


One of the most impressive aspects of the Pareto Principle is that if you eliminate 80% of the observations from any sample, the 80-20 rule will hold true for the remaining 20%true for the remaining 20%.

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What does it mean for your business?

This is typically what we see in industry

Often the “80/20 rule” is more like the “90/10 rule”Often the 80/20 rule is more like the 90/10 rule

Managers know what their top selling or top value products are

Typically a sense that a small group of products accounts for a significant share of sales volume

Real eye-opener is when you see how sales are concentrated

What does it mean for your business?

Revenues % of Total Cumulative # of Items % of Total Cumulative Revenues % of Total

RevenuesItems % of Total

Items

A $46,478,200 80.0% 80.0% 1,197 15.2% 15.2%

B $8,646,300 14.9% 94.9% 1,457 18.5% 33.7%

C $2,395,910 4.1% 99.0% 1,063 13.5% 47.2%

D $573 500 1 0% 100 0% 4 159 52 8 % 100 0%D $573,500 1.0% 100.0% 4,159 52.8.% 100.0%

$58,093,910 7,876

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205 major league baseball players (33% of non-pitchers) account for 80% of home runs

Source: downloaded data


205 major league baseball players (33% of non-pitchers) account for 80% of home runs.

Top 25 players account for 31% of home runs.

Baseball managersBaseball managers “manage by exception” to defend against themSource: downloaded data

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The 7 Steps for How to Execute the ABC Analysis Process1. Select the most appropriate time period to rank

How to execute the ABC Analysis process

2. Specify a unit of measure3. Assign thresholds4. Select the universe of items to rank5. Execute the ABC Ranking process6. Analyze the results7 A l h l7. Apply the results

A quick thought …

Managing by exception is like managingManaging by exception is like managing needles in a haystack.

What’s the quickest way to find the needles?

Shrink the haystack and use a magnet.

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1. Select the most appropriate time period to rankL t 12 th ?


Last 12 months?

6 months of history / 6 months of forecast?

Next 3 months?

2. Specify a unit of measure


A common unit of measure is essentialA common unit of measure is essential

Extended Revenue, Cost or Margin

Units / Equivalent Units of Measure

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3. Assign thresholds


A: the items that account for top 80% of volumeA: the items that account for top 80% of volume

B: the items that account for next 15% of volume

C: the items that account for next 4% of volume

D: the items that account for bottom 1% of volume Source:

Forecast Measurement & EvaluationWhit PWhite Paper- George Palmatier,

Oliver Wight Americaswww.oliverwight.com

4. Select the universe of items to rank


All ItemsAll Items

Any slice of your businessBy key customerProduct familiesCustomersA Items only

Let your imagination flow

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5. Execute the ABC Ranking process


Go for it! Don’t just keep a subjective ranking in your head.

How frequently should you update?

6. Analyze the results


Some considerations:

A ItemsWhat % of total volume falls into the A-Item category?What % of total volume falls into the A-Item category?How many items comprise this category?Are there any surprises in the list of top-selling items?Are there any items that you expected to see in this list but didn’t?Do you have the appropriate levels of inventory to ensure an ongoing supply of these items

D ItemsWhat % of total volume and how many items fall into the D-Item category?On how many of these items are you over-stocked?How many items had zero sales?

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7. Apply the results


N th t ’ bj ti l id tifi dNow that you’ve objectively identified your top-selling and worst-selling products, let’s move on and apply your results to manage by exception.

Vilfredo Pareto

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1889: Pareto married Allessandrina Bakunin, a spirited, penniless young Russian girl 12 years his junior.

Vilfredo Pareto

1898: Pareto inherited a sizeable fortune from an uncle and he purchased a grand house on Lake Geneva in the village of Celigny in Switzerland.

Pareto amassed an enormous personal library p yand an enviable collection of wine.

1901: Allessandrina absconded with many valuables … as well as their cook

How to apply ABC Analysis to manage what matters1. Vary your service-level targets by ABC Code2. Vary your inventory policies by ABC Code3 V f t t t i b ABC C d

How to apply ABC Analysis to Manage What Matters

3. Vary forecast strategies by ABC Code4. Run – and review – ABC Analysis in multiple units of measure5. Manage more efficiently. Spend quality time with your A Items6. Add additional dimensions to your analysis by combining additional

data with your ABC Codes7. Re-Run ABC Analysis against a different universe of data8. Run ABC Analysis for a specific season8. Run ABC Analysis for a specific season9. Add XYZ Analysis to the mix10. Think upside down

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1. Vary your service-level targets by ABC Code


A Items: 98% Service

B Items: 95% Service

C Items: 90% Service

D Items: 75% Service

2. Vary your inventory policies by ABC Code

The higher your service level target the higher


The higher your service level target, the higher the inventory investment

Don’t treat all items with equal reverence.

C and D Items are the least important items, and you can probably afford the risk of periodic stock-you can probably afford the risk of periodic stockouts.

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3. Vary forecast strategies by ABC Code

A and B Items: High volume easiest and most


A and B Items: High volume, easiest and most reliable items to forecast

C Items: More erratic; Be more restrictive

D Items: Consider a service-level based Safety Stock or Safety Time strategyStock or Safety Time strategy

4. Run – and review – ABC Analysis in multiple units of measure


High volume / low value & high value / low volumeHigh-volume / low-value & high-value / low-volume

“A” in Units, but “C” in Revenue

Periodically review alternate units of measure

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5. Manage more efficiently. Spend quality time with your A Items


Since your time is finite, spend it most effectivelySince your time is finite, spend it most effectively

Spend 80% of your time reviewing & Managing A’s

Analyze A-Items in detailStudy their sales trendsReview their forecasts against perspective of trendsAnalyze forecast accuracyDo you have adequate inventory on hand & in the pipeline?

6. Add additional dimensions to your analysis by combining additional data with your ABC Codes


Examples

Simulation Error

Weeks of Supply

Margin Rate g

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7. Re-Run ABC Analysis against a different universe of data


Just the items that a key customer buysJust the items that a key customer buys

Just the items within a product family or a sales channel

Rank and stratify your customers

8. Run ABC Analysis for a specific season


If your product mix varies considerably from one season to the next, consider updating your ABC Codes within each season … and then apply the appropriate forecasting and inventory strategies

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9. Add XYZ Analysis to the mix




XYX Analysis: used to categorize items based on frequency of demand.

Especially applicable to businesses that manage spare parts or haveEspecially applicable to businesses that manage spare parts or have significant “low and slow” moving items

If 2 items each sold 12 units last year, with one selling all 12 in one month, and the other selling one per month over that period, it would make sense to manage them differently.

Runners, Repeaters and Strangers:Runners: Products that have had demand in at least 10 of the last 12 monthslast 12 monthsRepeaters: Products that have had demand in at least 4 (and no more than 9) out of the last 12 monthsStrangers: Products that have had demand in 3 or fewer months out of the last 12 months

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Include a policy matrix in your review process

Weekly Review

Monthly Review

Quarterly Review


upside10. Think

down

Assumes that high-volume A-Items have more reliable gforecasts, and more consistently replenished.

Be sure to consider lead time.

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Manage What Matters … Where to Begin?

Manage What Matters … Where to Begin?

% f l C l i # f I % f l C l iRevenues % of TotalRevenues

Cumulative % of TotalRevenues

# of Items % of Total Items

Cumulative % of Total

Items

A $46,478,200 80.0% 80.0% 1,197 15.2% 15.2%

B $8,646,300 14.9% 94.9% 1,457 18.5% 33.7%

C $2,395,910 4.1% 99.0% 1,063 13.5% 47.2%

D $573,500 1.0% 100.0% 4,159 52.8.% 100.0%

$58,093,910 7,876

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Vilfredo Pareto

1901: Shortly after Allesandrina left, Pareto fell in love with Jane Regis, a Frenchwoman, 30 years younger than him

Vilfredo Pareto

younger than him.

They lived together for the remaining 22 years of his life.

Vilfredo and Jane had 18 Angora cats

They named their house Villa AngoraThey named their house Villa Angora

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Divorce was illegal in Italy, and Vilfredoremained legally married to Allessandrina until

Vilfredo Pareto

g ya few months before his death in 1923

In early 1923 Pareto became a citizen of the Free State of Fiume, where divorce was legal.

He divorced Allesandrina and married Jane

Vilfredo Pareto died August 19, 1923

Manage What Matters White Paper

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Questions?

Contact Info:

bwhiteside@demandsolutions.comwww.demandsolutions.comwww.twitter.com/BillWhitesideDS

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