Towards a normative model for inventory cost management in a generalized ABC classification system

Abstract

This paper establishes a general ABC inventory classification system as the foundation for a normative model of the maintenance cost structure and stock turnover characteristics of a large, multi-item inventory system with constant demand. For any specified number of inventory classes, the model allows expression of the overall system combined ordering and holding cost in terms of (i) the re-ordering frequencies for the items in each inventory class and (ii) the inventory class structure, that is, the proportion of the total system's items that are in each inventory class. The model yields a minimum total maintenance cost function, which reflects the effect of class structure on inventory maintenance costs and turnover. If the Pareto curve (a.k.a. Distribution-by-value function) for the inventory system can be expressed (or approximated) analytically, the model can also be used to determine an optimal class structure, as well as an appropriate number of inventory classes. A special case of the model produces a simply structured, class-based ordering policy for minimizing total inventory maintenance costs. Using real data, the cost characteristics of this policy are compared to those of a heuristic, commonly used by managers of multi-item inventory systems. This cost comparison, expressed graphically, underscores the need for normative modelling approaches to the problem of inventory cost management in large, multi-item systems.