SKU rationalization: A holistic approach in a customer-sensitive marketplace

Retail merchandising decisions are often tough to make. The evolution of an increasingly competitive marketplace has forced retailers to take a hard look at the products they sell to see if it really makes sense to offer them from a business perspective. Additionally, multiple studies have shown that the sales floor is disproportionally occupied by products that collectively only make up a small percentage of sales.  A good remedy for this is an industry practice called SKU Rationalization, or the evaluation and subsequent elimination of products from a store that don't sell well or have a low turnover.

The benefits of simplifying the product mix are easy to see and stretch across the supply chain, ranging from the upfront reduction in inventory costs all the way to the reduction in labor and shrinkage costs associated with each product. The underlying principle of it all is demand transferability, the idea that customers aren't loyal to every product in the store and will just as easily buy something similar if another product isn't available. For example, customers don't need 13 types of bottled water to choose from when four will suffice, thus saving money in the supply chain while also creating a simpler, more customer-friendly shopping experience–a win-win for both sides.

Most SKU Rationalization efforts begin with a similar approach: The team first looks at sales data from the past year to see which items in a category haven't performed well. They then compare this information to each item's inventory in the store or the amount of facings it has, and make a blanket recommendation for what products should be eliminated. But what is often glossed over is the effect of eliminating products that customers have an attachment to, despite them being slow-movers or generating low sales dollars. Not only will these customers buy their favorite product elsewhere - an initial loss for the company - but they'll bring with them their entire shopping list, something known in the retail world as the "market-basket effect". That's why a better approach–a comprehensive, holistic approach–is needed for effective SKU Rationalization. Companies need an approach that's both quantitative and qualitative in order to take into account the complex factors of demand transferability and market-basket effect.

Understanding the complexity of demand transferability and developing an appropriate strategy for analysis can be a difficult process. How is a company supposed to analyze the buying patterns of all its products (which for some retailers total more than 150,000), obtain some sort of customer loyalty data on each of them, and predict the effects of eliminating a product from its offering? Retailers should also consider the effects demographic factors have on buying patterns when implementing this on a national level, or how supplier relationships may be affected by potential changes. Thankfully, while these definitely pose unique challenges to effective SKU Rationalization, they are not impossible to overcome. Buying patterns can be analyzed by customer loyalty data - data that's readily available at stores that require membership, and is likely possessed by stores based on recurring credit or debit card purchases. If several customers are found purchasing the exact same product during every visit, then that item can be considered to have a low demand transferability, and caution should be exercised before eliminating it from a store's offering.

On the other hand, if customers are found purchasing a similar but different product, that would indicate a high demand transferability, and the company could further explore rationalization. While this is only one method to survey the effects of demand transferability, and there are certainly several other factors in general that need to be analyzed before implementing any sort of program, it goes to show that with a little critical thinking and perhaps the right functional team, it can in fact be done.

Even though the analysis may be complex, putting forth the effort to take both a quantitative and qualitative approach is a necessary and unavoidable step in order to ensure lasting success. If companies are serious about simplifying their supply chain, then SKU Rationalization is a great place to start.