How Should National Brands Think about Private Labels?

Throughout the 1990s, interest in private label brands in the U.S. grocery industry has increased. Store brands currently account for slightly less than 15 percent of total dollar sales. In several European markets, private labels have been even more influential — for instance, in the United Kingdom, they accounted for 20 percent of sales in 1971 and 36 percent in 1994.1 With current demographics guaranteeing low growth in consumer spending on food and packaged goods far into the next century, private labels can be a formidable force in an already highly competitive grocery environment. The disposable diaper market suggests that, when not supported by a continuous stream of product innovations, categories can turn into commodities, rendering the retailer’s built-in distribution an even more valuable resource. Retailers get quick, cheap sales feedback that allows them to mimic what works for national brands while avoiding more costly mistakes. For example, being close to the customer has helped Starbuck’s turn a long-declining commodity into a value-added, distinctive store brand. Consequently, national manufacturers have become more alert to the threat of private labels, most retailers have taken steps to exploit the opportunity, and many smaller (and a few larger) manufacturers have begun to supply private label alternatives.

In this paper, I focus on the food retailing industry, where private labels are the dominant “brand” in about 20 percent of the more than 350 product categories that supermarkets carry.2 In the fresh produce and meat departments, which account for about 25 percent to 30 percent of total store sales, virtually all products are sold with the retailer’s name on a variable-weight package (like meat) or carry no brand name at all, so the retailer is the provider by default. Retailers make higher gross profit margins on private labels, usually about 20 percent to 30 percent on a percentage basis, which at times translates into higher profits on a dollar basis. Private label performance varies widely across product categories and items.3 For example, 65 percent of dollar sales in frozen green and wax beans accrues to the private label, whereas, in deodorants, private labels have only a 1.1 percent market share. Historically, private labels have had a greater presence in the frozen and refrigerated categories (20.4 percent and 15 percent, respectively, in 1989) than in health and beauty aids (4.4 percent).

Private labels come in various forms but always offer some local exclusivity for the retailer that carries them. For instance, some retailers carry private labels that provide an exclusive trademark, either the retailers’ own name (e.g., “Dominick’s” or “Jewel”) or another name (e.g., “Heritage House” or “Lady Lee”), that only they can sell in their market. Exclusive marks are the province of large retailers that have the economies of scale necessary to justify a substantial investment in label inventory. A second private label form is the trademarks that brokers or buying cooperatives offer. Private label brokers, such as Federated Foods and Daymon Associates, and buying cooperatives, such as Topco, maintain large label inventories (e.g., “Red & White” or “Food Club”) that numerous smaller, noncompetitive retailers can use to achieve necessary economies of scale. In general, retailers that rely on a broker’s mark carry fewer private label items, both in the number of product categories and in the assortment of items in a category. More recently, a number of “premium” marks have emerged, including “President’s Choice,” developed by Loblaw’s in Canada and now distributed exclusively by various U.S. retailers, “World Classics” from Topco, and “Sam’s Choice” from Wal-Mart. The biggest success story in premium private labels is the President’s Choice Decadent Chocolate Chip cookie, a high-quality item (with lots of butter and chips) that has become the single best-selling cookie in many markets where it has been introduced.

How do and should national brands think about private labels? In one traditional view, private labels have offered the consumer an inferior-quality alternative at a value price. This perception of private labels was prevalent and reasonably accurate through the mid-1970s. However, the manufacturing technology of private label suppliers has increased dramatically since, and many retailers have deliberately moved upscale, relegating the low-quality value role to either white-label generics or a distinct second-tier private label (e.g., A&P’s “Savings Plus” line). It now appears that most national brand manufacturers often think of private labels as they would any other national brand — tough competition that they must take seriously. Although, in many ways, private labels are just like any other national brand, I argue that there are several crucial differences that a national brand manufacturer must consider in order to compete more effectively and coexist. These differences suggest a third view that recognizes the store brand as one element crucial to a category management process, which by necessity is a joint responsibility of both the national brands and the retailer.

Are Private Labels Just Another National Brand?

In many respects, we should expect private labels to function much like any other brand in a category. For example, we might imagine that all brands, including private labels, occupy positions in a quality and price product space where consumers must make trade-offs between quality (attributes) and price when choosing among brands. In fact, understanding generic brand competition and the factors that influence national brands’ performance should help us understand most of the factors that determine whether private labels succeed or fail.4 At the same time, however, private labels differ from national brands in several distinct ways that may eventually influence how national brands approach competition:

• The private label is the only trademark that recurs throughout the store. No other brand name appears in as many product categories. Even the biggest packaged goods companies do not come close in storewide coverage and penetration. P&G products make up 6 percent to 10 percent of supermarket sales, but P&G uses a different brand name in each category. Kraft General Foods uses the same names in multiple categories but has a concentrated presence in only a subset of the key food categories. A consistent name reinforces the private label mark, creating both positive and negative spillover and item extension opportunities.5
• Private labels are the only products (other than fresh meat, produce, and deli items) for which the retailer absorbs all marketing and inventory investments. This fundamental difference from national brands internalizes the retailer’s decision-making process. With a national brand, the retailer has little or no influence over product quality, advertising and brand image, packaging, and wholesale cost. With a private label, retailers have more control but, at the same time, must take more initiative and absorb greater risk (e.g., costs of inventory). They can choose a quality level and set investment levels for other interdependent marketing activities. The endogenicity characterizing retailers’ private-label decision making implies that retailers can exert more influence over the performance of their store brands. For example, retailers can more easily use the implied threat of overmerchandizing private labels as a lever to gain better trade terms from a powerful manufacturer — a possible practice in the soft drink category in the United States and Canada.6 Opportunistic retailers can gain further by piggybacking on traffic-generating national-brand feature advertising with shallow in-store price reductions on their store brands during the same week. Retailer actions and attitudes, however, can range from benign neglect to proactive evangelism, so this endogenicity is problematic when projecting the future of private labels. The obligation for product development and brand management falls firmly on the retailer’s shoulders.

• Private labels are guaranteed full distribution and good shelf placement. Private labels do not have to pay slotting allowances to obtain distribution.7 Retailers usually sign long-term sourcing contracts with private label suppliers that specify quantities and prices and commit the retailer to a course of action. Moreover, since 90 percent of people are right-handed, the retailer invariably places the private label directly to the right of the leading national brand it is imitating. Compared to national brands, this substantially reduces the marketing resources that the retailer must expend in order to accurately position its products relative to the competition.
• Private labels get 100 percent pass-through on trade deals. When national brands offer trade deals to retailers to motivate temporary in-store price reductions, fewer than 50 percent of the wholesale price reductions get passed on to the consumer.8 Private labels do not suffer the adverse consequences of massive forward buying and diverting that plague national brands. When retailers decide to promote private labels, they do it without the distractions that accompany a decision of whether and how much to arbitrage a national-brand trade deal. If simple is better, then private labels are the beneficiaries.

Price Sensitivity and Private Label Demand

Because of private label products’ perception as prototypical inferior goods, most observers assume that they are likely to be bought by price-sensitive shoppers. But do consumers behave toward private labels as they would toward any other low-priced, low-quality national or regional brand? Or is the profile of the private label buyer somehow distinct from buyers of other lower-cost, national-brand alternatives? To address these questions, I examined how both price sensitivity and private label market share vary with comprehensive customer/demographic and competitive factors. I analyzed store-level scanner data for fourteen product categories from Dominick’s Finer Foods, an eighty-six-store Chicago supermarket chain.9 (For the consumer and competitive characteristics determining local area differences in both price sensitivity and private label penetration, see Table 1.)

In general, we might expect a strong (negative) relationship between price sensitivity and private label penetration. And, in fact, this clearly is the case. The average simple correlation between store-level elasticities and private label share is -.60, with a low of -.14 for laundry detergent and a high of -.93 for refrigerated juice. Moreover, the relationships between the individual demographic and competitive independent variables and the two dependent variables generally are quite similar, both in direction (we expect opposite signs) and magnitude. For example, trading areas populated by more elderly people, more large households, more women working outside the home, and a larger percentage of black and Hispanic consumers tend to be both more price sensitive and more prone to purchasing private labels. Alternatively, when household incomes and housing values are higher and competition is less intense, stores are less price sensitive, and private labels do not perform as well.

The only reversal in these data occurs with the education variable. Higher levels of education are associated with lower price sensitivity.10 Higher education is also associated with better private label performance. This anomaly suggests another reason that national brands should not think of private labels as just another low-priced, inferior national brand competitor — a significant portion of private labels are purchased by educated consumers who usually are less influenced by price than the rest of the general public. Possibly, more educated consumers are better informed about the relative quality of private labels compared to national brands.

How Should National Brands React?

In simple terms, national brands have to think about private labels differently, if for no other reason than the private label (or at least the organization that sells it) is both competitor and customer. Increasing sales in the zero-sum world that characterizes most packaged goods categories requires stealing share from competitive brands. When national brands take market share from each other, there are few financial implications for the retailer. If anything, the increased competition probably gives the retailer the benefits of lower wholesale prices and better trade terms. However, when sales come at the expense of the private label, national brands may need to tread more carefully; they could be shooting the very horse that transports their product to the consumer.

So what strategic options are available to the national brand? There are several moves that a national brand (and private label) can make to improve its competitive position (see Figure 1). These options are meant to be neither mutually exclusive nor exhaustive. Each option’s viability can depend on the distance between the private label and the national brand on both quality and price dimensions.

Wait and Do Nothing

One alternative for the national brand is to simply wait. It may be imprudent for a national manufacturer to react quickly and aggressively to recent increases (e.g., in the early 1990s) in private label penetration if the market is characterized by high volatility or cyclity, especially if such reactions require large, long-term investments that are not easily reversed.

· Private Labels and the Economy.

Consider the relationship between aggregate private label share and variations in personal disposable income in the United States from 1971 to 1993 (see Figure 2).11 First, there is an obvious negative relationship between income and private label purchasing, again confirming that the private label product satisfies economists’ definition of a classic inferior good.12 Second, there is remarkable stability in the relative performance of private labels — a range of fewer than five market share points (a low of 12.2 percent to a high of 16.8 percent) — despite quite dramatic developments and changes in both the conduct and structure of the grocery industry.13

The robustness of the overall pattern suggests multiple factors at work. Clearly, the data show the importance of an income effect that leads consumers to switch to and from private labels depending on personal fortunes or misfortunes. Both manufacturers and retailers act in response to changes in the economy that help produce the observed relation.14 Because manufacturers often budget promotional spending as a percentage of sales, brand support grows in good economic times and declines (at least on a real basis) during bad.15 For example, real spending on advertising declined by 6 percent in fiscal 1992 when private labels gained at the expense of national brands.16 Retailer behavior also is influenced by expectations about how the economy may influence consumer behavior. When the economy softened in the early 1980s and again at the beginning of the 1990s, numerous supermarket chains revamped their private label programs with new logos, new items, and increases in shelf space for private labels and generics.

· A New World Order for Private Labels?

The value of adopting a reactive wait-and-see strategy depends on the degree to which history repeats itself. Hundreds of articles in the business press quote industry observers who argue that underlying conditions have changed. These experts suggest a period of very strong growth in private labels, with estimates ranging from 20 percent to 33 percent of total dollar sales going to the private labels before the year 2000. Such estimates imply a big change. If the relationship between private labels and the economy were to remain unchanged, recent improvements in the economy suggest that even the 16.8 percent share achieved in 1982 would be lofty. Therefore, large increases in private label penetration require a discontinuity. Do any bellwethers suggest such an abrupt change?

There is some evidence that private labels can assume a more prominent position vis-à-vis the national brands. Private labels are the dominant brand in Canada (with 25 percent of the total dollar sales of the grocery market) and several European markets, notably the United Kingdom (36 percent), Germany (24 percent), and France (20 percent). How do the U.S. and European markets differ? Does evidence suggest that these differences are converging? An obvious difference is the level of retail concentration. In Canada and Europe, all the major chains are national. For example, in France and the United Kingdom, the top five chains account for 65 percent and 62 percent of grocery sales17; Loblaw’s controls 27 percent of the Canadian market. In the United States, on the other hand, the top five firms account for less than 20 percent of the industry. By virtue of its geographic dispersion and separation of major metropolitan markets, the United States is characterized by many medium-sized regional chains with strong customer franchises. Kroger ($21 billion in sales in 1994) is the largest supermarket chain but has less than 6 percent of the total U.S. grocery industry and is absent from many important regional markets.

Because of regionalization, however, national changes in retail concentration may provide a deceptive picture of trends in the grocery industry (see Table 2). Industry concentration depends on whether statistics are computed at a national or local market level. Whereas concentration at a national level has remained fairly constant over a thirty-year period, the retail grocery industry has consolidated regionally. If the surviving firms are better positioned to exploit private labels because of greater economies of scale and scope, then further concentration could bode well for the private labels.

At the same time, Canada and Europe also differ in industry structure on the manufacturer side. In virtually all product categories, there are fewer national brands compared to the U.S. market; also, product assortment (i.e., sizes, flavors, and forms) is more limited. Both factors reduce manufacturer competition, which in turn creates greater opportunities for private labels, a condition not currently met in the U.S. market.18 The U.S. market is much larger than the individual European country markets, a situation that creates the potential for greater national brand economies of scale in both production and advertising. Will the U.S. retail market become more like the Canadian and European markets? The evidence suggests that the convergence in market similarities will not be great enough to justify the optimistic scenarios advanced for private labels. And, in fact, as the European Community evolves and trade barriers are reduced (except for language and its effect on packaging), the European market may become more like the U.S. market. Some developments, however, are favorable to private labels.

Private label performance varies dramatically across retailers (see Table 3). The heterogeneity in private label performance highlights the endogenous nature of private labels and implies that the retailer’s effort is an important determinant of private label success. Also, compared to the total U.S. average, the larger retailers did better with private labels in an absolute sense (more than 29 percent in 1993) and grew at a faster rate (20 percent versus 14 percent) between 1990 and 1993. If the average retailer performed to the standards of the best retailer, private labels could account for a substantially greater share of the grocery business.

Finally, there are changes in the relative importance of different retail formats. In many categories, traditional grocery and supermarket chains are losing business to the discount mass merchants and drug outlets (see Table 4). Data show that mass merchants have gained substantial share at the expense of the traditional supermarket format and that private labels are growing faster than national brands.

More germane is that private labels are expanding more quickly in the faster-growing retail formats. This suggests that, if mass merchants such as Wal-Mart and Kmart continue moving into traditional grocery categories and, at the same time, commit to private labels, then significant growth opportunities may accrue to private labels as a whole. Unlike the regional supermarkets, national mass merchants are more likely to achieve the economies of scale in advertising and other marketing expenses that are available only to the large national brands.

In summary, if retail concentration continues to increase at both regional and national levels, if the weaker private label retailers either begin to perform like the best retailers or drop out during industry consolidation, and if alternative formats continue to take business away from traditional supermarket retailers and at the same time invest in their own brands, the wait-and-see strategy is very precarious for national brands. However, such a future is based on lots of “ifs.”

Increase Distance from Private Labels

Another strategic option requires the national brands to further separate themselves from the private label. These distancing moves, either “more for the money” or “new and improved,” require a combination of increases in quality and price (see Figure 1). In the “more for the money” tactic, the manufacturer must maintain current prices while giving the consumer additional value. For example, when brands improve packaging — by making environmental packaging, more compact containers (e.g., ultra detergents), and no-mess containers (e.g., dripless spouts) — prices usually remain constant while value to the consumer increases. National brands also make fundamental (“new”) improvements in quality, whether in existing categories (e.g., light or fat-free cheeses or microwave french fries) or in products that create entirely new categories or subcategories (e.g., refrigerated pickles, pastas, and sauces or combined shampoo and conditioner). While there is no direct evidence on how giving more for the money or introducing new and improved products influences the competition between national brands and private labels, there is some related research.

Although consumer behavior is influenced by numerous product and retail factors (price, assortment, and location), product quality consistently emerges as the tantamount factor. For instance, in a 1990 nationwide Gallup poll, 85 percent of consumers rated product quality as very important in their decision to repurchase a store brand, as contrasted with 73 percent who rated price as very important.19 Another Gallup study found that 73 percent of consumers rated private label quality as very important in deciding where to shop, and 60 percent rated the variety of store brands as very important in store choice.

In a cross-sectional analysis of 185 grocery categories, a coauthor and I found that quality was an important determinant of store brand success (as measured by market share).20 We considered quality on two dimensions: (1) quality delivered by the best private label manufacturer relative to the national brands, and (2) the level of variability in the quality of private labels. Twenty-five quality assurance or control managers from the fifty largest supermarket chains and grocery wholesalers in the United States completed a questionnaire. The first question measured the retailers’ ability to procure high-quality private labels if they so desire. The second question measured consumers’ risk in buying a low-quality private label due to the inherent variability in quality either over time or across retailers with different store brand policies. Taken together, the two questions measured the tendency and dispersion of private label product quality across categories.

The independent variables can be divided into three groups depending on whether the driver is the consumer, the retailer, or the manufacturer (see Figure 3).21 The regression model containing the variables shown in the figure explained more than 70 percent of the cross-category variation in aggregate private label market share. Both product quality and quality consistency emerged as statistically reliable determinants, supporting the idea that the consumer’s concern with quality and the retailer’s and private label manufacturer’s ability to provide quality comparable to the national brands is key to the rivalry between national brands and private labels. The results support the value of distancing strategies when the national brand invests in new alternatives and improves quality or provides more value to the consumer at the same price. At the same time, the price of the private label relative to the national brand had no effect on market share.22

Two other relevant issues emerged from the previous study. First, the retailer can have a big impact on private labels’ success. Private labels perform much better in large categories that offer the retailer high profit margins. Private label investment demands that the retailer take over the functions of branding, packaging, producing, and advertising that the national manufacturer traditionally handles. But with private labels, retailers must rely on internal funds, because the expenses associated with promotions, displays, and feature advertising are no longer shared with manufacturers. When there is the potential for a big return on investment (large categories offering high margins, such as dairy cheese), retailers are more willing to expend the resources necessary to compete. When retailers have little to gain (e.g., in table salt), they do not invest and the private label does not gain much share even when quality is high. This provides additional support for the endogenicity of private label decisions; limits to retailers’ resources, whether due to insufficient monetary or human capital, and their intentions to invest those limited resources in a comprehensive corporate branding program are crucial determinants of future private label growth.

Finally, national brand manufacturers can exert an important force against private labels. Private labels can be effectively crowded out of the market when competition is high, with more national brands in a category, and when those brands also invest advertising resources into building and maintaining their consumer franchises.

· The Disposable Diaper Industry.

The effect of product quality on private label performance should not be underestimated. For example, disposable diapers, which have existed since the early 1930s, have been characterized by many innovations including refastenable tape, elastic waistbands and leg openings, contoured shaping, increased cellulose fluff content, super-absorbent gel technology and thinner diapers, developmental sizing, gender specificity (pink and blue), and pull-up diapers. There have been dramatic changes in market shares and market presence from 1984 to 1994 (see Figure 4). Johnson & Johnson left this capital-intensive industry in 1981 when it saw its share drop from 20 percent to 12 percent in three years due to P&G’s cost advantage on Pampers, then its economy brand, and Luvs’s elastic leg technology.

From 1985 to 1986, P&G introduced thinner Pampers using a Japanese technology that combined wood pulp and polacrylate granules into a gel that absorbed 100 times its weight. P&G reportedly invested more than $500 million on retooling.23 Data suggest that gel technology had a huge impact on Pampers’s market share in 1986, hurting both Kimberly-Clark and the private labels (see Figure 4). By the late 1980s, however, the market appeared to stabilize as gel technology became a commodity. Since 1990, private labels have gained market share steadily while P&G shares have eroded, especially for Luvs after repositioning as a lower-priced value brand. At the same time, Kimberly-Clark gained share because it was able to expand the category with its Pull-Ups diapers for older children; without Pull-Ups, Kimberly-Clark’s share would have remained flat.

Although these data are not definitive, they do support the importance of quality in national-brand private label competition. Currently, 90 percent of the disposable diaper market is a commodity market relying on very good-quality gel technology. The price advantage that the private labels offer can be important when quality differences are small (pink and blue colors apparently are not significant enough differentiators). The success of the pull-up product shows that there are opportunities for value-added, premium-priced innovations even when the basic technology has peaked.

Reduce the Price Gap

On average, the wholesale cost of private labels is one-third less than that of comparable national brands and, in some categories (e.g., analgesics), more than 50 percent less. Even after the retailer takes a 25 percent to 30 percent greater markup, shelf prices for store brands usually are 25 percent less than those for the national brands. During the early 1990s, many national brand manufacturers became concerned that the good economic times in the previous decade may have contributed to their complacency and resulted in price gaps that exceeded many shoppers’ tolerance. Numerous manufacturers reduced wholesale prices in an attempt to encourage the retailer to reduce the price gaps between national brands and private labels at retail.

A large-scale study was conducted investigating the influence of price gaps on the sales and profit performance of both national brands and private labels. The objective was to utilize marketing information technology to improve decision making at retail and to better leverage existing promotional expenditures — including issues relating to space management.24 (These price experiments were part of the Micro-Marketing Project, a joint venture between the University of Chicago Graduate School of Business, Dominick’s Finer Foods, and twenty leading packaged goods companies.)

Dominick’s Finer Foods conducted price gap experiments in eighteen different categories representing about one-fourth of total store sales volume and involving more than 5,000 different items. In some of the categories, private labels already had substantial share (e.g., refrigerated juices had more than 25 percent of dollar sales), and in others, private labels had a small presence (e.g., hair care had less than 2 percent). Moreover, private labels had a growing presence in some categories (e.g., ready-to-eat cereals) and were stable in others (e.g., frozen beverages). Everyday prices were changed for a minimum of sixteen weeks to create three separate price gap conditions —small (a 15 percent difference on average), medium (25 percent), and large (35 percent). In the medium price gap condition, prices of both the private label and all the national brands remained at existing levels. We created the small gap by increasing private label prices and decreasing the prices of all the national brands by approximately 5 percent, whereas, for the large gap, we decreased private label prices and increased national brand prices by the same 5 percent. Eighty-six stores were randomly assigned to price gap conditions, separately for each category. Only the everyday prices were manipulated; temporary price promotions occurred as they would normally. All price changes were made using existing scanner technology along with shelf tags, which ensured high-quality implementation.

To account for idiosyncratic differences in stores (e.g., store size, weekly customer count, and so on), each store served as its own control. Changes in sales and profits during the sixteen-week tests were calculated in percentage terms relative to a baseline of either the immediately preceding six-month period or, in the case of seasonal categories, the same time period a year ago. Because prices in the medium-price gap stores remained constant at pre-experimental levels, changes in sales and profits for the medium gap stores were indexed at 100. Performance numbers for the low- and high-price gap stores are relative to this index of 100.

In all eighteen categories, the price gap had a statistically significant effect on the sales and profits of both the national brands and private labels (see Figure 5).25 A small gap increased unit sales of the national brand relative to the private label, while a large gap had the opposite effect, exactly the pattern expected. More interestingly, the data show that private labels were approximately two times as sensitive to the gap compared to national brands, shown by the distinctly steeper slope of the private-label unit sales curve. This result is consistent with the asymmetries between national brands and private labels observed when estimating cross-price elasticity matrices.26 Because consumers appear more willing to trade up in quality rather than down, price changes by national brands affected private labels more than corresponding price changes by private labels affected national brand sales.27

Whereas the unit sales data indicate that increases or decreases in the price gap resulted in a trade-off between national brand and private label sales, the profit data provide a less ambiguous outcome for the retailer. Specifically, larger price gaps clearly dominated smaller gaps. The retailer made higher profits on both national and private label brands. These profit data are calculated assuming that wholesale prices remain at current levels (which was the case for the purpose of these tests). The retailer lost money on the private label despite the higher margins accompanying a small gap because of the private label’s higher price sensitivity. It also lost on the national brands because the increase in sales of national brands was insufficient to compensate for reduced margins.28 Within the context of these experiments, however, the national brand was better off, in terms of profits, with small gaps because sales increased without a change in the price charged to the retailer.

What do these price gap studies mean for the national manufacturer? Should national brands attempt to get the retailer to reduce the price gap? The problem the manufacturer faces is age-old — getting a channel partner to do something that is not in its best interest. Why should retailers reduce price gaps at the manufacturer’s request when they profit more with larger gaps? It seems likely that the only way the national brand can get the retailer to reduce the price gap is to give the retailer sufficient incentives to compensate for the lost profit opportunities that accompany a pricing change. The magnitude of that incentive is equal to the lost profits for both the national brand plus the lost profits on the private label, a large sum compared to the relatively modest sales gains accruing to the national brand.

The data are oversimplified because we have lumped together all the national brands. Clearly, not all national brands are created equal. Many categories are characterized by one or two very strong leading national brands and another group of weaker brands with an uneven presence in the category that may vary geographically. For example, in the processed cheese category, Kraft has two very strong names (Kraft and Velveeta), continues to introduce new product variants (low fat and fat free), and spends aggressively on brand advertising. Alternatively, both Borden and Land O Lakes are weaker secondary brands with less brand awareness and parent companies that lack the necessary resources to build their brands through national advertising.

To examine the distinction between leading and secondary national brands, I reanalyzed the data from ten categories in which there were clear leader and follower brands (see Figure 6). The data indicate that the leading national brand is even less sensitive to the price gap; sales remain constant irrespective of the gap. The picture for the secondary national brands, however, is much different; these weaker brands appear to be about as price sensitive to the gap as is the private label, which suggests that it may be appropriate to think of them as “national” private labels.

Within the context of these studies, it appears that the leading national brand is much less sensitive to price gaps than either the private label or a secondary national brand. Moreover, it is not in the retailers’ best interests to reduce price gaps because they make more category profit with larger gaps. Reducing price gaps does not appear to be a worthwhile short-run investment for leading national brands either, because small price gaps are only a slight win for the manufacturer while a big loss for the retailer. For the secondary national brands, however, price may provide the only currency with which they can effectively compete against the private label and the leading national brand.

I do not mean to imply that a price reduction is never an appropriate tactical decision for a national brand. For example, aggressive pricing may serve as an effective signal to competitors (including private label manufacturers, retailers, and other national and regional brands) of a long-term and potentially costly commitment to maintaining or growing market share. For a large brand owned by a firm with the deep financial resources to survive the short-term pain accompanying a price decrease, such a signal might serve to deter new entry or reduce the likelihood that a price brand engages in further price reductions.

· The Marlboro Case.

Although these pricing studies have the virtue of tight experimental control coupled with real market conditions, it is not easy to generalize the results to other retailers, markets, and categories.29 We need to consider a related case study in which a broader market test was conducted. In late 1992, Marlboro was ending a five-year period in which its share of the domestic cigarette market had declined from about 26 percent to 23 percent of total unit sales. At the same time, the market share of “value” brands had increased from about 3 percent to 30 percent of unit sales (less than 20 percent of dollar sales). Marlboro decided to defend its market position by offering $.40 per pack incentives directly to the consumer through coupons and other schemes or premiums. Of course, as soon as Marlboro announced its intentions, other leading national brands (RJR’s Winston and Camel) matched Marlboro’s program. On the day of the announcement, investors reacted very negatively, evidenced by a one-day drop of 50 percent in the market value of the parent company, Philip Morris. Undoubtedly, this reaction was too extreme, but market data six months later suggest that investor reaction was at least in the right direction (see Table 5).

Although Marlboro’s price promotion policy resulted in a 9 percent increase in unit sales market share, the total category grew less than 2 percent, which means that Marlboro’s unit sales increased 11 percent. This sales increase came at a price, however — a 23 percent decrease in revenue per unit and a 15 percent decrease in total revenue. The picture was more bleak for the other national brands that followed Marlboro’s promotion policy. Most other brands saw either no sales gains or slight declines. Again, the long-term effect of Marlboro’s actions is more difficult to gauge in terms of its influence on competitors’ future actions and investments.

Formulate a “Me Too” Strategy

Another strategic option involves imitating the private label, which suggests the national brand’s desperation, possibly precipitated by resource constraints.

· Introduce a Value Flanker.

The most ambitious “me too” strategy requires that the national brand introduce a value flanker. Unlike the “new and improved” strategy in which national brands distance themselves from private labels through investments in product quality, by introducing a value flanker, national brands move closer to the private labels. The intent is to offer a lower-priced, possibly lower-quality item to crowd out the private label or preemptively limit the private label’s viability to move up-scale. There are many examples of value flankers. P&G uses Gain and Lever Brothers uses All as value flankers in laundry detergents, a category in which private labels have very low penetration. In paper towels, Scott Paper maintains three quality tiers: high (Job Squad), medium (Viva), and low (Scottowel).

There are some clear advantages to the value-flanker strategy. First, it allows the national brand to preserve both a premium image and, at the same time, avoid excessive price competition that may erode both manufacturer and retailer profit margins. Second, it can provide an outlet for utilizing excess manufacturing capacity. Capacity utilization is critical when manufacturing is based on continuous process technology, as in paper products, where huge capital equipment costs require that machines never stop.

At the same time, however, the decision to introduce a value flanker is not without cost. First, the flanker could cannibalize sales currently accruing to the premium national brand. This is especially likely in grocery categories in which differences in quality between the best national brand and the private label are either insubstantial or in-apparent. In essence, the quality dimension may be too limited to carve into three distinct quality tiers. The flanker brand must be able to distinguish itself from the regular private label in order to generate enough of a premium to cover marketing and distribution costs without diluting the flagship national brand. For example, small differences in quality apparently have contributed to the failure of Kodak’s value-priced Funtime film introduced in 1994.30

Specifically, a value flanker requires that the manufacturer pay an advertising entry fee; without doing so, there is little hope for establishing a market presence quickly enough to capture an adequate share. Moreover, in many cases, the national brand also will have to pay slotting allowances to gain distribution, adding to the marketing ante. Even with a reduced marketing budget, it is likely that these value brands will not offer the manufacturer as healthy a profit margin as existing premium offerings. Finally, proliferating brands to crowd the product space goes against current industry initiatives focused on removing needless costs from the retail logistics system. Industry leader P&G has eliminated weaker flankers in several categories (bath tissue, vegetable oil, and detergent). All told, value brands probably cost more to introduce than anticipated, given the low probability of new product success.

Make Regular or Premium Private Labels

In another strategy, the national brand can elect to manufacture private labels directly for the retailer. The national brand can produce a private label that it can then sell at a substantially lower wholesale cost than it would charge for its own brand names. This can be accomplished by either: (1) reducing raw materials and/or processing costs, resulting in lower quality, or (2) reducing marketing costs associated with distribution, advertising, and sales promotion. For example, in comparing the decision to introduce a flanker brand or supply the retailer a premium private label, the national brand must trade off guaranteed distribution of a product that will generate less profit per unit (premium private label) against the higher distribution costs associated with establishing a clear brand identity (for both the retailer and consumer) for a higher margin item (the value flanker).

Although the trade press during the early 1990s economic slump suggested that more national brands may be offering their manufacturing capacity to retailers, in actuality, the practice is uncommon. To determine the prevalence of national brands making private labels, I examined the Private Label Product News’s Supplier Source Book.31 Sixty-one national manufacturers were listed, fewer than 5 percent of the total, including Kraft, Heinz, Kimberly-Clark, Borden, Jergens, and Reynolds Metal. About 30 percent of these firms, however, were willing to supply private labels but only in categories in which they did not also distribute a national brand (e.g., Kraft in vegetable oils, Hershey in pastas, 3M in film). Some leading national brands manufacture private labels in their own categories, but, in the majority of instances, the category is a commodity (e.g., Reynolds Metal in aluminum foil and Star-Kist in canned tuna) or involves continuous process manufacturing technology (e.g., Kimberly-Clark and James River in paper products). Most national manufacturers making private labels are long-standing secondary brands desperate to utilize idle capacity (e.g., Beatrice, Borden, Dole, and Hills Brothers).

Of course, some national brands may manufacture private labels but are not listed in this source book because either they did not know about the directory or they chose not to be listed because of the economic signal conveyed to the marketplace. Despite the limitations of this evidence, it appears that most private label manufacturers are small regional players not coincidentally playing on the national brand field.

Conclusion

There are various actions that a national brand can take to better compete with private labels. I have attempted to provide pros and cons for each strategic alternative without being overly prescriptive or advocating only one. Under the appropriate circumstances, virtually any strategy can and will work. Big national brands that really want to remain both big and national should adopt a wait-and-see attitude while they vigorously pursue and invest in opportunities to distance themselves from the best private label substitutes. “Me too” strategies involving reductions in either price or quality may be appropriate in some instances (e.g., as a competitive signal or under conditions of long-term excess capacity) but match the capabilities and resource constraints of secondary brands and regional players better.

National brands must continue to invest in brand building. This requires vigorous adherence to the traditional formula: (1) solve an important consumer problem with a higher-quality product and then (2) aggressively communicate the differentiating benefit through good advertising. National brands should emphasize their strengths:

• New product innovation.
• Long-term investments in advertising.
• Ability to generate traffic for the retailer.
• Broader assortments made possible by greater economies of scale.

National brands should also support the retailer by committing to value-added category management and improved logistics programs. Profitable coexistence with the retailer requires national brands to recognize that it is in the retailer’s best interests to sell both private labels and national brands. In the long run, it does not make sense for leading national brands to compete directly on price — the only attribute on which private labels dominate. Price is important, but not key.

Finally, in forecasting the future of private labels, it is important to recognize that their destiny is largely in the retailers’ hands. While it is easy to generate optimistic scenarios, at the same time, there is the question of whether retailers can maintain the organizational structure for building and managing brands in more than 300 categories. Most retailers cannot. It may not be the best resource deployment to focus on store brand management when the more important task for profit maximization is category management.