Optimizing the Product Portfolio
Customer expectations are higher than ever, and the most successful distributors continue to accommodate their customers through multiple channels designed to attract and retain them.
Despite all the business emphasis on community, engagement, and relationship, the importance of offering the right variety of products remains—and it cannot be overlooked.
In this environment, the constant pressure to expand product offerings can be enticing. Adding new products can lead to new customers, increased sales, and a higher switching cost for customers.
However, a large portfolio can also add hidden cost and complexity to the business, creating narrower margins and reducing overall profitability. Declining performance means it’s time for change, beginning with a good assessment of the current state of affairs.
The quality of that assessment is only as good as the depth and reliability of all the information that’s available about the symptoms—and that means not only gathering data from sales, but also from customer service, distribution, and other aspects of the business. Is there a spike in materials handling and warehousing costs associated with handling of smaller orders? Is the ever-expanding product line leading to a scarcity of floor space? Are logistics managers struggling to get product out the door on schedule? Has demand planning become too much art and not enough science?
Each of these symptoms can point to a handful of business issues, so it is important to first diagnose the problem. A simple analysis can help determine whether SKU sprawl is the culprit: The 80/20 rule. Commonly known as the Pareto Principle, this metric assumes that 80 percent of outputs are driven by just 20 percent of the inputs. When applied to SKU proliferation, that means that 20 percent of your products are delivering 80 percent of your profits—which means that the obvious and hidden costs of managing the remaining bulk of the portfolio is adding little to the bottom line.
Once diagnosed, it is time to identify problem products. Getting good answers means investing in decision-grade data, and then applying that data correctly. One of the most common mistakes companies make when conducting a SKU rationalization project lies in the definition of profitability.
The simplest expression of this approach to getting the data you need is to ask, “What costs would go away if this product were to go away?” Activity-based costing methods will result in a more accurate product cost, rather than flat, proportional assumptions. This full-absorption method, especially when incorporating seasonal, commodity-based, or other variations, delivers better data and then can be extended to geographic models, sales categories, vendor pricing, and other SKU influences.
Once that hard work is complete, the measurements become a foundation for a SKU rationalization process that reflects the balance of profitability with customer value. Each product can be placed into a category based on sales and profitability (see below).
Because the techniques deliver more nuanced definitions of what true profitability means, portfolio managers are equipped with the right information and well-poised to make strategic decisions about their SKU sprawl. The assessment matrix indicates which products to maintain—or invest even more—in the portfolio, and specifies which SKUs are worth fixing, and which products it’s time to sell or to plan for phasing out.
Here, too, it’s important to evaluate special considerations that are unique to the product, brand, or company. For example, product bundling, footprint optimization, or strategic loss leading are portfolio considerations that change the value of an item beyond pure-data assessments. A successful and smart rebalance will always include the qualitative features that portfolio managers know best, and their inclusion will not only get to the best answer, but will gain team-wide support for the initiative.
During the SKU rationalization process, delivering the message to key stakeholders is what will make or break the success of managing changes in the portfolio. A major strategic shift may require broader communication, while enforcement of minimum order quantities or discontinuation of certain products may require that extra attention be given to key customers. In either scenario, the best solution is to connect with customers and other stakeholders on the basis of what your decision means to them, providing one clear, consistent message across all channels.
Successful SKU rationalization results in an increase in profitability, decrease in working capital, and improvement in customer service levels. The overall complexity of running the supply chain will drop as the portfolio becomes more streamlined. And, if done correctly, this exercise can result in a shift in behavior across the company.