Microsoft Escalates Vertical Integration Wars

The WSJ reported today that Microsoft has decided to enter the rapidly escalating battle over how the consumer electronics market space is being fundamentally restructured (Microsoft Seeks to Take a Bite Out of Apple With New Stores).

Unlike Gateway's anemic efforts at forward integration into retail (1997-2004), I anticipate Microsoft's moves, along with those of other leading players, will dramatically reshape the landscape. Those moves include Best Buy's backward integration in private label (see: In Hard Times, Is Best Buy’s Best Good Enough? ), Wal-Mart's and wireless service reseller Tracfone's entry into mass market electronics (see: Wal-Mart Wireless Expands), Samsung's designs on the content and apps end of digital retail (see: Samsung Seeks Some iPhone Magic ) and Amazon's rabid appetite to dominate the conventional 'click and buy' internet merchant space (see: Can Amazon Be the Wal-Mart of the Web?).

But back to Microsoft's forward integration into consumer electronics retailing: here's the bottom line perspective from the company:

"Our customers have told us they want more choice, more value and better service, and that's what we'll deliver through our Microsoft Stores" David Porter, corporate vice president . Microsoft retail stores, WSJ, 10/15/09

This is only the latest entry of another major player in what is shaping up to be a battle of the titans. Noisy dithering by wall street analysts, journalists, and other pundits over who's making the most aggressive price reductions, who's sourcing smartest, who's ramping up their M&A engines for greater scale and efficiency, and who's "getting the value message from consumer" is simply obscuring a more fundamental and ultimately dramatic business model restructuting hidden in plain sight.

So, buckle up - it's going to become a (much) bumpier ride competing in the consumer electronics space! (due credit to Bette)

Private Brand Supplier Comes Out

Along with investors, I’ve been watching Ralcorp Holdings closely since it bought Post Cereals from Kraft Foods in late 2007. Post was half as big as Ralcorp ($1 billion in sales versus $2 billion), making it a big gulp to swallow.

Sheer size is one challenge to integrating Post. The other, bigger challenge is in meshing the marketing and distribution.

Up to the acquisition, Ralcorp was a pure-play supplier of private label foods for Wal-Mart and other giant grocers’ house brands. Buying Post Foods changed that. Side by side with Ralcorp’s traditional behind-the scenes processing business, invisible to consumers, Post would be operating in full view with its own name prominently on the box.

Could Ralcorp manage both the PL and name-brand channel relationships at once? Could the executive team align the manufacturing and transactional sales culture which dominated Ralcorp with the marketing mindset inherited from Kraft ?

So far the evidence is encouraging, and more. Ralcorp’s stock has been rising at a time when most of its peers have been losing value. More important, the company’s most recent quarterly report credits Post with making an outsized contribution: $279 million out of $305 million of Ralcorp’s quarter-to-quarter incremental revenue growth.

During a severe recession when private labels have been transcendent, this kind of growth by a branded foods player is extraordinary. It’s clear Ralcorp made a good buy. And they’re obviously not botching it. What’ harder to know from the outside is whether they could be driving their powerful two-horse chariot even harder. Even with Post, Ralcorp is still a distant third in the cereals category to Kellogg’s and General Mills. And at the negotiating table it’s dwarfed by the big retailers. Given those externalities, you have to wonder if there aren’t still opportunities to structure distribution relationships for even faster growth and even higher profitability.

I’d bet there are. When I’ve worked with companies in similar situations, in-depth conversations with branded product managers and retail customers virtually always kick up an attractive mix of short- and long-term possibilities. We then design new programs to go after them. Some are modest, fast, and easy to realize. Others are larger but harder to structure. Either way, my hunch is there’s still plenty of upside left for Ralcorp to optimize its “PL + branded” channel system.

Is Private Label Taking on Water?

RetailWire reports that according to numbers from The Nielsen Company, sales of private label goods in food, drug and mass lost share year-over-year for the period ending April 18, 2009.

For retailers who were simply sourcing for higher gross margin, the picture is bleaker as they factor in all the costs of taking responsibility for a category, including innovation, quality and safety control, inventory, promotion, and logistics to name only a few. And what about the loss of vendor support funds? And national brands have been fighting fire with fire, " introducing value lines or lowering the cost of existing items to cut into the price advantage held by retailer brands".

Unless the retailer is as dedicated to private label as, say, a Trader Joe's, the strategy will often backfire. Of course, this begs the question: instead of getting revenge, wouldn't smart independent brand players use this opening as a chance to structure new relationships built on trust, system wide improvement, and win-win results?