Product Rationalization – The consultant’s big promise to clients that often ends in results far below expectations. Why does this happen? Product rationalization is a complex strategic and operational initiative that requires much more than the 50,000 foot Excel-based product/volume/profit contribution analyses at the finished goods SKU level. This such a small swag of the larger puzzle of waste in terms of potential end-to-end supply chain opportunities. Like every other major improvement initiative, the devil is always in the human drama of change and the details of execution. This post provides insight on how to achieve new breakthroughs in operating performance by implementing a more robust approach to product rationalization.
Over the past decades, most organizations have placed a high emphasis on time-to-market and revenue from new products. This strategy has expanded their product portfolio of platform and derivative offerings, and other options to capitalize on global niche markets and customer needs. On the surface, proliferation of new products works. How do organizations know this? Their cost accounting system reports favorable overall margins of (for example) 50%, and increasing revenue from new products. Organizations may also see evidence in market share and customer satisfaction metrics. The one shot product rationalization studies produce some immediate benefits, but are quickly replaced by the hidden wastes of the ongoing process of introducing more SKU offerings to an already overloaded portfolio of products and services. A product rationalization study isolated from all other total supply chain activities and costs produces self-limiting results. These academic exercises by themselves have zero impact on reducing supply chain infrastructure costs – Where the real money exists.
The Problem with Product Rationalization
The intent of product rationalization is sound, but growth and this unchecked proliferation of new products is always accompanied by new hidden inefficiencies that are often unknown and/or tolerated in light of short term profitability and margins. It’s the instant gratification and close enough is good enough mindset at play. At a more granular level, the experienced professional understands how this unchecked proliferation increases supply chain complexity and significant value leakage. SKU reduction alone does not reduce supply chain infrastructure wastes and costs. These costs keep growing in the absence of deeper deliberate corrective actions. The largest impact is inventory performance and excess supply chain costs (e.g., procurement spend, space, logistics and transportation, manufacturing inefficiencies, overall management and overhead, quality costs, lost capacity, write-offs, warranty and returns, disruptions to premier customers, a symptomatic firefighting culture, etc.). These are real inefficiencies and real costs that never show up on traditional cost accounting systems . . . Or maybe they do at some point in the non-actionable operating variances accounts. Below is a simple graphical representation of this challenging dilemma.
The other dilemma is that most cost accounting systems lie about margins and contribution analysis by the very mechanics and assumptions of the process. What does a more activity-based, total cost-to-service costing approach reveal? It discloses that some products may have 100% margins and some may have negative margins, and everything else between the two extremes. Organizations need to be looking more at true value contribution at the SKU level, and not the imaginary cost accounting numbers at an aggregate allocation level. Sure, the goal is to focus more attention on the higher value contribution products. What are your sales representatives selling at the end of the month to make their numbers? The answer is anything that is available, including the negative or low margin products. Short term performance and reward systems add to the cost accounting dilemma.
Recognize that the true cost-of-goods-sold is dynamic, it varies significantly across the margin spectrum, and the majority of overhead servicing costs are usually tied to the lower tier margin categories. We have actually conducted this analysis and validated that most of a particular client organization’s resources (and associated overhead costs) were focused on the lower value portfolio areas – And often to the detriment of serving the higher value contributing products and customers. But the more important factor is that organizations also need to reengineer these costs out of their supply chain infrastructure. The traditional SKU-level swag at product rationalization totally misses all of these deeply embedded wastes and improvement opportunities in the operating infrastructure of the organization. It is just a snapshot in time where every line item situation has the potential to be improved by the right means and deliberate actions. Waste is an organic phenomena: It grows when it is not addressed in a correct and timely manner.
Part of the Answer – Go Deeper, Achieve Greater Success
The stratified ABC or Pareto-based product rationalization analysis is the correct approach. Ideally, 80% of value is derived from 20% of the product portfolio, but very often the analysis yields surprising results. Sometimes the portfolio distribution is more stratified, and sometimes the portfolio distribution is flat and broad. It’s not the end of the analysis. More assumptions, data categories (customers, geography, end use, markets served), and analytics is mandatory (e.g., squeeze the data until it talks to you) for a thorough analysis.
Here is the big problem – A true representation of what is going on needs to be restated in the baseline revenue and cost accounting data as a prerequisite. The labor and materials part of the data is usually sound. The traditional basis of allocating overhead is the problem that distorts the rationalization analysis. Bad data and assumptions, combined with uninitiated analysts conducting the rationalization efforts can lead to the wrong conclusions about how to restructure the product portfolio. Product rationalization should never be treated as a simple, mathematical spreadsheet exercise. Here are a few examples:
- Low volume/low or negative margin products are usually straight forward. But what about a premier customer who purchase these associated products or accessories? Some exceptions need to be recognized (Some C products are really A products). For the remaining SKUs, what is the detailed plan that minimizes lost value? Short term sell strategies to particular customers? Last time buys? Discounts and promotional buys? Donations? Many other options? Just putting these products in a pile in the back of the warehouse (out of sight, out of mind) is not the right answers;
- Low volume/high margin and low margin/high volume products may be more of a sales and marketing problem than a specific product functions and features problem. Often these situations can be improved by new customer and selling strategies to improve margins, volumes, or both. In essence, there is an opportunity to move a stratified grouping into a higher performing grouping;
- High volume/high margin products are usually assumed to be in good standing. Rarely does a rationalization effort recommend how to grow and protect this most valuable segment of the organization’s product portfolio. In other words, success does not last forever. There’s only so much time in the life cycle to achieve success. The right improvement/cost reduction moves combined with strategies to extend the success horizon is critical.
- The risks of lumpy or localized demands, seasonality, positive and negative cannibalization, customer response, brand depth and breadth, and other risks are often not evaluated. A trial or pilot period is the best way to make decisions and observe the impacts over time. Products that look less favorable from a cost accounting perspective may need to be added back into the portfolio for pure service reasons.
Now the cascading operating problems – Stopping the rationalization effort at the F/G SKU level and not going deeper to rationalize and align people, process, equipment, technology, measurement systems, and behaviors is the larger problem . . . A multi-million dollar problem. Here are just a few examples:
- Ecommerce and other order entry options and configurations are not updated and aligned in a timely manner, making customers and the sales organization think that products are still available for sale;
- Many new products are launched with negative margins when the overhead associated with engineering changes, field quality problems, warranty and returns, customer service, and reputation is factored into overhead costs. No, they are not suspects for elimination but the future of the organization. The goal is to understand true costs, and then aggressively reduce these costs to a high margin status;
- The rationalization effort removes SKUs at the F/G level, but often future demands for these products remain in the Sales and Operations Plan (S&OP). Additionally, the lower level make and procurement requirements and their respective priorities remain unadjusted in the ERP architecture. This drives phony demands for capacity, materials, and supplier requirements. Operations and the total supply chain can become chronically clogged and artificially disrupted by these hidden inefficiencies;
- Manufacturing and supply chain operations are typically structured around the characteristics of customers, products or product groups, material consumption, routings, volumes and mix changes, schedule predictability, or some hybrid model of all of the above (e.g., Lean – high volume/low mix, low volume/high mix, custom engineered, configurations and options, etc.). Obsolete product routings, BOMs, schedules, and other plant documentation combined with the addition of new products with different process, material, and performance requirements influences the operating footprint design requirements, adds hidden wastes/costs, and reduces the ability of operations as a whole to respond to inevitable change;
- New product proliferation is accompanied by design, process, materials, and supplier proliferation due to a lack of design standards and a robust product development process. In the interest of time, engineering and technical resources are forced into drive-by features/functionality and shortcuts to the formal development and design and phase review process. Since 85% of a new product’s life cycle cost is determined at the functional specification level of the design process, there is a significant opportunity to improve current and future SKU profitability;
- Traditional product rationalization efforts rarely propose a good plan for moving and phasing out the dead stock or negative margin products recommended for elimination. Eventually, distribution center operations and networks feel the same inefficiencies creeping into their organization. These products usually sit around and collect dust (and cost) until they are written off. In the meantime this creates wastes in warehousing, storage, material handling, counting and controlling, and other basic distribution and pick activities. Then the organization pays the Piper with a big restructuring hit to the P&L;
- At month end, sales representatives attempting to make their numbers cut deals and sell whatever is available, including the obsolete products. This stimulates future customer demand for these negative margin products.
These things never happen in your organization, right? Fact is, these challenges exist all the time in a highly disruptive operating environment – With or without a product rationalization initiative. The important takeaway here is that a limited academic product rationalization effort can add much more wastes and inefficiencies to operations, the total supply chain, and the organization as a whole. As we stated earlier, these wastes and inefficiencies happen. It’s nobody’s fault, stuff happens. But they must continuously be mined for, and engineered out of the operating infrastructure. And they must not be tolerated and allow to grow in the interest of short term performance.
The Rest of the Answer – Product Rationalization as an Embedded, Holistic Process
The one shot, high level SKU rationalization studies every few years are obsolete. Markets and customer preferences are unpredictable and evolving daily. Innovation and the introduction of new products continues to be on the rise because it is the best strategy for growth. Mass customization is driving opportunities across the globe. Product life cycles continue to shrink, so organizations must become much smarter at how they manage life cycle costs and margins. Process innovation in terms of how to serve markets and customers is occurring at an increased rate due to evolving technology. The world has become much more complex, known and unknown value leakage and its associated operational inefficiencies are occurring at a much faster rate and magnitude. A lot of inefficiencies and margin drains can creep into an unattended operating infrastructure over a 2-3 year period. The same traditional approaches to continuous improvement are no longer good enough to manage the sheer magnitude and velocity of change. Product rationalization must become an embedded continuous integrated business process, not an occasional standalone, superficial, top down project.
So how do organizations accomplish this bold effort? Today, it’s no secret that digital technology and the socio-technical (people) evolution are the big drivers of breakthrough improvement. We will leave the culture discussion for another blog for now. Digital technology is now available to manage product portfolios and align supply chain operating infrastructure on a real time basis. Features such as cost/margin modeling based on total cost of ownership assumptions, commercialization and financial modeling, dynamic and segmented Sales and Operations Planning (S&OP), multi-channel cost-to-service optimization, capacity and operations footprint modeling, flow and throughput design/modeling, inventory pipeline optimization, supply chain visualization and scenario modeling, manufacturing and distribution network optimization, logistics and transportation optimization, make vs. buy and sourcing analysis, and other digital product management and supply chain functionality are being deployed more and more in organizations.
Organizations play in a fierce world of competitiveness, disruptions, and unpredictability. These harsh realities are totally uncontrollable, but they offer enormous opportunities for competitive advantage and superior market and operating performance. It’s an adapt rapidly or fall behind world. The choice is up to you. The best way to win in this economy is through the right intelligence, knowledge, velocity, and operational capabilities to respond to and benefit from these challenges. When product rationalization becomes an embedded continuous process, the potential issues and risks are constantly on people’s minds. The detractors to performance are identified quicker, the corrective actions are more proactive, and the negative impact is reduced significantly. The key to success is a fact-based understanding how to manage the product portfolio and align the organization’s operating infrastructure for efficient execution. We refer to this as a “No Doubt” operating strategy – Whatever the changes may be, there is no doubt that the organization can adapt, align, and execute with great sustainable success.
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