ABC analysis

The ABC analysis is a business term used to define an inventory categorization technique often used in materials management. It is also known as Selective Inventory Control. Policies based on ABC analysis:

• A ITEMS: very tight control and accurate records
• B ITEMS: less tightly controlled and good records
• C ITEMS: simplest controls possible and minimal records

The ABC analysis provides a mechanism for identifying items that will have a significant impact on overall inventory cost, while also providing a mechanism for identifying different categories of stock that will require different management and controls.

The ABC analysis suggests that inventories of an organization are not of equal value. Thus, the inventory is grouped into three categories (A, B, and C) in order of their estimated importance.

'A' items are very important for an organization. Because of the high value of these ‘A’ items, frequent value analysis is required. In addition to that, an organization needs to choose an appropriate order pattern (e.g. ‘Just- in- time’) to avoid excess capacity.
'B' items are important, but of course less important, than ‘A’ items and more important than ‘C’ items. Therefore ‘B’ items are inter-group items.
'C' items are marginally important.

The task is to identify the products that have the highest annual consumption value regarding their portion of their annual consumption. Thus what we have to do is to conduct an ABC - analysis in order to structure the product range in A, B and C products. For this example the procedure is the following:

1. Calculation of the annual consumption value.
2. Sorting of the products regarding their annual consumption value in decreasing order.
3. Calculation of the ratios of the annual consumption per product and accumulation of it.
4. Calculation of the ratios of the annual consumption value per product and accumulation of it.
5. Arrangement in A, B and C product groups.

An orientation for the arrangement is given by:

Product group	Value percentage	Percentage of product range
A	60% - 80%	10% - 20%
B	10% - 20%	20% - 30%
C	5% - 10%	60% - 70%

Example

A producer of consumer goods wants to analyse its product range. The goal of this analysis is to evaluate which product is of particular importance and which products are less important. The management has decided to use the annual consumption value as the key figure to assess the product range. An ABC analysis shall be conducted.

Therefore we have to collect the raw data first:

Product	annual consumption (in units per item)	Price per unit	annual consumption value
1	1.480	6,10	9.028,00
2	1.680	0,15	252,00
3	10.120	0,20	2.024,00
4	3.520	0,40	1.408,00
5	3.830	9,50	36.385,00
6	4.368	0,25	1.092,00
7	4.180	0,45	1.881,00
8	3.590	0,90	3.231,00
9	4.820	0,70	3.374,00
10	6.000	0,02	120,00
11	1.900	1,01	1.919,00
12	2.980	4,20	12.516,00
13	1.050	0,30	315,00
14	1.100	0,44	484,00
15	710	31,60	22.436,00
16	4.700	0,38	1.786,00

After that we order the raw data in decreasing order regarding the annual consumption value and calculate the ratio of annual consumption and the ratio of annual consumption value and cumulate it. We can use the classification proposed above to classify the goods into A, B and C products.

Product	Annual consumption (in units per item)	Price per unit	Annual consumption value	Cumulative ratio of annual consumption [%]	Cumulative ratio of consumption value [%]	Product group
5	3.830	9,50	36.385,00	6,84%	37,03%	A
15	710	31,60	22.436,00	8,10%	59,87%
12	2.980	4,20	12.516,00	13,42%	72,61%
1	1.480	6,10	9.028,00	16,06%	81,80%
9	4.820	0,70	3.374,00	24,67%	85,23%	B
8	3.590	0,90	3.231,00	31,07%	88,52%
3	10.120	0,20	2.024,00	49,14%	90,58%
11	1.900	1,01	1.919,00	52,53%	92,53%
7	4.180	0,45	1.881,00	59,99%	94,45%
16	4.700	0,38	1.786,00	68,38%	96,26%	C
4	3.520	0,40	1.408,00	74,66%	97,70%
6	4.368	0,25	1.092,00	82,46%	98,81%
14	1.100	0,44	484,00	84,42%	99,30%
13	1.050	0,30	315,00	86,29%	99,62%
2	1.680	0,15	252,00	89,29%	99,88%
10	6.000	0,02	120,00	100,00%	100,00%