The Shrinking SKU: What Causes Company Product Lines to Blow Up in the First Place?

By Markets Fool.com

As companies adopt "SKU rationalization", the end result is often a decrease in the number of stock keeping units, or SKUs, a manufacturer offers.

Continue Reading Below

In the accompanying Industry Focus: Consumer Goodssegment, Motley Fool analyst Vincent Shen is joined by senior Fool.com contributor Asit Sharma to discuss the three major factors that can drive a company to develop bloat in its products line in the first place.

A full transcript follows the video.

A secret billion-dollar stock opportunity
The world's biggest tech company forgot to show you something, but a few Wall Street analysts and the Fool didn't miss a beat: There's a small company that's powering their brand-new gadgets and the coming revolution in technology. And we think its stock price has nearly unlimited room to run for early in-the-know investors! To be one of them, just click here.

This podcast was recorded on Oct. 12, 2016.

Continue Reading Below

Vincent Shen: Our next supertrend has companies turning their attention, I think, a bit more into their internal operations. That's with SKU rationalization or specifically for our discussion, SKU reduction. So we'll look at this through the lens of two leading consumer products companies: UnileverandProcter & Gamble. But before we get any further than that I mentioned SKU rationalization and I think some of our listeners could probably use just a quick update or refresher on exactly what we're talking about there.

Asit Sharma: Absolutely. What is an SKU? It's shorthand for "stock keeping unit" and Wikipedia has a great definition. I'm going to read this for our listeners. It's a "distinct type of item for sale." So manufacturers identify their products by unique codes that they've built. Those may actually be different than the barcodes that you see in, let's say, a grocery store when you're picking up a package to scan and pay for, but each product a manufacturer builds has this code and every time they vary the product whether it's size, color, anything, that creates a new stock keeping unit, or SKU.

Shen: So, I think that with the SKUs and it kind of comes into conflict a little bit. On the one hand, we're going to talk about in this discussion how companies are working to basically make their operations more efficient, more profitable, and in some cases they are able to even boost their sales by reducing some of the offerings that they give to consumers. But in the last episode, we talked about on the customization side, giving more optionality, more potential to personalize and customize a product for each consumer, but I guess my question is can you give us an idea of how things flow through a company? We can use maybe one of the two companies, Unilever, or Procter & Gamble as an example, but how this decision in terms of what products are offered, the number of SKUs in a company's portfolio kind of flow through and can impact some of the metrics that investors are focused on generally.

Sharma: It's a good question. Companies play a guessing game when they create products for a particular brand portfolio. And that guessing game is: What will the consumer want? What's the consumer's tolerance for product variation? And there are three major factors that drive the expansion of a product portfolio.

First is to keep those product lines fresh and relevant. Most of us have seen the phrase "new and improved," and I guess listeners are familiar with the concept that this is all in a marketing ploy, but companies also create more products to suit the changing whims of the customer. I have these whims, and you have these whims, we may not know it, a lot of times these are internalized and it's based on what we imbibe from our culture, popular culture. Just also what's practical in our lives. Could be a very small variation on, let's say a handle of a grocery jug. We've seen milk cartons change over time. So, these whims drive product innovation as well.

The third thing is product innovation. Now, when I think of product innovation, I think of a brand-new product. Because, well, innovate; you must be creating something new. But corporations look at slight variations in product packaging or say they change a formulation, add a flavor to a juice. If you are a beverage manufacturer that is a third reason. And innovation to a manufacturer can be very slight tweak.

So these three factors drive that expansion of a portfolio and what we see is that in the consumer marketplace, companies will first expand their portfolios and then start to draw them back because it's an art, it's not a science. If a company had a handle on exactly how many variations of a product per each geographical region was necessary, then they would find this miraculous optimization of profit. And that's just not something that comes easily.

Asit Sharma has no position in any stocks mentioned. Vincent Shen has no position in any stocks mentioned. The Motley Fool recommends Procter and Gamble and Unilever. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.