In the wake of one of the most dramatic economic downturns in U.S. history, retailers are tackling the sticky problem of how to grow revenue when consumers are reluctant to spend money. One way retailers differentiate themselves in a competitive climate is through private-label product development. It’s not a simple undertaking, though, and a flawed strategy could damage a retailer’s brand, not to mention its bottom line.

The advantages of private-label development are indisputable: lower costs, higher margins, enhanced branding. Small wonder, then, that out of the 100-plus retailers we surveyed, 36% said they generate more than half their revenue from private-label and exclusive products, and roughly 41% expect to generate more than half their sales from their private stock by 2013.

In this two-part report, we’ll identify the pitfalls of in-house product development and we’ll examine how some retailers have successfully launched profitable private-label operations.

Product Development: Elevating Your Private-Label Strategy

Excellent product development begins with a clear idea of where retailers can differentiate themselves and the customer needs they hope to meet. We refer to this as creating a product-line architecture—essentially, deciding what product lines to pursue. We found it helpful to categorize retailers’ offerings, both products and fee-generating services, as one of four types:

  • Ubiquitous—The same brands and items sold by other retailers.
  • Imitative—Lower-cost versions of national product brands, which we believe characterize most non-apparel retailers’ private-label brands. These products compete on the basis of price.
  • Enhanced—These products are better versions of national product brands in that they have certain features not available elsewhere. These products can be developed in-house or be exclusive national brands.
  • Breakthrough—These offerings provide substantial new value in terms of new features, functions, etc. They are exclusive products or they may be sold under a proprietary retail brand. A good example of a breakthrough product is Apple’s iPhone.

Becoming a proficient innovator begins by determining how much of your product and service offering to apportion to each of those categories. For each company it’s different, depending upon how they choose to distinguish their products and customer experience.

The top management team must answer such questions as “Which products and services would make us distinct in the minds of our target customers?” or “In which categories do we need to distinguish ourselves with ‘enhanced’ and ‘breakthrough’ offerings?” This is especially critical to retailers with broad assortments—such as department stores, mass merchandisers, drug and grocery store chains—that must choose from hundreds or thousands of categories in which to distinguish themselves.

Other aspects of product-line architecture include determining the products’ unique characteristics, the positioning vs. other products on the market, opening price points, the margin roll of the product or category (e.g., loss leaders) and inventory roll (e.g., “once and done,” replenishment or seasonal).

To be sure, certain products carry more risk than others, especially highly complex products that require significant engineering talent and intricate manufacturing processes to get right. (See Exhibit.) While highly technical products can generate significant profits, they can also pinch earnings if they don’t sell. On the other hand, low-tech products that sell at a discount to competitive, premium-branded offerings are a much lower risk strategy. This is a typical private-brand strategy of many retailers, particularly in the grocery and drug sectors.

Low-tech products don’t often need a strong national brand to attract customers. High-volume sellers increase margins for retailers because of lower sourcing costs. This is what drives most private-brand strategies: creating discounted versions of national brand products. In fact, many retailers’ first step in private branding is increasing the amount of product they source directly.

But more technically complex products present challenges for retailers to design, develop and source. For high-tech products, a retailer should outsource the design to a partner—with, of course, the retailer’s input.

One recent example of this is Best Buy’s 2008 deal with Hewlett-Packard and Toshiba on its exclusive line of Blue Label enhanced notebook computers. The computers were designed based on Best Buy’s customer data, which showed the need for certain features, such as longer-life batteries and thinner and lighter models. Similarly, Sears has had an arrangement for many years with outside designers, developers and manufacturers of its Craftsman tools and Kenmore appliances. Sears doesn’t do the technical designs, but it does determine which product attributes and features are necessary to give the products a competitive edge over national brands. Such highly respected proprietary lines have helped save Sears from extinction.

After determining which products to develop under private labels, retailers must establish product development operations that consistently deliver innovative offerings. Because many retailers are not hotbeds of product innovation, determining who the function reports to, how it’s staffed, how it’s measured and rewarded and how it operates is paramount.

18 August 2009