The 80/20 Rule: Manage the 20% of Stock Items That Matter
The Pareto Principle, also known as 80/20 rule, state that “80% of events come from 20% of the causes”. This principle has been applied to a number of managerial strategies including inventory management.
If the company applies the 80/20 rule to its inventory management it will find that;
- 80% of all products sold comes from 20% of product items
- 80% of total gross profit comes from 20% of product lines
The 80/20 rule uses data to find which product items are key to your business. It uses raw data to analyse your stock items. It is not complicated to calculate, it is very simple. You can even use Excel to to come up with the key stock items. The 80/20 principle is a very simple and accurate method for viewing which product lines move the fastest. These are the 20% of products that generate 80% of total items sold. With this information the purchaser can prioritize what the company needs to have in stock on a day to day basis and avoid stock depletion.
A primary object of any company is to be highly profitable. The 80/20 principles allows the company to be able to know which products are its most profitable. These are the products (20%) that generate 80% of total gross profits. Over the long term these are the products that the company will need to sell to stay in the black.
When it comes to using the 80/20 principle management can be creative. If the objective is to get more traffic into the store and make quick sales, and then promote the fastest moving items. If the objective is to increase profits, then promote the high gross margin products. Alternatively, the company could look at what moves fastest and has high gross margins and promote those stock items; this should be the default position of any company.
Using the 80/20 rule a company can prioritize its resources towards the stock items that matter and have the biggest impact towards the success of the business.