Managing inventory is critical but expensive. In fact, it’s the single biggest expense in running a business. (Some 69% of merchants surveyed used funding through Shopify Capital to buy inventory.)
US retailers are currently sitting on about $1.39 in inventory for every dollar of sales they make. That’s a lot of tied-up expenses—and making too big an investment runs the risk of dead stock. Getting inventory management right really can make or break your business.
An ABC analysis is the best tool to do this. With it, you can identify your best and worst performing inventory, optimize your investment, and increase profitability.
Ahead, you’ll learn how to get started with an ABC analysis.
Table of Contents
- What is an ABC analysis?
- The importance of ABC analysis
- The benefits of ABC analysis in inventory management
- How to run an ABC analysis
- A grade strategies: what to do with your best inventory
- C grade strategies: what to do with your worst inventory
- Using ABC analysis for cycle counting
- Shortcomings of the ABC method
- ABC inventory management best practices
What is an ABC analysis?
An ABC analysis is an inventory categorization technique that helps merchants find their most (and least) valuable products.It gives you greater inventory control and profitability by helping you identify the products that make—and cost—your business the most money.
Inventory ABC classification is based on the Pareto principle, also known as the 80/20 rule. It classifies your inventory using three categories based on total revenue:
- A grade. This is your best performing inventory: the money maker. The items with the highest annual consumption value and customer demand. The A grade represents the specific inventory—in many cases, only a small percent of the total—that accounts for 80% of your revenue. As your most valuable inventory, it should be protected and prioritized as much as possible.
- B grade. B grade is middle-of-the-road inventory that accounts for the next 15% of your revenue, and should be treated as such. B grade can often fluctuate between an A grade and C grade.
- C grade. Your worst performing inventory. C grade represents the specific inventory that accounts for the remaining 5% of your revenue. You might also call this slow moving or dead stock. C grade brings very little value to your business and should be deprioritized as much as possible.
The importance of ABC analysis
Inventory investment optimization is a challenge for any business. It’s difficult to know which products to purchase so you can meet future demand without having an excess of leftover stock. Likewise, it’s nearly impossible to know which products to avoid when you’re purchasing blindly or based on intuition.
Inventory management means striking a balance between having products available and minimizing inventory cost. Selling out of in-demand products could mean missing future sales—disappointed shoppers will likely seek items from your competitors, where they may become repeat customers. All together, US and Canadian retailers miss out on roughly $350 billion in sales every year due to stockouts and overstocks alone.
But you don’t want to buy too much—keeping dead or slow moving stock is a drain financially. Storage fees are increasing by the year, so it’s important to make the most of it. Unnecessary holding costs in the form of warehousing, insurance, and labor suck money from your bottom line. And when perishable products expire, there’s no salvaging them, even at discounted rates.
Businesses need to regularly analyze inventory if they want to ensure long-lasting success. ABC analysis is one of the best inventory management methods to do that. It’s easy for Shopify merchants—just go to the reports section in your dashboard to pull an ABC analysis by product report.
Separating your inventory into these three categories will give you a good indication of what items you need to stock more, and which items you need to reduce stock value.
The benefits of ABC analysis in inventory management
Better inventory control
Demand forecasting is notoriously difficult. How are you going to predict how many units you’ll sell over the next month? Since we don’t have telescopes to see into the future, historical data is the next best thing.
An ABC analysis shows your top performing products. Use your open-to-buy budget on those—they have the most potential to earn money for your business. You’ll also see your worst-performing products, and know not to order large quantities of them (which will likely eat up storage fees).
Improved customer satisfaction
McDonald’s is known for its French fries. Imagine your frustration if you visited the restaurant at lunchtime and it didn’t have any fries to go with your McChicken sandwich. Chances are, customers have the same expectations for your store. They turn up expecting a number of items to be in stock.
By identifying your grade A inventory, you can put processes in place to make sure you never run out of grade A stock. You don’t want there to be an opportunity for someone to visit your store, be unable to buy a bestseller, and leave empty handed.
More informed pricing decisions
It makes sense to invest in products that return the most revenue for your store. An ABC analysis is a great way to uncover that because “it ensures you know exactly what products are on the shelves and in your warehouse,” says Jara Moser, digital marketing manager at Shopventory.
“By categorizing products based on their value and usage, you have greater insight into what slow-moving products you’re losing money from, so you can discount them and make room for more profitable products.”
Improved sell-through rate
Sell-through rate (STR) is the percentage of inventory you’ve sold to customers. Ideally, your store would have a STR of more than 80%. Fewer products sitting in storage means cheaper warehousing fees and better customer insight. A high STR means your customers are enjoying the products you’re selling—and they’re voting with their wallets.
An ABC analysis helps improve your storewide STR because you know which products are most popular. Plan any upcoming replenishment orders against that data. Order fewer grade C products; put more of your budget into grade A inventory. You’ll have fewer unsold products left in storage.
PRO TIP: Find your STR in the Percentage of Inventory Sold report inside your Shopify back end.
Using data to drive better decisions on in-season planning and management of inventory will allow you to better understand the shifts in customer shopping behaviours. Predicting what the customer wants, at the right time and in the right channel, will shift, and the more you meet art with science when planning, the more full-price sales you will have.
Lower storage costs
Keeping too many items in storage adds up in cumulative costs. Not only are you paying to keep unsold items in storage, but there’s the opportunity cost of wasted space. The shelves storing grade C products could be holding more of your bestsellers.
It's pointless to overstock your warehouse with low-margin items that are only sold sometimes. ABC analysis enables planners to determine service levels based on product classification, which enhances overall supply chain performance by reducing the amount of safety stock carried.
Improved resource allocation
Say the words “limited resources” to any store owner and, chances are, they’ll answer, “I get the frustration!”
In an ideal world, you’d have enough shelving capacity to hold large quantities of every item you sell. But this is not an ideal world. Even if you secured a location large enough to hold your total inventory, you’d pay extortionate monthly fees to have it. You have to work with what you’ve got.
Once you run an ABC analysis, you’ll clearly see your grade A inventory. Items that fall in the top 80% should get the most love and attention—including shelving space. You can better allocate the shelving resources you have to make sure they’re not being wasted.
How to run an ABC analysis
ABC analysis formula
To run an ABC analysis, start by calculating how much revenue each individual product has generated for your store. Divide that number by the total revenue generated by all products over the same period.
For example, if your store sold $50,000 of serving bowls in 28 days and the entire store generated revenue of $200,000 in that same time period, the serving bowls would account for 25% of your store’s revenue.
Repeat this process for every item in your inventory. Then, list your products in descending order of percentage of revenue generated.
The top 80% are grade A items—your bestsellers and those you should prioritize when managing your inventory. Those falling in the middle 15% are grade B. Anything in the bottom 5% is grade C.
Businesses need to regularly analyze inventory if they want to ensure long-lasting success. And ABC analysis is one of the many ways you can do that. It’s easy for Shopify merchants—just go to the reports section in your dashboard to pull an ABC analysis by product report.
Example of ABC analysis
Below is an ABC analysis example for a home décor brand. It categorizes SKUs into grades A, B, and C depending on the percentage of revenue each item has generated for the store.
Serving bowls and serving trays are the A grade products. This merchant would want to make sure they always have these products in stock, maybe showing them on their homepage or in a top-selling products collection on their online store. If they also sell in person, they could show them in high-traffic areas within their retail store (like the checkout desk as an impulse buy).
Plate sets, mug sets, and glassware sets, on the other hand, make up the C grade products. The merchant might consider no longer carrying those items, improving the products themselves, or running extra promotions.
A grade strategies: what to do with your best inventory
Make the most out of your ABC analysis by leaning into grade A products. Here are seven tactics you can apply to A grade inventory items to maximize your sales and profits.
Create strong relationships with A grade suppliers
Business is built on relationships, and that doesn’t stop when it comes to your suppliers.
A grade suppliers are those you want to nurture. Not only will your supply chain and reordering process be more efficient, but as the relationship with the supplier develops, communication improves.
Suppliers will know who they’re manufacturing products for, and merchants will better understand the manufacturing process on the supplier side. This helps mitigate any delays in the supply chain, so you’re never let down by a supplier who can’t deliver your grade A inventory.
Plus, if you’re easy to work with, you may also benefit in other ways—better pricing, quicker turnarounds, and other preferential treatment on your grade A products.
Want to know how to improve your supplier relationships? Here are a few supplier relationship management tips to keep in mind:
- Make sure you’re clear on what you want to order. Discrepancies can cause headaches for you and your suppliers.
- Put your order in writing. Create and send purchase orders so everything is documented and all parties stay on the same page.
- Always pay on time. This should go without saying, but on-time payments also build a good reputation for your own business.
- Get to know your supplier’s business. Learn about your supplier’s business so you can give adequate lead time and build empathy around their own limitations.
- Connect on a personal level. Remember, all businesses are founded and run by humans.
Identify multiple suppliers for A items
While you want to have a positive relationship with your supplier, that doesn’t mean you can’t shop around and pursue other options as well. In fact, it’s critical to establishing a resilient supply chain, which is important for category A products—especially when preventing stockouts of your high-value items.
Suppliers can run out of manufacturing capacity if they face unexpected or uncontrollable circumstances, like too many purchase orders, manufacturing maintenance mishaps, or equipment breakdowns. These challenges can increase prices, which affects your break even point and can negatively impact your profit margins. And in a worst case scenario, your supplier could go out of business or discontinue the high-demand products you need, leaving you to scramble for a replacement.
So reinforce your supply chain by identifying multiple suppliers, or at least a back-up supplier, for all your A grade products. They’ll be your safety net, protecting your supply chain and reducing the risk of costly stockouts.
Always have A grade inventory on hand
Recall that stockouts cost merchants nearly $350 billion in sales in a single year. It’s critical to ensure you always have A grade inventory on hand, as it represents your highest-performing and highly demanded products.
Lots of shoppers will seek you out for those exact products. If you don’t have them, it leaves a bad impression.
This is where safety stock comes into play—a small surplus of inventory you keep on hand in case of a change in market demands or lead times. You can calculate safety stock in a number of ways. Market variability, supply chain reliability, and the inventory carrying cost you’re willing to hold all impact the amount of safety stock required.
Here’s the basic formula for calculating safety stock for your A grade inventory:
Safety stock = (max daily sales x max lead time in days) - (average daily sales x average lead time in days)
You can pull all these metrics directly from Shopify. To determine the max daily sales volume, use the Sales over time report and the “variant” filter to determine daily sales of the unit for which you want to calculate the reorder point. From this view, you’ll be able to determine the maximum daily sales over a specific time period.
The average daily unit sales refers to the number of units you sell of a particular product over a specified period of time. To determine this, refer to the Average inventory sold per day report in Shopify.
Say you sell 1.5 units of serving bowls per day.
The average delivery lead time is the amount of time it takes to receive a shipment of stock. To get this, divide your total number of lead times by a set period of time.
You know that the longest they’ve had to wait for a purchase order was 15 days, but on average, it takes 10 days to receive serving bowls from their supplier. Therefore, the safety stock is: (5 x 15) - (10 x 1.5) = 60 units.
Identify a reorder point for A grade stock
Once you know your optimal inventory levels for A grade stock, you can identify a reorder point for those products. This allows you to prevent stockouts and automate the purchase process.
The reorder point is a simple calculation that lets you know the lowest amount of inventory you can sustain before you need to order more to maintain the optimal stock level. You can calculate the reorder point for each individual product (or variant) that you sell.
Reorder point = (average daily unit sales x average lead time in days) + safety stock
Using the same example above, this merchant’s reorder point is: (1.5 x 10) + 60 = 75 units.
In Shopify, use the Month-end inventory snapshot to monitor your inventory quantities for A grade products. Once your product or variant quantity hits the reorder point (i.e., 75 units), you know it’s time to order more products.
Invest more in A grade inventory
Since your A grade inventory is your highest value stock, it’s likely a good idea to invest more in these products, especially if demand is steady and sustainable.
In some cases, you might order higher quantities of inventory from your suppliers so you have more to sell. Or, you could increase your marketing and advertising spend on A grade products to drive more demand and sales.
Increase prices for your A grade inventory
Pricing products is a challenge in itself and many variables need to be considered. Target audience, cost of products, revenue targets, competitor pricing, seasonality, and knowing where the market is headed all play a role.
But given that demand is highest for your most valuable inventory, you may want to consider raising prices slightly in order to increase your profit margin. Take a look at your pricing strategy for A grade products. Would shoppers be willing to pay more for their favorite items? If so, you can improve your bottom line.
Secure and control A grade inventory
A grade inventory is high performing and highly coveted. It should be treated and protected as such. Place better security and control over your A grade stock to ensure it stays safe and pristine so you can sell it.
Unfortunately, products are misplaced, damaged, and even stolen. To prevent this from happening to you, consider the following ideas:
- Secure this inventory with multiple locks, security guards, and other safety measures, especially if you use your own warehouse or keep your inventory at home.
- Monitor A grade stock with a security system and video surveillance. Your third-party logistic partners (3PLs) likely already have strong security precautions in place.
- Conduct cycle counts on a regular basis. This will help you detect discrepancies early.
For inventory across multiple warehouse or retail locations, you can also use electronic article surveillance (EAS), cameras, RFID tags, and merchandising security.
C grade strategies: what to do with your worst inventory
Your C grade products are at the bottom of your sales priority list. They’re essentially dead weight.
Generally, your best bet is to “get rid of C” so you can limit the financial burden of keeping it on the shelf. C grade products take up space in your warehouse and prevent you from purchasing A grade inventory—the products your customers actually want.
However, you can also use many strategies to optimize your C items, helping you reduce inventory costs and free up cash flow without ditching them altogether.
Reduce the price or sell C grade products at a discount
While you raise prices for A grade products to maximize profitability, you want to consider lowering prices for C grade inventory items to get them off the shelves. Many shoppers, especially online shoppers, still make purchasing decisions based on the lowest price.
It might sound counterintuitive to make even less revenue from your lowest performing items, but lower prices could make your C grade products more attractive to buyers. And, by reducing your price to be lower than your competitors’ (or even offering the product at cost), you’ll move it more quickly and save money in the long run. The longer you hold onto it, the longer it costs your business.
Give your C grade products to charity
Philanthropy is great from both a human and a business perspective. On one hand, you’re contributing to a cause and making the world a better place. On the other, you’re giving customers a more compelling reason to support your brand and buy your products.
This is a strategy that can work well for C grade products, giving shoppers an extra incentive to buy.
In addition to donating proceeds to charity, donate actual products to those in need. Look for local charities that would specifically benefit from your slower-moving inventory, such as women’s shelters or food banks. Grade C products are much more appreciated there than in the garbage.
Bundle dead stock products with A grade or B grade products
Product bundles are groups of similar products offered as a package for one discounted price. Bundling works well because many buyers like to feel they’re getting a deal. When you bundle complementary C items with A or B items, it makes shoppers feel like they’re getting more bang for their buck.
Bundling can serve to reduce the ‘pain of paying’ because it makes it harder for consumers to know what the ‘right’ price is for the products.
As a result, demand for those C grade products increases, you can sell them at a slightly higher price, and you get rid of your dead stock, all at the same time. By pairing a C grade product with a top performing product, you’re also improving the buy rate of your bundled A and B grade products.
Increase visibility for your C grade inventory
Sometimes C items land themselves at the bottom of your list because they haven’t been given much attention. Perhaps they’re the lowest-earning items because they’re at the back of your 10,000-square-foot store—a place few people venture.
Giving your C grade products more visibility online and in your brick-and-mortar store can help drive more demand and sales.
Consider placing C grade items next to complementary A grade merchandise. You could even strategically display them in the checkout line or other highly visible and trafficked locations in your retail store or run online marketing campaigns to promote them on your website.
We seamlessly position A/B and A/C together to help with the sell-through of grade B and C inventory. We keep the Bs at eye level, Cs above eye level, and As at the lowest level. Our customers know how to find the As, and we enable complementary discovery of Bs and Cs through smart shelf management.
Give away your C grade products as gifts
Everyone loves a free product. Plus, online shoppers are more likely to pay for a product that has something included for free.
Giving C grade products away to customers as freebies gives you the chance to offload excessive inventory while also creating an enjoyable and memorable experience for your customers. For example, for every serving bowl (grade A) you sell, give shoppers a free mug (grade C).
You can even give away your C grade products to your top customers as a way of recognizing and thanking them for their business. These tactics can lead to increased loyalty and repeat purchases.
Discontinue and stop ordering C grade inventory
When all else fails, C grade inventory is likely a candidate for discontinuation. Unless your product serves another purpose for your business, consider removing that product from your store so you can focus your investment on better performing products.
Using ABC analysis for cycle counting
Cycle counting is a physical inventory check that merchants do periodically throughout the year. Instead of a full inventory count (which would likely take hours), you can use your ABC analysis data to prioritize these cycle counts. Grade A items should be counted first, followed by category B and, finally, category C.
It’s the best use of your time. You’ll confirm you have the right amount of inventory for your highest value products, rather than waste precious time cycle counting low value stock.
Shortcomings of the ABC method
While an ABC analysis is a simple way to find your best and worst performing stock, it does have its downsides. Here are some things to consider when doing an ABC inventory analysis.
It doesn’t account for seasonality
An ABC analysis only uses data from a given time period. If your products are affected by seasonal changes, they might be incorrectly categorized and deprioritized. For example, toys may be considered C grade through the summer and fall, but sales typically skyrocket for the holiday season, when they become A grade or B grade products.
ABC analysis uses standardization. It takes into account the revenue each item has generated across any given time period (usually one month).
So exclude any seasonal items from your ABC analysis. In a worst-case scenario, you could offload most of your inventory in the months it falls into the grade C category. If you do, you’ll have a crazy scramble trying to restock during the time of year it becomes a bestseller.
It doesn’t account for changing consumer behavior and trends
Trends can impact how and what buyers shop for during a period of time. The most obvious example is movie-related costumes.
Google searches for “Star Wars costumes,” for example, skyrocketed when the sequel series launched in 2016—costume companies likely ranked it as grade A inventory at the time. Now, the novelty has worn off. The once grade A inventory sits on a back shelf, purchased once in a blue moon. It’s now placed in the grade C bucket.
Because trends shift over time, it’s difficult to predict whether your grade A inventory will stay that way. Historical data isn’t always reliable for forecasting either, making ABC analysis troublesome.
It doesn’t account for new product launches
If you’re launching a new product, you won’t have historical data to predict that product’s performance. You can make your best estimates, but sometimes the only way to figure out whether a product will be in demand is to test it. A few months’ worth of data is necessary to know if it will be a top-selling product for your store.
An inventory-wide ABC analysis doesn’t take this into consideration, potentially leading you down the wrong path and causing you to discontinue new product lines before they’ve had a chance to sell. With ABC analysis in Shopify, you can filter out new products from the report for a more reliable analysis.
Percentage of revenue is one of many important inventory metrics
When using analytics in your business, it’s always important to consider multiple sources and data points.
ABC analysis is just one of many reports you should consider when analyzing inventory performance. While ABC analysis is valuable for seeing which products account for the greatest percentage of store revenue, you also want to look at metrics like your inventory turnover rate, days on hand, stock-to-sales ratio, sell-through rate, rate of return, and profit margin.
Qualitative insights are valuable, too
Another shortcoming of ABC analysis is that it doesn’t account for qualitative insights that store associates may have on a product’s performance.
“The biggest fail with ABC analysis is that nuances between stores are not taken into consideration,” says Liza Amlani, principal and founder of Retail Strategy Group and The Merchant Life.
“There needs to be a human element of walking the shop floor and talking to brand ambassadors as well as customers to gain insights on product success and failures that sitting behind a computer screen can’t tell you.
“If a product is not selling and you are able to capture feedback on fit or styling challenges, you have the ability to take action right away. Taking returns into consideration and moving inventory to another season could give you the opportunity to avoid marking down products and trigger more full-price selling.”
ABC inventory management best practices
Long gone are the days of manually counting inventory and recording it in an Excel sheet. There are tools and apps that exist to make your life easier, especially when it comes to inventory counting.
With Shopify POS, merchants can count inventory quickly using a bar code scanner and the Stocky by Shopify app. Equipped with these tools, merchants can significantly cut down the time it takes to perform an inventory count.
💡 PRO TIP: If you’re looking for an alternative to external bar code scanners, Shopify POS lets you scan and count inventory using your tablet or smartphone camera instead. Merchants can also use the Shopify mobile app to scan and count inventory from their warehouse floor. Variant quantities are automatically updated in the inventory list section of Shopify.
Analyze inventory across all locations
Similarly, Shopify merchants can view inventory reports to analyze their inventory data across all locations from one centralized dashboard. You’ll see your A, B, and C inventory across the entire business, allowing you to make better restocking decisions and maximize storage resources. Retail merchants can also access this data right from Shopify POS.
Use simple classifications
An ABC analysis gets complicated when you’re analyzing too many small details. Streamline your report using simple inventory classifications, such as revenue generated by product name or category. There’s no need to break each one down by color or size just yet. (You can always do that later with a mini ABC inventory analysis for each item.)
Optimize your inventory with Shopify
There’s no doubt that ABC inventory analysis is a helpful way to see which products perform best and worst so you can optimize for sales and profitability. Remember to exclude seasonal items and new product lines, and to reference other inventory metrics for the most accurate grades.
Prioritize A grade inventory by investing heavily in it—both in terms of stock levels and the relationship with those suppliers. Get rid of grade C inventory (and cut storage costs on dead weight) by bundling it with other items, offering them at a lower cost, or donating it to people in need.
It’s easy to get started with ABC analysis by product in Shopify. It’ll pull historical sales data to show you your best (and worst) performing inventory within just a few clicks.
This post was originally written by Emily Manley, and has been updated by Elise Dopson. Illustration by Rachel Tunstall