The ABC analysis is a methodology that provides us with a quick and easy review of our product assortments in retail, wholesale, or manufacturing businesses. But, this analysis can be used in all areas of your business when you, as an entrepreneur, must make decisions about inventories, product assortments, marketing techniques, business processes, costs… The ABC analysis provides us with a mechanism to identify the products that have a high influence on overall inventory costs and identifying the category of inventory that requires different management and control.
Similar or the same as the ABC analysis is the 80/20 rule which is also known as the Pareto Principle. This rule tells us that 80% of the effects come from 20% of our activity, or 80% of our sales come from 20% of our customers.
In every business there are products that are not equal in value. Some products are more required by customers, for some products you have a higher margin, some you must have in stock to complete the assortment. Therefore, all products are different in sales volume, value, meaning, etc. You should aim to have a lower level of inventory or an optimal level because inventory has a very negative impact on overall business activities. With this method, entrepreneurs can have a clear view of the entire variety of products and the significance of this variety for the total sale and total revenue.
You need to differentiate two things, first, how much revenue do you have from each product line? Second, how much are these products required which means what is the turnover for those particular products? Some products may have a higher turnover but at the same time they have lower revenues and due to that higher turnover we have higher profits from that product. Perhaps customers in most cases will come to the store for that particular product and buy something else or another product. That’s why you should make two tables.
In the first table, you’ll analyze product variety (number of products) against total revenue, and in the second table, you’ll analyze product variety against total revenue. In this way, you will be able to combine these 2 analyzes and see real situations and choose variants that maximize the results and give us better results at work.
You can do an article classification with ABC analysis when we divide the assortment (complete articles) into 3 segments.
- The first segment is Segment A, where belongs the products that earn at least, for example, about 20% of the total turnover and this item gives us great revenue, for example, 70% of the total revenue.
- The second segment is the B segment, where we have much more items in quantity, for example around 30-50% of all the products we have, but they give us only 20% of the total revenue.
- The third segment is the C segment, where we may have about 50% of all the items we have, but they give us only 10% of the total revenue.
These percentages were taken at random and serve as an example only. All tests can have different percentage numbers. Upon completion of this analysis, you will be able to make decisions about which products or assortments to provide to your customers that will increase the potential energy of your business.
This analysis is similar to the 80/20 rule. The 80/20 rule or Pareto principle is suggested by business and management expert Joseph Juran and he named this rule after the Italian economist Vilfredo Pareto, who observed that 80% of income in Italy goes to 20% of the people. . This rule tells us that:
- 20% of your activity gives you 80% of your income. Should you have the remaining 80% of the activities?
- 20% of your customers give you 80% of your income.
- 20% of your products give you 80% of your income. You must eliminate products that do not give you income and invest in products that give you a large part of the income.
- 20% of your staff gives you 80% of the success of your business. Should you have the remaining 80% of your staff and why do you need it?
- 20% of your marketing activities give you 80% of your customers. Eliminate activities that do not bring you additional customers.
- 20% of your money spent gives you 80% of your income. The remaining 80% of your spending money may be costs.
The 80/20 ratio is crucial to developing and increasing the commercial potential energy of your business and also to the overall performance of your business. This rule can also be used in personal life to make your life of better quality.