Whether you’re managing a heaving warehouse or a humble shop stockroom, inventory classification is a valuable tool that can take your inventory management to the next level. At its heart, grouping inventory or stock is a powerful way to determine the value of stored items to your business, improving transparency, speeding up storage tasks and enabling informed decision making.
Sadly, inventory classification methods are also littered with abstruse acronyms, which can lead managers to avoid them like the plague. ABC, VED, HML or SOS – what do they mean and what are they all for? Most are extraordinarily easy to explain, with an equally apparent application. In this ultimate guide, we’ll be tackling eight of the most popular categorisation techniques – please check in soon to discover five more methods!
VED – Vital Essential Desirable
In our first guide we looked at ABC analysis, which is a technique for categorising inventory into three or more groups on the basis of a quantifiable value metric, usually purchasing costs. VED, an acronym that stands for Vital Essential Desirable, takes a more qualitative approach.
The fundamental question behind VED analysis is: what items could your business not operate without? To understand this question, it’s useful to know that VED began its life in manufacturing. In most manufacturing environments there are a few components without which production will grind to a halt. Failing to order those items on time is clearly an expensive mistake.
The trouble is, it’s also a mistake that ABC analysis fails to solve. It’s quite possible that your essential manufacturing components are not your most costly. That means they could fall into category C – the least important – when considered under ABC analysis. If your business will fail without that item, you have a major problem.
In other words, ABC generally looks at the intrinsic value of items – what you paid for them or how much you’ll sell them for. VED instead takes into account another crucial factor: ‘nuisance value’, or how much it’ll cost you to not have that item in stock.
VED analysis therefore encourages you to divide inventory into three groups: vital items, essential items and desirable items. Vital items are critical to keep your business running; essential items are those without which you can function but the quality, speed or cost of service will be damaged; unavailability of desirable items will not affect the functioning of your business but may incur minor costs or short-term disruption.
Though this type of classification will be most useful to manufacturers (especially when setting the appropriate levels for spare parts), it can be helpful for any business to think about their stock in these terms.
There are a number of sensible approaches to performing VED analysis. The difference tends to be an emphasis on either qualitative or quantitative methods. At the most qualitative end, you can simply sit down, have a think and draw up each item under the appropriate header, either by yourself or with the best experts in your business:
If you’re a small business owner, that’s probably the most sensible approach, but for larger organisations, it may not be so obvious which items are vital and opinions may differ. In this case, the preferred method is to survey a panel of experts from every area of your business and set agreement thresholds for each category.
How does that work? Simply follow these five steps:
- First, draw up a list of every non-trivial item your business has ordered multiple times in the past 1-5 years. You can be as detailed as you like, but looking at pencil purchases is unlikely to yield much insight.
- Assemble a panel of experts from your business. It’s absolutely critical that this panel is representative of every area and every level of your organisation. Which inventory is vital is completely dependent on perspective, so there needs to be someone present who can make a fair case for each department.
- Set an agreement threshold – 50% is generally a good starting point. That means if 50% of votes agree, the item is placed in that category.
- Have your panel discuss and vote on a category for each item.
- If any items fail to reach the 50% threshold then they will require further discussion until an agreement is reached. You might also want to define a failure option, which will usually be an executive decision by senior management, if a category simply can’t be agreed upon.
Most importantly, try to encourage discussion. For manufacturing businesses, whether a part is vital or not is reasonably clear. In other industries, working out the role an item or product plays in your larger strategy will need some debate.
If a voting panel isn’t quantitative enough for you, there are still other options. You can (and should if data is available) rank and group items in terms of stockout costs. Sadly, calculating stockout costs across industries is well beyond the reach of this article. For manufacturers there is often historical data from which to extrapolate, but for other industries, like retail, it’s immensely difficult to accurately quantify the impact of stockouts.
For a quick review of some factors to consider when calculating stockout costs, try this article.
Lastly, many organisations will combine VED and cost ABC analysis – an approach that’s especially popular in hospitals. That way you’ll have a complete picture of what inventory is costing you and how critical it is to your operation.
Though it sounds complicated, combining ABC and VED is a simple matter of applying each technique separately and then grouping items in a new two-dimensional matrix. Using the data from our previous ABC guide and the random VED categorisations above, it would look something like this:
The result is 9 categories: AV, AE, AD, BV, BE, BD, CV, CE, CD. These give our inventory much greater transparency – we know both the value of each group and how important it is to maintain. A common approach is to recollect these back into three categories. At the top is Category I: AV, BV, CV, AE, AD; next Category II: BE, CE, BD; lastly Category III: CD.
Now we’ve grouped our most essential items and our most costly items in Category I, which needs careful management to avoid serious disasters. II & III, on the other hand, will require progressively less management.
The question that really counts: how will this help you manage your business better? Traditionally, VED is used to set the level of spare parts in production environments. However, just like ABC analysis, VED can be used more broadly to develop processes that are specific to the needs of different inventory categories.
In short, it’s likely you’ll want high level managerial oversight on any items deemed vital, while essential items can be monitored by lower level managers. Desirables can normally be handled by the employees that need them, or even totally automated, slashing labour costs and boosting productivity.
Most importantly, VED will ensure you avoid inventory catastrophes – embarrassing stockouts that damage your business in the long term or irrevocably. That’s an upshot that’s as useful to retailers as it is to manufacturers. Making sure you can deliver on your most important products will keep customers happy and loyal, and you’ll avoid eating into margins with last minute deliveries and overtime staff.
How can we improve this guide? If you spot any errors or anything we’ve missed, please let us know in the comments section or on Twitter @ActionStorage.