SKUs explained: SKU meaning and how to manage them

[Updated post from January 28, 2021]

Every brand knows that a healthy bottom line rests on one thing ingredient: Good inventory management.

It's easy enough to say it, but it's another to carry it out in practice. The average U.S. retailer has an inventory accuracy of just 63%, which seriously affects their ability to maintain consistent revenue and quality shopping experiences. Meanwhile, according to the IHL Group, worldwide inventory distortion (including overstocking and stock-outs) costs retailers an estimated $1.1 trillion a year.

By implementing a comprehensive SKU system to manage inventory, brands can be confident in their audits and spend more time focusing on the rest of their supply chain. In this blog, we're going to explore SKU meaning, how SKUs work, and how to implement an effective SKU system in your retail business.

SKU definition: What is a SKU?

SKU stands for Stock Keeping Unit and refers to unique alphanumeric bar codes that are assigned to each product in order to track inventory levels and variations of that item, including size, color, and model. Generating unique SKUs makes it easier for retailers to optimize inventory tracking and management, map sales data, and determine which SKUs are generating the most revenue for your business.

How SKU numbers work

A stock keeping unit is usually made up of a series of letters and numbers that references important information about that specific product, such as the brand, model numbers, color, or size. These SKU numbers are then used by backend inventory management systems and POS systems in storefronts to process and identify stock. When formatted well, a scanned SKU number makes it easy for 3PL staff or retail store staff to identify products quickly and avoid order errors.

Here's a SKU example for a pair of sneakers. Each unique SKU code for this product includes the season, product name, and product type, followed by the size and color variants:

Fall 2020, All-Star Sneaker, White, Size 9 = F20-SN-AS-W-9

Fall 2020, All-Star Sneaker, White, Size 10 = F20-SN-AS-W-10

Fall 2020, All-Star Sneaker, Pink, Size 9 = F20-SN-AS-P-9

This is SKU example illustrates why giving products a unique identifier is important for proper inventory tracking. Each SKU code holds product data about turnover, days on hand, return rate, and more. By generating SKUs for every new item that enters your inventory, you have complete visibility over the performance of your products and what your next purchase orders should look like.

How are SKUs and UPC codes different?

Stock Keeping Units and UPCs (Universal Product Codes) are often talked about interchangeably in retail, but actually refer to different ways of identifying inventory.

A Universal Product Code is a 12-digit numeric code assigned to an item at the time of manufacturing. This means a UPC code remains the same, regardless of which region it's sold in and what vendor is selling it. For this reason, UPC codes are often required to sell items on global marketplaces like Amazon and eBay.

By comparison, a SKU is a unique code only found at a specific retailer, even if the exact same product is sold elsewhere. These internal SKUs form a tailored stock management system that highlights certain product characteristics to make tracking more efficient.

Some brands may opt to use the UPC barcode as their own SKUs, to save generating SKUs from scratch. However, these 12-digit codes are not designed to help retailers identify products, and cannot be altered in any way to suit the individual retailer's needs or POS system requirements.

In sum, in-house SKU management gives offline and online retailers a competitive advantage – if they create and organize their SKUs in a way that streamlines inventory and order management.

Why SKUs are essential for good inventory management

Improved inventory tracking

Even if you're a small vendor with low order volumes, the number of product variations in your warehouse is still likely to number into the hundreds. This means that keeping track of what sizes or colors are available - and where they're located - is a herculean task.

An effective stock keeping unit system that integrates with your WMS enables you to identify stock levels accurately, avoid errors during the picking process, and set automated reorder points to avoid stock-outs.

More accurate demand forecasting

Because every product in your inventory can generate as many as 20-30 different SKUs to account for all of the product variations. This amount of data allows you to monitor demand on an extremely granular level and determine which variants are performing well.

With SKU numbers, it's an intuitive process for brands to forecast peaks and troughs in consumer demand. This ensures that inventory levels align closely with actual consumer demand, and avoids situations like excess inventory or stock-outs that disrupt fulfillment operations.

For example, if the color red is outselling green 3 to 1 for a certain t-shirt style, you may want to consider reducing reorder amounts of green or discontinuing it altogether. Reducing stock-outs and excess inventory in this way can lower your inventory costs by as much as 10%!

Moreover, accurate sales forecasting enables your business to execute more effective sales and marketing strategies by pinpointing what products customers will be interested in and when, thus increasing revenue.

Enhanced customer service

Because SKU management gives merchants advanced abilities to track stock levels in real time, they can also choose to make this information available to their customers.

For example, customers could look up stock availability at their local store through your e-commerce website, rather than turning up in person and discovering the product isn't available. Alternatively, a store assistant could use their POS system to check stock levels at other locations. This creates a much more transparent approach to CX management, as well as minimizing the odds of a stock outage.

Furthermore, if a stock outage does take place, SKUs can help customer service teams to make much more accurate alternative product recommendations to customers, which helps to boost customer loyalty and retention.

How to create SKUs

When creating SKUs, businesses can either use an SKU generator (normally included with their inventory management system) or else manage SKU architecture independently in their own system.

However, great stock keeping unit needs to be readable for humans as much as for computers. If you're going to minimize confusion and errors, it's important that SKUs are clearly identifiable to both your staff in the warehouse and sales associates on the shop floor.

You can achieve this by implementing the best practice guidelines for SKU anatomy:

Keep every SKU number clear and concise. Your SKUs shouldn't include any more characters than needed to communicate essential product information. It's a good idea to avoid the use of characters that can be easily confused. For example, ‘0' and ‘o' are easy to mistake at a glance, as are ‘1' and ‘l'.

Start with general information, then go more specific. It's logical for each SKU number to start with the base characteristics of the product before moving on to variations. For example, the first section of your SKU could represent the product type, followed by variations like size or color.

Avoid using manufacturer data as part of SKUs. While using a serial number or product code from the manufacturer might be convenient in the short-term, this can spell future difficulties for inventory management. If you ever decide to change manufacturers, all of your SKU architecture would have to be overhauled and re-added to your POs software and WMS.

Tips for effective SKU management

Set the right reorder points

Knowing when is the right time to reorder inventory is the key to avoiding the twin extremes of excess inventory and stock-outs. Some SKUs will turn over faster than others, so it's important to set a custom reorder point for every SKU that reflects sales data. For example, if a size 8 in a certain garment sells out faster than a size 4, then you need to arrange for more frequent replenishments.

Keep an eye out for SKU proliferation

If certain SKUs prove to be best sellers, it's tempting to keep adding SKUs and products that match consumer preferences. However, uncontrolled SKU proliferation can result in more capital being tied up in inventory, more complex picking strategies, and a higher likelihood of order errors. Proliferation can also cause the cannibalization of sales in different product collections, if you've introduced multiple SKUs that are too similar to one another. Carefully check your sales data to see whether proliferation is actually increasing overall revenue, or is being eaten into by storage costs.

Think about how to organize SKUs in the warehouse

SKUs aren't just there to help you track inventory, but to make it easier to set up appropriate picking strategies in your warehouse. For example, if your sales data is telling you that certain SKUs are commonly being ordered together, it makes sense to place them in the same or adjacent picking locations to reduce walking time for warehouse staff.

Rationalize and remove unpopular SKUs

Slow-moving SKUs take up valuable space in the warehouse and increase your storage costs, so it's important to keep a close eye on which SKUs are performing well and which aren't. If certain variants, such as colors or sizes, aren't seeing good results, this is a sign you need to streamline your inventory by rationalizing certain SKU variants - or even total SKUs that aren't appealing to current tastes.

Partner with a 3PL

Introducing and maintaining a SKU system requires a lot of internal expertise that emerging brands don't always have on hand. Moreover, inventory management takes valuable time away from managing other facets of your business that are integral to brand growth, such as marketing and brand management. By partnering with a 3PL for SKU management, you can leverage the expertise of industry professionals and focus your attention on other parts of your business.

Without strong inventory management, it's almost impossible to fulfill consumer expectations for fast, effective order processing and delivery. But by adopting an effective SKU architecture and management strategy for tracking inventory and sales activity, your business will be much better placed to take advantage of growth opportunities and facilitate positive customer experiences.