Private Labels

There are 800 categories of Private Labels. These categories include medications, vitamins, pet foods, apparel, and grocery items among others. Private label products are a large part of many stores’ products: 55% at Sears. 20% at Kohls.

Private label products are typically positioned as cheap, generic, substitutes for other products. They generally have similar quality and lower price.

The following are typical characteristics of Private Label Brands:

• Mimic brand name packaging.
• Products similar to major brands – including quality.
• Associated with a particular store.
• The actual manufacturer is hidden from the end consumer.

The actual manufacturer is usually hidden from the consumer to prevent cannibalization of the name brand. For example, assume that Kelloggs is producing a store brand for Wegmans. Consumers won’t see any reference to Kelloggs on the box; if consumers knew that Wegmans and Kelloggs cereals were identical, they would never buy the higher priced Kelloggs brands.

Of course, not all private labels share the above characteristics. For example, Marks and Spencer has the store brand St. Michaels. Until recently, their products were not sold as a “national brand” in other stores. However, Marks and Spencer products are medium to high priced; they are not inexpensive knockoffs of major brands. St. Michael is an example of a Premium Private Label. Premium Private Labels have superior standards. They are most often seen in the apparel industry; but they can be seen in the packaged goods industry as well.

Packaged goods are the place where private labels create the most havoc. In retailing, a “detailer” is a person who works for a national brand whose job entails stocking shelves in retailers. The detailers ensure that the national brands gets its products to the location or aisle where it will do best. Such positioning is extremely important for national brands. The most valuable spots are at the end of the aisles. Its also critical that a brand be placed at the customers’ eye level. By having detailers stock the shelves, national brands are more able to control where private label competitors are positioned relative to them in stores.

Of course, the retail establishment has a competing interest if it sells private labels. The retail establishment’s strategy might be to get consumers hooked on a private label with the store name. Then, the person feels she has to go to that store to get the product she wants. This can be a double edged sword because the brand reflects the store and the store reflects the brand. A brand with a bad reputation reflects badly on the retailer. Likewise, a good product carrying the label of a retailer with a bad reputation is likely to be poorly perceived. Yet, such a product can be effectively used to build up the retailer’s reputation.

Given current growth rates, improving quality, and lower prices, private label products are likely to continue gaining market share in the future. However, national brands, arguably, keep product categories alive since they provide category awareness through advertising.

In some cases, private labels have actually become the dominant product. A case in point is generic drugs. In some cases, its not even obvious that a particular drug is a generic version of a brand name drug. Today, there is a whole set of prescription drugs now sold only under their generic names. HMO’s will typically insist on generics once patent protection expires.

Supplying Both Brand Name and Private Label Equivalents

When a firm supplies or manufactures both brand name products and private label equivalents, its quite important (as stated above) that it keep secret the fact that both products are the same.

Another thing to be concerned about is maintaining a strict price premium. This becomes increasingly difficult in cases of fierce private label competition. An example is Coke and Pepsi versus grocery store brand soft drinks. At any given time, Coke or Pepsi seem to be on sale. The sale price is similar to the price of the grocery store brand. Unfortunately for Coke and Pepsi, such regular promotions erode the perception of added value for their brands. After all, if Coke/Pepsi sells for the same as a brand like W-Pop every two weeks, many customers will not consider it to have higher quality or market position than W-Pop.

The problem is that, once a national brand starts such a cycle of promotions, its difficult for it to break out. Customers will wait to purchase the products until they go on sale.

Advantages for the Retailer to Sell Private Labels

Margins on private labels are better for the retailer. Typical margins for private labels are 35% compared to 25% for national brands. But, comparing these two numbers directly is not possible because national brands significantly contribute to the overall market for a category through advertising.

When a retailer sells private labels, it is able to increase its bargaining power with national brands. As a purchaser, the retailer can threaten national brands by either introducing private labels or promoting them more heavily.

Private labels can be used to differentiate a retailer from its competition. For example, W-Pop is only available at Wegmans. Competing grocery stores do not sell W-Pop.

Finally, private labels can be used effectively to reposition a retailer in the market. This repositioning is most often seen when premium private labels are used to promote the store as an exclusive outlet. In addition, private labels can be promoted through other channels (for example, President’s Choice is promoted through many retailers as is Safeway’s organic brand, “O”.) In the case of President’s Choice chocolate chips cookies, the private label brand has repositioned the retailer as a seller of high quality food items.

From suppliers’ point of view, there are real advantages to private labels.

One advantage is Economies of Scale. Making another brand of corn flakes imposes very low extra cost to the producer. By not making private label, a firm may very well be giving business to a competitor who is welling to make it.

The big problem, though, is that cannibalization of the national brand can occur even if the private label agreement is secret. The reason is that a successful private label will effect the pricing of national brand.

Concept of a “Fighting Brand”

A “Fighting Brand” is new brand that’s positioned half way between a firm’s national brand, a private label, or another brand. Fighting brands are often used when it’s difficult to differentiate between the attributes of various brands. Fighting brands can provide a buffer between brands, but often lead to brand cannibalization.

A firm must be very careful with introduction of a fighting brand because the linkage between fighting brand and flagship brand is hard to protect. When word gets out, a substitute has been created with the flagship brand at a lower price.

A good illustration of this is Kodak in its fight for market share of film with Fuji in US. Fuji’s film was not quite as good when they first began selling it in the US market. But, it was fairly low cost and Fuji had 10% market share. Kodak had 80% margin on its consumer film products. Kodak began asking itself how it should deal with Fuji. Kodak talked about making a fighting brand. But, what would happen if people found out that Kodak was making the fighting brand? Customers would know that the product would be high quality because it came from Kodak. The debate went on within Kodak for a decade.

Another big problem for a firm supplying both brand name and private label products is distraction and inadequate economic analysis of the true cost of supplying the private label. Too often, firms simply look at the low marginal cost of supplying the private label and, based on that, decide to produce the private labels. For example, a firm might say, “Our factory is operating at 75% of capacity. We can produce produce private labels at marginal cost to bring the factory up to full capacity.”

The problem with this approach is that, over time, the firm will have to add or replace capacity with capital investment. When that happens, the capital investment involved in continuing to produce the private labels can be substantial. Yet, firms often just look at the capital investment in relation to the national brand. They make the investment. Then, they have even more excess capacity which is used to produce even more private labels. So, when making a decision about adding or replacing production capability, its imperative that the firm analyze the trade-off between yet more capability and just giving up private label production altogether.

Another problem for suppliers producing private labels is that it is difficult to take price action on a customer; raising the price charged for a private label may cause the retail to find an alternate supplier for the private label product. So, suppliers lose bargaining power with retailers. Not only do they lose bargaining power with private label, they also lose bargaining power for their name brands. For example, if Kelloggs produces private label cereal for Safeway, Safeway can demand a reduction in the price it pays for name brand cereals or, else, the private label contract will go to General Mills. In an extreme case, the supplier becomes a commodity supplier and most of the bargaining power goes to the intermediary (the retailer.)

Private label management can also take up a significant amount of senior management time. Senior management time is one of the most scarce resources in a firm, but its use rarely shows up in the accounting/economic analysis of private labels.

Private Labels in Recessionary Economies
The market penetration of private labels goes up and down with the economic situation. Private label penetration does not change at a constant rate. As private labels get better, however, substitution improves. The key for a private label is to try to get customers to try it. This is especially true for packaged goods since packaged goods are high experience products. At every downturn in the economy, more people try private labels. When the economy improves, some consumers stick with the private labels. So, over the long run, economic downturns are good for private labels.