Optimize your inventory management with the ABC Method

The inventory management method known as ABC is one of the most widely used methods when it comes to controlling your inventory. Do you want to know how to apply it to your eCommerce? We will tell you all about it!

What is the ABC method?

The ABC method in inventory management is an inventory management technique used for inventory based on the classification of items according to their importance. The items are divided in categories: A, B and C, depending on the value each category has to the total number of sales:

Category A: refers to items that represent 20% of the total value of inventory. They are the most important and therefore, the ones that need more control. The value of this category represents 80% of the total value of the whole inventory.
Category B: refers to items that represent 30% of the total value of inventory. They are less important than items from category A and consequently, they require less strict control.
Category C: refers to items that represent 50% of the total value of the inventory. They are the least important ones and therefore, they require the least amount of control compared to all the other categories.

When it was created, the method ABC was based on the Pareto Principle, also known as the 80-20 rule. In essence, this model describes the statistical phenomenon in which, in any population with a common effect, it is a small proportion that contributes to most of the common goal. When the 80-20 rule is applied to business reality, it is 20% of all the products that would generate 80% of the benefits.

Category A products

Items belonging to category A are the most relevant for the company, which generally translates into those goods with the highest value and those that are sold most frequently.

These items are the most important ones because they entailed the biggest part of the inventory movements, they have the most rotation and they also contribute the most to the generation of revenues for the company. They are around 20% of the total inventory, but they suppose approximately 80% of total revenues.

This is the priority category, and the one to which the company should devote most resources, carrying out more exhaustive and complex stock controls on a regular and frequent basis. In general, these products should be located in an easily accessible area and close to the dispatch area of the warehouse. The aim is to speed up the order preparation process as much as possible.

Category B products

Category B products are of moderate importance to the company, as they also contribute to revenue generation, although to a much lesser extent than category A products. They account for around 30% of the total products in the warehouse, and generally do not generate more than 20% of the company's revenue.

It is an intermediate category, and therefore, it also requires some supervision and monitoring on a regular basis, especially if any of the items in this part of the warehouse are likely to be upgraded to category A.

Its location in the warehouse should be accessible and direct areas that are available after organizing and saving the best spots for items of category A. They are stored at intermediate levels in which the access is fast but not always direct to the loading units.

Category C products

The last category within the ABC method consists of category C products. These are the most numerous goods, but at the same time the least important, especially in terms of their contribution to the company's revenue. In general, they can account for more than 50% of the product references, but they do not generate even 5% of the company's total revenue.

Their stock rotation is very low and, therefore, it is not necessary to allocate too many resources to their management. In addition, their location in the warehouse should be as remote as possible, away from the dispatch areas and they should not interrupt the passage to the areas destined for category A and B products.

In general, for category C products, it is not usually worth allocating resources to their storage and stock, since the costs derived from their storage may be higher than the profitability obtained from their commercialisation.

Cómo clasificar los productos de acuerdo al método ABC

There are different methods for classifying items in a warehouse according to the ABC method. Each company does it as it sees fit, depending on the characteristics of the demand and the products marketed. But the general convention is to classify products by the following methods:

Unit cost, depending on the level of investment in inventory for each of the goods in the warehouse. The higher the cost of an item, the more important it is and therefore the more attention is paid to it in inventory management. The most expensive items are those that would form category A, while the items with the lowest unit cost would be those categorised as C.
Total value in inventory: unlike the previous method, this method takes into account the total value of all items of the same lot or with the same characteristics in inventory. The main disadvantage of this method is that the ABC classification changes continuously, which makes a continuous recalculation necessary to avoid the system becoming out of phase.
By use and value: This is the most widespread method of the ABC method. The basic criterion of this system is the demand and value of the traded goods. It goes beyond the previous ones, as it takes the sales of the products as relevant, even when the value of the goods is not the highest.

In reality, there are as many methods for ABC categorisation as there are business needs, and demand is not the only thing to consider. The important thing is to choose the categorisation that best fits reality, including other metrics such as the profit margin of each product or the impact of stock-outs on inventory.