ABC analysis is a methodology that gives us a quick and easy review of our variety of products in retail, wholesale or manufacturing businesses. But, this analysis can be used in all areas of your business when you as an entrepreneur must make decisions about inventories, product assortments, marketing techniques, business processes, costs … ABC analysis provides us with a mechanism to identify Products that have high influence overall inventory costs and identify the inventory category that requires different management and control.
Similar or equal to ABC analysis is the 80/20 rule which is also known as the Pareto Principle. This rule tells us that 80% of the effects come from 20% of our activity, or 80% of our sales come from 20% of our customers.
In all businesses there are products that are not equal in value. Some products are more required by customers, for some products you have a higher margin, some you must have them in inventory to complete the assortment. Therefore, all products are different in sales volume, value, meaning, etc. You should tend to have a lower inventory level or an optimal level because inventory has a very negative impact on overall business activities. With this method, entrepreneurs can have a clear view of the entire product assortment and the significance of this assortment for total sales and total revenue.
You must differentiate two things, firstly, how much income do you have from each product line? Second, how much are these products required which mean what is the turnover of those particular products? Some products may have a higher turnover but at the same time have lower income and, due to that higher turnover, we have higher profits from that product. Perhaps customers in most cases come to the store because of that particular product and buy something else or another product. That is why you must make two tables.
First, you will analyze product variety (number of products) versus total revenue, and in the second table, you will analyze product variety versus total turnover. In this way, you can combine this analysis and visualize real situations and choose variants that maximize results and give us better results at work.
You can perform article sorting with ABC analysis when we divide the assortment (whole articles) into 3 segments.
- The first segment is segment A where they belong to products that are minimum obtained, for example, about 20% of the total turnover and this article gives us great income, for example, 70% of the total income.
- The second segment is segment B, where we have many more items in quantity, for example, around 30-50% of all the products we have, but they give us only 20% of the total revenue.
- The third segment is segment C, where we can have around 50% of all the items we have, but they give us only 10% of the total revenue.
These percentages were taken at random and serve as an example only. All analyzes can have different percentage numbers. When you are done with this analysis, you will be able to make decisions about products or assortments that you should offer to your customers and that will increase the potential energy of your business.
This analysis is similar to the 80/20 rule. The 80/20 rule or Pareto principle is suggested by the business and management expert Joseph Juran and he named this rule after the Italian economist Vilfredo Pareto who observed that 80% of income in Italy goes to 20% of the people. This rule tells us that:
- 20% of your activity gives you 80% of your income. Should you have the remaining 80% activities?
- 20% of your clients give you 80% of your income.
- 20% of your products provide you 80% of your income. You should eliminate products that do not give you income and invest in products that give you a large proportion of income.
- 20% of your staff give you 80% of the success of your business. Should you have the remaining 80% of your staff and why do you need it?
- 20% of your marketing activities provide you with 80% of your customers. Eliminate activities that don’t get you additional clients.
- 20% of your spending money gives you 80% of your income. The remaining 80% of yours spends money perhaps on costs.
The 80/20 ratio is crucial to developing and increasing the commercial potential energy of your business and also the overall performance of your business. This rule can also be used in personal life to make your life with better quality.