Question

The Pareto (or 80/20) rule applied to inventory would suggest that...?

a) 80% of a firm's SKUs account for 80% of the cost of goods sold (COGS)
b) 80% of a firm's SKUs have below-average unit costs (at least 20% below average)
c) 20% of COGS are generated from 20% of a firm's SKUs
d) 20% of a firm's SKUs account for 80% of COGS

Answer 1

The Pareto Principle suggests that 20% of a firm's SKUs account for 80% of COGS, supporting focused inventory management on a small number of critical items.

Step-by-step explanation:

The Pareto Principle, or the 80/20 rule, when applied to inventory management in a company, suggests that a small percentage of items contribute to a large percentage of the company value or sales. In the context of inventory, this usually means that approximately 20% of a firm's Stock Keeping Units (SKUs) account for about 80% of the firm's Cost of Goods Sold (COGS). This principle helps businesses to identify the most important items in their inventory that drive the majority of their sales or costs, allowing them to focus on managing these critical items effectively.

Therefore, the correct answer to the student's question would be that 20% of a firm's SKUs account for 80% of COGS, which aligns the Pareto Principle with how inventory costs are often distributed within a company.