PRIVATE LABEL : TO DO OR NOT TO DO?

More than 50% of brand manufacturers have succumbed to the lure of producing private label. But is it a good idea?

When the UK’s leading retailer Tesco first introduced its “Tesco” private label in 1924 few people would have foreseen how dramatic an impact the concept of the “store brand” would have on the global retail market. 84 years on, Tesco has not only developed its private label offering, it has perfected the art and created a segmented portfolio approach which has most brand manufacturers quaking in their boots.

Faced with the realization that the private label phenomena is here to stay (in fact, they are now more commonly referred to as “retailer brands” since that is essentially what they have become) many brand manufacturers have chosen to adopt an “if you can’t beat ‘em, join ‘em” approach and have started to produce retailer own brands alongside their established brand offerings. Adopting such a “dual approach” strategy is potentially attractive but is equally potentially dangerous as many producers have already discovered. So how should manufacturers, many faced with declining market shares and reduced shelf space and listings as a result of private label growth, respond to the challenge?  To do or not to do?

The initial response of most people is usually a resounding “no”. As brand manufacturers, who have invested significantly to create and develop their own branded offerings, the very thought of producing a competing product to help somebody else to build their brand and, at the same time, potentially devalue everything you have invested in seems like an act of madness. Yet if 50% of branded suppliers do decide to say “yes”, there must be more to it than just this. In essence, there are only two logical reasons why brand manufacturers should even consider taking the bold step into supplying private label; profit and category influence.

Profit is an obvious motive and it is important to raise this because most private label products supplied by brand manufacturers are far less profitable than their brands. Not only does this dilute overall company gross margins (the visible effect) it also often deflects management and/or sales force attention away from the branded business resulting in something of a “double whammy” negative. Many manufacturers justify the venture into private label because they have spare capacity. If the assets are not being fully sweated, why not fill them up with any kind of business that makes a profit? The problem here is that companies delude themselves by justifying the private label business on a marginally costed basis so that what appears to be a profitable business can actually be a loss-making one if the full cost apportionment is done. If the real issue is excess capacity and this is a structural rather than temporary issue, companies would probably be better off reducing capacity than filling it with unprofitable volume

The second rationale in favour of private label, category influence, sounds logical and even compelling but hard evidence that this works in a positive way for manufacturers who choose to produce private label is difficult to find. If the category is important in the retailer’s business he will have a clear strategy for his own brand and it will usually involve imitating the category leader at a more attractive price point. The supplying manufacturer will, therefore, have little influence over this strategy and, if they are the category leader themselves, will find that they are collaborating in a deliberate attempt to derail their own strategy! Indeed, there is no logic for a category leader to produce a private label brand to rival its own offering if there is likely to be a degree of cannibalization at play. Only if the opportunity is to segment the category with a “value” private label and a “premium” brand which appeal to different consumers does the rationale even begin to stack up

If there are only two valid reasons for entering a private label agreement, there are a whole lot more for avoiding it. Manufacturers who follow a “dual strategy” often find that their business becomes more reliant on a few large retailers which is clearly fraught with danger. A client of ours who are now desperate to develop their branded business more quickly have a dominant retailer who accounts for 25% of total company turnover of which 92% is private label on which they have realized they are losing money! If they withdraw from the private label contract they believe they will lose their branded presence but the account is currently unprofitable. A dilemma indeed! Having a private label as well as a branded business can have an impact on the whole organisation which can border on schizophrenia if people are unsure where the real focus should lie. Some large suppliers run separate account management teams but this is an expensive option and can lead to conflicting messages and even strategies within the same customer account. Finally, one of the pressures which many manufacturers find it hard to resist is the retailer’s demand that the branded formula be used for their private label. Even if the supplier successfully rebuffs this demand, the “quality gap” between brand and private label is usually reduced and often without the resultant increase in price!

The argument for brand owners avoiding private label would appear to be a compelling one so why do so many companies choose to do it? For one, not all companies are category leaders and as the private label share in many categories grows, No 3 brands and those with low category shares are being delisted by retailers for not earning their keep. A manufacturer with a large factory and faced with a loss of branded business may well reluctantly concede that at least supplying private label will keep the factory turning and their presence in the account alive. Some even abandon the branded route and become dedicated private label suppliers. Some companies enter the private label arena to stop a competitor doing it. They convince themselves that it is better for them to produce the competitor to their own brand than someone who is beyond their sphere of control. Finally, in low innovation categories, particularly fragmented ones, where no brand is particularly strong as a result of a lack of differentiation, the price gap between brand and private label is often small making the private label option a more attractive proposition than in high innovation, highly diffentiated categories

One thing is for certain, private label is here to stay and here to grow. In developing markets such as those in the Middle East private label is still very much a price-driven purchase but in Europe and the USA in particular the game has moved on to an entirely different set of rules. A few of the elite group of brand manufacturers such as Proctor & Gamble and Mars have continued to resist the private label bandwagon and been very successful for having done so. Many manufacturers, however, have already made the move or are considering doing so either actively or at least examining the option. That such a seemingly unattractive proposition has snared so many big suppliers in its net seems to underline the extent to which the balance of power in global consumer products has shifted dramatically in favour of the retailers. It will be interesting to see how the trend develops over the next few years.