The Inventory ABC Analysis: Find Your Top and Worst Performing Products

Hrvoje Smolic
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28/07/2022

The Inventory ABC analysis, Pareto analysis, or the 80/20 rule, refers to the method used to classify and prioritize tasks, items, and events based on their importance. 

It is a cause-and-effect framework used to organize and manage information. 

The ABC analysis in general, can be used to 

  • determine priorities for improvement in a process 
  • or help to identify the causes of a problem. 

It is used in business management to organize and prioritize tasks, analyze costs, and plan production. 

Managing inventory is the most significant expense in running a business. US retailers are sitting on about $1.35 in inventory for every dollar they make. When you have a complete insight into your inventory costs, you can control them more easily. 

The amount that business spends on holding inventory over time is usually 15% to 30% of the value of a company's inventory.

In the Inventory ABC analysis, items are classified into three categories to create a top-down approach.

In this article, we'll walk you through everything you need to know about utilizing Inventory ABC analysis for your business.

 

What Is Inventory ABC Analysis?

Inventory ABC analysis is a classification method in which products are divided into three categories, A, B, and C.

Category A is typically the smallest category and consists of the most important items/entities ('the vital few'), while category C is the largest category and consists of least valuable items/entities ('the trivial many').

  • A category. The vital few. The best performing products, the money makers. Typically, only a tiny percent of the total accounts for 80% of your revenue. This is your most valuable inventory and should be protected and prioritized as much as possible.
  • B category. Your middle-value products. They should be treated as such. They typically account for the next 10%-15% of your revenue.
  • C category. The trivial many - your worst performing products. Usually, it represents products that account for the remaining 5%-10% of your revenue. C category products bring very little value to your business, and you should deprioritize them as much as possible.

These three categories are used to determine the "Golden Ratio" (the 1:1.618 sequence of priorities) to determine the importance of products. This is a method that has been around for centuries, with its origins in ancient Greece. However, it was only in 1940 that this method was formally recognized.

The ABC analysis, in general has a very simple logic — the more resources that are allocated to an item, the sooner that item can be accomplished. This enables decision-makers to identify and focus on the critical tasks needed to accomplish a goal.

This analysis method helps to improve performance and efficiency by identifying bottlenecks and prioritizing tasks. The key is keeping track of all possible causes of a problem or improving performance. 

inventory abc analysis
Image by the author: Inventory ABC analysis in Graphite Note

 

What Is General ABC Analysis Used For?

ABC analysis can be used by anybody who needs to determine the priorities of a set of tasks. However, the method is primarily used in businesses, such as manufacturing and service operations, and is even popular in the nonprofit sector. It's also used in the financial sector to prioritize withdrawals from investment portfolios.

The ABC analysis can be used by people who want to do their job more efficiently, managers who want to allocate resources properly, and even those working on a single project. It's also popular among individuals who are trying to improve their own efficiency or manage tasks effectively.

A Pareto chart can be used to show the relationship between various activities that contribute to the results of a company.

 

What Is a Pareto Chart?

One of the easiest tools to understand, the Pareto chart is a graph that shows the percentage of changes. It helps you track defects and how these defects affect a goal. 

These charts may seem confusing at first look as they combine the main aspects of a bar and line graph. Usually, the bars are used to indicate a problem or defect. Its height will then show a corresponding measurement unit. In most cases, this refers to the cost or the problem's frequency.

Traditionally, the bars should descend and indicate which aspects need more attention. This will allow you to identify which problems require the most attention quickly.

Further, the line indicates cumulative data from the bar graph. Measured in percentage, this will help you gauge the long-term effects of each defect.

Inventory ABC analysis
Image by the author: Inventory ABC analysis Pareto chart in Graphite Note

 

How Do You Conduct ABC Analysis

Software like Graphite Note can help streamline your Inventory ABC analysis process. However, it's also important to know how to do it on your own, especially if you want to stay on top of your business.

The first step is evaluating the process and prioritizing the steps needed to improve it. You can then use a Pareto chart to identify which portion of your problems can impact your results the most.

Here's how you can do it:

Step 1: Define Your Goals

The first step is to define your goals. Determine what you want to improve upon or what your end goal is. Allow the problem to sit on your mind for a little while, this will help you focus on it.

Then, make a list of your problems or areas that need improvement. Organize them into different categories. This will give you an idea as to which areas might need some extra attention.

Step 2: Evaluate Your Process

Now, evaluate your process. Separate your problems into different categories and begin analyzing the problem. For example, you might have different categories for problems that occur frequently, the most frequently occurring problems, or those that cause the most damage to your business.

Step 3: Make a List of Possible Solutions

Next, make a list of possible solutions for each problem. Look at your list of problems, and then try to come up with solutions that could help you avoid these problems in the future. This is where your expertise will come into play.

Step 4: Prioritize Problems

Next, prioritize your list in an ABC analysis format. Start with your most important problem. If it's a problem that causes serious damage to your business, put it in the A category. Next, decide if problems in the B category are causing considerable damage to your business or if they're costing you a significant amount of money.

Finally, move on to the C problems. These are problems that cost you some time and money, but not as much as those in the B category. Complete your analysis by determining if anything can be put in the "No Action" category. By placing items in the "No Action" category, you're letting your team know that these problems aren't as important as those on the other lists.

Step 5: Select a Solution

After you've completed your analysis, you should have a few solutions that could improve your business or solve your problems. Go over them again and find the best solution for each problem. You can also review your list of possible solutions and evaluate them individually.

When you've chosen a plan of action, it's time to move forward and implement the change. This will help you implement your strategy and improve your business.

Successful companies need to be flexible enough to adapt to change. This is why they must prioritize what needs more attention and spend their resources accordingly.

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Why You Should Look Into ABC Analysis

ABC analysis is an exceptionally effective way of identifying problem areas. The method helps you identify precisely what needs to be addressed immediately and what can be addressed later. This, in turn, will help you hold individual contributors and teams responsible for the problems that affect your business. 

Moreover, when you use a Pareto chart to identify which problem causes the most damage to your business, it allows you to decide where to spend your resources so that you can avoid those problems in the future.

 

Conclusion

An ABC analysis differs from an A/B test, but they're both very useful techniques for determining where problems occur most often or where you can see the most improvement.

Whether working on a new project or trying to improve your business, or working on your inventory ABC analysis, you need to use these handy charts to identify where your problems lie. Then, by prioritizing the problem areas, you can avoid the mistakes that will cost your business the most money.

However, if you'd like to automate this process even further, look into software like Graphite Note to make your job easier and more productive. 

Now that you are here...

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