What It Really Means: SKU segmentation

A term often used in discussions to improve supply chain performance is SKU segmentation. But what does that mean in real-world, practical application?

While every product a company makes and sells can be considered important, in reality each item or SKU serves a different purpose in the company’s product portfolio. Therefore, to optimize total portfolio results, it can be very helpful to divide the portfolio into more similar subgroups. Because these subgroups together equal the whole, they are commonly referred to as segments. The practical use of segments is to clarify the differing role the items or SKUs in each segment play in the portfolio. Then, strategic choices can be made and operational policies enacted by segment to maximize portfolio results. 

Examples of typical segments include trial sizes/market entry products or otherwise strategic items, high volume items, high profit items, ‘fill out the line-up’ items that meet a specific customer or consumer niche, seasonal/promotional items that need responsiveness, and low/slow moving items—these exist in the portfolio but may not have a role in the future. The right number of segments will vary by company and category considering the breadth of the portfolio and business needs. Generally, fewer is better, and most companies can manage with about four or five segments.

Once the role of the segment and items in that segment are defined, strategic policy choices can be made. For example, seasonal/promotional items may need a very responsive supply chain design (shorter lead times, closer suppliers, instantaneous capacity.) Strategic items may carry higher inventory levels to prevent out-of-stocks. High-volume and high-profit items may have more installed capacity, representing their importance to overall portfolio results. The low/slow-moving segment typically will have lower service targets and inventory levels reflecting its overall lower priority. Done correctly, segmentation helps both set up supply chains to match the way the business views SKU priorities, but also to manage basic cost/service/cash trade-offs and to align overall supply chain KPI’s.  

Two things to be aware of: (1) it can be easy to confuse segmentation and the use of product families.  Families aggregate items that are similar (e.g., common production resources or financial profiles).  The purpose of families is management simplification (ability to look at meaningful higher-level aggregate numbers vs. individual items/SKUs). This is not the same as segmentation, which is disaggregation to enable strategic policy differentiation. (2) Organization dynamics often will lead to someone (typically in sales or marketing) being able to make a case for each SKU being strategic. In a typical portfolio (>100 SKUs), it is not realistic for each SKU to be strategic to the same level—this leads to avoiding making prioritization choices on trade-offs needed based on supply chain capabilities. 

Why is segmentation important? The power of segmentation is converging everyone in the organization (commercial + supply chain) to understand the role of the item or SKU in the portfolio. This convergence allows management strategies and decisions to be consistent with the items segment, as well as all supporting planning and operational systems. For example, on POME items, a business should never be out of stock—this is where your strategic target is first entering and shopping your category. If your product is unavailable, they may choose a competitive brand and never give your product a chance.  Therefore, even though trial-size items are ‘starters’—typically young or new to the category with lower price points and not large volume or margin, they are very strategic (examples: teen cosmetics or lower-priced cars for first-time buyers). So for trial items, service is king—and operational policies like inventory and service target setting will be developed to ensure high in-stock levels. Other metrics, like OEE, might be deprioritized for trial-size SKUs. Where segments are coded in planning systems, the segment priority and policies are factored into recommended plans. 

Segmentation enables focus. For example, it’s typical to have differentiated service targets—higher targets on more important segments, lower on less important. This helps the organization deliver the best results where they matter most. Similarly, segmentation helps identify choices on where to invest more inventory—higher safety stock on more important items, lower on less important items. This mindset carries across the supply chain: a business should expect and tolerate lower OEE on trial sizes since service is the priority.

For analogy, an example of segmentation in the service industry is different airline classes of service. First Class passengers are at a higher margin, and as such, get special treatment. All airline systems advise personnel who the first class passengers are and how to provide differentiated treatment (ranging from lounge access, priority security screening, priority boarding, differing on-board experience and service levels, etc.)

Benefits of segmentation: The overarching benefit of segmentation is strategic and operational congruency. The treatment of an item is consistent with its segment, defining its role and importance in the portfolio. The benefits of segmentation show up in areas like:

• increased sales revenue and profit by focusing more on important items, less on the others
• capital and capacity analysis matching business importance
• organization alignment and common focus
• setting service and inventory targets that match the importance to the business vs. one size fits all.
• ability to hard-code segmentation into planning and operational systems to generate recommendations consistent with segment choices.

Watchouts: Unfortunately, there can be many intended or unintended barriers to segmentation, including:

• treating segment as a synonym for product category—it is an item/SKU level assessment
• not having full lead-team participation and treating it as a supply chain only exercise
• static models. Especially at the item level, portfolios change, and the role of items in the portfolio can also change. Segmentation needs to be checked quarterly, renewed at least annually (best practice starting is semi-annually).
• Analysis paralysis. Start light, start quick, learn and adjust. 

How to implement segmentation?

Segmentation is a business team decision, and should be implemented at the multi-functional lead team level sponsored by the general manager (or whoever has P/L responsibility). Particularly if there are current gaps vs. targets (e.g. volume, profit, service, inventory), segmentation should be viewed as an enabling tool to increase focus and improve results where they make the biggest difference.

About the authors

Andrew Byer is a former P&G Supply Chain Leader.  Mike Dobslaw leads EY’s Supply Chain Planning Practice. To learn more about how EY and P&G team to support supply chain transformations please write [email protected]

SC
MR