SKU Rationalization | 5 mins read

SKU Rationalization- Maximize Profits By Stocking Less

sku rationalization maximize profits by stocking less
Jin Hyun

By Jin Hyun

Companies that deal with large quantities of inventory know its important to find a balance between understocking and overstocking. However, another potential problem that businesses tend to overlook is having too much product variety.

As customers crave more product variety and options for customization, companies have responded by adding more SKUs (stock-keeping units) to their inventory. But problems such as high holding costs and poor inventory tracking arise when they go overboard. This is where SKU rationalization comes in.

What Is SKU Rationalization?

SKU rationalization, also known as SKU optimization, is the process of trimming a business inventory. Think of it as spring cleaning for businesses. The idea is to go over your stock of inventory and decide which products should be kept and tossed out.

But before going deeper into this process, it's important to understand what an SKU is.

SKU's explained
An SKU is a unique code assigned to a product, holding vital product information such as price, manufacturer, and product variation (e.g., color, size, flavor) among many other things. While there is no international standard for SKU codes, each identifier typically comes in the form of an alphanumeric code, which can then be printed as scannable barcodes. This allows businesses to scan these codes for
inventory control as well as tracking.

SKU proliferation vs. SKU rationalization
Today's customers have never been more spoiled for choice. For example, you don't just get to buy a tube of toothpaste, but you also get to choose a variant with a specific flavor, size, and feature set (e.g., whitening, for sensitive teeth, gum health)all from the same brand. As businesses add more products to their inventory, the number of SKUs in their supply chains also grows. This is known as SKU proliferation.

Today's grocery stores typically carry around 40,000 to 50,000 items - up from around 7,000 in the 1990s. In the pharmaceutical industry, the average distributor typically carried 55,000 SKUs in inventory.

The problem is that a high number of SKUs can lead to increased inventory costs, particularly holding costs. In addition, carrying too many product categories can quickly lead to diminishing returns - a result of insufficient research on customer demand.

How to Perform SKU Rationalization

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The process of SKU rationalization seeks to solve this problem by going through product catalogs and determining which SKUs are worth keeping. Its about maintaining enough variety while ensuring the business stays profitable.

Below are five steps to use this process for effective inventory management.

1. Re-evaluate Your Marketing Efforts
For operations managers, marketing is often low on their list of priorities. But marketing strategy can be used to sharpen your product mix and SKU count. For example, the 4Ps of Marketing, which stand for product, price, place, and promotion, can help managers understand what their customers need, how much they're willing to pay for it, and where they're willing to make purchases.

In any case, assessing your marketing strategy will help you develop your value proposition - the core of what customers get from an enterprise and its solutions.

2. Go Over Your Product Catalog

With the marketing strategy and value proposition sorted out, the next step is to go over the product catalog and see which SKUs align with the marketing plan. This will be easier to do if the product, price, and place of the marketing mix have been determined.

Think of this step as spring cleaning. Organize your SKUs into three categories-

  • Keep
  • Remove
  • Set aside
Knowing which products to set aside can be tricky, especially if the value proposition isn't clear. But be ready to revisit them as soon as your marketing efforts gain more traction.

Let's look at a pet store as an example.

  • We can use the 4Ps framework to decide whether to focus more on basic and affordable pet items or specialized, high-end products.
  • Is there a need to sell items in an online shop? Or do the majority of customers prefer to visit a physical store?

3. Analyze Customer Behaviors

Established businesses that use some kind of recordkeeping system, whether its supply chain management software or inventory spreadsheets, will have a history of sales orders for each customer.

Go over this data and sort customers by total order value in the last 12 months. This should reveal whether the demand for products (or category of products) is evenly spread out across all customers or the bulk of sales are dominated by a small group of customers.

For example, a home furnishings store that uses this method may learn that the majority of their sales come from property developers and investors that want high-end furniture. The store can then prioritize SKUs for premium raw materials.

For smaller businesses, something as simple as quick interviews and customer satisfaction surveys will reveal plenty of information regarding the items consumers prefer from the enterprise.

4. Predict product switching and cannibalization
Another benefit of having historical customer sales data on hand is being able to look at instances of product switching and cannibalization.

  • Product switching is when customers switch between brands for parity products - think fast-moving consumer goods (FCMG)
  • Sales cannibalization occurs when existing products lose sales when new products are introduced
By looking at sales records, it's possible to detect seasonal product switching and cannibalization. For example, a clothing store may see a surge in customers buying holiday-themed apparel during November and December. An electronics store will know to reduce stocks of certain smartphones when new models come out during October.

5. Balance high carrying costs and low SKU counts
Finding that middle ground between high carrying costs (which includes the cost of warehouse storage space, rent, and utilities) and low inventory counts can be the single most challenging thing supply chain managers have to deal with. But there are a few tricks to find this balance.

For B2B companies, long-term contracts ensure that any inventory the business keeps is already locked up and spoken for. Strong agreements with vendors also allow businesses to reduce their prices and freight costs through economies of scale.

For retail companies, their managers will have to learn to liquidate slow-moving and outdated stock sooner than later. Don't be tempted to hold on to these SKUs in the hopes of selling them at full value as they have most likely become obsolete.

Rinse, Wash, Repeat

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It's also important to note that SKU rationalization isn't just about reducing SKUs - anyone can do that. Instead, it should be viewed as a component of product management, where trimming inventory is driven by data-based decisions. Doing this prevents businesses from alienating their customers with a limited product mix or one that's too diverse.

SKU rationalization is a marathon, not a sprint. For best results, commit to repeating this process every six months.