Over the past three years, the distribution sector has navigated a dynamic market landscape characterized by both challenges and opportunities. It has grappled with supply chain constraints, high labor costs, and the ongoing threat of disintermediation. Despite these headwinds, industry leaders have been able to rebound, achieving 16 percent revenue growth post-COVID-19. But the tides are shifting again. The current market landscape poses new challenges, including economic uncertainty, interest rate moves, and the stabilization of supply chains. These trends are making it increasingly difficult to safeguard hard-won profit margins and unit volume growth.
Fortunately, a robust private-label offering can be used as a powerful tool to address margin and volume challenges. In many industries, private-label products can carry about two times the gross margin that national brands can. Moreover, according to a recent McKinsey survey of B2B procurement leaders, about 92 percent of buyers say they plan to purchase private-label or distributor-branded products in the coming year and expect to increase their private-label purchase volume by approximately 21 percent over the next one to three years.
Winning in private labels can be a critical factor in remaining competitive in an ever-shifting industry and is strongly correlated with improvements in gross margins.
Benefits of a robust private-label program
Building an industry-leading private-label program can have a positive impact across many aspects of distributors, which could manifest in the following ways:
- Expanding profit margins. In addition to higher margins for “like-item SKUs,” leaders in private-label products are now creating and offering premium products and services that elevate the category and enjoy premium margins.
- Increasing growth (volume and sales). Beyond offering customers savings (for example, “switch and save”), distributors can use their direct customer insights and data to create innovative products and services. These products can attract new customers and increase loyalty and purchase volumes (for instance, labor-saving products that create an increased value proposition for the customer).
- Enabling greater supply chain control. Distributors that control their supply chain can make optimized decisions for their businesses, including fill rates, changes in shipping modes, prioritization of orders, and inventory and cost trade-offs.
Prioritizing the voice of the customer
Battered by the recent pandemic and high inflation, customers have become more cost-conscious and are more willing to buy private-label products. Many customers are looking for private-label brands with quality similar to that of national brands at a lower cost (Exhibit 1).
Building a winning private-label strategy
Establishing and accelerating the market penetration of a private-label brand involves four major pillars: (1) defining an assortment strategy, (2) designing a go-to-market (GTM) strategy, (3) optimizing sourcing and a design-to-value approach, and (4) developing an organization and operating model (Exhibit 2). The foundation of all four pillars is a strong understanding of customer needs.
1. Define the assortment strategy
The best assortment strategies are developed based on: (1) the voice of the customer, (2) the attributes of the product category, and (3) the presence of national brands in that category. Distributors should target private label for categories where they have a “right to win” based on customer value creation and carefully consider their options. (For more information, see sidebar “Questions to ask when developing an assortment strategy.”)
While brand awareness is important, focusing on product attributes and their value proposition to the customer can be essential to outcompeting in a category and inducing conversion. For example, a major, multinational healthcare distributor offered private-label products in several geographies without conveying a clear and consistent value proposition to customers. The products’ market share differed in each area because the distributor lacked a consistent, cross-geography strategy that would allow it to prevail in its markets. The organization needed to listen to the voice of the customer to understand why the brand’s performance was so varied.
The situation turned around when the distributor strengthened its private-label brand with a convincing value proposition and used local markets’ feedback to expand its portfolio of product categories. The distributor is now on a path to increase its private-label sales penetration by 15 percentage points.
2. Define an end-to-end GTM strategy
Having a robust GTM strategy can be critical to enabling private-label growth. Distributors need to have the right targets (customers and SKUs) with the right pricing and incentives, supported by the value proposition and materials, at the right time. And with the right sales enablement, they can accelerate growth.
Pricing is critical, as 76 percent of the B2B customers surveyed said that they selected private-label products because they were less expensive. Best-in-class distributors price their assortment by closely comparing the attributes and features of national-brand products in their category. Distributors need precise policies and processes for setting pricing and discount structures, assessing other products’ pricing behavior, and analyzing historical pricing data to optimize gross margin.
Many successful distributors also use customer segmentation to design their GTM strategies. A major food distributor, for example, created a holistic, customer-centric approach using customer segmentation to ensure sales effectiveness. The distributor surveyed customers at each category level to understand their primary buying factors and then applied the resulting analytics to enrich product descriptions and identify the customers who were most likely to convert to private labels.
The distributor then used multiple private-label brands and tiers to create ethnically inspired and cuisine-based private-label products. It sourced new packing and pricing agreements for each category and partnered with suppliers to offer customer-specific benefits such as discounts and sample kits. In the end, the distributor increased its private-label penetration by approximately 5 percent over five years, driving up margins in multiple categories. (For additional tips, see sidebar “Questions to ask when defining a go-to-market strategy.”)
3. Optimize sourcing and design-to-value (DTV)
Optimized sourcing and product design can be essential to competing successfully and saving costs—for both distributors and their customers especially in private labels. Best-in-class distributors execute sourcing strategies across businesses and integrate suppliers into product development goals. The best private label–focused distribution companies operate with an OEM mindset by building out full capabilities for their private-label businesses. These capabilities may include identifying global suppliers, fact-based negotiations, establishing robust supply chain analytics, planning inventory, and quality control.
A Fortune 100 healthcare distributor experienced declining margins because suppliers were passing on cost increases. It decided to overhaul its sourcing approach and used it as an opportunity to reset its private-label sourcing strategy. The distributor’s sourcing team used underlying commodity data, information on suppliers’ performance, and industry knowledge to systematically prioritize product categories for renegotiation. For the top ten categories, the team created a detailed fact base on the expected cost for each product, the changes to underlying commodity values since previous negotiations, and the availability of other suppliers in the industry. The distributor then sent out an RFP that culminated in fact-based negotiations with both incumbent and new suppliers. The team’s efforts decreased acquisition costs from incumbent suppliers by 5–10 percent and provided the opportunity to cut costs even further—by 15–30 percent—by switching to new suppliers across the distributor’s brands.
![The coming shakeout in industrial distribution](/~/media/mckinsey/industries/advanced electronics/our insights/the coming shakeout in industrial distribution/the-coming-shakeout-1536x1536-5050-600.jpg?cq=50&mh=145&car=16:9&cpy=Center)
In formulating their sourcing strategies, distributors should consider how they can use preexisting relationships, contracts, and processes. For example, a distributor could partner with an incumbent supplier to establish a private-label brand and build products using a design-to-value strategy, or they could simply work with a supplier to create sample kits for testing. When choosing new suppliers for sourcing, distributors should ensure that the supplier can meet both customers’ and the distributor’s expectations for quality and timelines.
4. Building a strong organization and operating model for private-label brands
Best-in-class distributors with high private-label penetration have a dedicated leader: a general manager who strives to optimize profit and loss (P&L) and has a mandate to work cross-functionally and propel private-label growth. These distributors also have good governance mechanisms and track performance to help achieve financial goals, optimize resource allocation, and identify opportunities and challenges that need intervention.
One leading industrial distributor with a private-label penetration of less than 10 percent wanted to increase its private-label sales. However, ownership of private-label brands was dispersed among business units, creating challenges with cross-selling, supply chain optimization, and communication. The company decided to reshape its private-label business by creating a general-manager role to lead the private-label brands, centralizing dispersed private-label team members, and building out a robust support team. As a result, the distributor increased its private-label sales by over 2 percent while increasing gross margins from 35 to over 40 percent within 24 months.
Making it happen
In a challenging market with competing priorities, private-label branding offers a rare opportunity to propel sustained, profitable growth and boost customer satisfaction and retention. Pursuing private-label success requires just a few important steps:
- Set the goal and ambition. Best-in-class private-label organizations can achieve average penetration of more than 35 percent in some segments. Some categories will be “whales” that yield substantial sales, while others may win a smaller share. Regardless of size, the broader organization must treat its private-label business as a world-class competitive advantage. This mindset must come from the top and permeate the entire commercial organization, including merchandising, sourcing and inventory, and the C-level team.
- Devise a customer-centric strategy. Understanding the target audience’s needs and motivations should shape a distributor’s approach and value. Using customer research and insights, purchasing data, and product testing is critical to formulating core value propositions by category and product.
- Prepare and inspire the sales organization. Ensure that the sales organization has the right incentives, training, targets, and support to be successful. Confirm that the sales organization has a clear understanding of the positive impact private-label products have on their customers (for example, saving money, improving quality, improving supply) and their compensation (for example, higher commissions for conversion, no negative impacts).
- Align the organization. Ensure there is clear alignment and joint incentives across the entire organization (commercial, operational, sourcing, etcetera) so that it is committed to improving private-label success.
- Shift to an OEM mindset. Having an OEM mindset means creating unique, high-quality product offerings that are distinct and differentiated. When a distributor “owns” all elements of the value chain, it is also accountable for any weak or broken links in the chain. Establishing an ownership mindset up front will help the distributor develop strong relationships with suppliers and manufacturers and hold the private label to high standards that meet customers’ needs.
- Apply digital and analytical capabilities. Technology enables private-label distributors to track sales, inventory, and customer behavior to gain insight on what is and is not working within their businesses. By applying customer segmentation, a distributor can tailor product development, pricing, and marketing decisions against tested outcomes, and it can analyze potential product offerings before investing in them.
The power of private-label products lies in control. Distributors can mold their offerings to customers’ needs and desires from start to finish—a capability that is not available in the traditional distribution business. By defining a clear, bold objective and deploying the right team and customer-centric strategy, a private-label business can enjoy both low costs and high margins and set a steady course for success in an often unpredictable marketplace.