ABC Analysis

Focus on Critical Issues by Conducting an ABC Analysis

Learn to differentiate between relevant and irrelevant issues in a case interview

The ABC analysis is based on the pareto principle and helps in the prioritization of key issues. The method creates transparency showing the significance of various revenue segments. For instance, an ABC analysis can be used to segment product lines as important/less important according to their share of sales or the overall value they provide to the company.

Using the ABC analysis, a company's material selection can be divided into A-, B- and C-goods. Let's assume that “A-goods” are materials that are often scarce and have a high value per unit. Consequently, a few units of "A-goods" account for significant revenues (as a share of the total revenues). In addition, “C-goods” have a low value per unit with no scarcity within the company. Thus, whenever you are asked which materials are “strategic” or worth being looked at, your answer should be: “Let’s focus on A-goods first” to focus on items with the highest impact with minimal efforts.

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Conduct an ABC analysis to tackle the right cost blocks within a supply chain optimization

Suppose you have determined that an automotive company is making losses due to high working capital within the supply chain (see value chain for more info). What could you do to reduce the working capital?

Since you need to cut costs you should first focus on the right cost blocks. Try to cluster your inventory based on its stock quantity and value by conducting an ABC analysis. You will quickly notice that most of your working capital is tied up for the purchase or production of motors. Compared to other materials such as screws, there an only a few motors on stock, but they are extremely expensive. In addition, because they are considered as “important”, the head of production insisted on high safety stock. But, through advanced demand planning and just-in-time delivery, you determine that you could reduce the inventory level and cut costs significantly. Moreover, you can possibly even increase the availability (reducing stock-out events).

Key takeaways

• ABC analysis is a simple method of prioritizing issues.
• The analysis classifies different kinds of products based on their value or share of sales.
• This differentiation provides a better understanding of the anatomy of the cost structure and a good foundation for further analysis.