This post explores ABC Analysis – a framework and technique use in inventory analysis. It further explores where it applies to strategy and project management – and strategic project managers.
What Is ABC Analysis?
ABC analysis refers to the classification of inventory items into three classes, A, B. and C. Inventory items are classified based upon their importance or value. The intent is to enable prioritization of inventory items and allocation of resources.
The A-B-C categorization can be based on a number of factors. Some example factors, all related in some way to value, include sales volume, cost of the item, cost of storage, cost of shipment, or other relevant metrics. The driver behind the categorization is the Pareto principle, or 80/20 rule, which suggests that a small number of items will naturally account for a large proportion of the value.
Here’s some more detail to think about on the A, B, and C categorizations:
- Category A: These items are of the highest value or significance. They usually represent a small fraction of the total items but contribute a much more significant portion of the overall value or impact. Strict inventory control and frequent monitoring are often applied to Category A items to avoid stockouts or disruptions.
- Category B: These items are of moderate value or significance. They are more numerous than Category A items but contribute less overall value than Category A items. As a result, they should be given a moderate level of control and monitoring, balancing the resources allocated to them.
- Category C: These items are of relatively low value or significance. They usually represent a large percentage of the total items but contribute a small portion of the overall value or impact. They naturally have less strict control measures and can be managed with more relaxed inventory policies. Low value requires low cost, control, resources, and attention.
By categorizing items through ABC analysis, organizations can prioritize their efforts and resources according to the value they produce. This classification can assist in setting inventory levels, determining procurement strategies, identifying items that require more attention, and optimizing overall inventory management processes.
How Does ABC Analysis Fit With Pareto Analysis?
ABC Analysis has a great deal in common with Pareto, or 80:20, Analysis. I believe it is simply a specific application – to inventory management – of the 80:20 principle.
Like 80:20, ABC Analysis can go deep.
- What are the 20% of inventory items that produce 80% of the value?
- What are the 20% of those first 20% that produce the most value?
- And again, what is the top 20% of that second 20% that provides most of the value?
This does not mean that you should necessarily eliminate the bottom 80%. It may be critical to have a broad set of offerings in order to derive the value from the top 20%. But it is good to think about that, as eliminating some low value items might be wise.
Low value items can also help to enable sales of high value items.
Another factor is that many businesses do not make so much profit on the initial sale of an item, but make a large profit on the service and support. That might take the form of individual service experiences, such as with automobile service. Or it could be from a “service subscription”, such is commonly embedded in many ‘Software as a Service’ (SaaS) items.
Another consideration is that the cost and availability of low value items might be low, and they might be used as loss leaders to drive sales of the high value items. This gets more into marketing than inventory management, but sales/marketing and inventory management are, in fact, closely linked.
Where Does ABC Analysis Fit With Strategy?
ABC Analysis fits as an important component in the process of strategy formulation. It can be a lot of detailed work and thus must be appropriate for the particular subject business.
When might ABD Analysis be appropriate as part of a strategy development effort?
- Inventory Intensive Business – Many businesses, with both retail and business-to-business (B2B) products, rely heavily on maintaining a significant and active inventory of finished products. The balance sheet of such a business would have assets heavily weighted to inventory.
- Large Volume of Products – A business with a large volume of products may need to carry a large inventory. In order to control costs, ABC Analysis can provide guidance as to how to manage the inventory smartly, allocating resources according to value provided by the item.
- Physical Products – Inventory is for physical products! Electronic products, being ‘virtual’, can be stored and reproduced at near zero cost. That’s not the case for physical products. Physical products cost money t make, store, handle, and ship. Handling returns is also a cost item related to inventory.
Any one of these factors can make a business a good candidate for ABC Analysis, which can provide the foundation for cost-efficient inventory management.
What Impact Does ABC Analysis Have on Project Management?
ABC Analysis can be relevant to project managers in a number of situations. Many of these situations will involve implementation of Enterprise Resource Planning (ERP) systems, such as those offered by Oracle and SAP.
Here is an outline of three broad categories:
- Selection of Projects – In performing portfolio management, formally or informally, consideration needs to be given as to the type of business, such as outlined in the strategy section above. Project and portfolio managers need to select projects based on their potential value. Focus should be on selecting the projects involving the management of inventory for the 20% of the inventory items that produce 80% of the value.
- Prioritization on and within Projects – Once projects are selected, they need to be prioritized. Even items falling into the 20% will vary in value. In addition, there will be a myriad of prioritization decisions within projects that call upon an understanding of the relative value of inventory items.
- Sustainment Projects – Many projects – some ongoing programs – involve maintaining systems related to inventory management. Such project may involve improvements of existing systems, Such project would be classified as ‘sustainment projects’.
Where you might be working as a project management In the realm of inventory management, applying ABC Analysis is a strategic project management skill. It can greatly enhance the results produced.
Conclusion
This post has explored what ABC Analysis is, and where it applies to strategy and project management.
Please share any experience or insights you have on ABC Analysis.
Below is an excellent 21-minute video on ABC Analysis from AbcSupplyChain, experts in the field: