The Complexity of Reducing Complexity

The Complexity of Reducing Complexity

SKU reduction: when to jump on the bandwagon, when to jump off.

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The Complexity of Reducing Complexity

Packaged-goods manufacturers are under pressure to cut the number of SKUs (stock-keeping units) they produce. Some of this pressure is internal-large numbers of SKUs increase complexity, and complexity costs money. But most of the pressure comes from retailers who want to reduce their own costs by stocking fewer SKUs. To some extent, there is also pressure from consumers, many of whom are overwhelmed by the present profusion of SKUs and seem to want simplified shopping. Prompted by these pressures-and by the wish to jump on a bandwagon that appears to be saving money for competitors-quite a few consumer products companies have reduced SKUs. To their surprise, however, many of these companies have seen very little of the savings they expected. What is worse, some have seen their revenues decline. Clearly, SKU reduction is not as simple as it's been made to look. In fact, despite the pressures, SKU reduction is not always a smart move. There are three key elements in executing a rational approach to SKUs that will save money without losing revenue:

  • First, you must take a hard look at your product category. In premium categories, you will want to trim SKUs very cautiously or not at all. You may even want to add SKUs.
  • Second, in the categories where SKU reduction does make sense, you must cut deeply enough to reduce fixed costs and overhead, not just nibble at your variable costs.
  • Third, whether or not you're in a premium category, you must attack other sources of costly complexity as well as standard SKUs. In particular, you need to make big cuts in promotional SKUs, in trade deals, and in wasteful design and manufacturing extravagance.

Good SKUs and Bad Ones 

In product categories where consumers focus principally on price-sliced meats is one, roast and ground coffee another-the market seems relatively indifferent to a broad array of choices and to a steady diet of innovation in the product, the packaging, or the advertising. In these so-called value categories, consequently, SKU proliferation is often a poor source of revenue (though still a prime source of cost). Since the name of the game is price, price, price, eliminating SKUs to pare down costs is an excellent approach.

In premium categories, however, the name of the game is innovation, innovation, innovation. Consumers of, say, breakfast cereals or analgesics respond to aggressive marketing, and they insist on variety in the product and the presentation. In premium categories, in other words, SKU proliferation tends to be a good thing despite the cost, partly because consumer loyalty is to some extent dependent on choice and novelty, and partly because the proliferation of SKUs can be a way of increasing shelf space.

One excellent example of a leading brand in a premium category is Tylenol, and its SKUs are legion. Tylenol comes in regular, extra strength, and children's dosages; in normal and extended relief; in tablets, caplets, gelcaps, geltabs, and as a liquid; in combination with other over-the-counter medications; in packages that are child-proof and, for arthritis-sufferers, in packages that are extra easy to open-all of these and more in a variety of sizes. Altogether, Tylenol is sold in at least 70 SKUs. The manufacturer has now developed what it calls a Tylenol Store, a special display that separates the various SKUs into different compartments with pictures that tell which SKU to buy for which need-pain with a cough, pain with sleeplessness, pain with muscle aches, and so forth. And the historic annual growth rate in Tylenol sales is clear evidence that consumers take a positive view of this level of choice and variety.

Cutting Deep

Suppose you make and market a line of body lotions with 40 standard SKUs-with and without sunblock, with and without fragrance, in tubes, tubs, and bottles, and in a variety of sizes. Retailers are urging you to reduce the number, so you take a careful look at sales figures, and decide to eliminate eight SKUs or 20% of the total. How much money will you save?

In marketing, nothing. You never did advertise the SKUs, only the brand, and since you now hope that your customers will buy just as much of the product but in different configurations, your marketing budget stays the same.

In overhead, nothing. Your office expenses will not go down, your buildings will still need maintenance, your utilities usage will hardly change.

These are fixed costs, and discontinuing a few SKUs will not affect them. Nevertheless, you will see some modest savings in your variable costs.

In direct product costs, for example, you will save the cost of eight packages and the cost of setting up for eight relatively short product runs. In accounting and logistics, you will see small savings in paperwork.

In labor, unfortunately, your savings are likely to be trivial. Eliminating eight product runs (but increasing the length of several others) may permit you to lay off a few workers and eliminate some overtime, but it will not allow you to cut an entire shift.

As for revenues, you hope the customers who bought the discontinued SKUs will now buy your body lotion in other sizes and configurations, but you can't be sure. Every SKU has some diehard fans who turn to another brand if they can't get yours. In some product areas, brand loyalty is nearly always secondary to some other consideration. Ice cream is an obvious example. If you stop making pistachio, it doesn't matter how brand-loyal your customers are.

The pistachio fans among them will buy someone else's pistachio before they'll try your butter pecan. By the same token, it may be that some consumers are so attached to the sunblock additive in the handy 4-ounce tube-one of the SKUs you've trimmed-that they'll simply buy another brand. There is also the very tricky question of shelf space, which may go down if you cut the number of SKUs.

All in all, you will see some modest cost savings at the risk of seeing some significant losses in revenues. This is not an acceptable tradeoff, but it is exactly what has happened to many of the packaged-goods producers whose SKU reductions have left them net losers. The fact is, cutting a few SKUs is just not much help because it affects only variable costs. To save real money, you have to go after fixed costs, which is where the big economies are found.

So instead of cutting 8 SKUs, or 20%, why not slash your standard offering in half and do away with 20 SKUs? You still save nothing in advertising, but now you're in a position to see significant savings in every other category. If you can eliminate an entire shift or, better yet, close an entire plant, your costs will begin to show sudden, dramatic improvement. Labor will plummet, and so will maintenance, utilities, bookkeeping, logistics, warehousing, and most other costs. You will again enjoy economies of scale, partly because product runs grow longer and partly because overall inventories grow smaller. What's more, since it is much more difficult to predict unit sales for 65 different configurations than for 25, you can work with smaller comfort margins on product quantities.

You have now made a huge dent in your costs, more than enough to offset any possible decline in revenues. Yet why should revenues have to decline? Hasn't the trade promised equal visibility and prominence? Haven't customers asked for a simpler set of choices? Market research can answer such questions and help to solve many of these problems. As for that nagging question of shelf space, when a retailer pressures you to cut back on SKUs, you must make certain-you must make it a condition of compliance-that the same demand is made on your competitors.

In fact, there are good ways of reducing costs-even of eliminating SKUs-without affecting either shelf space or revenues, and they work whether you are in a value category or a premium one and whether or not you decide to cut back on your standard SKUs.

Cutting Waste and Extravagance

Usually, a brand with a number of standard SKUs makes and sells a number of promotional SKUs as well-all the trial sizes and giveaways and special packages associated with advertising campaigns and product promotions. These promotional SKUs often increase the total number of SKUs produced by 25% to 50%. In the most egregious cases, from 60% to a nearly unbelievable 90% of a manufacturer's SKUs are tied to promotions. Worse still, a great many manufacturers don't know how many promotional SKUs they make and have no idea what this explosion of short, expensive product runs is costing them. This complexity costs money, and cutting back on promotional SKUs will undeniably reduce costs. Yet promotions are obviously important; cut back too far and your revenues may suffer. One way of reducing SKUs without necessarily reducing promotional activity is to stop making special SKUs for individual retailers and standardize promotional SKUs throughout the marketplace.

While SKU reduction can be an effective way to cut costs, it is not the only way, and it is not even always the best way. Another area manufacturers must look at is the complexity created by trade deals. Simplifying trade deals gives manufacturers a great opportunity to eliminate considerable costs in the supply chain.

Manufacturing is another arena where costs can be reduced. As part of its cost-cutting program, Procter & Gamble has standardized container "footprints" across different sizes, harmonized across different product lines, in order to eliminate costly alterations in the way machines grasp and move SKUs in the production process. Manufacturers must also make an effort to distinguish between the SKU variations that matter to consumers and the ones that don't. One packaged-goods producer spent a lot of money making different colored caps for different SKUs only to discover that purchasers neither cared nor noticed.

It's monday morning-What do you do next?

The pressures to jump aboard the SKU-reduction bandwagon can be compelling. They can also be confusing and counterproductive. Before making the leap, you must get good answers to these five questions:

  1. In your portfolio of brands, which ones are candidates for SKU reduction and which are not? In each case, you must use market analysis to make sure you understand the nature of the category and the motives of the consumer.
  2. What drives complexity and costs in your product line? It may be SKU proliferation, and it may be trade deals or manufacturing and logistical waste.
  3. If you contemplate SKU reductions, will they be deep enough to affect fixed costs? Unless they are, you may be cutting off your nose to spite your face.
  4. How many of your SKUs are promotional? What gyrations does your organization go through to produce them? How many can you eliminate?
  5. What tradeoffs are you making between cost and complexity on the one hand and revenues and consumer loyalty on the other? In a premium category, not all complexity is bad. In no category is revenue reduction good.
Jonathan Mark is a former Director of Bain & Company. Vijay Vishwanath is a Vice President of Bain & Company and leads Bain's Consumer Products Practice.

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