ABC analysis is an inventory management technique that determines the value of inventory items based on their importance to the business. ABC classifies items based on demand, cost, and risk data, while inventory managers group items into classes based on these criteria. This helps business leaders understand which products or services are most critical to the financial success of their business. Knowing how to run an ABC analysis is also an effective way to better manage bundled sales.
Inventory control, which is knowing what products you have on the sales floor and in your stockroom (and how many you have), is the bedrock of retail store operations. Knowing how much product is in stock is paramount to all aspects of inventory management: meeting customer demand, reordering and replenishment, inventory counts, and ultimately, bottom line profits.
Inventory disorganization increases the risk of discrepancies between the inventory levels in your point of sale system and what you can account for in your store or stockroom. That’s why using an ABC analysis is one of the most effective tools for avoiding the repercussions of poor inventory management. For a while, it’s easy to overlook that systematic inventory classification is vital to retail operations.
However, it’s one thing to know the importance and benefits of ABC analysis. It’s a whole other story to understand how to run it in your retail store. And that’s what this blog will be covering.
Table of Contents
- What is an ABC analysis
- How to run an ABC analysis?
- Why is it critical to use ABC analysis for inventory management?
- ABC inventory management best practices
- Streamline your inventory with KORONA POS
What Is an ABC Analysis?
An ABC analysis is a technique you can use to identify your best and worst-performing inventory over a period of time. It helps you improve inventory control and profitability by identifying the products that are making and costing your company the most. The approach is based on the Pareto principle (namely, that 80% of consequences come from 20% of cases) and is used to classify your inventory using three categories (A, B, and C) based on total revenue:
- “A” items are goods with the highest annual consumption value. Using the Pareto principle, they comprise a relatively small number of items but have a relatively high consumption value. Therefore, it makes sense that analysis and control of this class are relatively intense, as the potential for cost reduction or waste is highest. In many cases, it’s only a small percentage of the total but a large percentage of your total revenue. Being your most valuable inventory, it should be protected and given priority as much as possible.
- “B” items are cross-class items. Their consumption values are lower than those of A items but higher than those of C items. They account for the next 15% of your revenue and should be treated as such.
- “C” items have the lowest consumption value. This category may have a relatively high percentage of the total number of store products but low sales values. Category C products are the inventory that accounts for the remaining 5% of your revenue. These items can also be referred to as slow-moving or dead stock inventory.
You can run an ABC analysis in two different ways: manually or through inventory management software that can generate an ABC analysis in an automated way.
Manual calculation of the ABC analysis
To run an ABC analysis, start by calculating each individual product’s revenue generated for your store. Then, divide that number by the total revenue generated by all products during the same period.
For example, if your store sold $20,000 worth of women’s high-end shoes in 28 days and the entire store generated $100,000 in revenue over the same period, women’s shoes represent 20% of your store’s revenue.
Now repeat this process for each item in your inventory. Next, list your products in descending order of the percentage of revenue generated.
The top 80% are category A items – your best sellers and the ones you should prioritize in managing your inventory. Those in the middle 15% are Category B. And those in the bottom 5% are Category C.
Tips From KORONA POS:
Companies need to analyze their inventory regularly to ensure sustainable success. ABC analysis is one of the many ways to achieve this. However, performing a manual ABC analysis can be fraught with errors, which can be detrimental to your business if you use incorrect data. Hence, it is rather advisable to opt for an inventory software management that can generate an automated ABC analysis and save you time.
You might also want to read: ABC Retail Analysis – Advanced Inventory Management Software
ABC analysis with an automated inventory management software
Many companies still use spreadsheets to run their inventory classification. It doesn’t take much to see how complex a spreadsheet needs to be if you want to run it accurately. Setting up an
ABC analysis may be simple with a few SKUs, but as soon as you introduce a second set of classifications or a few hundred SKUs, it becomes clear that a spreadsheet is not the ideal tool to use. In addition to the formulas and macros, the risk of human input errors is extremely high, not to mention the time it takes to re-enter data and continually update it.
Using advanced inventory management software, like KORONA POS, allows you to efficiently establish classifications and then move on to setting inventory policies using the sales history of their POS system. Once all the data has been entered and run through the many algorithms, you receive a summary dashboard that allows you to proactively manage your inventory.
KORONA POS’s ABC analysis allows you to evaluate your products based on net income and net yield. The software will then make a recommendation based on these categories.
To list a product, simply tell KORONA POS to stop automatically replenishing these products and remove them from your store’s inventory when they are sold out. The analysis will recommend that you list products marked C or your worst performing products.
The software also offers the ability to apply a label to all products listed in the selected categories. You can choose one of the highlighted product names for various menu options, including Edit Product, Discount Reasons, Product Report, Products by Day of the Week, Recipes, Inventory History, Inventory Return Rate. Click on this link for further information on the KORONA POS ABC analysis. In addition, a video is available for all retailers using the software to guide them through the ABC analysis.
Why is it Critical to Use ABC Analysis for Inventory Management?
Many businesses have substantial problems with their SKU management. There are many other inventory management challenges that retailers face, too. These may include insufficient knowledge of the inventory, an inefficient management process, personnel and space management issues, etc. Inventory classification is a viable solution that can help companies streamline their inventory management process. As the name suggests, inventory categorization is a method of strategically pricing various products based on their demand value. The ABC method of inventory categorization is a classification technique that helps inventory managers solve all the problems related to inventory maintenance and maximize the inventory value of goods.
Analyze customer demand for a particular product category
Every product has to go through four main stages: launch, growth, maturity, and decline. It’s bound to drop at some point when the product reaches its optimum value. This is called the product life cycle. It is important to note that the life cycle of a product depends on the customer’s needs.
And this is where ABC inventory classification comes in. Business owners and inventory managers can analyze consumer demand for specific products and manage their inventory accordingly. If the market for an item increases, the sell-off period is further delayed.
Increase sales rate
The sell-through rate (STR) is the percentage of your inventory that you have sold to customers. Ideally, your store’s STR should be greater than 80%. Fewer products in stock mean lower storage fees and better customer insight. A high STR means your customers enjoy what you’re selling – they’re voting with their wallets.
ABC analysis can help improve your store-wide STR because you know which products are most popular. Use this data to schedule any upcoming replenishment orders; order less for class C products and more for class A.
Conducive negotiation with the supplier
ABC analysis is also helpful in obtaining a favorable negotiation with the supplier. For example, if a company is negotiating with suppliers of Category A products, it should make maximum investment in them because it offers maximum revenue. Even if the company makes a lucrative offer, there are chances that the supplier is still not willing to enter into the deal.
In such a scenario, the company can still seal the deal by offering other benefits, such as reduced down payment and free delivery. This helps to create a favorable situation for both parties. It also allows companies to save more on their top products and keep more profits.
ABC inventory analysis also allows organizations to price different products strategically. Once the cost of the products is set strategically, it becomes relatively easy to align them according to different categories. If the demand for the product increases, the seller can increase the price.
Reduce storage costs
Keeping too many items in stock is a costly mistake. Not only are you paying to keep unsold items in storage, but there is also the opportunity cost of wasted space. The shelves where C-level products are stored could hold more of your best sellers, thus avoiding excess inventory.
Streamlining and optimizing the inventory process
Unique selling points (USPs) of ABC analysis streamlines the inventory management process. It helps organize and segregate inventory based on its annual consumption value and revenue generation. Products can be categorized according to customer demands.
The days of manually counting inventory and recording it in an Excel sheet are long gone. Tools and apps make your life easier. Retail merchants can quickly count inventory using a barcode scanner with KORONA POS. These tools allow retailers to significantly reduce the time needed to perform an inventory count and better optimize inventory management.
Use simple classifications
An ABC analysis gets complicated when you analyze too many small details. Streamline your report by using simple inventory classifications, such as revenue generated by product name or category. You don’t need to break down each product by color or size at this time (you can always do this later with a secondary ABC analysis of inventory for each that has such classifications).
ABC inventory analysis is a useful way to see which products perform best and worst to optimize sales and profitability. Keep in mind to exclude seasonal items, new product lines, and refer to other inventory metrics to get the most accurate scores.
Prioritize your A-level inventory by investing heavily in it, both in terms of inventory levels and supplier relationships. Get rid of C-level inventory (and reduce deadweight storage costs) by bundling it with other items, offering it at a lower price, or donating it to those in need.
It’s easy to get started with ABC analysis with KORONA POS. It will leverage historical sales data to show you your best (and worst) performing inventory in just a few clicks. Click the button below for a free demo with one of our product analysts.
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FAQs: How To Run ABC Analysis
Companies can conduct an accurate ABC analysis by following these steps. Determine the elements to be analyzed and predict the success rates. Then collect the data to be analyzed. Rank the inventory in descending order. Calculate the cumulative impact and then rank the inventory according to demand. Finally, monitor categories and allocate products accordingly.
You can perform an ABC analysis in seven steps: The first step is to organize the inventory data in Excel. Calculate the additional columns needed for the ABC classification. Then create an inventory allocation table. The next step is to define the thresholds for the ABC classification. Add the ABC item and total cost % columns to the chart. Add error bars to ABC markers to get boxes. Finally, clean up the chart, and add labels and titles.
The first step in performing an ABC analysis is to know which method to use before doing the analysis. Will you be performing it manually or using inventory software management? The choice of this method will determine the procedural steps in the calculation of the ABC analysis.