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Use the Pareto Principle for Effective SKU Rationalization

Behind every great retailer, there is a warehouse receiving, stocking, sorting, and distributing its products. These operations serve an invaluable service to these enterprises, but if one had to put a number on it, Supply Chain Digest estimated the total cost of logistics in the U.S. just under $1.5 trillion in 2014. Businesses spend significantly on their warehouses and logistics teams, trying to hone processes and accrue efficiency wherever possible, like building a better scheduling system so pickers can coordinate better with transportation or designing a more organized floor plan that limits excessive travel.

However, one lean processing enhancement retailers often balk at the opportunity to adopt is stockkeeping unit (SKU) rationalization, the act of reducing the number of different products they sell to streamline business all along the supply chain. According to research from the Association for Convenience and Fuel Retailing – formerly the National Association of Convenience Stores – the average retailer stocks between 2,500 and 3,000 SKUs. Paul A. Myerson, professor of Supply Chain Management at Lehigh University and contributor for Inbound Logistics, wrote grocery stores can easily hold up to 40,000 SKUs. Even removing a handful of these SKUs put less of a logistical strain on warehouses and creates space for newer, more profitable products.

How can retailers get the most out of SKU rationalization initiatives?

As far-reaching as these benefits of removing a few underachieving products could stretch, some retailers may still find it difficult to decide which items should be removed from shelves for the sake of optimization. What sorts of tools could retailers adopt to create the most cost-effective cuts?

The Pareto Principle
Distinguish between successes and failures using one time-tested method: the Pareto Principle.

Apply the Pareto Principle
Merchandise can only be profitable to retailers if it indeed turns a profit, if customers buy it, and a demand is evident. Otherwise, retailers waste money, time, and valuable shelf space stocking products no one wants. Worse still, they’ll need to pay for removal of these failing products as well.  If retailers could collaborate with their warehouse logistics teams, be they in-house or third-party, to create a reliable metric by which to separate products on the grounds of success, these enterprises could intelligently discern which products actually move through the supply chain and which ones simply crowd the aisles of their stores.

In doing so, retailers should keep the Pareto Principle – also known as the “80/20 Rule” – in the back of their minds. As this economics cornerstone dictates, 80 percent of effects come from only 20 percent of causes. In this case, 80 percent of sales only come from 20 percent of the items on warehouse shelves. Identifying and quarantining the highest fifth of SKUs within a given inventory can help inform retailers as they make their decisions as to what needs cutting. For example, if a brand with five overall SKUs has four in the top percentile, perhaps retailers would benefit from holding onto all five. Alternatively, if another brand only has one of its five SKUs in the most profitable echelon, perhaps this would make a good area for SKU rationalization.

“Tracking end-user purchasing activity can simplify SKU rationalization.”

Count on customer-focused cutbacks
All this aside, the most trying reason why retailers find SKU rationalization so difficult is the inherent element of customer retention. Should a retailer discontinue a product popular to a small, but loyal customer base, they risk losing its business permanently. So, when developing a plan for implementing SKU rationalization, forgetting to consider what the customer thinks would be foolish, for a number of reasons. Most importantly, tracking end-user purchasing activity can simplify the process even more.

For instance, a Marketelligent study found the success rate of SKUs segmented by color and style stayed relatively constant year after year, and any designs reactivated after being discontinued because of underperformance experienced no great gains or losses either way. In fact, on a list of SKU popularity rank from highest to lowest, the farther one descends, the steeper the climb to “long tail” logistics. This means mid to low-selling items suffer more from a greater number of options. By studying customer buying habits and their cumulative effect on sales, retailers and their warehouse teams can plot a course for effective SKU rationalization that reduces costs, complexity, and waste.


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