Most manufacturing companies, especially in the consumer products industry, will encounter the situation when the sales department presents an opportunity to sell a private-label product to a customer. Unless you have a strategy in place to determine if you can compete in this area, properly vet the opportunity, and then price it, your bottom line could be adversely affected.
A manufacturing company’s branded products are specifically identified to their company, and a strong brand value enables premium pricing for those products. Branded products are offered to multiple customers and distribution channels at prices your company determines, and can change as your company sees fit to match market conditions. A private-label product, however, normally requires a contract between the manufacturer and a specific customer where the product, its component parts, and the price to be charged are defined for an agreed-upon period.
Branded products generate better margins then private-label products for manufacturing companies because product pricing is adjustable and value has been earned. But they do require more effort with regard to marketing, promotion, and sales. Private-label parts are lower margin because they are competitively sourced by the customer, but they do not require much heavy lifting by the sales team beyond the initial bid. Therein lies the problem and the need for a private-label pricing strategy. Normally, it is the sales team who brings forth private-label opportunities. If some or all of their commission is tied to volume, this is an easy way for them to boost their numbers. They may be biased toward the deal.
A company that has won a private-label contract will soon see problems arise if the contract had not been properly negotiated. Strategically, each contract should project as being profitable or it should be dropped. Be careful not to rationalize taking a lower margin in exchange for some nebulous other potential business. It never materializes. No need to be a hero for a day by offering a less-than-optimal price to win the contract and live with a loser for the length of the deal.
Here are some suggestions to incorporate into your private-label pricing strategy.
The product and its components should be defined in detail as to usage and price. These items need to be validated along with wording that the contracted price will change if the components change. As part of the contract, the cost of production needs to be estimated. This is normally based on the customer’s volume forecast. If that volume forecast is incorrect (outside some agreed-upon range), the price of production should be changed. My experience has shown volume forecasts are normally overly optimistic. Incorporate a minimum volume requirement before considering bidding on a new private-label part.
Adding a new private-label part to your existing stockkeeping units will not only add that part, but all the unique component parts that make it up, which can add complexity to your purchasing and production processes. Make certain your company has the proper resources in place to handle the additional complexity.
Over time the cost of the product will normally increase. If you did not incorporate an objective periodic price change mechanism, such as a cost of living factor, your original margin will get smaller.
The final step in the strategy is the eventual ending of the contract. Normally some of the component parts are unique to the finished part, so there must be a definition in the contract agreement as to who will pay for the remaining inventory when the contract ends.
The sales team and the customer may place unreasonable due dates for the new private-label product pricing bid. That may be a tactic to rush the process before all the facts are in and an optimal price determined. The strategic group should never feel compelled to produce a bid price without all the facts.
Sales can introduce potential private-label opportunities, but it should be left to the strategic pricing group to determine the price. That group should include members from the purchasing, production, and finance teams, along with a legal person to review the contract. This group should meet on a periodic basis to monitor the progress of all private-label parts, with the understanding to improve the process where possible and to take any lessons learned to the next opportunity. The group should also assess the overall blend of their branded products and private-label parts to make sure it has the optimal mix to drive bottom-line growth.
If you do not have a private-label strategy in place, you run the risk of an overall deteriorating company margin while adding undo complexity to your operation.
Timothy P. Dinan, CPA, ABV, CGMA, is vice president of finance of Berks Packing Company Inc. in Reading and a member of the
Pennsylvania CPA Journal Editorial Board. He can be reached at firstname.lastname@example.org.