Ford T or the Long Tail?
The dimensions of product complexity
Ever since the launch of the Ford T, when Henry Ford famously claimed that “Any customer can have a car painted any colour that he wants so long as it is black”, firms have learnt to give customers what they want, with more and more people looking for customizable products and keen to be different from the Joneses.
Efforts to satisfy customer wishes or generate new customer demand often lead companies to develop a complex product range.
The development of e-commerce has only accentuated that phenomenon by making it possible to sell small amounts of lots of different items (the “long tail” phenomenon): Internet makes it easy to put buyers in touch with retailers selling low volume items. Amazon, for example, has built its success on this very phenomenon: its total sales volumes for low volume items (the long tail) are higher than its sales volumes for high volume goods.
With a basic search engine optimized website, a firm can now easily sell its products in “exotic” locations, although it must nonetheless ensure that the products meet the market’s requirements in terms of language and standards, etc.
Range complexity in the FMCG sector
Range complexity means that there are a large number of SKUs, some of which are extremely similar; that the range is hard for clients to understand; and that there are huge differences between flagship SKUs and low volume lines. Range complexity generally results from a combination of several factors:
• Developing a differentiated range per country, per distribution channel and per client segment,
• Creating new SKUs without eliminating old ones,
• Having on-going promotional SKUs,
• Market reactions,
• The desire to occupy more shelf space than rival brands,
• The lack of “opposition” to this penchant for range expansion and the lack of monitoring.
Spectacular savings: production costs slashed by up to 30%.
These complexities generate additional costs, some more obvious than others (production costs, management costs, etc.), yet they do not always create value for clients. In fact value can even be lost if the range or product end up becoming unclear in the consumer’s mind. The efforts to reduce complexity outlined below can generate spectacular savings whilst creating client value: production costs can be reduced by 5 to 30%, based on our clients’ experiences to date.
For the approach to be effective, the first thing that needs to be done is to think about the clients themselves, their segmentation, their needs and what the most suitable sales and marketing policy would be. Each brand, each SKU, has something different to offer the consumer, so the firm must adopt a differentiation-oriented marketing strategy. This early-stage work on the brands’ relative positioning then allows you to determine:
• Brand presence by distribution channel,
• The size of your in-store product range (brand effect).
This early-stage work can also lead to “full-scale” in-store trials in order to test different options and assess impact.
Which indicators should be used?
Once the sales and marketing policy has been defined, the next stage is to set a relevant cost indicator.
Once again, there is no magic formula – it is up to you to find the answer that best suits your goal. When assessing and countering range complexity, the most relevant indicator is the SKU cost, combined with an indicator that allows you to assess the complexity-generating factors.
How do you define an SKU?
As simple as it may seem, the question is definitely worth asking. Manufacturers have learnt how to standardize and handle small productions runs, so there are several SKUs… the master SKU (end of production line), the inventory SKU, the labelled SKU (featuring the brand), the marketed SKU, etc. It really doesn’t matter what terms you use, what matters is that they reflect the realities of your business and are meaningful to operational staff.
A concrete example in the FMCG sector
We have chosen a representative example of range complexity in the fast-moving consumer goods sector.
The firm was complaining that production costs were too high and that its market positioning was too unclear: there was hesitation between adopting a premium positioning and responding to low-cost competitors, resulting in a confusing range. It didn’t take us long to convince the General Management team that the range needed to be reworked. The project lasted for three months and involved an in-house team and three consultants.
The additional costs generated by range diversity were assessed. They were caused by the time it took to change format from one SKU to the next, but also by the organisation that had been introduced to manufacture and manage the range: planning, scheduling, mistakes stemming from SKUs being switched, marketing management, etc.
The extra cost per SKU amounted to 30,000 euros per year and by master SKU, and €300 for a labelled SKU (products exported to an “exotic” country), if this SKU was manufactured to order.
This clearly demonstrates how much impact the plants’ delayed differentiation and differentiation-to-order processes had, and how important it was to divide up the processes and tools to suit each range. It is quite possible for made-to-measure products and mass-produced goods to co-exist within the same firm.
The range was analysed using SKU trees, which allowed us to identify similar SKUs and to quantify the diversity factors, with the goal being to reduce the number of SKUs by 40%. That kind of objective ruffles everyone’s feathers, and notably upsets the sales team – the very people who generate turnover! “They always have a tendency to offer their retailers customized products in order to win more business”, according to the General Management.
The goal was nonetheless reached and optimizing the range helped cut production costs by 10%. The “exotic” products were identified and suitable differentiation processes were introduced at order level. The clients remained faithful to the company, turnover remained stable in a difficult market, and costs were reduced to such an extent that they practically generated net value!
Let’s talk labels!
While we were at it, we had to resolve a labelling problem. One of the costs we had identified came from stock holding and obsolescence. Once again, choosing the right indicator is crucial.
The cost of producing labels follows a typical printing price curve with high fixed costs (plate preparation, the makeready process, etc.). In actual fact, the marginal cost is practically zero. Valuing surplus and obsolete stock when calculating average costs results in management errors: holding back orders based on stock actually resulted in stock-outs that were three times as costly: lost sales, disorganisation and an order for the additional quantity that then incurred the fixed costs for a second time.
We put together a simple probabalistic model, based on the game theory, which ensured that order volumes were optimized, thereby minimizing the aforementioned problems. Even if that has meant having a little bit of stock whose value is “zero”…
A real opportunity for the company
The project was perceived to be a real opportunity for the company:
The manufacturing managers praised the simplification of the range, which allowed them to cut costs in both the short- and medium-term once they had adjusted their organization accordingly.
The sales and marketing managers appreciated the project’s qualitative results:
• Enhanced product positioning and better visibility for the customer,
• The creation of a vision shared by all the different functions, and improved awareness of the cost of managing an SKU and of each department’s constraints,
• Accommodation of the real value generated by export sales, without disrupting production.
Sustaining the approach
One of the project’s key added values came from ensuring the approach would be sustained over time:
• Forming cross-functional teams and ensuring experience was shared,
• Defining a virtuous range management process,
• Setting up indicators and benchmark figures, all grouped together in a dashboard.
Success can be contagious
The General Management team saw this project as a practical way of restoring its margins and consequently made a strong personal investment in driving the project to successful completion. Their involvement paid off, with the project recording a return on investment in a matter of months.
On the back of this success, having initially been launched within the French subsidiary the approach was rolled-out to the firm’s other European subsidiaries, coordinated by the Marketing Europe team.