At Hershey’s, our entire Latin American portfolio suffered from a malaise that plagues countless other corporations – a portfolio that drastically exceeds the optimal number of SKUs. The result of this unfortunate situation? Unprofitable items, under-optimized items and the risk of losing customer loyalty and brand equity. Unprofitable or dead-end SKUs are a drain on resources and take up time and effort that can be spent on your most valuable products. Culling unprofitable SKUs through SKU rationalization, therefore, is a must, and in this article you’ll learn how do it effectively. But what’s more interesting is identifying the SKUs with untapped potential and figuring out the ways to increase their profit margins. Here’s how I did exactly that Hershey’s.
What Is The Optimal Number of SKUs In Demand Planning?
Sales and Marketing’s motivations will not always align with yours as a demand planner. They will always seek to maintain a rounded portfolio and introduce seasonal and non-seasonal SKUs that drive your planning book items up, and Hershey’s was no exception. In our case for Mexico it went over 500 SKUs and over 2000 for the rest of the region. For us, in our particular industry, we didn’t want more than 100-120 SKUs to plan for, instead focusing on the 10-20 top SKUs that provide most of the revenue (+80%). Given our over-sized portfolio, it was no surprise to see that the majority of my demand variation came from the tail end of 70-100 SKUs. These were C grade items that together generated less than 5% of the total revenue.
We had a compelling case to cut these lower tier SKUs that were difficult to forecast. Cutting them was easy to sell to Finance but we faced a struggle with Sales & Marketing, who saw this SKU rationalization as a threat to customer needs and brand strategies. This resistance made me want to bolster my argument by gaining extra insight that most demand planners wouldn’t consider. But first, let’s look at the initial steps I took to rationalize and streamline our very bulky portfolio.
Step 1: SKU Rationalization And Segmentation For A Healthy Portfolio
This was a simple case of sitting down with Finance and crossing off SKUs that negatively impacted revenue. This was straightforward because we can easily identify the SKUs that lose money, and there is little argument to keep them unless there is a wider brand strategy at play.
Step 2: Analyze Your Tail Items
Then we focused on that dreaded tail, those difficult to predict, barely profitable items that are rounded up or linger for reasons unknown even to the commercial teams. These are often items that used to make money but have since become unprofitable, or have become too complex to manufacture. Often these items have been challenged for years by demand planners, but have remained in the portfolio as demand planners consistently fail to communicate the benefits of cutting them.
Step 3: SKU Performance Analysis and Phasing Out
We conducted analysis into SKU performance by generating 2x2s based on revenue, or gross margin, and total sales per year. Those quadrants were divided by standard or expected gross margins or break-even revenue by item. When doing this, concentrate on eliminating or phasing out over 6-12 months as there can be implications with retailers and inventory planning. We chose this 6-12 month in conjunction with our Brand Managers who knew what the negative implications of withdrawing particular SKUs from their portfolio would be. This gave them enough time to develop short term strategies to mitigate any negative effects.
Step 4: Identify Items That Are Profitable But Cannot Be Improved
Then we looked at the items that were profitable but lacked dimension capacity for increasing more sales volume by correcting distribution or substituting less profitable items. In short, these are profitable items but ones that cannot be further optimized for greater profit. Cutting these SKUs is important to the long-term strategy as we want to prioritize our bread and butter items, those workhorses that are profitable and still have plenty of room to increase revenue via CI or financial initiatives. We knew our core was chocolate, and in the chocolate group we had 8-10 items we could improve our revenue projections for. These improvements required moving away resources away from lower tier items. This reallocation of resources allowed us to increase tier 1 sales mix and volume.
Step 5: Gain Multidimensional Insight From Across The Business
A great component to consider when making these decisions is a thru analysis on several dimensions from your financial partners and manufacturing colleagues. Yes, it makes sense to consider total sales and gross margin (or standard gross margin) as your initial differentiators to create your 2×2, but I expanded this out to include insight from other areas of the business. From the demand planning side, you need to look at fixing errors to improve forecast accuracy, namely WMAPE and BIAS. But going beyond this, I sought out opinions from experts in the fields I knew impacted profitability. From Manufacturing, I extracted data on turns, number of cycles and batches. Given the nature of our products at Hershey’s, it was important to consider the remaining shelf life after the date of manufacture.
Step 6: Look at How Transportation Costs Affect Item Profitability
Then I turned to Logistics, focusing on a very important point: total transportation costs. There were some customers that are located far away from our distribution network and as such are more expensive to deliver to. I identified these customers by looking at product per pound shipped and the number of racks we used, indicating utilization of space. This gave a sense of how complex and costly it was to move and distribute particular items
Step 7: Incorporate All The SKU’s Financials Into One Easy To Understand Figure
On the financial side, we looked at every single indicator of profitability including SGM, VCM and SAM, etc., but we also focused on final sales margins, accounting for G&A and marketing expenses as well as costs of obsolescence. To each dimension I gave a weight and multiplied all dimensions in order to generate one representative number that helped me differentiate one item from the other. This was incredibly useful in making final recommendations to Sales & Marketing, helping me explain why some SKUs deserve to continue due to their strategic or brand value, or whether they needed the attention of our engineering teams to reconfigure packaging or other manufacturing improvements, or maybe outsourcing to reduce our fixed costs. In all cases, these numbers meant something to other areas of the organization that had expressed concerns but had no way to make themselves heard, or were overlooked because there was no way they could clearly illustrate the negative impacts of certain things on the product. We succeeded in quantifying these concerns in a way that was easily understandable and communicable to all stakeholders.
This all resulted in cutting the portfolio by 25-30% and helped boost profit margins for our leading items. One important point I learnt throughout this whole process was that item review must be done on a regular basis, at least once a year to provide an update on items that were improved, and to see the actual impact of the discontinuation or substitution initiatives. That way we can check which decisions added value and those that didn’t.