At the moment everyone is talking about chatGPT (or talking to chatGPT), and the simmering interest in AI over the last decades has reached boiling point. Companies are plagued by the AI FOMO (Fear Of Missing Out) scrabbling to get “some AI” to improve their annual ROI (and consequent end of year bonus #CaribbeanHoliday?).
But some of the most reliable methods for identifying and prioritizing a company's resources are as old as your grandparents. ABC Segmentation (also called ABC classification or ABC analysis) is such a method. What is innovative is the way this analysis can be performed on user-friendly platforms that do the math for you.
But before we get ahead of ourselves, let's define what we're talking about.
What actually is ABC Segmentation?
ABC Segmentation is based on the Pareto principle, otherwise known as the “80-20 rule”, formulated by the economist Vilfredo Pareto, who noted that 80% of the land in Italy was owned by only 20% of the population, and, on a more personal level, 20% of the pea pods in his garden were producing 80% of his peas!
This rule can be applied pretty much anywhere: 80% of software problems are caused by 20% of bugs, 80% of the wealth of the planet is held by 20% of its inhabitants, 20% of people in a company do 80% of the work (are you in that 20%?). You get the gist.
How does this classification apply to business?
From a business perspective, 20% of company resources generate 80% of the total sales revenue. Resources can be products, customers, services, data or even staff members.
So, fundamentally, only 20% of a company's resources are so valuable that losing one of them would cause serious damage to the business.
What do the categories stand for?
The “ABC” part of its name comes from the way this method groups resources into three categories, unsurprisingly called A, B and C.
- Class A represents the top 20% of resources that generate the highest profits for the company, usually around 60-80% (that's where Pareto's 20-80 rule comes in).
- Class B contains middle-range performing resources, which usually generate the next 30% of profits. The Class B group is usually slightly larger than Group A.
- Class C covers the remaining resources that don't make an enormous impact on the overall profit (no more than 10-20%), but often contain the majority of resources and is usually the largest category.
To check this out graphically, have a look at this plot.
It shows the ABC Segmentation results for the 5,515 products sold by a UK company (x-axis), that made nearly £18 million revenue (y-axis) in one year.
The top 70% of revenue (Class A - in blue) is generated by only 13.98% of all their products, while a whopping 65% of their products only generate 10% of the revenue (Class C - in red).
That's food for thought.
What should I do with these classes?
This analysis basically helps you get a clear picture of your customers and products, and look at the questions you should be asking for each group:
- Class A items should be the main focus of your business. Are Class A customers looked after? Do they get priority support? Are the materials required to build Class A products well sourced? Are they placed in pole position in sales brochures?
- Class B items represent potential, potential, potential! They could grow up to become Class A items with the right TLC and positioning. How can I help them grow?
- Some of those Class C items may need to be phased out. Which ones should I gently let go? But speak to your marketing team first - some of them may have been used to attract the public to the brand, building trust, and leading to the purchase of more premium Group A products. Promotional products, for example, that often make no profit whatsoever, are part of Class C, but they know their importance in the overall plan.
What industries perform ABC Analysis?
Despite its simple sounding name, ABC analysis is widely used in multiple industries. For example, in the supply chain it is an important inventory management method for ranking items based on their importance to the business, to avoid stock outs of Group A items. Customer support teams use the same method for customer segmentation, to identify and look after valuable customers.
Performing ABC Segmentation in Rulex Platform
So, why is a software company like Rulex, well-known for its explainable AI solutions, talking about this archaic method?
Well, we help industries increase their revenue through ABC analysis in a simple drag-and-drop platform, which requires no coding skills or knowledge of complex math.
All these resources are free of charge on Rulex Community (where you can also find other free courses & videos, get support and share ideas with other like-minded souls). All you need to do is sign up.
And if you're still in the grips of AI FOMO, we do that too.