ABC Inventory Management Technique: Pros and Cons

Controlling inventory is the top-priority task for each retailer and procurement manager - the better inventory is managed the more sales the company gets and the less money is tied in slow-movers.

There are lots of inventory management techniques which are used by retailers and warehouse managers all over the world.

Some of the technologies are basic and can be performed on a single spreadsheet, some of them require complex automated solutions. Introducing automated inventory control systems will surely drive your business profitability, as manual inventory control can be tiresome and routine, and take hours of your precious time. On the contrary, automated systems can optimize all warehouse operations in seconds, obtain real-time synchronized data for all warehouses and stores, track and forecast demand for all SKUs across all storage and sales locations.

Before you integrate an automated inventory management system, you should be aware of different inventory management techniques used around the world, so that you can choose your inventory control and the approach it uses wisely and rationally.

ABC inventory management technique is one of the most popular and widely-used systems of inventory control.

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What is ABC Inventory Management Technique?

ABC inventory management technique is often described as “ABC analysis” and sometimes is called “a selective inventory control method”. This method is all about prioritizing.

ABC analysis prioritizes inventory depending on its importance for company’s business activity. Importance in this case means inventory value and ranges from the least “valuable” items (C-category) to the most valuable and top-selling (A-category). Product value which serves as a basis for ABC analysis is also defined as “consumption value”.

As soon as all company’s inventory is prioritized according to A-B-C categories, the retailer, procurement manager or company owner can focus and concentrate the efforts on the top-selling and most valuable goods - the items which bring value and money to the company.

A couple of words on the theoretical grounds the ABC inventory management technique is based on: the method uses 80-20 concept. This observation is based on Pareto* principle, which can be interpreted the following way: 80% of all company’s revenues and sales are driven by 20% of its inventory.

*Pareto principle is a theoretical empirical observation named by an Italian economist. Founded at the end of the 19th century the observation says that not everything is distributed equally, and sometimes the “vital few” (20%) are accountable for the “trivial rest” (80%). This observation can be applied to economic growth, business activity or productivity etc.

So, getting back to the inventory analysis, ABC technique is grounded on a theory that the minor percentage of all SKUs (A-category) is accountable for the large part of company’s profits. ABC analysis visionaries recommend focusing more attention on these profit-making A-category goods.

Let’s take a closer look at the categories:

A-items: “Extreme importance”

A-class inventory usually generates the larger volume of sales, these goods are very profitable and thus are very important for business activity. These items are few in numbers ( regularly these goods constitute about 20-25% of the whole inventory quantity) and bring 75-80% of profits.

Importantly, these items have to be always available on the warehouse and store shelves, so they have to be reordered more frequently than B- and C-items. In other words, they shall receive “priority” attention and shall be monitored more accurately.

In addition to inventory management, A-classified goods require more thorough and well-thought marketing, merchandising and sakes strategies. For example, a retailer can introduce a wider colours range, or different variations of the top A-class goods and generate more cash and profits by selling them.

B-items: “Average importance”

B-class items have significantly lower consumption value than A-class goods. This category of goods is also called “an interclass” section, as it has a potential to move up to A-class or go down to C-class. Usually, B-goods account for about 30% of inventory quantity. Such goods do not require any special focus, and they should be monitored occasionally.

C-items: “Low importance”

C-class goods have the lowest level of sales and consequently, low consumption value (5 to 15%), but at the same time they are large in numbers (usually, 50% and higher). These items do not require consistent monitoring and availability control. ABC analysis can also point out the items which are the slow-sellers, which can be taken away from product assortment.

Here we use the term “usually” when referring to the items percentage and consumption value, because these numbers can somewhat vary from business to business, from industry to industry, from market to market.

Pros of ABC inventory management technique:

  1. ABC analysis is a relatively easy and effective tool which can help to manage and control inventory, track goods profitability and make rational reordering decisions.
  2. ABC method is perfect for setting the basics of customer service in retail, as you can identify the customers who buy your top A-class goods and give them special care and treatment, boosting their customer loyalty and your profits.
  3. You can save space in your warehouse by storing and ordering lower volumes of C-class items and keeping stable quantities of A-goods.
  4. You can perform ABC analysis at any stage of your inventory life cycle and track the inventory consumption value dynamics.

Cons of ABC inventory management technique:

  1. ABC analysis relies heavily on data accuracy and transparency, which means that you have to very carefully calculate inventory consumption value and take all factors into account (such as storage costs, sales data, transportation costs etc). In case you make errors in product value calculation, the whole prioritizing thing will go wrong and the ABC analysis will be incorrect. And sometimes, identifying and determining item’s consumer value can be a very challenging task, especially for seasonal, new or promotion goods.
  2. ABC analysis can not be applied for complex solutions which require integrated data, demand forecasting, customer behaviour tracking etc. ABC analysis is a part of the strategy, an element of the puzzle, which shall be applied in synchronization with other techniques, methods and data-driven solutions.
  3. ABC is not integrated with GAAP accounting principle. GAAP stands for Generally Accepted Accounting principles, used in the US.

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