What is an ABC Analysis
An ABC Analysis is a method for e-commerce businesses to classify their inventory into different categories. These three categories are A, B and C. Each letter represents a level of importance an item has to the profitability of the business. The analysis itself is an extension on the Pareto principle (the 80/20 rule) which is a common business rule which states 80% of effects come from 20% of the causes.
For example, 80% of sales come from 20% of visitors.
We can use the ABC analysis to find our top 20% of products which are most effective for our e-commerce store so we know where to focus our inventory and marketing efforts when it comes to making our store more profitable.
ABC Classification Segments
Segment A: Products that provide 80% of total revenue and 20% of stock
Segment B: Products that provide 15% of total revenue and 30% of stock
Segment C: Products that provide 5% of your total revenue 50% of stock
These categories can be categorised more simply:
Segment A: the smallest group of products that is classified as most important to the business
Segment B: this group of products is a little larger but contributes less to the business
Segment C: the biggest group of products that contributes the least
How to perform an ABC Analysis
You may assume that the products that are the most valuable are your most expensive- while that may be true your most valuable inventory items may be moderately priced items that sell in large quantities or they may be low-cost items that are used as upsell that turn unprofitable orders into profitable ones.
To perform an ABC Analysis on your inventory you have to:
- Make a list of all your products
- Work out the quantity you have of each product/SKU and the prices
- Multiply the price by the amount in stock to find out the potential revenue
- List your products in order of highest revenue to lowest
- Add the potential revenue from each product to calculate total revenue
- For each product divide, that product’s potential revenue by the total potential revenue to find out what percentage each product contributes to the total revenue of your e-commerce store.
- To complete the analysis you divide your inventory into one of three categories based on the value of the product to the company.The ABC Analysis often looks like this.
Why should you use an ABC Analysis?
Dividing your inventory into these three segments gives you a way to focus on the products that affect your e-commerce store the most. It informs which products need constant restocking which products you can discount if need be as you know their margin’s and you can lower your capital costs by reducing the amount of obsolete inventory on hand.