Home' MHD Supply Chain Solutions : MHD Mar-Apl 2016 Contents informal priority decisions, resulting in a lack of
whole-of-company perspective. Furthermore,
priorities in an informal environment tend to be
handed onto new people and the original reason
for the priority gets lost over time.
Although ABC analysis is most frequently
applied on a company’s product range with
a focus on revenue or profit, it can also be
• Business services.
• Customers and consumers.
• Salespeople’s revenue-generating capability.
• Distribution channels.
• Manufacturing materials.
• Root-causes of errors.
• Machine breakdowns.
To begin formalising the process, it is
best to examine the organisation and make
classifications based on:
Once the areas of classification have been
agreed and people are working to the behavioural
expectations, there needs to be a process in
place to make sure it is routinely reviewed and
refreshed. This should be done no less than once
a year, but preferably once a quarter.
It might seem to be far too much work to
review ABC of products, customers, suppliers,
etc., every quarter, but in reality, if it is part of
the routine integrated business planning (IBP)
process, it will end up being a relatively swift
and painless exception-driven activity.
The standard definition of ABC classifications
are in Table 1.
After classification, the outcome is then to
communicate where we want to focus attention.
While some might want to argue about the
exceptions to the rule, the fact is that the B and
C overall impact is less than 20 per cent. The
weight of the numbers should win the argument,
unless proven otherwise. ABC classification then
becomes one great-big communication and
priority-setting process and set of rules.
The astounding fact is that the C tail makes
up 50 per cent of the items (customers,
products, suppliers, etc.), but accounts for less
than 5 per cent of the value (cost, revenue,
Working with clients for more than 30 years
has led to the observation of a reciprocal law,
which assesses the amount of effort used to
manage the splits. As in the case of many
organisations, if all items are treated the same,
then the table can be expanded to resemble
In other words, the largest amount of effort is
being applied in the wrong place. This has also
been validated a number of times in a slightly
different way: when applying an activity-based
costing analysis on the C tail of products, the
typical result is that 50 per cent of those items
are losing money.
ABC analysis, however, requires a reasonable
number of data points to work well. That is not
to say it can’t be applied with a small number of
data points; in such circumstances, a company
would need to apply another technique. For
example, when using Pareto for root causes of
errors for customer service misses, only three
errors in a week may occur, which is too small
a number to get any meaningful pattern. If,
however, numbers are accumulated week to
week, developing a rolling quarterly, or even
rolling annual set of data, there would be 40 to
50 data points per quarter, or 160 to 200 for the
rolling annual data set – more than enough to
start seeing the Pareto pattern emerge.
ABC analysis in practice
To demonstrate how effective ABC analysis can
be in practice, consider the following example.
If a company was to use the volume, the
revenue and the margin/profit to classify
products, they would create a simple column
classification, as depicted in Table 3. This shows
that the product with the highest volume of
sales is actually not the most profitable.
Choosing different ‘lenses’ to view products
can be helpful in accurate classification; in this
example, it is not unusual to see changes in
classification from volume, to revenue, to profits.
Some companies will use a reference code,
such as AAC, but it is important not to make the
code so subtle that it loses its meaning.
Once decisions are made about ABC
classification, the communication of behavioural
elements can drive a huge cultural shift. If a
product isn’t making a profit for a company,
why make so much of it? However, sometimes
things are not so clear-cut. A consumer
packaging company that worked with Oliver
Wight identified through ABC analysis that
a jumbo pack of product was not making a
profit, so cut the product line. However, this
product was a special item found only at one
retailer, and this soured customer relations. By
considering the product through the ‘lens’ or
MHD SUPPLY CHAIN SOLUTIONS — MARCH / APRIL 2016
SUPPLY CHAIN 49
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