Manufacturers are facing an unnerving scenario—a large, important distributor has taken on a "private label" product as a direct competing brand.
We have been approached by several manufacturers to help deal with this issue. Amazingly, most of them are looking for tactics that are intended to persuade the distributor to continue to promote the manufacturer's brand over the distributor's brand! These manufacturers are missing the point.
A distributor selling a private-label product manufactured specifically for that distributor is, in effect, a competing manufacturer! A manufacturer of branded products that continues to utilize a distributor that carries a competing private-label brand has placed its future sales and market share position in the hands of a "competitor." Tactics to encourage the distributor to focus on your brand versus their own brand will not be successful in the long run, unless the distributor is only using the private-label product for unique situations.
Large distributors are moving to private-label products (typically manufactured off shore) to improve their competitiveness against competing distributors via lower prices and to improve profit margins. Significant investments are being made by these large distributors to establish sourcing offices in countries around the world and create distribution centers in the U.S. to handle the large volumes of inventory sourced overseas. When they can, these distributors will sell their private-label products to pay for these investments. Your "encouragement tactics" will not refocus their sales efforts on your brand.
Distributors are sourcing "off-brand" products from off-shore manufacturers at an alarming rate. A subset of these "off brands", which compete with recognized North American brands, are private label products (products branded for a specific distributor). As noted in a new report by Scott Benfield and Stephen Griffith, entitled Disruption in the Channel—The New Realities of Distribution and Manufacturing in a Global Economy, distributors are seeking out "off brands" to take advantage of better price points and to gain price advantages over domestic brands. Benfield and Griffith point out that the products are often of comparable quality and at a price point that is, on average, 35% lower than a comparable domestic product (which may have been made overseas)!
While off-shore sourcing is a major problem for manufacturers at these types of price differences, it is a problem manufacturers have contended with in distribution for a long time. Regardless of where the product is manufactured, if the low-cost product is supplied to a distributor by a competing manufacturer, it is a low-priced competitive product. But, when the product is your distributor's private-label product, you have, in effect, placed your product in the hands of a direct selling competitor.
The growth in off-shore sourcing is significant. W.W. Grainger directly sources more than 5%of its products from outside the U.S., mostly from Asia, and is growing this by 30% each year. Most of this off-shore product is private labeled for Grainger—24% of its branch business is private labeled.
Similarly, The Home Depot sources products from over 500 factories in more than 40 countries. It has created sourcing offices in Shanghai and Shenzhen, China and invested in several of its own distribution centers. The Benfield/Griffith report points out that only 37% of the distributors surveyed do not have any interest in sourcing private-label product.
What Products Are Likely to be Private Labeled?
Product categories with little brand recognition or brand preference are the first to be evaluated by distributors as private-label candidates. Large distributors will become commodity manufacturers.
Frank Lynn & Associates has conducted a number of studies for manufacturers that deal with distributor requests for private label quotes. All situations must be evaluated individually; however, we generally discourage manufacturers from providing distributors with a private-label product. Distributors like it because they can offer customers a product that cannot be shopped/compared at other distributors. Consumer electronic manufacturers have addressed this by providing large retailers with manufacturer branded product that has unique features and, therefore, a unique model number. Manufacturers with strong brand positions and a desire to reinforce the importance of the brand to end customers can undermine the investments they have made in the brand if they also provide a private label. In our experience, the market eventually learns the source manufacturer of the private-label product. What distributor sales force would not want to say they have products from a major manufacturer for less?
Not all products and/or customer segments are as susceptible to a distributor private label. Product categories that are viewed as integral to a customer's business and/or viewed to be differentiated by key customers will be more difficult for distributors to penetrate with a private label. When a distributor approaches you to supply a private-label product, or if your distributor is investigating off-shore sources directly, we recommend that you analyze your customers buying behaviors and preferences. This assessment will tell you how at risk you are to encroachment by a private-label product. We conducted a number of these assessments for clients in 2007. Examples of our findings included:
- An aftermarket truck parts manufacturer was asked by one of its
largest distributors to quote prices for a private-label part. We
learned from key fleet customers that for this part, our
client's branded product was viewed to be a "critical
part" that was tested, measured and viewed to have an impact
on engine performance. Our client decided not to quote prices for a
private-label part and shared the results of the assessment with
- A manufacturer of printing products was concerned that its
distributors were offering private-label product and wanted to
lower prices to appease their distributors. We found 15% of the
end-user market to be "price buyers", and printers used
this product to compete for the price buyer. Printers that used the
lower-priced, private-label product experienced issues with
consistency and scrap and were cautious not to grow this
segment of their business. We advised our client to keep prices as
is, as distributors did not have the ability to grow this position
off their business.
- A client planning to acquire a manufacturer of commodity
fasteners and cabinet hardware asked us to assess the growth
opportunity for this company. We learned this category of products
was highly undifferentiated and its two largest distributors were
actively engaged in establishing a Chinese private-label source. We
recommended against moving forward with the acquisition.
These assessments helped the manufacturer to avoid making big mistakes in reaction to different distributor private label confrontations.
What Are Your Options?
Some of our clients, especially those with strong brand positions, have contracts in place that prohibit the distributors from carrying any competing products. Distributors that bring on a private-label product (or any competing brand for that matter) are in violation of their contract and would be terminated.
If you have the brand power, but it is difficult to prohibit the distributor from carrying competing lines due to customer expectations, you can structure your agreement to prohibit the distributor from offering private-label products in your category. Remember, we view a distributor with a private-label product as a competing manufacturer. Again, the penalty for violation would be termination of the distributor relationship.
If Your Distributor Takes on a Private-Label Product, What Should You Do?
Many manufacturers would have a hard time terminating their relationship with a very large distributor. However, inaction will encourage, and perhaps force, other distributors to follow suit and also pick up private-label lines. A middle ground is to establish a distinction in your distributor pricing. Those offering private-label products that compete with you, by our definition, are not your most supportive distributors. To get your best price, the distributor must not offer private-label products.
We have helped some clients analyze the product category the distributor is considering for private label. We have learned through these analyses that some products are not as inexpensive as the distributors thought they would be. When the distributor essentially becomes the manufacturer of an off-shore, private-label product, many other costs enter the picture. The can include:
- Inventory—capacity problems exist in almost all parts
of the West Coast supply chain. The ports in Los Angeles and Long
Beach handle more than 40% of all inbound Asian freight.
Distributors must carry greater levels of inventory to account for
port delays which are expected to exist for years to come. This
results in increased inventory costs and reduced inventory
- Freight—freight costs to move inventory from the
coastal ports must be picked up by the distributor
- Warranty costs—the distributor will increase the
costs of processing product warranty for private-labeled product
even if the manufacturer has included a provision for warranty in
their price to the distributor
- Returns—distributors rarely can return products
specifically manufactured under their private label
- Marketing—co-op funds, sales literature, demo kits,
samples, etc. that are typically supplied by the manufacturer, must
be generated by the distributor
- Insurance for product liability
- Other potential costs that would typically be incurred by the
domestic manufacturer (for example—training expenditures,
scrap and currency fluctuations)
Additionally, distributors do not always understand the long-term impact and results of the non-economic aspects of the relationship with the domestic manufacturer, especially related to creating demand. Field and inside sales resources that get brands placed on approved vendor lists can be very powerful ways to curtail private-label acceptance. Manufacturer advertising and trade shows create brand recognition and demand. Distributors with private-label product will still have to sell against customer preference, if a preference has been created by the manufacturer. Like-for-like replacement for aftermarket parts and components can be extremely common and can account for 30% to 60% of the aftermarket in many product categories. A private-label product would not qualify as "like-for-like" based on our research.
Whether or not you have a strong brand position, if one of your key distributors becomes your competitor via private label, action is required. Alternative distribution options need to be part of your contingency plans. Some distributors recognize this and have publicly announced their intent not to offer private-label products. Graybar Electric Co. is an example in the electrical industry. In June of 2007, Graybar took a public stand against private-labeling. "It has come to our attention that the distribution industry is, in some ways, having an identity crisis. As a distributor, we believe it's critical that we distribute our suppliers' products, not develop and market our own." Manufacturers that can appoint someone like Graybar as a distribution partner have lowered their risk.
Simultaneous to developing alternative distribution contingencies, manufacturers must begin to identify the end customers that purchase their products. Knowing the end customer allows manufacturers to directly influence those customers to maintain their current brand preference. It also allows manufacturers to provide customer names to new distributors if desired. Some manufacturers collect point-of-sale/sell-through information from their distributors. For those of you that do not collect this information, there are ways to capture information about the end users of your products. Warranty cards, customer service calls, trade shows, parts purchases and even your receptionist can be sources of customer information. Frank Lynn & Associates can assist you in building, creating and maintaining a customer database (which we recommend whether or not you have a private-label concern).
If your distributors are selling private-label products in your product category, they are a competitor. Manufacturers must take action. You cannot allow a "competitor" to control the fate of your product line. At a minimum, manufacturers must develop contingency plans which include identifying alternative distribution options and building a database of your end customers. Additionally, manufacturers should determine the level of risk they face in the specific product categories in question. While distributors may offer a private-label product, it may only fit a small segment of your target market.
Manufacturers with brand strength should consider contractual restrictions on private-label or economic penalties for distributors that offer a private-label alternative.
Be prepared to withdraw support and make sure distributors understand the support that is currently provided, will be withdrawn. For example, it makes no sense to provide leads to a distributor/competitor that offers its own private label. It should also make you cautious about what information you share with your distributor/competitor.
Don't treat a distributor's private-label product as another "competitive line." It is your channel partner's competitive line, which means it will almost always be the preferred line. Once your distributor begins competing with you, the nature of your relationship will change, negatively.
If you would like assistance dealing with private-label issues in any of the following areas, please contact me.
- An audit to assess the risk associated with your product
- Changes in contractual relationship
- Changes in distribution pricing
- Contingency planning including identifying alternative
- Marketing due diligence for a new acquisition target
If you are interested in obtaining a copy of Disruption in the Channel by Scott Benfield and Stephen Griffith, it can be purchased by visiting Frank Lynn & Associates' Web site. This report thoroughly explores the rise in use of off brands produced in foreign countries.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.