You’ve probably heard of the 80/20 rule, or Pareto Principle, at some point. Originally theorized by economist Vilfredo Pareto in the late 19th century to highlight income inequality in Italy, the Pareto Principle has found application across all facets of life and society. At its simplest, the principle states that a small percentage of a given group will account for a majority of total production. For instance, the wealthiest 20% of a population might control 80% of the total wealth. Or 80% of peas are produced by 20% of the pods.
The retail world is no exception to this rule. In general, a vast majority of sales come from a much smaller group of customers. Additionally, this majority of profit typically comes from just a small percentage of total profits. Retail analysts have divided a hypothetical business’s products into three categories: A, B, and C. A items consist of 70-80% of total sales but only 10-20% of total inventory; B account for 15-25% of sales and 30% of inventory; and the C products only provide 5% of total sales but control 50% of inventory. The strategy has been aptly coined ABC retail analysis. Advanced points of sale, like KORONA’s retail POS system, can actually complete this ABC analysis for you. But before getting into that, let’s look at a few details of this simple, but ingenious inventory system.
Why Is ABC Analysis for Retail Important?
More retailers are dealing with a large amount of inventory, sometimes even thousands of different products, that can be challenging to organize. ABC analysis allows this vast amount of data to be broken into three, simple categories. Again, to summarize slightly differently from above, category A products are your money makers. They bring in the most profit while costing you fewer resources. Category B products are right in the middle – they don’t bring in the majority of sales but they don’t cost your small business too much either. Finally, category C accounts for few of your total sales, but take up a much larger percentage of resources.
Once you have your products broken down into these three categories, making meaningful adjustments becomes a whole lot easier. Mountains of raw data are overwhelming and relatively useless. Once you know which products are your real money makers, inventory, pricing and store layout can be much more strategic.
Profits & Revenue
Ultimately, the most important number in retail is your profitability, or how much money your business is generating. Products that don’t generate any profits are generally not worth selling. They are wasting money, time and precious shelf space. Total revenue, while not as important of a factor as profit, is still worth considering. A product could, for instance, be a large factor in revenue but contribute minimally to your profit. These products might seem worthy of discontinuing, but a high revenue stream means that people are coming into your retail store and (hopefully) spending money on other more profitable products while there.
Comparing Revenue and Profit ABCs
An ABC ranking for each product in terms of revenue or in terms of profit is helpful. But looking at the combined ranking is more enlightening. Each combination of revenue and profit rating indicates certain actions you can take to improve the overall success of your retail business. Keep in mind that there are certain exceptions such as promotional items or anchor products that are on your selves to either get customers in the door or to influence their buying decisions. To learn more about this, check out our pricing strategy blog post. Other than these few exceptions, the following combinations are strong indicators of a certain product’s value.
- Revenue A, Profit A: These items are your most valuable. This is the best combination and one that is probably not worth messing with. However, in some situations, you might consider slightly increasing the price to boost profits.
- Revenue A, Profit B or C: As seen above, products that generate a high revenue but still bring in low profits are generally priced too low.
- Revenue C, Profit C: The image below depicts the simple, unfortunate case of an item not selling well at all. There can, of course, be many reasons for this. The product could be priced too high, it could be positioned poorly, or it could just not fulfill expectations. Either way, this is a red flag. Something needs to change or it should be taken off the shelves.
ABC Retail Analysis with KORONA
KORONA is now including ABC analysis software in each of our points of sale. Once you enter each product’s wholesale cost and retail price, our software will total the number of sales, revenue, and profit, and in about 15 seconds give you a full ABC report on every single product in your store. Our POS software is much more than a cash register; it’s meant to help you make the best decisions for your business. With a free trial, you can find out more about your store than you might have imagined your POS could tell you. Find out more about a POS system for your retail store by clicking below!