5.1 Inventory Classification (ABC Analysis)

Treating a $500 FPGA and a $0.001 resistor with the same level of physical control is operational suicide. It wastes labor on trivialities while exposing the business to massive financial variance. Inventory ABC Analysis is not merely a reporting exercise; it is the Risk Management Architecture for the warehouse. It dictates where you spend your limited cycle counting hours to ensure 99.9% accuracy on the items that drive 80% of your balance sheet.

Classification Logic: Value + Criticality

Do not confuse this with "Spend ABC" (Chapter 1.3). Spend ABC drives negotiation; Inventory ABC drives security and counting.

The Pareto Baseline (Usage Value)

Rank every SKU by (Unit Cost × Annual Velocity).

• Class A: Top 80% of Inventory Value (usually ~10-20% of SKU count).
• Class B: Next 15% of Inventory Value.
• Class C: Bottom 5% of Inventory Value (usually ~50-60% of SKU count).

The "Strategic Override" (Criticality)

Pure math fails when a cheap part stops the line. Apply manual overrides to upgrade classification:

• Pilferage Risk: Small, desirable items (e.g., high-capacity SD cards, consumer-grade SSDs) → Force to Class A.
• Long Lead Time / Single Source: If a $0.50 part has a 52-week lead time → Force to Class B (Minimum) to ensure frequent validation.

Control Intensity Matrix

The classification dictates the rigor of the physical process. Configure your Warehouse Management System (WMS) to enforce these rules.

Class	Definition (Value)	Count Frequency	Accuracy Target	Access Control	Count Method
A	Top 80%	Monthly (12x/yr)	99.8%	Restricted / Cage	Unit Count (1:1)
B	Next 15%	Quarterly (4x/yr)	98.0%	Standard Aisle	Unit Count
C	Bottom 5%	Annually (1x/yr)	95.0%	Open Bin / Kanban	Scale Count / Weight
D	Obsolete / Dead	Annual Audit	100%	Segregated	Visual

Cycle Counting & Discrepancy Logic

Stop doing "Annual Physical Inventories" that shut down the factory for 3 days. Implement Cycle Counting based on ABC logic.

The Schedule Generator

• Logic: Divide the total SKUs by the required count frequency.
• Example: If you have 500 'A' items, you must count ~25 items per day to hit the Monthly target.
• Trigger: The ERP should generate "Count Tasks" daily for the warehouse staff.

Discrepancy Escalation (Write-Off Authority)

When the count does not match the system, who signs off on the loss? Define this by value, not just quantity.

• Variance < $100: Warehouse Lead (Auto-adjust allowed).
• Variance $100 - $1,000: Supply Chain Manager (Root cause required).
• Variance > $1,000: Operations Director + Finance (Full investigation required).

Pro-Tip: Never let the person who made the error approve the adjustment. Segregation of duties is mandatory for audit compliance.

Common Traps

Avoid these structural failures that render ABC analysis useless.

1. The "C-Item" Perfectionism: Spending $20 of labor to investigate a $2 discrepancy on washers. Stop. If Class C variance is low value, write it off and move on.
2. The "Static List": Running ABC analysis once during ERP setup and never updating it.
   • Result: An item that was "Class C" becomes "Class A" due to a volume spike, but is still counted only once a year.
3. The "Ghost" A-Items: High-value items with zero stock on hand.
   • Trap: If Qty = 0, the system often skips the count.
   • Fix: Mandatory "Zero Confirmation" count. You must physically verify the bin is empty.

Refresh Cadence (The Automated Loop)

Inventory dynamics change. Your classification system must breathe.

Quarterly Re-Classification

• Action: Run the ABC algorithm based on Projected usage for the next 12 months (not just historical).
• Output: Update the "ABC Code" field in the Item Master.

Trigger-Based Updates

• New Part Introduction (NPI): Default to Class B until 3 months of usage data exists.
• Cost Change: If a part price increases > 50%, trigger immediate re-eval.

Final Checklist

Control Point	Requirement	Critical Threshold
Data Integrity	ABC Codes populated in ERP	100% of Active SKUs
Cycle Count	'A' Items counted	100% per Month
Blind Counts	Counter cannot see System Qty	Mandatory
Override	Pilferable items marked 'A'	Security Audit
Refresh	Classification Update	Quarterly
Write-Offs	Approval Ladder Enforced	System Block