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What Is SKU Rationalization and Why Is Everybody Doing it?

by Anna Ngo
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Big corporations like Procter & Gamble and Unilever are getting better performance from their inventory through SKU rationalization, so much so that the process is now trending across companies of all sizes.

But what is an SKU? Or, rather, what is a SKU? How do you even say it? SKU can be pronounced like the word “skew” or like its letters spelled out. SKU stands for “stock keeping unit” and is a unique code assigned to a product to identify and track information and related to that product: price, product options (or variations) and manufacturer. A SKU takes the form of a scannable barcode, like so:

What is the meaning of SKU in retail?

First and foremost, tracking inventory using its SKU code helps inform retailer purchasing decisions with regard to profitability. SKUs are also referenced to pick and pack orders and even make product suggestions to online shoppers.

What is the difference between a SKU and a UPC? Unlike universal product codes (UPCs), SKUs are not universal, meaning that each retailer has its own set of SKUs it assigned to its merchandise, generally to group like items, categories and subcategories together for analysis. That’s how sites like Amazon are able to display similar items you might be interested in, based on the features indicated by that SKU and other SKUs in the same category, sharing the same prefix. 

Most POS systems allow you to create your own SKU hierarchy based on what you want to track. For example, a shoe store would probably classify shoes first by customer type (men, women or children), then style (dress or casual), then color and possibly material. A larger operation may choose to get even more granular to facilitate more detailed reporting, particularly if it carries many similar SKUs. 

SKUs are used for inventory and sales tracking, meaning they help stores know which products are selling quickly and when items need reordering. Ultimately, this will determine the product mix, which is where SKU rationalization comes in. 

Organizations use SKU (or product) rationalization to decide which items to keep/order more of, reduce or eliminate in inventory based on historical sales data, weighing the cost of producing and stocking against the benefit of selling each product. Rationalization, in short, frees companies to spend time and money on the products that work best. SKU rationalization is a kind of inventory optimization.

From Proliferation to SKU Rationalization

There are more SKUs today than ever, especially in the retail sector. Yes, suppliers use SKUs too! As mentioned earlier, because they aren’t universal, vendors will have their own supplier SKU for any given item and will be interested in tracking different aspects of the supply chain than a retailer would. Scannable barcodes help vendors easily monitor the movement of inventory and can be used to track repairs, services and warranties.

But back to the topic of retail. One report states that grocery stores, for example, carried 7,000 SKUs in 1970, a figure that soared to more than 40,000 by 2014. This “SKU boom” is the result of companies matching products to more particular customer preferences. Variations, like a low-fat version of a food product or a limited-edition flavor, contribute to SKU proliferation, but so do shorter development cycles, which pile new inventory on top of old in anticipation of rapidly changing consumer tastes.

The problem is that more SKUs can mean an increased cost of inventory, specifically holding costs. Demand for a particular SKU may not be high enough to quickly clear inventory. Money spent to maintain a stock of goods in storage can amount to an extra 15% to 40% of product cost a year.

Brand Rationalization

The world’s second-biggest home products provider, Procter & Gamble (think Crest toothpaste and Gillette shaving products) consolidated or exited 61 brands over the past 18 months. While these brands represented 6% of P&G’s profit in that time frame, rationalization improved overall cash flow by lowering days inventory outstanding (DIO), also known as days sales of inventory (DSI), from 78 to 58. DIO is an efficiency metric that indicates the average number of days a company holds inventory before selling it. Industry-specific, this ratio should be used to compare competitors over time.

Unilever, the world’s number-three home-product provider, 10 years ago found that the variance of SKUs in their UK and Ireland operations accounted for 20% of their inventory but contributed only 5% to their sales. The company has since made it a goal to reduce SKUs by 20%, a complex job for a company with 50,000 SKUs in many markets around the world.

While rationalization is most commonly used among manufacturers and retailers with tens of thousands of brands, products and variations in their inventory, experts say it’s becoming a trend across companies of all sectors and sizes.

The bottom line: If you can determine which SKUs you can do without based on your analysis of sales data, you can increase your cash flow and have more resources on hand to focus on the products that perform best.