The ABC Analysis

What is it?
ABC analysis, Pareto’s law or “80/20 rule” are all-synonymous of the same tool which basically states that 20% of a given population represents 80% of a specific characteristic. In purchasing, the basic ABC analysis is used to identify which segments represent most of the spend in a given category or portfolio. Most of the time, few segments in a portfolio constitute the largest part of the total spend. Usually, - The A segments represent approximately 80% of the total spend within a category - The B segments represent the following 15% of the total spend within a category - The C segments are the remaining (most of the time several segments) which represents the final 5% of the total spend The ABC approach can also be used in other analyses such as: Spend per supplier in a portfolio: few suppliers will represent most of the spend Number of orders per supplier: few suppliers will have most of the orders in a portfolio Number of items bought per supplier: few suppliers will deliver most of the articles in a portfolio

When and why to use it?
The ABC analysis can be also be useful in several steps of the Sourcing Value Chan: ! Demand Identification, to gather the annual spend of a site ! Demand Aggregation, to gather the annual spend of several sites ! Opportunity Assessment, to identify leveraging opportunities The ABC tool is used to identify the “vital few” from the “trivial many”, according to a defined set of criteria (e.g. annual expenditure, number of orders, number of claims, occupied space in the inventory, etc.). Different decisions may be taken from the result of the ABC analysis. The basic utilization of the ABC analysis for a buyer is to use it with the spend as a criterion. It helps the buyer to identify the few A segments which will require special attention due to the “large amount of money” they represent. A small “mistake” in managing the few A segments may cost a lot to your company. The C segments will require a different approach to simplify the administrative burden to handle them. Special attention must be given to some C segments which may represent high risk for the business! This is one of the limits of the ABC analysis on spend!
High

RISK: How critical is the segment? What are the consequences internally if something goes wrong with the product or service?

1st Priority

Minimize Attention
Low Low High Spend: « C » segments How significant is the spend? « A » segments ABC analysis

© EIPM 2004 – Toolbox – ABC Analysis

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1st step – Identify the objective and the analysis criterion In this step. We would like to know which equipment segment should be considered for renegotiation efforts and resources. Different categories will have different “risk” criteria.00 € Thermal underwear 300.00 € Eye wash stations 19 300.00 € Fall arrest equipment 6 600.00 € Total 1 473 670. For examples: production items may be classified by “lead time”.Risk must be discussed with the stakeholders.00 € Safety reflective tape 2 600.00 € Welding protection clothes 2 700.00 € Apparel shirts.00 € First aid kits 9 150. by renegotiating existing contracts. collect the data necessary to carry out the analysis: The list of the different safety equipments.00 € Safety beacons 11 180. Other criteria for risk may be customer sensitivity to the segment.00 € Safety gloves 35 400. In the proposed example below.00 € In this step. we choose to undertake an ABC analysis of the purchasing category. classified by annual spend.00 € Safety signs 7 750. 2nd step – Collect data about the analyzed population Category : safety equipment Description Annual spend Hard hats 27 900. Therefore.00 € Safety glasses 49 200. jackets 120 600. respirators 19 700. we are responsible for buying security material for a plant.00 € Fire extinguishers 16 100. and the corresponding annual spend.00 € Monitoring systems 367 000. The longer the lead-time the “riskier” the segment is. with an example. the objective is clearly understood.00 € Safety boots 122 500. safety issues.00 € Masks.00 € Ear plugs 4 600. etc… Tool Description The following 6-step’s are used to perform an ABC analysis: 1st step – Identify the objective and the analysis criterion 2nd step –Collect data about the analyzed population 3rd step – Sort out the list by decreasing impact 4th step – Calculate the accumulated impact and the percentage 5th step – Identify the classes 6th step – Analyze the classes and take appropriate decisions This approach is detailed below. so that the maximum savings are generated.00 € Floor marking paint 1 090.00 € Coveralls 650 000. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 © EIPM 2004 – Toolbox – ABC Analysis 2 . They will define with the buyer which of the C segments may be “risky” for the business and will require special attention from the buyer. Our objective is to generate savings on the price of the different equipments.

the coverall and monitoring systems make together 1017 k€.26% 98.00 € 49 200.11% of the total spend.73% 99.32% of the total spend. Coverall + monitoring systems + safety boots make 1139 k€.00 € Fire extinguishers 16 100. sort out the list of equipment.64% 98.00% 15 12 2 16 3 6 1 5 7 9 11 8 13 19 4 14 17 18 10 © EIPM 2004 – Toolbox – ABC Analysis 3 .00 € Safety glasses 35 400.00 € Total 1 473 670.79% 96.00 € Thermal underwear 300.00 € Safety beacons 11 180.11% 69. which is 69.00 € Apparel shirts.00 € Fire extinguishers 16 100. accumulate the annual expense and calculate the percentage of the accumulated spend compared to the total.00 € Fall arrest equipment 6 600.00 € + Safety gloves 1 344 700.00 € Ear plugs 4 600. according to our criterion of analysis.25% 93.00 € Safety reflective tape 2 600.00 € 300.00 € / Welding protection clothes 2 700.00 € Masks.00 € Safety signs 7 750.00 € Hard hats 1 372 600.00 € Eye wash stations 19 300. which is 77.00 € 6 600.00 € Safety gloves 35 400. jackets 120 600.00 € Welding protection clothes 2 700.00 € Safety glasses 49 200.00 € Fall arrest equipment 1 462 380.01% 77.00 € 9 150.00 € Monitoring systems 367 000.00 € Safety beacons 11 180. respirators 19 700. i.00 € 1 472 280.00 € Safety boots 122 500.00 € 1 427 700.00 € Monitoring systems 367 000.85% 91.00 € Floor marking paint 1 090.00 € 1 017 000.00 € Eye wash stations 19 300.00 € 1 469 680.00 € 1 473 370. respirators 19 700. Example: the coverall category alone makes 650 k€.91% 99.01% of the total expense. jackets 120 600.23% 99.00 € 1 438 880.00 € Safety boots 122 500.00 € Percentage 44.79% 99.00 € Masks.98% 100. Etc.00 € 1 309 300.00 € 7 750.00 € Safety reflective tape 2 600.48% 95. in decreasing order. which is 44.00 € Ear plugs 4 600.55% 99.00 € First aid kits 9 150.00 € Safety signs 1 455 780.14% 94.00 € 1 392 300.3rd step – Sort out the list by decreasing impact Category : safety equipment Description Annual spend Coveralls 650 000.51% 88.00 € Floor marking paint 1 090.00 € 1 466 980. annual spend.00 € First aid kits 1 448 030. 15 12 2 16 3 6 1 5 7 9 11 8 13 19 4 14 17 18 10 4th step – Calculate the accumulated impact and the percentage In this step.32% 85.00 € 650 000.88% 97. Category : safety equipment Description Annual spend Cumulative Coveralls 650 000.00 € 1 260 100.e.00 € In this step.00 € Thermal underwear 1 473 670.00 € Apparel shirts.00 € Hard hats 27 900.00 € 1 411 600.00 € Total 1 473 670.00 € 1 139 500.00 € 27 900.

14% 94.00 € Ear plugs 4 600.26% 98. Keep in mind that the aim of the game is not to go for precise 20%-80%.00 € 1 344 700. If there are several.00 € 15 12 2 16 3 6 1 5 7 9 11 8 13 19 4 14 17 18 10 Percentage 44.00 € Safety gloves 35 400. jackets 120 600.85% 91.00 € First aid kits 9 150.79% 96. As it was already stated.00 € 1 472 280.00 € 1 469 680.00 € 1 017 000. respirators 19 700.73% 99.00 € Hard hats 27 900.11% 69.25% 93.00 € Safety reflective tape 2 600.00 € 1 372 600.00 € Apparel shirts.55% 99.00 € Thermal underwear 300. it does not mean that the class C segments are not important: They are not important regarding negotiation levers.00 € 1 466 980.00 € 1 448 030.00 € 1 309 300.88% 97.00 € Fire extinguishers 16 100.00 € 650 000.00 € Monitoring systems 367 000.91% 99.00 € Safety boots 122 500.48% 95.00 € 1 260 100.00 € 1 139 500.00 € 1 455 780. and the potential savings would probably not be worth the necessary efforts. but rather to understand which segments to focus efforts to get the results that are expected in the example by renegotiating prices.00 € 1 473 670. do a final analysis to determine next steps.00 € Floor marking paint 1 090.5th step – Identify the buy classes In this step.23% 99. Category : safety equipment Description Annual spend Cumulative Coveralls 650 000.51% 88.00 € Eye wash stations 19 300.00 € 1 438 880.00 € 1 392 300.00 € Masks.00 € 1 427 700.00 € Safety beacons 11 180.00 € Total 1 473 670. since the spend is very low.00 € 1 462 380.32% 85.64% 98. separate the categories into three different classes.01% 77.00 € 1 411 600.00 € Welding protection clothes 2 700.79% 99.00% A segments B segments C segments 6th step – Analyze the classes and make appropriate decisions In this final step.00 € Safety glasses 49 200. © EIPM 2004 – Toolbox – ABC Analysis 4 . what do we gain by consolidating the volume on one supplier? • Should an on-line negotiation be considered? Note: the ABC analysis does not provide a direct solution: it is used to point out the “few important areas” to explore for further leveraging opportunities.00 € 1 473 370.00 € Fall arrest equipment 6 600.00 € Safety signs 7 750. The decisions out of this analysis could be: • To investigate how many suppliers offer coveralls (and monitoring systems and safety boots).98% 100.

a conversion of data using product standard codes is mandatory. to use “future annual spend” provided by the internal customers or “budgeted” figures.Required Resources An ABC analysis requires directionally correct data.. is not coded in a homogeneous way. it would be better. Tool Limitations / Common Pitfalls Most of the time only past annual spend is available to perform an ABC analysis. countries. whenever available. or worse. The buyer may consider that next year figures will be the same as the last year’s one. Attached tools See the Presentation for ABC Analysis (a summary of the tool for a group presentation) See the ABC Examples © EIPM 2004 – Toolbox – ABC Analysis 5 . By definition it is what was “bought” but not what will be the next year’s spend. In the case where the buyer considers that the future needs may vary from the past figures. etc. This availability of data becomes critical whenever the population on target is spread over several sites. Special attention must be given to risk issues as explained in the When and Why to use it section. The use of past annual spend is fine if the business needs will not change in the near future. Sometimes. It relies on the availability of systems allowing measurement of the criteria chosen for the analysis.