Rule number one of creating a private label product or line is that if you don’t start, don’t start. Faced with the pros and cons of private-label production, what should national-brand manufacturers do? Our recommendation to companies that do not yet make products for the private-label market is simple: Don’t start. Some brand-name manufacturers make private-label goods only to use occasional excess production capacity. In those circumstances, private-label production may seem tempting. But beware. Although the system may work well for a company for a time, private-label production can become a narcotic. A manufacturer that begins making private-label products to take up excess capacity may soon find itself taking orders for private-label goods in categories where the market share of its own brand is weak.
That step, too, may seem reasonable enough. Indeed, production managers may argue that in addition to using up excess capacity, private-label production can increase cumulative production experience and lower unit manufacturing and distribution costs. Heinz, for example, is a major supplier of private-label baby food. However, it is easy to slide down the slippery slope. The next step in the process is to supply private-label goods in categories that are the lifeblood of the manufacturer’s branded sales. After all, the thinking goes, high-volume private-label orders placed well in advance of required delivery dates can help smooth production and take less time and effort per unit to sell than the company’s own branded goods. From that point, however, the results of those tactics are predictable: The company’s strategy becomes confused; it starts to cannibalize its brand-name products; and it may even face financial disaster. Consider what happened to Borden. Once a strong manufacturer of well-known brands, Borden found itself floundering in the early 1990s largely because of a progressive, and eventually excessive, commitment to private-label manufacturing, which eroded its focus on sustaining its branded products. As a result of declining margins and cash flows, the company was finally sold to an investment firm in 1995.
Manufacturers still tempted by private-label production should understand, first, that managers invariably examine private-label production opportunities on an incremental marginal cost basis. The fixed overhead costs associated with the excess capacity used to make the private-label products would be incurred anyway. But if private-label manufacturing were evaluated on a fully costed rather than on an incremental basis, it would, in many cases, appear much less profitable. (See the chart “The Real Cost of Private-Label Manufacturing.”) The more private-label production grows as a percentage of total production, the more an analysis based on full costs becomes relevant.Second, private-label production can result in additional manufacturing and distribution complexities that add costs rather than reduce them. For example, packages and labels have to be changed for each private-label customer, and inventory holding costs increase with each private-label contract. Third, efficiencies of selling private-label contracts are also exaggerated. Whenever a private-label contract comes up for renewal, there is inevitably a long and arduous negotiation as competitors attempt to steal the business. And most retailers employ different buyers for national brands and private labels, so manufacturers must maintain two sales relationships with each retailer.