This analysis can be used in all areas of your business when you as an entrepreneur need to make a decisions related to inventories, products assortments, marketing techniques, business processes, costs…
So, ABC analysis will give you mechanism for identifying the products that has high influence on the overall costs of inventory in your company and will help you in identifying the categories of inventory that will need totally different management and control.
Similar or the same as ABC analysis is 80/20 rule that is also known as Pareto Principle. This rule tells us that 80% from effects will come from 20% of our efforts for these effects, or 80% of our sales income come from only 20% of our customers.
In all businesses there are products that aren’t equal in their value. Some of them are more popular and required from customers, and some of them allow you to have larger margin. Other products you must to have in inventory if you want to have better assortment of products for better offering possibilities. So, all products are different in sales volume, value, meaning and so on.
So, you will need to always work on having lower level of inventory or simply said optimal level because high-level inventory can have very negative impact of your overall business activities. With ABC analysis you can have a clear view of the assortment of products and the real meaning of this assortment to your whole income.
You must to differentiate two things, first how much income you have from each product line, and second what is the demand of the specific product line as the figure of total turnover of that particular products. Some products can have higher turnover but in the same time to have lower income. In many cases some of the customers come in the store because of that specific product with high turnover and low income and will buy something else or another product.
Because of that you will need to create two tables. In the first table you will analyze assortment of products (number of products) versus income, and in the second table you will analyze assortment of products versus overall turnover. In such a way you can combine this 2 analysis and view real situations that will enable you to choose variants that will maximise the results.
ABC – analysis of assortment versus overall turnover:
ABC – analysis of assortment versus overall income
You can make classification of products with ABC analysis when you divide assortment (all products) in 3 different segments.
- First segment is segment A where are products that are least obtained, such as about 20% from overall turnover are this product’s group that brings you the largest part of your income, such as 70% from your overall income.
- Second segment is segment B, where you have more products in quantity, such as about 30-50% of all your products, but they give you only 20% from your overall income.
- Third segment is segment C, where you can have about 50% of all products that you have, but they give you only 10% from your overall income.
This percentage was randomly taken and serve only as example for this purpose. All analysis can have different numbers in percentage. When you finish with this analysis, you can to make decisions about products or assortments of products that you must to provide to your customers and that will increase your business potential energy.
This analysis is similar to 80/20 rule. The 80/20 rule or Pareto principle suggested from Joseph Juran a business and management expert who name this rule by Italian economist Vilfredo Pareto who observed that 80% of income in Italy goes to only 20% of people. This rule tells us that:
- 20% from your activities will bring you 80% of your income. Do you need to have the rest 80% of activities?
- 20% from your customers will bring you 80% of your income.
- 20% from your products will bring you 80% of your income. You must to drop products that don’t bring you income and invest in products that give you large proportion of your income.
- 20% from your staff give you 80% of success of your business. Do you must to have the rest 80% of your staff and why you need it?
- 20% from your marketing activities give you 80% of your customers. Eliminate activities that not give you additional customers.
- 20% from the amount of money you spent will bring you 80% of your income. The rest 80% of your spending is simply cost for you.
80/20 ratio is crucial for developing and increasing your business potential energy and your overall business performances. This rule also can be used in your personal life to improve the quality of your life.