What is ABC analysis?
The ABC (or ABCD for more detail) analysis is a way of categorising, prioritising and streamlining your inventory to make the management of your inventory more efficient and therefore profitable.
ABC analysis, also known as ABC classification, sorts your inventory into three categories using the Pareto Principle. The Pareto Principle, also known as the 80/20 rule, suggests that roughly 80% of effects come from 20% of causes. In the context of inventory management, it implies that around 80% of a company’s sales revenue comes from approximately 20% of its products.
Using the company’s historical sales data, generate a report showing the best-selling products and how quickly goods are being sold. Information such as the sell-through rate (STR) is also useful. The sell-through rate (STR) can be quickly calculated by measuring the percentage of inventory sold relative to the amount of inventory received from manufacturers during the same period.
Using this data, the company inventory should be categorised as below:
- A-Items – these are the key items to the business that have the highest value and importance to the business. They are often the most profitable and might include best-selling products or critical components.
- B-Items – these items are the regular sellers but not as high a value or as profitable as A-items. These may be seasonal items or slower moving items.
- C-Items – these are the slow selling items that may be inexpensive with a low or sporadic demand.
- D-Items – are an expansion of the standard ABC analysis. D-items should be end of line or obsolete items that are not cost effective to keep in stock. The company should phase out and remove from all D-Items from the inventory.
With the inventory sorted, focus on closely managing the A-items, as they often contribute the most profitability. Also, keep in mind that stock items could change categories as new products become available or market trends and customer demands change.
The benefits of ABC Analysis
Categorising inventory items based on their importance using ABC analysis offers several significant immediate and longer-term benefits such as:
- Improved Warehouse Layout: stock should be physically organised so quicker moving, higher value A-items are more accessible and closer to the packing and despatch areas. Slower selling items should be moved further away. The ABC analysis can complement systems such as Lean 5S and can help reduce wastes such transport, motion and waiting.
- Improved Cash Flow: Reducing inventory of slower moving C-items and obsolete D-items will help free-up and improve cash flow by reducing the amount of inventory remaining in stock for longer periods of time. This optimised cash flow can be focused on A and B-items which are more profitable and have a quicker turnaround.
- Inventory Optimisation and Turnover: focusing A-items will reduce the risk of stock outs potentially leading to supply chain disruption, added costs and lost sales. Inventory turnover will be improved by reducing the amount of time stock is stored unnecessarily. This can help to build the company reputation as that of reliability and efficiency and will quickly lead to new and return business.
- Improved Supplier Relations: an increased focus on A-items will help build a stronger relationship with product suppliers which should provide a more efficient service. As sale numbers start to increase there may be additional benefits such as a lower purchase cost and shipping cost per item by increased volume.
- Forecasting Improvement: with an increased focus on inventory management the business can increase its forecasting accuracy capability therefore reducing the risk of both over or understocking items.
Plan, Do, Check, Act
Like most business strategies, ABC Analysis should be dynamic and not a static process. Integrate the ABC analysis into your existing business strategies and complete regular reviews and updates based on changing market trends, product portfolios or pricing strategies. This will ensure that the company inventory management strategy remains effective and aligned with the business goals.
Ultimately the successful implementation of ABC Analysis can complement existing inventory management strategies resulting in a quicker turn around, greater customer satisfaction, improved cash flow and increased profit.
AK Logistics and Supply Chain 