How Target’s Private-Label Push Could Backfire

Target (NYSE: TGT) has launched more than a dozen exclusive brands since the beginning of 2017 as part of its strategy to differentiate itself from other retailers. That includes various apparel brands like Wild Fable, JoyLab, and Universal Thread, as well as brands focused on electronic accessories and home products.

On top of helping Target stand out, private-label products typically carry higher gross margins than national brands. Shifting sales toward private-label merchandise can help boost margins, which is especially important for a mass retailer like Target that typically manages operating margins in the mid single digits.

But it’s a balancing act. Pushing exclusive brands too hard, and displacing national brands in the process, can drive customers away. Target’s strategy, if taken too far, could backfire.

Image source: Target.

Good intentions, bad results

Target isn’t the first retailer to bet on private-label brands to boost sales. Department store Kohl’s (NYSE: KSS) ran into some big problems a few years back after spending a decade increasing its assortment of exclusive merchandise. Kohl’s generated 52% of its sales from private-label products by mid-2014, up from just 30% in 2005.

It was too much of a good thing for Kohl’s. Every new private-label product meant a national-brand product got pushed aside. Well-known national brands help get customers in the door, and if shoppers can’t find what they’re looking for, they may go to a different retailer. Kevin Mansell, Kohl’s CEO at the time, admitted to Fortune that the retailer had “slipped with consumers in the perception of Kohl’s as a place to get great national brands.”

Kohl’s has been rectifying the situation by shifting back toward national brands. Just 42% of sales came from private-label products in 2017, down about 10 percentage points in a few years. The company’s results finally started to improve last year, with both revenue and earnings growing. The newfound focus on national brands helped the cause.

J.C. Penney (NYSE: JCP) also jumped on the private-label bandwagon. The company announced plans to boost its private-label penetration as high as 70% in 2016. Despite management shuffles and terrible results since then, the strategy hasn’t changed. In J.C. Penney’s annual report in March, the company stated that its first priority is growing private-brand penetration to improve profitability. It hasn’t helped so far — the company posted a massive net loss in the second quarter of this year and slashed its earnings guidance for the full year.

Time will tell

As Target continues to roll out new exclusive brands, the company needs to make sure that it’s not being too aggressive in displacing national brands in its stores. That’s not an issue online, where selection isn’t limited by four walls. But Target’s e-commerce business remains small relative to its stores.

Target has already made one fairly bold move, ending a successful partnership with Hanesbrands (NYSE: HBI). For more than a decade, Target has been selling exclusive C9 by Champion athletic wear. The retailer will stop carrying that brand when the contract ends at the beginning of 2020. Most likely, Target will replace those products with new private-label athletic wear.

The C9 by Champion line generated $380 million of revenue for Hanesbrands over the past 12 months, so Target’s move is a bit of a gamble. Customers who have embraced the brand may end up shopping elsewhere, especially if Hanesbrands resurrects C9 at a different retailer or if Target’s private-label replacement falls short.

Target isn’t as dependent on apparel as department stores like Kohl’s, so the risk of going too far with private-label clothing isn’t as acute. Target generated about 20% of its sales in 2017 from apparel and accessories. For Kohl’s, the women’s apparel business alone accounted for 30% of revenue, with an additional 20% coming from the men’s business, 13% from the children’s business, 9% from accessories, and 9% from footwear.

Even so, Target could run into problems if its new exclusive brands underperform the national brands they’re displacing. The strategy appears to be a success so far, with store traffic surging and with three brands already on pace to reach $1 billion of annual sales. But only time will tell whether Target’s private-label strategy pays off in the long run.

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Timothy Green owns shares of Hanesbrands. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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