Analysis of Private label’s role in distribution channel design

Private label (PL) has been growing twice the rate of famous brands over the last

decade. Wal mart’s and Tesco’s PL sales account for 40% and 50% of total sales

respectively (Saatchi & Saatchi, 2007). Many large national brands (LNB) are feeling

the increase pressure for them to keep the business running. Some may have even

deploy wrong strategies and suffer from severe loss like the reduction in pricing of

Marlboro causing 15% reduction in revenue (Hoch, 1996). More retailers would

develop their own PL programs as anticipated by various scholars. At the same time,

some scholars claim that the benefits of PL are actually exaggerated. Therefore there

is a need for manufacturers of LNB and retailers to understand the nature of PL in

order to deploy the best strategies to maximize their profits. In the first part of this

article the nature of private label issue would be discussed, the importance of the issue

would be stated and the a stakeholder analysis would be illustrated. The private label

issue would be discussed in terms of distribution management theory in the second

part. The third part consists of a comparison between conflicting views among

scholars on this issue would be described, analyzed and integrated with my own

views.

Nature of private label issue

Reasons for the increase in Private Label

According to Keith (2008), PL is defined as a brand developed, owned and distributed

by retailers. It can also be defined as store brand products sold under a retail store's. It

is created exclusively by the retailer (Industry Directions Inc., 2002). The retailers’

PL and LNB manufacture have very special relationship in which they are

competitors but at the same time, retailers are the customers of LNB manufacture.

After looking at their definition, the reasons for the increase in PL would be

discussed.

Firstly, global economic environment is hampered to a great extent by the financial

tsunami, thus reducing people’s spending power. Sean (2009) mentioned that it is

more difficult for retailers to increase their revenue by giving the example that the

American retailer Target's profits dropped a stunning 22.3% in total and a 40.7%

earnings collapse in the fourth quarter in 2008. People are more attracted to PL which

is always cheaper than LNB in many product categories (Cynthia, 2008).

Secondly, Cynthia (2008) also mentioned the rapid growth of private label is also

driven by rising commodity and food prices so more retailers and manufactures are

investing in the private label business.

Furthermore, PL now are not just a low priced option as there are more premium

private label products available and they are increasingly competitive with branded

products, like the World Classics from Topco and Sam’s Choice from Wal mart

(Hoch, 1996).

Lastly, Industry Directions Inc. (2002) quoted recent research published by the

Private Label Manufacturers Association (PLMA) shows that private label sales in US

grocery, drug and mass merchandise outlets have grown three times faster than

branded in recent years, and sales grew in 2001 while branded unit sales decrease

(Figure 1). Private label products are now frequently taking the number three spot for

specific product categories, hurting all but the market leaders’ business.

Stakeholders analysis

The introduction of PL would affect 3 major parties: the retailer, who introduces the

PL, the LNB manufacturer and the customers. The effects of PL on them would be

discussed.

Firstly, PL enhances the retailer’s image and strengthens its relationship with

consumers (Industry Directions Inc., 2002) if the PL conveys greater value to the

customers in terms of cost and quality. Hence PL helps improve customer loyalty

towards the retailer.

Secondly, PL helps a retailer to differentiate it from others. Since consumers can buy

a national brand anywhere, but they can only buy their store brand at their stores

(Robert 2004).

Thirdly, it can earn higher profit margins by selling the same amount of PL compared

with same amount of LNB (Robert, 2004). Since many LNB openly tout that they

outsource the production to developing countries, large distributor with the financial

ability can purchase PL from the same or similar suppliers, in order to eliminate the

middle men cost to earn higher profit (Quelch, 1996).

Fourthly, the retailer benefits from gaining more bargaining power towards LNB

(Robert, 2004). Since the retailer’s PL is costing lower than LNB, it is a threat to the

sales of LNB. Also, since retailer are the one with power to affect customers’ choice

by financing different promotional tactics to affect customers’ choice, for instance, by

placing the PL in better position in the store and subsidizing promotion of PL.

Retailers can elicit concession from LNB to reduce the price paid by retailers to their

products. Robert (2004) stated that even Coca cola needs to reduce the invoice cost to

major retailers because of the aggressive shelf placement of PL.

For the LNB, it suffers a loss if the retailers copy its successful products. It bears the

total research and development cost, advertising cost and the effort of promoting a

certain pattern of consumption, like the early introduction of ready-to-eat cereal

products (Batra, 2000). However, they are still a very important income source for

retailers since there are still customers who are loyal to them, retailers dare not to drop

LNB in order to promote its PL which has little image and does not have the ability to

induce impulse purchase just like the LNB (Narasimhan, 1998). However, since the

relationship between the retailer and the LNB has changed due to the significant

power of PL, LNB needs to reduce their selling price of products to the retailers in

order to minimize the retaliation of retailer’s PL(Batra, 2000).

For the consumer, store brands represent choice and the opportunity to regularly

purchase quality food and non-food products at considerable savings compared to

buying national brands, without relying on coupons or promotional pricing.

Moreover, store brands are made of the same or comparable ingredients as the

national brands and because the store's name or symbol is on the package, the

consumer is assured that the product is manufactured to an acceptable quality

(Narasimhan, 1998). Customers benefit the most in a situation that LNB is challenged

by retailers’ PL vigorously. In order to gain an advantageous market position,

manufactures need to invest in research and development constantly in order to create

more value to retain customers (Robert, 2004). While retailers need to do the same to

attract customers in the same way, sometimes they still need to advertise or carry out

promotion of LNB to attract traffic to the store due to the intra brand competition in

different channels.

PL issue explained in distribution management concept

Firstly, the channel value provided by the PL in some categories is higher than LNB.

Industry Directions Inc. (2002) states that the advertising and promotional costs

incurred by national brand makers that are passed on to consumers in the form of

higher prices at the shelf. Also, the LNB makes use of their economies of scale

brought by universal distribution volume is mainly used to fund the cost of

advertising to build the imagery value of the LNB (Nirmalya, 2007). In this way,

those advertisings are not providing solid value to the customers. However, retailers

are educating their customers to understand the tradeoffs between some

“unnecessary” service output, like fancy packaging and lower cost (Perriello, 2008).

Moreover, now the PL is using the profit margin mainly to invest in minimizing the

uncertainty of customers like providing more accurate information about the formula

of the PL to facilitate trial and purchase of it (Insider, 2006). The more effective use

of resources help PL to provide more channel value and to maximize the service

output of the retailers to the customers, it greatly enhance to customer loyalty to the

retailers (Brad, 2008).

Robert (2004) mentioned that there are channel conflicts among the retailers and

LNB. While both are performing complementary functions, there is also a competitive

dimension to their relationship. They compete vertically to obtain a larger share of a

brand’s retail price as their own profit. Horizontal and vertical competition often

reinforces each other. If a manufacturer’s brand becomes more popular and gains

horizontal market share against

rival brands in different distribution channels, competition among its retailers is

intensified, retailers’ margin falls, and the manufacturer captures vertical market share

from his retailers. Since the smaller margin means that the brand’s retail price is now

lower and its unit sales

is greater at any factory price, it is likely to gain additional horizontal market share

from higher margin brands. The latter will be further disadvantaged because they

must now have a lower factory price to obtain the same retail price as the brand

with the reduced margin.

If a retailer captures horizontal market share from rival dealers, the retailer’s vertical

bargaining power will be strengthened (Kusum, 2008). As earlier noted, that will

enable the retailer to obtain better prices on the national brand and often on its PL as

well. In turn, this should increase the retailer’s margins and profits, making it an even

stronger horizontal competitor.

My view of different scholars’ opinions

Firstly, Robert (2004) indicates that the it is a good strategy for retailers to sell PL in

order to increase loyalty to the store, so traffic would increase to the channel and

people would also buy other higher margin stuff. However, Kusum (2008) argues that

heavy PL buyers are only loyal to the PL instead of the brand as they are so

concentrating on cost saving only. So it cannot help differentiate the store. Also, these

group of customers bring buy the least items then other customers (table 1). I agree

with Kusum since it is very difficult to judge which factor matter most when

customers are deciding to go to a particular distributor for different purposes.

Emphasizing too much on PL will reduce the retailers profitability if it only draws

price conscious customers to the store. I believe a successful PL program should be a

2-tier program, selling normal successful formula which are cheaper and also it

should sell more expensive premium PL products like the Sam’s choice fresh pressed

apple juice to differentiate itself from other market channels.

Secondly, the Hoch (1996) mentions that the expansion of PL business would dilute

the image of retailers, while Robert (2004) thinks that it can in fact bring an umbrella

effect to the retailer, allowing public to choose retailers who in turn choose the best

product choices from them. I agree with Robert since it is actually the model of the

ultimate successful PL program, in which the people have trust in the retailer, treating

it as another LNB. However, it is difficult to achieve, as the retailer needs to have core

competence in sourcing worldwide for the best product with good value and also I

think that quality assurance system is very important to the success of PL, which

benefits the retailers.

Nirmalya (2007) mentions that the operation of retailers, as a distributor, would

change when the PL is launched due to the fact that the relationship between LNB

manufactures and retailers would have changed. The power in distribution channel

would shift from the LNB manufacturers to retailers. I agree with Nirmalya that LNB

needs to focus on finding new strategy to cooperate with retailers. As it should not

continuously reduce its invoice price to retailers. I t should cooperate with retailers,

like providing expert opinion on the product category information (Hoch, 1996) in

order to have a win win situation.

Keith (2008) mentioned that normal strategies like cost reduction, innovation and

diversification would not solve all the problems. New strategy is need for LNB to

survive in competition by finding new ways to create greater value. I agree with him

and I believe LNB should rethink value streams used to serve retailers to revaluate

methods of maximizing service output and channel values to customers. It needs to

challenge old assumption about what brings value to the product and also to the

channel relationship between it and the retailer.

Also, Saatchi & Saatchi (2007) mentions that both LNB and PL should develop by

increasing people’s love and respect towards it in order to become a love marks in

people’s mind (table 2). While Periello (2008) focuses on the fact that PL should find

ways to develop in terms of searching product categories that people have less brand

awareness. I agree with Saatchi & Saatchi since it is a very good framework for both

retailers and LNB to work with actively to increase sales. Periello’s approach is too

passive.

Reference:

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Kusum, L., Koen, P., Steenkamp Jan-Benedict E.M. (2008), Private Label Use and

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daily

Tables and charts:

Table 1: Source: Kusum L., Koen P., Jan-Benedict E.M. Steenkamp. (2008), Private

Label Use and Store Loyalty, Journal of Marketing, Vol. 72, Issue 6, p29

Table 2: Source: Saatchi & Saatchi (2007), Private Label, Global Research & Analysis

Highlights- An All Party Perspective, Summary Report, p17