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At Ease, Private!

Private labeling offers an end to all the woes of dealing with retailers.
April 1, 2002
URL: http://www.entrepreneur.com/article/49954

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.

Striking the Deal

To find the right company to work with, Levin started by collecting the names of the vendors that sold the products in drug store nail departments, mass merchandisers like Kmart and nail salons. He then contacted the president of each company. "I found quickly that I always got the best response from the president, even if I had to contact him or her repeatedly," Levin says. Sometimes he was shuffled off to someone else in the company, but that person was, according to Levin, "always more receptive when I was referred by the president."

Private label deals don't have standard terms. In Levin's case, he provides his product to his customers, who then package and sell the product themselves--with Levin receiving a percentage of each sale. Other private label sellers get a fixed price.

The goal of any private label agreement is for both parties to make money. Typically, companies marketing private label products have a 25 to 30 percent cost markup (see "M&Ms"), and if retailers are involved, they will mark the product up another 50 to 100 percent. The kinds of products most likely to succeed at private labeling are therefore those that feature a sizeable percentage difference between what they cost to produce and what they end up selling for. One unit of Levin's nail-repair product, for instance, costs less than 20 cents to make and is eventually sold for $2 to $3.

The other big concern in private label sales is exclusivity. Inventors don't want any exclusive contracts that would prevent them from selling either to other private label customers or directly to consumers on their own. But often, the private label customer wants an exclusive deal in order to avoid competition. Most inventors agree to an exclusive contract only when the private label customer agrees to a minimum (usually a high minimum) yearly purchase that makes it worthwhile for the inventor to go with just one customer. Levin doesn't have an exclusive agreement, and he is free to sell the product himself or to other private label customers. He has had two other private label customers over the years, but they didn't keep selling the product. Levin is also free to try to market the nail-repair kit on his own. He has chosen not to do so because his experience has been that retailers aren't receptive to one-line companies. But he's working on expanding his product line so that one day he might be in a position to sell his own product line under his company's own name.

Going Private?

Private label sales are a great option when you run into market obstacles. But they're also an ideal choice if you'd prefer your product be a part-time venture, or if you can't properly fund the product yourself. A part-time effort works well with private label sales because you have just a handful of customers who purchase your product. Your customer takes care of distribution, marketing and invoicing--and, as a result, the only role for you to play is providing the product.

If you lack funding, you can use a private label sales agreement to get a manufacturer to make the product for you without an upfront investment on your part. Or you may be able to persuade a manufacturer to wait for payment until the private label customer pays you. With a deal like that, you can sell your product with virtually no investment.

Despite the drawbacks to private label sales--lower profits and less control over how the product is sold--these agreements offer many advantages, especially for those who lack the experience, funding or time to market their products. Private label sales are an option worth investigating for every new product.

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Don Debelak is a new-business marketing consultant and author of Think Big: Make Millions From Your Ideas.

Contact Source

Custom Solutions Inc.
(925) 837-4324