Finding Hidden Profit Potential in Your CPG Portfolio Through Strategic Optimization

Consumers crave a wider range of products, and their appetite for variety has grown dramatically in recent years. More than half of the global population now has access to mobile internet, and this adoption rate continues to rise at a compound annual growth rate of 4.8 percent. E-commerce accounts for over 13 percent of retail sales in the top ten developed countries. This continued digital expansion has enabled a profusion of SKUs (stock-keeping units) that intensifies supply chain complexity. For consumer packaged goods (CPG) companies, the challenge lies in balancing between meeting customer demands for diverse products and maintaining healthy margins.

SKU proliferation can signal innovation and fuel growth, but it often becomes unsustainable when new products or product variations enter the market without a strategic plan or rigorous performance assessment. Many CPGs will approve new SKUs if the standard gross margin (gross sales minus standard COGS) remains positive. In reality, companies need to measure the true incremental bottom-line profitability of each SKU—and the broader impact on the overall portfolio—to preserve margins and secure growth.

Figure 1, a typical illustration for most CPGs, shows that half of all SKUs in a portfolio contribute less than five percent of the gross margin. Even this calculation does not fully reveal the hidden complexities and costs of the "long tail." Weeding out marginally profitable SKUs can unlock unexpected savings.

Challenges in assessing proper portfolio health

On the surface, determining the overall health of a portfolio may seem straightforward. In practice, though, companies face five significant hurdles:

1. Unclear Strategic Objectives: Stakeholders are not always aligned on whether to prioritize top-line growth through volume and market share or focus on bottom-line profitability.
2. Decisions around SKU assortment often occur in functional silos rather than through coordinated, cross-functional collaboration and communication.
3. Companies sometimes lack accurate SKU-level data because their systems do not precisely capture activity-based or actual costs.
4. Gauging the substitution effect for a new SKU can be difficult, as cannibalization within the existing portfolio blurs the incremental impact.
5. Operational Excellence Remains Challenging: If the organization has limited visibility into how portfolio size and complexity affect the supply chain and sales channels.

Despite these challenges, leading CPGs maintain robust, high-performing portfolios with a pragmatic approach. They develop analytical capabilities to uncover the proper drivers of bottom-line profitability, establish cross-functional teams and transparent processes for ongoing SKU rationalization, and track performance with well-defined metrics and leadership dashboards.

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Step 1: Understand the proper drivers of bottom-line profitability

A single SKU's standard gross margin can obscure more than it clarifies. Significant cost elements, including the incremental expenses linked to supply chain complexity, are often missing from simple calculations. Figure 2 underscores the importance of looking beyond standard gross margin to capture a complete profitability picture.

Consider a scenario in which a customer or retailer requests an exclusive SKU from a CPG firm, committing to 10,000 units per year at ten dollars per unit. The CPG quickly calculates a standard cost of six dollars per unit, yielding a gross margin of 40 percent, or $40,000, and agrees to proceed. During the launch, however, hidden factors emerge:

• The new SKU requires an upfront investment of $7,000 for development and sampling.
• The vendor's minimum order quantity (MOQ) is 25,000 units, which requires $50,000 in capital—a significant cash-flow impact for an order worth only $100,000 in annual revenue.
• The extra inventory will be stored for 1.5 years, assuming a stable sell-through of 10,000 units per year.
• Additional indirect costs related to warehousing, inventory management, and lower actual yields further erode profitability.

When these hidden costs surface, the SKU that initially appeared profitable may generate a net loss.

Step 2: Adopt a rigorous process for periodic SKU portfolio clean-up

Analyzing the actual performance of each SKU requires cooperation across multiple functions—finance, supply chain, operations, manufacturing, vendors, IT, and HR—all of which must share accurate SKU-level cost data. CPGs that manage activity-based costing and understand the specific drivers for each SKU stand a better chance of building a reliable analytical model.

A cohesive enterprise resource planning (ERP) platform with accurate, cross-functional data is invaluable.

Financial metrics should be balanced with the company's short- and long-term vision. A fast-growing CPG might weigh supply chain and strategic growth objectives more heavily, while a mature CPG could focus on financial profitability. Each SKU has a disciplined evaluation after determining how to weigh these metrics. The company designates it as viable, at risk, or needing elimination or renovation. In this way, executives decide whether to keep, cut, or modify each SKU based on clear financial and strategic rationale.

Companies that commit to this portfolio clean-up process quickly spot patterns among underperforming SKUs in each category. By addressing these issues early—ideally during product innovation and development—CPGs can avoid launching new SKUs that repeat the same mistakes.

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Step 3: Use a leadership dashboard to track and monitor overall SKU performance

Gaining visibility into real-time performance helps leaders across brands and business units make swift, evidence-based decisions. A dynamic dashboard shows how well each SKU is doing, which ones need attention, and where potential cost savings might lie. This transparency enables leadership teams to set informed thresholds, decide how often they will clean up the portfolio—annually, bi-annually, or at another interval—and schedule product launch events accordingly. Figure 3 shows how effective dashboards consolidate data from across the organization.

By following these three pragmatic steps—deeper analytics, a systematic rationalization process, and continuous performance tracking—CPGs can achieve significant bottom-line improvements. Figure 4 highlights examples of the impact on profitability when companies address SKU portfolio complexity. Beyond the financial gains, instituting processes and metrics to assess portfolio health encourages functional teams to share insights and collaborate on more holistic decisions.

A practical way to begin is to establish a small, cross-functional team and empower them to create or refine an analytical model for SKU profitability. Piloting the initiative on a limited SKU set before expanding it across the entire portfolio can generate quick wins and build organizational momentum. Setting ambitious targets helps shift mindsets and fosters innovative thinking.

Santiago & Company has developed a digital solution for SKU portfolio management and can implement this analytical capability. It can be tailored and deployed rapidly to meet the specific needs of other organizations. In recent years, several large CPGs have undertaken SKU rationalization and removed up to half of their SKUs while strengthening the overall profitability of their portfolios. Eliminating unproductive products frees up resources and redirects focus toward the most promising growth areas, resulting in leaner, more resilient operations. Get in touch with us today to learn more.