Retail: Exclusive and Private Labels

I'm sort of new to the concept, but private label products are brands that are owned by retailers that are often produced by third parties at very low prices. Exclusive brands are brands licensed by a retailer for exclusive sale within their stores. I had always knows Sears to be very big on private label brands for differentiating itself. Kenimore, Craftsmen, Diehard, Land End are some of Sear's more famous brands. Apparently, though, the trend to create in house labels has increased dramatically.

In a previous entry about Steve & Barry I posed the question of whether Wal-mart has its own private clothing labels. As should have been obvious, Walmart has no shortage of its own brands. Subjectively speaking, some of their brand names are bizarrely unappealing sounding. For example, there is a mens fashion line named "Puritan," a women's beauty product line named "Simply Basic," and a clothing line named "Faded Glory."

Walmart's Equate brand of generic drugs have rather interestingly entered the news for insanely cheap prices on commonly used drugs no longer protected by patents.

In any event, as the WSJ article below states, there are indeed some risks associated with having in-house brands - namely inventory risks as well as risks associated with possible "minimum guaranteed royalties."

Exclusive Lines May Prove Risky In Cool Economy

By VANESSA O'CONNELL and CHERYL LU-LIEN TAN
April 11, 2008; Page B1

(See Corrections & Amplifications item below.)

With sales falling dramatically, one looming question for big department-store chains is whether their recent push into in-house labels and designer lines made exclusively for them will come back to haunt them.

In good times, such products help retailers differentiate themselves from competitors, while generally producing higher profit margins than national brands. That's why department stores have poured millions of dollars into exclusive lines of clothes and home goods, such as the new American Living line at J.C. Penney Co., Simply Vera Vera Wang at Kohl's Corp., and Martha Stewart Collection at Macy's Inc. Some of these are the result of licensing deals with designers, while others are labels produced in-house.

Kohl's relies heavily on exclusive lines, like the in-house label Elle.

But with sales declining -- department stores' March same-store sales reported Thursday were the weakest in the retail sector, dropping 11.4% from the previous year -- that equation could change. If the retailers are forced to sharply mark down their exclusive goods, that could hurt the image of both the brand and the store.

What's more, retailers can't share the pain with suppliers, as they do with national brands that offer allowances for markdowns, meaning retailer profits will suffer. And, retailers often commit to large minimum orders to get the best prices on their in-house products -- and can wind up with far more inventory than they need.

"This vehicle for improved profitability is a double edged sword when sales are weak," says Bill Dreher, an analyst with Deutsche Bank Securities.

While department stores say they haven't yet had to make widespread markdowns on in-house labels or exclusive brands, analysts see these goods -- which stores have ramped up dramatically in recent years -- as a vulnerable spot if the economy continues to worsen. "The indication is that the customer is not shopping, so you may have across-the-board markdowns," including in private label goods, says Linda Beauchamp, CEO of Beauchamp Vision in Commerce, a retail consulting firm.

The higher margins in some private-label programs, which might have provided a cushion for retailers' markdowns, now are coming under pressure as retailers grapple with higher sourcing costs in China and elsewhere.

In licensing exclusive brands, retailers often must agree to pay minimum royalties to the designers or celebrities the brands are named for, regardless of sales. Sears Holdings Corp.'s struggling Kmart unit paid $65 million in minimum guaranteed royalties to Martha Stewart Living Omnimedia last year, even though the Martha Stewart Everyday products it sells exclusively didn't meet sales targets. For 2008, its obligation is $20 million. Kmart declined to comment.

Similarly, Macy's agreed to minimum guarantees to Martha Stewart's company for the use of her name in its Martha Stewart Collection products, according to Martha Stewart's company, Macy's bears all the inventory risk if those products don't sell. Macy's declined to comment.

At Macy's, where private and exclusive brands account for 35% of sales, Chief Financial Officer Karen Hoguet acknowledged in a February conference call with analysts that "sales were disappointing in some of our private brands," though private brands in total still had outperformed other brands.

Macy's strategy has long been to develop big private brands such as Alfani and I.N.C to offer shoppers "differentiation and value," with profit margins that are "roughly equivalent to other brands," says spokesman Jim Sluzewski, who added that "we carefully plan our inventories, which remain in good shape."

Proponents of exclusive lines say house brands hold up better than national brands during economic downturns.

Kohl's -- which gets nearly 40% of its sales from these programs, double the amount 10 years ago -- says its lines including Simply Vera Vera Wang, Elle and Food Network all did well last year, and are "outperforming their planned sales even in a tough selling environment." Kohl's President Kevin Mansell acknowledged that the chain's exclusive arrangements require a commitment to minimum volumes but said they are "set just as a basement."

"Consumers are interested in newness, things that differentiate one store from another -- they want a reason to come to you versus somebody else," he said. "And generally, private and exclusive brands do offer better value." On Thursday, the chain cut its quarterly earnings forecast to 40 cents to 42 cents a share from 50 cents to 54 cents.

Penney, which gets 50% of its revenue from in-house labels and exclusive designer lines -- among them the American Living line of apparel and home goods produced by Polo Ralph Lauren Corp. and launched in February -- reported a 12.3% drop in March same-store sales.

Penney President Ken C. Hicks says the company's private-label arrangements allow it to be more nimble than it can be with national brands. Last fall Penney zeroed in on improving the flow of merchandise into its 1,073 stores, and it now places "discretionary orders" for 40% to 50% of its private-label and exclusive merchandise, meaning it reserves the right to cancel deliveries if an item isn't selling well, he says.

Dillard's Inc., too, has been expanding its stable of exclusive brands. Last year, 24.2% of its sales came from exclusive brands, up from 15.4% in 2001. Last month, it started another -- Pink Twill, a casual, contemporary women's line -- and plans to roll out more labels later this year.

In July, Penney will introduce Fabulosity, a juniors sportswear line designed by Kimora Lee Simmons and produced by Kellwood Co.'s Phat Fashions, in 630 stores. Bernt Ullman, president of Phat Fashions, acknowledged it could be a risky time to start an exclusive line.

"But it's significantly riskier to maintain the status quo -- that is a recipe to shrink your business," he said, adding, "We need to excite the shopper."

Write to Vanessa O'Connell at vanessa.o'connell@wsj.com and Cheryl Lu-Lien Tan at cheryl.tan@wsj.com

Corrections & Amplifications:

At Macy's Inc., where private and exclusive brands account for 35% of sales, Chief Financial Officer Karen Hoguet acknowledged in a February conference call with analysts that "sales were disappointing in some of our private brands," though private brands still had in total outperformed other brands. A version of this Marketplace article on private-label brands didn't include Ms. Hoguet's comment that private brands as a whole had outperformed other brands.