Pareto's Inventory Insight: 80% of a company's inventory sales stem from just 20% of its stock, showcasing the imbalance that challenges inventory management practices.
ABC to the Rescue: ABC inventory analysis categorizes products into three classes (A, B, C) to prioritize management focus and resource allocation, enhancing efficiency.
Strategize and Optimize: Different inventory strategies for A, B, and C items aid in prioritizing high-value products, improving turnover, and optimizing overall inventory management.
Numbers Game: Implementing ABC analysis involves listing inventory, setting category boundaries based on specific metrics, and regularly reassessing to adapt to sales and stock changes.
Ecommerce Inventory Boost: ABC analysis offers benefits like inventory optimization, forecasting, resource allocation, and improved vendor negotiations, vital for managing e-commerce inventory effectively.
Like many other aspects of life, inventory management seems to follow the Pareto Principle. You have a ton of SKUs, yet 80% of your revenue comes from just 20% of them.
While frustrating for inventory managers, it should help to know you aren’t the only one. Do you feel seen now? Good.
Many of us are wasting 80% of shelf space, labor, and logistics to get just 20% of the bottom line. But, that’s not the end of the story (we’re only in the intro!).
ABC inventory analysis can, to a large degree, fix this vexing issue.
In this article, we'll explain how to use ABC analysis, how it works in inventory management, how to calculate and implement the process, and how the right technology can lend a hand.
What is ABC Analysis?
ABC inventory analysis is a method of categorizing inventory into three classes (A, B, and C) based on importance and inventory value to prioritize management and resource allocation.
ABC analysis is a simple approach to a lot of complex management systems. By splitting inventory into three categories—A, B, and C—you can assign them different priorities depending on their importance.
Some excellent inventory management software and enterprise resource planning (ERP) tools can do this analysis for you.
However, the system isn't limited to inventory management or inventory control. An ABC analysis and ABC classification can also be helpful for accounts receivable, personnel management, and warehouse operations.
The ABCs of ABC Analysis
To understand why brands use ABC analysis for inventory management, you need to know what these categories mean.
- A-items: These high-value items represent only 10-20% of your stock, but are responsible for 70-80% of your revenue.
- B-items: The middle child of the bunch, these items are 20-30% of your inventory and 15-25% of your sales.
- C-items: The bulk of your inventory at around 50-70%, yet only 5-10% of your sales.
While each category of stock is important, the classification matters for how you approach the management of each across your inventory.
ABC Analysis in Action: An example
Classification is at the heart of the ABC method.
It works by spreading out all the items in your inventory and ranking them according to their output value. You then separate the highest-value items from the middle and lowest tiers.
Your inventory management software might display the data in any number of ways. Or you could build a simple spreadsheet in Excel that looks like this:
This data gives you a snapshot of the 80/20 rule, and a few things pop out.
Notice the top 20% of items by volume on your shelves make 80% of your sales output. Meanwhile, the bottom 50% only earns 5% of your sales.
It also reveals potential for future revenue growth.
So, say you scaled back your C inventory and gave all that shelf space to more A items. You could see up to a tripling of your return since you'd be moving 2.5 times more high-value inventory.
An example of ABC product categorization
Say you have an online store that sells kitchenwares. You sell a wide variety of small appliances, cookware, and gadgets. You might break up your inventory like so:
- A products: Home espresso machines, stand mixers, rice cookers, food processors, etc.
- B products: Kitchen knives, pots and pans, silverware sets, dutch ovens, etc.
- C products: Gadgets like spatulas, whisks, can openers, ladles, etc.
With this hierarchy in place, you can start implementing strategies for each category that respect the revenue-generating potential for the different types of products.
ABC Inventory Control Strategies By Category
With your inventory broken up into these three distinct categories, you can start devising your strategy for each. Let’s take a look:
- A-items: These require tight inventory control, regular review and cycle counting, and accurate demand forecasting to maintain a stable stock without overordering or enduring stockouts. Example: Stand mixers.
- B-items: Use a more balanced approach for these SKUs, with less frequent cycle counts and a moderate use of forecasting to stay stocked. Example: Saute pans.
- C-items: There’s a lot of leniency here. You can purchase these low-cost items in bulk, store them more efficiently, and prioritize sales for higher inventory turnover. Example: Whisks.
Developing these hierarchical inventory strategies saves you time and puts the priority on what sells best.
By focusing on the number of items in each category, brands can better understand their inventory turnover and develop a more efficient reorder point system. This alone can reduce carrying costs and improve the overall management process.
How to Calculate ABC Inventory Analysis Step by Step
Getting started with an ABC system to manage your inventory is a three-step process.
Step 1: List your inventory on a spectrum
First, list all your inventory items in a single place. This can be in a spreadsheet or an enterprise inventory management software. Then, rank these items in descending order according to your preferred metric.
Common metrics include:
- Total sales of each item
- Gross margin of each sale
- Purchasing costs
- Holding costs
- Annual consumption value
Step 2: Set boundaries for each category
You have to cut the categories off somewhere, and it's best to set objective criteria for categories A, B, and C beforehand.
For instance, if you're tracking sales, you may consider a high-value item to move more than 1,000 units a month. Or you may set a dollar value at $10,000 a month and above as a category A item.
Set a maximum threshold for a category C item, such as 100 units a month or $1,000 in sales. Anything between these values would be a category B item by default.
You're not trapped inside a strict three-item scale.
Depending on the needs of your business and what information you're interested in, you could use as many categories as you'd like.
ABCDEF inventory analysis?
The table below shows how you might structure your inventory based on total net profit per category, with much finer divisions than a simple ABC model:
Breaking things down into smaller categories has spread out the 80/20 effect quite a bit, but the data is still useful.
In this hypothetical, one category of items, which would have been lumped in with C items, has low profits and low sales volume, earning it an F status.
Note that there is still a broad division between the two top tiers, the two middle tiers, and the bottom two, which are each closer to each other than they are to the other item classes.
Alternately, use annual consumption value
Another way to break your products up is by finding the annual consumption value for each product.
To get that number, you use the following formula: Number of units sold per annum x cost per unit.
After sorting your products in descending order by their annual consumption value, you can split them up by the percentage of your total revenue they represent.
Step 3: Keep an eye on things and reassess
Nothing in inventory management ever stays the same.
As your sales and stock levels evolve, item performance is bound to change. Try to run an ABC inventory analysis at least once a month for every category or data set you're interested in.
Do it weekly if you can.
Never hesitate to alter how you treat different items in your stock based on your most recent inventory analyses.
Most cloud based inventory management software comes with robust reporting—use it to iterate, improve, and learn.
As you embark on this calculation, remember that managing your inventory doesn't stop here. Dive deeper into the complexities of inventory management, including common challenges and solutions.
What are the Benefits of ABC Analysis for Ecommerce Inventory?
There's no end to the amazing things you can do with all this information. Here are just 10 ways the ABC inventory analysis system can help your business:
- Inventory optimization: An ABC analysis optimized for sales volume reveals which items are flying off the shelves and which are sitting under a coat of dust. Look at your figures and start moving things around.
- Inventory forecasting: The ABC approach helps develop trend lines to see where inventory levels are going over the next few months.
- Resource allocation: As customer demand shifts from one class to another, you'll see it on your ABC sheets. With regular updates, you can reallocate labor and other resources to focus on your A items and boost sales.
- Negotiations with suppliers/vendors: The ABC inventory management method shows which items are the most important to keep in stock. Use this information to negotiate a safety stock you must always have while rewarding or incentivizing your vendors.
- Lifecycle management: Products have a lifecycle. ABC analysis reveals how things are going for each item. Chart the trajectory of an item in your inventory from launch to initial growth, to maturity, and into decline, and know when a drop in sales is organic and permanent.
- Prioritize high-value items: Everything in your class-A category is vital to your success, and you should never be without them. Inventory classification using ABC analysis reveals must-have items to reorder in bulk, so you always have extra on hand.
- Cut the low performers: Every item you keep on hand has carrying charges, which might not be worth the inventory cost for category C stock. Spot these wastes of space early, and cut bait when you can. Fill the empty spot with something else that might have a better profit margin.
- Simplify your supply chain management: Is it time to merge into a single supply chain for any given item? A rolling ABC analysis gives you month-over-month data to help make these decisions.
- Improve pricing: If one of your class-C items starts moving up the ranks, it's probably because demand for that item increases. Consider a price increase to make the most out of this fortunate trend.
- Make customers happy: You should expect the highest customer support demand from sales of your most popular items. Focus the training of your customer service staff on these items.
Tools For More Effective ABC Analysis
With the advent of modern warehouse and inventory management technology, ABC analysis has become so much simpler.
No more relying on basic spreadsheets and manual data entry to get started!
By automating the categorization process and surfacing real-time insights, these tools allow ecommerce brands to move faster on ABC analysis implementation.
Let’s look at the technology that can help:
- Inventory management software: Highly advanced inventory systems do much more than simple stock tracking. Of their many benefits, inventory software has features like automatic reordering, real-time sales and inventory tracking, demand forecasting, and automatic categorization based on ABC criteria.
- Analytics and reporting tools: These tools, usually a part of a larger platform, help you analyze sales trends, forecast product demand, and identify inventory issues early on. This enables brands to see when products are shifting categories (from B to A, for instance).
- Integrations with other business systems: When your systems integrate, they can seamlessly share and use data to perform more efficiently. So, your accounting software, inventory management system, ERP, and ecommerce platform can work together to improve your stock management, financial outlook, order fulfillment, and ultimately, customer satisfaction.
With the right tech, ABC categorization is an ongoing process, enhancing how you treat every SKU to maximize efficiency and revenue.
Advanced ABC Analysis Strategies
After building out the foundation of an ABC inventory analysis strategy, you can take it to the next level with a few advanced tactics.
- ABC cycle counting: To save yourself from the onerous task of a full-on inventory count (which can take out a whole day of shipping), you can instead implement ABC cycle counts. These focus on items based on their category, with A-items counted more regularly (say, monthly) than B or C-items (which could be quarterly and biannually respectively), saving you time and money while keeping stock accurate.
- Dynamic ABC analysis: With powerful tools in place, you are capable of a more reactive analysis than the standard. Dynamic ABC analysis means that categorizations are regularly reviewed and adjusted based on current sales data and market trends.
- Combining ABC with other inventory strategies: ABC analysis doesn’t need to be a standalone strategy. Brands can combine it with Just-In-Time (JIT) inventory and/or Economic Order Quantity (EOQ) to minimize holding costs and maximize cash flow.
Leverage ABC Inventory Analysis for Ecommerce Success
At its heart, ABC inventory analysis is all about making your life easier and your ecommerce store more profitable.
It slices through the chaos of managing tons of different products by sorting them into three neat categories: the all-stars (A-items), the reliable middle players (B-items), and the seat fillers (C-items).
Think of it as organizing your products not just by what they are, but by how much they're really doing for your business.
- A-items demand a bit more TLC because they're the big earners, despite their lower sales frequency.
- B-items are your quiet regulars, not too demanding but still worthy of attention.
- C-items keep the engine running, often overlooked but essential for those quick wins.
This smart sorting helps you cut down on waste, sharpen your reorder point strategies, and ultimately beef up your bottom line. Plus, when you loop in some snazzy inventory management software, you're not just guessing but making decisions based on real, actionable data.
So, why is ABC analysis a game-changer for ecommerce?
It tackles one of the biggest headaches in the biz: managing a dizzying array of products without dropping the ball on what makes your store tick.
With ABC, you're always on top of your game, ensuring that your stock levels are smart, your cash flow's smooth, and your customers are smiling.
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