ABC analysis is a classification method to rank a company's resources according to their importance and profitability. It is based on the Pareto principle: 20% of all products generate 80% of sales.
In relation to ABC analysis, the Pareto principle can be formulated as follows: The reliable observation of 20% of the items allows the system to control 80%, whether it is stocks of raw materials and components or goods sold etc.
In ABC analysis, goods are divided into three categories: A — most valuable, B — average, and C — least valuable. In essence, ABC analysis is a ranking of the assortment according to various parameters. Anything that has sufficient statistical data (e.g., suppliers, buyers, inventory) can also be classified in this way. The result is a grouping of the objects after the degree of the influence on the total result.
The ABC analysis is based on the principle of imbalance. When performing it, a diagram of the dependence of the total effect on the number of elements considered is plotted. It is called Pareto curve, Lorenz curve or ABC curve.
Based on the results of the analysis, the assortment items are ordered and grouped according to the size of their contribution to the total effect. In logistics, ABC analysis is typically used to track the shipment volume of certain goods and the frequency of call-offs, as well as to classify customers by the number or volume of orders they place.
The procedure for performing ABC analysis includes the following steps:
Purpose of the analysis is defined;
Actions based on the results of the analysis are defined (How can the obtained results be used?);
Selection of the object and parameters of the analysis (the criterion to be used for the analysis);
The ranking list of objects is created in descending order of the parameter value;
The share of the parameter in the cumulative total of parameters is calculated. The share with cumulative sum is calculated by adding the parameter to the sum of the previous parameters;
Groups A, B and C are formed.
The objects of ABC analysis are usually product groups, product categories, individual products, suppliers. Each of them has different parameters to describe and measure: sales volume (in monetary or quantitative terms), profit (in monetary terms), product inventory, turnover, etc.
The choice of parameter thresholds according to which an object is assigned to one of the categories depends on the specific characteristics of the problem. For example, we can assume that the narrow assortment of category A with 10% of the goods generates 70% of the income.
Of the remaining goods, 20% (category B) generate 20% revenue and the other 70% (category C) generate only 10%. From the obtained results it can be concluded that the goods of category A should be given the most attention, the goods of category B less attention, and the goods of category C can be considered additional products.