Do you want to improve your business performance drastically? Probably the answer is yes. So, you will need to use ABC analysis or sometimes called as 80/20 rule. What is ABC analysis?
ABC analysis is a methodology that can give you a quick and simple review of your range of products in the retail store, wholesale, or manufacturing company.
The Basics of ABC Analysis and 80/20 Rule
This analysis can be used in all areas of your business when you as an entrepreneur need to decide about inventories, product ranges, marketing techniques, business processes, costs, etc.
So, ABC analysis will give you a mechanism for identifying the products with the most significant influence on your overall costs of inventory in your company. It will help you identify the three different categories of inventory that will need totally different management and control.
Similar or the same as ABC analysis is the 80/20 rule known as the Pareto Principle. This rule tells us that 80% of the results will come from 20% of our efforts to get these results. For example, if we translate this into sales terms, 80% of our sales income will come from only 20% of our customers.
In all businesses, some products don’t have the same value. Some of them are more popular and required from customers. Some of them will allow you to have a more significant margin. Other products you must have in inventory if you want to have a better range of products for better offer possibilities. So, all products are different in sales volume, value, meaning, and so on.
Example of ABC analysis for inventory control
You will need to always work on having lower levels of inventory or simply say optimal level. High-level inventory can have a very negative impact on your overall business activities. With ABC analysis, you can have a clear view of different ranges of the products and the real meaning of these product lines to your whole income.
You must differentiate two things. The first thing is how much income you have from each product line. The second thing is the demand of the specific product line as the figure of the total turnover of those particular products. Some products can have higher turnover, but at the same time to have a lower profit. In many cases, some customers come in the store because of those specific products with higher turnover and low profit and will buy something else or another product with lower turnover and higher profit.
Because of that, you will need to create two tables. In the first table, you will analyze product type versus income, and in the second table, you will analyze the product types versus overall turnover. In such a way, you can combine these two analyses and view real situations that will enable you to choose variants that maximize the results.
Doing Classification of Products According to ABC Analysis
You can make classification of products with ABC analysis when you divide ranges into three different segments.
- The first segment is segment A where are products that are the smallest turnover. Here are about 20% of overall turnover and brings you the largest part of your income, such as 70% of your overall income.
- The 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% of your overall income, from 70-90%.
- The third segment is segment C, where you can have about 50% of all your products, but they bring you only 10% of your overall income.
This percentage was randomly taken and served only as an example for this purpose. All analyses can have different numbers in percentage. When you finish with this analysis, you can decide about a range of products that you must provide to your customers. Those products will increase your overall business potential energy.
80/20 Rule is the Basis of ABC Analysis
This analysis is similar to the 80/20 rule. The 80/20 rule or the Pareto principle was suggested by Joseph Juran, a business and management expert who gives the name of 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% of your activities will bring you 80% of your income. Do you need to have the rest 80% of activities?
- 20% of your customers will bring you 80% of your income.
- Also, 20% of your products will bring you 80% of your income. You must drop products that don’t bring you income and invest in products that give you a large proportion of your income.
- 20% of your staff gives you 80% of the success of your business. Do you need to have the rest 80% of your staff and why do you need it?
- Or, 20% of your marketing activities give you 80% of your customers. Eliminate activities that aren’t giving you additional customers.
- 20% of 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 performance. This rule also can be used in your personal life to improve the quality of your life.