Pareto's Law:

● To understand ABC analysis​, it is important to understand Pareto's law first.

● Pareto's Law:​ In most inventories, 20% of items may be accounting for 80% of total
annual cost.

Concept of ABC analysis :

● In ABC analysis, the cost of all items used is counted and needs to be controlled. But as
per Pareto's Law, there are significant few items which require our most attention and
need to be strict control.
● ABC analysis states that
○ 10% of drugs would cost 70% of the total cost of drugs ​(Group A).
○ 20% of drugs would cost 20 % of total drug cost ​(Group B)
○ 70% of drugs would cost 10 % of total cost ​(Group C)

The figure​ shows the percentage of inventory items and percentage of average inventory
annual usage value.

● Inventory worth of annual consumption = demand x unit price

● It can be seen from the figure, 10% items are consuming 70% of annual usage value
which are 'A' class items (significant few), another 20% of items account for 20% annual
usage value and another 70% items account for 10% expenditure on material
consumption which constitute "insignificant money" are called "C" items.

Steps to prepare ABC analysis :

● Calculate annual usage value of each drug.
(Annual Usage value = Annual demand X unit cost)
● Keep in order according to annual usage value. That means most expensive items to be
kept at top and cheapest at bottom.
● Here you will find a cut off point where there is perceptible sudden change of cost which
can also be found out by a graph and it would approximately be at 10% items.
● 20% items are where change can be observed, However there may be variation of upto
5 %.

The Purpose of doing ABC analysis :

● To keep strict financial control.
 ● 'A' items have to be under strict control of higher management since they consume 70%
of consumption cost, Their safety stocks are kept to be low and need high turnover and
frequent procurement and requirement of these items need to be audited.
● 'B' items fall in between A and C items and need maderate control by middle
management since consumption cost is 20%.
● 'C' items are consuming 10% of cost hence need control by lower management, Hence
they can have a high safety stock and procurement could be less frequent.

Parameters to be monitored and controlled :

Every item in the inventory requires attention but A Class items need to be controlled and
monitored the most because 10 % of A class items are contributing to 70% of total
consumption. They should be monitored and controlled on the following parameters :

● Type of control & authority :

A class items require Very strict control. Controller should have great authority.
● Quantity of safety stock :
Should be kept very low based on previous data / extension data / expansion plans /
disaster contingency combined with frequent ordering & / or staggered supplies.
● Consumption control :
Should be regular daily or weekly.
● Material planning :
Should be accurate. Database should be up to date.
● Application of value analysis :
A concerted attempt should be made at value analysis, waste reduction, obsolete &
surplus reduction.
● Number of sources of supply :
Increase the number. Centralize purchase and store. Reduce lead time.