ABC Classification Systems

Firms use thousands of varieties of materials that vary in prices, usage and lead-time. It is neither desirable nor possible to exercise the same degree of control over all the materials. So, materials managers should pay more attention to those items whose usage value or consumption value is high and less attention to those items whose usage value is low.

To demonstrate the usefulness of an ABC classification system, we consider an example. A materials manager is engaged in the construction of a reservoir. He has to manage materials like cement, concrete, steel and sand. The materials manager should not take the same protective measures for storing of all four types of materials. Since cement and steel are costlier than concrete and sand, the materials manager should assign more resources to store and control cement and steel. Concrete is cheaper than cement and steel, but is costlier than sand. So, moderate resources should be assigned to store and control concrete. A very low level of resources would be enough to control sand.

Thus the materials manager classifies the materials into three categories: 'A', 'B', and 'C' on the basis of value of consumption (also called usage value). The usage value is the product of the unit cost and the amount used in a year.

Here, A represents the materials of high usage value (per annum), 'B' represents materials of moderate usage value, and 'C' represents the lower usage value items. In general, A category items account for 60 to 70 percent of the total cost, B category items 10 to 30 percent, and C category items account 5 to 15 percent. But the percentage of values of these categories varies from industry to industry and also from one firm to another within the industry.

The ABC classification system is sometimes referred to as ABC (Always Better Control) analysis. The purpose of this analysis is to alter the expenses associated with controlling the materials, according to their usage value.

The procedure is explained in the following steps:

• List all the materials that the firm holds.

• List the unit cost and the annual demand (in units) of each material.

• Calculate the usage value of each material. The usage value is obtained by multiplying the unit cost of a product with the numbers of units likely to be used in the year.

• Tabulate the materials in descending order of their usage value.

• Assign item one of the three classifications; A, B and C.

The working of ABC analysis is explained in the following example. Suppose a company uses 11 types of materials; viz, 1, 2, 3, 4, 5, 6, 7, 8, 9, 10 and 11. The following table lists quantity used per year and cost per unit of the materials.

Now we calculate the usage value of each material and arrange the materials in descending order of their usage values.               

Here, we can see that two materials (materials 1 and 2) out of 11 materials account for 66 percent of total costs. So 66 percent of the total resources are to be assigned to control 18 percent of the materials (two out of eleven materials). So, materials 1 and 2 are categorized as 'A' type materials.

Three materials namely materials type 3, 4 and 5 (27 percent of the total materials) account for 29.5 percent of the total costs. So these are grouped as B type materials. The remaining six materials account for 4.5 percent of total costs. So the materials 6, 7, 8, 9, 10 and 11 are categorized as C type materials.

Even though the method facilitates selective control of materials, the method suffers from several limitations. ABC analysis does not consider the aspect of availability of materials. In general, firms assign more resources to control the materials that are not easily available. The importance of a material is another aspect that is not considered in ABC analysis. For example, C type items like diesel oil are very important to a firm, and also become more valuable during a power crisis.                  

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