Headaches have a way of coming back if not treated properly. If you have a recurring headache, you can either run to the closest pharmacy to pop in aspirins, or get a root cause diagnosis to treat the real problem. Similarly, supply managers plagued with factories and warehouses that are littered with product find that no short-term fix like expedites, renting more storage space or using the latest supply chain visibility software can provide a permanent cure. The only long-term fix is to focus on substantially changing operating practices, and part of it means dealing with complexity management.
Complexity, in this instance, refers to the proliferation of individual items, either in input components and subassemblies or finished goods. Excessive item counts are a sure way to bring a supply chain improvement effort to its knees. No one magic pill or technology will provide a solution for managing complexity. Rather, it takes a structured, holistic team approach to methodical product rationalization.
Insidious Product Proliferation
Much has been written about what causes product proliferation. This article will focus on how to deal with it, rather than the "why's" and "what's."
Nevertheless, to put product rationalization in perspective, some of the major reasons why companies amass countless SKUs in their arsenal are due to mergers and acquisitions, companies placing more emphasis on new product introduction than end-of-lifecycle management, and product families growing into multiple SKUs as packaging variations are put in place, among others.
But all this proliferation leads to complexity. In manufacturing, SKU proliferation can lead to frequent setups and short production runs, driving up manufacturing costs. For supply chains, proliferation of SKUs can cause difficulties in forecasting sales volumes, ultimately resulting in increased inventory and transportation costs. For Sales and Marketing, proliferation can result in dilution of brand power and sub-optimized shelf space. And finally, for Procurement, proliferation can create supplier fragmentation leading to loss of buying leverage and ultimately higher material costs.
Getting a Handle on All that Product
Now that we understand SKU proliferation, the question is how do you deal with it to make it go away? While narrowing the component selection and finished goods offerings to just a few items would be a logical decision, it's not that simple. If not managed carefully, the same steps that might simplify the supply chain can more than offset that benefit by reducing revenue. Here is a real life example, from one of my previous employers, where I led a team successfully through the product rationalization effort.
It started with an e-mail from our global director of Manufacturing wherein he asked the Supply Chain managers to provide a list of items that gave us the most headaches to manage and what would we gain or lose if we eliminated them. For me, images of items that caused stock-outs, created warehousing pandemics and caused our cost of poor quality to soar came rushing to mind.
Project Stage 1: Scoping and Planning
Formation of the Headache Index:
The word "headache" in the e-mail spurred a thought. "What if I created a ‘Headache Index,' which would simply represent a list of items, sorted high to low, signifying the most disliked items?" But then, how would I calculate the most disliked items?
Using Excel I extracted the Sales history for all SKUs for the past year. I applied three financial filters for starters, but decided that couldn't be enough, as Marketing would have eliminated these SKUs before with this information. I then came up with questions to ask other departments to grow the list of criteria that would make the Headache Index more comprehensive. Those were:
- Marketing for whether a product was core and whether it was replaceable by a close alternative or not
- Manufacturing for Complexity and Capacity/Changeover Issues
- Quality Control for spoilage history
- R&D for design stability
- Environment, Health and Safety for any associated safety issues
The above departments were given the "Headache" list grouped by product families and asked to rate them on a scale of 1 to 5, 1 being worst and 5 being excellent for the criteria listed above. When the data came back, I consolidated the list by weighting the criteria. The individual Gross Margin contribution and the Marketing Core Product Strategy and Replaceability questions were weighted most heavily to balance profitability with potential for loss of revenue. This balance is extremely important, as lost revenue can very quickly offset the complexity related cost reductions. Then I plotted the distribution of the index and determined three categories: "Green" (Go), "Orange" (Check) and "Red" (Gone). The results showed that 50 percent of our SKUs should be gone.
Exhibit A (Formation of the Headache Index)
What's In It for Me — the Total Cost Model:
Depending on the industry, type of company and extent of rationalization, SKU reduction could yield such benefits as improved manufacturing efficiency, reduced inventory, reduced warehousing, and reduced raw material and packaging spend.
I captured the above benefits with some assumptions as standard industry benchmarks could be used for initial model creation, which could be tightened later once buy-in was created and a team was formed. Initial assumptions and calculations would have to be made regarding:
- What SKU will replace the rationalized SKU?
- What is the cost of manufacturing complexity (cost of changeovers)?
- What is the lead time and inventory strategy (make-to-stock v/s make-to-order) of the SKU being rationalized v/s the SKU replacing it?
- What are the historical obsolescence and warehousing costs as a percent of inventory?
- What is the inventory carrying cost as per the company financial policy?
- What is the contribution to the overhead calculation?
Once the model was created, the rolled up number was large enough to turn heads. We presented it to our division general manager and got his buy-in; he agreed to sponsor the project and create a high-level team.
Project Sponsorship and Project Team Formation:
Under the direction of the general manager we formed a cross-functional team that included members from the surveyed departments. The key members of this team were from Marketing/Sales, as they had the toughest job at hand. They would first work with their teams to understand what SKUs would replace the rationalized SKUs, and then get their teams to sell that change to their customers and receive their input.
Project Stage 2: Analysis and Negotiation
Marketing and Sales Work Sessions:
We spent countless hours with the Marketing team members, going through the entire SKU list. From this effort emerged the core packages the company was to carry. The data actually drove us to the answer, but there were some outliers, which the Marketing folks promised to sell to their teams. The list was presented at the next national sales meeting, which included a working session to educate the sales team on the list and our findings. They spent a good half day further refining the list and suggesting alternatives where applicable.
Two-phased Implementation Plan:
When the project team met next, Marketing came back with their finalized list. They suggested a two-phased implementation strategy.
The first phase would start quickly (within the next month) and cover about 70 percent of all SKUs. These SKUs would not require any customer trials. The second phase would be longer term (within the next six months) and cover the rest. These were the items the team thought they needed more time to convince the customers and would require trials.
Both phases had a conversion or rationalization date that was within three months of implementation. The timing and two-phased implementation plan was to bleed the inventory at the customers and conduct trials if necessary.
Project Stage 3: Communication & Preparation
We created an implementation plan that was communicated to all internal departments as well as customers. A comprehensive list of original v/s replacement SKUs were created. This included the switchover timing, a product/engineering change number if required and action items. We used the list to track the progress of the project.
Project Stage 4: Inventory Ramp Up/Ramp Down
Next was the inventory ramp up/ramp down phase. We created and processed product/engineering changes for the affected SKUs, analyzed consolidation and change of demand, and updated replenishment parameters in the company's materials requirements planning system. We also updated and issued a new product/sales catalog to internal and external customers. Updated forecasts were also sent to the affected raw material and packaging suppliers where impact was significant (+/- 10 percent).
Project Stage 5: Go-live
In preparation for going live, inventory of any old SKUs was reviewed weekly. We worked with Sales to sell the remaining inventory, sometimes at a discount. We flagged the deleted SKUs in the enterprise resource planning system. We monitored inventory levels for make-to-stock strategy SKUs that were being eliminated. Finally, we had Customer Service focused on providing superior service during the change-over process. The concrete deliverables of this phase were no stranded inventory and the old SKUs flagged for deletion by our master data group.
Control Plan (How to Avoid SKU Proliferation)
Now that we have successfully implemented the project, how do we make sure that what was done sticks? A key measure of success for the effort is to have a solid control plan in place that keeps the proliferation from creeping in again. Some of the key elements of the control plan are:
- Planning and Inventory Management: Inventory of rationalized SKUs is monitored and only the agreed upon SKUs are planned to be produced.
- Deletion of Rationalized SKUs: The master data group makes sure the SKUs in question are deactivated from the enterprise system, so that no new orders can be entered against them and they will not linger.
- Customer Conversion to Chosen SKUs: Sales validates that targeted customers actually convert to the agreed alternatives.
- Sunrise and Sunset Rules: Sunrise rules need to be created where a cross-functional committee makes a decision on whether a new SKU is viable by focusing on the same criterion described in the formation of the "Headache Index" above. The same thought process is applicable with the creation of sunset rules for identifying and retiring SKUs at the end of their lifecycle.
While I left the company for another opportunity as we went live on Phase 2, I was able to find out the results. They were:
- While adding a handful of new innovative items, the North American sales SKUs for 2006 were cut by 55 percent. More importantly, revenue increased during this time.
- The impact on working capital was over $1.2 million. Total inventory, as measured in days-on-hand, was reduced by 39 percent.
- Operationally, the project strengthened the level loading in all three departments and freed up some hourly positions. This allowed the company to staff a second shift in one of the departments to support the growth driven by new products.
- Customer service level as measured by on-time deliveries was up in 2006, averaging 95-97 percent, compared to 90-95 percent previously.
- Revenue increased by 5 percent with 1.5 percent volume increases. Gross margins improved enough to offset the raw material and commodity cost increases, which was partially driven by keeping higher margin SKUs in the core portfolio.
Key Success Factors
Here are some of the key success factors for any product rationalization/complexity reduction effort:
- Senior management sponsorship. Everyone in the organization, especially the project team, should understand that it is a high-profile effort and results need to be delivered.
- Marketing/Sales partnership and commitment, without which the effort would go nowhere.
- Replacement strategy, where Marketing/Sales decide whether products can be replaced and are able to drive the strategy to the customer.
- A well-thought-out control plan with metrics to avoid reverting back to the original state.
- Accessible sales and cost data to develop a clear understanding of the impact caused by SKU proliferation, which is the starting point of the "Headache Index."