A Complete Guide to ABC Analysis in Inventory Management

Inventory control is integral to any retail business but can be costly. It’s the single largest expenditure associated with operating a business. Inventory, accounts receivable, and accounts payable account for $1.1 trillion in assets.

US merchants presently hold $1.39 worth of inventory for every dollar of sales. That entails significant fixed costs, and an excessive investment carries the danger of dead stock. Effective inventory management can either make or break your online business. 

Today, many businesses struggle to manage their inventories adequately. After all, managing various client demands makes it challenging to maintain the ideal inventory quantity. However, you can effectively handle your products with a solid inventory control system.

Inventory control helps retail companies keep the right amount of product on hand. It is an essential process for various industries, including eCommerce, manufacturing, logistics, retail, and more. For any business that handles inventory, proper control should be at the top of the list of priorities. Inventory control can be achieved using various techniques, of which ABC analysis is one.

ABC analysis is a valuable tool for online merchants. You can use it to determine how well your merchandise is performing. By identifying the best and worst-selling items, you can maximize your return on investment and boost sales. 

ABC Analysis divides inventory goods into three groups: A (high-value products), B (medium-value items), and C (low-value items) according to their value and significance to your business.

The A items, usually the most significant and costly, must be handled carefully. Though not as crucial as A, the B components are necessary for the company to succeed. The success of the firm is not as dependent on the C items.

Breaking Down ABC Analysis for Inventory Management

ABC analysis is closely related to the “Pareto Principle.” It is also known as the 80/20 rule and was named for the Italian economist Vilfredo Pareto. According to this theory, just 20% of valuable efforts provide 80% of the output.

In terms of inventory management, we can assign specific numerical values to the three groups of inventory items mentioned above. 

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A-Grade 

The items in your inventory that perform the best but also cost the most. These are the goods that customers seek and have the highest yearly consumption value. Usually, this only represents a small portion of your entire inventory, around 20%. However, if it accounts for 80% of your sales, it is considered an A-grade item. It must be prioritized and protected as your most valuable inventory.

B-Grade 

B-grade products are more critical than C-grade items but less important than those considered A-grade items. These “middle-of-the-road” goods generate 15% of your revenue. Depending on demand, they can fluctuate between both A and C-grades. Ideally, these items should make up 30% of your total inventory.

C-Grade

Although more C-grade products are in store, they are less valuable in making money. In contrast to categories A and B, C-grade goods generate just 5% of the stock’s maximum share of 50%.

These items might also be referred to as dead stock or slow-moving. C-grades are extremely low-value and should be given low priority in marketing and sales.

The Pareto Principle doesn’t give you a perfect picture of how your items perform. Further analysis does reveal that valued items tend to lean toward an 80/20 distribution. ABC analysis helps you find the “sweet spot,” items that can net you the most profits with the least effort. 

Here’s a simple computation that can help you with ABC inventory analysis. 

Annual number of items sold x cost per item = Annual usage value per product

You can allocate human and financial resources more effectively by knowing which products are profitable. Therefore, your best-selling items should be prioritized based on the results of your analysis.

A simple spreadsheet program can be used to perform ABC inventory analysis. Sort the products or resources based on their product usage value, then arrange them in descending order. 

Determine how much each item contributes to the overall total. After determining the values for the A, B, and C grades, you can categorize them according to your specifications. Pay special attention to the items that have the highest value.

Why You Should Consider ABC Analysis

Many eCommerce businesses that have a large number of SKUs often find it difficult to grow their operations. Large retailers also face many inventory management challenges. Lack of stock information, inefficient processes, trouble managing staff, and a cramped warehouse can stifle growth.

ABC analysis is an excellent way to manage your inventory. It allows you to understand which of your products move the fastest. With ABC analysis, you can prioritize merchandise for fulfillment and the best way to organize your storage.

Reliable Inventory Control

The main factor that makes ABC analysis a popular choice for many businesses is inventory optimization. You can classify items according to value and income. All these products are then grouped based on the needs of the customers. You’ll know how much of each product category to order and store in your warehouse.

Forecasting demand is a challenging task. While it is impossible to predict the future, using historical data is the next best thing. You’ll better understand ideal stock levels by identifying key buying trends among your product line-up.

Superior Customer Satisfaction

Imagine a potential customer’s frustration with discovering their intended purchase was out of stock. Fifty-five percent (55%) of lost sales are due to stock-outs. 

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By determining your A-grade inventory, you can set up procedures to ensure you never run out of your best-selling products. Customers can consistently check out their carts by guaranteeing their most valuable items are always in stock.

Strategic Pricing Strategies

Strategic pricing of your items increases the value that your business derives from the ABC analysis of the inventory. With ABC analysis, online merchants can strategically adjust product prices and classify them into several areas. A vendor will have more opportunities to raise prices if there is a greater demand for the goods.

Informed Supplier Negotiations

Grade-A goods generate between 70% and 80% of a company’s revenue. ABC analysis makes obtaining a fair price on a product from a supplier easier. 

For example, you’re negotiating with a supplier for a shipment of a grade-A product. You must invest the largest amount possible because it brings in the most money for your business. You can entice the provider with any more perks if they are unwilling to accept your offer or make you the proper one. For instance, you might offer to purchase the following shipment of items from the same vendor.

You could get a better price that meets your needs in this situation. At the same time, you can also save more money on grade-A items. Being able to stock your best-selling products consistently has more benefits for your business in the long term.

Improved Resource Allocation

In a perfect world, your warehouse shelves would be spacious enough to accommodate enormous inventories and offer any product. However, this is unlikely to happen in reality. You would have to pay outrageous monthly costs to keep all those items. That’s even if you could find a space big enough to house everything. You have to make do with what you have. 

Your grade-A inventory will be easily identified once you have completed an ABC analysis. The top 80% of items, including shelf space, should receive the most care and consideration. Maximize the limited space that you have in the warehouse. Faster-moving items can be placed closer to the packing and shipping areas. 

eCommerce businesses may utilize ABC analysis as a helpful inventory management technique. Leveraging this technique allows online merchants to manage their stock levels better.  You can also make more informed decisions about what to store and how to handle it. Concentrating on grade-A products and minimizing needless storing and handling less valuable products helps companies save money. 

Companies will also see improvements in setting, ordering, replenishment, and reordering priorities for their inventory products. It can, however, provide several difficulties, like finding the precise inventory levels required for the A, B, and C goods. You may also encounter problems categorizing objects into the ABC categories and receiving correct and current product data.

With logistics technology and some best practices, ABC analysis allows businesses greater insight into their inventory. 

ZhenHub has all the digital logistics software online merchants need to start with ABC Analysis. Monitor your entire eCommerce inventory online and receive real-time updates wherever you are. Sign up for free at our website and get access to our dashboard. Contact our fulfillment experts for more information on our complete suite of logistics software solutions.