Imagine walking into a warehouse overflowing with unsold stock. Now imagine fielding dozens of complaints from customers who paid for goods you couldn’t deliver because they were out of stock.
While these scenarios cover different problems — overstocking and stockouts — they can each be solved with one highly effective inventory management approach: ABC analysis. This strategic categorization method helps you maintain the right amount of product, please customers, and save on storage costs.
ABC analysis: An overview
ABC inventory classification is an inventory management technique that categorizes items into three groups — A, B, and C — based on their value and importance to your business. It follows the Pareto Principle, also known as the 80/20 rule, which states that roughly 80% of effects come from 20% of causes. In inventory management, a large portion of your sales results from a few products, and an ABC analysis helps identify what makes up the 80%.
Here’s how this classification method works:
- A items: Your top-selling, most profitable products likely account for a significant portion of your company’s revenue. These are your A items.
- B items: B items are the mid-range goods that contribute a moderate amount to your revenue.
- C items: Low-value, slow-moving products that make up a small portion of your revenue are your C items.
The exact percentages vary from company to company, but the principle holds true for most businesses that carry a range of products. By categorizing your items with an ABC analysis, you unlock a whole new level of inventory optimization based on the stock that actually sells.
ABC analysis does have its limitations. It’s only useful for items with a robust sales history, so you can’t categorize new inventory. Plus, some products have lots of variations (like sweaters in different sizes and colors), and counting the variations individually instead of cumulatively could cause you to erroneously rate them lower than you should.
The importance of ABC analysis in inventory management
Cleaner shelves and happier customers aren’t the only positive side effects of using ABC analysis. Here are some of the other benefits of categorizing your goods this way.
Reduced inventory costs
By identifying C items, which represent a small percentage of sales, you avoid wasting space on items that don’t sell as well as others. This helps you avoid overstocking and reduce the risk of obsolescence or expired goods while saving money on holding costs. You might even choose to remove unprofitable SKUs from your product offerings entirely.
Optimized safety stock levels
Safety stock is the extra inventory you keep on hand to prevent stockouts, and ABC analysis makes it much easier to figure out just how much you need.
Since A items are critical to your business’s success, it’s a good idea to maintain higher safety stock levels to avoid running out of those high-value products. But for C items that have a less significant impact on your operations, you don’t need to keep many extras on hand. This tailored approach helps prevent carrying costs from eating into your profits while getting customers the products they want most.
Improved inventory control
Low-, mid-, and high-value items require different levels of attention and management. ABC analysis gives you visibility into which products fall into what category. You can then set specific reorder points, safety stock levels, and audit frequencies to ensure you have the right amounts on hand at all times.
Increased profitability
ABC analysis tells you which products bring in the most cash — so when you prioritize A products, you prioritize profits. At the same time, recognizing slower-moving products allows for strategic decisions like reducing stock levels, offering discounts, or even discontinuing items that aren’t selling.
Enhanced decision-making
Identifying A, B, and C items requires a deep dive into sales and profit insights, plus analysis and updates as time goes by. All of that data helps you understand the impact different product categories have on your revenue and make smarter choices about your inventory mix, marketing strategies, and overall business direction.
How to conduct ABC inventory analysis
You likely have some ideas about which of your products are the fastest and slowest moving. But ABC analysis is most effective when you break down the numbers and quantify your product statistics. Follow these steps to get started:
- Gather data: For each item in your inventory, collect sales data for a specific period (like six months or one year). Include the quantity sold and the unit cost.
- Calculate annual consumption value: Multiply each item’s quantity sold by its unit cost to determine its annual consumption value. This represents the total cost of the items sold in the period.
- Rank items: Sort every product in descending order based on the annual consumption value.
- Calculate cumulative percentage: Calculate what percentage of your total inventory value is represented by your top-ranked items, then mid-ranked, then lowest-ranked.
- Assign categories: Based on the cumulative percentage, assign the top items as A items, the mid-range as B items, and the remaining as C items.
Here’s a quick guide to the relationship between these terms and numbers:
|
ABC Type |
Value |
Percentage of total inventory (cumulative percentage) |
Annual consumption value |
|
A |
High |
10%–20% |
70%–80% |
|
B |
Medium |
20%–30% |
10%–20% |
|
C |
Low |
50%–80% |
5%–10% |
And here’s an example to illustrate what the process looks like. Say you run a sporting goods store. To start your ABC analysis, you gather sales data for the past year, including items like name-brand sneakers, basketballs, and water bottles. You then calculate the annual consumption value for each item by multiplying the quantity sold by the unit cost.
Sort the items according to cumulative percentage. You find that sneakers alone represent 20% of your consumption value, putting them in category A. Basketballs and other basics are included in another 30%, classifying them as B items. Water bottles and other low-value products make up the remaining 50%, putting them in the C category — the percentage is bigger, but because these items have the lowest annual consumption value, they represent the smallest portion of your overall inventory value.
Applying ABC analysis to inventory management
Once you categorize everything, the real work begins: using these insights to optimize your inventory management strategy. Here’s how to translate an ABC product analysis into information you can act on.
Prioritize your inventory tracking
To give high-value A items the attention they deserve, invest in a robust inventory management system that monitors stock levels in real time so you never run out. Prioritize forecasting and demand planning for items in this category to anticipate fluctuations and avoid stockouts.
Maintain healthy stock levels
ABC analysis gives you a deeper understanding of demand patterns for each category, allowing you to set optimal reorder points and safety stock levels. By balancing inventory levels, you keep the right amount of stock on hand while minimizing storage and carrying costs.
Target your high-value customers
Analyzing sales data and customer behavior alongside ABC analysis identifies your most valuable customers — those who consistently purchase your A items. With this knowledge, you can tailor marketing and sales efforts to these high-value customers, fostering loyalty and increasing sales of your most profitable products.
Price more accurately
ABC analysis reveals the true cost of carrying each item in your inventory, and you can use that information to refine your pricing strategy — for example, by lowering prices of C items to encourage faster turnover. Incorporating carrying costs into your pricing decisions helps you ensure that each and every product contributes to your bottom line.
Refine your product portfolio
With the right insights, you can find opportunities to discontinue low-performing products, freeing up resources to focus on A and B items with higher growth potential. You can also make informed decisions about where to focus your product development efforts to ensure your new items align with customer demand and profitability goals.
6 tips for ABC analysis success
ABC analysis isn’t a one-and-done inventory manager. It’s a strategy that requires commitment for the best results. These tips will help:
- Keep it simple: Avoid overly complex classifications. Stick to the A, B, and C classifications for easy interpretation and action.
- Regular reviews: Don’t set it and forget it. Regularly review the products in each category to account for changing demand patterns and product performance.
- Track lead times: Monitor the time it takes for items to arrive after ordering, also known as lead time. This gives you the information needed to optimize your reorder points and determine the appropriate amount of safety stock.
- Tailor service levels: Assign different service levels (like target fill rates or delivery timeframes) to each item class, prioritizing higher levels for A items.
- Analyze across locations: Demand may not be the same across locations. Conduct ABC product analysis across all areas to get a holistic view of stock levels and identify any imbalances or inefficiencies.
- Leverage technology: Use inventory management software to create product lists, track performance, and set reorder points for high-value items.
Make your ABC classifications count with Fishbowl
Prioritizing your inventory items is easier with Fishbowl, the all-in-one inventory management solution. It’s designed to streamline stock management, warehouse operations, manufacturing workflows, and more. The platform also integrates with QuickBooks to promote financial visibility.
Fishbowl is the only inventory management solution in its class that offers an ABC analysis tool. With the click of a button, you’re able to automatically separate your inventory into ABC categories, saving you a lot of time and effort. Doing all those calculations manually is a chore, but Fishbowl makes this process a breeze.
If you’re ready to take a more strategic approach to managing inventory and gain end-to-end visibility over your operations, schedule a demo today.