How many SKUs? Indicators for when you may have too many (or too few)

Fulfillment Stock and Inventory

While some online stores sell large quantities of just one or two products, others have a catalog stretching to several thousand. There is no right number of SKUs to have of course, but there are some indicators for when you might not have enough, or might have too many.

How do you know if you have too many?

When we assess our fulfillment clients we try to ensure that the number of SKUs is less than the number of orders dispatched in a month. This is not a strict rule as the circumstances below will show, but gives a rough idea which increases profit in many cases.

Firstly it’s worth looking at how the market you are selling in responds as you change the number of products you stock. While choice is something many consumers look for, too much choice might make it difficult for consumers to decide; possibly reducing (or at least not improving) sales but considerably increasing your overheads and inventory value. What an acceptable level of choice looks like will depend on your market sector. For example, customers looking to buy sports clothing will expect you to have a range of garments, available in many sizes, with a selection of styles and colors, whilst those looking to buy kitchen utensils will probably settle for very little choice, provided you have the item they require.

A good way of getting a feel for the sector is to have a look at your competitors’ websites (I assume you do this regularly anyway? You should do!). From this, you may already be able to assess whether you need more lines or fewer, but there are other factors.

Too much choice?

How big is your company?

As your company grows, you will sell more stock and so have a quicker stock turnover. Since large companies can place larger orders more often, it’s much easier to have more product lines. For example, a small company might order a box of 10 of something once a month, providing them with four weeks stock of that line. A larger company might sell that quantity in a week, so could place an order for 4 boxes and still have the same stock holding (i.e. 4 weeks stock). Alternatively, they could order 1 box each of 4 different SKUs without increasing their warehousing requirement. If a small company were to try and do this by ordering in part cases, purchase costs would likely rise, and just one customer order for 3-4 of the same item would put them out of stock – which will definitely lose them sales.

What are the costs of too many lines?

There are some fairly obvious ones and some less obvious ones. Clearly, if you have more lines, you’ll need to keep more inventory which equals more capital investment. If you assume a 10% cost of capital (what the bank will charge you for a loan, or what you could make with the cash elsewhere) then the cost of holding $10,000 more stock is $1,000 a year. So to justify the additional lines on this value alone you would need to make an additional $1,000 more profit after tax (not just $1,000 more income) to break even. This might be $4,000-10,000 in turnover for most businesses.

You will also need more space to store the inventory, and to invest more capital again in shelving and racking to hold it. The cost of storage can vary from free (back bedroom) to cheap (sub-urban warehouse) to expensive (city center store).

Other costs include the overheads which are very hard to apportion, but from experience they can be substantial. Managing the inventory levels and producing orders, managing more suppliers, time spent stock counting, time spent looking for items! Remember, the greater the number of lines you have, the harder it will be to pick and pack orders without increasingly sophisticated software.

If you outsource fulfillment you’ll be able to apportion the costs of storing, picking and packing a product quite easily but you can still do this calculation if you fulfill orders yourself. You just need to calculate a storage cost per cubic foot, and a pick cost per product (divide total annual labor cost by the number of items).

Likewise, other costs can be apportioned in a similar fashion. It may take you a while, especially if you have a lot of lines, but I guarantee it’ll be a real eye opener.

But I need lots of different lines…

In some markets, shoes being one and perhaps toys and gadgets being another, there is no space for the low SKU retailer. Unless you have a unique product that you are marketing, without a big selection in these markets people will not spend the time to browse only a few. So how is the smaller retailer to compete? There are several methods but most revolve around not holding inventory to start with (the other option is to invest millions and hope for the best).

– Just in Time ordering (JIT). Advertise a large range of products, but by buying only what you have sold and probably by buying several times a week, it’s still possible to offer a good service to the customer (if not the best) without any inventory. Overheads will still be high, but not intolerable.

– Drop ship. You are in effect just advertising someone else’s products and taking a commission, however unlike an affiliate scheme you take payment and deal with the customer service side, while they ship the inventory. (If you go down this route, make sure you choose a good partner).

While the above solutions are certainly successful for many companies, in our experience companies that have a small, but carefully selected range of niche or specialist products which they dispatch from stock, stand the highest potential of making the best margins.