As interest in private labeling heats up, the question arises, “Is private labeling an offensive, defensive or opportunistic strategy for a manufacturer?” Discussions with more than 20 manufacturers indicate that for some the answer is, “it depends,” and for many others it's, “I just don't know.”

Many name-brand manufacturers may reject the idea of private labeling, but they fear their electrical distributors will seek to private-label high-volume stock-keeping units (SKUs) and reduce the manufacturers' sales and profits. Manufacturers we spoke with feel the sole reason distributors are interested in private labeling is to gain a price/margin advantage. Distributors don't appear to be using private labeling as a component of a branding and market-positioning strategy.

Channel Marketing Group and Allen Ray Associates spoke with manufacturers to gain their perspective on private labeling. Most had been approached by at least one distributor to discuss becoming a private-label manufacturer to them. Many had declined. Private labeling in electrical distribution isn't new. A few of the national chains and some regional distributors have private-labeled select SKUs for years. These efforts were targeted at specific price-sensitive, customer groups, and the scope of the effort did not represent a significant threat to manufacturers.

Many electrical manufacturers believe distributor apathy for manufacturer brands in selected product categories may be driven by three factors: a reduction in manufacturer brand investment; minimal new product development; and the pursuit of lower manufacturing costs. But they feel the emergence of private labeling is an outgrowth of distributors' focusing on selling price and their services rather than on supporting manufacturer brands, products and service differentiations.

The manufacturers with whom we spoke said distributors private-label for the following reasons:

  • The increased economies of scale, resources and market control that come with consolidation.

  • The desire to increase margins on products viewed as commodities.

  • The desire to build their brand rather than support a manufacturer's brand.

  • The opportunity to increase sales and market share using a price-driven strategy for price-sensitive products.

However, every manufacturer with whom we spoke questioned why a distributor would want to take on the expense of replicating a manufacturer's services, potentially absorbing product liability concerns and becoming responsible for product development and marketing. They also wondered why electrical distributors would think manufacturers would support them if they “cherry pick” selected products and private-label others.

A number of brand-oriented manufacturers felt distributors do not understand the array of services they offer or the functions they perform. Others feel the move to private labeling, while having significant risks for distributors, is no different than the off-shore/import brand competition that the manufacturers face in the marketplace.

Why Manufacturers Private-Label

Some manufacturers are into private labeling, too. They may want to improve operating margins by increasing plant utilization. According to Rick Sievert, president of The Sievert Group, Schaumburg, Ill., studies have found that it is more difficult to generate profits when plant utilization is below 80 percent. Other companies recognize their products — and company — are a commodity. Said one manufacturer, “Manufacturers have allowed brand equity to diminish.” An executive of a marketing group said, “I would say that only 10 percent to 15 percent of our manufacturers, and maybe 20 percent of industry manufacturers, are good marketers.”

Other reasons are:

  • The manufacturer is unable to differentiate the product line to justify a price premium.

  • The manufacturer is willing to cannibalize its current business to retain some of the customer's business rather than potentially lose all of it.

  • The company seeks to increase distributor account penetration in the belief that the more volume it has with the distributor, the more important the manufacturer will be.

  • The company is a small manufacturer and is willing to dedicate itself to becoming a private-label manufacturer.

  • The manufacturer is the low-cost producer in its category and is known as a product follower.

However, many manufacturers question why a name-brand manufacturer would consider a dual (brand and private labeling) approach. According to research conducted by Nirmalya Kumar and Jan-Benedict Steenkamp in The Private Label Strategy, a dual approach only works if total costs are less than competitor variable costs and if the strategy provides a company with a significant cost advantage. In this scenario, the private-labeling strategy and the associated production run is a short-term strategy, and the manufacturer separates its brand and private-label businesses.

Manufacturers with a dual-labeling strategy face the challenge of potentially risking two businesses — their brand business and their fledging private-label business. This challenge is illustrated in the chart above.

The authors say a dual strategy detracts from the brand strategy as it distracts management, misallocates costs and inevitably does not result in a better relationship with the distributor. Rather than compete for low-operating- margin business that manufacturers are typically ill-prepared to support, manufacturers who are No. 1 or No. 2 in their categories should focus on their brand and compete based on innovation, marketing and operational efficiencies. Frequently a dual strategy is tried by weaker brands or when a top-tier brand questions its value.

Conversely, for small to medium-sized manufacturers, price leaders and low-cost manufacturers, becoming a dedicated private-label manufacturer and “copy-catting” products can be an effective business strategy. These manufacturers typically do not offer distributors comprehensive marketing, product development and sales and service support that full-service manufacturers provide.

The Role of the Rep

Complementary to the decision to become a private-label manufacturer is the role of a manufacturer's sales organization, especially if it goes to market with independent reps. Our research shows that some brand manufacturers who are private labeling or are considering private labeling compensate their reps for this business. The additional cost is either allocated to the price or absorbed by the manufacturer.

They do this to ensure that the rep continues to support the distributor for the SKUs the manufacturer is not private labeling and to encourage the rep to support the line within the marketplace. While there isn't evidence to date that reps have diverted business from a distributor offering private-label products to distributors supporting brands, some respondents said reps will support the lines — and distributors — who have the highest profitability for them as well as those who are most loyal to them. One respondent said reps are linked to manufacturer brand equity because most reps have not built their own brand within their marketplace.

The drive to private label reinforces the need for reps to generate customer product and brand preference for the manufacturer. Depending upon a distributor's avowed strategy, reps, regardless of the direction of their manufacturers, want to work with distributors who support them. Reps work on a concept of “lifetime revenue.” They spend time with end-users to create demand that they expect will generate a future revenue stream based upon that customer continuing to purchase the brand. Manufacturers and distributors that private label may need to consider an alternative rep compensation model, and reps who have these lines may need to consider alternative business models. Interestingly, in the grocery industry there are brokers who represent both brand and private-label manufacturers.

Manufacturer Response to Private Labeling

According to the Private Label Manufacturer's Association, New York, 20 percent of items sold in U.S. supermarkets, drug chains and mass merchandisers are store brands. While the electrical industry has different needs, it's not a stretch to project that 15 percent to 25 percent of electrical materials, excluding wire, cable and conduit, could become private-labeled products due to brand insensitivity. The challenge is the channel's ability to support store brands and manufacturers' willingness to encourage this effort. Essentially, how many distributors are capable of developing, managing and promoting store brands?

Essential to the decision by a distributor or manufacturer is having a long-term strategy to act upon versus focusing on short-term profit potential. To capitalize on private labeling, manufacturers should ask themselves these questions:

Are they a low-cost producer who can maintain operating margins while moving to a private labeling strategy? In the food industry, brand operating margins can be 2x to 3x private label operating margins.

Is the manufacturer a manufacturer or a sourcer/aggregator? A few manufacturers commented that companies that utilize contract manufacturing are the most susceptible to being disintermediated unless they add value to the product or the relationship with distributors.

Do they have a strong information-gathering process? To support private labeling, manufacturers need good information from their distributors (who typically are not good demand forecasters).

Several manufacturers said if private labeling grew significantly, they may need to revise distribution policies and choose partners differently. Said one manufacturer, “If many distributors private-labeled products, manufacturers may need to develop consortiums to sell direct utilizing the web, regional warehouses and logistics firms. Manufacturers would secure agreements with large customers and appropriate end-users, and could develop ‘replenishment’ agreements with end-users.”

The Difference is in the Brand

Interest in private labeling is a battle for customer visibility. Some industry observers believe customers are only interested in price, and that they must compete on that basis. Others see value in brands and product innovation and the support that brand manufacturers bring.

For many years, some product categories have been brand agnostic. These manufacturers competed based upon distributor-focused services, relationships and price. Many of them are susceptible to private labeling and/or imported, lower-cost products, as distributors may see limited value in these manufacturers.

Just as a distributor's decision to private label should be based upon a long-term strategy, manufacturers should consider the decision to private label for a distributor (as some manufacturers are doing now) as a component of a broader initiative. The decision to private label also may influence a company's willingness to invest in product development and its brand, because the operating margins generated from private labeling are significantly lower than those from branded products.

One manufacturer spoke for many other vendors on the issue of distributors privately labeling products. “We don't like customers competing with us,” he said.

The next article in this series will share contractor research on the value of brands and their acceptance of alternative manufactured product sources.

Allen Ray is principal of Allen Ray Associates, www.allenray.com. Allen Ray Associates helps companies improve profitability through effective pricing strategies and streamlining business processes through effective e-business utilization. Ray can be reached at (817) 704-0068 or allen@allenray.com.

David Gordon is a principal of Channel Marketing Group. Channel Marketing Group develops growth strategies for manufacturers and distributors. He can be reached at (919) 488-8635 or dgordon@channelmkt.com. Register for monthly newsletter at www.channelmkt.com.

Defending the Turf Against Private Labels

Some respondents in this study were brand-name manufacturers who were not interested in private labeling. To defend their brands against privately labeled products, they plan to utilize the following strategies:

  • Review the support that they provide to distributors and tailor future support and services based upon the level and breadth of product support. They defined “support” as pricing levels, rebates, access to SPAs, tools and funds, access to new products, training and sales support.
  • Increase their investment in product development to generate a stream of products to incrementally offer value to customers as well as develop breakthrough new products.
  • Emphasize their brand to end-users, contractors and installers.
  • Consider offering new services and procurement strategies.
  • Focus on ensuring that they have the lowest feasible cost while delivering services that all channel partners value.
  • Communicate the value that they bring to their distributors.
  • Stress product quality.
  • Emphasize product liability assurance.
  • Defend their share by “sharpening their pencils if necessary.”