Overcome the cost challenge to private label sourcing

Retail has entered a period of rapid change — omni-channel forces are reshaping consumer behavior and the competitive landscape. With nationally branded merchandise easily sold by online competitors, retailers are turning to more exclusive private label offerings to maintain loyalty. The demand for innovative or customized product is contributing to sourcing complexity. These changes are elevating the strategic importance of the sourcing function as retailers seek to drive more differentiation on the shelf while managing their margins.

In developing a strategy for private label, sourcing professionals must balance a number of critical considerations, including cost, quality of product, speed-to-market, production/order flexibility, and ethical sourcing objectives. The critical question that sourcing professionals need to ask themselves is: How should these tradeoffs be weighed?

Merchandising strategy (e.g., product differentiation), product characteristics (e.g., raw material content) and supply market characteristics (e.g., supplier fragmentation) can increase complexity when balancing these tradeoffs. Retailers that understand how to juggle these tradeoffs are best equipped to prioritize their sourcing objectives and focus attention on achieving the greatest value through the sourcing function.

Despite the need to consider all of these elements, cost continues to be the primary focus for retailers, according to Deloittes recent 2012-13 "Private Label Sourcing Survey" (http://tinyurl.com/mf4rgyn) of 266 individuals from apparel, general merchandise and grocery retailers. The results show that retailers top three pressures are raw material cost increases and/or volatility, rising production labor wages and fuel price volatility. These cost pressures might be felt more acutely as retailers manage margin in an environment of increased competition from online retail.

While top-line strategies continue to be a focus for almost every retailer, an increasing number of companies are turning the spotlight on the "cost" side of the margin equation. Naturally, the question will arise as to whether the sourcing function is doing an effective job at managing cost. Leading sourcing organizations are proactively developing approaches to drive greater insights from cost data to more effectively engage with their merchant counterparts and finance executives.

While not easy, develop a structured approach to analyzing cost

Some more sophisticated sourcing organizations are investing in advanced methods to analyze cost, such as "target costing" to evaluate the full lifecycle impact on margins from design-to-shelf. Even organizations not adopting advanced methods are developing enhanced approaches to better measure cost. A critical piece of these approaches is being able to differentiate the complex factors that may be impacting the overall average cost for a category/subcategory. Segregating changes in product mix and specifications that are typically driven by design and/or merchants from like-for-like unit cost changes provides more clarity on what sourcing can influence.

Given the number of SKUs in a particular category, as well as the number of cost components and influencing factors, isolating specific drivers is not easy. Determining the right level of "zoom" to segment the SKUs in a category — using product specifications — is critical to driving actionable cost insights. For example, the "inflatable toys" category includes a wide variety of SKUs, including inflatable swimming pools and inflatable beach balls — subcategorizing within the inflatables category would be essential to identifying more like-for-like comparisons in unit cost.

Unit costs include raw materials, production, freight, customs/duties and commissions paid internally for the sourcing function or externally to a buying agent. Isolating external drivers behind each of these factors can help identify strategies to offset rising cost increases; external factors include commodity pricing, labor and fuel, and supply market capacity/fragmentation, to name a few. Internal factors can also impact these cost elements, including low-volume orders, late adds and volume projections, as well as multiple low-quantity purchase orders. Managing cost against these external and internal factors requires a holistic approach to the value chain and sourcing footprint strategies.

Optimize the value chain from design to shelf

A "Value Chain Strategy" focuses on deciding which players — such as the retailer itself or its partners such as supply chain agents — are responsible for which sourcing activities, from design to logistics. Retailers can choose to take on activities themselves or collaborate with their value chain partners for a variety of reasons, including cost, sourcing volumes, exclusivity of product design, the desire to spot trends in the supply markets or the upstream complexity of their product development processes.

A common trend over the past few years has been retailers opening their own offshore sourcing operations to eliminate the need for buying agents. Looking ahead, we are likely to see more dramatic shifts in how value chains are organized due to technological changes in manufacturing automation. As the level of sophistication of robots and 3D printing increases and the costs continue to decrease (rivaling that of cheap off-shore labor), the drive to manufacture and source locally may accelerate, changing the game for various players in the private label value chain.

Establish a flexible sourcing footprint

A "Sourcing Footprint Strategy" focuses on where, and from whom, retailers will source. Operating environment and costs, clustering of complementary supply partners and government incentives are just some of the considerations that are driving changes in global supply patterns. Factors including cost, quality, ease of doing business and compliance to ethical sourcing requirements drive supplier selection.

For more than a decade, China has been the undisputed leader as a sourcing and manufacturing base, especially for the apparel and general merchandise categories. But over the last few years, China's appreciating currency, economic growth and rising labor costs have started to impact its dominance in the supply market. Reshoring to local markets is becoming an increasingly attractive option for some respondents in Deloitte's survey, and is most appropriate for those seeking lower transportation costs and product with high automation and low labor content. The survey indicates this strategic response is being adopted by grocery and large (>$10 billion revenue) general merchandise retailers, in particular.

If the cost conversation has not already begun at your organization, it is likely not too far off. Be prepared for a complex, but necessary analysis of the true cost drivers to facilitate more effective engagement with the merchants and finance, as well as a clear prioritization of both value chain and sourcing footprint strategies. In this environment of rapid change, data-driven insights and ideas will win internal deliberations on cost and ultimately position the retailer to win in the (virtual) shopping cart.