We develop warehouse management systems and are looking at Magento as a possible ECommerce platform for a couple of our customers.

The usual definition of a SKU (stock keeping unit) in a warehousing environment is that it should be used as the unique identifier sufficient to identify a stock item.

If you have three rolls of fabric in three different colours each should have it’s own SKU if you want to track stock levels for each colour separately.

It is not necessary to create separate SKUs for different lengths of cloth, the length should be specified a the “Unit of Measure” associated with the SKU.

A SKU quantity of 50,000 might mean 50,000 square yards or 50,000 rolls, depending on the unit of measure associated with the SKU.

The best way of looking at SKUs is to consider whether or not it is sufficient to uniquely identify a product, the quantity value (or values) then define the amount of the SKU being reported on, delivered, moved, picked or whatever.

http://en.wikipedia.org/wiki/Stock_Keeping_Unit

This is a great example of how things can get carried away when building your online store if there isn’t enough project planning in place.

I worked on a project for a company that sold different lengths, material and colors of tubes.  Given their inventory, they could have easily had over a million SKUs, but the sensible approach (and what Charlie mentioned) is to have unique SKUs for the different material and colors, but not size.

For the project, we ended making size a dynamic addition to the SKU, since in reality size is a dynamic attribute and it worked out fine.  You may still end up with a few thousand SKUs, but in your case you should be able to generate dynamic SKUs that are easy to decipher by humans which should save time at the warehouse.

Just my 2 cents on the whole thing.