Streamlining Inventory Through SKU Rationalization

While supply chain and logistics managers pursuing Lean operations generally seek to eliminate excess inventory, sales and marketing programs often lead companies to increase the volume of products they keep in stock.

During the past few decades, the number of stockkeeping units (SKUs) retailers offer has soared. For example, in 1970, the average grocery store carried 7,000 SKUs. Today the average is more than 40,000.

This surge is the result of several factors, including increased popularity of private label brands; brand extensions, such as low-sodium and low-fat versions of existing products; shorter product development cycles and lifecycles; and the emergence of mass customization.

The Price of Holding On

Managing the increased number of SKUs has proven difficult for manufacturers, wholesalers, and retailers. Many logistics executives and business owners are in denial when it comes to paring down inventory. They don’t always realize that the longer the inventory stays around, the more it costs them.

Carrying or holding costs—the money spent to keep and maintain a stock of goods in storage—can range from an extra 15 percent to 40 percent of the product cost every year.

Companies can always make excuses to keep slow-moving products or inactive inventory around:

ldquo;The customer may want it eventually.”

ldquo;It’s still selling.”

ldquo;We spent $25,000 on the mold for this item.”

SKU rationalization—analyzing the merits of adding, maintaining, or removing items from a retailer’s range of products—is a valuable Lean process that can help streamline inventory.

One of the best ways to start a SKU rationalization project is to conduct an ABC analysis of current inventory.

ABC inventory management uses the Pareto Principle—also known as the 80/20 rule—to identify the relatively few items that contribute the most revenue or profit to the bottom line (the A-ranked products), and the many items that don’t contribute much, other than taking up space and money (the C-ranked products).

An example of how extreme this imbalance can get is a craft supplies distributor that had 5,000 SKUs in inventory. Of those, only two percent—or 105 products—were considered A items. The company’s situation was so extreme that analysts assigned a D ranking to the more than 4,000 stock items that generated only five percent of annual sales.

After the ABC analysis, the next—and often more challenging—step is developing a plan to dispose of excess or inactive inventory. That plan may involve disposal and write-off, re-work, repair, or finding alternative distribution channels at potentially marked-down prices.

Once this plan is in place, the company must work to not only follow through with it, but also use tools such as root cause analysis to avoid building up excess inventory again. The business can also use ABC inventory management for forecasting and planning to keep inventory under control.

Parts of this column are adapted from Lean Supply Chain & Logistics Management (McGraw-Hill; 2012) and Lean Retail and Wholesale (McGraw-Hill; 2014) by Paul A. Myerson with permission from McGraw-Hill.

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