SKU Rationalization

What is SKU Rationalization?

SKU rationalization is a strategic process businesses use to review and optimize their inventory by evaluating each individual product in their catalog. It involves analyzing SKUs based on sales performance, market demand, profitability, and other factors to decide whether to keep, discontinue, or modify products in the inventory.

A stock-keeping unit (SKU) is an alphanumeric identifier that helps companies track products for inventory purposes. Each product has a unique SKU that represents its specific characteristics (e.g., size, color, or packaging). This unique code facilitates inventory management by allowing businesses to track sales, restock items, and analyze product performance on a per-product basis.

Businesses go through the SKU rationalization process to enhance operational efficiency, reduce inventory costs, and ultimately improve business performance. It’s a way for companies to focus on their most successful products while eliminating underperforming or redundant items from their catalog.

Synonyms

• Inventory optimization

Importance of SKU Rationalization

To “rationalize” something is to justify it with reasoning. In the context of your product catalog, that means looking closely at each SKU to determine if it is still necessary, profitable, and meets customer demand.

Having too many SKUs carries with it several issues:

• Excess inventory
• High storage costs
• Increased operational complexities
• Difficulty in monitoring sales and restocking
• Lower profit margins due to slow-moving or obsolete products
• Potential product cannibalization
• Supply chain inefficiencies

SKU rationalization addresses these issues by streamlining inventory. Since the process involves reviewing the entire product portfolio to identify and eliminate underperforming products, it optimizes storage utilization and reduces carrying costs.

Long-term, inventory optimization directly increases profitability and boosts customer satisfaction. Businesses minimize capital tied up in unsold stock and reduce storage and handling expenses by maintaining a leaner inventory. And, by simplifying product choices and improving the availability of high-demand products, customers enjoy a more streamlined buying experience.

Measuring SKU Performance

Effectively quantifying the performance of each SKU requires you to look at several different metrics both broadly and per product:

• Sales data, which includes the total revenue generated by each SKU. This helps businesses understand product popularity and market demand. Tracking sales by category can further refine this analysis by showing which product categories perform best​.
• Profit margins tell you the profitability of each SKU by comparing the cost of goods sold to the revenue it generates.
• Inventory turnover rate measures how often inventory is sold and replaced over a given period, typically a year. A higher turnover rate suggests efficient sales, whereas a lower rate might indicate excess inventory or poor sales. To calculate inventory turnover, divide the cost of goods sold by average inventory.
• Gross margin return on investment (GMROI) assesses how effectively a company’s inventory generates cash flow and profits. It combines margin and turnover into one metric, providing a comprehensive view of inventory efficiency.
• Sell-through rate compares the amount of inventory sold to the amount received from the manufacturer, providing insights into supply chain efficiency​.
• Backorder rate shows the percentage of orders the business cannot fulfill when requested due to inventory shortages. It underscores the effectiveness of procurement and inventory stocking​.

Businesses can access and analyze these metrics using inventory management software, which offers tools for collecting and analyzing SKU-level data, forecasting demand, setting reorder points, and identifying sales trends.

SKU Rationalization Steps

Carrying out the SKU rationalization process requires a systematic and data-driven approach. While the specifics of course differ between industries and businesses, here are some general steps to guide you:

1. Define business goals and target audience.

The business goals for SKU rationalization typically focus on enhancing operational efficiency, reducing costs, and improving profitability by optimizing the product portfolio and eliminating low-performing SKUs. To measure progress toward those goals, set specific, measurable objectives, like:

• Reducing inventory levels by X%
• Cutting down carrying costs by $X
• Increasing inventory turnover rates by X%
• Improving GMROI by X%

You’ll also have to understand the specific needs, preferences, and buying behaviors of your customer base. You can do so through methods customer surveys, purchase data analysis, customer segmentation, and monitoring social media and other platforms where customers express their opinions and preferences.

2. Gather and analyze relevant data.

To effectively gather and analyze data for SKU rationalization, start by collecting sales volume, revenue, profit margins, production costs, and inventory level data for each SKU in your product portfolio.

It’s a good idea to break down this data by:

• Individual SKU
• Product line
• Brand
• Category

This helps in understanding the specific performance and costs associated with each SKU and how they contribute to the overall portfolio. You can use your inventory management software to organize, visualize, and analyze this data.

Look for SKUs that are underperforming, have high costs for their ROI, or are not aligning well with customer demands. Tools and techniques like AI-powered analytics can significantly enhance the efficiency of this process by quickly identifying patterns and anomalies that might not be apparent through manual analysis.

3. Categorize SKUs based on performance.

Using the performance metrics from Step 1 and the data collected in Step 2, separate SKUs into categories (e.g., high-performing, moderate-performing, and low-performing). Depending on the complexity, you may want to use a grading system, such as an A-F rating, or any other method that works for your business.

As far as “performance” is concerned, there are a few factors you’ll have to consider:

• Customer demand
• Sales volume
• Turnover rate
• Profitability

With SKUs categorized, analyze each group to identify patterns and outliers. For example, high-performing products might share certain characteristics — price points, customer segments, or seasonality.

At this stage, utilizing visual tools like charts and graphs can help stakeholders better understand the distribution of SKU performance. And tools like heat maps or bar graphs can illustrate which SKUs are exceeding expectations and which are not meeting set thresholds​.

4. Evaluate non-performance factors.

Of course, the ability to make the most money possible from a product isn’t the only reason to keep or do away with it. There are plenty of reasons you might choose to keep a product that performs low on paper:

• It holds a significant cultural presence and loyalty among consumers, which benefits the broader brand.
• It supports other products or processes in a way that is not easily quantifiable. This might be the case with a product that introduces new customers to your brand (e.g., a loss leader).
• Discontinuing it may have negative implications on overall business operations, such as supply chain or production efficiency.

In these cases, it’s probably better to optimize these SKUs rather than eliminate them.

5. Develop action plans for each SKU category.

As we’ve slightly touched on above, you have three options when it comes to dealing with SKUs: keep, discontinue, or optimize.

• Keep when the SKU is a top performer, aligns well with business goals and customer demands, and supports other products and processes.
• Discontinue when the SKU performs poorly across all metrics, is not aligned with business goals and customer demands, and has negative implications on overall business operations.
• Optimize when the SKU has potential for improvement and can align better with business goals and customer demands through changes in pricing, promotions, bundling, or other strategies.

How exactly you go about making these changes is entirely subjective. But it’s helpful to develop specific action plans for each category of SKUs. These can include tasks like renegotiating supplier contracts, implementing dynamic pricing, or optimizing inventory levels to reflect demand.

6. Implement the plan and monitor results.

With your action plans in hand, it’s time to put them into action. This might take a few weeks or months, depending on the size of your portfolio and the complexity of changes being made.

During this time, monitor KPIs in your CRM and inventory management system to determine if the SKU rationalization process is having its desired effect.

It’s also important to regularly review and reassess the need for SKU rationalization. As business goals, market trends, and customer needs change, staying agile and adapting your product portfolio is what determines long-term success.

SKU Rationalization Best Practices

There are a few best practices to follow in order to rationalize your SKUs effectively. Let’s dive in.

Leverage AI for deeper insights.

In just about every facet of business, AI tools can supercharge your revenue growth. SKU optimization is no different. AI-powered analytics give you a comprehensive understanding of SKU performance. And they do it on a continuous basis, without the need for manual data analysis.

AI can help you identify underperforming SKUs and subtle patterns that aren’t visible through traditional analysis methods like Excel sheets or basic software. For more nuanced decisions about which SKUs to discontinue, maintain, or promote​, AI is an absolute necessity​.

Adopt a phased approach when implementing changes.

Implement your SKU rationalization in stages rather than all at once. That way, you can monitor the impact of each change incrementally and adjust your strategy based on real-time feedback and performance data. A phased approach helps mitigate risk by allowing adjustments before full-scale implementation​.

Incorporate customer feedback directly into the process.

Beyond sales data, actively seek and incorporate direct customer feedback through surveys, focus groups, reviews, UGC, and social media listening. This feedback contains insights into why certain products underperform and offers opportunities to adjust product features and marketing strategies accordingly.

Facilitate a cross-functional environment.

Engage teams from across your business, including sales, marketing, and operations, to provide diverse perspectives on SKU performance and needs. Cross-functional involvement ensures that decisions are balanced, and each department will play a role in implementing the changes​.

For instance, procurement renegotiations are a job for the ops team, while marketing is responsible for updating product labels and redesigning packaging.

Dynamically adjust SKUs based on seasonal and market trends.

Using the steps outlined in this article, update your product strategy to reflect changing market conditions, seasonal demand shifts, and emerging trends. A dynamic approach allows you to be proactive rather than reactive, keeping your inventory aligned with current consumer preferences and market conditions​.

Hyper-localize your SKU assortment.

Use granular store-level data to tailor SKU offerings based on local market demands and preferences. Or, as an ecommerce seller, localize your ad targeting and content strategy to reflect regional interests.

For products with seasonal and cultural relevance, a hyper-local approach can significantly increase the relevance and appeal of your product assortment to specific customer segments, improving both sales efficiency and customer satisfaction​.

Consider stages of the product life cycle.

A new product normally needs more time and resources to gain traction, while a mature product with declining sales might signify discontinuation is the best move. If a product hasn’t been on the market for long enough to prove itself, don’t make hasty decisions to eliminate it until you’ve given it enough time to gain traction.

Technology Requirements for SKU Rationalization

SKU rationalization as we know it today would be impossible without software. To support detailed data collection, analysis, and management, businesses need the following systems in place:

• Inventory management software (to monitor inventory turnover, calculate holding costs, and analyze sales patterns at the SKU level)
• Data analytics platform (to process large datasets and extreact actionable insights)
• ERP software (to integrate all facets of an operation, including product planning, development, manufacturing processes, sales, and marketing)
• CRM software (to gather and analyze customer feedback and buying behaviors)
• Supply chain management platform (to optimize the flow of goods and services from manufacturing to end-sale and ensure inventory levels are aligned with market demands)
• Collaboration and data sharing tools (to facilitate communication between sales, marketing, finance, and operations)

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