What is ABC Analysis in Inventory Management?

Not all inventory items in businesses are equal. Only a few items drive most of the value. One of the most popular methods used by businesses to control inventory is ABC analysis. This method classifies items based on their contribution to your business’s value. 

In this blog, we will explain what ABC Analysis is, how it works, its importance, and how to use it to manage inventory more efficiently. We also provide a detailed guide on the ABC analysis process, along with pros and cons.

Table of Contents:

• What is ABC Analysis in Inventory Management?
• ABC Analysis Inventory Classification: A, B, and C Categories
• Why Use ABC Analysis in Inventory Control?
• ABC Analysis: Step-by-Step Process with Example
• How ABC Analysis is Used Across Different Industries
• Real-Life Success Stories of ABC Analysis in Inventory Management
• Best Practices for ABC Analysis
• Advantages and Disadvantages of ABC Analysis
• ABC Analysis vs. Other Inventory Management Techniques
• Innovative Applications of ABC Analysis

What is ABC Analysis in Inventory Management?

ABC analysis is an inventory categorization method based on the Pareto Principle, which suggests that a low percentage of items usually represent a high percentage of the total value or usage.

This helps the companies focus on the value of the few items that will provide value in the business. ABC Analysis divides inventory into three categories: A, B, and C, based on their value and importance to the business.

To put it simply, ABC analysis helps management prioritise what matters most. Businesses emphasize high-value products that make a difference in profits, as opposed to treating all goods equally.

ABC Analysis Inventory Classification: A, B, and C Categories 

ABC analysis is a system that came up in inventory management, segregating inventory items into three groups: A, B, and C, in terms of value and frequency of sales. 

Here’s a tabular view of ABC classification, showing what each category means, examples, and how they should be managed.

ABC analysis supports smarter inventory prioritization by helping companies focus on what matters most.

Why Use ABC Analysis in Inventory Control?

ABC analysis helps businesses identify which items are tying up capital and which truly drive value. It allows businesses to focus on high-value items, improving reordering accuracy, and ensuring essential goods are available when needed. Lower value, slow-moving items require less frequent replenishment, freeing resources for more important stock. 

Toyota, for example, keeps fast-moving parts readily available and only orders slower-moving parts when needed. Something similar is done by Walmart. They ensure that their high-demand products are always in stock while allowing suppliers to deliver their slow-moving products as needed, reducing storage expenses.

ABC Analysis: Step-by-Step Process with Example

ABC analysis helps you identify which inventory items are most valuable to your business so you can manage them more efficiently.

Here’s how to do it, with a simple ABC analysis example:

Step 1: Gather Inventory Data

Start by listing all your inventory items along with their annual demand and unit cost. 

Step 2: Calculate Annual Consumption Value

Multiply each item’s annual demand by its unit cost to get its annual value.

Step 3: Sort Items by Total Value (Descending Order)

Rank items in descending order of annual value. Use cumulative percentages to assign categories:

• A items: about  10-20% of the total items account for 70-80% of the total consumption value (a few items, high value). 
• B items: about 20-30% of items account for 15-25% of the total value.
• C items: the remaining 50-70% of items that make up 5-10% of the total value 

Example of ABC Analysis

Here’s an example of ABC analysis showing demand, cost, annual value, percentage contribution, and classification.

Step 4. Set Control Policies

Now assign management strategies:

• A items: Tight control, frequent review, low safety stock
• B items: Moderate controls and regular monitoring
• C items: Basic controls, reorder occasionally or on demand

Step 5: Review and Update Regularly

Run ABC analysis every few months or quarterly to reflect changes in demand and ensure accuracy.

How ABC Analysis is Used Across Different Industries

ABC analysis is indeed a clever method of handling inventory and putting it in three categories depending on value and importance. Most industries use this to keep the costs low and concentrate on the most important thing.

1. Manufacturing Industry

ABC analysis helps manufacturers ensure that the essential parts are always in stock. For example, in a car factory:

• A-items: Engine components that are expensive and critical
• B-items: Wheels or doors, important but easier to replace
• C-items: Bolts, nuts, or washers that are cheap and used in bulk

This classification helps prevent delays by ensuring important parts are always in stock, which keeps production running smoothly.

2. Retail Industry

Retailers use ABC analysis to manage shelf space and avoid overstocking.

• A-items: Best-selling products like mobile phones or trendy clothing
• B-items: Seasonal items like winter jackets
• C-items: Low-cost accessories such as keychains or socks

Focus stays on fast-moving products that drive revenue.

3. Healthcare Industry

Hospitals and clinics rely on ABC analysis to prioritize critical supplies.

• A-items: Life-saving drugs and surgical tools
• B-items: Bandages, gloves, and syringes
• C-items: Items with lower usage, like certain supplements

It ensures essential equipment is never out of stock.

4. E-commerce Industry

Online stores use ABC analysis to balance warehouse space and delivery times.

• A-items: Fast-moving products like smartphones or headphones
• B-items: Mid-level items like casual wear or backpacks
• C-items: Niche products or slow-moving goods

It helps avoid dead stock and improves order fulfillment.

ABC analysis assists all businesses, including hospitals and e-commerce, in concentrating on the inventory that affects them most.

Real-Life Success Stories of ABC Analysis in Inventory Management 

Here are some real-life success stories of companies that implemented ABC analysis in their inventory management and saw measurable results:

1. Apollo Hospitals (India): Medical Inventory Optimization

Apollo used ABC analysis along with VEN (Vital, Essential, Non-essential) classification to improve medical inventory control across hospitals and pharmacies. A-items included life-saving drugs and high-value devices. This resulted in:

• Reduced stockouts of essential medicines.
• Lowered wastage due to the expiry of slow-moving drugs.

2. Unilever: Streamlined SKUs Across Product Lines

Unilever applied ABC analysis as part of a broader supply chain revamp, using it on its massive product portfolio to focus only on SKUs that mattered most in terms of value and demand. This resulted in:

• Minimize overstocking and obsolescence risk, leading to less waste and lower holding costs.
• Improved working capital and shelf availability for key products.

3. Amazon: Optimizing Warehouse Picking with ABC

Amazon uses an ABC analysis in its bin and picking system. High-value items (A-items) are placed in locations with the fastest access to reduce picking time. C-items are stored farther away or grouped with other low-priority items. This resulted in:

• Improved inventory turnover
• Faster order fulfillment
• Reduced warehouse labor costs

Best Practices for ABC Analysis 

The entire process of ABC analysis can become easier by using inventory software. Here is how to apply it effectively:

1. Keep It Simple

Rank and categorize items by annual consumption value. Focus on the total contribution each item makes, not just its cost and profit margin. Put high-value items in Class A, mid-range in B, and the low total value in C.

2. Set Service Levels by Class

Allocate a specific duration to each of the classes and determine how much energy you want to devote to them. 

3. Use Different KPIs for Each Class

Monitor the performance of every class individually with the proper analytics and dashboards.

4. Do Regular Reviews

Look at the effectiveness of your ABC system, particularly when carrying out complete inventory checks or when your rules, as well as schedules, depend on these groupings.

5. Manage Surplus Stock and Locations

Control excess inventory and make sure to accurately track across all storage sites. 

6. Track Inventory in Transit

When goods are being transported from one place to another, track the scheduled time that has been taken between the shipment and the delivery of goods. It helps detect delays, damages, or losses during transit.

7. Use Technology and Data

Monitor the demand, manage stock using inventory software, and identify the problem at the early stages. Restocking decisions and plans should be made using data.

Advantages and Disadvantages of ABC Analysis

ABC analysis groups inventory by value to focus resources where they matter most.

Advantages of ABC Analysis 

Here are some of the benefits of ABC analysis in inventory management:

• Smart resource allocation: Spend your money, effort, and space on the items that matter most, while keeping low-value items under control. 

• Maintain stock availability: Make sure that essential items are always available to avoid running out and keep customers happy.

• Improve efficiency: Makes inventory management easier and reduces unnecessary confusion. 

Disadvantages of ABC Analysis 

Here are some disadvantages of ABC analysis:

• Requires continuous effort: In the ABC analysis, classification must be reviewed regularly, which demands staff, time, and resources.

• Limitations for classifications: New, seasonal, or low-selling items may be misclassified, which leads to neglecting their value.
  
• Risk of imbalance: Sometimes, low-priority items can be overstocked or understocked, which can affect operations.

ABC Analysis vs. Other Inventory Management Techniques

Inventory management techniques such as ABC, XYZ, and VED analyses are valuable tools, each providing a unique perspective on how to optimize inventory control. 

Let’s take a look at the difference table between ABC, VED, and XYZ analysis:

Innovative Applications of ABC Analysis

ABC Analysis can be applied in various fields apart from inventory management to make business operations better and efficient. Here are five practical ways:

1. Manage Suppliers Better

Always rank suppliers by the importance of their items. Spend more time with Category A suppliers to secure better terms, faster deliveries, and more reliability. For Category C suppliers, use automated communication or cost-effective options.

2. Prioritize Sales and Marketing

Focus on Category A customers or products with customized offers and priority service. Use automated tools or broader marketing campaigns for Category C to save time and resources.

3. Efficient Storage 

Keep high-value, fast-moving items in easy-to-access spots for faster picking and packing. Store slower-moving items in less prominent areas to save space and improve efficiency.

4. Plan for Risk 

Ensure essential items are always available, even during supplier delays or disruptions. Keep extra stock or backups of Category A items. Manage Category C with more flexible plans.

5. Budget Wisely

Invest more in high-value items by focusing on quality, safety, and careful management. Spend less on low-value items to keep costs in check and free up working capital for the things that matter most.

The Bottom Line

ABC analysis helps businesses manage inventory more effectively by sorting items based on their value. It gives businesses a clear way to focus on important products while reducing waste on less priority ones. Figuring out the right inventory levels for each category takes careful planning. When done right, ABC analysis makes inventory management smoother and more efficient.

To explore ABC Analysis in depth and understand other smart inventory strategies, consider the supply chain management course by IIT Indore DRISHTI CPS. It is a practical way to improve your skills and advance your career.

ABC Analysis in Inventory Management – FAQs