What is ABC Analysis? How is it used in Inventory Management with AI

One of the predominant  techniques helping managers to optimize the inventory levels is ABC Analysis. The following article will run through a detailed discussion on its definition, the categories, the calculation methodology, and the benefits. 

ABC Analysis, also referred to as ABC Classification, is an integral part of material management in which inventory is categorized primarily into three distinct categories based on the revenue generation and significance. ABC inventory helps business entrepreneurs and stock owners identify the essential products in the stock and prioritize their management based on the value. The inventory analysis is based on the Pareto Principle. 

The Pareto Principle is a popular economic theory, discovered by renowned Italian economist Vilfredo Pareto. Pareto believed that optimum economic growth occurs only due to a small part of the economy. It means that the relation between the input and output is always unequal. 

Pareto Principle states that 80% of the sales volume gets generated from the top 20% of the items. It says that in any group, there are significant few and insignificant many. It is also known as the 80/20 rule.

ABC Analysis is based on the theory that all inventory items cannot have similar or equal value. Hence, the three categories include-

If one implements the Pareto Principle to ABC Analysis, then A consists of 20% of the total products with almost 80% revenue generation. Hence, it demands a robust and consistent control. B regulates approximately 30% of the goods with 15% revenue, while C has the lion's share controlling almost 50% of the stock but only powering 5% of the total revenue. Hence the stock managers are quite lenient while calculating this category of inventory. 

ABC Analysis Graph 

The two pyramids represent the ABC Analysis Graph.

   

The first pyramid suggests the percentage of the total number of inventory items. Here Category A comprises only 10% of products, B contains 20% items, and C has the maximum number with 70% of products.

Similarly, if one perceives the second pyramid representing the percentage of average inventory value, the structure reverses. Here, A gains the spotlight with almost 70% of inventory value and revenue generation, while B retains its mid-level spot controlling 20% of inventory value. C only generates 10% of revenue; hence it has limited control. 

In short, A signifies most important, B indicates moderately necessary, and C denotes least essential inventory goods. 

ABC calculation has been further illustrated through an example containing a few tables. 

One can take the example of a Furniture Store.

Step 1: Multiply the total number of items by the cost of each unit to find the annual usage value. 

Step 2: After noting all the products of the inventory, it’s time to list them in descending order based on annual consumption value.

Step 3: Sum up and add the total number of units sold and the annual consumption value. 

Step 4: Find out the cumulative percentage of products sold along with the percentage of annual consumption value. 

Step 5: In the last step, split the data and numbers into the three A, B, and C categories. Remember, it’s essential to set the data in the ratio of 80:15:5. 

The table shows that items listed in Category A generate approximately  79% of annual consumption value, B yields 13%, while C generates 8% revenue.

How is ABC Analysis Calculated with AI Integration?

While the traditional ABC analysis techniques used static, Excel-based methods, modern ABC analysis is powered by AI integration that makes the overall process more dynamic, smooth, and predictive. Businesses can calculate ABC analysis with AI integration in the following manner;

• First, AI-powered tools can automatically gather the required inventory data from different sources, including ERP, WMS, CRM, etc.
• Then AI cleans and standardizes the data by removing duplicates, managing missing values, and identifying other anomalies.
• Once the data is cleansed, AI algorithms can dynamically classify it based on multiple factors, such as demand, revenue, supplier reliability, etc.
• AI can also constantly re-evaluates inventory data to move the items between A, B, and C categories as per market trends, customer demand, and seasonality. 
• Additionally, AI can predict future demand by analyzing multiple parameters instead of relying only on past consumption.
• Once the analysis is done, multi-criteria ABC classification is displayed on AI-powered dashboards, allowing inventory managers to gain instant insights.

It’s essential to highlight the pivotal features of all the three categories viz—A, B, and C on a separate note. Have a look at the image below. 

Many organizations have massive Stock Keeping Units or SKUs, but it hasn't helped them to flourish and upscale their business. Furthermore, there are various other inventory management challenges that a business entrepreneur has to tackle. It may include inadequate knowledge about the stock, inefficient management process,  finding problems in managing people and space, and more.

AI-powered inventory classification is a viable solution that can help enterprises streamline their inventory management process. As the name suggests, AI-powered inventory categorization is a method that uses advanced Artificial Intelligence and Machine learning algorithms to strategically set the price of various products based on their demand value. The integration of AI in the ABC method of inventory is a classification technique that helps stock managers seamlessly resolve all concerns related to maintaining, categorizing, and managing inventory and maximize the inventory value of the goods. 

1. Predictively Analyze the Customer Demand for a Particular Product Category

Every product must pass through four main stages; launch, growth, maturity, and then declination. When a product gains optimum value, it inevitably sinks at a certain point in time. It is known as the lifespan of a product. 

It is essential to note that the lifespan of a product depends on the customer demands. It is here that AI-powered ABC inventory classification gains the spotlight as it helps business enterprises in precisely analyzing customer demands and rethink inventory control. AI helps business owners and inventory managers  analyze the consumer needs of a specific product and manage their inventory accordingly. If the market for an item escalates, the downfall period gets pushed further. Additionally, AI can also analyze seasonal patterns, past sales, external market data, etc., to anticipate potential shifts and accordingly optimize the stock levels.

2. Streamlining  and Optimizing the Inventory Process

One of the significant Unique Selling Points or USPs of AI-powered ABC Analysis is that it can automate goods classification for streamlining and optimizing the inventory management process. AI-powered ABC analysis tools can constantly track and analyze customer behavior, generated revenue, demand variables, sold goods, etc., to dynamically update the items in real time. Through this, inventory managers can continuously organize and segregate stock based on their annual consumption value,revenue generation, and customer demands. 

3. Conducive Negotiation with the Supplier

AI ABC Analysis is also useful in getting a conducive negotiation with the supplier. For example, if an enterprise is negotiating with the suppliers of A category products, it has to make a maximum investment there since it offers maximal revenue. Even if the business is making a lucrative offer, there are chances that the supplier is still unwilling to strike the deal. 

In such a scenario, AI can help inventory managers analyze the supplier performance history, lead times, delivery reliability, pricing trends, etc. Inventory managers can use this data to conduct negotiation scenarios to seal the deal. AI can also analyze and suggest other benefits such as lowering the down payment, extending the credit, and providing free shipping. It helps to create a favorable win-win situation for both parties. It also allows businesses to save more on A category products and reap more profits. 

4. Strategic Pricing of the Products 

AI-powered ABC inventory analysis also allows organizations to set the price of various products strategically and dynamically. AI models can monitor market trends, demand spikes, competitor pricing, etc., in real time and allow inventory managers to strategically adjust the prices for different items. It enhances the inventory value of the products. Once the cost of the products is set strategically, it becomes relatively easier to align them based on different categories. If the demand for the product increases, the seller can automatically hike the price. 

5. Enhancement in Customer Service Levels

Proper stocks ensure customer satisfaction and optimal customer service. But, if the item constantly stays out of stock, then it can impact the customer’s trust and loyalty. AI-powered ABC analysis offers a great solution to this problem. It allows the warehouse managers to stock the products based on their value and importance. It means that they do not need to overstock any such items that are not sold regularly and have a low margin and can ensure availability of items that are of great demand.  Through AI, inventory managers can prioritize stocking of high value items for high-value markets and for low demand markets, stock levels can be adjusted downward.

6. The Intelligent Allocation of the Resources

In traditional ABC analysis, inventory managers gave higher preferences to A category products and less to B and C category products. This often leads to certain issues in cases when demand patterns shift unexpectedly. AI-powered ABC analysis  can eliminate such issues by constantly monitoring the sales and profit margins. AI can determine which items need more focus and which items need less focus at any given time. For instance, if A items loses its popularity, AI tools can shift it in place of B or C category, preventing resource wastage. If B shows sudden signs of growth, then AI can place in the A category, allocating additional resources to support the surge.

A business organization can conduct a precise ABC Analysis by ensuring the following steps-

• Find out what needs to be analyzed and anticipate the success ratio

When a business conducts an ABC Classification, it has two prime objectives. First, to ensure that supply costs are highly competitive and second to boost the cash flow by storing high demanding products in the stock. 

• Gathering Data for Analyzing 

If the company uses an inventory management system or accounting software, it can easily collect vital data related to various stock items. Plus, it can also gather information on its annual expenditure, orders and purchases, transportation costs, and more.

• Rank the Inventory in Descending Order

Next, it's essential to classify or organize the inventory in the descending order. Place the maximal-priced product on the top and the minimal-priced item at the bottom. Even during cycle counting - a process where high inventory accuracy can be maintained throughout the year can be done using the ABC method.

• Calculating the Cumulative Impact

Now make a note of all the products and add them in a spreadsheet. It's time to calculate their cumulative effect on the business. The products are divided into two columns; the total number of products sold and their annual costs. Take out the cumulative percentage of annual usage value to categorize the inventory. 

• Classify the Inventory Based on the Demand

It is at this stage that one needs to apply the Pareto Principle. It's not necessary to use the 80/20 rule, but it's essential to take a few pivotal measures. The steps include conducive negotiation with the suppliers, framing a product price strategy, ensuring the optimal value of the products, and more. 

• Monitor the Categories and Allocate the Products Accordingly

It is the last step where managers have to keenly analyze the categories and then allocate the products based on revenue generation. It means that an item minting the highest money will peak the class. But it contains only a few product sources. On the other hand, the ones providing lower returns will drop down the list.  Besides that, the managers need to continuously keep an eye on pricing, customer demand, and product performance. 

The Manufacturing Sector

ABC  Inventory Analysis helps manufacturers to improve the inventory replenishment schedule. It allows managers to categorize stock items based on the total annual cost. Also, ABC Analysis becomes mandatory if the organization plans to integrate the Kaban to manage the workflows. 

Supply Chain and Warehouse

The supply chain and warehouses use ABC Inventory Classification mainly for the stock count cycles. For instance, items placed in category A have to be counted quarterly. B class items need a bi-annual counting. On the other hand, C category products get the most liberty. They are calculated on an annual basis, once in a year. 

Retail and E-commerce

The retail and the e-commerce industry usually choose ABC Management for customer segmentation. It helps retailers and e-commerce owners to pinpoint their most valuable customers. ABC Analysis is performed using key metrics such as sales revenue, buying potential, and contribution margin. The retailers can create a chart based on the metrics and then rank their customers in A, B, and C categories accordingly. 

Logistics Industry

The logistics industry is also reaping the benefits of ABC Analysis. Here ABC management plays a pivotal role in controlling the inventory. The products are classified according to their importance based on different criteria such as sales ratio, profit margin, cost of transportation, etc.  

Healthcare Industry

In the healthcare industry, ABC analysis could help healthcare professionals efficiently manage inventory supplies and classify the medicines as per their significance and value. From life savings and chronic diseases drugs, OTC products, and surgical equipment to gloves and cotton, hospitals, pharmacies, and medical supply chains can use ABC analysis to efficiently handle thousands of medical supplies with varying costs and criticality. 

Automotive Industry

At present, the automotive industry is experiencing increased complexities in the supply chain. These complexities can be optimally managed through ABC analysis. ABC analysis helps automotive businesses, such as dealers and suppliers, in prioritizing the stocking of critical components and automating the replenishment of consumables. 

ABC Analysis in AI Era

At present, AI is one of the few technologies that can completely redefine the ABC analysis. Through AI-powered ABC analysis,  businesses get the flexibility to automate the inventory classification, predict and forecast inventory demand, optimize stock levels, and exponentially save inventory management costs. Multi-factor analysis, predictive insights, automated inventory decisions, ML techniques, etc., are a few features of AI-powered ABC analysis that businesses can use to continuously update and classify the inventory as per real-time data. AI-powered inventory tools also support integration with ERP and WMS systems that can automatically adjust ABC categories, trigger reordering, recommend optimal procurement cycles, and track real-time stock movements.

The business enterprises today are operating more in a data-driven era powered by digital transformation.In such a scenario, inventory management has already upscaled and potentially escalated; all thanks to the best free and open source inventory management software. Additionally,  innovative and modern technologies are also playing a dominant role in modernizing and upgrading the ABC method of inventory management.

It is interesting to note that futuristic trends such as Big Data, the Internet of Things, and AI could help inventory managers in automatically replenishing data. For instance, the ABC Inventory System powered by AI  comes with multiple criteria to create a more holistic classification.

Future driving trends will help managers to make a more accurate and complete inventory analysis with data transparency. Furthermore, it will also allow them to save a  lot of their valuable time and labor costs.  

Also, it is interesting to note that ABC Analysis is no more restricted to inventory management and supply chain business. Even large service sector organizations such as healthcare firms and retail banks have started to use ABC Analysis successfully. It is expected that more industries will join the party within the next few years. 

ABC Classification indeed offers a plethora of benefits, but it has a few limitations as well. It consumes much of the valuable time and effort as all inventory items have to be divided into three categories based on its value. Also, the ABC inventory systemis based on the monetary value of the products and ignores all other factors. 

One of the best ways to resolve all these issues is to implement an inventory optimization software that can automate and streamline the entire process. 

Conclusion 

ABC Analysis is one of the best ways business entrepreneurs and inventory managers can classify their stocks based on their value and revenue generation. The ABC method of inventory allows them to focus on essential products and monitor their pricing. It also helps businesses keep the inventory under control, and plan their expenditures accordingly. 

Also, if you are interested in investing in viable and futuristic inventory management software, then please go through the inventory management software buyer’s guide, where you will find a comprehensive overview of the software, including its vital features and advantages.