Skewering SKUs

When Wal-Mart emptied its shelves, consumers took their business elsewhere.
David KatzSeptember 29, 2010

It isn’t easy for giant companies to make a 180-degree turn in their merchandising strategies. But Wal-Mart US is in the process of doing just that, said Bill Simon, the retail chain’s new president and chief executive officer, at a Goldman Sachs conference two weeks ago.

Throughout 2009, said Simon, Wal-Mart moved aggressively to slash the types of products on its shelves — in industry parlance, it was engaged in a massive “SKU rationalization.” By cutting back vast numbers of underperforming stock-keeping units, executives reasoned, the company’s outlets could lure consumers to its best-performing products and thereby use its shelf space more efficiently. Wal-Mart could stock more private-label products, which have a lower cost of sales than brand-name goods, and the stores would look spiffier, too.

Customers, however, voted with their feet when they saw that Wal-Mart stores were no longer carrying their favorite products. Those consumers went to other chains to not only buy the brands that Wal-Mart jettisoned but also fill their entire shopping baskets.

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The company’s management began to change course in March by reportedly returning 300 “rationalized” products to store shelves. By the middle of September, Wal-Mart was “in the process of reviewing literally billions of items, store combinations of products and item[s] and SKUs that were in stores, and restoring anything and everything that was profitable for us from a [gross margin return on investment] perspective,” said Simon.

The problem, he said, was that the company’s plans were built more on theory than marketplace reality, alienating suppliers as well as consumers. “If you are a supplier and you are told your bread and butter at your biggest business is going to be minus 15 [SKUs], well, guess what?” said Simon. “You’re not going to be minus 15. You’re going to pack up your stuff and all your funding and you’re going to go somewhere else and sell it. And [suppliers] did.”

Does the Wal-Mart turnabout herald the death of SKU rationalization? No, say consultants. They maintain it’s important for suppliers to stop making products consumers aren’t buying — and for retailers to replace them on their shelves. “Some of the retailers went too far” and created “a consumer backlash,” acknowledges Hanna Hamburger, a director of the strategy and operations practice at Archstone Consulting, a division of The Hackett Group. But retailers must also hold the line against suppliers who, having put large amounts of research and development money behind their products, are eager to get them on the shelves.

Indeed, says Bob Allen, another consultant at the firm, Archstone’s clients in the consumer packaged-goods industry set “very aggressive targets” for their new products, looking for 20% to 30% of their revenues from item introductions. Since such manufacturers must fight hard for retail shelf space, it “makes sense for them to be rationalizing their SKU set with some regular process, because they’re essentially creating a place for the next product to reside,” says Allen.

Thus, suppliers should do an annual “spring cleaning” of their product portfolios, rating their brands and SKUs based on set criteria or metrics, the consultants advise. Engaging in such a pruning can be a painful process if it’s done haphazardly every three to five years, “particularly when the process is initiated in an adverse business environment,” according to an unpublished paper by Hamburger and other consultants at the firm.

Besides institutionalizing SKU rationalizing, another way to strengthen the process is to bring the perspectives of other company disciplines such as marketing, sales, and operations into the deliberations. Doing too much planning in a vacuum may have been one of the flaws that sunk the Wal-Mart effort, Simon’s remarks suggest.

To avoid such breakdowns, companies need the perspective of a cross-functional approach, according to Allen. And the ideal person to run the show? The finance chief. Explains Allen: “If you go to the operations group in the business and ask them which products they should cut, they’ll cut 80% of them. If you go just to sales and marketing, they’ll say none. But if you go to the CFO’s office, they’re making a more balanced decision based on the economics of those trade-offs.”

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