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# INVENTORY CONTROL TECHNIQUES ANALYSIS

ABC

PARETO ANALYSIS / ABC ANALYSIS

Pareto analysis is also called ABC analysis , named after a 19th century Italian economist, Vilfredo Pareto. He observed that 80 per cent of Italy's wealth was owned by 20 per cent of the population. Since then this is also known as 80/20 rule. It is a method of classifying items or activities according to their relative importance. It is also known as "separating the vital few from the trivial many" because for any group of things that contribute to a common effect, a relatively few contributors account for a majority of effects. Pareto analysis is a method of classifying items, events, or activities according to their relative importance. It is frequently used in inventory
DEPARTMENT OF PHARMACY PRACTICE, COLLEGE OF PHARMACY, SRIPMS, COIMBATORE-44.

## INVENTORY CONTROL TECHNIQUES ANALYSIS

ABC

management where it is used to classify stock items into groups based on the total annual expenditure for, or total stockholding cost of, each item. Organizations can concentrate more detailed attention on the high value/important items. Pareto analysis is used to arrive at this prioritization. The analysis classifies the items into three categories: The first 20 per cent of the items which accounts for approximately 80 per cent of cumulative value (cost), 40 per cent are category B items that that account for a further 15 per cent of cumulative value and remaining 40 per cent are C items accounting for mere 5 per cent of total value. The ABC analysis can be done manually but help of a computer makes work simpler especially when large numbers of items are to be analyzed. Software for ABC analysis of drug consumption is available at Management Sciences for Health website (www.msh.org) for free downloading. ABC analysis groups objects within a list according to their significance in regard to a particular numerical key figure. ABC analysis is available with singlelevel lists if the list has at least one key figure. The result of ABC analysis can be applied in the following ways: 1. Identifying the high usage items (A) for which low cost alternative is available. The information can be useful selecting cost effective alternative medicines leading to major cost reduction. 2. Measuring the degree to which actual consumption of A items reflect the public health needs through comparing consumption with morbidity pattern. 3. Reducing inventory levels and cost by arranging for more frequent procurement of small quantities of class A items. 4. Utilizing the data for reducing inventory cost by keeping a balance of items in the stock. 5. Analyzing the individual therapeutic category where all medicines have equal or similar efficacy, help in selecting alternative cheap item instead of a more expensive ones. The ABC analysis can be applied to other situations too. In a sales organization, this analysis identifies the main items or products that contribute the major portion of sales revenue. The management of the organization may continue concentrating on these items and may develop new strategy to exploit B category to improve sales revenue. ABC analysis is not one time job; it needs to be performed periodically. Even though ABC analysis offers vital information for further action to improve
DEPARTMENT OF PHARMACY PRACTICE, COLLEGE OF PHARMACY, SRIPMS, COIMBATORE-44.

## INVENTORY CONTROL TECHNIQUES ANALYSIS

ABC

medicine management, it is neither exploited fully nor is pharmacists trained for performing and interpreting analysis report. This can be kept as an exercise at under graduate level of pharmacy programme especially in hospital pharmacy module for training the students, the future custodians of drug management. Taking inventory as an example, the first step in the analysis is to identify those criteria which make a significant level of control important for any item. Two possible factors are the usage rate for an item and its unit value. Close control is more important for fast moving items with a high unit value. Conversely, for slow moving, low unit value items the cost of the stock control system may exceed the benefits to be gained and simple methods of control should be substituted. These two factors can be multiplied to give the annual requirement value (ARV) - the total value of the annual usage. If the stock items are then listed in descending order of ARV, the most important items will appear at the top of the list. If the cumulative ARV is then plotted against number of items then a graph known as a Pareto curve is obtained.

In this case, typically, the first 20% of items in the list will account for approximately 80% of cumulative ARV. For a company with a stock list of 1,000 different items this means that paying more attention to the top 200 items (with a sophisticated stock control system) will give close control of about 80% of total stock investment. The next, say, 40% of items, will, typically, account for a further 15% of cumulative ARV. These can be subject to less precise control methods. The last 40% of (low value of low usage) items then account for a mere 5% of ARV and can be controlled with a simple system. The alternative term ABC analysis stems from the fact that the first 20% of important items are known as Category A items, the next,
DEPARTMENT OF PHARMACY PRACTICE, COLLEGE OF PHARMACY, SRIPMS, COIMBATORE-44.

## INVENTORY CONTROL TECHNIQUES ANALYSIS

ABC

typically 40% are Category B items and the relatively unimportant, though larger in number, 40% are Category C items. Features: ABC analysis allows the grouping of objects in three segments:

A segment = important objects B segment = less important objects C segment = relatively unimportant objects

You use ABC analysis in order selection in Product Cost Controlling (CO-PC) to receive an overview of the production orders in a plant that incur the most actual costs. In the A segment you can see the orders that incurred the highest costs and that represent 50% of the entire actual costs in a plant. In the B segment you can see the orders with the next-lowest actual costs; up to 80% of the total costs of the plant are now reached. The orders that incurred low costs are shown in the C segment. The object to be grouped must have a value for at least one key figure. In ABC analysis the objects are first sorted in ascending or descending order with reference to a pre selected key figure. Then the list is subdivided using a predefined strategy. The following strategies can be used for grouping:

Key figure (percentage) The division into groups is based on the percentage shares of the key figures on the total value. For example, if the selected grouping is A = 50%, B = 30% and C = 20%, the objects in the list are sorted in ascending or descending order according to the value of the selected key figure and then assigned to segment A if the percentage share of the total of the key figures of the total value does not exceed 50%. Then the objects are assigned to the B segment if the percentage share of the total of the key figures does not exceed 80% of the total value. The remaining objects are assigned to the C segment.

Key figure (absolute) The division into groups is based on the absolute values of the key figures. Two limiting values must be specified: the limiting value between the A and B segments and the limiting value between the B and C segments. The objects are assigned to groups using these limiting values.

Characteristics (percentage)
DEPARTMENT OF PHARMACY PRACTICE, COLLEGE OF PHARMACY, SRIPMS, COIMBATORE-44.

## INVENTORY CONTROL TECHNIQUES ANALYSIS

ABC

The division into groups is based on the percentage number of objects in the list compared to the total number of objects. For example, if the selected grouping is A = 50%, B = 30% and C = 20%, the objects in the list are first sorted in ascending or descending order according to the value of the selected key figure. The A segment therefore receives 50% of the total number of objects with the highest or lowest key figure value. The B segment receives the next 30% of the objects, and all remaining objects are assigned to the C segment.

Characteristics (absolute) The number of objects to be assigned to the A and B segments is specified by the user. The remaining objects are assigned to the C segment.

Activities To perform ABC analysis: 1. Select a key figure column in the list to be used as the criteria for ABC analysis by positioning the cursor on the column header. 2. Choose ABC analysis. A dialog box appears showing the key figure you selected that is used as the basis for ABC analysis. The characteristics of the columns that are in the list to the left of the selected key figure column. 3. Choose the type of sorting (ascending or descending) and the strategy for grouping. Specify values for the grouping within the selected strategy. 4. Choose Enter. Result A list is displayed with the segment (A, B, or C) in the first column. This is followed by the object and further characteristics (such as the order type) and the selected key figure. After each key figure the percentage share of that key figure on the total is shown, along with the cumulative percentage share. In addition, the list contains the total and the subtotals for the segments and for the totals of the A and B segment and for the B and C segment.

## A number of functions are available in the results list of ABC analysis:

DEPARTMENT OF PHARMACY PRACTICE, COLLEGE OF PHARMACY, SRIPMS, COIMBATORE-44.

## INVENTORY CONTROL TECHNIQUES ANALYSIS

ABC

Hide columns: This functions allows you to remove selected characteristic columns from the visible display. The cursor must be positioned in the column and then the function accessed. Show columns: This function allows you to display the columns you previously hid with the Hide columns function. All characteristics: If the characteristic columns in the list are to the right next to the selected key figure column when ABC analysis is accessed, these characteristics are not shown in the results list at first. Choosing All characteristics displays these characteristics in the results list. Print: This function prints the results list of ABC analysis. The printout corresponds to the screen display hidden columns are not shown in the printout. New analysis: This function initiates a new ABC analysis on the same objects. End / back: This function returns you to the initial list.

Pareto (ABC) Analysis (a.k.a. 80/20 rule) Group A (say 10% of items) - frequently account for say 70 % of usage value and could be controlled with continuous monitoring. Tight control can have a great impact over the cost of inventory Group B A reorder cycle system could control group B (the next, say 20% of items and 15% value) Group C (70/10%) a two-bin or annual demand system could manage the final 70%. The analysis points the way to where control efforts are best directed. Judgment is needed on critical items or security matters that Pareto analysis in itself does not reveal. remember in assembly situations where items from A, B and C are combined in an assembly, a C item out of stock can delay production just as much as an A or B item. The analysis requires items to be listed with their unit costs and average rate of usage. We then

## INVENTORY CONTROL TECHNIQUES ANALYSIS

ABC

sort the list into items by value descending calculate % that each item contributes to total value derive a cumulative % list evaluate the cumulative list and identify appropriate breakpoints

A data set which may be used to illustrate the Pareto method is available as a downloadable Excel spreadsheet.

## INVENTORY CONTROL TECHNIQUES ANALYSIS

ABC

ABC ANALYSIS The ABC categorization of items is based on the principle 'Vital few, Trivial many" . It can be applied to any branch of management with success and is considered as "Always Better Control" technique in inventory. It controls the best items with maximum concentration, then better items and lastly good and other items. The principle of concentrating on the few vital items and ignoring the many trivial items wil1 help to avoid absolute bloody carelessness in inventory. ABC analysis is based on the cost criteria 8,'ld tells the purchase officer to place his efforts on those items where the result will be greatest. It helps to identify where one should be strict and where one can be liberal; where one should concentrate and where one need not put his entire effort. The principle of ABC analysis is applicable in all situations where materials are stored. It can be seen that we all practice theA8C technique knowingly or unknowingly in some or other human activities. In house we always concentrate on a few costly or important items among the hundreds of items available there. The same principle can be wisely employed in the drug stores in the hospital. Various studies conducted in the drug stores in different hospitals in India have re-established the fact that ABC technique is applicable as a tool of materials management in the case of drug stores. According to the ABC method, the items in a store can be categorized into 3 groups-'A' items, 'B' items and 'C' items. The 'A' items comprising about 10%
DEPARTMENT OF PHARMACY PRACTICE, COLLEGE OF PHARMACY, SRIPMS, COIMBATORE-44.

## INVENTORY CONTROL TECHNIQUES ANALYSIS

ABC

of the total number of items are responsible for 60-70% of the total annual consumption cost; the 'B' items comprising about 20% of the total number of items are accountable for nearly 20% of the total annual consumption, the C items comprising about 70% of the number of items responsible for the specified costs. It can be seen that approximately the first 10% of items are coming in the A group, the next 20% of items in the 'B' group and the remaining 70% of items in group C. A more accurate and practical method of doing ABC analysis is the graphical method. Here the items and their cumulative costs are plotted on a graph. A ITEMS These items require strict and close watch and should be monitored by top manager in the hospital pharmacy, that is the Chief Pharmacist. Tight control should be put on these items and the forecast for them should be Very accurate and data Used should always be up-to-date. Purchasing department has to take maximum possible efforts to reduce the lead time and expediate the delivery of these items. Rigid estimates of requirements should be procured on planned basis in order to ensure that only the required quantities arrive at the right time. As far as possible, two or more supplirs shoul be sought for each item so that dependency on one supplier is totally avoided. Very strict control on consumption should be exercised to prevent pilferage. Stock and issue records should be meticulously mentioned in the drug stores. In order to get the up-to-date position of stocks at any time.
DEPARTMENT OF PHARMACY PRACTICE, COLLEGE OF PHARMACY, SRIPMS, COIMBATORE-44.

## INVENTORY CONTROL TECHNIQUES ANALYSIS

ABC

B ITEM These items required a reasonable amount of control and supervision. The chief pharmacist can delegate the charge of these items to a senior pharmacist. The B items can be procured in sufficient quantity at a time and are accountable for about 20% of the total annual consumption. C ITEM Since these items are too many and the value less, the objective should be to reduce the ordering and stock keeping cost to the extend possible. Authority for purchasing and their management in the store can be delegated to the junior pharmacist. Liberal quantities can be purchased once or twice a year and kept in stock to ensure availability at all times. So in the ABC system the items are categorized based on their annual budget requirement. This method gives an instruction to manger of the store. Give maximum attention to A items, reasonable attention to B items and routine normal attention to C items. How to do the ABC analysis? The ABC analysis can be performed in any existing drug store and the procedure involves the following steps.

## INVENTORY CONTROL TECHNIQUES ANALYSIS

ABC

1. Taking the list of all items kept in the store along with their annual consumption in rupees. The quality of the item used is not taken into consideration. 2. Rearranging the list in the descending order of their annual consumption cost. Item with maximum value in rupees will be at number one position and the item with least value appear last in this list. 3. Finding the cumulative cost for each item. The cumulative cost is worked out and shown against the item in the next column. 4. Categorization of the list into 3 groups-A, B and C based on either the number of items of on the cost. If grouping is based on the number of items, the first 10 percentage of items arranged as above are grouped into A items, the next 20 percentage items into B items and the remaining 70 percentage items into C items. Now the corresponding costs for the three groups are found. It can be seen that the A items are taking a share of about 70% of the total cost, the B items about 20% of the total cost. Eventhough there can be some variations in the figure, it can be seen that the general principles will hold good in all cases. The ABC analysis can also be done by concentrating on the cost factor finding the central basis with scheduled deliveries over a period of time. Ordering can be done on quarterly basis. Stock and issue records are to be maintained to have a check on consumption pattern.
DEPARTMENT OF PHARMACY PRACTICE, COLLEGE OF PHARMACY, SRIPMS, COIMBATORE-44.

## INVENTORY CONTROL TECHNIQUES ANALYSIS

ABC

The following logical steps are followed for the analysis: 1. List all items purchased or consumed and enter the unit cost. 2. Enter consumption quantities over a defined period of time. 3. Calculate the value of consumption. 4. Calculate the percentage of total value represented by each item. 5. Rearrange the list. Rank items in descending order by total value, starting at the top with the highest value. 6. Calculate the cumulative percentage of the total value for each item at the top; add the percentage to that of the item below in the list. 7. Choose cut off points for A, B and C categories. 8. Present the result graphically. Plot the percentage of total cumulative value on the 1. Y-axis and the item number in X-axis.

An Example Objectives: Primary: To conduct economic analysis of drug expenditures in the Government Medical College Hospital, Nagpur, India to: Identify the drug categories needing stringent management Find influence of inflation on drug purchase Forecast the drug expenditure for future years. Secondary: To computerize the data from the medical stores. Method: Annual expenditure of each drug was calculated. ABC cost analysis and Vital, Essential, Desirable (VED) criticality analysis were done. A matrix based on coupling of ABC and VED was formulated. From this two priority groups were constituted. Drugs consuming >5% of the total annual drug expenditure were included in the Priority I group for greater managerial monitoring and the rest were included in group II. The Cost Inflation Index (CII) determined by the Government of India was applied to find the influence of inflation on the drug expenditure. Difference between actual expenditure and inflation derived expenditure was found. Expenditure for forthcoming years was forecast by linear regression analysis using Forecast and trend function of Excel. Results: Annual drug expenditure was found to be 11.59 % of the total hospital budget. Division of the drug inventory into two priority categories resulted in identifying the priority I (56 out of 218) drugs for stringent control. Percentage cost for each drug helped determine economical order quantity and the schedule of placing purchase orders for drugs with high value but low criticality. Using the CII, it was observed that the overtly seen increase in annual drug expenditure over previous year was in fact 2.70% lower than CII derived expenditure.
DEPARTMENT OF PHARMACY PRACTICE, COLLEGE OF PHARMACY, SRIPMS, COIMBATORE-44.

## INVENTORY CONTROL TECHNIQUES ANALYSIS

ABC

Conclusions: Drug categorization by ABC-VED coupling helps to narrow down the number of drugs needing effective control. Application of inflation factor provides justification for increased claim for annual drug budget. Forecast of drug expenditure assists better management of the limited resources. Drug inventory management helps in narrowing down on select drugs - effective control and improved efficiency. Review and control measures bring down expenses, Economic analysis generates data ,Various inventory control models helps in Cost containment (ABC), Improved drug availability ( VED) Primary: Conduct economic analysis of drug expenditure to : Identify drug categories needing stringent management Find influence of inflation on drug purchase Forecast drug expenditure for future years Secondary: Annual Hospital Expenditure (AHE) Total Annual Drug Expenditure (ADE) ADE of each drug ABC cost analysis of ADE VED criticality analysis of ADE Constitution of ABC - VED matrix Identification of priority group Group I > 5% Budget - AV, AE, AD, BV, BE Group II - BD, CV, CE, CD Cost Inflation Index (CII) - Govt. of India Indexed cost of ADE for 2001-02 = ADE of 2000-01 x Index factor for 200102 Index factor for base year 2000-01 Difference between ADE and inflation derived indexed cost Linear regression analysis done with Forecast and trend function of Excel (ADE data 1991 onwards) to forecast expenditure for forthcoming years