ABC

Analysis, Pareto
Analysis, 80:20 Rule,
Law of vital few

All three refer to categorization of various items, products & services into three
groups depending upon their importance & significance so that their handling is
done accordingly.

ABC ANALYSIS (Always Better Control)

Category A represents the most
valuable products or customers.
These are the products that
contribute heavily to the overall
profit without eating up too
much of the resources. This
category will be the smallest
category in quantity but largest
in monetary terms.

These are “critical few” items at which management must have max attention.
Category B represents your middle of the road customers or products. They are
larger in number than category A but smaller in monetary term. The members of
this category can, with some encouragement, be developed into category A
items.


Category C is all about the hundreds of tiny transactions that are essential for
profit but don’t individually contribute much value to the company. This is the
category where most of your products or customers belong. It is also the category
where you must try to automate sales as much as possible to drive down
overhead costs. These are “trivial many” items which don’t catch much strict
management attention.
ABC Analysis of Inventory
ABC analysis is very useful
to categorize the inventory
into different items as per
their importance or
significance. Category “A”
items are lesser in number
but have very high value &
hence strict inventory
control is required for

them.
These must be insured items. Proper data must be maintained for them & no
shortage is permitted for them.

Inventory management policies

Each item should receive a weighed treatment corresponding to its class:

• A-items should have tight inventory control, more secured storage areas
and better sales forecasts. Reorders should be frequent, with weekly or
even daily reorder. Avoiding stock-outs on A-items is a priority.
• Reordering C-items is made less frequently. A typically inventory policy for
C-items consist of having only 1 unit on hand, and of reordering only when


an actual purchase is made. This approach leads to stock-out situation

after each purchase which can be an acceptable situation, as the C-items
present both low demand and higher risk of excessive inventory costs.
• B-items benefit from an intermediate status between A and C. B items are
treated more like A than C, these are assumed to be potential A items.

THE PARETO PRINCIPLE

ABC analysis is based on what is called the Pareto

Principle, an economic principle created by the
economist Vilfredo Pareto. Pareto gained
notoriety for saying that most economic
productivity comes from only a small part of the
economy.
Essentially, it shows that there is an unequal relationship between your input and
your output. It is drawn as a cumulative diagram from ABC diagram.

For example, a business might get 80% of its results from only 20% of its staff.
This demonstrates that 20% of the staff is more productive than the other 80% of
the team.


Law of Vital Few, 80:20 Rule

• 80% of effects comes from 20% of causes
• Also called Pareto principle
• 80% profit comes from 20% customers

Basically, only 20% of your customers
are valuable enough that losing one
would significantly hurt the business.
Pareto Principle becomes the
foundation of ABC analysis by providing
guidelines for breaking down customers
into different groups (A, B and C).

Another common example of
the Pareto Principle suggests
that you get 80% of your
sales from only 20% of your
customers. In this case, these
20% would be your category
A customers, hence, those
who make the biggest
contribution to your revenue.

WHY USE ABC ANALYSIS?

ABC analysis helps to deal with large and complex data sets by breaking them
down into three segments. These segments define the priority of the data. Once
the data is broken down into segments, it is easier to focus on the data and use it
in a meaningful way. Breaking down the data into these segments makes specific
issues in the data more obvious. It also helps in prioritizing the different
segments.


For example, ABC analysis can be used to segment your customers and break
down customer-specific data. First, you would divide the customers into each of
the three categories based on the sales volume the customer provides. Then, you
would consider how that volume relates to your margin contribution.
If you segment the customers successfully, the customers with the most value will
go into the high priority category A, while less important customers would be
placed in the bottom category C. Customers that are somewhere in between will
stay in category B.
The segmentation allows you to pinpoint your most valuable customers. It then
allows you to examine them separately so that you can form a plan of action.
When you can look at things in three different categories, it is easier to allocate
your resources in a more strategic way. The benefit of taking this extra step is that
it makes it easier to analyze the data strategically which in turn makes it easier to
maximize your profits.

CONCLUSION
ABC analysis is a great way to transform your data into well interpreted segments
that you can use to reduce overhead costs and drive profits. Do not force data
into the 80/20 rule but to use is as a guideline for determining who your most
valuable customers are and what you can do to get more of them.











Qn ABC analysis in materials management is a method of classifying the
inventories based on the (ESE 2018)
a)Economic Order Quantity
b)Value of annual usage of items
c)Volume of material consumption
d)Quantity of material used

Ans b) A items are high value low volume items




Qn Which of the following may NOT be the management policy for inventory
control of A type of items as per ABC analysis

a) Strict management control is required

b) No stock out situation must be created
c) Frequent Reorder should be avoided
d) Sales forecasting should be precise

Ans c) Frequent reorder ensures that stock out situation does not arise & at the
same time not much quantity is ordered at a time since items are costly.

Qn Which of the following is NOT true, as per 80:20 Rule

a) 80% of the problems in an organization are due to 20 % of the employees

b) 80% of profit in an organization is due to 20% of the customers
c) 80% of the output in an organization is due to 20 % of employees
d) 80% of the salary of organization goes to 20% of the employees

Ans d) 80:20 rule is vital few rule & relates the input & output of the organization.

Qn ABC stands for

a) Annual Balance Chart

b) Always Before Customer
c) Awareness Brings Control
d) Always Better Control

Ans d) ABC is methodology to categorize items in items of their significance

Qn Statement I Pareto analysis is related to ABC analysis

Statement II ABC analysis is principle behind 80:20 rule of the vital few
a) Both statements I & II are individually true & statement II is correct
explanation of statement I
b) Both statements I & II are individually true & statement II is NOT the correct
explanation of statement I
c) Statement I is true but statement II is false
d) Statement I is false but statement II is correct

Ans c) 80:20 rule or rule of vital few is the Pareto principle which is principle
behind the ABC analysis

Qn Statement I ABC analysis categorize the data into three segments

Statement II Such categorization helps prioritize the segments & make
management of such segments more scientific & better
a) Both statements I & II are individually true & statement II is correct
explanation of statement I
b) Both statements I & II are individually true & statement II is NOT the correct
explanation of statement I
c) Statement I is true but statement II is false
d) Statement I is false but statement II is correct

Ans a) The reason for categorization of entire data into ABC items is to prioritize
the items as per their worth & value

Qn Statement I Pareto principle is guiding principle for ABC analysis

Statement II It was born as an important management principle
a) Both statements I & II are individually true & statement II is correct
explanation of statement I
b) Both statements I & II are individually true & statement II is NOT the correct
explanation of statement I
c) Statement I is true but statement II is false
d) Statement I is false but statement II is correct

Ans c) ABC analysis is based on what is called the Pareto Principle, an economic
principle created by the economist Vilfredo Pareto. As per this, most economic
productivity comes from only a small part of the economy.

Qn Consider the following statements related to ABC analysis

1. Items A are the most critical & require very strict managerial control
2. Items C are the trivial few, lesser in number & are not much focused
3. All items are important for the profit of the organization

Which of the above are correct statements?



a) 1 & 2 only
b) 2 & 3 only
c) 1 & 3 only
d) 1, 2 & 3

Ans c) Item C are maximum in number & are not few though these are trivial &
not as important as item A