Rethink sourcing strategies

In its 2015–2016 Private Label Sourcing Study, New York-based Deloitte said that private label purchases account for more than one in every six dollars of spend in the United States, representing a significant opportunity for retailers to drive margin, differentiate products and serve customers’ wide and changing tastes. However, if not managed well, private brand product sourcing and procurement costs could cut into retailers’ profit margins. To remain profitable, therefore, retailers must regularly evaluate their private label sourcing capabilities.

Some of the top procurement pressures facing retailers include raw material costs and/or commodity pricing volatility, supplier consolidation, and consumer desire for innovative private brand products. Store Brands discusses these pressures and the strategies retailers potenitally could take to reduce costs without sacrificing product quality.

1. Raw material costs/volatile commodity pricing

In its study, Deloitte found that, for two years in a row, the top pressures facing grocery retailers were raw material cost increases and/or commodity pricing volatility. This is unsurprising, given that raw material/component costs represent 30 to 39 percent of total landed cost, depending on the category, and are essentially the largest single element of the cost structure.

“With commodity prices jumping up and down, it’s very hard for retailers to make sure they’re always getting the best price,” says Daniel Smythe, managing director for Accenture Strategy (Retail), a Chicago-based professional services company that provides a broad range of services and solutions in strategy, consulting, digital, technology and operations. “Price increases are always passed along to them, but price decreases usually aren’t. Therefore, the more prices move, the worse it can be for a retailer.”

According to Smythe, some of the more “sophisticated” retailers are able to tackle commodity pricing volatility with commodity hedging. Similar to the way airplanes purchase fuel, these retailers can lock in prices using commodities futures.

“It’s not common,” Smythe notes. “It’s among the most sophisticated sourcing strategies, and it’s probably not something most retailers are doing.”

In the Deloitte study, retailers said they’re working to enhance quality assurance programs and are engaging in advanced planning/scheduling to help decrease the impact of raw material cost increases and/or commodity pricing volatility.

Not only are commodity prices constantly fluctuating, but U.S. consumers also expect high-quality products at entry price points more and more, says Jacqueline Martinez, partner with the Retail & Consumer Products Practice of New York-based Oliver Wyman. She believes this is due to the increased prominence of hard discount retailers within the United States. In Europe, some retailers are forming private brand buying alliances “that can join volumes to buy for less and that can develop better capabilities than any one retailer can develop on its own,” she notes. U.S. retailers could possibly form similar purchasing alliances.

2. Supplier consolidation

With more suppliers consolidating, retailers are sometimes finding it difficult to cut costs.

“A traditional sourcing manager would like to put everything out to bid to as many suppliers as possible,” Smythe says. “He can’t do that when there is only a handful of suppliers and they’re already at capacity.”

Therefore, Accenture recommends that retailers create better, stronger partnerships with suppliers. The relationship should become less transactional and more collaborative, Smythe notes.

“Look across the value chain for cost savings opportunities on both sides; don’t just try to extract the most value from one another,” he adds. “Ask: ‘What can we do differently as a retailer to lower your costs, and what can you do as a manufacturer to lower our costs?’”

For example, a retailer might go to a packaging company and negotiate certain prices for its private label packaging, states Kumar Venkataraman, a partner in the retail practice of A.T. Kearney, a global strategy and management consulting firm. The retailer could then inform its suppliers of the negotiation and ensure they are taking advantage of the lower rates from the packaging supplier. In effect, the retailer is passing along a cost reduction to its private label suppliers — benefitting both partners.

However, it won’t be easy for retailers to implement this type of relationship with manufacturers and suppliers.

“It’s hard for retailers to get out of the transactional/commodity mindset,” Smythe states. “It’s a difficult transition. It requires a change in management. It requires raising the profile of the private label sourcing group and treating it similar to the branded buying teams, giving it the attention it deserves.”

3. Product innovation

Another pressure facing retailers is private brand product innovation and differentiation, Venkataraman states.

“There is so much innovation happening in the food categories that it puts a constant pressure on retailers to come up with private label offerings that are differentiated” he says. “That puts a lot of pressure on the private label group and merchandising teams to go after costs.”

It’s expensive and difficult to be innovative and exclusive, Martinez agrees. Traditionally, R&D and innovation were required only of national brands not retailers. That’s no longer the case

The time and money spent creating new and unique products aren’t the only challenges associated with product innovation. With product differentiation comes product proliferation, Venkataraman states. And whenever a retailer has more SKUs to manage and a larger supplier base to deal with it’s going to have increasing cost pressures

Plus these same retailers are also expected to package their innovative store brand products in well-designed packaging.

“It used to be that private label was a plain can that said ‘Green Beans,’” Smythe notes. “Now customers want more complexity around package design [from retailers].”

Retailers have a couple of options to help them defray some of the costs associated with product innovation. Some retailers might want to create deeply integrated partnerships with select vendors to produce exclusive products, while other might decide they would be better off building these R&D and innovation capabilities in house, often drawing on talent from consumer packaged goods companies, Martinez says.

A collaborative relationship between retailers and suppliers could help retailers to defray packaging design costs as well, Smythe states.