Yesterday, I wrote about how Amazon is copying Sears’ roadmap from the late 1920s. In short, 100 years ago, the emergence of the automobile allowed Sears to reach new customers with the kind of scale necessary to displace its competitors. Replace “automobile” and “Sears” with “Internet” and “Amazon”, and you have the analogy.
One important takeaway is that while scale gets most of the press, it wasn’t scale alone that allowed Sears and Amazon to succeed. Both companies had tremendous success before they reached scale. In fact, that’s how they became as large as they did, through success accumulated over a decade or more before they made their large scale splash.
In my previous post, I used excerpts from Alfred Chandler’s Strategy and Structure to describe Sears’ move into the retail store space. In this post, I want to use another excerpt from Strategy and Structure. Let’s focus on one specific tactic that Sears employed…a move into private label products:
Beside providing a renewed interest in factory ownership, the emphasis on consumer durables led to much more “specification buying” or what came to be called “basic buying”. The merchandising departments began to design their own products, to determine the best location for production in relation to the market and supplies, and then to go to a manufacturer in the given area with these specifications and negotiate a contract. Specifications, as well as price, became the criteria for purchasing. In this way Sears increased its control over the function of coordinating the flow of product to include every step from the initial design of the product to its sale to the ultimate consumer.
Strategy and Structure was published in 1962. This story about Sears comes from an important inflection in their history, in the late 1920s. All of this is well before the Internet, well before anyone had any idea about Amazon or Walmart or any large scale retail endeavor. In this sense, Sears discovered a tactic that later fueled some of the world’s best-known companies.
Now, what do we mean by private label products? We mean products that a retailer releases under its own brand name. In the case of Sears, you have brands like Kenmore and Craftsman. In the case of Amazon, you have Happy Belly (for coffee) and Mama Bear (for baby food).
Why do retailers stand up their own brands? Why not just keep purchasing products from established manufacturers and selling these products via their storefront?
Chandler gets at the answer in the excerpt above. He called it “specification buying”. Sears identified products where people bought simply because of specifications. In other words, brand loyalty made little to no difference to buyers. The only thing that mattered was the ability of the product to perform in a certain way.
Why would Sears find these kinds of products attractive? Because they could contract with a manufacturer to make the products at scale, driving out as much cost as possible. Plus, Sears wouldn’t have any of the overhead cost that traditional manufacturers of these products have.
Take Black & Decker as an example. Black & Decker is a standalone manufacturer of power tools. It has its own finance department, human resources department, marketing department, et cetera.
If Sears wants to make power tools under the Craftsman name, it can contract with an existing manufacturer, and it can leverage its existing corporate functions. It spreads its fixed cost base across its whole business, where power tools is one small part.
In addition to cutting out cost, the retailer can capture the margin with a private label brand that would otherwise leave the company. Rather than paying some premium to Black & Decker to purchase its tools, Sears can make Craftsman tools at cost and retain whatever profit it captures via retail.
The private label game is all about volume. The margins are small. That’s the whole point. As a retailer, you target private label efforts at products where branding matters little, where customers only care about the product specifications. As a result, you don’t have a lot of margin to begin with.
But if you can operate at scale, you can capture meaningful margin dollars via a private label offering. You also reduce your supplier risk. It’s much easier to negotiate a favorable contract manufacturing agreement for a private label product than a whole purchasing agreement with a third party supplier. If, as a retailer, your suppliers can’t meet you at an acceptable price point, you can still offer your own private label products and satisfy customer demand.
My point with this discussion is that while Amazon’s business looks shiny and new from a technology perspective, it’s taking advantage of century old tactics. Sears perfected this game. Walmart iterated on it. Amazon is iterating further.
Amazon is in the very early innings of its private label game. I haven’t heard any indication of how much success they’re seeing. But it’s an age old move for retailers at scale. Amazon is adopting a century old best practice, as you’d expect a smart company to do. It reminds me of the well-known Picasso quote: “Good artists copy. Great artists steal.”