How to Do an ABC Analysis?

There are six basic steps1.

Identify the objective for the analysis. Determine success criteria.

An ABC analysis can accomplish one of two primary goals: to reduce procurement costs or to increase
cash flow by having the right items available for production or direct to customer sales.

Collect data on the inventory under analysis.

The most common data, generally available from standard accounting already in place, is annual spend
per item. This can be in terms of raw purchase dollars, or weighted cost including all ordering costs and
carrying costs, if those can be readily calculated.

Sort inventory in decreasing order of impact.

From most to least, rank order each inventory item by cost.

Calculate accumulated impact.

Using a spreadsheet tool, calculate the cumulative impact of the list of inventory items by dividing item
annual cost by total inventory annual spend, then adding that amount to the cumulative total of
percentage spent.

Divide inventory into buy classes.

This may not be a precise 80/20 characterization. Take a holistic view and do not concern yourself with
an exact 80/20 rule. The goal is to find areas where renegotiating contracts, consolidating vendors,
changing strategic sourcing methodology, or implementing e procurement may deliver significant savings
or ensure in-stock availability of high-volume items.

Analyze classes and make appropriate decisions.

The key to this step is follow-up and tracking. Once strategic cost management is in place based on
categories, periodic review is critical to monitoring the success or failure of the decisions.

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Vendor Evaluation:

There are basically three different types of vendor evaluation. These are:

-Informal use of records

-After-The-Fact Evaluation

-Before-The-Fact Designed
 Informal use of records: In this type of vender evaluation, data is collected from many sources such as
journals, diaries, log books, or financial records, and knowing what happened in the past allow one to
evaluate an event in order to make better decisions for the future.

After-The-fact-Evaluation: When event has occurred, a manager may ask questions like What happened?
How did it happen? Why did it succeed? or why did it fail? How well did it do? Responses to such questions
give data for decisions and future planning after an event has been completed.

Before-The-Fact-Designed, evaluation: In this type of evaluation, the evaluator plans and starts
gathering data early in the history of the project. Evaluation vendor capabilities is an example.

According to Frank Caplan, the vendor surveys and capability determination is an important tasks to the
purchaser's organization to determine, in advance, the capability of the vendor to produce quality
products on schedule. Efficacious companies hold their suppliers and vendors, consider them as partners
to assist in their business. It is viewed as mutually beneficial partnership. If a supplier/vendor is major part
or service to operation invite that supplier or vendor to strategic meetings that involve the product they
work with.

There are numerous tips and tools through which companies need to effectively rate their suppliers and
vendors, track their performance, and ultimately increase company's overall productivity.

1. Establish Performance Indicators: At the beginning of the vendor relationship, managers have to
determine what characteristics a vendor needs to have, demonstrate, or maintain to continue doing
business with company. It is important to create specific performance criteria for tracking and evaluating
suppliers and vendors regularly on monthly, quarterly, and/or annually. Considerations include size of the
company, number of certifications, quality management systems, complaint history, and financial stability.

A basic consideration for all business owner should be whether the supplier has a quality management
system in place. This does not just apply to manufacturing but any business including service providers. If
the supplier has a certain set of procedures in place then its people are expected to follow.

2. Classify Multiple Suppliers and Vendors: If company has a huge number of suppliers and vendors and
managers intend to craft a survey to evaluate them, it will be burdensome to apply the same survey to
each and every one. It is better to separate suppliers into levels based on how critical they are. Decide the
classification that is best for company and evaluate suppliers according to the effect they have on your
product or service in order of importance.
3. Devise an Evaluation Method: There are common methods to rate a supplier's performance including
evaluation forms, surveys, system metrics, and software applications.

Company professionals can craft a survey where they ask their own employees to answer questions and to
rate suppliers and vendors. Then, evaluators can review how many corrective actions they have to issue a
supplier or vendor, how many products they have to scrap or return because the supplier or vendor failed
to meet specifications, or how many customer complaints they receive due to a bad part or service from a
vendor. Evaluators must also monitor suppliers and vendors by doing an audit periodically. They need to
generate measurements or reports at the onset of the purchase and throughout the course of the supplier
and vendor relationship.

Experts stated that periodic vendor reviews would also involve a discussion about what the company had
been buying, how much it had been buying, what did that vendor have on the shelf or working on for push
out six months or a year down the road and did it represent a significant improvement over what had been
previously purchased, and what were competitors buying from a particular vendor.
 4. Determine Who's Calling the Shots: Once evaluators of company establish the criteria for evaluating
suppliers and vendors, it is to determine who in company will be responsible for reviewing the data. It
depends on how much Resources Company has to dedicate to evaluate their suppliers.

5. Maintain Good Relationships: It is very important to retain healthy business relationship with suppliers
and vendors as part of the team and treat them as such. Company managers must communicate often and
openly. Also, it is advised to avoid supplier and vendor conflicts by paying on time or at least honestly
addressing late payment issues and talking with supplier or vendor about it. Be frank and transparent with
suppliers and vendors. Make sure they understand company needs and expectations.

6. Decide When to Issue a Red Flag: When evaluators of company monitor a supplier's performance, they
have to decide when to praise them and when to issue a red flag.

7. Cut Loose Weak Links: Company should tolerate ongoing bad service. There may come a time when
managers have to let go of an underperforming supplier or vendor. The relationship with supplier is a
business partnership and if both parties are working to make sure that the partnership is a success it will
be a success. In the long run, having a win-win supplier and vendor relationship will be a competitive
advantage.

Vendor assessment process

Vendor assessment process

Vendor Rating (Ranking) and Certification:

The vendor rating system is used by many companies around the globe. It is explained by Feigenbaum as a
technique that provides vendor-to-vendor assessment, whereby each vendor is measured against another
specific vendor or group of vendors for price, quality and delivery. Rating results are reported quarterly,
and used to determine all future business activities with the vendor. There are different types of vendor
ratings established to fit the changeable needs of plants and companies. The basic and extensively used
vendor rating plan weighs the key factors as follows:
Price rating is:

Service rating is based on the percentage of promises kept. If vendor kept 90% of his promises, then,
service rating is equals 0.90 (25) = 22.5.

Vendor Audit:

All companies manage vendors to achieve SCM's deliverable of supplying safe and reliable goods and
services to customers, the operations. In vendor management, auditing process is vital in offices and
companies. It is done to do the required checks. It might be for the operations or it might also be done for
the vendors who supply goods. Traditional vendor audit procedures are time-consuming and therefore
very expensive for the average organization to undertake with the required scale and thoroughness. And
they are often not particularly effective.

Generally, manufacturing, factories and industries use suppliers to get there raw materials. These goods
should be of quality and standard. Anything bad cannot be used by the company, because the end product
reaches the customer. If the customer gets poor or damaged product then it degrades the image of
company and customers will purchase it from other company. Due to these reasons, supplier audits are
conducted by giant companies. There are different vendors and suppliers who supply goods to companies.
It is necessary for company to make a systematic check before approaching to any vendor for getting the
raw materials. It is of paramount importance that the raw material is of good quality and standard. Once
the product is developed in to finished good and it is circulated in the market, then it cannot be changed.
So, if the raw material is of poor quality, then end product is definitely going to face lot of problems and
issues. The customer might return the product with complaints.

Therefore trained supplier must be recruited. There are certification courses that an individual can take to
become a supplier auditor. The certification gives the individual an upper hand over others. The auditor
has thorough knowledge and practical knowledge of how to check and do the audits for the vendor's
items. There is a checklist which the auditor should follow and comply with. Supplier audits are very
essential for the organization. This audit makes sure the quality of the product and also the raw materials
are such that it will last for long and will not get damaged within short period of time.

Vendor evaluation or supplier audits should be done once in a year. In this kind of audit, the vendor's
location, the products and his manufacturing unit should be audited and checked well. The kind of audit
and how many times it should be done depends on the kind of products and service the company is using
or buying from the vendor. It also depends on how important is that vendor and his products for
company's business. Based on that, one can decide on the kind and times an audit should be done.

Vendor audit

In supplier audits, the facilities of the vendor must be checked. The auditor should check and appraise
short shipments, invoice to and fro from the supplier. The deliveries should always be checked in order to
keep the quality standards intact. Auditing is a very crucial task and the supplier auditor should have the
knowledge and ability to fulfil this responsibility with sincerity. It is not at all easy to check the vendor and
his products. There needs to be smartness, ability and tact in doing this. Auditors should make sure that
the vendor does not get upset and understands the importance of this check. This will make sure that the
business relations remain good. The vendor also eagerly complies with the audit and checking procedures.
It is the responsibility of any business owner to give importance to quality checks and audits. If company
has to grow and flourish in the business, then it is always best to do proper checks of the equipment and
raw material that the vendor is supplying for the said business.

It has been documented in many studies that Supplier quality management is a critical business practice
for firms that gradually outsource business processes to strategic associates and have increased
dependence on vendor products and services. The audit process guarantees that suppliers are continually
performing at or above the levels delineated in procurement contracts. Incorporate industry practices for
developing supplier audit procedures and checklists to recognise underperformance that might be timely
improved and encourage support quality efforts in high-performing areas.

Procedure of Vendor Audit:

 Planning: Audit planning is done by the lead auditor charged with recognizing the scope of the audit.
Here, an audit performance metric a combination of a checklist and scoring card, might be developed that
identifies measurable performance areas that will be the subject of the audit. Measure factors might
include such matters as on-time delivery, order response times, response times to requested corrections
and product quality. Furthermore, audit plans should address the essential technical, capital and human
resources necessary to adequately perform the audit.

Audit Management: During audit period, performance data is secured, measured and recorded over a
course of time. Information from the supplier is normally required to effectively perform the audit process
such as acquiring and reviewing supplier's quality manuals, policy and procedures, as well as current
certifications. There are many areas that require effective management during the procedure. It is
important to be prepared for changes to audit schedules to the scope of supplier performance appraisal.

Reporting: Audit reports comprises of measurements and data collected using the performance metric.
Audit reporting highlights the major cause of identified performance problems. In reporting, remedial and
preventive actions are included as recommendations. Furthermore, prior audits should be incorporated
into reports as a way to track historical performance variations. Audit reports include qualitative data
about the supplier, such as noted performance observations or internal interviews with staff members that
work with the supplier. Also, industry performance data is generally incorporated as a comparison tool
that provides additional supplier ranking against benchmark standards.

Review: After report is made, a company must review the results of an audit report with supplier
management. This should be a formal meeting that allows supplier representatives to provide feedback
about the performance data contained in the audit. Audit review process is beneficial and gives an
opportunity to support the collaboration between the vendors, but be honest about any
underperformances. This is the time when supplier performance goals and objectives might be established
to correct any existing problems.

To summarize, vendor evaluation is done to ensure a portfolio of good suppliers available for use. It is also
a process applied to current suppliers to measure and monitor their performance to decrease costs,
mitigate risk and improve continuously. It can be believed that there is a need to conduct vendor audits for
quality control in an organization. This need for a closer monitoring of a vendor's qualities and practices
stems from an ever-evolving quality control market, and an industry where quality products are a
requirement. The main areas that need to be appraised in a vendor audit are vendor viability,
management responsibility, system accuracy, and data integrity. The prime aim for a vendor audit are to
evaluate the quality management of the whole organization, through its procedures and data processes. It
is an assessment of quality control measures taken by the vendor to guarantee that their products and
services are satisfactory for business transaction and beneficial for end users.

Full Partner

 Goals are compatible with your organization's future plans.

  Demonstrates 100 percent on-time delivery performance and is capable of participating in your
organization's automatic ordering systems.
 Fully ISO 9000 or QS 9000 approved.
 Provides full field response and support within 24 hours of notification.
 Provides assistance with new designs.
 Provides proto-samples within one week or less (depending upon tooling).
 Consistently meets the full partner criteria in five key areas: technology, quality, responsiveness, delivery
and lowest total cost (see below for more details).

Associate Partner

 Satisfies most of the full partner criteria as agreed upon by management.

 Supplier's management and its employees demonstrate an ongoing commitment to continuous
improvement in quality and delivery. Develops goals, objectives and action plans to meet or exceed the
goals and objectives of your organization.
 Supplier's services or products fulfill a strategic need in your organization.
 Requires little effort and expense to achieve full partner status.

High Risk Supplier

 Supplier's goals and action plans are not compatible with your organization.
 No benefit in developing these sources to associate partner or full partner status.
 Current quality and delivery are acceptable to sustain present production.
 Not economically feasible to move tooling for parts these sources are currently producing.

Incapable Supplier

 Supplier does not meet quality and delivery goals.

 Does not demonstrate a desire or a capability to improve deficient service areas, such as quality and
delivery.
 Has no interest in obtaining ISO 9000 or QS 9000.
 This supplier should be dropped immediately.

Once you have agreed upon these categories and established criteria, you're ready to focus on the topic that many
accountants claim is the most important--cost. However, cost must be taken to the next step. In other words, you
need to look at the total cost--not only piece price.

The lowest total cost of a product includes not only its initial procurement cost, but all those factors that
went into getting it to market and keeping it there. Therefore, you must take into consideration these added
factors.

Lowest total cost can be calculated as: LTC = Piece Price x IV. In this equation, IV is a composite index
determined by tables developed and agreed upon within your organization.
For example, if you select quality, delivery and proto lead time as the factors you want to assign an IV to,
then the formula would appear as: LTC = Piece Price x Quality IV x Delivery IV x Proto Lead Time IV.

If one supplier exhibits a 315 PPM performance level, a 100 percent on-time delivery record and a 10-day
lead time, its composite index would be 1.04. If a second supplier exhibits a 12,400-PPM performance level,
a 20 percent on-time delivery and a 20-day lead-time, its composite index would be 3.65.

If the first supplier's part cost $0.06 each and the second supplier's part cost $0.03 each, whose part is
better?

By following this formula, you can develop tabulated charts (see below) that track lowest total cost for all
your suppliers. This can be a very effective evaluation tool.

Full Partner Criteria

Suppliers qualify as "full partners" if they meet the following key criteria: Technology:

 Demonstrates an ongoing ability to assimilate state-of-the-art technology into their business.

 Demonstrates an ability to quickly develop new processes and modify existing processes as necessary to
create a sustained competitive advantage for customer and self.
 Strong commitment to R&D.
 Demonstrates a willingness to invest in the business and grow.
 Willingness to pursue mutual product and process development.
 Complete understanding of process capabilities.
 Provides documented design guidelines usable by customer engineers.
 Full ISO 9000 or QS 9000 approved.

Quality:

 Consistently meets or exceeds your organization's quality goals.

 Knows whether or not the parts being produced for your organization meet or exceed the letter and intent
of the specification.
 Does not ship out-of-spec parts.
 Has well-documented processes (both manufacturing and administrative).
 Demonstrates a willingness to say "no" and present alternatives to new designs that lack process capability.

Responsiveness:

 Demonstrates an ability to interact directly with your engineers and maintain ongoing business
relationships.
 Actively supports your remote manufacturing sites.
 Provides timely responses to technical and business issues.
 Demonstrates a high level of commitment to your organization.
 Is a long-term thinker and is financially stable.
 Demonstrates flexibility to quick changes.

Delivery:

 Willingness to work with your organization to optimize lead times.

 Consistently meets delivery goals.
 Allows order flexibility within acceptable limits.
 Has business systems in place to accurately schedule product and procure material in an economical
manner.
  Notifies your organization in advance of shipments delayed for any reason.

Lowest Total Cost:

 Demonstrates a commitment to continuous cost reductions.

 Willing to work with you to perform value engineering for new and existing designs.
 Openly shares cost structures and pricing models.