What is ABC Analysis in Inventory Management?

Not all inventory items contribute equally to a business. Only a small percentage of items drive most of the inventory 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 the business’s value. 

In this blog, we will explain what ABC analysis in inventory management is and how it works. We also include its process, why it is important, and how to use it to manage inventory more efficiently.

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 classification method based on the Pareto Principle, where a small percentage of items account for most of the total value or usage.

This helps companies focus on the few items that create the most value. ABC analysis divides inventory into three categories: A, B, and C, based on value and importance to the business.

To put it simply, ABC analysis helps management prioritize 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 widely used inventory management technique. The table below shows the ABC classification, including what each category means, examples, and how to manage them.

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 helps businesses focus on high-value items, improving reordering accuracy and ensuring essential goods are available. 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. Walmart follows a similar approach. They keep high-demand products in stock while letting suppliers deliver slow-moving items as needed, reducing storage costs.

Supply Chain and Logistics Management Course

Learn end-to-end supply chain planning, operations, and logistics management

Explore Program

ABC Analysis: Step-by-Step Process with Example

ABC analysis identifies the most valuable inventory items, helping you manage them more efficiently. Here’s a simple step-by-step ABC analysis process:

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 a practical method that classifies inventory into three groups based on value and importance. Most industries use this to keep the costs low and concentrate on the most important items.

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 real-life examples of companies that used ABC analysis in inventory management and achieved 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 supply chain revamp. The company focused only on SKUs that mattered most in terms of value and demand. This resulted in:

• Reduced 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 stored for the fastest access to reduce picking time. C-items are kept 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

Define different review frequencies for each class and allocate management effort accordingly. 

3. Use Different KPIs for Each Class

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

4. Do Regular Reviews

Evaluate the effectiveness of your ABC system. Pay special attention during full inventory checks or when rules and schedules rely on these groupings.

5. Manage Surplus Stock and Locations

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

6. Track Inventory in Transit

When transporting goods from one place to another, track the time taken from shipment to delivery. It helps detect delays, damages, or losses during transit.

7. Use Technology and Data

Monitor the demand, manage stock using inventory software, and identify problems at the early stages. Make restocking decisions and plans based on 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: Invest your money, effort, and space on high-value items while controlling low-value ones. 
• 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 in classification: New, seasonal, or low-selling items can get misclassified, which may cause their value to be overlooked.
• Risk of imbalance: Low-priority items can sometimes become overstocked or understocked, affecting operations.

ABC Analysis vs. Other Inventory Management Techniques

Inventory management techniques like ABC, XYZ, and VED analyses are valuable tools, each providing a unique approach to optimizing 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 more efficient. Here are five practical ways:

1. Manage Suppliers Better

Rank suppliers based on 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 lower-priority ones. Determining 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.

Frequently Asked Questions