3. Inventory management classification (ABC XYZ and points to be careful with) 

Before diving into inventory policies, it’s essential to understand inventory classification. Regardless of your company type or inventory variety, it’s highly unlikely that all of your products or categories will behave the same way. 

Some products sell in higher volumes, some are seasonal, some have higher price points, and some have longer lead times, and so on.  

These variations impact how you should manage each item. 

ABC and XYZ Classification

A common approach is to classify inventory based on volume (ABC) and demand variability (XYZ). You can find a clear example of ABC-XYZ classification on TrueGradient AI’s Medium post here. This classification is a basic starting point, as detailed in ABC Supply Chain’s guide on conducting this analysis (ABC Supply Chain details how you can conduct this analysis in detail (their first article on the topic here)) 

ABC XYZ classification by Truegradient AI

 

But this method has limitations. Relying solely on volume may cause you to overlook high-value or business-critical items that need special focus.  

Refining Your Classification Approach 

1. Use value, profitability, and criticality: Instead of volume alone, factor in an item’s value, profitability, and business criticality. Some items are critical to customer retention and must be prioritized, even if they are low-volume. 

2. Set inventory levels through service levels: Don’t assign stock directly based on categories. Instead, determine service levels for each classification. Higher service levels mean more stock needs to be available to reduce the risk of stockouts. 

3. Adjust for demand predictability: Even among high-value items, the level of safety stock needed will vary. A predictable high-value item needs less safety stock than an unpredictable one, though both might require similar service levels. 

4. Consider lead time variability and other factors: Lead time differences can also impact required stock levels. For instance, a high-value item with a variable lead time may need higher safety stock to offset supply uncertainties.
   

Practical Application 

1. Classify first by value, criticality, and profitability: Start by sorting items based on their financial impact and importance to the business. 

2. Apply ABC-XYZ for service level targets if you have many products: Use this classification to set service levels for each category. Then, factor in demand variability, supplier reliability, and specific constraints (like minimum order quantities) to automatically determine the optimal stock level for each product.  

Yes, it is more complex than just setting a basic inventory level for a product, but it is much better as it ensures that your inventory policies align with business priorities, and these will allow you to optimize stock levels without compromising on service levels.