In order to maximise service levels whilst minimising cost, a process of stock classification is used to set stock levels. Because inventory usually comprises of slow-moving and fast-moving products, management of the inventory is often based on a technique referred to as the ABC analysis.
The ABC analysis relies on the Pareto Principles (or Pareto’s Law) of distribution. This method was named after Vilfredo Pareto an Italian engineer and mathematician and was built on his observations that 80 percent of Italy’s wealth was owned by 20 percent of the population.
The 80/20 rule (as it is often referred as) applies to inventory where an organisation may hold thousands of stock lines with only tiny value, while a few stock lines are highly valuable.
In such cases 80% of inventory items typically make up only 20% of the total inventory value, while the remaining 20% of (high-value) items account for 80% of the total stock value.