The recent trend towards SKU proliferation causes inventory dollars to balloon and margins to fall. These problems have been exposed by Covid-19 demand shifts.
Companies are falling into the trap of fractionalization in an attempt to appeal to all consumer types across all retail channels.
Product Portfolio Management as part of the S&OP process can be used to identify candidates for rationalization along with a valuable new metric: SKU Economic Value.
A few months back I read an article about plans by international snack food company Mondelēz to rationalize their SKUs by 25%. It was apparently part of a larger effort to simplify the supply chain in response to the Covid-19 pandemic, while also doubling down on—and delivering strongly against—core products.
Proctor & Gamble and Coca-Cola announced similar efforts to deliver a narrower portfolio of their most strategic products. Coke even announced it was discontinuing the Tab diet soda platform. It seems Covid-19 forced decisions that ultimately helped refocus resources.
It wasn’t long before the article started making the rounds on LinkedIn and various supply chain forums, and even less time before supply chain talking heads started pronouncing the ills of SKU proliferation. Then came the virtual finger-wagging. It was as if supply chain practitioners were complicit in some egregious crime.
I shook my head. This is not the first time recently that such pundits missed the point. So, after resolving my own work-related flurry of activity related to Covid-19, I thought I should add a few thousand more words to the public discourse around this topic.
Before settling down to write, I reached out to about a dozen colleagues in the consumer goods space and asked their opinions on SKU rationalization and portfolio management. From the outset, it was apparent they shared my personal observations. Every contact I polled had experienced extensive SKU growth within their organizations, and nearly all of this expansion was directly attributable to some very specific market drivers and dynamics.
No one felt that their product portfolios were bloated because of neglect or a broken process. It also became apparent that one cannot properly discuss or examine the problems of SKU proliferation without first contextualizing these influences.
Why Is SKU Proliferation Happening?
First and foremost, the primary reason for SKU proliferation is the ongoing adaptation (migration, transformation) toward new ways of doing business, notably e-commerce. The most common example is eCommerce retailers requiring a consumer package that is different than the normal open stock item—such as a product bundled as a three-count vs. a single count SKU.
I suspect the first question one might ask is “Why would they want a different pack out?”
The answer is pretty simple, e-tailers want to make money. And a larger-size or multipack offering improves the per order “ring” of any item and helps overcome the expensive order processing and shipping costs. This change to a multi-item pack out results in the creation of a completely different salable item, often much different than the traditional, open stock product sold by brick-and-mortar retailers.
Many of the companies I talked to admitted to nearly doubling the number of SKUs in their portfolios simply by establishing items specifically for sale via e-commerce.
Why There Is No Easy Solution To SKU Proliferation
While these eCommerce items afforded opportunities for sales in an explosive new growth channel, it also triggered a whole host of downstream repercussions, including fractionalization of demand, subscale operations, and additional costs.
In light of such implications it is easy to understand why traditional inventory metrics start to look out of control compared with those from just a few years ago, as inventory value increases disproportionately to top-line revenues, margins, or any other typical comparators.
Different Retail Channels Force SKU Proliferation
Of course, this reality begs the question: why not just create a common, open stock package that also serves the needs of eCommerce? It seems easy enough to do, right? It is not. Simply put, a package optimized for e-commerce may not be right for a brick-and-mortar retailer. Imagine for a moment having a shampoo product on a shelf at a typical brick and mortar retailer.
Then consider that the shampoo is taped and double-sealed to help prevent leakage in a format optimized for eCommerce sales. In the traditional retail environment, this iteration of the SKU prevents an at-shelf consumer from smelling the product they might wish to buy. The e-commerce version of the product works against the at-shelf consumer experience.
Of course, even if there were no in-person consumer implications, special pack outs for eCommerce can add considerable costs such as bundling and labeling materials, which you would not want to extend over the entirety of a product line.
Another reason for SKU proliferation is the prevailing strategy to be everywhere a potential consumer may shop.
Another reason for SKU proliferation is the prevailing strategy to be everywhere a potential consumer may shop, and with a channel-appropriate product. This has caused both SKU and inventory bloat by creating more packaging options than ever before. Using our shampoo example, consider an organization seeking to penetrate the dollar class of trade by offering a smaller, more price-sensitive package—an 8 oz. vs. a 12 oz. format for the same shampoo.
This downsizing creates yet another new SKU that further reduces scale, adds inventory, and adds demand volatility while increasing costs.
Beware The Pitfalls Of Fractionalizing Demand
Similarly, “supersizing”—the creation of jumbo sizing or multi-pack preferences specific to club-channel products—has the same effect. Very quickly the single open stock item for retail has grown into 4 different variants: open stock, eCommerce multi-pack, downsized dollar offering, and the club version of the product.
This desire to meet consumers at every consumption touchpoint is a significant driver of SKU proliferation. And to make matters worse, businesses are not targeting just any consumers; they are now targeting all manner of very specific consumer types.
Microtargeting All Consumer Groups Creates Downstream Problems Without Driving Revenue
Spurred by changing demographics in the U.S. alone, there are now more SKUs than ever before targeted to the needs of distinct population cohorts—with distinctive packaging reflecting the needs of these various communities. Many consumer goods companies have developed special multi-language packages, or packages with ethnic models, or slightly modified formulas or sizing to meet the specific needs of these consumer communities.
These consumer goods organizations are acting in earnest to meet the changing needs of their diverse consumer base. Of course, this effort requires a considerable number of special SKUs with all of the incumbent subscale and portfolio bloat implications.
I too know the difficulty of arguing to discontinue an item when the overarching commercial strategy insists that every case matters.
And finally, in the quest for every last revenue dollar, many items that traditionally would have been discontinued because of lost distribution at brick-and-mortar outlets have found a new home online. Whether these “long tail” items are sold through direct-to-consumer or eCommerce channels, it has become harder to give up and surrender revenue on items with residual sales and very limited overhead requirements.
Of course, not every item belongs online and many are less beneficial to margins than one might suspect. However, I too know the difficulty of arguing to discontinue an item when the overarching strategy insists that every case matters.
SKU counts have mushroomed and inventory has expanded and become more costly as we fractionalize our demand.
So yes, product portfolios and SKU counts have mushroomed; inventory has expanded and become more costly as we fractionalize our demand without a corresponding increase in top-line sales. It is a predictable side effect of trying to meet the demands of every consumer wherever they might chose to shop. To those of us working the supply chain front lines every day, we are very aware of these changes that the pundits and prognosticators have mostly missed in their analyses.
How Can We Manage Portfolio Bloat?
These seismic changes mean we need to think differently about a lot of things—most importantly, traditional measures of inventory need to be reprocessed to reflect our new reality. We should expect that inventory dollar values will swell with increased SKU counts. Product margins may sag as our MOQs and EOQs take a hit due to fractionalization. Ratios of inventory margins or sales-to-inventory will suffer, as top-line sales grow at a slower rate than that reflected by inventory expansion.
The new ways of doing business have altered set points from just a few years ago, making comparisons, well… silly. And it goes without saying that Covid-19 has accelerated the move toward e-commerce offerings. In fact, I am not sure the full impact of SKU proliferation has been realized yet.
I am a huge proponent of using the S&OP “Product Portfolio Management” process to manage product portfolios. If used well, the portfolio review process could be leveraged not just for new products but also to examine commercial innovations such as package size changes. The process can also be used to identify products for potential rationalization as well as those products in need of cost-based renovation.
When well executed, portfolio review examines the entire lifecycle of a product, from ideation to rationalization and all the changes in between.
When well executed, portfolio review examines the entire lifecycle of a product, from ideation to rationalization and all the changes in between. It is uniquely predisposed to assessing issues relating to SKU bloat and rationalization. The magic of this process lies not in establishing blanket rules like examining “anything less than 2% of top-line revenue in a product category” but with a more targeted approach that first evaluates the SKU-level economic value-add of an item.
This inherently elevates the level of analysis and promises more strategic precision in the process, while potentially preventing gross mistakes like cutting low-volume items that are nonetheless margin accretive while keeping higher-volume items that have little or no margin.
Because economic value-add methodologies account for the implications of inventory carrying costs (of any product), the portfolio review offers a stronger assessment of an item’s margin quality. Any item with a low or negative economic value deserves a robust assessment to determine whether to keep it. Following this analysis, other filters, such as volume percentages within a category, can be considered and properly weighted.
Slimlining Your Portfolio Using The SKU Economic Value Formula
SKU economic value is really a simple calculation if you want it to be: SEVA= (SKU Margin—Inventory Costs). The complexity comes in defining margin, and the inventory cost. Here again, as a first level sieve, I keep the math simple. Gross margin contribution for the SKU—the cost of capital for the average inventory held in support of the SKU.
I don’t include all of the other costs of inventory such as insurance, administration, loss etc. as they tend to be captured in COGS. I include all forms of inventory (raw, pack, WIP and FG) against either a set of averages or an inventory simulation.
In the past, I have assembled these and other relevant metrics and facts into a matrix with other elements that are important to decision-making. Most of these are typical commercial or operational parameters.
I then consider a raft of simple yet relevant questions for discussion. For example, “Does the item have a strategic purpose?” The number of potential questions for evaluating SKUs are countless. Ask yourself:
- Is the SKU an entry product in a category you wish to penetrate?
- Is the product a placeholder for a future one-for-one swap out?
- Does the product cannibalize your core offerings?
- Is the product easy to make?
- Are there reasonable cost improvement opportunities to improve margin?
- Are there opportunities to reduce EOQs and/or MOQs to make the product less impactful from an inventory perspective?
- Does the product help to absorb significant overhead expenses?
- Can different package formats be collapsed?
- Does the product have an on-shelf purpose (i.e. to enhance a billboard effect)?
- What is the ACV percentage?
- Has the product experienced delistings at multiple retailers?
- Is the product competitive with other product offerings?
The list can go on. While these questions reflect some obvious CPG examples, every organization across any industry should be able to establish similar market-based criteria that can be leveraged for SKU analysis. The questions are always best when tailored to the specific operating model and commercial strategy of an organization.
Once completed, this matrix and questionnaire become the source documents for constructive conversation within the product portfolio review process.
I would also highly recommend investigating technology solutions currently available that merge big data sources with predictive analytics engines to help understand the futures of some products, as well as the changes in consumer behaviors and demographics.
I have found these useful in providing some the “relevant factors” I mention. However, I do not think these tools are best used as a primary filter but instead better leveraged when the analysis of low/no economic value is completed.
Merging the S&OP product portfolio process with SKU-level economic value analysis is a much smarter way to manage your SKU portfolio.
Merging the S&OP product portfolio process with SKU-level economic value analysis—while also examining targeted, relevant factors—is a much smarter and deliberative way to manage your SKU portfolio. It helps define the value and role of each item in the portfolio. And deepening the analysis by building a questionnaire helps to refine and improve the decision-making around individual SKUs.
Despite these very public pronunciations by the likes of Mondelez, I suspect expanded SKU counts will remain higher than the targeted reductions. Hopefully, the teams assigned to execute against the strategy work through a smart and deliberate approach to evaluating which SKU’s should stay.
I have personally observed the combined focus on value-add, the leveraging of relevant factors and analytics, and the questioning process I describe lead to pricing changes, size consolidations, cost-based renovation and reformulations, improvements in plant operating parameters, agreements from vendors for lower EOQs and from contract manufacturers for lower MOQs, as well as the expected discontinuations. It is an effort that always puts money on the table.
If you are not currently using a product portfolio review process, read this article that can offer insights into the elements required.