Paying the Price for Outdated SKU Clusters
The segmentation practices of a major CPG company were studied to find out whether the enterprise was experiencing these problems, and to assess the impact of these problems as well as possible solutions.
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Editor’s Note: Every year, 40 or so students in the MIT Center for Transportation & Logistics’ (MIT CTL) Master of Supply Chain Management (SCM) program complete one-year thesis research projects. The students are early-career business professionals from multiple countries with 2 to 10 years of experience in the industry. The research projects are sponsored by and carried out in collaboration with multinational corporations. Joint teams of company people, MIT SCM students, and MIT CTL faculty work on real-world problems chosen by the sponsoring companies. In this monthly, series we summarize a selection of the latest SCM research. The researchers for the project described below, Axel Barbará and Tomás Dominguez Molet, analyzed how a global CPG company clusters SKUs to determine whether improved groupings could lower costs and increase supply chain efficiency. The project was supervised by MIT CTL Dr. Edgar Blanco. For more information on the program, visit http://scm.mit.edu/program.
Companies often group inventory items into classes in order to manage them more efficiently. Managers routinely use these clusters or segmentations in their inventory replenishment planning decisions.
However, as companies grow and their operations expand, these classifications can become outdated. If this problem is not addressed, products can become misclassified. Inaccurate SKU classifications add cost to supply chains and hurt service levels as inventory managers misallocate resources to meet demand.
The segmentation practices of a major CPG company were studied to find out whether the enterprise was experiencing these problems, and to assess the impact of these problems as well as possible solutions.
Four-phase project
The research was carried out in four stages: data collection, qualitative analysis, quantitative analysis, and cost analysis.
After gaining an understanding of the company’s end-to-end supply chain, the researchers developed an initial data set containing a detailed list of every SKU in the US market. The data included product characteristics, and snapshots of the previous year’s demand from each regional distribution center.
The qualitative research entailed analysing categories with the highest number of SKUs.
These groups had the most varied product characteristics, and the highest demand value per SKU. Using this data, the researchers compared the actual product clusters with a theoretical one, and captured similarities and mismatches.
Finally, the researchers looked at the implications of mismatches for safety stock and stock out costs.
Service paybacks
The research showed that even when SKU clusters are well-defined, over time they tend to become overwritten perhaps by category planners, creating mismatches. These misclassifications incur cost mainly by assigning SKUs to medium- or low-demand categories when they should be in high-demand clusters.
Correcting these mistakes and optimizing the classification process could yield savings of up to 20% in the total cost of safety stock and stock shortages. Optimized service levels could achieve a 25% reduction in working capital tied to the maintenance of safety stock levels.
Another notable finding is that for high demand items (or A items), improving service levels – even though these were already relatively high – was cost-effective because the cost of achieving higher sales outweighs the cost of increased inventory. However for items with lower demand levels (B and C categories), even if the company lowers service levels significantly the resulting inventory savings outweigh the cost of sales losses.
The research created new insights into the comparable cost of under-forecasting and over-forecasting on safety stock and customer service levels.
For further information on the research contact Dr. Bruce Arntzen, Executive Director, MIT Supply Chain Management Program, at: [email protected].
About the Author
Patrick Burnson, Executive Editor Mr. Burnson is a widely-published writer and editor specializing in international trade, global logistics, and supply chain management. He is based in San Francisco, where he provides a Pacific Rim perspective on industry trends and forecasts. He may be reached at his downtown office: [email protected].Subscribe to Supply Chain Management Review Magazine!
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