Before distributors consider private labeling, they must first understand all of the issues, including liability, the trade-offs of inheriting the role of a manufacturer, the message it sends to manufacturer, the level of support reps will offer, the reality versus dreams of maximizing profits and the problems of incurring the related logistics and inventory expenses. If you are a manufacturer, whether a private-label producer or a name-brand competitor (or for some, both), you should ask yourself: How does this strategy affect my profitability, brand and distribution strategies?

The first three articles in Electrical Wholesaling's “5-Ton Elephant” series (January-March 2007 issues) shared insights from distributors and manufacturers. We are conducting contractor research on the value of brands and customer acceptance of privately branded products. While we await the results, we wanted to share the following myths and realities.

MYTH #1 — DISTRIBUTORS ARE ONLY PURSUING PRIVATE LABELING TO IMPROVE THEIR MARGINS OR GAIN LOWER PRICES.

Realities: The drive for improved profitability is only part of the answer. Traditionally, companies pursue private-label initiatives to increase their market share and to improve overall margins. More importantly, it's about control of the customer and who has leverage in the channel. Market share is improved by greater appeal to customers who are more price-sensitive, and using price as a marketing tool. Private labeling helps distributors improve their margins because of several key factors:

Better margins on private-label products. With acquisition costs 25 percent to 50 percent lower, an opportunity exists to improve margins. Profit dollars per unit may decrease due to lower selling prices. The key is achieving high inventory velocity.

The ability to leverage name-brand manufacturers who want to remain on the distributor's shelf. The leverage comes from improved rebates, marketing funds and other sales resources.

Earlier research projects by Channel Marketing Group, Raleigh, N.C., and Allen Ray Associates, Kennedale, Texas, have shown the top four reasons why contractors purchase from a distributor are:

  1. Relationship with distributor personnel
  2. Product availability
  3. Price
  4. Overall service

Manufacturer brand is fifth. For most products, a significant percentage of customers are brand agnostic, especially when the perception is that most manufacturers outsource manufacturing.

For private labeling to be effective, the relationship needs to be with the distributor. If distributors who pursue private labeling don't have a high level of salesperson retention, they will become transactionally-oriented companies with limited value-added services and essentially compete based solely upon price.

Increased loyalty from customers who prefer the distributor brand vs. the name brand. Some distributors believe it's more important to only market their brand and that there is limited, if any, value in marketing a manufacturer's brand.

Improved customer profitability. By adding higher-margin sales and gaining a greater percentage of the customer's business, a distributor can improve the net profit on sales to that customer.

Additionally, companies actively pursuing private labeling believe their customers are more loyal to them than to manufacturers, and that they have more power or control in the channel. Consumer products research has shown that 33 percent of customers are loyal to stores, 50 percent are loyal to manufacturer brands and that the rest are undecided. Coincidentally, research has shown that for unsophisticated private labeling initiatives to be profitable for a multi-brand company, private labeling should represent 20 percent to 30 percent of their business.

MYTH #2 — IMPORTING IS PRIVATE LABELING.

Reality. In discussions at the NAED South-Central Conference in San Diego in February, these two words were interchangeably referenced as threats to the industry.

The desire for increased margins and market share is leading a drive to reduce product acquisition costs. In many instances, this is opening distributors to the idea of imported lines, niche and regional manufacturers and private labeling. In some instances, counterfeit products have been encountered. Unfortunately, the perception of product quality is being colored by these counterfeit products. Some distributors naively say since private-label products are imported, imported products are of poor quality.

Although the old adage of caveat emptor (buyer beware) is incumbent upon distributors for all manufacturers and products they represent, the fact that an overseas manufacturer wants to expand distribution into the United States does not mean their product quality is unsatisfactory. Many U.S.-based manufacturers seek to distribute product overseas, but that doesn't mean they offer inferior products to those countries. If importing infers poor quality, then the inference carries to U.S.-based companies that manufacture overseas.

Yes, a private-label manufacturer could have product quality problems, but this is the exception. It's more common that the product is of similar quality, but may not be exactly the same. This is called “copy cat” private labeling and allows the distributor to offer a comparable product at a significant savings and positions the line as a value line. The product is frequently designed through reverse engineering.

From a market penetration viewpoint, why do U.S. manufacturers have people with titles like “Global Distribution Manager”? Importing and expanding distribution networks are an outgrowth of a global marketplace and represent a desire to increase sales, not an indicator or predictor of product quality.

MYTH #3 — ALL PRIVATE LABELING IS DONE OVERSEAS.

Reality. Private-label brands are produced by many different companies. Essentially, any company willing to change the packaging of its products can conceivably private label for a distributor. Private-labeled products can be procured from:

  • Name-brand manufacturers (some of which manufacture overseas, some domestically). Typically, these companies believe they are selling excess capacity. Unfortunately, this can create a self-fulfilling prophecy. When they sell excess capacity, they sell less branded products. This creates more excess capacity, which can be sold to the distributors who want to private label.

  • Regional domestic manufacturers

  • Sourced by brokers

  • Produced by domestic and overseas contract manufacturers

MYTH #4 — PRIVATE LABELED PRODUCT IS NOT QUALITY PRODUCT.

Reality. Consider your life as a consumer. Have you purchased any store brands from your local grocery store? Have you had a drug prescription filled as a generic or purchased a CVS or Walgreen's product? How about Staples-brand copy paper? Does the gas from your local non-branded gas station power your vehicle?

If you purchase store-brand apparel or food and believe these products are quality products, why would you presume store-brand electrical materials would not be quality products? The difference between knock-off and counterfeit products is intent.

Counterfeit products. Several high-profile product counterfeit cases recently resulted in prosecution and contributed to product liability concerns. A drive to buy and sell less-expensive products can contribute to counterfeiting while increasing channel costs. Costs increase as manufacturers develop processes to reduce counterfeiting, incur increased legal fees to address counterfeiting, and absorb increased insurance costs.

The Better Business Bureau estimates counterfeiting costs U.S. businesses as much as $250 billion every year and costs the U.S. economy 750,000 jobs. In our research, some electrical manufacturers said counterfeiting affects their production costs by 1 percent to 3 percent and in some product categories could represent 2 percent to 4 percent of sales.

This should be especially disconcerting to small- and medium-sized distributors considering private labeling. If a distributor is not knowledgeable about manufacturing and cannot ensure product quality, the risk of unknowingly accepting counterfeit products — with the associated product liability — can be significant.

Larger distributors can invest the resources to employ personnel to distinguish between counterfeit products and knock-offs and to protect themselves from the liability.

Knock-offs. Knock-off products differ from counterfeit products, as they are copies of products and don't represent themselves as name-brand manufacturer products. Typically, private-label products are knock-offs.

The difference between knock-offs and counterfeit products, according to www.wikipedia.com is intent. “A counterfeit is an imitation made with the intent to deceptively represent its content or origins. By contrast, a knock-off item may imitate a well-known one, be sold for a lower price, and be of inferior quality, but there is no attempt to deceive the buyer or infringe upon brand names, patents, trademarks or copyrights.”

As you can see, fear breeds misunderstanding. In many industries, private labeling as a percentage of industry sales has grown faster than manufacturers' brands. While consolidation, combined with a drive for increased market share and profitability drives the effort, in an industry as fragmented as the electrical industry there is no need to panic or copy the competition. Private labeling may not prove to be a significant competitive advantage, or may be successful for only the largest of distributors. Distributors and manufacturers who focus on their core competencies, pay attention to customers, innovate, offer value and market effectively can thrive. Relevancy requires providing the customer with value and creating your own reality.

Allen Ray is principal of Allen Ray Associates, Kennedale, Texas, 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, Raleigh, N.C. 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.