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August 10, 2020

Get Rid of The Long Tail to Release Cash and Reduce Cost

By Istvan Bodo  – Manager, The Hackett Group

The current coronavirus pandemic has seriously tested the resilience and agility of every organizations’ supply chain function. Lockdowns have disrupted global supply chains at production and distribution level, huge swings in demand lead to constrained raw material as well as limited availability of goods.

Managing a complex product portfolio and forecasting future demand is problematic during this type of turmoil. Supply chain leaders have had to find innovative solutions to deliver the desired products and cover swinging demand, while also paying attention to not horde cash in excess inventory.

Reducing supply chain complexity and focusing on core products seems to be one solution preferred by organizations with a large product portfolio and various brands, to maintain profitability and be more resilient to increased demand volatility. These organizations realized that keeping a wide variety of

SKUs or adding SKUs to their portfolios can adversely impact the value chain through:

  • increased customer planning complexity
  • decreased customer service
  • increased supplier fragmentation
  • increased delivery risk
  • diluted brand

Ever-growing product families and a lack of active product lifecycle management slowly leads to product proliferation, and potentially a long tail of inefficient SKUs. Over time, the costs of managing a multitude of SKUs can outweigh the benefits realized or assumed at their inception.

Various issues can be blamed as the main drivers behind product proliferation:

  • Assumption without sound market research, that a customer requires a particular SKU, product or brand
  • Emotional attachment to a SKU or brand, because it has existed for a long time
  • The belief that frequent new product launches are required to keep the company relevant
  • Introduction of newly developed products without phasing out old ones
  • A historical assumption that SKUs are grouped or desired as ‘families’ or sets, when actual demand data may reflect the opposite
  • Maintaining SKUs which never quite took off after being developed and introduced
  • Excessive and uncontrolled innovation, allowing the development of variations and limited editions of existing products
  • Pressure from retailers for new features, packaging, or new product introductions based on actions by competitors

When the costs to serve are up due to the disruption created by the pandemic, reducing product variability through the elimination of inefficient SKUs or brands is key to keep manufacturing costs in check.

Benefits of SKU rationalization:

  • SLOB (slow moving and obsolete) reduction: discontinued SKUs will no longer generate excess inventory
  • Working capital improvement: reducing product proliferation will release cash tied up in inventory
  • OTIF (on time in full) improvement: planning and process simplification will focus resources on core SKUs
  • Inventory cost reduction: SKU rationalization reduces product mix, allowing for less inventory to be held onsite
  • Material cost reduction: material costs will decrease from less varied materials and improved economies of scale
  • Manufacturing costs reduction: rationalized SKUs keep costs under control by reducing machine changeovers and downtime
  • Improved buying leverage: with limited SKUs, more procurement dollars can be spent on less individual material items

Companies have always kept reducing product proliferation on the radar, but in good times the initiatives never really took off. The main reason was, that supply chain leaders and sales leaders viewed the topic from different perspectives. Sales wanted more products and a diverse portfolio to meet revenue targets and keep up with the competition, while supply chain leaders wanted to focus more on selling existing products and reducing inventory to improve the company’s cash flow through SKU count reduction. Both positions have merit, but organizations must balance the different perspectives to find a solution that delivers the desired results to the business and its customers.

Complex tradeoffs must be made to find the right balance between sales and supply chain objectives. But once the objectives are aligned and the desired balance is achieved, no more roadblocks are preventing financial performance improvement.

Here are some key considerations to guide your SKU rationalization effort:

  • Ensure ongoing executive management support with clearly stated objectives
  • Dedicate resources representing various functions (finance/sales/marketing/supply chain/manufacturing) to deliver success
  • Consolidate appropriate data sets to enable a quantitative and qualitative assessment
  • Evaluate the financial contribution of each SKU by factors including: margin contribution to the total portfolio; individual margin contribution; and volume contribution to the total portfolio.
  • Define qualitative complexity scoring criteria, such as: Design Stability, Manufacturing Complexity, Strategic Role etc.
  • Conduct SME and business owner interviews to assign a qualification index score to the levels identified within the quantification exercise
  • Use this information to create a rationalization index, assigning SKUs to levels based on where they fall in the quantification exercise
  • Challenge the organization on those SKUs which remain because “they have always been there”, or because one customer takes them. Understand the attributes that the customer requires and identify substitution opportunities from the wider portfolio
  • Integrate the quantitative and qualitative findings to align on the final list of SKUs to discontinue.
  • Transform the process to a regular portfolio review against the predefined criteria, apply a threshold and assess the candidates which fall below the threshold to ensure sustainable results

Supply chain professionals have seen decades of SKU expansion with the assumption that consumers wanted more choice, styles and variety. The pandemic has provided the unprecedented opportunity to see how true this is, and companies are encouraged to analyze which products are really desired by consumers, or which never went out of stock.  Reducing product proliferation should be viewed as a continuous improvement exercise to gain maximum benefits. Companies able to continually engage in the process of analyzing and identifying products or even brands which do not add value to the organization and focusing on the more profitable lines will experience sustainable gross margin improvements, reduced costs and improved working capital.