Nothing slows a business quite like excess inventory. Underperforming products clog your supply chain, bloat overhead costs, and prevent you from updating your product lines to meet current market trends.
Businesses address this by auditing every stock keeping unit (SKU) they carry and analyzing product performance across sales channels. If SKU data reveals minimal market demand for specific items, the company may discontinue them; if it shows high-performing products within the target market, the business will increase stock. This analysis, called SKU rationalization, is a common inventory management process used by thriving ecommerce businesses.
Implementing a SKU strategy can help you maximize profits, reduce overhead expenses, and stay aligned with market demands. Here’s how the process works.
What is SKU rationalization?
The SKU rationalization process is an inventory optimization operation where you ensure that each SKU contributes effectively to your business’s profitability, efficiency, and overall goals. Because of this, the process is sometimes known as SKU optimization. It involves studying sales data to see if each stock keeping unit is generating enough revenue to cover its carrying costs.
If the data collected shows, hypothetically, that a product generated $80,000 in sales last year, but production costs and unusually high storage costs totaled $73,000, you’d be making only $7,000 per year carrying that product. You might ask, in the name of operational efficiency and business performance, whether it’s worth stocking that SKU for a return of $7,000 per year.
On the other hand, your SKU analysis might reveal low storage costs and impressive SKU performance, giving you a reason to keep stocking that product line. In many ways, you won’t have a true portrait of sales performance versus inventory holding costs unless you perform the SKU rationalization process. Many business owners regard SKU rationalization as an essential aspect of an inventory efficiency project. Stocking fewer SKUs can improve your profit margins by helping you focus on the products with legitimate customer demand. On the other hand, stocking more SKUs can help you expand your target audience.
3 benefits of SKU rationalization for ecommerce
Here are three key benefits of SKU rationalization that apply to businesses of all sizes:
1. Opportunity to reduce inventory costs
To improve your inventory processes and reduce costs, it’s wise to put most of your resources into your most profitable stock. In a SKU analysis, you’ll study historical sales data to identify low-performing SKUs that haven’t sustained a sufficient sales volume. You can then eliminate those SKUs from your product catalog, cutting down on storage costs, labor costs, and other factors that may eat into your profit margins.
2. Improved customer experience
A more focused product catalog helps you clarify your brand identity and improve customer satisfaction. Online customers have an easier time navigating your ecommerce store, finding items, and purchasing them. A happy, well-served customer base potentially means more cash flow for your business, making this a win-win proposition.
3. Enhanced operational efficiency
Streamlined SKUs improve inventory management and supply chain efficiency. You can simplify your supplier relationships by eliminating low-performing or redundant SKUs. You can speed up inventory turnover by stocking only high-demand products. And you can leverage inventory performance data to improve your future sales projections. All of these combine to boost your operational efficiency.
How to implement SKU rationalization
- Gather relevant data
- Evaluate customer preferences
- Assess in terms of product lifecycle management
- Calculate the profitability and value of each SKU
- Forecast future demand
- Take action and monitor results
The SKU rationalization process is designed to derive actionable insights that help to create the optimal product assortment for your business. Here’s how to get there:
1. Gather relevant data
Start by collecting data relevant to the performance of each SKU. This includes current stock levels, reorder points, historic sales performance, and customer feedback from surveys if applicable. All sorts of businesses do this type of data collection, from grocery stores to boutique clothing shops.
2. Evaluate customer preferences
Once you’ve amassed your SKU data, analyze it to gather actionable insights about what your customers do and do not want. Some of your data analysis may align with the intuitive observations you’ve made while running the business. However, some data may surprise you, whether that means greater customer demand than you expected or less.
3. Assess in terms of product lifecycle management
Next, it’s time to consider each SKU one by one and assess where it currently exists within its product lifecycle—from introduction to maturity and potential decline. This assessment will aid you in forecasting demand and anticipating when to phase out underperforming SKUs.
For example, during a product’s introduction, initial market response can guide your stocking decisions. As the product matures, you can predict steady demand, which informs your inventory. Dwindling sales signal a decline stage, spurring you to take proactive steps like reducing the product’s inventory or discontinuing the SKU.
4. Calculate the profitability and value of each SKU
In this step, you’ll calculate each SKU’s profit margins, storage costs, and contribution to your overall sales. This helps you prioritize high-performing SKUs and eliminate those with a high product cost, declining sales, and low returns.
5. Forecast future demand
Use demand forecasting tools—including those powered by artificial intelligence (AI) and machine learning (ML)—to predict the impact of removing or retaining specific SKUs. This helps you avoid supply gaps and ensures that SKU rationalization won’t cause customer confusion or dissatisfaction. Beyond deciding which SKUs to keep or discontinue, you can also adjust order sizes to prevent stockouts or oversupply.
6. Take action and monitor results
You’ve now collected, analyzed, and applied your data. It’s time to take action by phasing out low-performing SKUs while increasing your commitment to popular SKUs that are boosting your bottom line. In most cases, you’ll still want to offer a diverse product mix that serves your longtime customers while properly adjusting to meet your evolving business goals.
SKU rationalization FAQ
What is an example of SKU rationalization?
An example of SKU rationalization is a grocery store reducing its assortment of similar cereal brands by discontinuing low-performing options based on customer preferences and sales data. The process lets the retailer trim down its inventory while maintaining a robust product mix to meet customer demand.
Why do we need SKU rationalization?
Businesses need SKU rationalization to optimize their inventory. They do this by eliminating underperforming or redundant products, reducing costs, improving operational efficiency, and aligning their offerings with customer demand.
What are the steps for SKU rationalization?
The steps for SKU rationalization include gathering product data, analyzing the data in terms of customer preferences, assigning a value to each SKU, forecasting future demand, and taking action to adjust inventory based on this data.
