Why 80% of your purchasing budget should be allocated to just 20% of your suppliers

The basis: How the Pareto principle shapes the ABC analysis

The theoretical basis of the ABC analysis is the Pareto principle named after Vilfredo Pareto, often also known as the 80/20 rule. It describes the statistical observation that in many cases around 80 percent of the results are achieved with only 20 percent of the total effort. Applied to supplier management, this means A small percentage of your suppliers (the A-suppliers) are responsible for a very large proportion of your total purchasing volume.

Conversely, a large number of suppliers (the C suppliers) are only responsible for a small proportion of the total value. This uneven distribution is the key to prioritization. The division into A, B and C is an extension of this principle to enable a more differentiated view.

This distribution can be represented graphically with a Lorenz curve. It visualizes how strongly the cumulative value share is concentrated on the cumulative number of suppliers and makes the class boundaries between the three classes A, B and C clearly visible.

Calculate ABC analysis for suppliers: A step-by-step guide

Performing an ABC analysis is straightforward and does not require any special software. A standard spreadsheet program such as Microsoft Excel is perfectly adequate. The method is based on a clear, comprehensible procedure that you can implement in four steps. The aim is to create a clean data basis in order to classify your suppliers objectively.

Step 4: Define class limits and assign suppliers

Now the actual classification into the three classes A, B and C takes place. The definition of the class boundaries is based on the Pareto principle, but is not rigid. Typical boundaries that have proven themselves in practice are

1. A suppliers: The suppliers that together account for approximately 80% of the cumulative purchasing volume.
2. B-suppliers: The subsequent suppliers that cover a further 15% of the cumulative purchasing volume (i.e. up to approx. 95% cumulatively).
3. C suppliers: The remaining suppliers responsible for the remaining 5% of the purchasing volume.

Now assign the appropriate class to each supplier based on their cumulative value share. It is important to understand that these percentages are guidelines. Depending on the structure of your supplier base, you can adjust these limits to achieve a categorization that makes sense for your company.

Practical ABC analysis example in a table

To make the theory more tangible, let's look at a simplified example. A company has 10 suppliers with a total purchasing volume of €2,000,000 per year. After carrying out the above steps, the following table results:

In this ABC analysis example, the unequal distribution is immediately visible. Only two out of ten suppliers (20% of the volume) fall into class A, but are responsible for 75% of the total purchasing value. These partners are of outstanding strategic importance to the company. Three other suppliers are class B and account for 20% of the value. The remaining five suppliers - i.e. half of all suppliers - fall into the C category and together account for only 5% of the purchasing volume. The results of the ABC analysis thus provide a crystal-clear basis for setting priorities in supplier management.

From analysis to strategy: measures for A, B and C suppliers

The classification of your suppliers into the three classes A, B and C is not an end in itself. Their true value only unfolds through the derivation of specific strategies and measures tailored to the respective category. The results of the ABC analysis provide the data-supported basis for differentiating your supplier management and managing your resources effectively. Instead of treating all partners equally, you can now develop prioritized support concepts that take into account both the value contribution and the effort required.

Strategies for C suppliers: Process optimization and automation

The large group of C-suppliers is responsible for a very low proportion of value, but often causes a high level of administrative effort. The leverage here lies not in the negotiation of individual prices, but in the radical minimization of process costs. The ultimate goal is to automate procurement processes. Implement e-procurement solutions, use electronic catalogs (e.g. via OCI/Punchout) or introduce purchasing cards (P-Cards) for low-value requirements. Bundle orders to reduce the number of transactions and consider consolidating suppliers. Support for this C category should be automated as far as possible and based on the "no-touch" principle in order to free up your purchasing resources for the more strategically important A and B suppliers.

Limits and extensions: When ABC analysis is not enough

Despite its undeniable advantages, the classic ABC analysis also has disadvantages and limitations. Its greatest weakness is its one-dimensional approach. As a rule, it is based exclusively on a single quantitative key figure, usually the purchasing volume. Qualitative and strategic factors such as delivery reliability, innovation potential, technological dependency or supplier risk (e.g. in the case of a single-source supplier) are not taken into account. A supplier with a low turnover (C-supplier) may be responsible for a critical, non-substitutable component and would therefore be of high strategic importance. To obtain a more comprehensive picture, the ABC analysis can be combined with other methods.

The solution: Combination with the XYZ analysis

A very useful extension is the combination with the XYZ analysis. This classifies objects not according to their value, but according to the regularity of their consumption or orders:

1. X suppliers/parts: High prediction accuracy, constant consumption.
2. Y suppliers/parts: Medium forecast accuracy, fluctuating or seasonal consumption.
3. Z suppliers/parts: Low forecast accuracy, irregular or sporadic consumption.

The combination of both analyses in an ABC/XYZ matrix enables significantly more differentiated control. An AX supplier (high value, constant demand) is an ideal candidate for just-in-time concepts. A CZ supplier (low value, sporadic demand), on the other hand, requires a procurement strategy aimed at minimal management effort and demand-oriented, simple orders. This multi-dimensional approach leads to a much more precise and effective supplier strategy.

Conclusion

The ABC analysis is more than just a calculation model; it is a compass for modern purchasing. By separating the essentials from the non-essentials, you can reduce operational hectic and instead build genuine strategic partnerships. Although the pure sales analysis does not always provide the full picture - which is why extensions such as the XYZ analysis are useful - it is indispensable as a starting point for professional supplier management. Use the transparency gained to finally deploy your resources where they create the greatest business value.