SKU proliferation: Too much or not enough?

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SKU proliferation: Too much or not enough?

SKU proliferation: Too much or not enough?

Xiang Wan and his team were trying to find out if managerial intuition about the pros and cons of SKU proliferation is correct—in effect, whether it is good or bad, or if there is a middle ground.

My twelve-year-old daughter filled her cup with cherry cola at our traditional Saturday lunch spot.  In a revelatory tone she exclaimed, “Someone should make banana flavored soda!  I would buy that.”

The operations manager inside me cringed. “Sure,” I asked, “but who else would? What about the inventory, the spoilage, and the transport?”

I explained that her idea had more fundamental implications than it might seem. She was invoking an important debate pertaining to SKU proliferation: When examining a product portfolio, when is more variety needed, and how much is too much?

I told her about an article published in the Journal of Operations Management called “Too much of a good thing: The impact of product variety on operations and sales performance.” In it, Xiang Wan and his colleagues examine the sales and operational performance of a major US soft drink bottler that distributed 328 SKUs from a network of 108 distribution centers.

Wan and his team were trying to find out whether managerial intuition about the pros and cons of proliferation is correct, and if so, which force is more dominant. In effect, he asks whether proliferation is good or bad, or if there is a middle ground.

The theoretical pros and cons of SKU proliferation are pretty straightforward. Proponents argue that the more you segment demand, the better you become at matching the needs of your customers. Customers like this, so sales increase.

Alternatively, SKU-proliferation skeptics suggest that it is costly to manage product variety. Forecasts are less accurate, more administration is required, and warehouse management becomes more complex. As a result, SKU proliferation can compromise operational performance. The study measures operational performance using “fill rate,” which is the percentage of product orders that are actually fulfilled (as opposed to stocking out of the product).

My daughter silently adjusted her straw, so I continued. The impact of increased SKU proliferation on operational performance (i.e., fill rates) is pretty clear—it hurts. Wan finds the costs associated with managing more things are as predicted. The good news, as I explained, is that the degradation of operational performance occurs at a decreasing rate. The worst of it occurs at the lowest levels of SKU proliferation when sales improvements are more likely to offset compromised operational performance. Nonetheless, fill rates continue to fall as product variety increases.

The sales impact of SKU proliferation is where things get interesting. The logic is that sales increase with product variety as a company better serves the needs of unique customer segments. The data support this view. However, as with operational performance, the rate of improvement decreases as proliferation increases. Research suggests this is because new products eventually cannibalize demand for existing products. In other words, if you go to buy regular cola and end up buying it with a “hint of lime” instead, then overall sales have not increased; instead, sales merely shift from one product to another.

“So, sales would increase (but at a decreasing rate) if a company decided to add banana cola,” she said. “It’s all good.”

“Not really,” I responded. We also have to deal with the indirect impact of operational performance on sales. Remember, you cannot sell what you do not have in stock, and the soft drink market is highly substitutable. You might have a preferred brand, but if it is out of stock, you are more likely to choose the other brand than to choose nothing. Therefore, a decreasing fill rate—our measure of operational performance—can have an indirect and negative impact on sales.

Pulling this all together, the critical finding of Wan’s study is that SKU proliferation requires a delicate balance. Variety can be good, but it is possible to have too much of a good thing. In the context of one major soft drink bottler, where the range of SKUs ran between eight and 114, the researchers determined that the optimal number of SKUs was 84. Below that number, the bottler could improve its position by better serving customer niches; above that number, the damage caused by lower operational performance overwhelms those benefits.

My daughter continued to play with her straw, so I continued my explanation.  At this point, I introduced a second critical insight to come from the study: optimal SKU proliferation is something that can be effectively estimated. Wan’s study uses data acquired from a real company. Other companies have the opportunity to use their data to perform similar analyses. Understanding the tradeoffs involved in SKU proliferation can provide critical insight to managers, and this insight is within their reach. “It’s just a math problem.” I concluded, “and you love math!”

She raised her eyes in response. “You’re such a geek, Dad,” she concluded. “All I said was a banana cola would be good.”

“Indeed,” I replied. “Nonetheless, successful companies look for ways to use the data they have to understand the tradeoffs between top-line and operational performance to maximize their most important metric—the bottom line.”

And with that, our impending feast of chicken fingers and fries led us to other distractions.

About The Author

Mark Cotteleer

Mark Cotteleer is a director with Deloitte Services LP.

SKU proliferation: Too much or not enough?
  • Amy H

    This is great analysis and observation of the study referenced. I’d be curious to understand if similar diminishing rates of return are seen when looking at SKU proliferation within a vendor, but across product categories, e.g. “big box” retailers. Additionally, how does the concept of SKU proliferation change when you consider services instead of products? Of course, there, there are different overhead costs, training instead of inventory, etc, etc, but that would be an interesting topic to consider as well.

  • Charles Ries

    Really loved your approach to article. I am not a geek, but I am a writer and I GOT IT! This also resonated with me and my work with entrepreneurs who over reach before establishing a solid foundation. While I understand the value of “focus” there seem to be times when opportunity becomes so loud and apparent that we must march onward, but at what cost? And after we have spent as much time as we can to evaluate cost, don’t we have to sometimes, just take a leap? This “leap” seems less a risk for well established enterprises then entrepreneurial ventures still in their formative stages. But enough said, your article got me thinking.

  • Peter

    Mark’s ‘delicate balance’ brought to mind my own class lessons on complexity versus choice which are captured well in the contrasting TED talks by Barry Schwartz (“The paradox of choice”; http://www.ted.com/talks/barry_schwartz_on_the_paradox_of_choice.html) and Malcolm Gladwell (“Choice, happiness and spaghetti sauce”; http://www.ted.com/talks/malcolm_gladwell_on_spaghetti_sauce.html). Schwartz overstates his premise when he argues that maximizing welfare means maximizing choice. Gladwell has a more thoughtful response: Market segmentation reflects the diverse and a large customer base. Schwarz’s problem is that he can’t see that customers want choices, but not an infinite number. “Paralysis of analysis” comes to mind here. And the market winnows down excess choices.

    I think that corporations and individuals benefit from the occasional “SKU review,” making sure that your inventory of assets are still assets, and not dead weight. I even try this at home, when I triage the refrigerator of items that looked great at the time but
    whose time has now passed.

  • Mark Polczynski

    The other day I walked into my local library to pick out a book. Man, they have a lot of books in there! I browsed around for a while, but I just couldn’t decide which book to choose, given my limited free time for reading. So I just ended up walking out without any books at all.

  • Bob Carver

    Great article Mark, excellent content and delivery. I have had the fortune (or misfortune!) to witness this in action myself having rolled out beverage distribution picking systems in over 100 DCs for a major soft drink bottler here in the US. I can’t speak to the sales impact of proliferation, but have to believe that marketing in these firm would have been throttled back if their many variations have (or had) not resulted in favorable sales impact. I can tell you from the operational standpoint proliferation has changed this firm’s DCs dramatically. New product (some now with temperature control requirements), as well as seasonal shifts in product preference, cause seemingly endless reslotting/rewarehousing efforts at their facilities. One thing I didn’t really see in the article (it may be in the study) is that SKU proliferation is impacted probably almost as significantly by packaging variation within a product, as it is by product variation. Any one particular soda that may have been sold in 12 oz cans, 2 liter bottles and 16oz bottles, now comes in multiple different qty packs of those sizes. Not only that, but now it’s available in 8 oz cans and 10 oz bottles. Add to that, packaging that varies depending upon the season, region and other factors and what was once maybe a 6-8 pack variations active on a single product can now be several dozen active at one time. And does it always result in new sales, no? Take for instance the white polar bear can Coke released in 2011 at Christmas, it bombed, too many folks thought it was Diet Coke. They quietly just stopped making the cans after a few short weeks. Looking forward to seeing more of your work!

  • John

    Mark , first nice topic.
    You know this something we have struggled with for quite some time. As you point out, looking at it from two
    different perspectives will result in two very different opinions. That said, I do think there is a middle
    ground. It does however depend on the
    costing model an organization chooses to utilize. Many times in a product family, there are
    core products that make up the majority of volume (either unit sales, cogs,
    revenue, whatever)…call it the 80/20 rule.
    The business, marketing and sales side are typically able to leverage
    both the supply chain and operational processes to maintain the margin on the
    tail of those products that is either exactly or very close to the margin of
    the core products. From their
    perspective, a part is a part is a part and based on what those organizations
    may be measured on, this works for them.
    The rub is obviously when one of the obscure SKU’s is ordered and is run
    through production, depending on the variation within the BOM and assembly, the
    burden costs for this “one-off” is much different, however, these costs are not
    typically passed on through the cogs.

    One solution is to set multiple burden standards (keeping
    cognizant of the effort to maintain extra data). If simply opened up to TWO burden costs, both
    parties would seemingly win their respective arguments, albeit at a reduced
    margin for the products on the “tail”.
    For the high running, core products utilize the standard burden rate set
    to that production line where product with volume truly drive the expense. For the remainder, set a burden rate at a
    much higher multiple. Business gets to
    keep the SKU’s and operations gets higher
    absorption for the slow mover (modified ABC accounting).

  • Derek H

    I definitely agree that some companies focus too much on adding products that could be substitutes for other products in their current line which potentially leads to no increase in total sales. You really drove it home when you said companies really need to “understand the tradeoffs between top-line and operational performance to maximize their most important metric—the bottom line.” The bottom Line; thats what it comes down to.

  • Joe S

    This reminded me of reading “The Goal”, by Eliyahu Goldratt. Very easy to follow and entertaining with a story, yet informative at the same time. Great article, I look forward to more in the future.

  • http://twitter.com/ProfDC David Croson

    Information products can be finely customized (sometimes even by the user) without batch setup costs. A picture of a banana-flavored soda is a lot easier to create than an actual beverage. (That’s why there can be an infinite variety of costumes in MMORPGS, for example.)

    For physical products, I would also argue that there’s a more subtle effect on industry structure: raising consumers’ expectations that their whimsical desires for small product variations will be met without needing to pay a price premium. Imagine a car buyer, completely spoiled by infinite variety in other areas of his/her life, saying “I’d buy it if it were the exact right shade of blue, but since it isn’t, I won’t buy any color until the perfect one comes out.” Making consumers extremely sensitive to small deviations from their ideal products will be *very* costly to retailers over time, particularly if competitive forces push all players into this type of hyperdifferentiation.

    There’s also a famous story about proliferation sapping your ability to defend your markets (originally from Ken Judd’s research on credible spatial preemption). If you have a lot of products spaced close together, it’s more expensive to start a price war against an entrant because you hurt not just one but *two* closely-adjacent products of your own.

    P.S. Two words for your next daddy-daughter date: Coke Freestyle. [Often found in combination with Fuddruckers]: http://www.youtube.com/watch?feature=player_embedded&v=9V-yphI7JPk. The Coca-Cola museum in Las Vegas also has many, many variant flavors (some delectable, others revolting) although I don’t remember banana specifically.

    P.P.S. Perhaps you could synthesize a banana cola from readily available ingredients. Coke makes a FUZE Banana Colada drink; perhaps an appropriately proportioned mixture with Coke Classic would produce a winner!

  • Trent Carlson

    In my current company we manufacture to customer specific parts and wait until we have a sales order to do so, however not to long we implemented a stocking program for those parts that are common amongst many different customers. In doing so, we have beefed up our finished goods inventory and have come to a point where we are holding a large variety of SKU’s. This is impacting our capacity as we try to fill all of our sales orders as well as be able to fill requests for parts in our stocking program.

    I think that as we move forward, we should be evaluating the number of SKU’s in our program and determine if we are carrying the appropriate amount of inventory and if some of our stock jobs should be converted to sales orders jobs. Thinking about how the optimum number of SKUs impacts our company and considering how it can impact a large soft drink distributor, I feel that an analysis of SKU’s and Opertional Performance should be done on an annual basis, something I am going to take back to the office and discuss next week.

  • Elliot Bendoly

    Ann additional interesting point of course relates to how variety impacts a larger supply chain, particular when various partners have vastly different takes (rationally or otherwise) as to what SKU mixes in fact are. I wonder if there has been a shift in recent years of where the influences in industry SKUs come from? It gets fairly complex, but this is reality. We have a sense that social network models of partnerships and competition are helping to explain the effectiveness of firms and supply chains as a whole. I expect this is likely to be part of the next frontier on SKU related research.

  • Lonnie Perrelle

    As a shopper, one thing I know for sure is that it now takes much longer to shop because of the proliferation of SKUs and I don’t see anyone measuring my discontent or even noticing it. As the population continues to age, smaller and easier are the key marketing concepts. Brands that are easy to recognized since we have trouble reading the print on merchandise would be much appreciated. Remember, the KISS principle.

  • Tricia Geraghty

    As in so many decisions, having access to the data–and actually listening to it–makes all the difference. We’re all pursuing increased demand but risk the substitution effects. Only the sales data can tell you what’s really happening.

    If you’ve read Jim Collins’ Great By Choice, you might be familiar with his bullet vs. cannonball analogy. He chronicles a successful strategy of trying and experimenting with bullets (might be banana soda) before deciding on a cannonball (go all in with cherry–there just aren’t as many banana lovers out there!). I see some parallels here.

    Good discussion. Thanks for starting it.

  • Jim S

    Great article. In addition to finding the optimal balance via mathematics, companies should rotate management between sales/marketing and operations. They can build first hand experience of the impact (positive and negative) of SKU proliferation after “walking in the other’s shoes” for a bit.

  • Dena

    Excellent article Mark! As a consumer, I want more choices and fewer options simultaneously. It’s our modern day conundrum. I look forward to reading your future essays.

  • Eric Meerschaert

    SKU proliferation also dampens marketing and branding investments, a factor often not well measured or discussed above. As the number of SKU’s rise, we spread our marketing dollars around like butter on warm toast, and seconds after the spend, the spend has disappeared with no visible effect in the marketplace and a decreasing ROMI (Return on Marketing Investment). Smart companies should go beyond the basic analytics of direct costs for launching a new product and consider the effects on branding and demand generation when budget dollars are spent on an increasing array of messages that diffuse brand and interactive awareness and dampen the ability to concentrate markets for direct demand generation.

  • Kevin Radewan

    Great article Mark. As I am in materials management for a heavy equipment parts and service operation, supporting 100′s of thousands of SKU’s, I know this problem all too well. As you touched on above, the majority of our customer fill comes from a very small percentage of our SKU’s I would say about 6% of our SKU’s represent 85% of our demand. The problem is almost all of our carrying costs (inventory space, inventory dollars, spoilage, scrap, etc.) come from sku’s with little or no demand.

    I love your concept of the optimal SKU quantity and something I wish our company would consider. In my assessment the sku’s are set-up for initial good intentions, like offering a sub-component for replacement rather than the full assembly to reduce warranty costs. The problem is most sub-components won’t ever need to be replaced or will rarely need to be replaced. The decision was made for a short-term cost benefit that can be easily quantified. However, the long-term costs of these decisions don’t occur for years later and are much harder to quantify. In your above scenario, the initial sales revenue of banana flavored soda will be highlighted as a success by sales and marketing and the product line will be expanded before the longer-term operational costs are incurred.

    A second issue in our business is that all parts are allocated the same percentage of fixed cost and carrying costs. This means the low-volume sku’s are highly subsidized by the portion of costs absorbed by the high-volume parts. Thus, the low-volume parts remain more competitive to the customer and therefore remaining active and creating problems longer and the high-volume parts are less competitive because they are incurring the additional costs of subsidizing the low-volume parts.

    One final thought is when taking these issues to marketing and sales they always fall back on the intangible value of “customer service” which is created by offering these parts and again is hard to quantify versus our inventory costs.

    Again, great article/topic Mark. Good luck.

  • Jennica Webster

    Your banana soft drink example referred to products, but I think your same logic would apply to services. The difference however, is finding the optimal balance of the types of services offered while at the same time insuring the customer has a differentiated experience. The primary way this is accomplished is through interactions with the front line customer service rep. It’s the customer experience co-enacted with the frontline CSR that becomes difficult to substitute and a real source of competitive advantage.

    Thanks for the post. It really spurred my thinking about this issue and its application in a customer service setting.

  • Andy S

    Great article – I am very curious about learning more and particularly if other operational costs to support slow moving SKUs are considered including the impact on margins and not just revenue

  • Ben Petry

    Thanks, Mark. I enjoyed the article and thought it was written well. I am a strong proponent for solving problems with numbers and would be interested in finding out more behind the math. Could you share how you measure the costs and benefits of SKU proliferation? What technique or techniques would you suggest for someone to use in order to find the optimal amount of SKUs? Cheers.

  • Tim Murphy

    Mark, I completely agree with you on “It’s just a math problem”. If a company is willing to have a bit of patience and gather the data, a series of quick tests certainly can reveal an optimal number. Now it’s just a matter of making sure you have the right people to conduct the analysis. Good stuff!

  • Amy Fannon

    Great article from another self-labeled geek. The insights definitely apply to the digital services we offer customers as well. We are working on proliferation patterns in social media right now. Thanks for this!

  • Matthew Hixson

    Mark, first off, very interesting article. I would definitely like to continue receiving these in the future. As for the SKU proliferation argument, my business is always trying to satisfy our customer´s needs. Historically, we´ve been known to go above and beyond to meet all of our customer´s desires. I think it offers us a unique offering over competition. Whether or not the cost-benefit turns out in our favor is another question (but the short run and long run cost-benefit analyses might be different. I definitely think there is a balance. Where can I find more research on this analysis?

  • Andrew T

    Mark,
    Nice article. Thanks for the opportunity to comment. Working in the retail space with millions of SKUs this certainly is a pertinent topic. I agree with the concepts developed in the article and agree that there is a delicate balance of achieving the increased sales and profitability. The risk factor of course is in spoilage for perishable products or waste vis a vis the need to mark down prices on slow moving products that are not perishable in the sense of food but rather have a finite shelf life such as apparel. Fashion varieties of course change annually and the colors that are in vogue this (insert season) will not be the same cool colors next year. Then there is the decision relative to apparel about when to begin the price mark down process – too soon and you will sell inventory at a discounted price that the consumer would have paid full price. Alternatively, waiting too long to mark down items such as apparel or seasonal items (lawn & garden furniture) relative to your competitors and you will be the last one on the street wtih inventory to be sold. Lastly, those marks downs eventually drive the final sales you generate into empty sales – meaning that they have negative margins – but you need the space to get the next season’s merchandise onto the prime retail space to maximize full profit sales.

  • Christina S.

    Here comes the Marketing response (self-identified geeks please insert groan here)… If it were ‘just a math problem’ we wouldn’t have these debates. I skimmed the other responses and didn’t see much about what the consumer wants and what the competition is offering, which is where my head went to first. Plus, how does the product and inventory reflect your brand promise?

    Consumers have expectations and needs and if we didn’t listen to them then everyone would have a black Model T car in their driveway. Which begs the conversation of competition. Using techniques like product variation* can help prevent a downward pricing spiral and can help reset the product category as a whole. (*Variations can include case qty changes – like Family Size versus Fun Size, or smells [...], etc…) Ultimately these ‘math problems’ force us to get smarter with how we present options to customers, too. Use the example of soda in a restaurant, now there is computer touch screens that allow you to have seemingly infinite choices.

    Anyway, fun example and a very real challenge for businesses. Thanks Mark! And your poor daughter having to endure such a conversation over chicken nuggets! Hopefully, she’ll still have lunch with you in the future! :) Take care!

  • Scott Searles

    Great article Mark…topic hits home with our consumer businesses in tissue and personal care products where we are constantly seeking differentiation from private label brands that are rapidly improving in quality. Some proliferation keeps consumers in our brand franchises, but there are also examples where our internal excitement for a new feature was not shared by the consumer. So your simple math problem does have a variable if psychology that comes into play. The holy grail is figuring out the supply chain…thinking about downstream differentiation of desk jet printers for Europe…

  • Chris Noorian

    Great article Mark. I especially like the idea that SKU
    proliferation can, at times, merely cannibalize current demand for existing
    products. This is very present in industries ranging from your soda example, to
    name brand HDTVs. However, if companies do not continue proliferating their
    goods offered, customers may go for that ‘lime flavored’ drink over the industry
    standard.

    Throughout the read, I could not help but wonder what impact
    this idea has to the service industry. If your company has a set amount of
    resources to provide a more open ended set of services, one may have to make
    the same calculation to maximize their position in the market place. Once I
    started reading other comments, I see this has been hit on. Clearly got people
    thinking, thanks for the read!

  • Jeremy G.

    Great article. I found your choice of products to be particularly interesting for the subject of SKU proliferation in light of the new fountain drink dispenser technologies that are being rolled out right now. The new dispensers allow manufacturers and retailers to stock fewer products, but fulfill a multitude of flavors at the point of sale. Furthermore, the ability to capture the changing consumer preferences on a real-time basis can be fed back to bottlers and marketing teams to develop new products targeted at specific regions. It will be interesting to see if this can be transformed into a competitive advantage in the years to come. If only all products could be as easily customized as flavored beverages!