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THREATS AND OPPORTUNITIES OF PRIVATE LABELS
Camelia PAVEL
„Dimitrie Cantemir” Christian University, Bucharest, Romania
camipavel2003@yahoo.com
Abstract: Across the entire world, consumers are being exposed to a proliferation
of national brands and retail offers, driven by both retailer and manufacturer
innovations. One of these innovations is referring to private labels which are one of
the most discussed issues and has a major impact on retailer’s activities nowadays.
Frequently decisions of manufacturers and retailers have to face regarding private
labels. It has been an important tool for the distributor in a very competitive sector
and has played different roles for the manufacturers, coming from threats to
opportunities. The purpose of this paper is to discuss the retailer’s reasons to
introduce private labels.
Keywords: private label, national brands, retailing
1. INTRODUCTION
The expansion of the modern retail sale forms and of the big retail areas
caused changes in consumers’ buying habits. Therefore it was noticed a trend for
more and varied shopping. These big retail areas are responsible not only for the
changes in the volume and structure of shopping, but also for the changes in buying
habits – consumers buy less frequent but in larger quantities – as it is shown in the
report „Buying power of multiproduct retailers” (Organization for Economic
Cooperation and Development, 2002). Another consequence for the development of
modern retail is the appearance of store brands also known as private labels, and the
increase of customers’ interest for them.
According to Private Label Manufacturers’ Association, private label
products encompass all merchandise sold under a retailer’s brand. That brand be the
retailer’s own name or a name created exclusively by that retailer. In some cases, a
retailer may belong to a wholesale group that owns the brands that are available only
to the members of the group.
Though private labels have attracted attention of channel researchers about
forty years ago (Stern, 1966; Boyd and Frank, 1966), in Romania, private brands
have attracted attention primarily only in the last decade, because, although their
penetration is likely to slow in more mature markets such as the U.S. and Europe,
their presence is expected to increase in Romania, driven by globalization of the
world’s leading retailers.
From a strategic perspective, three sets of players are affected by store
brand entry and interact to create its net impact: the retailer, the manufacturers and,
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the consumers. The focus of this paper is to explore the retailer’s reasons to
introduce private labels and show the threats and opportunities of private labels for
all involved parties. Terms such as private label, private brand, own label and store
brand are used interchangeably in this paper.
2. REASONS OF PRIVATE LABEL INTRODUCTION FOR THE
RETAILERS
Theoretical models suggest that the positioning of private label is a key
element of the strategy of a retailer (Scott-Morton and Zettelmeyer, 2004, Bontems,
2005). Retailers have different commercial objectives for their private label products
and use different types of ranges for different purposes.
Private label introduction may benefit the retailer in several ways, all of
which represent reasons to become a player in the category. First, store brand entry
can enable retailers to strengthen their bargaining position vis-à-vis national brand
manufacturers (Narasimhan and Wilcox 1998). In general, the channel power of the
retailer is believed to increase as a result of store brand entry, which changes the
nature of manufacturer-retailer interaction (Hoch and Banerji 1993; Raju et al. 1995;
Hoch 1996). Specifically, store brands may allow the retailer to negotiate lower
wholesale prices on national brands (Mills 1995). Moreover, retailers can
strategically position store brands in the product space to strengthen their bargaining
position when negotiating supply terms with manufacturers of national brands
(Scott-Morton and Zettelmeyer 2001).
A second benefit is that introduction of private label improve profitability.
According to ACNielsen, (2005) private label prices are generally at least 20% to
40% cheaper than manufacturers’ brand prices. Despite the fact that private label
products are usually priced lower than manufacturer brands, they generally carry
larger profit margins, though gross profits may be similar. Key Note (1997)
estimates that in grocery, margins are generally 5% higher. Corporate Intelligence
on Retailing (1998) (now Retail Intelligence) explain that “although in percentage
terms own-label is more profitable than branded goods, in cash terms the gross profit
is the same on average”. Laaksonen (1994) states that “the margins of own brands
can be 5-20 % better than the margins derived from the leading brands”. Profit
margins may therefore vary significantly across different retailers and product
categories.
Private label products may be cheaper to produce for a number of reasons,
including:
 where private label uses the manufacturer brands as the benchmark it might be
seen as capitalizing upon some of the original product development and
marketing;
 manufacturers may produce private label at prices that reflect only the direct
manufacturing costs – in order to fill excess production capacity;
 if the manufacturer’s sales force and distribution channels are not used, the
retailer’s buying price can be reduced;
 if the retailer has enough (marginal) buying power, it might be able to negotiate
a reduction in the manufacturer’s profit margin.
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The following example illustrates how a retailer’s buying price for private
label product might be up to 25% lower than the perceived comparable manufacturer
branded product.
Table 1
An Example of the Costs Avoided with Private Label
Raw materials
Packaging material
Manufacturing costs
- variable
- fixed
Research & development
Sales force
Advertising & promotion
Transport & distribution
Other costs
Operating profit
Retail Buying Price
Manufacturer brands
35
12
Private label
35
12
9
5
9
-
3
4
9
5
10
8
100
5
2
10
2
75
Source: KPMG (2004) on the basis of manufacturer annual reports and company
accounts.
This example shows how costs can be reduced for private label, although
the cost structure will vary between different manufacturers and products. Private
label products may also help retailers increase margins indirectly, by reducing the
reliance on a particular manufacturer, enabling tougher negotiations on price.
Providing a low price private label product may reduce pricing pressures on
manufacturer branded products, and by stocking differentiated products, in terms of
size and specification, direct price competition can be avoided. This means more
risk for the retailer, especially in terms of product development. By stocking only
private label product, this risk becomes fundamental to business success, as poor
product development may seriously impact consumer loyalty.
Consumers will then turn to the competition’s products, rather than other
products within the same retailers. Profitability results from a combination of factors
– the actions of retailers, consumers and manufacturers (as well as accounting
principles). This makes direct comparisons between retailers, product categories
and/or countries difficult. However, what is clear is that private label may be a
means to improve profitability, both directly and indirectly.
A third benefit of, and motivation for, store brand entry is category
expansion. If the private brand is more attractive than the best incumbent brand for
certain shoppers, store brand entry may increase category value and thus expand
category sales (Mason 1990). Moreover, store brand entry may shake up a ‘dormant’
category (Hauser and Shugan 1983). Competitive reactions of incumbent brands
include price reductions and higher promotional activity, which could in turn
stimulate primary demand.
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Fourth, the store brand itself may generate profits because of its high unit
margin and potentially high volume. As for the former, store brands typically carry
higher retailer margins than national brands do, even after accounting for direct
product costs (Ailawadi and Harlam 2001). As for the latter, the retailer may
introduce a store brand to exploit untapped segments or steal value-conscious
consumers away from the national brands (Connor and Peterson 1992).
Finally, potential retailer demand benefits at the store level include
increased store traffic and store revenues. Recent research suggests that store brands
make shopping easier for consumers, and that they increase store image and store
loyalty by improving store differentiation vis-à-vis other retailers. Empirical
findings indeed connect store brand use and store loyalty (Ailawadi et al. 2001;
Corstjens and Lal 2000). However, it appears unlikely that store brand entry in any
one category would significantly increase store traffic, given at best modest store
switching effects reported in previous literature (Walters and McKenzie 1988).
Therefore, we do not expect the introduction of a store brand in a single category to
influence store performance.
Others reasons that sustain the introduction of private labels are: (a) build
and maintain customer loyalty (b) improve their positioning and image (c) better
control over the supply chain and product quality (d) building the wider retailer
brand (e) ability to chose from several suppliers and (f) increase consumer choice.
The list should also include (g) enable the store to differentiate customers through
price-quality association by premium pricing the store brand and (h) the need for
differentiation from competitors.
In summary, it is expect the retailer to benefit from store brand entry
through (1) higher unit margins on the national brands, (2) profitability improvement
(3) category expansion from the store brand itself and/or from higher volumes on
the national brands, and (4) higher gross category margin, as a result of (1), (2), (3)
and retailer margin on the store brand itself.
Due to benefits which were shown before, I can say that the introduction of
private labels represent an opportunity for retailers, but in the same time is a threat
for the producers of national brands.
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