ABC Analysis is a method of tiered inventory or supplier valuation that
divides inventory/suppliers into categories based on cost per unit and
quantity held in stock or turned over a period of time. This is one of
the four methods of overall materials management and inventory
ABC analysis can often be confused with Activity Based Costing, a similar sounding term that refers to a method of manufacturing costing that is more refined than the traditional machine-hours method of determining the overhead cost of a finished product.
ABC Analysis allows inventory/purchasing managers to segregate and manage the overall inventory/suppliers into three major groups. This allows different inventory/supplier management techniques to be applied to different segments of the inventory/suppliers in order to increase revenue and decrease costs. In terms of a Pareto Analysis, it separated the critical few from the trivial many.
"A" Category items generally represent approximately 15%-20% of an overall inventory by item, but represent 80% of value of an inventory. By paying attention close attention in real-time to the optimization of these items in inventory, a great positive impact is possible with minimal increase in inventory management costs.
"B" Category items represent 30%-35% of inventory items by item type, and about 15% of the value. These items can generally be managed through period inventory and should be managed with a formal inventory system.
"C" Category items represent 50% of actual items but only 5% of the inventory value. Most organizations can afford a relatively relaxed inventory process surrounding these items.
There are six basic steps1.
ABC analysis is a valuable tool to enable companies dedicated to strategic cost management to measure the current status for their materials management system and look for the "low hanging fruit", the simple changes that can yield the largest cost management benefits in the near and middle term periods.