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Retailers face the problem of managing tens of thousands of products. For each of these products, retailers need to make marketing decisions concerning price, promotions, assortment, space and location for each stock keeping unit (SKU). The decisions for each SKU not only affect its own sales but also the sales of many other products (Ma et al., 2012). In practice, it is too complex to consider all possible interactions in this marketing decision process (Gooner et al., 2011). The category management approach is an attempt to tackle this challenge through the decomposition of this management problem into a set of sub-problems. Each of these is then considered as being practically independent from the rest. This is achieved by grouping highly interrelated products into categories in such a way that products contained in one category are almost independent from products of other categories. This property enables retailers to manage their categories as strategic business units (SBUs) with significant autonomy (Nielsen, 1992). In some cases, the management of each SBU is supported by partnerships between retailers and a specific manufacturer, which assumes the role of a category captain (Mouzas, 2006).
In category management, the definition of SBUs (categories) is usually done by grouping items assumed to exhibit high substitutability or sometimes high complementarity (Gooner et al., 2011). For example, if the price of one product (e.g. Tide detergent) has a strong impact on the demand for other products (e.g. Gain detergent and Snuggle softener), these products may be grouped into the same SBU. Evidently, this approach significantly reduces the complexity of the retailer’s problem, but it also ignores cross-category opportunities that arise because of the existence of other types of interrelations (Seetharaman et al., 2005; Srinivasan et al., 2008). For example, category management initiatives often involve the elimination of slow-moving SKUs. In this regard, Dupre and Gruen (2004) reported a 25 per cent reduction in the number of SKUs for a German retailer in the cleaning and household supply category. Assortment reductions may yield better performance metrics (e.g. contribution margin) for the focal category but may have negative externalities on the demand of other related categories, when interrelations among categories are ignored.
As proposed by Manchanda et al. (1999), there are...