How to Perform ABC Analysis: Step-by-Step Guide and Examples

Performing ABC Analysis is straightforward and especially well suited for beginners who want a practical tool to optimize inventory control. The method transforms raw demand and cost data into clear categories and action plans. Below is a step-by-step guide, simple calculations, and realistic examples to help you implement ABC Analysis in a warehouse or distribution setting.

Step 1: Prepare your data

• Choose a review period (commonly the most recent 12 months).
• Collect for each SKU: annual demand (units), unit cost (or unit value), and any other attributes you want to consider (e.g., lead time, criticality).
• Ensure data quality: check for outliers, discontinued items, and correct currency and units.

Step 2: Calculate annual consumption value

For each SKU, compute: annual consumption value = annual demand × unit cost. This creates a monetary measure of each item's contribution to total inventory value.

Example: SKU A sells 1,000 units/year at $50 each. Annual consumption value = 1,000 × $50 = $50,000.

Step 3: Rank items and compute cumulative shares

• Sort SKUs in descending order by annual consumption value.
• Compute each SKU's percentage of total value and running cumulative percentage.

Step 4: Define A/B/C thresholds

Common thresholds (adjust to context):

• A: top 70–80% of total value (usually 5–20% of SKUs)
• B: next 15–25% of value (usually 10–25% of SKUs)
• C: remaining 5–10% of value (often 60–80% of SKUs)

Use your cumulative percentages to place each SKU into A, B, or C categories.

Step 5: Design class-specific policies

• A items: Weekly or even daily review, tight safety stock, higher forecast accuracy, smaller order quantities but more frequent orders, priority picking and storage near dispatch points.
• B items: Biweekly or monthly reviews, moderate safety stock, batch ordering to balance cost and service.
• C items: Simplified controls—quarterly reviews, larger order quantities, or vendor-managed inventory; store in lower-cost locations.

Step 6: Monitor and refine

• Re-run the analysis periodically (quarterly or annually) because demand patterns, prices, and product mixes change.
• Track key performance indicators: service levels, stockouts, inventory days of supply, and carrying costs by class.

Worked example (short):

Imagine a small parts supplier with five SKUs. After computing annual consumption values and sorting, SKUs 1 and 2 account for 78% of the total value — they become A items. SKU 3 contributes 15% and becomes B. SKUs 4 and 5 combine for the remaining 7% and become C. The team decides to review A items weekly with tighter reorder points, B items monthly, and C items every quarter. Within six months they report fewer stockouts on A items and a reduction in overall inventory investment.

Advanced tips and variations

• Multi-criteria ABC: Combine value with other dimensions (lead time variability, criticality, or scarcity) by scoring items across criteria and using a weighted index for classification.
• Dynamic ABC: Automate monthly recalculation if you have a fast-moving assortment or seasonal demand.
• Fast-moving exceptions: For items with low value but very high movement (many transactions), consider separate handling rules to reduce handling costs.

Common beginner pitfalls to avoid

• Using too short a dataset — seasonal effects can distort short windows.
• Relying solely on unit cost when landed cost or margin matters more for decision-making.
• Neglecting to operationalize the categories — classification is only useful when it leads to tailored policies.

In practice, ABC Analysis is a practical first step for inventory control. It helps small teams make smarter, evidence-based choices without heavy software investment. Once comfortable with the basics, you can layer in more advanced metrics or automate the process through a warehouse management system (WMS) or inventory tool.

Remember: the real value of ABC Analysis is not the labels themselves but the focused management actions they enable. Start simple, measure impact, and adjust thresholds and policies as your business learns.