In the first part of this report, we discussed how retailers can minimize the risks of private-label development by selecting products that are both appropriate to the brand and that are cost-efficient to manufacture. In the second part of this report, we’re going to explore ways retailers can create private-label operations that will successfully generate quality products over the long term.

Organizing Product Development

Given that apparel retailers are farther ahead than most other retail sectors in developing their own products, there is much to be learned from them. And make no mistake, the key factors to successfully developing hot-selling clothes, handbags and shoes aren’t much different from the key factors to successfully creating new consumer electronics, appliances, food, tools and other non-apparel goods. Chains such as Aeropostale, Coach, Zara and H&M have found several factors critical to product development.

The first is brand management. The most successful consumer products companies are stellar in the art and science of managing their brands. They intimately understand the needs and aspirations of their target customer. They are adept at determining their products’ positioning (opening price point, features, functions, benefits, tradeoffs, etc.), and they are masters at creating robust demand through compelling marketing campaigns and attractive product packaging.

Retailers that are serious about product innovation establish a separate function run by a “brand owner”—an executive whose job it is to determine what products and product attributes are “on brand” and which are “off brand” (meaning, not to be pursued). Retailers with some of the most successful private-label apparel offerings—e.g., Target, Kohl’s and Macy’s—have a group developing private brands that is separate from merchandising. Importantly, they collaborate strongly to ensure minimal competition between the company’s private and exclusive brands and its national brands.

The second key success factor is having a dedicated product development function—within or outside of merchandising. When product development is a part-time job of dozens of people in a large merchandising function that focuses on buying products from the market, the retailer’s brand clarity can be placed at great risk. The authority to use the retailer’s brand becomes highly fragmented. Dozens of merchandising employees can interpret in vastly different ways what the retailer’s own products stand for, what customer needs they must meet, what benefits they must provide and how to differentiate them. The result can be little consistency in features and benefits across products, and thus a highly confusing brand image.

The most successful product innovators in retailing also have an effective operating plan. Realizing the significant risks of developing their own offerings, they actively lower those risks by knowing exactly what they must do every week to monitor product quality, sources of production, the status of new designs and packaging and consumer feedback—from both POS data and testing. Consumer research must be an ongoing process, not just a focus group done at the outset to test a new product concept or new attributes of an existing product. Such feedback must be communicated quickly to product design, development and sourcing personnel so they can rapidly adjust what they do.

Most retailers whose private-label offerings are lower-cost alternatives to national brands do not possess such capabilities. If they want to raise their game in product innovation, they need to raise their capabilities. The exhibit below shows the evolution of most retailers’ product development function and some of the key skills, responsibilities and reporting relationships they must gain. From buying copies of national product brands and slapping their store label on it, retailers evolve to establishing their own brands. They then look to cut the costs of sourcing high-volume, low-tech products by sourcing directly with manufacturers. In the next phase of the evolution, the merchants design concepts to fill voids in the product line but outsources design and development. The final step in the evolution is to significantly differentiate the offering, which requires the retailer to take on product design and development.

There is a certain amount of risk involved: First, product development and sourcing costs can become sizable. Second, product liability costs can be even greater. The third type of risk is inventory risk—of overbuying and getting stuck with unsold product that a retailer owns. And the fourth risk is to brand image: Becoming associated with poor factory working conditions can give a retailer a public relations black eye.

Sourcing: Creating Relationships That Ensure Quality, Safety and Good PR

Unlike fashion retailing star Zara, most retailers that ramp up product development are unlikely to build their own production facilities. The cost and complexities of setting up and running plants are too great for most. (Even Coach no longer owns factories these days; neither does Apple.) Yet when the retailer’s brand goes on the product, it puts its reputation squarely on the line. Defective offerings, unsafe products and unhealthy plant conditions can become liability and PR nightmares, and they become an issue when the retailer can’t control what goes on inside the four walls of a factory. As a result, a retailer must be very careful about the sourcing vendors it selects. It must structure deals that promote good working relationships for both sides, not ones that encourage corners to be cut. Our study found that 60% of the most successful Act Vertical® retailers had high levels of collaboration with suppliers in product design and development vs. only 27% of the least successful retailers. For many chains, that requires reducing their supplier base. For example, Aeropostale funnels two-thirds of its production to just five suppliers—many fewer than in the past.

Since a retailer takes on a product’s liability in a private-label offering, it needs a sound methodology for certifying vendors. Fortunately, there are many independent certification services which do that today. But while ensuring sound manufacturing practices may require an intermediary, finding a manufacturer no longer does. A decade ago, most retailers needed a middleman to help them wade through the mysteries of offshore manufacturers (especially in China). However, Asian manufacturers have grown in sophistication, and advancements in information technology (design/development software, videoconferencing, etc.) have made it far easier to collaborate with them in product development. Skipping the middleman has two big benefits: not having to give up margin and reducing the chance of a vendor misinterpreting a new-product idea.

Many offshore vendors not only run highly efficient plants, they have built elaborate distribution and logistics capabilities as well as product design and engineering functions. And the Internet has dramatically lowered the cost of collaboration with retailers. Everything is possible now, from cheap phone calls and videoconferencing to product designs that can be transmitted from the United States or Europe in seconds to the computer screens of product developers and plant engineers in Asia.

Still, retailers that outsource production must get better at forecasting demand for their products. Most sourcing vendors don’t have the replenishment capabilities of major consumer products companies. Retailers must also get more rigorous about setting margin targets and costs for private-label products. Many don’t have an adequate understanding of the costs of components and manufacturing, thus they have difficulty knowing a good sourcing deal from a bad one.

A retailer that wants to differentiate itself in part on proprietary offerings must be highly competent in product development and sourcing management. Those that have done so are giving customers a big reason to shop with them rather than on price with the discounters down the street.

18 August 2009