The Pareto Principle states that most things in life are not evenly distributed. It was originally used to describe Italy and how 80% of their wealth belonged to 20% of the population and is often called the 80/20 rule. This principle is not confined to Italy, or to wealth and population; it can be observed in countless situations. For example, at work – perhaps 20% of the employees accomplish 80% of the work, etc. The saying that a few bad apples spoil the barrel reflects this principle.
The percentages don’t always have to be precisely 80% and 20%. The numbers don’t have to equal 100%, but the Pareto Principle says that the majority of effects can be traced to a minority of causes.
The 80/20 rule, applied to parts inventory control, says that 20% of your product lines produce 80% of your profits and/or 80% of your sales. It also says that 20% of your vendors supply 80% of your inventory stock and that 20% of your customers account for 80% of your sales. Etc.
You can use this rule to focus your efforts on where they will be most effective, allowing you to simplify your inventory control and reduce costs. The use of an ABC inventory management system utilizes the 80/20 rule and works as such: you split your inventory into three sets of items – A, B, and C – based upon how often each item is used. Your “A” items will account for the majority of your sales, the “B” items will have your middle-of-the-road sales numbers, and your “C” items will be those that get used the least frequently.
Once you’ve completed this analysis, you will know how to optimize your inventory organization and re-ordering standards. If there are both A items and C items getting low, you know that you should prioritize the A items and order them first; the C items can be dealt with after your big money-making inventory items are taken care of. This analysis could also show that the cost of maintaining your C inventory items exceeds the money you make from their sale, allowing you to determine if you really do need to keep these items in stock.
Although there is more than one way to determine which items should be classified as As, Bs, and Cs, you may want to base your inventory analysis on the total profit of each item – that way, all the costs associated with the item are factored in. If you use sales numbers as the base metric, you won’t immediately be able to identify which items may be hurting your bottom line.
If you need help with inventory and would like to learn more about the 80/20 rules and how it affects your business, please contact Acumen today.
