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The Promise (and Complexities) of Private Labels

Written By: Predrag Jakovljevic
Published On: August 13 2007

Collaborative supply chain networks may benefit their participants in many ways. Information-sharing initiatives can increase profitability throughout the supply chain by way of cost reduction, demand augmentation, and better ability to respond quickly and accurately to market changes. For more background, please see The Blessing and Curse of Global Sourcing and Supplier Management and Distinctions and Benefits of Strategic Sourcing.

As for the retail sector, there is also a growing trend toward offering private labels and brands (also known as own and house brands and labels) to help retailers grow revenue. Consequently, there comes a fundamental reassessment of the structure of global sourcingwhether to use agents or other middlemen at all if companies can now work directly with manufacturers via the Internet. Therefore, given some reports of success with lower-priced house brands, retailers in several segments (including fast-moving consumer goods [FMCG], consumer electronics, and apparel) are increasing their focus on private label merchandise to take advantage of margin improvements, more consistent quality, and brand loyalty. To learn more, please see The Fragile Consumer Packaged Goods Market and Private Label Products and A Unique Product Lifecycle Management Tool for Private Label Retail.

Recently, Retail Systems Alert Group's (RSAG) Sourcing and Product Lifecycle Management (PLM) Benchmark Study reported that adding private label merchandise into the overall product mix drives not only margins for retailers, but also top line revenues and sustained growth. The study was based on survey responses and interviews with nearly 150 executives and managers representing retailers from around the world with annual revenues ranging from less than $50 million (USD) to more than $5 billion (USD). It reports that retail winners (that is, companies that outperform their peers in year-over-year comparable store sales) carry a significantly higher percentage of private label merchandise than their competitors do. These same leading retailers also achieve better return on inventory investments and outperform competitors in overall gross margin improvements. Further, according to a recent AMR Research report, even US grocers are beginning to respond to the growing demand for private label product, as they require even greater speed, visibility, and agility.

RSAG's study uncovered other key industry shifts. Namely, after a decade of reverse auctions and bidding events designed to drive cost out of merchandise without regards to impact on suppliers, RSAG found that retailers today are beginning to develop long-term, collaborative relationships with trusted suppliers. Winning retailers, according to the firm, are leveraging technologies to manage these relationships as well as for product development, supplier audits, managing and tracking merchandise status, and self-managing freight, all of which ultimately drive gross margin and sales improvements.

Similar conclusions were drawn in another late 2006 report titled The New Retail: Driving Growth through Product and Supplier Innovation by analysts Industry Directions. The research revealed that leading retailers are moving beyond the severe cost-cutting measures of the past decade to pursue more strategic private label programs that deliver differentiated products with higher margins to the market.

According to Industry Directions, retailers that are able to leverage the expertise of their buying and merchandising teams in order to seize the revenue-generating opportunities presented by private labeling, fast fashion, and global sourcing, will be the leaders of tomorrow. However, this type of integrated joint effort requires commitment to new cross-organizational processes and technology-enabled collaboration that support the entire product life cycle (from product concept to delivery to the importer and product discontinuation) coupled with the ability to proactively manage a multiplicity of tasks, activities, and relationships across the enterprise.

Other key recommendations to retailers looking to drive appreciable growth objectives included the following:

  • Retailers must prepare to work collaboratively within their supplier ecosystems to increase customer value while addressing corporate social responsibility (CSR).

  • The combination of manual processes, Microsoft Excel spreadsheets, and disparate technologies that most retailers use today will not support the collaboration required to deliver differentiated products into global markets.

  • Retailers must gain visibility into emerging product concepts to streamline and coordinate efforts across their organizations and throughout their supplier networks.

  • Retailers, sourcing offices, agents, suppliers, and other stakeholders require the ability to share critical information in a timely and appropriate manner.

  • Sustainable competitive advantage will belong to those retailers that are able to leverage the expertise of their buying and merchandising teams to build synergistic and strategic partnerships with selected suppliers.

One might wonder, from a sourcing perspective, what it has taken to accomplish this growth through private labelbased innovation. To that end, the largest and most forward-thinking retailers have, over time, certainly mastered tactical procurement and supplier performance practices. Namely, they have gradually moved beyond paper-based purchase orders (which merely require supplier identification in terms of managing supplier community) to online bidding processes (which at least demand more standardized processes when it comes to managing supplier community and structured responses when it comes to enterprise sourcing processes). As their supplier bases have grown, these companies have developed solid vendor stratification strategies, supplier scorecards, and other supplier performance management (SPM) technologies that have further helped their success. However, based on the above research reports, low cost sourcing, while necessary, will not be sufficient, since it is now more about collaborative product and market innovation (including strategic partner collaboration) and moving brand loyalty from national and international labels to local store brands.

While the above-mentioned focus on true cost remains of paramount importance, sourcing is often just as much about the delivered value to the end customer, where private label products are providing distinct offerings to companies like Tesco, for instance. Eqos cites as the primary reason customers purchase its software is that they want to scale their private label businesses. To that end, the software is a part of a grander strategy that normally includes opening a sourcing office (in Hong Kong, for example) and experimenting with going directly to prospective supplying factories to save the estimated 6 percent agent fee. Given that nowadays agents are acting as factories, many importers are looking for other options, and they generally use a combination of agents and direct offices, which is only possible with astute technology solutions.

And Now, the Complexities

Certainly, the retail landscape is changing, and the market is looking to differentiate through better tailoring the customer shopping experience and introducing private label products exclusive to their retail chains. However, bringing private label goods into the mix adds supply chain complexity, as retailers struggle to shorten the product life cycles in order to react faster to the latest fashion trends. The so-called retail balancing act of creating a superior consumer shopping experience (through better assortment, freshness, and relevance, and without stockouts) while simultaneously improving inventory productivity (optimized inventory levels to support profitable sales and lower supply chain costs) has only been aggravated.

As mentioned earlier, supply chains are getting longer. They need solutions that provide visibility from the early manufacturing process to the store shelf, with the ability to track merchandise throughout its entire life cycle and to reduce time-to-shelf, thus enabling better decision making capabilities during the selling season. In other words, the size and complexity of sourcing projects are increasing because such undertakings involve, in some cases, large teams operating at different remote sites. Moreover, the information itself that is involved in this process is more important than ever, comes in larger amounts than ever, and is more difficult than ever to manage manually with the speed and accuracy that is required.

Some retailers looking to gain a competitive edge in this area have been implementing the cycle time optimization solutions from certain savvy software vendors. Most recently, during its i2 Planet annual user conference in May of 2007, i2 Technologies (NASDAQ:ITWO), a prominent provider of supply chain management (SCM) solutions and services to various industries, announced the i2 Cycle Time Optimization (CTO) product, which was designed to reduce concept-to-store cycle time. The solution aims at creating capacity-constrained product plans to synchronize with in-store assortment plans; prepositioning key raw materials and optimizing inventory (finished and raw material) throughout the value chain; and reducing distribution and handling costs. The entire value chain becomes connected through the CTO solution using an integrated retail and supply chain planning (SCP) process.

Retailers can use i2 CTO to become more customer-centric by making assortment decisions (this is, reacting to fashion trends) closer to the selling season and keeping their private label products in tune with the latest global fashion trends. The idea is to reduce the risk in selection of style and quantity of purchase as well as to reduce inventory, distribution, and handling cost risks through cycle time reduction from store to storeall without sacrificing customer service levels. In addition to shortening lead times, by leveraging this solution, retailers also have the opportunity to optimize and manage spending across the supplier base by analyzing the sourcing spend, negotiating and selecting strategic sourcing partners, and allocating purchase orders to deserving suppliers accordingly. Further, the solution offers the capabilities of contract management to track consumption against contracts and associated SPM.

Can Information Technology Help, Then?

Many companies that have successfully deployed supplier relationship management (SRM) software tools have also discovered certain benefits related to the sourcing process itself, starting with reduced cycle times on sourcing projects. Instead of going through piles of request for proposal (RFP) documents and comparing a wide array of quotes, the software can actually help with bringing all of this data together into a simplified and unified selection process. Another way that SRM software can cut down on the time spent on sourcing is that sourcing projects can be saved and reused at a later time. Meaning, if the enterprise's needs recur frequently or come with small variations, this copy from and to capability can save a great deal of time.

SRM software tools also make it easier for companies to select suppliers, since not only can prices be compared quickly, but the software also allows buyers to add the past performance of vendors to the equation. For example, it may be enticing to instinctively choose a certain vendor on the basis of its lower price to deliver raw materials, but since that vendor's last shipment was delayed and of bad quality (which necessitated scrapping most of the parts), the buyer may want to change his or her mind this time around.

Another often-cited benefit is that SRM software makes it easier to standardize purchasing decisions and to instill the structure into the entire sourcing process. Again, most organizations do not have a clear basis for choosing their suppliers, but the software can make the selection criteria more readily apparent. Also, instead of having to deal with hundreds of separate suppliers personally, the software does most of the legwork for the buyers. SRM technology also accelerates communication between the buyer and the seller. Since the transfer of information can be done in real time, the vendor can check the buyer's inventory to determine whether new shipments are needed, and the buyer can instantly submit orders over the Internet without reducing overall productivity. Similarly, questions related to orders can be answered by checking details via the Internet, so no human interaction or human-related delays have to interfere with the work.

In summary, the purpose of SRM technology is to streamline the processes between an organization and its suppliers, and to make these processes more effective. Such software tools have automated many of the business processes that structure supply chains, and with this automation typically comes cost reduction and increased efficiencies. To that end, various SRM products are available from a number of vendors, and a review of the descriptions of SRM products offers a broad spectrum, but not quite a clear consensus yet.

Many vendors refer to themselves as SRM providers merely because of their solutions' Web-based sourcing and e-procurement (over the Internet or intranet) capabilities. While these are significant components, some other common SRM software capabilities include catalog management; service procurement; strategic sourcing; supplier rating and performance management; supply analytics; contract management; collaborative supply management and collaborative planning, forecasting, and replenishment (CPFR); vendor managed inventory (VMI); etc. According to the APICS Dictionary (11th edition), CPFR is a process through which supply chain trading partners can jointly plan key supply chain activities from production and delivery of raw materials to production and delivery of final products to end customers. VMI is a means of optimizing supply chain performance in which the supplier has access to the customer's inventory data and is responsible for maintaining the inventory level required by the customer.

Indeed, by better managing interaction with suppliers, an enterprise can have greater control and visibility of the supply chain, improve product and service quality, and drive additional savings through more effective and streamlined processes.

TradeStone Software, a provider of unified sourcing and PLM solutions for retailers, reports many midsized and large North American, European, and Asian companies that have adopted the strategic sourcing approach suggest that a business can reduce expenses by 10 to 30 percent. Eqos touts similar responses from many supply chain managers at the largest North American and European retailers, which indicates that the use of foreign suppliers will nearly double in the next five years. Offshore suppliers are expected to account for nearly a third of the typical company's total supply base by 2008. Most companies have been able to reduce material and service costs up to 35 percent (and thus improve profit margins accordingly) by sourcing from low cost country suppliers.

With strategic sourcing, major manufacturers, retailers, governments, and financial institutions can achieve significant savings while strengthening ties with suppliers that offer the best quality products and customer service. When approached properly and executed meticulously, global sourcing can also result in improvements in time-to-market, customer value, and innovation (via private labels and direct imports), as well as reductions in inventory, stockouts, etc. Last but not least, strategic sourcing can also allow small and medium-sized businesses to compete against larger companies for major contracts.

The Allure Comes with Some Inevitable Hurdles

Competing in supply networks that cross borders inevitably adds many problems when compared to doing business in a single, local market where competitors have to play by the same rules, invoice and pay in the same currency, communicate in the same language, and pay about the same rates for labor wages, indirect supplies, and direct materials. For one, the savings from global sourcing comes with the possibility of steep expenses elsewhere, since a company must prospect regulatory climates; find qualified factories; solicit bids; place purchase orders; inspect factories; monitor quality; handle logistics, customs, and duties; and so on, all on its ownwhich is no small feat.

All merchants nowadays have to manage numerous details on how private label brands are sourced, produced, and delivered, which can be quite a daunting task, especially when trading partners are scattered all over the world. The momentum of private labels in the retail industry (from grocery stores to major apparel stores) is driving even more opportunistic contracting with small and unknown suppliers in remote countries. This type of contracting is contrary to the concepts of strategic sourcing, as it requires buyers to take their chances when ordering from unfamiliar suppliers, with the hope of keeping total landed costs to a minimum.

What is also required with global sourcing is a mindset change with regards to timing given that most issues with domestic suppliers can be resolved right away (or at least within a week in a worst case scenario). Internationally, though, even with bordering countries, it might take a more special purchase order up to several weeks to be confirmed, let alone be processed and delivered over the ocean and through customs and duties, and multiple intermediaries.

With global sourcing, the challenge has become how to communicate with a factory that is in the wilderness of the Far East or Africa (though we by no means want to sound derogatory toward any third-world region) from a swanky, domestic office in a G8 country, and how to assimilate and communicate multiple data points effectively into a unified operation on a single screen. In the manufacturing process, communication must take place among retailers, manufacturers, brand managers, contractors, agents, brokers, and logistics providersand many still share product information either over the telephone, via e-mail or faxes, or by other means of physical communication.

Indeed, it is all too often true that sourcing supporting systems are still hodgepodges of point solutions that separately handle the complex issues and challenges of global trade regulations, logistics, timing, supplier relationships, and general SCM. Until a unified sourcing suite becomes readily available for smaller companies, such organizations will likely continue to use disparate sourcing and e-procurement solutions, not so much for low-cost country sourcing (LCCS), but within the context of a known, mostly domestic supply base.

This is part three of the series The Blessing and Curse of Global Sourcing and Supplier Management. Part four will focus on the specifics of sourcing in the retail sector, and its particular challenges.

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