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!

RISK: High
How critical is the
1st Priority
segment?
What are the
consequences
internally if
something Minimize
goes wrong with the Attention
product or service?
Low

Low Spend: High

« C » segments How significant is the spend? « A » segments
ABC analysis

© EIPM 2004 – Toolbox – ABC Analysis 1

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…

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, 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, classified by annual spend.

2nd step – Collect data about the analyzed population

Category : safety equipment

In this step, collect the data necessary Description Annual spend
to carry out the analysis: The list of the 1 Hard hats 27 900.00 €
different safety equipments, and the 2 Safety boots 122 500.00 €
corresponding annual spend. 3 Safety glasses 49 200.00 €
4 Ear plugs 4 600.00 €
5 Masks, respirators 19 700.00 €
6 Safety gloves 35 400.00 €
7 Eye wash stations 19 300.00 €
8 First aid kits 9 150.00 €
9 Fire extinguishers 16 100.00 €
10 Thermal underwear 300.00 €
11 Safety beacons 11 180.00 €
12 Monitoring systems 367 000.00 €
13 Safety signs 7 750.00 €
14 Welding protection clothes 2 700.00 €
15 Coveralls 650 000.00 €
16 Apparel shirts, jackets 120 600.00 €
17 Safety reflective tape 2 600.00 €
18 Floor marking paint 1 090.00 €
19 Fall arrest equipment 6 600.00 €
Total 1 473 670.00 €

© EIPM 2004 – Toolbox – ABC Analysis 2

3rd step – Sort out the list by decreasing impact

Category : safety equipment

In this step, sort out the list of Description Annual spend
equipment, in decreasing order, 15 Coveralls 650 000.00 €
according to our criterion of analysis, 12 Monitoring systems 367 000.00 €
i.e. annual spend. 2 Safety boots 122 500.00 €
16 Apparel shirts, jackets 120 600.00 €
3 Safety glasses 49 200.00 €
6 Safety gloves 35 400.00 €
1 Hard hats 27 900.00 €
5 Masks, respirators 19 700.00 €
7 Eye wash stations 19 300.00 €
9 Fire extinguishers 16 100.00 €
11 Safety beacons 11 180.00 €
8 First aid kits 9 150.00 €
13 Safety signs 7 750.00 €
19 Fall arrest equipment 6 600.00 €
4 Ear plugs 4 600.00 €
14 Welding protection clothes 2 700.00 €
17 Safety reflective tape 2 600.00 €
18 Floor marking paint 1 090.00 €
10 Thermal underwear 300.00 €
Total 1 473 670.00 €

4th step – Calculate the accumulated impact and the percentage

In this step, accumulate the annual expense and calculate the percentage of the
accumulated spend compared to the total.
Example: the coverall category alone makes 650 k€, which is 44.11% of the total spend; the
coverall and monitoring systems make together 1017 k€, which is 69.01% of the total
expense. Coverall + monitoring systems + safety boots make 1139 k€, which is 77.32% of
the total spend. Etc.
Category : safety equipment
Description Annual spend Cumulative Percentage
15 Coveralls 650 000.00 € 650 000.00 € 44.11%
12 Monitoring systems 367 000.00 € 1 017 000.00 € 69.01%
2 Safety boots 122 500.00 € 1 139 500.00 € 77.32%
16 Apparel shirts, jackets 120 600.00 € 1 260 100.00 € 85.51%
3 Safety glasses 49 200.00 € 1 309 300.00 € 88.85%
6 Safety gloves 35 400.00 € + 1 344 700.00 € 91.25%
1 Hard hats 27 900.00 € 1 372 600.00 € 93.14%
5 Masks, respirators 19 700.00 € 1 392 300.00 € 94.48%
7 Eye wash stations 19 300.00 € 1 411 600.00 € 95.79%
9 Fire extinguishers 16 100.00 € 1 427 700.00 € 96.88%
11 Safety beacons 11 180.00 € 1 438 880.00 € 97.64%
8 First aid kits 9 150.00 € 1 448 030.00 € 98.26%
13 Safety signs 7 750.00 € 1 455 780.00 € 98.79%
19 Fall arrest equipment 6 600.00 € 1 462 380.00 € 99.23%
4 Ear plugs 4 600.00 € 1 466 980.00 € 99.55%
/
14 Welding protection clothes 2 700.00 € 1 469 680.00 € 99.73%
17 Safety reflective tape 2 600.00 € 1 472 280.00 € 99.91%
18 Floor marking paint 1 090.00 € 1 473 370.00 € 99.98%
10 Thermal underwear 300.00 € 1 473 670.00 € 100.00%
Total 1 473 670.00 €

© EIPM 2004 – Toolbox – ABC Analysis 3

5th step – Identify the buy classes

In this step, separate the categories into three different classes.

Keep in mind that the aim of the game is not to go for precise 20%-80%, but rather to
understand which segments to focus efforts to get the results that are expected in the
example by renegotiating prices.

Category : safety equipment

Description Annual spend Cumulative Percentage
15 Coveralls 650 000.00 € 650 000.00 € 44.11%
12 Monitoring systems 367 000.00 € 1 017 000.00 € 69.01%
A segments
2 Safety boots 122 500.00 € 1 139 500.00 € 77.32%
16 Apparel shirts, jackets 120 600.00 € 1 260 100.00 € 85.51%
3 Safety glasses 49 200.00 € 1 309 300.00 € 88.85%
6 Safety gloves 35 400.00 € 1 344 700.00 € 91.25%
1 Hard hats 27 900.00 € 1 372 600.00 € 93.14%
5 Masks, respirators 19 700.00 € 1 392 300.00 € 94.48% B segments
7 Eye wash stations 19 300.00 € 1 411 600.00 € 95.79%
9 Fire extinguishers 16 100.00 € 1 427 700.00 € 96.88%
11 Safety beacons 11 180.00 € 1 438 880.00 € 97.64%
8 First aid kits 9 150.00 € 1 448 030.00 € 98.26%
13 Safety signs 7 750.00 € 1 455 780.00 € 98.79%
19 Fall arrest equipment 6 600.00 € 1 462 380.00 € 99.23%
4 Ear plugs 4 600.00 € 1 466 980.00 € 99.55% C segments
14 Welding protection clothes 2 700.00 € 1 469 680.00 € 99.73%
17 Safety reflective tape 2 600.00 € 1 472 280.00 € 99.91%
18 Floor marking paint 1 090.00 € 1 473 370.00 € 99.98%
10 Thermal underwear 300.00 € 1 473 670.00 € 100.00%
Total 1 473 670.00 €

6th step – Analyze the classes and make appropriate decisions

In this final step, do a final analysis to determine next steps. The decisions out of this
analysis could be:
• To investigate how many suppliers offer coveralls (and monitoring systems and safety
boots). If there are several, 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.

As it was already stated, it does not mean that the class C segments are not important: They
are not important regarding negotiation levers, since the spend is very low, and the potential
savings would probably not be worth the necessary efforts.

© EIPM 2004 – Toolbox – ABC Analysis 4

Required Resources
An ABC analysis requires directionally correct data. It relies on the availability of systems
allowing measurement of the criteria chosen for the analysis.
This availability of data becomes critical whenever the population on target is spread over
several sites, countries, etc., or worse, is not coded in a homogeneous way. Sometimes, a
conversion of data using product standard codes is mandatory.

Tool Limitations / Common Pitfalls

Most of the time only past annual spend is available to perform an ABC analysis. By
definition it is what was “bought” but not what will be the next year’s spend. The use of past
annual spend is fine if the business needs will not change in the near future. The buyer may
consider that next year figures will be the same as the last year’s one. In the case where the
buyer considers that the future needs may vary from the past figures, it would be better,
whenever available, to use “future annual spend” provided by the internal customers or
“budgeted” figures.

Special attention must be given to risk issues as explained in the When and Why to use it
section.

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