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Department stores play defense against Amazon

For retailers, selling the latest Samsung television or pair of Nike sneakers is no longer the advantage it once was.

Instead, as the internet's omnipotence has made it effortless for consumers to price shop, the same national brands that can generate major traffic for a retailer can also be a liability.

Kolh's Sonoma store.
Source: Koh's
Kolh's Sonoma store.

Because of price-matching policies at many traditional retailers — put in place to avoid losing sales to competitors — peddling popular national brands can likewise whittle away at their margins. Even when these policies are not in place, retailers can nonetheless be strong-armed into lowering prices on these types of labels.

As such, department stores are taking things into their own hands. By ramping up their focus on private-label brands, which are designed by an in-house team, and bringing in established brands that are exclusive to their stores, these retailers are curating unique assortments that can't be found — or sold for less — anywhere else.

These products serve a dual purpose in that they allow retailers to pocket a higher margin of their sale. And as Amazon elbows its way further into private-label offerings, their importance is only rising.

At J.C. Penney, CEO Marvin Ellison has made in-house brands a big part of his push to bring the department store back to its historical levels of profitability. That includes the launch of its first-ever plus size fashion brand, Boutique+, announced Tuesday.

Likewise, following efforts to strengthen its portfolio of national brands, Kohl's last month relaunched its billion-dollar Sonoma label. Even Nordstrom, a store better known for its pricey high-fashion labels, has identified an opportunity to grow its in-house brands.

"It's not unimaginable that in a few years… that commodity product purchases will start gravitating toward companies like Amazon, and perhaps Wal-Mart and Target," said Guru Hariharan, CEO of Boomerang Commerce. "[That's] where private label comes in."

Making the problem the solution

The shift toward private label was borne out of the internet, through which shoppers can quickly identify the store that's selling name-brand merchandise at the lowest price. The rise of Amazon, which now has more than 30 million apparel items for sale, has only exacerbated the problem. That's because the online retail giant has such strong vendor relationships that it's able to negotiate the best prices, and pass those savings along to consumers, Hariharan said.

But while the web created headwinds for retailers, it's also been part of the solution.

"The ability to go online and read ratings and reviews helps a customer feel better about their purchase," John Tighe, executive vice president and chief merchant for J.C. Penney, told CNBC. "Customers are more open to expanding their brand choice than they used to be."

Penney's private-label strategy dates all the way back to 1914, with a men's hat line that started under the leadership of James Cash Penney. Its in-house goods eventually grew to roughly 50 percent of the company's business, until the Ron Johnson regime downplayed their importance to the retailer's core customer — slashing their sales penetration and profitability in the process. Now under Ellison's leadership, the department store has restored its private-label business near its historical norms, and has plans to accelerate both its penetration and profitability.

Though Penney's renewed emphasis on private-label goods has already helped boost its profitability (they've contributed to a gross margin lift of 6.6 percentage points over the past three years), Tighe said there's further opportunity to more efficiently design and source the goods. The retailer is also pumping up these brands through its newly coined "Penney Days," a campaign through which shoppers can purchase merchandise from its Arizona or other in-house labels for only a penny.

"It's differentiated product [and] it offers great value," Tighe said. "We think it gives us a great position in the marketplace to control our destiny."

Fellow low-price department store Kohl's is likewise using its 20 private and exclusive labels — three of which generate more than $1 billion annually — to differentiate itself from the competition. After putting its national brands under the microscope, and growing its Nike business to $800 million, the retailer recently shifted its attention to the "crown jewel" of its private brands: Sonoma.

Source: Boomerang Commerce

After bringing all the Sonoma merchandise into one room — spanning women's, men's and home goods — Kohl's chief merchandising and customer officer Michelle Gass admitted the product had diverged a bit. So as part of its March relaunch, the retailer made sure the brand felt consistent across categories.

Kohl's sales mix skews 52 percent toward national brands — which it has said helps it attract new customers — and 48 percent toward private label.

"Having fantastic national brands has always been part of the DNA of Kohl's," Gass told CNBC. "What I get equally passionate about is the ability for us to create and bring to the customer our brands."

Even upscale department store Nordstrom has identified private label as an opportunity to expand its assortment in men's, women's and other categories. However, it's taking a decidedly organic approach. Instead of delegating a certain percentage of its product to in-house brands, Nordstrom makes its 60 exclusive labels — which account for roughly 10 percent of its sales — compete for space on the selling floor.

"There's not an explicit carve out… that is an entitlement for that group," co-president Pete Nordstrom told CNBC. "It makes it a customer-first proposition… if it performs well, it grows."

Different consumer, different rewards

One reason private-label brands have sparked the interest of major retailers is that consumers no longer make a big distinction between private and national brands, Pete Nordstrom said.

"Younger customers tend to have less brand loyalty. They buy what they like," he said. "If it looks good, they're going to buy it if it seems like a good value."

He added private-label offerings can also serve as an entry point for consumers who may not have $300 to shell out on a designer dress.

In-house brands also give more power to the retailers. On Kohl's latest earnings call, CEO Kevin Mansell said the brands created inside its organization allow the company to bring in fresh product more quickly.

Perhaps most importantly, they allow retailers to fend off price competition, and pocket a larger chunk of their sales. According to Hariharan, the cost of a branded HDMI cable costs a retailer roughly $6. They can then sell that item for about $10, netting them $4. However, if they produce the cable on their own, it costs roughly $1.50 or $2. Even if they sell that product for less, say $8, they're nonetheless recording and additional $2 to $2.50 in gross profits.

"That's a big deal in retail," he said.

These types of opportunities have led some 90 percent of the more than 100 retailers Hariharan has met with to ask about private label. Yet he cautioned that there are risks involved — namely, the amount of investment required to make it a success. For a 200-person design team, headcount and management costs alone can reach $40 million annually. And if an executive were to make the wrong decision about where to produce goods, it could end up costing 10 times more.

"Organizations right now are not necessarily set up for private label," he said.