In an earlier post, I mentioned I would be describing the ABC approach to inventory management in more detail. ABC is used in retail, and can be applied in healthcare, for example when trying to manage surgical inventory with reduced effort.
Before I get into ABC, I want to say that my mention of ‘analytics’ in the title of this post does not presuppose the use of any fancy software tool for analysis. Rather, it refers to a mindset. Specifically, it means that we are not content with simply measuring or reporting a situation, and that if a problem is detected we are also going to analyze its root causes and attempt to offer a fix.
ABC: ranking inventory by value and reducing management effort
A key idea in managing inventory is that not all stock is equally valuable, therefore not all stock requires the same management focus:
- from the inventory viewpoint, items have different cost and usage rates over a time period
- from the management effort viewpoint, resources, energy, and time are limited, so one should not spend them equally on everything.
Pareto analysis is widely used in Lean, and is similar in focus to ABC. Pareto helps answer the basic question as to which are the “important few items” vs. the “trivial many”. ABC tries to group items into bands that account for different amounts of inventory value and thus need to be handled with different criteria. Both approaches aim to reduce waste, with ABC specifically targeting managing effort.
How ABC works in practice
To perform an ABC inventory value analysis:
- Choose a time period over which to perform the analysis.
- Locate reliable data as to item cost and usage over that time frame.
- Calculate turnover ($) by multiplying item cost times quantity used during that time period for each item.
- Rank items from highest to lowest value (yearly turnover, in $).
- Group items into three “bands” (A, B, and C) for managing under different policies.
It is not uncommon for staff in charge of inventory to focus their stock managing efforts on expensive items and ignore cheaper ones which, however, may have higher turnover ($) due to much greater usage.
Ex. A typical result of ABC analysis
Band A – 10% of total items managed, accounting for 60% of total value
Band B – 25% of total items, 33% of total value
Band C – 65% of total items, only 7% of total value
Therefore, focusing on A + B bands takes 35% of total effort to manage but controls 93% of inventory value. This, of course, is not a given and needs to be established by careful analysis of the situation at hand. Note also that occasionally there is a need for more than three bands.
Analyzing surgical inventory with ABC
Surgery costs are a big part of hospital operational costs (40-50% approx.) The following is an illustrative example drawn from an analysis done for a client’s surgical inventory. The need for the analysis arose from a situation in which staff felt overwhelmed by the volume of items to manage, and management was dissatisfied with frequent overstocking and associated costs.
Annual turnover: $58.1MM
Total items: 4800 approx. — note: 1400 (29%) “zero usage” entries
In doing ABC assignments, thresholds were set at $100K and $10K, and bands were defined as A: item turnover > $100K/yr., B: item turnover > $10K/yr., C: item turnover < $10K/yr. Typically, this is a trial-and-error procedure that can be tweaked to allocate the band-limiting thresholds as is most convenient for the specific situation. There are no hard and fast rules as to how to allocate items to bands. See table below (note: it = item turnover.)
|Band A||Band B||Band C|
|22 items (0.46% of total)||254 items (5.3% of total)||4524 items (94.3% of total)|
|it > $100K/yr.||$100K/yr. > it > $10K/yr.||it < $10K/yr.|
|$47.7MM/yr. (82.3% of total / 82.3% cumulative)||$7.3MM/yr. (12.5% of total / 94.8% cumulative)||$3.1MM/yr. (5.2% of total / 100% cumulative)|
Focusing on bands A + B targets less than 6% of the items for close supervision yet controls over 94% of the inventory value. If one assumes that managing any two items takes a similar effort, having to deal with only 6% of the items means an effective reduction of 94% in control effort and thus cost from having to allocate one’s time across 100% of the inventory.
Interestingly, there was initial resistance at placing very expensive items (ex. spinal implants) in band B, as staff felt they belonged “at the top” in band A. Staff were clearly more focused on cost than on turnover $, and hence usage was less of a factor to them. Among other things, this spoke to the need to more closely integrate analyses done separately by Procurement, Finance, and Operations.
Another interesting point was that, despite this being a multi-practice client, with different procedures performed across a spectrum of specialties at each practice, the ABC approach yielded roughly the same results across the board, with 7-15% of the items being shown to account for 87-95% of the value of the surgical inventory regardless of site.
ABC band assignments
How do assignments to bands occur? Typically, band A is characterized by few items with the greatest turnover. There is little or no safety stock involved and deliveries are small and frequent — the extreme case being JIT, or Just In Time delivery of stock. This band requires very tight control and perhaps personal supervision by one or more trained specialists. With frequent monitoring and accurate record-keeping, sophisticated forecasting of demand/usage is possible.
Band B includes important items with significant turnover. Classic stock control management by exception applies and increased usage of safety stock is prudent. Controls are relaxed with respect to band A and therefore manpower requirements drop. Here one might have biweekly deliveries involving two weeks worth of supply.
Band C contains most items, with a low turnover — meaning either low value or infrequent movement. This band is best managed through minimum supervision, large safety stock, and relatively infrequent, large orders (ex. monthly deliveries of four weeks worth of supply.) The ability to step away from actively managing band C is one of the greatest benefits in organizations already strapped for resources. As in Lean, thinking about what not to do before getting stuck in is crucial.
These are the nuts and bolts of ABC inventory management. I hope the material presented here has shown how to 1) move beyond passive data monitoring (cost, usage), 2) do some useful analytics (turnover), which then allow for 3) band-specific inventory control policies (restocking frequency and quantities) to be put in place.
The implementation of the ABC approach should be preceded by removing obsolete, zero-usage items from inventory altogether. This is crucial both to declutter and repurpose physical space, and to allow staff to focus on a preliminary, reduced set of active items, realizing also the end goals of less personal fatigue from cognitive overload, redeployment of some to other tasks, and reduced stock management costs.