The ABC method is based on the concept that only a few of the inventory items in a facility are used on a regular basis, with the remaining items being accessed at much longer intervals. This concept can be used to employ different monitoring and positioning methods for the different tranches of inventory. In essence, inventory is divided into three classifications based on usage, which are as follows:
- Classification A. Contains the 5% of inventory responsible for 75% of all transactions.
- Classification B. Contains the 10% of inventory responsible for 15% of all transactions.
- Classification C. Contains the 85% of inventory responsible for 10% of all transactions.
The proportions indicated above for the ABC method are approximate, and will vary somewhat based on actual experience. Nonetheless, it is clear that quite a small proportion of the total inventory investment experiences a massive amount of the total transaction volume.
It is fairly easy to assign an ABC code to each inventory item, and then derive storage locations within the warehouse based on that designation. In a manufacturing environment, “A” raw material items should be positioned as close to the production area as possible, to minimize travel times. In a distribution environment, “A” items should be positioned as close to the shipping area as possible, to minimize the time required to fulfill orders. Conversely, “C” items can be positioned in the nether regions of the warehouse or even in off-site storage, since they will only be accessed at long intervals. “B” items are located between the locations occupied by the “A” and “C” items.
The ABC concept can also be applied to the cycle counting of inventory, where "A" items are counted much more frequently than "B" and "C" items. The justification for doing so is that the higher transaction volume of "A" items is more likely to trigger inventory recordation errors.
ABC designations should be based on projected activity levels, rather than historical levels. Historical activity may not carry forward into the future, especially if some products are being discontinued or have seasonal sales. The designations should be re-evaluated at regular intervals, which can result in alterations of the locations where inventory items are stored.