Hansson Private Label Expansion: NPV Analysis & Strategy

Introduction

Hansson is faced with the decision of whether or not to pursue a $50 million expansion. The decision is risky: it concentrates the firm's business with a single major customer, and that customer is only willing to sign a three-year guaranteed contract. Hansson has built a successful business as a supplier of private-label personal care products. This decision will have a significant impact on the firm, not just in terms of finances but also in terms of the firm's broader strategy. While many other firms in private label manufacturing had enjoyed significant success by tying their operations to a single retailer, this move was unusual for Hansson at the time. This analysis reviews Hansson's strategic position within the industry and calculates the net present value of the proposed project, before offering a recommendation on the course of action Hansson should take.

Background and Strategic Position

The personal care market is worth an estimated $21.6 billion and is a mature industry with annual growth of less than 1%. In mature industries, firms typically compete intensely for market share. Private label products generally compete using a cost leadership strategy. Within this market, private label holds a steady share of 21.3%, up from 21.0% two years prior. This sluggish growth is mirrored in private label's dollar share of the industry, which stands at 16.1%, or approximately $3.48 billion.

Hansson's annual revenues have been growing at a faster pace than the industry overall. The company's growth rate was 7% in 2007, 8.3% in 2006, 8% in 2005, and 8% in 2004. While the exact markup charged by retailers would need to be known to calculate precise market share, the firm's current revenues represent approximately 19.5% of the industry's retail revenues, suggesting that Hansson probably holds a total private label market share in the 30–40% range.

For Hansson, the strongest growth comes from drug stores and mass merchants. Companies such as CVS, Walgreens, Walmart, and Target are dominant firms with strong bargaining power over their suppliers. They are also growing concerns that are increasing their market share over time. The second-largest customer group — club stores such as Costco — has similar characteristics. Mass merchants currently hold a 39.35% share of Hansson's business, compared with 33.6% in 2003. Drug stores account for 11.7%, compared with 10.9% in 2003.

Private label goods represent a compelling investment for retailers. From the retailers' perspective, private label products offer an opportunity to lower their cost of goods sold while simultaneously offering consumers lower prices than branded alternatives. Given that most of Hansson's major customers compete on the basis of cost leadership, private label products have particular appeal because the retailer gains greater control over the value chain. This allows the retailer to offer the product at a lower price while also earning more profit per unit. Retailers therefore have a significant financial incentive to push private label products.

In the past, consumer acceptance was a constraint on private label growth, but that constraint has largely eroded: 99.9% of consumers purchased a private label product in the past year. However, with respect to personal care products specifically, there has been minimal growth in private label market share. So while retailers have a strong incentive to push private label products, they have not demonstrated much success in recent years in expanding that share, and the formerly powerful consumer-acceptance constraint has already been removed. This raises the question of how much additional room for growth remains in private label personal care products. For Hansson, meaningful growth will therefore come from only two sources: dollar increases in price, and expansion by its retail partners. If Hansson's partners grow, Hansson's volumes will grow with them.

Currently, Hansson is nearing its production capacity. The proposed investment would not only allow it to serve the needs of this major customer, but would also allow Hansson to meet growth demands from its other customers. Some degree of expansion is probably necessary regardless, given the company's steady growth rate of approximately 8% annually. The decision would allow Hansson to strengthen its position within the private label industry. While it would increase dependence on a single customer in the short term, the expansion may also give Hansson the opportunity to increase its bargaining power with other customers, as it would be less dependent on any single account. In an intensely competitive, low-growth environment, Hansson should consider the value of building out its market share and economies of scale, particularly as it pertains to dealing with its large and powerful retail partners.