What is SKU Rationalization?

In this article, learn about:

• What SKU rationalization is

• The value of SKU rationalization

• How to reduce SKUs

• Determining SKU profitability

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Successful suppliers know the value of regularly reviewing their inventory. Which items are thriving, and which are underperforming? SKU rationalization helps answer these questions. If done well, SKU rationalization can help suppliers increase profit margins and improve product lifecycle.

What is a SKU?

SKU refers to a stock-keeping unit (pronounced skew). It is the classification of a piece of merchandise or service using an eight-to-twelve-character alphanumeric code. Every product iteration has its own unique SKU code, enabling customers to differentiate them. For instance, one product with three different sizes must have three different SKUs. 

SKUs should not be confused with universal product codes (UPCs). An outside company universally applies UPCs. A UPC A barcode has 12 digits, and a UPC E barcode has 6 digits.

Source: GS1US.org > home > UPC, Barcodes and Prefixes > Barcode Types

Source: GS1US.org > home > UPC, Barcodes and Prefixes > Barcode Types

UPC barcodes are consistent across all retailers and identify items and their manufacturers. Suppliers determine their SKUs to track product variations, such as flavor or color, as well as inventory and sales.

What is SKU Rationalization?

SKU rationalization is also known as SKU optimization or product rationalization. It is the procedure of deciding whether you should retain or suspend a specific product. SKU rationalization enables you to cut down inventory costs and reduce purchasing, production, and distribution complications through effective inventory optimization.

SKU rationalization is a critical element that fuels the enhancement of personal consumption expenditures (PCE), as SKU proliferation raises extra non-productive time and also increases costs. These costs can include straightforward product manufacturing and release expenses, inventory investment, sales and marketing costs, service/support spending, and surplus and outdated inventory handling charges.

SKU rationalization is like giving your inventory a thorough clean up. Much like sorting through your closet at home, it involves carefully reviewing each SKU in your product catalog to decide which ones to keep and which to remove. After identifying the items to retain, a second review helps determine if they still align with your business needs or should ultimately be discarded. 

Related Reading: Retail Category Management

Is SKU Rationalization Valuable?

SKU rationalization can lead to higher cash flow by reducing days inventory outstanding (DIO), also known as days sales of inventory (DSI). DIO is used to calculate how long it takes to sell a particular product and compares that metric to the competition.

SKU rationalization results in more effective management decision-making and enhances activities such as:

• Developing efficient inventory management functions

• Lowering inventory transport costs

• Reducing shrinkage due to musty or obsolete inventory

• Increasing precision of replenishment reports

• Reducing inventory cycle time and enhancing inventory accuracy

• Creating systematic pickup, packaging, and deliveries

• Decreasing cost of stock replenishment operations

If you disregard SKU rationalization, you may have to pay the price for it through highly expensive, complicated, and inefficient back-end operations. Stocking up on excessive inventory without any performance insight is likely to result in:

• Underused data and inferior business decision-making

• Needlessly oversized teams for inventory management

• Intricate supplier management with an unreasonably high number of manufacturers

• Stock that has been on the shelves for ages, consuming warehouse room and resulting in unnecessary and endless costs for the business

The Benefits of SKU Rationalization

Apart from its positive impact on supply chain management, SKU rationalization also improves product lifecycle management. Applying SKU rationalization as part of your product lifecycle management processes facilitates delivering constructive budgetary performance for the company, assessing lifecycles at the grassroots level, divided into type, brand, category, or fineline.

Related Reading: Walmart Departments, Categories, and Finelines

SKU rationalization also makes marketing strategies highly effective. Based on the data examined during the activity of rationalization, analysts get a deeper understanding of consumer shopping patterns. Products and brands that have a very brief stay on the shelf denote that they have a broad and loyal customer base.

SKU rationalization is a solid base for promotion campaigns as they depend on past data of sales projections. Campaigns can apply strategies that have been successful previously and, at the same time, insert new components to address the ups and downs in demand.

SKU rationalization can positively impact your overall performance, from purchasing to storage, sales, and marketing. Therefore, it should be blended with the development strategies of every element of the business. 

When Should I Rationalize My SKUs?

You should rationalize SKUs twice a year. Rationalizing your SKUs less frequently will not present sufficient historical data to calculate product sales. Likewise, rationalizing more often may not be helpful if there hasn't been adequate time for changes to surface.

Retailers and suppliers alike have the maximum incentive to tidy their SKU numbers every second season: summer/spring and autumn/winter. SKU profitability data should be analyzed based not just on cost but also on what works best in the market. 

How to Reduce SKUs for Inventory Optimization

Considering the multiple factors that are involved, here are a few guidelines on how to reduce SKUs:

1. Choose product groups: SKU rationalization is not just the responsibility of the inventory control department; suppliers also need a cross-functional team to help. It is crucial to have a distinct project management team in place similar to that in a Six Sigma or a lean manufacturing program. This is the phase where you select the product group or category or brand to review.

2. Classify the niche market: There are cases where a single product category might cater to a select group of customers. In such cases, it becomes crucial to identify the market segment or sales channel to emphasize. Classifying your market also allows you to tighten the field of activity further.

3. Review all other SKUs: To get rid of bad SKUs without impacting customer service value, direct your efforts to find one or more of the following product features:

• Demand:
  • High product returns
  • High stock-out
  • High pack size variety
  • High shrinkage
  • Inconsistent demand
  • Demand falls in the latest one to two years
  • Large shelf space
• Production:
  • Low inventory turns
  • More defects
  • High labor processing
  • High setup time
• Supply:
  • Long lead-time
  • Strict import control
  • High currency risk

Take into account a product having an average sales volume with excessive lead-time and demand variations. After reviewing each product's characteristics, you can quickly negotiate and finally decide which products to retain.

1. Remove needless SKUs: Finally, you need to track down the SKUs that you are removing to their raw materials, Work in Progress, and all associated finished goods.

Tips for Creating and Managing SKUs

Effective SKU management involves creating, tracking, and updating SKUs, as well as using SKU data to make informed business decisions. Here are some tips for creating and managing product SKUs:

• Keep it consistent: Consistency is key when creating SKUs, as it makes them easier to understand for inventory management purposes. Develop a standardized format for your SKU numbers and stick to it across all products.

• Define popular product features: Use SKU numbers to highlight popular product features, such as colors, sizes, or styles. This helps in quickly identifying product variations and managing inventory more effectively.

• Make regular SKU updates: As product offerings change, SKUs should be updated to reflect these changes. Regularly review and update your SKUs to ensure they accurately represent your current inventory.

• Use SKU data to improve sales: Retailers can use SKU data to make business decisions, such as determining which products to promote or discount. Analyzing SKU performance can reveal which items are best-sellers and which are underperforming.

• Monitor SKU performance: Tracking SKUs can provide valuable insights into sales trends and inventory levels. Use this data to optimize your inventory, reduce stockouts, and improve customer satisfaction.

Effective SKU management is a critical component of a successful inventory management system, enabling companies to stay competitive in the market.

Determining Profitability by SKU

Accurate data is the first critical step toward successful SKU rationalization. Poor-quality data often undermines the SKU rationalization process, leading to ineffective decisions and eventual failure. Simply put, unreliable inputs produce unreliable outcomes.

SKU rationalization requires understanding the profitability of each individual SKU. To do this, you need to break down all the costs associated with running your business (e.g., transportation, software, advertising, marketplace fees, etc.) and allocate those costs to specific SKUs. This granular approach reveals how much each SKU contributes to---or detracts from---your overall profitability.

To calculate your profitability using SKUs, you must have the following data in hand:

• COGS data: For best results, track COGS data using the FIFO technique to trace any ups and downs in the costs of your products.

• Order charges: This covers all the expenses borne by you when your customer initiates an order for fulfillment.

• Overhead expenses: This includes the general costs of running a business, like Human Resources, staff payroll, utilities, etc.

• Transportation charges: These are the expenses sustained for using shipping services such as UPS and FedEx.

• Insurance charges: This includes any fees corresponding to merchandise or transportation insurance.

• Fulfillment fees: These are fees levied by a third-party logistics (3PL) company or Fulfillment by Amazon (FBA).

• Marketing capital: When you are using pay-per-click (PPC) advertisements, you must make them part of the overall profits. Monitoring your spending throughout your SKUs can make it easy for you to decide on the redistribution of advertising funds to maximize your marketing strategy. Additionally, you should consider coupons, print advertisements, and other promotional materials for each SKU.

With the help of SKU profitability reporting, you can draw comparisons of a product's performance with other products in your catalog. With the help of this data, you'll be able to find pain points and problematic SKUs.

Tools and Resources for Inventory Management

Inventory management software can reduce inaccurate decision-making with the help of automated calculations. In addition to saving time, they also help in tracking and computing data. 

Related Reading: Monitoring Store-Level Inventory

These are some of the characteristics to consider while assessing inventory management software:

• Integrations: Inventory management software is central to your business, and you must get it to work along with the services you are already using. It is also vital to ensure that it can blend with all of your sales channels and accounts.

• Comprehensive analytics: Good inventory management software should have comprehensive analytics. The software must have the capacity to determine the best and weakest performing items, as well as SKU profitability. You must be able to view the profitability on the SKU level and the channel listing level, and you must also be able to monitor it for every order.

• Support: It is essential to have software for managing data from different storehouses, regardless of your business size. It must facilitate registering costs from warehouses and implement these on every purchased SKU.

• Adjustment: The inventory management software should be flexible enough to adjust to your increasing needs. It should adapt as you change platforms so that you don't run the risk of data loss.

If done right, SKU rationalization can help you shrink the number of materials you have to manage, nonessential machine preparation time, and surplus storage conditions. You can also release your workforce so it can concentrate on more productive endeavors. Tracking profitability on the SKU scale is one of the means to identify low-yielding products and considerably boost revenue. Never undervalue the effect of SKU-level reporting on your bottom line.

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