Want to get focused on products or customers that bring you the greatest profits? Feel that some of your products are a burden to the company? Check that with the ABC analysis!
ABC analysis is a technique that allows you to classify company resources according to their importance. Business owners can apply this rationalization instrument to any enterprise and in any field of activity. The main goal of ABC is to identify customers or products within segments that provide the largest contribution (80%) to the company's profits in order to focus on satisfying the needs of this particular group. Want to find out how to apply this tool to your cannabis business and save money on deep analytics? Keep reading!
Definition of ABC analysis
ABC analysis categorizes goods or customers into 3 groups. Each group has a different ranking in terms of impact on revenues. Let’s take, for example, an ABC analysis when analyzing your company’s goods:
- Group A – the most important products. They make up that 20% of the assortment of goods while providing 80% of the revenue (based on Pareto Principle);
- Group B – medium-ranged goods. 30% of the whole assortment that provides 15% of the total revenue;
- Group C – the least important. The remaining 50% of the entire assortment of goods that provide only 5% of the revenue.
The boundaries of these groups (80% – 15% – 5%) can be changed and set individually by the user. You can also choose which indicator to use as the basis for ABC analysis - profit or sales - depending on your objective.
You can always carry out the analysis on any object of your choosing, for example, customers, stocks, all suppliers, etc. Therefore, this technique will be useful to almost any business. However, if you wish to apply the ABC tool to analyze your customer base – please bear in mind the following advice.
Evaluating customers by the level of income they generate for the company is the easiest way to evaluate a company’s customers, and often cannabis companies set up such an assessment in the accounting system. However, the company should not only focus on revenues, but also on the profit that derives from each dollar of sales. Therefore, it is important to understand not only the income from selling goods to a particular client but also the marginal profit from those sales.
Moreover, you should take into account all the costs associated with the sale to a particular client. It is frequently the case that a customer consumes a large volume of a product but requires the maximum discount and additional perks (such as free delivery, or after-sales service, or bonuses). This means that the sales cycle of this customer is longer than for other customers, and the sales staff spends more time on it than on others. As a result, considering all the costs associated with these sales they may not result in a net profit for the business.
Why use ABC analysis?
You should carry out the ABC analysis at a minimum annually or when developing and revising a company’s strategy, in order to develop a marketing strategy and a sales strategy for existing customers. The analysis should also be carried out for medium-term (annual) sales planning: sales to existing customers in the past can serve as the basis for forecasting future sales. However, for many markets and businesses – especially in the cannabis industry – it is advisable to conduct an ABC analysis more frequently (once a quarter). This is due to the fact that this industry faces constant legislation and other changes. Such an approach will help to quickly focus marketing and sales on the company’s best customers and identify the products with the highest demand.
You can also use ABC analysis to evaluate the most effective sales channels, most in-demand raw materials, most potential partners, etc. Moreover, when combining customer analysis and product analysis, businesses get a complex vision that allows them to focus on both priority customers and the goods that priority customers select.
How to do ABC analysis
In a nutshell, preparing to conduct an ABC analysis and analyzing the results consists of six core steps:
- Determine the purpose of the analysis (why do you need this analysis?);
- Determine the actions based on the results of the analysis (what will you do with the results obtained?);
- Select the object of analysis (what will you analyze?) And the analysis metrics (what is it you will you measure?) Typically, the objects of ABC analysis are suppliers, product groups, product categories, and product items. Each of these objects will have different metrics including sales volume, income, inventory, money turnover rate, etc;
- List chosen object (i.e. suppliers) by their values within a given metric (i.e. inventory) in descending order;
- For each object, calculate the percentage of that value against the cumulative total for that metric. (The cumulative total is calculated by adding the value to the sum of the previous values);
- Determine groups A, B and C, then assign group values to selected objects.
There are about 10 methods for determining groups. The most applicable are the empirical method, the sum method, and the tangent method. In the empirical method, separation occurs in the classical proportion 80/15/5. In the sum method, the share of objects and their total share, as a result, are added up - thus the value of the amount is in the range from 0 to 200%. Groups are distinguished as follows: group A - 100%, B - 45%, C - the rest. The advantages of the method are great flexibility. The most flexible method is the tangent method, in which a tangent is drawn to the ABC curve, first separating group A and then C.
It has been established that in most cannabis companies, approximately 80% of the value of the sales volume is only about 10% of the items (group A). ABC analysis is widely used in planning of cannabis goods and services before launching them in front of the client. You should also use it at various levels of logistics systems, and for the identification of the most valuable customers of your cannabis-related business.
ABC Analysis Example
Here is an example of ABC analysis performance of MedMen – a local retailer of cannabis-related goods.
They use a specific research algorithm:
- A special table is formed which represents data on cost, selling price and number of sales for a month / half a year/year for each product entered.
- Using the formula, they distribute products in the rating on a scale of 1 to 100, depending on their share in profit and turnover.
- Then they allocate positions to groups A, B, and C.
If the position on this scale is in the range from 1 to 50, then this is category A. If the assortment group falls into the range from 50-80, then it is group B. Everything that appears under the line – “80”, is “non-liquid". Products that turned out to be in group A and B are significant and effective since they are profitable and make up almost the entire turnover of the company. Group C must undergo a process of “recovery” or exclusion. In the first case, it is necessary to try to stimulate demand. In the second, hopeless case (usually when the item has appeared in the list more than once), such a product should be disposed of.
It is important to conduct analysis within the particular segments. Mixing clients of different segments or completely different product groups in the same analysis table will lead to incorrect assessment and incorrect management conclusions and decisions. If a cannabis-related company sells its products in different geographical markets, you should conduct an ABC analysis for each segment, each sales channel, each industry and for each market.
To obtain reliable estimates in ABC analysis, a business owner must have reliable data in the accounting system in the first instance. This requires a sound management accounting policy with detailed cost accounting and extensive sales analytics.
In order to get the maximum benefit from the ABC analysis, it should be used in the organization on a regular basis to ensure the possibility of identifying any trends in sales and timely response to them.
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