Question 14

Explanation

Pareto analysis and ABC analysis are two methods of prioritising and managing different types of items or activities based on the 80/20 rule. This rule, also known as the Pareto principle, states that, for many events, roughly 80% of the effects come from 20% of the causes. For example, 80% of the sales may come from 20% of the customers, or 80% of the problems may come from 20% of the processes.

Pareto analysis is a technique that helps to identify and focus on the most significant or influential items or activities among a large number of them. It involves creating a Pareto chart, which is a bar graph that shows the frequency or impact of each item or activity in descending order, along with a cumulative line that shows the percentage of the total frequency or impact. The Pareto chart helps to visualise the 80/20 rule, and to identify the items or activities that fall into the 20% category that account for 80% of the results. For example, a Pareto analysis can help to identify the most common causes of customer complaints, the most profitable products or services, or the most time-consuming tasks.

ABC analysis is a technique that helps to classify and manage different types of items or activities based on their relative importance or value. It involves dividing the items or activities into three categories: A, B, and C, according to their contribution to the total value or cost. The A category represents the most important or valuable items or activities, which account for 80% of the value or cost and 20% of the quantity or volume. The C category represents the least important or valuable items or activities, which account for 10% of the value or cost and 70% of the quantity or volume. The B category represents the items or activities that fall in between, which account for 10% of the value or cost and 10% of the quantity or volume. For example, an ABC analysis can help to manage the inventory of a warehouse, the spend of a procurement department, or the customers of a business.

ABC analysis helps procurement team target their effort in order to leverage better outcomes and add more value for the wider business. By using ABC analysis, the procurement team can allocate different levels of resources, attention, and strategies to different categories of spend, depending on their importance and impact. For example, the procurement team can negotiate more aggressively, monitor more closely, and establish long-term relationships with the A category suppliers, who provide the most critical and costly products or services. The procurement team can also reduce the administrative burden, simplify the processes, and automate the transactions with the C category suppliers, who provide the low-value and high-volume products or services. The procurement team can apply a balanced approach to the B category suppliers, who provide the moderate-value and moderate-volume products or services.

However, ABC analysis does not consider the supply risks or other non-cost elements such as quality, strategic importance, etc. that may affect the procurement decisions and outcomes. For example, a supplier may provide a low-value and high-volume product or service, but may have a high risk of disruption, poor quality, or unethical behaviour, which can harm the buying organisation’s performance, reputation, or sustainability. Similarly, a supplier may provide a high-value and low-volume product or service, but may have a low risk of disruption, high quality, or strategic alignment, which can benefit the buying organisation’s competitiveness, innovation, or growth. Therefore, ABC analysis alone may not be sufficient to capture the complexity and diversity of the procurement portfolio. Gelderman (2000) concludes that “The ABC-analysis however, does not provide strategic recommendations for the categories. Due to this lack of guidelines, the ABC-analysis can not be considered as a full portfolio technique.” A portfolio technique is a method that helps to analyse and manage the procurement portfolio based on multiple dimensions or criteria, such as value, risk, complexity, and relationship. For example, the Kraljic matrix is a popular portfolio technique that classifies the procurement categories into four types: strategic, bottleneck, leverage, and routine, and suggests different strategies for each type.

Reference:

- Gelderman, C. J. (2000). Rethinking Kraljic: towards a purchasing portfolio model, based on mutual buyer-supplier dependence. Danish Purchasing & Logistics Forum, 9-15.

- CIPS L4M6 study guide page 20-21 / The new syllabus 2024

LO 1, AC 1.2