Over the past few weeks, our supply chain research team at Auburn University has been busy preparing the 2010 State of the Retail Supply Chain report. It’s our second annual investigation of the retail industry’s current supply chain issues, strategies, best practices, and future directions. The report will hit the street in a couple of weeks (visit www.retail-scm.com for a copy), but I wanted to discuss one of our most interesting findings.
As we interacted with more than 175 retail experts during the first half of 2010, we learned that a growing number of retailers are taking an active role in product development and manufacturing. These upstream activities are frequently being led by supply chain management (SCM) executives who now manage the production and distribution of certain product lines. “We’ve decided to really grow our presence in self-manufacturing and that really ties to own brand and own brand penetration,” noted one of the retail executives whose title is now Executive Vice President of Supply Chain Operations and Manufacturing.
We identified this internal manufacturing strategy as one of three best-in-class retail SCM capabilities for 2010. Expanding the scope of responsibility provides a dual benefit—cost reduction and supply chain control. Best-in-class retailers use internal manufacturing to drive cost out of the supply chain. Owning the production echelon eliminates supplier markups and leverages the retailer’s existing logistics network, minimizing inbound freight costs. Internal manufacturing also gives greater control over product flow and availability. This allows retailers to reduce safety stocks of self-manufactured products.
Most retailers begin with a foray into store-branded products. The private brand business has grown rapidly over the last five years, reports Brandweek. As customers’ perceptions of store brands and private label products have shifted from skepticism to acceptance, retailers have ramped up their efforts to provide a wider array of their own goods. Retailers largely rely on contract manufacturers for these products.
Perhaps the most aggressive retailer in this regard is Trader Joe’s, a 344-store chain with $8 billion in revenues. The grocer carries approximately 4,000 stock-keeping units (SKUs) in each store, 80 percent of which is sold under the Trader Joe's brand. The company relies upon major food manufacturers to produce many of Trader Joe's products, according to a recent Fortune magazine cover story on the retailer. The company also works with the contract manufacturers to streamline the supply chain. Product moves directly from factory to Trader Joe’s distribution centers (DCs), cutting the cost and delays of flowing products through distributors and wholesalers.
The benefit of this private label strategy is stunning. Trader Joe’s stores sell about $1,750 in merchandise per square foot. That’s more than double its primary competitor, according to the Fortune article.
The growing importance of private label and store brands is closely tied to internal manufacturing for many retailers. Self-manufactured store brand designs may be changed more easily and inexpensively. Also, as Trader Joe’s success reveals, store brand designs can be adjusted to ensure they provide distinct offerings not found in national brands.
By “insourcing” the production role, innovative retailers are expanding their sphere of supply chain control. Said one SCM executive, “We’re very focused on how we develop and bring to market differentiated products at a lower cost.”
Self-manufacturing is most prevalent in the grocery industry. The Kroger Co. owns 40 plants that produce 39 percent of its store brand bakery, dairy, meat, deli, and other private label items, notes the company’s 2009 Fact Book. The company performs a make-or-buy analysis of each branded product before deciding whether to self-manufacture or contract-manufacture the item. The goal is to lower production costs and pass savings along to customers. H-E-B and Publix also have extensive internal production capabilities, each operating more than a dozen manufacturing facilities.
Pioneering apparel retailers have also developed internal production capabilities. American Apparel has adopted a vertical integration approach to retailing. Its Los Angeles manufacturing operation supplies all the clothes it sells in its 280 retail stores. The company’s website states: “We believe that having manufacturing under the same roof as design, marketing, accounting, retail and distribution gives us the ability to quickly mobilize all departments, to respond directly to changes in the market, and to have complete visibility over our product - start to finish. An added bonus - this business model is inherently sustainable.”
Zara, one of the world’s fastest growing retailers, similarly operates a vertically integrated supply chain to serve its worldwide network of over 3,000 stores. The company handles strategic apparel manufacturing activities—cutting, dyeing, and finishing—in-house. Sewing is sub-contracted to companies located in countries near the Zara headquarters in Spain. The vertically integrated supply chain processes give Zara the opportunity to stock its stores with completely new products every three weeks.
Experts may argue that these upstream retailer activities are merely a response to bargain-hunting consumers who will switch loyalties to national and global brands as economic conditions improve. However, the retailers interviewed during our research aren’t planning to turn back. This attitude is exemplified by a senior SCM executive who stated: “We’ve quadrupled our self-manufacturing volume in a year and plan to continue to grow.”
For now, internal manufacturing is gaining traction. Will the strategy grow? Will it make retail supply chains more efficient and effective? Should traditional consumer product and apparel manufacturers be concerned about retailer competition? Let me know what you think.