ABC / XYZ Analysis

Slimstock’s guide to making sense of your inventory and

how much to order using the ABC / XYZ Analysis framework

Working for a small business often means your office is in a spare room or garage, and ordering can be
done by simply looking to see what inventory you’re low on. However, once you begin searching for
warehouse space and applying for an expanded line of business credit, inventory management gets
increasingly complex. A growing business requires a more sophisticated approach to forecasting.

You’ve probably heard about ABC/XYZ analysis already, but do you know the first steps toward
implementing it for your inventory? If not, don’t worry – Slimstock is here to help with a beginner’s
guide to ABC / XYZ analysis.

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inventory optimization experts

As the name suggests, ABC/XYZ Analysis is a combination of two different analysis frameworks that allow you to prioritize your inventory
by both importance / profitability (ABC), and demand volatility (XYZ). When properly implemented, ABC/XYZ Analysis will make the job
of ordering easier by making sure you’re always in line with your company’s mission and the realities of the market.

ABC Analysis - What Is It?

ABC inventory analysis is the process of classifying inventory by priority in order to determine exactly how much to hold. With the insights
this analytical approach provides, businesses can identify meaningful opportunities to reduce inventory levels. This will, in turn, reduce
carrying costs and free up working capital, helping your business run leaner and more efficiently.

When you’ve finished, your inventory will be divided into three core categories – A, B and C - based on strategic importance.
A category: Products that are important and thus require tight control
B category: Products of lower importance but must still be managed with a medium level of control
C category: Products of lower importance that require the simplest and easiest level of control

Choosing Your ABC Analysis Criteria

What parameters should you use to determine whether a product is an A, B or C item? This will depend heavily on what
KPIs are most important to your business. The most common KPIs are financial, which means your focus should be on the
profit margins of an item or the turnover rate. However, if customer satisfaction is more important, order lines should be
the factor taken into account.
A good overall framework for a high-level inventory analysis is to look at what your fastest moving SKUs are, which SKUs
have the longest lead times, and which SKUs are most important for your company to deliver on its mission. Finding the
answers to these questions may require working across departments with supply chain and finance. This might seem like
extra work, but at Slimstock we believe in taking a wholistic approach to inventory management so the opportunity to
develop relationships outside of your own department will help you more fully understand your inventory needs.
After your inventory analysis has been carried out and reviewed, your assortment can now be categorized into different
groups. In order to have a consistent and effective strategy going forward, the insights gleaned from your analysis should
underpin all future decisions related to inventory management.
Here are two example SKUs that test the guidelines for what constitutes A items:

SKU A001 SKU A002

Units Sold = 24 Total Sales = $240,000 Units Sold = 240 Total Sales = $240,000
2 40
30

1 20
10

J F M A M J J A S O N D J F M A M J J A S O N D

Because the ABC categories are broad – after all you likely have more than 3 kinds of inventory – they can also be limiting. In the above
example both items are treated the same due to their annual revenue generation, however they have very different demand patterns.
Using the same inventory strategy for these SKUs isn’t beneficial. Let’s take a look at why -
• Item A001 costs $10,000 and has steady annual demand of two per month.
• Item A002 costs $1,000 and has sporadic annual demand, however 240 per year are sold on average.
Using basic ABC analysis, these SKUs have the same consumption ($240,000), and could both be classified as A items. However, given
their differences, this is problematic for running an efficient and optimized inventory strategy. This is why another dimension of analysis
- XYZ analysis - is needed.

Action Outcome SKU A001 Outcome SKU A002

Each month order annual
demand / 12 automatically
• Low or negligible buffer
• Take off equals redorder
quantity
• Facility costs low (low buffer)
• Stock levels will increase when demand
is low, making working capital illiquid
• Items may devalue while waiting to be
sold
• High facility costs (variable buffer level

Perpetual stock count • Cost / benefit makes • Irregular demand and / or long shelf
perpetual count worthwhile time makes perpetual stock count not
worthwhile

ABC Analysis Outcomes

XYZ Analysis - What Is It?

XYZ is the process of classifying inventory by demand variability.
• X Category: Products with minimal variability. They have steady turnover, and future demand can be reliably forecast.
• Y Category: Products with some variation. They don’t have steady demand, but because fluctuations come from known factors -
e.g. competitor action, product lifecycles, seasonality, etc. - future demand can be somewhat reliably forecast.
• Z Category: Products with high variation. They have high demand variability and sporadic turnover. Future demand cannot be
reliably forecast because there are no patterns in sales data.
Visually, demand for X,Y and Z items can be illustrated as -

X Items Y Items

J F M A M J J A S O N D J F M A M J J A S O N D

Z Items

J F M A M J J A S O N D

Categorizing your warehouse via XYZ analysis allows you to allocate the right amount resources for to each group of items, reducing
the work required for inventory management.
Ordering X category products is typically automated due to their minimal variability. Hight forecast reliability also allows for less stock to
be kept on hand, lowering warehouse costs.
Products in the Y category usually require higher on-hand inventory, and/or more human oversight before computer generated orders
are placed.
Z category products are usually made-to-order or replenish-to-order. Customers typically understand that there are longer lead times
for ordering these, but always be sure to establish these expectations with them to ensure a positive customer experience.

Calculating Demand Variation Coefficient

If you’re not sure where to start in your XYZ analysis, calculating the variation coefficient of your fastest moving or most profitable items
is a good place to start. Here’s a useful framework for organizing your SKUs by demand variability:
1. Determine which SKUs to include. If you’ve already done your ABC analysis, this can simply be including all A items or, A and B, etc.
2. Calculate the variation coefficient for each item. More information on finding this coefficient can be found here or there are numerous
free online tools that can be found with a little searching around.
3. Sort your SKUs by variation coefficient from lowest to highest.
4. For cumulative variation coefficients, stay consistent by using agreed upon boundaries.
A successful XYZ analysis requires using the right timeframe for assessing demand volatility. For example, for products with seasonal
demand, only using a month’s worth of data would not yield accurate results. Similarly, products with a short lifecycle may become
obsolete on the shelf if too long of a timeframe is used.
Item cost is also a factor in XYZ analysis. For high cost products in the X category, your finance team might not want completely
automated replenishment. If even a single customer changed their order date by a week or more, excess stock for high-cost products
can result in large demands on working capital. Likewise, some Z category products may be very low cost and therefore do better with
manually set buffers. Once the buffers are decided on, an automated replenishment process can be set to maintain them, instead of
replenish-to-order.
As with ABC analysis, applying XYZ analysis on its own is too limited because it fails to consider consumption value. For example, Item
A001 may be in the X category, and item A002 may be in the Z category, though they are both high revenue generating items. Policy
may be that X category item replenishment is fully automated and Z items are manually replenished only on customer order.

Action Outcome SKU A001 Outcome SKU A002

Each month order annual
demand / 12 automatically
• Low or negligible buffer
• Take off equals redorder
quantity
• Facility costs low (low buffer)
• Stock levels will increase when demand
is low, making working capital illiquid
• Items may devalue while waiting to be
sold
• High facility costs (variable buffer level

Perpetual stock count • Cost / benefit makes • Irregular demand and / or long shelf
perpetual count worthwhile time makes perpetual stock count not
worthwhile

XYZ Analysis Outcomes

The solution to the limitations inherent in both individual frameworks is to combine them. By adding an additional factor for decision
making, ABC/XYZ Analysis makes two high-level frameworks useful for real world forecasting and ordering.

ABC/XYZ Analysis
Combining ABC and XYZ Analysis frameworks gives you a more wholistic view of demand variability and item priority. Once these
actions have been effectively implemented across your warehouse or distribution centers, you will have a more efficient and optimized
inventory management strategy.
While the ABC / XYZ analysis has more categories to place products into, the work you’ve put into aligning your product array so far
will help you make these final determinations.
A B
AX Category
• High Consumption Value
X • Even Demand
• Reliable Forecasts
AY Category
• High Consumption Value
Y
• Predictable Demand Variability
• Less Reliable Forecasts
AZ Category
• High Consumption Value
Z
• Sporadic & Variable Demand
• Unreliable / Impossible to
Forecast
ABC/XYZ Analysis Categories
Based on the characteristics of each category, actions for ordering can be formulated. The below example actions are categortized by:
♣ Degree of automation of replenishment processes
♦ Buffer stocks
♠ Inventory control
A B
AX Category
• Automated Replenishment
X • Low Buffer
• Perpetual Inventory
AY Category
• Automated w/ Manual Review
Y • Low Buffer / Stockout Risk OK
• Perpetual Inventory
AZ Category
• Buy to Order
Z • No Buffer / Customer
Understands Lead Times
• Not Stocked
ABC/XYZ Analysis Ordering Actions
BX Category
• Medium Consumption Value
• Even Demand
• Reliable Forecasts
BY Category
• Medium Consumption Value
• Predictable Demand Variability
• Less Reliable Forecasts
BZ Category
• Medium Consumption Value
• Sporadic & Variable Demand
• Unreliable / Impossible to
Forecast
BX Category
• Automated Replenishment
• Low Buffer - Safety First
• Periodic count / Medium
Security
BY Category
• Automated w/ Manual Review
• Buffer Manually Adjusted for
Seasonality
• Periodic Count / Medium
Security
BZ Category
• Buy to Order
• No Buffer / Customer
Understands Lead Times
• Not Stocked
C
CX Category
• Low Consumption Value
• Even Demand
• Reliable Forecasts
CY Category
• Low Consumption Value
• Predictable Demand Variability
• Less Reliable Forecasts
CZ Category
• Low Consumption Value
• Sporadic & Variable Demand
• Unreliable / Impossible to
Forecast
C
CX Category
• Automated Replenishment
• Low Buffer - Safety First
• Free Stock or Periodic Estimation
by Inspection / Low Security
CY Category
• Automated Replenishment
• High Buffer - Safety First
• Free Stock or Periodic Estimation
by Inspection / Low Security
CZ Category
• Automated Replenishment
• High Buffer - Safety First
• Free Stock or Periodic Estimation
by Inspection / Low Security
Managing a product assortment is an ongoing process and after your initial ABC/XYZ Analysis is complete you should revisit it every
quarter, or more often depending on your turnover and the average lifecycle of products in your market.

Since 1993, Slimstock has been synonymous with better demand forecasting, effective
inventory optimization, clear inventory analysis and continuous inventory reliability
improvement. Our customer base consists of over 925 companies worldwide, across a diverse
range of industries, covering large, medium and small enterprises.

CONTACT SLIMSTOCK
DENNIS WEIR
Tel. (331) 457-2225
info.us@slimstock.com
www.slimstock.com