Private labels, by first principles, are the products manufactured by third party contract manufacturers for sale under a different brand name. Private labels come into play when the brand is having a huge distribution. For the brands, there are following benefits of private label:
Low Cost: Brands get it manufactured from third parties. Thus it is a low cost proposition in the sense that brands do not have to invest in Capex or huge working capital to get this going
High Visibility on shelf space: Since the brands own the shelf space, they give the preference to their own brand rather than other brands and thus bringing their own brand to the customer’s consideration set
Better Margins: Brands get it manufactured from third parties and directly sell it to their customers via retail channels without involving intermediaries like distributors, super stockists etc.
Think of DMart/Big Basket/Grofers. They are present in every category one can think of. However, there is one exception: Basmati Rice. Before we elaborate on reasons, we should understand the process of manufacturing Basmati Rice.
Basmati Rice Manufacturing
Basmati Rice involves certain stages of manufacturing before it is ready to be sold/consumed by end customers:
Harvesting which involves ripening the rice crop which takes 3 months
Drying which involves eradicating moisture by artificially drying
Hulling which involves loosening and removal of hull from crop
Milling which involves further removal of hull and polishing of crop
Enriching which involves replenishment of nutrients and vitamins in crop
Once the crop gets harvested, the entire onus of drying, hulling, milling and enriching lie towards the manufacturer of Basmati Rice.
Intensity of Working Capital for Inventories
With the manufacturing of Basmati Rice explained, let’s deep dive into the working capital requirement for these industries.
The crop is harvested once in Kharif cycle (June-July). Now the manufacturer has to undertake the entire crop in that cycle to process it further. This entails huge working capital requirements due to the following reasons:
Manufacturing of Basmati is a time consuming process
Manufacturer has to undertake entire crop in one go and hence requires huge working capital
The sale of end product would spread out entirely in the year and hence working capital cycle is large. Add to that receivable cycle and we would be looking at even larger working capital requirement
LT Foods, the maker of Daawat Basmati for example has close to 900cr of inventory and 300cr of receivables out of a total Asset base of 1700cr. That is nearly 178 days of inventory and 50 days of receivables in their cycle! 6 months worth of inventory is not what a lot of players are willing to hold, but what becomes an absolute necessity in the Basmati business.
The Basmati Immunity
Consider a scenario where the retailer needs to enter the Basmati Rice category. Here would be the entry barriers for such a retailer:
Contract manufacturers won’t be able to commit to manufacturing as they don’t want to take the additional burden of inventory
Even if they agree to supply the rice, they cannot be assured of huge demand from retailer since there is no guarantee that people will altogether leave DAAWAT/INDIA GATE and go for private labels
Now even if guarantee is secured for minimum volume, retailer would be burdened with huge inventories throughout their stores which would itself take a lot of time to liquidate
The ultimate crux of this argument is the private labels are strong in categories which can be manufactured in an instant and does not require a huge pile up of inventory by the retailer. However, if the manufacturing takes a lot of time, the private label retailers would not have an incentive to enter this category until they want to make it as a loss leader.