ABC AnalysisABC Analysis

Rajnish KumarRajnish Kumar

► What is ABC analysis ?What is ABC analysis ? ABC analysis is done to identify the quality ABC analysis is done to identify the quality

of inventory that a retailer is holding. of inventory that a retailer is holding. It classifies items based on set criteria of It classifies items based on set criteria of

sales and profitssales and profits► Why is it done ?Why is it done ? It helps to understand what is the It helps to understand what is the

contribution of various product lines to the contribution of various product lines to the profits and which products are blocking the profits and which products are blocking the working capital due to slow movement.working capital due to slow movement.

Then outcome is to optimize the inventory so Then outcome is to optimize the inventory so as to have the most efficient products in as to have the most efficient products in your lineyour line

What is A,B and C ?What is A,B and C ?

When carrying out an ABC analysis, inventory items When carrying out an ABC analysis, inventory items

are valued and then ranked. The results are then are valued and then ranked. The results are then grouped typically into three bands. These bands are grouped typically into three bands. These bands are called ABC codes :called ABC codes :

► A classA class inventory will typically contain items that account for inventory will typically contain items that account for 80% of total value, or 20% of total items. 80% of total value, or 20% of total items.

► B classB class inventory will have around 15% of total value, or 30% of inventory will have around 15% of total value, or 30% of total items. total items.

► C classC class inventory will account for the remaining 5%, or 50% of inventory will account for the remaining 5%, or 50% of

total items.total items. Nomenclature remaining the same the classification Nomenclature remaining the same the classification

parameters may change based on business realities parameters may change based on business realities and requirements.and requirements.

The Pareto PrincipleThe Pareto Principle The The Pareto principlePareto principle also known as the also known as the

80-20 rule or 80-20 rule or the the law of the vital fewlaw of the vital few states that, for many events, roughly 80% states that, for many events, roughly 80% of the effects come from 20% of the causesof the effects come from 20% of the causes

► It is a common Thumb rule in business.It is a common Thumb rule in business.

Ex : 80% of your sales can come from 20% Ex : 80% of your sales can come from 20% of your products or 20 % of your clients of your products or 20 % of your clients give you 80 % of your business.give you 80 % of your business.

► 20 % of the rich countries contribute more 20 % of the rich countries contribute more than 80 % of the world’s GDP and 20 % of than 80 % of the world’s GDP and 20 % of India’s Population pays 80 % of the Tax India’s Population pays 80 % of the Tax collected !collected !

ABC in Category ManagementABC in Category Management

Like many other areas the ABC analysis is widely Like many other areas the ABC analysis is widely used in category management too.used in category management too.

► Buyers may use sell thru % analysis to arrive at Buyers may use sell thru % analysis to arrive at the top 20 articles and then see what percentage the top 20 articles and then see what percentage of sales or margin they are responsible for.of sales or margin they are responsible for.

► The sell thru analysis is a factor of denominator or The sell thru analysis is a factor of denominator or base on which the sell through is determined so if base on which the sell through is determined so if the base is small then it may cause a big variance the base is small then it may cause a big variance in terms of contribution to overall salesin terms of contribution to overall sales

► It simply means that if we only purchased 100 It simply means that if we only purchased 100 pieces and 80 of them got sold across 20 stores pieces and 80 of them got sold across 20 stores then this product may not have a significant role then this product may not have a significant role to play in overall sales or profitabilityto play in overall sales or profitability

► Therefore, it is important to look at sell thru % in Therefore, it is important to look at sell thru % in conjunction with absolute qty sold and its value conjunction with absolute qty sold and its value before taking any decisionsbefore taking any decisions

Inventory OptimizationInventory Optimization

► A simple tool that may be used to optimize the A simple tool that may be used to optimize the inventory is to measure inventory efficiencyinventory is to measure inventory efficiency

► Inventory efficiency can be defined as % contribution Inventory efficiency can be defined as % contribution of a product or a sub cat to sales divided by % of a product or a sub cat to sales divided by % contribution to the stock of that category.contribution to the stock of that category.

► Inventory efficiency of 1 suggests that the product in Inventory efficiency of 1 suggests that the product in question contributes equally to the sales as well the question contributes equally to the sales as well the stock so it may be continuedstock so it may be continued

► Similarly an inventory efficiency of 0.5 tells that the Similarly an inventory efficiency of 0.5 tells that the product is not doing well and may need to be product is not doing well and may need to be discontinued or reduced in buying value.discontinued or reduced in buying value.

► An important observation is that an efficiency of An important observation is that an efficiency of greater than 1 for Ex. Inventory efficiency of 3.5 may greater than 1 for Ex. Inventory efficiency of 3.5 may suggest widespread stock outs and the fact that the suggest widespread stock outs and the fact that the product is not getting replenished as frequently product is not getting replenished as frequently resulting in lost salesresulting in lost sales

What Actions to take ?What Actions to take ?After classifying items into ABC following After classifying items into ABC following actions may be initiated :actions may be initiated :

► Increase buying of class A items and increase Increase buying of class A items and increase investment in Inventory of these products investment in Inventory of these products

► Reduce or eliminate items which are C class Reduce or eliminate items which are C class items as these products probably do not meet items as these products probably do not meet the value expectations or taste of the the value expectations or taste of the consumer consumer

Inventory optimization is a continuous process Inventory optimization is a continuous process and the items may keep falling in ABC or and the items may keep falling in ABC or categories as the market evolves, new categories as the market evolves, new competition emerges and the business competition emerges and the business lifecycle of the retailer attains maturity.lifecycle of the retailer attains maturity.

Impact of ABC analysisImpact of ABC analysis► Improved Working capitalImproved Working capital► Freshness and relevance of Freshness and relevance of

MerchandiseMerchandise► More efficient resource planningMore efficient resource planning► Reduced manpower requirementReduced manpower requirement► Consolidation of suppliersConsolidation of suppliers► Higher In stock % Higher In stock % ► Customer satisfactionCustomer satisfaction► Better space allocationBetter space allocation►MORE from LESS MORE from LESS is the Net effect is the Net effect