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?
Low Low High Spend: « C » segments How significant is the spend? « A » segments ABC analysis
© EIPM 2004 – Toolbox – ABC Analysis
Risk must be discussed with the stakeholders. 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. Different categories will have different “risk” criteria. For examples: production items may be classified by “lead time”. The longer the lead-time the “riskier” the segment is. Other criteria for risk may be customer sensitivity to the segment, safety issues, etc…
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, with an example. 1st step – Identify the objective and the analysis criterion In this step, the objective is clearly understood. In the proposed example below, we are responsible for buying security material for a plant. Our objective is to generate savings on the price of the different equipments, by renegotiating existing contracts. We would like to know which equipment segment should be considered for renegotiation efforts and resources, so that the maximum savings are generated. Therefore, we choose to undertake an ABC analysis of the purchasing category,...