What is an Inventory ABC Analysis? (+ How to Do It)
Working out which inventory items are the most profitable for your business can be challenging. Many businesses use ABC analysis to determine the most important SKUs (stock keeping units), but what is ABC analysis, how does it benefit inventory management and how do you use it?
In this article, you’ll discover the answer to those questions, learn the best practices for implementing ABC inventory analysis and get a better understanding of how it’s used in wider inventory planning.
Table of Contents
- What is ABC Analysis?
- The Benefits of ABC Analysis in Inventory Management
- How to Do an ABC Analysis
- What to do With A Grade Items in ABC Analysis
- What to do With C Grade items in ABC analysis
- ABC Inventory Analysis and Cycle Counting
- Shortcomings of ABC Analysis For Inventory
- Best Practices For Implementing ABC Analysis
- ABC Analysis and Wider Inventory Planning
- Start Your ABC Analysis For Better Inventory Planning
What is ABC Analysis?
ABC (always better control) analysis is an inventory management method that grades inventory items on their importance to the business. Demand, cost and risk data are key parameters for ranking inventory. ABC analysis puts stock into three categories with A items being the most important and C items being the least important. Some businesses spread their stock across more categories, e.g A-F.
ABC Analysis and The Pareto Principle
Named after Vilfredo Pareto, The Pareto Principle states that 80% of consequences come from 20% of causes. In other words, the relationship between what goes in and what comes out is unequal. ABC Analysis suggests that 20% of stock generates roughly 80% of your inventory’s value (i.e., 80% of your sales come from 20% of your product styles). That’s why most businesses will have a smaller percentage of goods in the A category than in B or C.
Forecast demand, issue and track POs, re-order on autopilot, and step up your reporting game across multiple channels and locations. Get in touch to see how Singuli can help you optimize your inventory.
The Benefits of ABC Analysis in Inventory Management
Your business’ inventory relies on good inventory management. Applying ABC analysis helps with that and has many other benefits:
Inventory Forecasting Data
Accurate inventory forecasting requires robust inventory planning software and strong data. Understanding which category your products fall into using ABC analysis strengthens your data inputs, which in turn, creates better forecasts.
📌Get Started: With Singuli’s Advanced Forecasts, it’s easy to analyze historical data, market trends and customer inputs, which saves you or your inventory planner time and increases forecast accuracy.
If you’re not sure about the value of a product, you might overstock. When you use ABC analysis, you can reduce the C inventory to create more room for A items.
If you start to see a big increase in demand for a particular product, it might be time to reassess your pricing. You need to be careful not to overcharge and to keep ahead of the competition but there could be scope for increasing your prices on certain items.
Keeping a good relationship with suppliers helps you keep a good relationship with customers. You’ll find it easier to manage lead times, to get emergency stock and to request flexibility in certain terms, like minimum order quantities (MOQs). You can also use your relationship to improve terms on A products. You might not be able to negotiate cost price but you could ask for free shipping, post purchase services and other cost savings.
Supply Chain Management
Better supplier relationships help with supply chain management, but sometimes it requires a closer examination. ABC analysis offers data to help you assess the right time to consolidate suppliers or to shift to a single source to save costs and simplify logistics.
💡Pro Tip: Maintain optimum stock levels and adjust to sudden changes by using Singuli to manage multiple vendors and products with different lead times.
It’s important to carefully manage staff, equipment, shelving space and other resources. You don’t have unlimited resources so you need to know where they are best suited to help grow your company and increase profits. ABC analysis tells you which products are of the highest value and those products are often where you should allocate the most resources.
Cost of Inventory
Holding onto too much inventory means you’ll incur holding costs and you won’t have enough room in your warehouse for more profitable stock. Not having enough inventory means you’ll lose out on sales and possibly lose customers forever. There are many costs of inventory but knowing which stock is the most valuable allows you to focus on having the optimum inventory, with more of a focus on A stock than C stock.
📌Get Started: Optimize your inventory levels and reduce overstocks. Use Singuli to replenish the right amount of stock at the right time so your inventory costs stay low.
Product Life Cycle
Product life cycles are different for every item. Some products slowly grow into the market, have great sales for a while, then drift away. Others hit the ground running and disappear when something new comes out to replace them. Some have ups and downs. They work with seasonality. ABC analysis helps to determine where a particular product is in its lifecycle. When you know what stage it’s at, it’s easier to decide how to manage it.
📌Get Started: Every product has its own story. However your products are growing, whenever there’s a change, Singuli’s forecasting models will identify it and adapt accordingly.
How to Do an ABC Analysis
Your first task when completing an ABC analysis is to identify an objective. With that in place, you can complete the rest of these steps:
- Set your goal. An ABC analysis gives you the information you need to improve cash flow or lower procurement costs. You do this by optimizing inventory levels of your most important items based on production or customer sales.
- Gather data. Gather data on how much is being spent on each SKU over a specified period of time. If possible, collect information on the weighted cost, including gross-profit margin, ordering and carrying cost data. This is much easier with the right inventory planning software.
- Analyze order of impact. You can use the ABC analysis formula to rank each SKU by cost, from the highest to the lowest impact.
- Calculate ABC analysis for sales. For each product, divide the annual item cost by the aggregated total of your business’ sales. You can use this number as a percentage or a fraction to compare items in your list.
- % impact = (annual item cost) / (aggregated total of all items spent) x 100
- Sort items into classes. You’re ready to renegotiate supplier contracts to benefit A items, to shift your sourcing methodology and to find other ways of making savings based on your results. Remember, you don’t have to have an exact 80/20 split.
- Analyze results Periodically repeat the process. Products have lifecycles and their class will shift. Keep on top of their class to make the most of ABC analysis.
ABC Analysis Example
Take a look at the simplified ABC analysis example below for a men’s t-shirt retailer. Each item is placed into class A, B or C, depending on the percentage of revenue generated.
|Product||Revenue (365 days)||% of Revenue||Grade|
Red, white and black t-shirts make up 80% of the total revenue, so they are categorized as A. You need to pay extra attention to these SKUs and make sure they are always in stock. You can also put A products front and center of the store or add them to the homepage of your website to attract more customers.
Orange, maroon, violet and pink t-shirts are all C. It might be worth selling these at a discounted price or not keeping them in stock. You could also consider improving the products or run extra promotions to increase their popularity.
What to Do With A Grade Items in ABC Analysis
There’s a lot you could do with the items ABC analysis puts into grade A:
Focus on Supplier Relationships
Relationships make business work, whether it’s with customers, collaborators, staff or suppliers. A good supplier relationship gives you more room to ask for support with lead times, to be first in line when new products are on the market and in the case of A product suppliers, you can make sure you’re always their priority. It’s important to have a good relationship with every supplier but if you have to focus your time on one or two, make sure it’s the ones looking after your most valuable products.
Have a Wider Pool of Suppliers
As good as any relationship is, if something goes wrong with your supply chain, you need a back up. Make sure you have a wide pool of suppliers to prevent stockouts for your highest value products.
Much of what happens to your supplier’s inventory is out of your control. They could face a surplus of orders, have manufacturing mishaps or even go out of business. Having multiple suppliers means you’re not overly reliant on one source and your customers can better rely on you.
Having a wider pool of suppliers helps to make sure stockouts never happen but it’s not enough on its own. You need an inventory planning procedure and software in place to make sure you never run out of A stock and never incur stockout costs. Retail demand planning with the right software allows you to plan for shifts in demand for A, B and C class SKUs based on numerous factors.
📌Get Started: Never miss a potential sale. Use Singuli to send reorder alerts straight to your inbox so you’re always ready to meet customer demand.
Setting the right price for a product is never easy and ABC analysis isn’t the only variable to consider when increasing or decreasing prices. That being said, it’s worth reassessing A products to see if there’s room for a price increase. They’re the most popular products you have and your customers might be willing to pay a little more to make sure they don’t miss out.
Before you make a decision, remember to consider your target audience, product costs, revenue targets, competitor pricing, seasonality and any other variables that might affect the ideal price.
What to Do With C Grade Items in ABC Analysis
C grade items are the least valuable at the time of your ABC analysis but that doesn’t mean you should ignore them. It’s likely that you’ll stop stocking a lot of your C products to reduce their financial burden but there are a few options you can look at first.
You’re not getting many sales from your C grade products but that doesn’t necessarily mean they’re the least popular. Think about where they’ve been placed in the store previously — or how your e-commerce website is merchandised — and how much marketing effort has gone into selling them in comparison to your A and B grade products. There could be an opportunity to make profits from these items if you change how you market them.
If your C grade products really aren’t very popular, one way to make them more popular is to reduce their price. If you can reduce their price and still make a profit, you might want to reorder in the future but if you’re making a loss, this might be the time to take them off future purchases.
Look for Alternative Value
Even when C grade products aren’t making a profit, they could be helping your other products do better. For example, some products look beautiful in window displays. They draw customers into the store who want to take a closer look, even if they’d never buy the actual item.
From there, they buy other things. Another reason to hold on to a small amount of C inventory is to use them as a comparison to promote A products. Your sales people could talk about how the A version of a C product is so much better, which is why your customer needs to buy it.
Offer Dead Stock to Charity
As well as being a good thing to do, philanthropy can be good for business too. You’re supporting a cause you truly care about and you’re enhancing your brand’s status, as long as you’re not doing it cynically. Plus, you can sometimes get a tax deduction if you’re based in certain geographical locations.
Offering grade C products is a good way of passing on the stock that isn’t selling well but that can still be extremely valuable to people who can’t afford any grade of products you sell. If the charities you want to support have no use for your grade C products, you can sell them at a lower price and give the revenue to that charity instead.
Sell Grade C Stock in A or B Grade Bundles
Some grade C stock might not be appealing enough for customers to buy by itself but could be appealing as part of a deal. You can offer a free C product with your A and B products to get rid of inventory or you could have specially priced bundles, to make sure you’re still turning a profit.
Once you’ve exhausted all your options, you’re ready to get rid of your C portfolio and to stop ordering. By this point, you’ve done all the marketing you need, you’ve reduced prices and you’ve looked for alternative value but none of that has upgraded your C products to an A or B status. The best thing to do is to stop replenishing and to focus on your A and B products instead.
ABC Inventory Analysis and Cycle Counting
Cycle counts are inventory checks performed regularly on smaller sets of stock, in place of the traditional method of inventory checks, which counts the whole inventory periodically. The reason many businesses use cycle counting is that you don’t have to close the whole store or work late into the night to check your stock.
When you include ABC analysis in your cycle counts, you can prioritize more regular checks on your A and B products. That way, you’re making better use of your time.
Shortcomings of ABC Analysis For Inventory
You’ve already learned that ABC analysis has many benefits but it’s not perfect. There are shortcomings, as you’ll see:
ABC analysis is based on a specific time period. If that doesn’t match your SKUs seasonal sales, you might incorrectly categorize your products. For example, you might sell more coats closer to the winter holiday season so they’ll be grade A but their sales drop off in the spring, changing them to grade B or C. Make sure you use an inventory planning software that makes use of ABC analysis and takes seasonality into account.
💡Pro Tip: Avoid unexpected changes in demand and automatically account for seasonality in your inventory forecasts with Singuli’s Advanced Forecasting tools.
Changing Trends and Behaviors
You’ve completed your ABC analysis and accounted for seasonality but sometimes your inventory doesn’t follow the patterns you expect. Imagine Rhianna wears one of your C dresses to an award’s ceremony. That dress won’t be a C dress for much longer, it’ll jump to the A category.
Some trends are easier to plan for, such as a spike because of a sports or music event but you need to be ready for every change. Good supplier relationships and the right inventory planning software will help with that.
📌Get Started: Seasonal trends change all the time so make sure you’re planning for them with Singuli’s Advanced Forecasting.
Misses Alternative Value
You learned earlier that C products can have alternative benefits. ABC analysis doesn’t account for that. It narrows product value to direct revenue and cost. As long as you’re aware of this, you can make sure you’re not dismissing C products based purely on ABC analysis.
If you switch most of your focus to A products based solely on ABC analysis, you might start to have challenges when you need to supply B and C products. Even if B and C products are deemed to be lower value, you still don’t want overstocks or stockouts. A comprehensive inventory planning software that forecasts demand to the SKU level helps to mitigate this.
Lack of Oversight
Even though B and C products aren’t deemed to be as valuable as A products, that doesn’t mean they hold no value at all. If you only concentrate on your A products, your B and C products will be more prone to theft and loss, plus you’ll miss out on potential sales because you lose focus. You need to be careful to look after your A products without completely neglecting your B and C items.
No Plan For New Products
New products don’t have historical data so you can’t measure their performance. That means you won’t be able to place them in category A, B or C using the traditional ABC analysis. Instead, when you’re launching a new product, you need to use as much data as possible in the right inventory planning software to predict the product’s value.
💡Pro Tip: Use your past sales and product attributes to recommend accurate initial inventory orders with Singuli’s New Product Forecasts.
Best Practices For Implementing ABC Analysis
You know the benefits and the shortcomings of ABC analysis, so how do you implement it?
Classify Your Inventory and Keep It Simple
You don’t need to overcomplicate your inventory classifications. Categorize them by how quickly the stock moves, their value or the gross profit margin. You can do further analysis of size curves and more complicated attributes later.
💡Pro Tip: Automatically compute the right size curve for every sized-based product in your assortment with Singuli’s size-based forecasting and planning tools.
Set Labor Levels and Rules
Set rules on how much time and resources are spent on A, B and C products. For example, instead of spending 10 hours on A and C product inventory checks, spend 16 hours on A and four on C. You can also set a rule that A products must never go out of stock and C products are never written off as spoiled inventory.
Review Each Class Individually
Don’t rely on your overall ABC analysis. Once you’ve completed it, check each class to make sure you’re happy with the results. If you feel like a product in class C should be in class A, ask why. Make sure your numbers are correct and if they are, test different marketing options and promotional techniques to improve sales of B and C products.
Monitor and Revisit Class Allocations
Your A products won’t always be A products. You need to be ready for the change. When they become less valuable to your business, you need to change their class to B or C. You can monitor this easily with the right software. If you keep on top of these classifications, it’ll be easier to avoid stockouts or overstocks.
Make the Most of Inventory Planning Software
You don’t have to try and keep on top of ABC analysis manually. Great inventory planning software will do this for you. Make sure you invest in software that can handle all your data and forecast accurately. The best software is able to receive multiple inputs and feed out relevant information at the right time.
💡Pro Tip: Give context to your sales history with Singuli’s ABC reporting and make it part of your wider inventory planning.
ABC Analysis and Wider Inventory Planning
ABC analysis is an important part of inventory planning for many businesses but it’s just one part of it. Use the data to support your forecasts by adding it to software that can help you plan for the future. Make sure you always take a holistic approach to demand forecasting, which includes seasonality, spikes in demand, size curves, promotional marketing and all other relevant data into account.
💡Pro Tip: Get a holistic view of your inventory data with Singuli’s Reporting & Analytics. Track not only inventory data, but also marketing, promotions, site traffic, historical sales and customer behavior. You’ll have all of your information in one place, ready to use in inventory forecasting and planning.
Start Your ABC Analysis For Better Inventory Planning
You know what ABC analysis is, you understand its benefits and shortcomings, you know how to do an ABC analysis, you’re aware of the best practices and you understand its role in inventory planning. All that’s left to do is start.
Forecast demand, issue and track POs, reorder on autopilot, and step up your reporting game across multiple channels and locations. Get in touch to see how Singuli can help you optimize your inventory.