If you're reading this, you've probably also read that home goods retailer Bed Bath & Beyond (BBBY) is planning to launch eight new private-label brands in the current fiscal year, six of which are set to debut before Sept. 2021. With this launch, the company believes private-label revenue will grow from 10% of its top line to 30% over the course of the coming three years.

You may be asking yourself: So what? If Bed Bath & Beyond is struggling to draw people to its stores, what it sells inside them is irrelevant. But this private-label strategy is set to have a bigger impact on the company than most investors appreciate, particularly given the retailer's revitalization plans.

Woman browsing cookware in a home goods store.

Image source: Getty Images.

Private-label power

Private-label brands -- also referred to as owned brands -- are goods a retailer has designed for itself and directly arranged for the manufacture of (as opposed to buying them from a national brand on a wholesale basis). Some private-label brands you may be familiar with include Kroger's Simple Truth, Target's Cat & Jack, and Costco's Kirkland Signature.

Those brands have the look and feel of nationally-branded competitors, and that's the point. Retailers have gotten very good at packaging and promoting private-label goods.

An upside of a well-managed owned goods program is differentiation, and perhaps with a little luck, a particular private-label item may turn into a key profit center. Take Kroger's private labels as an example. They now generate more than $26 billion of its annual revenue, and its Simple Truth line is reportedly the country's leading brand of natural and organic foods. Once customers are in a Kroger store to purchase their preferred organic groceries, they're more likely to finish out their shopping list in the same place.

The biggest motivation for moving deeper into owned brand waters, however, is money. More specifically, private-label goods produce higher margins.

Crunching numbers

Take these numbers with a grain of salt, because they're only ballpark averages within a wide range of possibilities. But whereas the retail price of most non-food consumer goods is about twice the wholesale price, the markup on private-label merchandise is roughly three times the retailer's cost to procure it.

That doesn't mean retailers are regularly doubling their money on all the nationally-branded goods they sell or tripling their investment in owned brands. Most are forced to discount their inventory to compete. Target's gross margin on merchandise sales is typically in the 30% range, meaning $0.70 of every $1.00 it collects at its cash registers ultimately goes back to its vendors. Walmart's gross margin hovers around 25%, similar to Best Buy.

Bed Bath & Beyond's gross margin is typically better than 30%, and that's with owned brands only accounting for a tenth of the company's sales. If the home-goods retailer can ramp up its private-label sales to 30% of revenue, these higher-margin goods could feasibly improve gross margin to around 40% or more.

That doesn't sound like a big leap, but in the low-margin world of retailing, every penny counts. A small improvement in the difference between sales and inventory costs is actually a big deal.

Take Bed Bath & Beyond's results through the first three quarters of fiscal 2020 as an example. The company spent $4.32 billion on inventory it sold to customers for $6.61 billion, leaving behind $2.29 billion of gross profit. That's a gross margin of just under 35%. But were the retailer able to expand its gross margin rate to 40% of revenue -- by lowering its total cost of sales to $3.97 billion -- there would have been enough money left to keep Bed Bath & Beyond in the black even after its one-time charges like impairments and restructuring costs.

For the nine months ended
Nov. 28, 2020
Actual results
(34.7% gross margin)
Pro forma results
(40.0% gross margin)
Net sales  $6,613,887  $6,613,887
Cost of sales  $4,321,294  $3,968,332
SG&A expenses  $2,461,365  $2,461,365
Impairments $172,434  $172,434
Restructuring expenses  $47,648  $47,648
Loss (gain) on sale  ($75,619)  ($75,619)
Operating profit (loss)  ($313,235)  $39,727

Source: Bed Bath & Beyond Inc. fiscal 2020 Q3 report. All dollar figures are in thousands.

The same goes for the results from fiscal 2019, and for that matter, the most recent quarter. With a five percentage point improvement in gross margin, this company is reporting consistent operating profits.

The most expensive piece of the puzzle

It's admittedly just back of the envelope math but illustrative all the same.

Retail operations require a lot of relatively expensive input ranging from labor to rent to advertising and, of course, inventory. The biggest cost any retailer faces, though, is merchandise costs. Private-label goods are often the most effective way to curb this expense.

Yes, Bed Bath & Beyond needs to pair this strategy with other growth initiatives, but it's doing just that. Over a year ago, the company laid out a five-pillar strategy that rethinks the company's pricing, technologies, product mix, and method of connecting with consumers how and where they shop. Paired with this top-down overhaul, even just slightly higher gross margin can give this home-goods seller a great chance at surviving the retail apocalypse.