Also known as selective inventory control, this classification highlights the fact that not all products are of equal value. More attention should be placed on more profitable products. This includes production, stock levels, marketing, customer acquisition, and customer service.
Let’s explore the benefits of ABC inventory management, how the analysis works for products and customers alike, and how you can make it work for your business.
ABC inventory management comes from the Pareto principle, which states that 20% of a company’s activities generate 80% profit and output. Therefore, more focus should be placed on the activities that generate the strongest performance in your business.
Some say that the cons to this form of analysis is that it …
But, the pros outweigh the cons, which include:
Categorizing inventory enables businesses to make strategic decisions about where to invest time and resources, with class A products taking top priority.
Understanding demand for products through the ABC model helps determine optimal stock levels for products.
Products in high demand may be able to command a higher price, positively impacting profitability.
ABC analysis provides insights into a product’s stage in the product life cycle — launch, growth, maturity, or decline. This lets you forecast demand and manage stock levels accordingly (including safety stock).
ABC analysis also sets customer service levels based on what they’ve ordered, giving precedence to class A high-value customers.
Even though there are no fixed rules, it’s important that you do know which products to prioritize so that you can maximise profit. ABC categorization leans on annual consumption unit, inventory value, and cost significance.
Products are split into three categories:
A: Items of high value (70%) and small in number (10%)
B: Items of moderate value (20%) and moderate in number (20%)
C: Items of small value (10%) and large in number (70%)
Category A
Items of high value (70%)
and small in number (10%)
Category B
Items of moderate value (20%)
and moderate in number (20%)
Category C
Items of small value (10%)
and large in number (70%)
As you assign merchandise to each category, align those values with your company’s goals.
Normally, that’s profitability. However, it can also be increasing your market share through gross sales. This model can be adjusted to suit different types of products and businesses, with the key focus being identifying and nurturing top sellers.
So, what does it look like in action?
By way of illustration, let’s say a women’s skincare company wants to discover (1) hard data behind it’s best-selling products and (2) also understand how those products translate into long-term value.
The owner starts by running a sales over time report for products. There, she determines that one eye cream accounts for about 65% of the business’ first time buyers and 30% of its overall revenue. Because of its high number of overall products, those data points represent a prime example of Category A.
Armed with that knowledge, the owner decides on a three pronged strategy.
First, the company will begin producing that same eye cream in different sizes and for three skin types. Second, she also reallocates her digital marketing spend to increase bids through Google Ads, Instagram, and Facebook. Third, the website places the eye cream front and center as the hero product.
As a result, sales of Category A increase by 20% over the course of three months. Even better, the smaller size at a lower price point initially reduces her return on ad spend, but through retargeting and email marketing … customer lifetime value from the eye cream increases by more than double.
You can also use the ABC approach to segment customers, prioritize service accordingly, and target other people with similar characteristics.
Assuming that 80% of a company’s sales come from 20% of its customers, look at those high-value customers to determine what common characteristics they have. This includes buying preferences, location, demographics, etc. Then, focus on finding more customers that fit the same pattern.
For instance, let’s say the owner of a wholesale pet food supplier runs a sales over time report for customers (instead of products) and notices that their top buyers are from the east coast of the US and typically buy the one of three brands of dog food.
With that in mind, the company starts going to trade shows in the area and introduces discounts for bulk buys on only those three brands. Consequently, they get four new buyers in two months and their average order value increases by 10%.
Looking forward, ABC inventory management will be an increasingly important tool for eCommerce retailers and wholesalers alike as cost optimization, efficient supply chain management, and smart customer segmentation become the norm.
In fact, it’s only one of many tactics the fastest-growing brands are using to master inventory management. If you’d like to discover the rest:
