Dont Let Unproductive SKUs Sink Your Boat

By Guy Schneggenburger
In good times and in bad, businesses look to increase profits. However, it is during troubled times when
businesses focus on aggressive cost reductions. There is no doubt that taking actions such as making
across-the-boardcuts or playing hardball in negotiations with suppliers will provide direct, near-term
savings. One of the fundamentals to The KGI System is that not all cost cutting efforts have equal
value, and there is a need to look long-term and evaluate both sides of the profit equation revenues
and expenses.

While reducing expenses is often more immediate in impacting the bottom-line, changing focus to
identify unprofitable products and services often goes further to increase the health of a business.
Time and again, the most constructive action a business can take to increase profits is to stop doing
something that is unproductive.
Businesses must determine which products drive profitability versus those that drain it. Product or
Stock-Keeping Unit (SKU) rationalization enables a business to do so identifying and keeping the
profits earned with Value-Add SKUs and also identifying and reducing the impact of Value-Cost
SKUs.
The graph below demonstrates the concept. Value-Add SKUs are the individual products and services
that have a positive net margin for the business; Value-Cost SKUs are those that have a negative net
margin when all associated expenses are tallied. The Available Profit is the amount of profit provided
by the contributions of the Value-Add SKUs. It is the maximum profit available to the business with the
current product line. TheActual Profit is the Available Profit minus the net loss of the Value-Cost SKUs,
also referred to as Lost Profit. The process of SKU Rationalization identifies and quantifies the ValueCost SKUs and the Lost Profit to enable a business to realize its Available Profit.

While this may seem to be a simple concept, a significant barrier stands in the way of successfully
identifying the elements so neatly displayed on the concept graph the business must have financial
reporting that correctly allocates costs to SKUs. This type of financial reporting is in contrast to typical
GAAP accounting. Sometimes called Value-Stream accounting, it tracks the flow of materials and
information required to bring a product or service to a consumer. In doing so, each SKU or family of
SKUs is assigned with its share of expenses from both the Cost of Goods and the SG&A sides of the
business (i.e., machines, facilities, labor, investment, inventory, and management). Several issues
contribute to the aforementioned barrier of accurately and systematically tracking this information:

Lack of expertise
Incorrect allocation methods
Incomplete or missing data
Poorly designed or implemented IT support
Difficulty in quantifying departmental activity
Complexity of analysis
Time required to perform the analysis
KGI has the experience and the skills to help businesses recapture Lost Profits and make strides
toward achieving the maximum Available Profit. We have a strong track record of assisting businesses
with efficiently implementing a SKU Rationalization process to increase profitability without incurring
downtime, excessive costs, or unnecessary reorganization. Here are some recent examples:
1.

Problem: A $120M food processing company ran three shifts, five days per week, and
maintained a highly specialized delivery network to bring products to their customers. Years of

increasing losses despite across-the-board cuts and price increases caused the company to
seek assistance.

Solution: KGI discovered that a particular product line was driving the need for a three-shift
operation, and this line also cost the company an additional $2.5M in unique transportation
expenses. Once identified, the company decided to limit production on this product family to
the amount that could be made in one shift. Given that all other products could be processed
in one shift, this was the lowest common denominator.
Result: The company increased net income by $9M from the eliminated expenses
associated with the Value-Cost SKUs despite a $5M decline in sales.
2.

Problem: A manufacturer of medical products had annual sales of $195M with a product line
of 380 different varieties of a product. The company suspected that it had too much product
variety, but did not know how to quantify each varietys effect on the financial results. Afraid of
sacrificing top-line sales by offering fewer products, the company did not act upon their
suspicions without the getting expert advice.
Solution: KGI demonstrated how to allocate costs to specific varieties in order to determine
the profitability of each. After a period of product reengineering, the company simplified their
product line from 380 to 75of the highest Value-Added SKUs. Taking this action allowed the
company to i) decrease raw material expense from higher volume and fewer materials, ii)
decrease manufacturing expense from simplified scheduling, and iii) decrease distribution
expenses from increasing interchangeability of customer orders.
Result: The companys net income improved from $1M annually to over $15M
annually while maintaining the same sales level.

3.

Problem: A transportation manufacturer had 34 varieties of a product that produced $150M in

annual revenue. The company understood that some varieties required more parts and
materials than others and questioned whether all products generated relatively similar
revenue streams and sought help with this issue.
Solution: KGI determined that the products could be divided into two different groups of equal
size based on their number of parts. Interestingly, the two groups were very unequal in regards
to their total sales: one group required fewer parts and provided 80% of the companys sales;
the other group required more parts and only provided 20% of sales. Once this was known, KGI
conducted a market analysis to determine if the company would be materially harmed from
discontinuing the product varieties that provided only 20% of sales. The study found that
customers were indifferent to the varieties in the 20% group, and if these lines were not
available, customers would willingly substitute such with varieties in the 80% group. On the
basis of this information, the company discontinued the product group that was not only
generating the lesser 20% portion of sales, but was also fueling higher inventory levels by
requiring more parts.
Result: By forgoing only $3M in revenue (2% of the total) due to lost sales, the company
gained $9M in working capital from reduced inventory investment and increased net
profit by $5.5M as a result of simplified assembly, supply, and engineering functions.

4.

Problem: A multi-billion dollar distributor of medical products had a company policy of

providing its customers with a fill rate of greater than 98% on all products. The company
believed in its concept and made significant capital investments in systems and safety stock to
support it. Nevertheless, the company was generally unsuccessful in fulfilling its commitment

and was incurring sizable expenses in the process. The company asked for a review of its
policy in relation to achieving company goals while meeting customers' needs.
Solution: KGI devised a strategy that enabled the company to achieve both a high fill rate and
lower total costs. The key to the strategy was to work with the companys customers in
developing a Product Significance list so that the company could maintain a local supply of
must have products while aggregating demand for lesser used items on a regional and
national level. With the appropriate SKU rationalization system, the company could then track
specific products and align such with the Product Significance list in order to create optimal
inventory levels.
Result: The company is now able to consistently fill orders at the policy level without
draining profits through unnecessarily expensive systems and safety stock.
KGI offers solutions and obtains results. We can help your business achieve its optimal position on the
SKU-to-Profit graph. We specialize in:

Distinguishing the Value-Add SKUs from the Value-Cost SKUs

Identifying non-value-added activities
Discovering planning and control problems
Correcting cost allocation models
Understanding capital investment requirements
Closing the gap between operations concept and operations reality
By taking a proactive stance on unproductive SKUs, businesses can significantly increase their
profitability and cash flow.
Whether a Company is struggling financially or on the cusp of breakthrough growth, KGI can help. Our
seasoned experts work alongside management to solve complex cash flow issues, operational
challenges and other business crises. If liquidity or sale is needed, KGI provides a powerful
combination of services and expertise to achieve outcomes that cannot be duplicated by other
standalone consulting firms.
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