ABC analysis, also known as Pareto analysis, is a method used to categorize something according to its importance or value in a given context. The practice is commonly used in IT (information technology) and business to improve the efficient use of resources in areas including procurement, staff evaluation, marketing, inventory management, customer relationship management (CRM) and supplier relationship management (SRM).
Determining the importance of items or entities helps guide further decisions, such as the level of resources that should be devoted to their oversight. In procurement, for example, ABC analysis can be used to help evaluate items according to the amount of money spent on them. To perform this type of ABC analysis, a list of items is generated in top-down order based on cost per item over a defined time period. Category A might include the top 20 percent of items, which account for 80 percent of the money spent on the entire list. (This 80/20 rule is known as the Pareto principle, which is why this method is sometimes called Pareto analysis.) Category B might be made up of the next 30 percent of items, which represent approximately 15 percent of the total money spent; category C might comprise the bottom 50 percent of the items, which account for just five percent of the total.
This categorization provides a clear basis for determining how stringent the controls and documentation should be for managing these three categories of items. Category A should have the tightest controls and all processes involving them should be scrupulously documented. Category B items require less careful oversight and Category C items should involve the least administrative resources possible for responsible management.
See a video introduction to ABC analysis in procurement: