ABC Analysis

ABC analysis is an approach that is mainly use in operations and supply chain for classifying inventory items based on the items’ consumption values. It is one of the most essential concept  It helps in classifying inventory items based on the items consumption value. The ABC tool is used to identify the vital few from the trivial many, according to a defined set of criteria. Consumption value is the total value of an item consumed over a specified time period, for example, a year. The approach is based on the Pareto principle to help manage what matters and is applied.

We classify items as “A” class:

  • Annual consumption value is the highest.
  • Small in number, but consumes a large number of resources.
  • Analysis and control of this class are relatively intense since there is greatest potential to reduce costs or losses.
  • Tight control and aggressively managed.
  • It is managed by top management.

We classify items as “B” class:

  • These are inter-class items
  • Consumption value is lower than “A” items but higher than “C” items.
  • The scope of this class and the inventory management policies are determined by the estimated cost-benefit of class cost reduction and loss control systems and processes.
  • Moderate control.
  • Less frequent re-orders.
  • Purchase based on rigid requirements.
  • Managed by middle-level management.

We classify items as “C” class:

  • Lowest consumption value.
  • It is not usually cost-effective to deploy tight inventory controls, as the value of the risk of significant loss is relatively low.
  • Large in number but consumes lesser resources.
  • Low inventory turnover.
  • Purchase based on usage estimates.

ABC analysis is mainly used in 3 major industries:

  • First is in factories with raw materials where objective is to control inventory and tool used is ABC analysis using consumption value.
  • Second is in retail outlet where the objective is profit maximization and tool is ABC analysis which is done using sales value.
  • Third is stock verification where objective is to verify the stock and tool is ABC using stock value.

Disadvantages of ABC Analysis

  • It needs to be completed in the moment for more accurate results.
  • There might be chances of biases on analysis of data.