SKU Rationalization

Learn about:

• What SKU rationalization is
• The value of SKU rationalization
• How to reduce SKUs
• What data you need to rationalize SKUs

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Successful suppliers know that sometimes they need to re-evaluate their stock. What is selling? What isn’t? SKU rationalization can help answer these questions. If well done, SKU rationalization can help increase your profit margins and improve your product lifecycle.

What is a SKU?

SKU refers to a [stock-keeping unit](https://www.investopedia.com/terms/s/stock-keeping-unit-sku.asp#:~:text=A%20stock%2Dkeeping%20unit%20(SKU,eight%2Dor%2Dso%20characters.) (pronounced skew). It is the classification of a piece of merchandise or service with the help of 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 having three different sizes must have three different SKUs. Also, SKUs help track the number of product variants a company has.

SKUs should not be confused with universal product codes (UPCs). An outside company universally applies UPCs. They are always 12 digits, 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 complications in purchasing, production, and distribution.

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and release expenses, inventory investment, sales and marketing costs, service/support spending, and surplus and outdated inventory handling charges.

SKU rationalization is a thorough general cleanup of your stock of inventory. It is similar to picking through your closet and dresser within your home. You comb every SKU in your brochure of products carefully and determine what to retain and what to remove. Whatever you keep, you would check again in a second stage to decide whether to keep them or discard them.

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 astute management decision-making and enhances your activities, such as: 

• Develops efficient inventory management functions
• Lowers inventory transport costs
• Reduces shrinkage due to musty or obsolete inventory
• Increases precision of replenishment reports
• Reduces inventory cycle time and enhanced inventory accuracy
• Creates systematic pickup, packaging, and deliveries 
• Decreases 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. When you apply SKU rationalization as part of your product lifecycle management processes, it facilitates delivering constructive budgetary performance for the company, assessing lifecycles at the grassroots level, divided into type, brand, category, or fineline. 

SKU rationalization also translates marketing strategies into highly effective ones. 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. Additionally, a multi-discipline team must take on the task of performing the rationalization, instead of handing it over to the operations team or inventory manager. 

When should I rationalize my SKUs?

Similar to domestic house maintenance, 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 exhibit adequate time for changes to surface to tackle inflated inventory and any opportunity cost.

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

How to reduce SKUs

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. Compile a list of critical products: Compiling a list of products determines which SKUs are to retain. Following this, gather information on every SKU on demand, profitability, and common pack sizes. 

4. 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. Should you continue to retain this product?

After reviewing each product’s characteristics, you can quickly negotiate and finally decide which products to retain.

5. 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.

What data do you need for SKU rationalization?

Accurate data is the first critical step towards successful SKU rationalization. Frequently, SKU rationalization is substandard or eventually collapses because the source of significant decisions is an inferior product costing data — trash inputs result in trash output. 

Once you visualize the costs of running a business, you should consider transportation, software, or advertising. The spending that would go in managing your store merchandising, the charges you may have to pay to marketplaces, and the general overhead charges also need to be taken into account. 

All these together drive your profitability, and if you implement them at every individual SKU level, they reveal all the products that may be low achievers. Given these points, you can consider your company’s profitability from a variety of perspectives:

• Analysis of the expenditure: Each market has its type of costs. By monitoring these costs, you can integrate them with your cost of goods sold (COGS) to discover whether you may have to incur a loss with every sale you do.
• 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.
• Channel performance: Make a comparative analysis of the performance of a product across different channels. For instance, the sale of an item on Amazon may not be as profitable as on Walmart. Considering this comparison, you can make modifications in other areas where you have made investments.

Determining Profitability by SKU

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).

With the help of SKU profitability reporting, you can draw comparisons on 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 SKU 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. Let us look at 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.