Product Rationalization for Efficient and Highly Profitable Inventory Management
As the economy slows down, a challenge facing many companies is how to achieve continued growth in productivity and profitability. Improvement is essential to ensure survival in the world economy. An often overlooked opportunity to simplify operations and free up critical resources, resulting in improved productivity, profits and cash flows, may be right in front of them.
That opportunity is the rationalization of the product line and all component parts. This rationalization process requires a commitment by management throughout the organization to judge each product (and its respective components) per the business case: margin contribution (not revenue), tie-in to marketing strategy, or required with other retained products, etc. The operating credo must be "guilty until proven innocent." In this process, products will be eliminated unless justified through the business case.
Our experience with first-time product-line rationalization efforts has shown that more than 60 percent of the product line contributes less than 10 percent of the total margin. This rationalization process provides a framework to focus resources and reduce costs. It is a major element in the strategy to turn around underperforming (or near bankrupt) manufacturing operations. We find that the benefits of a successful rationalization effort impact all major areas of a company as follows:
Manufacturing, Product Development and Engineering. A reduced product offering will simplify production processes, reduce costs, enhance material management and increase economies of scale in purchasing. There should be a parallel effort to reduce the number of vendors as part of a commodity strategy undertaking. In product development/engineering, a reduced product line will provide the opportunity to improve "parts commonality" and curtail the "not invented here syndrome" prevalent in many corporations. Critical resources will suddenly become available.
Selling & Marketing. Promotional efforts will become more focused, with improved market segmentation and reduced in-house brand competition. Distribution channels will become more efficient.
Logistics & Administration. Inventory control and logistics will improve with fewer products to manage. Investment in inventory will be reduced with less risk of obsolescence. Database efficiency and throughput will be enhanced.
The operating credo must be "guilty until proven innocent."
In summary, a company can get much closer to the goal of resource optimization, leading to increased productivity, cash flows and profits.
Seven Steps to Profitable Inventory Management
Summarized below is a practical approach to begin the process of product-line rationalization:
- Confirm the commitment of top management. Top management must direct the process from the top down, with sufficient priority and resource commitments. This is the most important element to be successful. The entire management team must be directed to support the effort.
- Appoint the right champion within the organization, acting as project manager and reporting directly to the CEO or COO, to drive results. The critical skill sets are the ability to command respect and trust, a results orientation and operations/financial experience.
- Logically group all products/ components—by family, market or plant (if not multi-sourced). Each product will only appear in one grouping.
- Gather the right data. Develop contribution to margin results for each of the prior two years per the above groupings, at the lowest product/price offering/SKU (stock-keeping unit) available. The work product is a detailed report that includes (in descending order based on revenue):
- line item count (1 to X)
- SKU ID number
- number of units sold
- net revenue
- cumulative margin
- percent of total revenue
- margin contribution
- cumulative margin
- percent of total margin
- current inventory (units and values)
Net revenue excludes all discounts, allowances, trade-ins, rebates, etc. If the difference between gross and net revenue is not available at the SKU level, allocate that difference per the contribution to gross revenue (peanut butter approach) to arrive at net revenue. Relative accuracy across the product portfolio is the critical element—not absolute accuracy. As long as all products (SKUs) are treated equally, the analysis will be valid.
Product cost is actual (or standard cost if actual is not available) and includes direct material, direct labor and variable overhead. Again, relative accuracy is the guiding principle.
Continue working the database until you are satisfied with the relative accuracy and tie-in to the general ledger (90 percent plus relationship), with a rationale for major differences.
- Divide each grouping by doing an "ABCD" analysis on revenue contribution developed in step 4, where:
- A items=50 percent of revenue
- B items=the next 20 percent
- C items=the next 20 percent
- D items=the remaining 10 percent
- Study the "D" pool—determine the greatest number of product line items (SKUs) that yield the smallest margin contribution. This pool of products is the first grouping to rationalize the bottom 5-10 percent of revenue contributors, which yield little or no margin but make up the majority of product offerings (more than 50 percent). Present summary findings to management for action. For each product grouping, display by ABCD classification the following:
- number of products/SKUs
- percent of total product offerings
- margin contribution
- percent of total margin contribution
- inventory value
- Assign cross-functional product teams to rationalize the product line and implement approved recommendations. These teams should include representatives from sales, marketing, manufacturing, materials, product support, engineering and finance to undertake the rationalization process. For the "D" pool of products (and some in the "C" pool) that each team will address, the operating principle must be "Guilty Until Proven Innocent." Products will be eliminated unless the business case justifies retention.
The business case justification must consider margin contribution, critical customer requirements, tie-in to market strategy (if any), relationship with other retained products (e.g., must have four tires with each vehicle, but do we need to offer 10 different sets of tires?), opportunities for price increases and ongoing product support requirements in the marketplace.
The teams should present their recommendations to management and be empowered to implement the approved actions. Phase in the elimination of specific products per customer commitments and residual inventory levels. This strategy should encompass working through respective user groups within the customer base. If done properly, the total process can be accomplished in three to six months.
Requirements for Ongoing Control of the Product Offering
In addition to addressing marginal products for retention, use this process to formulate ongoing policies for the creation of new products to prevent the build-up of future excess style offerings. Such policies should include (1) volume and margin thresholds, with appropriate follow-up reviews of actuals vs. plan, and (2) establishment of planned "sunset dates" up front to control products as they move through their entire life cycles (from development through release and withdrawal from the marketplace, and discontinuance from a support viewpoint).
After the rationalization effort is completed, operations will be more focused on those products, customers and market segments that are profitable. Resources will be optimized to improve efficiencies and customer service. Policies will be in place to maintain a simplified product offering. The net result will be reduced costs and increased profits/cash flows—the key drivers of sustainable growth.
1 Bill Seng specializes in designing and implementing materials management and margin improvement strategies, process restructuring and business analysis. He has significant experience in helping both multi-billion and middle-market corporations to improve margins and inventory through-put and to simplify processes to optimize operations in turnaround situations. He formerly was Vice President of Operations Support at Unisys. He led cross-functional teams focused on improving margins and inventory management in a multi-national environment during the company's successful turnaround in 1991-92. His team achieved in excess of $300 million in financial benefits in 20 months. Return to article