At Ease, Private!

Private labeling offers an end to all the woes of dealing with retailers.

Private labeling wasn't part of Michael Levin's initial game plan. The idea for his innovation, a clear plastic overlay for broken fingernails that adheres with a nail-friendly adhesive, first struck Levin back in 1989, when his then-girlfriend cracked a nail. At the time, she couldn't find a product to repair the nail-and she complained to Levin that cracked nails were a common problem among all women. Levin, sensing an opportunity, decided to hire a market research firm to evaluate the market. The results were staggering. Levin, now 42, reports that "60 percent of the women [surveyed] broke a nail once a month, and 35 percent broke a nail once a week."

Levin perfected his clear plastic overlay design in 1992, after searching for and experimenting with dozens of plastics and adhesives. But when Levin tried selling the product directly to retailers, he was in for quite a reality check. With the product retailing for just $3 to $4, Levin found that "drug store chains weren't willing to add a low-priced, low-volume item from a one-product vendor."

That's when Levin considered all his options and decided to private label. "Lots of nickels are better than a few dimes," Levin reasons. The most consistent of the three private label customers he's worked with, Professional Solutions, signed on in 1994 and has since sold Levin's product under the name Instant Nail Repair. The decision proved to be a smart one for Levin: Since 1995, his Danville, California, company, Custom Solutions, has been selling about 1.5 million units of the instant nail-repair product per year.

Making the Choice

Is private labeling right for you? Before making any final decisions, consider the following pros and cons:

Pro: You have very low sales and administrative expenses.

Pro: The risks are lower because you don't have to invest heavily in a product with uncertain sales potential.

Pro: You get an established sales force and distribution system.

Pro: You get better upfront input about how your product can be improved to increase sales.

Con: If you lose a private label customer, it will have a dramatic impact on your business.

Con: You have no control over how the private label partner sells your product. Says Levin, "One private label agreement we had was with a company that put too much of the product in each set and sold it in mass merchandisers for $5. We told the company the price was too high, but they went ahead with their plan. Sales didn't materialize, and the company then cancelled the agreement."

Con: You can't make the company promote your product. According to Levin, "We could have dramatically higher sales if our customers would spend more money letting people know the product is available."

Despite the disadvantages, Levin feels that private labeling still turned out to be the best choice for his product: "I just don't see any other way that we would have been able to get by the resistance of stores to carry a cheap, relatively low-volume product from a one-product supplier."

M&Ms
"Margin" and "markup" are important to any private label agreement negotiation, yet understanding the difference between the two sometimes confuses inventors.

Margin usually refers to gross margin, which is the percentage of profit a company makes on a sale before expenses. For example, consider a company that sells a product for $100, with the cost of goods sold, including acquisition and/or manufacturing costs, totaling $70. The profit per sale is then calculated as $30 ($100 - $70). Margin is equal to the profit per sale divided by the total sale, or $30 divided by $100, or 30 percent.

Markup is the percentage a company raises the price of a product. For example, if a company has a 50 percent markup and it buys a product for $100, it will then mark it up 50 percent, or $50, and sell the product for $150.

Companies that private label will use either a markup or margin approach when determining how to price your product. Knowing the approach they use helps you figure out how much the company will sell your product for.

To find out which approach your customer uses, simply ask the company if it bases pricing on markup or margins, then ask what markup or margin percentage is used to determine pricing. If you feel the price is too high for your product to sell well, you might want to look for another private label customer.

A markup approach is easier to figure out, as the company simply takes your price and adds a certain percentage. A company using a margin approach, on the other hand, will take your price and divide by 1 minus the margin to determine the price. For example, if your price is $1, and the private label customer wants a 30 percent margin, the company will use this formula to determine a minimum price of $1.43: 1/(1-0.3) = 1/0.7 = $1.43.

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This article was originally published in the April 2002 print edition of Entrepreneur with the headline: At Ease, Private!.

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