SKU Optimization: A Parable and 10 Provocations for Action

By Bob Byrne
Partner
December 2009

Many companies are trying to cut costs by reducing the number of product classifications (stock-keeping units or SKUs) they offer. Here’s a story of a typical SKU optimization effort and 10 provocations that companies can use to help achieve lower costs, fewer out-of-stocks, higher revenues and lower prices.

The Parable

The CEO of a leading CPG manufacturer believed that the proliferation of SKUs was driving up costs—the well-known cost of complexity. Indeed, a company task force eventually found that about 40 percent of SKUs were either marginally profitable or unprofitable. Further, these SKUs generated only about 5 percent of total volume.

But the list of SKUs targeted for elimination caused an outcry from the marketing department. SKUs on the list were “critical to my brand’s identity” or served “a unique consumer micro-segment.” Likewise, the sales group had concerns about differentiated pack sizes and customer-specific promotion packs. The arguments proved long and contentious. Marketing and sales won some and lost others. A final target list, about 25 percent of all SKUs, represented the real dogs.

Then, six months later, an amazing thing happened: The CEO asked the CFO how much ingredient and packaging costs had been reduced. “Zero,” said the CFO.

                Distribution costs? Zero.

                Manufacturing costs? Zero.

                Advertising? Zero.

                Promotion costs? Zero.

                G&A?  Zero.

                Inventory? A little, but not 15 percent.

                Then the CEO asked, “How could this happen?” and the room fell silent.

10 Provocations for Action

When the CEO later told this story to a friend, the friend responded, “So you got rid of items that you didn’t make many of, and that nobody bought—and then were surprised that it didn’t make a noticeable impact?”

Is there a better way? Yes, but it takes some fresh thinking and counterintuitive approaches. Rather than attempting to describe the universal model for perfect SKU optimization (both impossible and boring), let’s think anew about the problem. Let’s call this our 10 Provocations for Action.

1. Start with the consumer, not with you.

Redefine what your consumer values, wants, buys, uses—and work backward from there.

Although most initial line and SKU decisions are based on rich consumer understanding, they tend to be unilateral and narrow. What have all of these individual decisions done to the overall portfolio and the consumer’s interaction with it?

Complexity costs are not a burden on the manufacturer. In reality, these costs are passed on to the consumer, as a kind of nVAT (non-Value Added Tax). You may have 50 variations of shampoo, but 80 percent of your consumers are buying just 10 of them—all priced 7-8 percent too high.

Do consumers value variety? Certainly not the way brand managers do. The record is clear: more choice seldom results in more sales, and may even cause shoppers to simply walk away from the shelf.

Reverse your thinking: Focus on necessary SKUs. Then use research on consumer preferences and switching behavior to design an optimal product portfolio based on what consumers really want, not what you can produce most efficiently.

Many SKUs end up as consumer or business “mistakes” that fragment volume for unnecessary or outdated reasons. But these mistakes are not just the low-volume SKUs!

So forget about eliminating just the easy 30 percent and instead focus on eliminating unnecessary medium- and high-volume SKUs. Imagine taking your highest-volume SKU in a category—24-oz. white—and replacing it with two SKUs—20- and 28-oz. white. Both would probably be pretty good sellers, but they’d be fragmented into two mid-sized SKUs. Wouldn’t you prefer to (re)-consolidate into a single Power SKU?

This is a huge trap. Is reducing SKUs 20, 30 or 40 percent good? Is it bad? In truth, it’s neither: It’s just something to do. What are you aiming for?

A large body of evidence shows SKU reduction can be a growth initiative.

How? Start with out-of-stocks. Most leading brands are out of stock at retail 4-6 percent of the time. But the SKUs that are out of stock are not the slow movers; they are the Power SKUs. Simplify the line. Simplify the shelf set. Reduce out of stocks, and grow volume.

If you’re starting with the consumer, you need to start with your departments that are closest to the consumer. So rather than running a supply-chain initiative, put marketing and sales in charge. Give them an opportunity to clean out and re-fashion the portfolio. (And give them very big targets.)

When a company introduces a new line, an enormous effort ensures that customers switch from competitors’ products and don’t cannibalize sister brands by using special introductory pricing, coupons, advertising, sweepstakes, etc.

Now, what happens when a product or SKU is de-listed? Nothing. Why shouldn’t the same discipline and energy expended in fattening the portfolio be expended to get it into shape?

Retailers will also reap benefits—better shelf alignment, lower out of stocks, rationalized promotion calendars, and improved inventory turns. It only makes sense to include retail partners in your thinking about SKU optimization.

The Moral of the Story

SKU optimization is more complex than many companies assume, but it also opens more doors than many companies can see. A far-reaching SKU optimization strategy offers the opportunity to identify and exploit keys to positive business transformation—and a chance to stand out from your competitors by doing it right.

Contact

Bob Byrne is a partner in A.T. Kearney’s New York office.
contact

The views expressed in this paper are those of the author(s) and do not necessarily represent the views of A.T. Kearney or the Global Business Policy Council. The views are not meant to suggest specific inducement to make a particular investment or follow a particular strategy, but only as an expression of opinion.