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Growth Through SKU Optimization - Part 2 of 4: SKU Your Rationalization

Nine reasons why SKUS are not sexy...but hot.

Optimize me, please.

Running a business is not for the faint of heart. More businesses are going to be sold in the next 12-15 years than any other time in America. You heard that right. In fact, according to InvestmentBank.com, more than eight million private businesses will be flooding the market. There are many reasons why, but let’s focus on the fact that if you’re even thinking of selling in the next decade, your company will need to know how to stand out in a saturated market. Being prepared to sell is a process, not an event, and one important step you can take to prepare is to conduct a SKU rationalization analysis. 


There are more SKUs in the market today than at any other time. 

This should not be a big surprise to anyone alive and interacting in the world around them. Amazon Marketplace alone has more than 353 million SKUs. You can purchase virtually anything, anywhere, at any time of day or night, and the choice of products is seemingly endless. 

Each of these products are identified by something called a SKU, or stock keeping unit. A SKU is the alphanumeric or bar-code equivalent on every product you purchase. It serves as a unique identifier for an item or service. A SKU is representative of everything a business sells, including services. Many Enterprise Resource Planning (ERP) systems will have a SKU set up that can handle a service. 


SKU from the start.

Whether you're positioning to sell, growing your organization, or just starting your business, maximizing product value and accelerating growth and profitability means making strategic decisions about which SKUs (products and services) to keep and which to discontinue. 

For a younger company, this process can be daunting, but planning or strategy around SKUs and how they can help in scaling the organization over time should be prioritized from the beginning. As the company grows and sales get more complex, organizations will typically find they get to $20-25 million and can’t grow. Gross margins go down. This is why putting SKU planning in your strategic sessions is so important.


SKU rationalization and how it helps.

The first article in this series talked about Growth Through SKU Optimization: SKU Your Proliferation. In this article, we’re looking at SKU Rationalization, which is done by conducting regular reviews to analyze how a company’s SKUs are performing, and what percentage of revenue and gross margin they contribute, among other factors. 

Typically, an organization will go through the SKU list and analyze sales for the past year, factoring out seasonality. The “tail” or bottom performing 10-20 percent of SKUs are often cut. By eliminating underperforming SKUs, a company can reduce inventory and supply chain complexity with little impact on sales. And done properly, SKU Rationalization should improve your company’s gross margins.

The benefit of undertaking a SKU Rationalization can be significantly substantial in terms of inventory carrying costs as well. According to Netsuite, a leading ERP company, inventory carrying costs average between 20 to 30 percent, with costs going up the longer a company holds the inventory. 

A typical SKU Rationalization program can reduce your SKUs by 20 percent. And, there are other savings in terms of direct dollars and in indirect items such as improved customer service. 

Below is an example of the cost savings in inventory cost:

Company Sales: $100,000,000

COGS: $65,000,000

Inventory Turns: 7

Average Inventory on Hand: $9.2 million

20 percent SKU reduction: 

  • One time cash pickup of $1.9 million of inventory reduction
  • Annualized savings of $370,000 to $550,000 in carrying cost savings


Determining which SKUs you can do without.

The process of SKU rationalization can begin with a simple analysis of sales data and gross margin. If your company has gross margin data at the SKU level, it will be easy to identify the low-margin SKUs (those that lose money). There are times when you may keep a low margin or negative margin SKU, but you should understand why.  

If you don’t have gross margin at the SKU level, look at overall gross margins and determine if they are getting thinner and thinner.  If this is the case, get a SKU listing of the items that make up the bottom 20 percent of your sales, which could be as high as  80 percent of your SKUs. 

As a side note: If you do not know your gross margins by SKU, you should consider implementing an Activity Based Costing (ABC) system and supporting MRP/ERP.  SKU level margin data is extremely beneficial to a company.


The dreaded tail, or knowing when to phase out.

The “tail” are the low margin or negative margin (loss) items that linger for reasons sometimes even unknown to the company. These may be products that used to make money and have since become unprofitable. Or teams have developed an emotional connection to the product they developed and hate to see it disappear. Or sometimes the benefits of cutting these products has never been consistently communicated. 

Analyze your tail items. An organization should have a compelling case to cut lower-tier SKUs. Cutting them might be an easy sell to Finance but a struggle with Sales and Marketing, who might see this as a threat to customer needs and brand strategies. 


Gain insight from across the business.

When making SKU decisions, an important component to consider is gathering input from colleagues. The Finance team often leads the charge. These folks are typically dispassionate—they don’t feel the pain, so their perspective is neutral. 

Finance should build hypotheses about what to discontinue and what is a topic for broader discussion, then get Sales and Marketing, Operations and any other departments involved in the process to gain insight from their perspectives. 

The input from all relevant teams is highly valuable and adds a crucial perspective on what to keep or discontinue and why. The SKUs that are retained are typically sorted into an A, B and C category (A equals the top 60 percent of sales, B is the next 30 percent, C is the bottom 10 percent). This allows for dashboard reporting and a framework to maintain SKU Rationalization over time. 


I’m just starting. How do I do this?

If you are a smaller company or just starting this process, sure, you can get a fair amount of this information from Quickbooks. However, I would suggest moving up to an Enterprise level ERP, such as Netsuite or similar, once your company gets over $20 million or so in revenue.   


Wait a sec, SKU rationalization is not sexy.

It’s almost impossible to overstate how important SKU strategy is to your business. Is it really sexy? If you think if sexy means to deeply understand your products and services and how they work together to grow your business, then yes, it’s sexy as all get out. 

Selling products or services like a maniac will ramp up revenue in the short term, but eventually sales will stall and your company will stagnate. SKU rationalization gives you a firm base from which to make smarter business decisions and ensure future profitability. 


Click here for Part 3, SKU Analysis, where we dive even deeper into the magic of SKUs.

About the Author

Robert Nix has more than 25 years of experience in accounting, financial and operational leadership roles. He is an expert in cost accounting and a lean six sigma certified. He believes in utilizing processes, data and technology to drive revenue improvement, cost savings and scalable efficiencies. He also believes in servant leadership; putting the needs of the team first and driving a strong group performance towards helping our clients.

To learn more about SKU management, contact Robert Nix at: rn@orchid.black.