Stop chasing your SKU tail
Your fast-moving products are the source of volume and profitability. And if you're like most, you regularly eliminate the weakest performers. But taking the same approach time and again is, well, a little like chasing your tail: Despite the effort, the results are always the same-and always disappointing. For a real impact, you have to take aim at some of your unnecessary, high-volume products as well.
Every three or four years, manufacturers roll up their sleeves, muster an ounce or so of determination, and perform the obligatory SKU reduction effort. They set out to rid their inventories of the slow-moving items and line extensions that are either past their prime or simply never lived up to their promise. Armed with Pareto charts, they go after the low-hanging fruit—the easy 30 percent of slow-moving, low-volume SKUs that tend to clog up an otherwise efficient pipe to the consumer. These SKUs are easy to spot because they almost always turn up as the "tail" on the Pareto chart (see figure 1). This effort is at once necessary and commendable. But it's not enough.
Let's consider a radically different approach to SKU optimization. So radical that it will seem obvious until you realize that no one does it. First, forget about eliminating just the easy 30 percent and instead focus on eliminating unnecessary high-volume SKUs. We'll come back to the easy 30 later. Second, decide which SKUs are necessary. Rather than sorting through products to find those that are superfluous, look at your products from the consumer's perspective and find those that score big points with customers. Finally, reverse the new product introduction process and launch a failed-product elimination process. That's right. A failed-product elimination process. We put energy into product launches and sneak back in the dead of night to de-list the laggards.
Every one of these ideas makes sense on its own, but together they hold the prospect for a portfolio transformation.
The Problem with Proliferation
The SKU proliferation problem began decades ago as consumer products companies—electronics, food, cosmetics—answered the siren songs of the era: Get close to the consumer, use target marketing to respond to their every need and fill shelves with enough choices so not to miss anyone. It has been a drive to innovate—or pseudo innovate—based on what consumers want or what research says they want. The result of this single-minded focus? More than 500 shampoos at Wal-Mart, 85 30-inch televisions at Circuit City, 120 varieties of pens at Office Depot and 52 versions of a single brand of toothpaste at the local drugstore. Doubtless, our demanding consumers feel targeted, if not a little overwhelmed.
The trouble is that more choice seldom results in more sales, never mind that it may harm margins and reduce customer satisfaction by crowding retail shelves. It is unusual for retailers to provide more shelf space to a category simply because new SKUs are added. Retailers' response has been to ration shelf space—stocking slow-moving items only when promoted by the manufacturer and charging fees to manufacturers when products don't sell quickly.
Meanwhile, manufacturers continue to struggle with the hidden costs of SKU proliferation. With thousands of SKUs, forecasting and planning products is not only difficult but also requires more of everything—supervisors, training, inventory, production-line changeovers, capital, and time and expense in product development. These costs ultimately represent hidden taxes on consumers who end up paying more for a variety they neither need nor want.
Even worse, meeting every consumer's every whim has prompted both retailers and manufacturers to take their eye off other important areas. Do managers regularly review the overall product portfolio to ensure that it supports their business objectives? Are the obvious inventory costs, or the not-so-obvious manufacturing and supply chain costs being addressed? What about the larger issues in marketing and R&D as innovation is stifled and communication muddled?
No Improvement Opportunities In the Tail
For practical purposes, attacking the SKU tail is an exercise in futility. It's precisely because the easy 30 percent comprises the lowest-volume SKUs that nothing really comes of the effort. Products disappear, but nothing—shelf space, inventory, gross margin, or market share changes. Factories remain open, production lines continue to sputter along, changeovers go on disrupting, and physical distribution is still a maze. Go after SKUs that account for just 2 to 5 percent of sales volume and the opportunity for a transformational change is limited, if not impossible. Reduce these low volume SKUs and your costs just might go down by a fraction of a percent, but only temporarily. The effort is akin to cleaning out the kitchen pantry and pitching that can of capers that seemed like a good idea five years ago. Is there more room in the pantry? A little. Is there a major impact? No.
Interestingly, these attacks on the easy 30 are usually run as supply chain initiatives—aimed at cutting operating costs by reducing product-line complexity. Marketing and sales people argue that eliminating the latest promotion pack will negatively affect brand equity, but they needn't worry, for nothing really happens.
There is a better way to clean the pipe. Rather than focusing solely on attacking the SKU tail, reverse your thinking: Decide which SKUs are necessary rather than which are not. Then use research on consumer preferences and switching behavior to design an optimal product portfolio based on what the consumer really wants, not built around what you can make most efficiently. We call this a ConsumerFirst approach. Companies identify and eliminate redundant mid-size SKUs—those that neither meet a true consumer nor retail need—in addition to the easy 30 percent on the SKU tail. If different retail channels need additional unique SKUs, add them back in. But sparingly. The result will be fewer, but bigger, mid-range "power" SKUs. And there will be more room for growth because there is less shelf clutter, fewer out of stocks and more time to focus on true innovation.
Our ConsumerFirst approach is not a unilateral effort in which the rewards are reserved for manufacturers. Retailers will also share in the benefits—better shelf alignment, lower
out of stocks, rationalized promotion calendars and improved inventory turns. In many cases, optimized shelf sets will increase revenue on their own. (Remember, out of stocks hurt fast movers infinitely more than those slow movers in the easy 30 percent tail.) And all you have to do to achieve these benefits is to stop chasing your SKU tail (see figure 2).
If Consumers Got Us into This Mess, They Can Get Us Out
SKUs proliferate for one of two reasons: to fulfill a consumer need, or to provide unique products for different trade channels. Either way, many SKUs—and not just the low-volume ones—end up as consumer or business "mistakes" that fragment volume for unnecessary or outdated reasons. With this in mind, SKU optimization should be undertaken for the same consumer and business reasons that spawned them—and not simply to make the supply chain more efficient. In a ConsumerFirst approach, the goal is to identify SKUs that are genuinely valuable and eliminate the rest. The challenge is in gauging which SKUs are genuinely valuable to consumers. How many SKUs would it take to make consumers happy? If a brand has 60 SKUs, could 25 do the job if a company didn't have to worry about shelf space, competitive encroachment, or channel differentiation?
Answers to such questions require a deep understanding of consumer needs, and purchase and usage behavior. Manufacturers already have this information; they used it to develop and launch these SKUs in the first place. By modeling consumer-switching behavior, companies can identify SKUs that have the minimum impact on consumers' probability to buy a competing product. In other words, before eliminating a higher-value SKU, find out where the sales volume will go. Ideally, it should go to either a larger or smaller size product of the same brand. As an example, take the various sizes of spicy tomato sauce—6-, 12-, 16- and 32-ounce cans. All are moderate sellers. But does any retailer really need three or four of these different sizes? Say you eliminate the 12-ounce size, and make an assumption that half of customers who purchase the 12 ounce size will migrate to the 6-ounce size and half to the 16-ounce size. So instead of having three medium-volume SKUs, the same volume goes to two—an appealing scenario for both the manufacturer and retailers. Several years ago, Peter Boatwright and Joseph Nunes found that different types of SKU reductions affect consumers' buying and switching behavior differently. 1 Consumers generally have a positive reaction to fewer sizes, and most welcome the elimination of clutter. Among households loyal to a single brand, size, or brand-size combination that was eliminated, nearly half continued purchasing within the category. In fact, their findings suggest that category sales depend both on the total number of SKUs offered and the availability of key product or category attributes. So while risk-averse manufacturers may take the safe path of reducing only low volume SKUs (and see little benefit as a result), more knowledgeable companies will reduce an SKU based on attributes or a combination of attributes. Of course, the risk is higher, but the potential rewards are far greater.
Let's apply the Boatwright-Nunes theory. Say we begin with 120 SKUs in a category, and eliminate the easy 30 percent. Then, starting from scratch, we define the perfect Consumer-First portfolio—without regard for any other consideration—and end up with 40 SKUs. We take that 40, and after addressing the unique needs of various trade channels and promotion requirements, add 20 SKUs back into the portfolio. This brings the number to 60. Although it's not as good as 40, it is still pretty sharp. Our SKU number is halved, and the eliminated SKUs are not just the slow movers. As you look down the Pareto chart, a few are pretty large, but they are not necessary to retailers and they are not the products consumers will miss.
What happens if you can whittle those 120 SKUs down to 45 or 50 instead of 60? Then you have taken the first step toward a transformational change. Of course, transformational change is not possible when performing an SKU optimization in a single category. But do it in three or four categories, taking 1,000 or more SKUs out of 2,000, and pretty soon you're talking about real numbers—the kind that drive the elimination of plants and distribution centers, and perhaps even a floor of the corporate headquarters.
However, when eliminating higher volume SKUs, or trying to eliminate them, be prepared for a backlash. Some executives will be quite vocal in their objections; and for good reason—a lot of SKUs are not created for the consumer, but for retailers. Companies don't create five sizes of spicy tomato sauce because they think the consumer wants them, but because they have to fulfill the unique needs of different classes of retailers. Unless Sam's Club, Costco and Aldi can sell for less, they won't stock an item. "If I try to sell the same size can of tomato sauce to Costco as I sell to A&P, A&P would de-list me," explains one of my manufacturer friends. So manufacturers invent numerous new SKUs and special packs to keep all channels happy. This isn't necessarily bad, but may not be completely necessary.
Execute a Failed-Product Elimination Process
But wait a minute. What if half of consumers move to another size of a de-listed SKU, but the other half go to a competitor's brand? This is the central issue, of course, and the reason for thorough analysis and testing around consumer-switching behavior. Clearly, these portfolio decisions need to target only situations where revenue will remain flat or grow. So, we have to think differently about this elimination business. When a company introduces a new line or series of line extensions, an enormous effort is made to ensure a successful launch: special introductory pricing, coupons, advertising, sweepstakes, and all manner of other tools to get consumers to switch from their current favorite products to the new ones. Plus, significant thought and marketing resources are put into ensuring that the line extension does not cannibalize sister brands and SKUs. Further, the sales organization is energized: Leaders organize sales meetings, develop collateral material, offer incentives, and orchestrate trade shows and presentations. The entire company is lined up behind each new product's success. These product launches are major events.
Now think about what happens when a product or SKU is de-listed. Nothing. Maybe someone has a short discussion with the retailers but not much more than that. Executives sit back to see what happens. If consumers switch, if revenue migrates, if bad things happen. So be it. We strongly believe the same effort and energy expended in making the portfolio fat should be expended to get it into shape. Let's call it what it is—a failed-product elimination process. Although it will not require the resource investment of a launch, it should reflect every bit as much marketing and sales discipline (see figure 3). After all, our objective is to maintain (or even grow) volume while reducing shelf clutter. There must be incentives for switching to remaining SKUs. Retailers must be sold on new shelf sets. And maybe this is an opportunity to introduce innovative new products. Detailed marketing and sales plans must identify actions to ensure that consumers switch to our remaining SKUs, that the retailer sees this as a benefit, and that we take advantage of our new room to grow.
Don't Hold on Just to Protect Shelf Space
Finally, it's important to ensure that SKUs don't return and again drag down operating performance and profitability. Consumer products companies need to innovate and develop new products. No one wants to stop that process. But it is important to recognize that not every new product will be a barn burner, so get rid of the failures (and mediocre products) and clear the way for the next innovation. Don't hang on to it just to protect shelf space. Have the discipline to say goodbye. In fact, consider it an opportunity to introduce new products and SKUs. The shelf is not static or slow-moving. In any category, there are hundreds or thousands of new items that appear every year. This is a way to keep the system lubricated.
Sometimes this is accomplished by enforcing a simple rule: For every new SKU that comes in, one has to go out. This is a pretty heavy-handed way to handle SKU proliferation so we don't typically recommend it. Instead, we suggest using a reverse hurdle rate. Once the current SKU portfolio is rationalized, set a profit and strategic importance hurdle that new SKUs must achieve over an average three-year lifespan. Declare low profit sub-categories, regions and channels off limits to new product development.
Establishing a hurdle rate requires upfront decisions on product success. For example, if you bring in five line extensions of Spring Bouquet fragrance shampoo, use the business plan that your brand group put together to track their performance. If sales volume for an SKU does not match the brand group's promises in a reasonable amount of time, then cut it. Meeting 80 percent of plan volume should not be good enough. This approach will also force the brand group to be more realistic when developing their business plans for SKUs.
Room to Grow
Tired of SKU reduction efforts that create a lot of sound and fury from brand managers, the sales force and customers, but never seem to meet accompanying complexity reduction goals? Be bold. Go after unnecessary medium-to-high volume SKUs, not just the easy 30 percent. Build your new SKU portfolio based on what the consumer (and trade) needs, not based on what you make. Put as much effort and discipline into eliminating SKUs as you put into launching them.
Do all three and you can achieve a transformational complexity reduction that promises fewer ingredients, formulas, packing lines and plants. More importantly, you will create what everyone wants—room to grow. Room on the shelf for more power SKUs. Room in your marketing budget to generate more demand. And room in your labs and kitchens for true innovation. It all starts when you begin with the consumer and stop chasing your SKU tail.
Consulting Author
Bob Byrne is a vice president in the firm's consumer industries and retail practice, and is based in New York. He can be reached at
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