7/25/2012

ABC Analysis—Manage What  Matters The Pareto Principal, ABC Analysis,  and How to Manage by Exception g y p Bill Whiteside

Bill Whiteside • Bill Whiteside is a principal in Demand Solutions Northeast,  which markets and supports the Demand Solutions suite of which markets and supports the Demand Solutions suite of  forecasting and supply chain management software in the  Northeast U.S.  After purchasing the software and using it for  3 years while serving as director of marketing for a dairy  products manufacturer, Bill made the ultimate product  endorsement by quitting his job and founding Demand  Solutions Northeast in 1990.  Prior to working with Demand  Solutions, his real‐world experience included 14 years of  consumer goods marketing.  Bill is a graduate of the University  of Notre Dame and a member of APICS and the IBF.

1

7/25/2012

Big Data kilobyte megabyte gigabyte terabyte petabyte exabyte zetabyte yottabyte

Time Management? seconds minutes hours days weeks months years decades d d generations lifetimes

2

7/25/2012

Managing by Exception ABC Analysis

80/20 Rule

Pareto Principle

3

7/25/2012

Managing by Exception ABC Analysis

80/20 Rule

Pareto Principle

Who is this Pareto guy? When did he live? Did he lead an interesting life? Other Oth ideas? id ?

About this Pareto Guy A fascinating story Today is more about the principle than the man It’s a story about the value of quantitative analysis It’s a story about managing what matters

4

7/25/2012

About this Pareto Guy A fascinating story Today is more about the principle than the man It’s a story about the value of quantitative analysis It’s a story about managing what matters It’s he managed It’ also l about b t Vilfredo Vilf d Pareto P t and d how h h d what truly mattered in his life

Vilfredo Pareto

5

7/25/2012

Vilfredo Pareto Born July 15, 1848. The Pareto Principle is little more than a footnote in most biographies biographies. Much more widely celebrated as an economist and a sociologist. Most controversial idea: “The circulation of elites” – Just as water seeks its own level, people will also settle in to the level of social status at which they belong.

Vilfredo Pareto His great-great-great grandfather was awarded the title of Marchese in 1729. When his father died in 1882, Pareto refused the title on the grounds that since it was not earned, it was of no interest to him. In 1893, Pareto was hired as a lecturer in economics at the University of Lausanne in Switzerland. In Benito Mussolini’s autobiography, the Fascist dictator claimed to have attended one of Pareto’s lectures. Most serious historians believe that Mussolini just flat out made that up.

6

7/25/2012

Birth of the Pareto Principle

Pareto, an engineer by training, and an economist and sociologist by avocation, noted that 80% of the land in Italy was owned by 20% of the population This, however, was an insignificant chapter in Pareto Pareto’ss vast output, and might have remained obscure …

Pareto’s Debt to Dr. Joseph Juran A pioneer and a guiding light in quality management (as well as lean f t i and d Si manufacturing Six Si Sigma)) Juran’s Quality Control Handbook (1951) is still a standard reference. While writing “Maldistribution of Quality Losses” chapter, sought a simpler, more memorable tag. Juran was the first to evoke “Pareto’s Principle.”

7

7/25/2012

Pareto’s Debt to Dr. Joseph Juran

Applied the 80-20 Principle much more b dl th t broadly than P Pareto Promoted “the vital view and the trivial many.” Died in 2008 at the age of 103. Pareto’s legacy benefited from Juran’s modesty.

Juran’s Mea Culpa

8

7/25/2012

The Pareto Principle A small, vital percentage of any population will account for the majority of observed results. a.k.a. The 80/20 Rule a.k.a. The law of the vital few

The Pareto Principle in the Real World

20% 0% o of tthe eU U.S. S popu population at o accounts for 80% of total health care expenses

Source: U.S. Dept. of Health & Human Services Agency for Healthcare Research & Quality

9

7/25/2012

The Pareto Principle in the Real World

80% of all U.S. flight delays occur in 18% of our major airports Source: downloaded FAA table

The Pareto Principle in the Real World

80% % off horse races are won by 20% of jockeys Source: Flatstats.co.uk

10

7/25/2012

Managing by Exception Collective experience from 1,000+ companies over 20+ years y 70-90% of most companies’ sales come from 10-20% of their products 70-90% of most companies’ sales come from 10-35% of their customers 70-90% of most companies’ total forecast error comes from 5-25% of their products

The Pareto Principle in the Real World

38% off th the songs in iTunes account for 80% of my listening Source: way too much time on my hands

11

7/25/2012

The Pareto Principle in Pareto’s World

The Pareto Principle in the Real World

One of the most impressive aspects of the Pareto Principle is that if you eliminate 80% of the observations from any sample, the 80-20 rule will hold true for the remaining 20% 20%.

12

7/25/2012

What does it mean for your business? This is typically what we see in industry Often the “80/20 80/20 rule” rule is more like the “90/10 90/10 rule” rule Managers know what their top selling or top value products are Typically a sense that a small group of products accounts for a significant share of sales volume Real eye-opener is when you see how sales are concentrated

What does it mean for your business?

Revenues

% of Total Revenues

Cumulative  % of Total Revenues

# of Items

% of Total  Items

Cumulative  % of Total  Items

A

$46,478,200

80.0%

80.0%

1,197

15.2%

15.2%

B

$8,646,300

14.9%

94.9%

1,457

18.5%

33.7%

C

$2,395,910

4.1%

99.0%

1,063

13.5%

47.2%

D

$573 500 $573,500

1 0% 1.0%

100 0% 100.0%

4 159 4,159

52 8 % 52.8.%

100 0% 100.0%

$58,093,910

7,876

13

7/25/2012

The Pareto Principle in the Real World 205 major league baseball players (33% of non-pitchers) account for 80% of home runs

Source: downloaded data

The Pareto Principle in the Real World 205 major league baseball players (33% of non-pitchers) account for 80% of home runs. Top 25 players account for 31% of home runs. Baseball managers “manage by exception” to defend against them Source: downloaded data

14

7/25/2012

How to execute the ABC Analysis process The 7 Steps for How to Execute the ABC Analysis Process 1. Select the most appropriate time period to rank 2. Specify a unit of measure 3. Assign thresholds 4. Select the universe of items to rank 5. Execute the ABC Ranking process 6. Analyze the results 7 Apply 7. A l the h results l

A quick thought …

Managing by exception is like managing needles in a haystack. What’s the quickest way to find the needles? Shrink the haystack and use a magnet.

15

7/25/2012

How to execute the ABC Analysis process

1. Select the most appropriate time period to rank L t 12 months? th ? Last 6 months of history / 6 months of forecast? Next 3 months?

How to execute the ABC Analysis process 2. Specify a unit of measure A common unit of measure is essential Extended Revenue, Cost or Margin Units / Equivalent Units of Measure

16

7/25/2012

How to execute the ABC Analysis process

3. Assign thresholds A: the items that account for top 80% of volume B: the items that account for next 15% of volume C: the items that account for next 4% of volume D: the items that account for bottom 1% of volume

Source: Forecast Measurement & Evaluation White Paper Whit P - George Palmatier, Oliver Wight Americas www.oliverwight.com

How to execute the ABC Analysis process 4. Select the universe of items to rank All Items Any slice of your business By key customer Product families Customers A Items only Let your imagination flow

17

7/25/2012

How to execute the ABC Analysis process

5. Execute the ABC Ranking process Go for it! Don’t just keep a subjective ranking in your head. How frequently should you update?

How to execute the ABC Analysis process 6. Analyze the results Some considerations:

A Items What % of total volume falls into the A-Item category? How many items comprise this category? Are there any surprises in the list of top-selling items? Are there any items that you expected to see in this list but didn’t? Do you have the appropriate levels of inventory to ensure an ongoing supply of these items D Items What % of total volume and how many items fall into the D-Item category? On how many of these items are you over-stocked? How many items had zero sales?

18

7/25/2012

How to execute the ABC Analysis process 7. Apply the results Now th N thatt you’ve ’ objectively bj ti l id identified tifi d your top-selling and worst-selling products, let’s move on and apply your results to manage by exception.

Vilfredo Pareto

19

7/25/2012

Vilfredo Pareto 1889: Pareto married Allessandrina Bakunin, a spirited, penniless young Russian girl 12 years his junior. 1898: Pareto inherited a sizeable fortune from an uncle and he purchased a grand house on Lake Geneva in the village of Celigny in Switzerland. y Pareto amassed an enormous p personal library and an enviable collection of wine. 1901: Allessandrina absconded with many valuables … as well as their cook

How to apply ABC Analysis to Manage What Matters How to apply ABC Analysis to manage what matters 1. Vary your service-level targets by ABC Code 2. Vary your inventory policies by ABC Code 3 Vary 3. V fforecastt strategies t t i by b ABC Code C d 4. Run – and review – ABC Analysis in multiple units of measure 5. Manage more efficiently. Spend quality time with your A Items 6. Add additional dimensions to your analysis by combining additional data with your ABC Codes 7. Re-Run ABC Analysis against a different universe of data 8. Run ABC Analysis for a specific season 9. Add XYZ Analysis to the mix 10. Think upside down

20

7/25/2012

How to apply ABC Analysis to Manage What Matters

1. Vary your service-level targets by ABC Code A Items: 98% Service B Items: 95% Service C Items: 90% Service D Items: 75% Service

How to apply ABC Analysis to Manage What Matters

2. Vary your inventory policies by ABC Code The higher your service level target target, the higher the inventory investment Don’t treat all items with equal reverence. C and D Items are the least important items, and you can probably afford the risk of periodic stockstock outs.

21

7/25/2012

How to apply ABC Analysis to Manage What Matters

3. Vary forecast strategies by ABC Code volume easiest and most A and B Items: High volume, reliable items to forecast C Items: More erratic; Be more restrictive D Items: Consider a service-level based Safety Stock or Safety Time strategy

How to apply ABC Analysis to Manage What Matters

4. Run – and review – ABC Analysis in multiple units of measure High volume / low-value low value & high value / low volume High-volume high-value low-volume “A” in Units, but “C” in Revenue Periodically review alternate units of measure

22

7/25/2012

How to apply ABC Analysis to Manage What Matters 5. Manage more efficiently. Spend quality time with your A Items Since your time is finite, spend it most effectively Spend 80% of your time reviewing & Managing A’s Analyze A-Items in detail Study their sales trends Review their forecasts against perspective of trends Analyze forecast accuracy Do you have adequate inventory on hand & in the pipeline?

How to apply ABC Analysis to Manage What Matters

6. Add additional dimensions to your analysis by combining additional data with your ABC Codes Examples Simulation Error Weeks of Supply g Rate Margin

23

7/25/2012

How to apply ABC Analysis to Manage What Matters

7. Re-Run ABC Analysis against a different universe of data Just the items that a key customer buys Just the items within a product family or a sales channel Rank and stratify your customers

How to apply ABC Analysis to Manage What Matters

8. Run ABC Analysis for a specific season If your product mix varies considerably from one season to the next, consider updating your ABC Codes within each season … and then apply the appropriate forecasting and inventory strategies

24

7/25/2012

How to apply ABC Analysis to Manage What Matters

9. Add XYZ Analysis to the mix

How to apply ABC Analysis to Manage What Matters 9. Add XYZ Analysis to the mix XYX Analysis: used to categorize items based on frequency of demand. Especially applicable to businesses that manage spare parts or have significant “low and slow” moving items If 2 items each sold 12 units last year, with one selling all 12 in one month, and the other selling one per month over that period, it would make sense to manage them differently. Runners, Repeaters and Strangers: Runners: Products that have had demand in at least 10 of the last 12 months Repeaters: Products that have had demand in at least 4 (and no more than 9) out of the last 12 months Strangers: Products that have had demand in 3 or fewer months out of the last 12 months

25

7/25/2012

How to apply ABC Analysis to Manage What Matters 9. Add XYZ Analysis to the mix Include a policy matrix in your review process

Weekly Review

Monthly Review

Quarterly Review

How to apply ABC Analysis to Manage What Matters

down upside

10. Think Assumes that high-volume A-Items have more reliable g forecasts, and more consistently replenished.

Be sure to consider lead time.

26

7/25/2012

Manage What Matters … Where to Begin?

Manage What Matters … Where to Begin?

Revenues

% off Totall % Revenues

Cumulative  C l i % of Total Revenues

# fI # of Items

% of Total  % f l Items

Cumulative  C l i % of Total  Items

A

$46,478,200

80.0%

80.0%

1,197

15.2%

15.2%

B

$8,646,300

14.9%

94.9%

1,457

18.5%

33.7%

C

$2,395,910

4.1%

99.0%

1,063

13.5%

47.2%

D

$573,500

1.0%

100.0%

4,159

52.8.%

100.0%

$58,093,910

7,876

27

7/25/2012

Vilfredo Pareto

Vilfredo Pareto 1901: Shortly after Allesandrina left, Pareto fell in love with Jane Regis, a Frenchwoman, 30 years younger than him him. They lived together for the remaining 22 years of his life. Vilfredo and Jane had 18 Angora cats They named their house Villa Angora

28

7/25/2012

Vilfredo Pareto Divorce was illegal in Italy, and Vilfredo remained legally g y married to Allessandrina until a few months before his death in 1923 In early 1923 Pareto became a citizen of the Free State of Fiume, where divorce was legal. He divorced Allesandrina and married Jane Vilfredo Pareto died August 19, 1923

Manage What Matters White Paper

29

7/25/2012

Questions?

Contact Info: [email protected] www.demandsolutions.com www.twitter.com/BillWhitesideDS

30