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:

Brad, P. (2008), The state of private labeling in distribution- Industrial Distribution

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Batra, R., Sinha, I. (2000), Consumer-Level Factors Moderating The Success Of

Private Label Brands, Journal of Retailing, Vol. 76, Issue 2, p 175–191

Cynthia, Y. (2008), Brentwood promotions firm plans to double revenue with private
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Management Review, Vol. 37, Issue 2, p 89–102

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Interview scripts, retrieved from the World Wide Web on 4/3/2009 from:
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Keith, L., Lars, T. (2008), Private Label: Turning the Retail Brand Threat Into Your
Biggest Opportunity, Kogan Page Publishers, ISBN 0749450274, 9780749450274,
p.23-98

Kusum, L., Koen, P., Steenkamp Jan-Benedict E.M. (2008), Private Label Use and
Store Loyalty, Journal of Marketing, Vol. 72, Issue 6, p19-30

Narasimhan, C., Wilcox, R.T. (1998), Private Labels and the Channel
Relationship: A Cross-Category Analysis, Journal of Business, Vol. 71, Issue. 4,
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Nirmalya, K., Steenkamp Jan-Benedict E. M. (2007), Private Label Strategy: How to

Meet the Store Brand Challenge, Harvard Business Press, ISBN 1422101673,
9781422101674, p.98- 230

Perriello, B. (2008), Private Labeling Gains Ground, Industrial Distribution, Vol. 97,
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Quelch, J. A.; Harding D. (1996), Brands Versus Private Labels: Fighting to Win,
Harvard Business Review, Vol. 74, Issue 1, p99-109
Saatchi & Saatchi (2007), Private Label, Global Research & Analysis
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Sean, G. (2009), Wal-Mart vs. Target: No Contest in the Recession, retrieved from the
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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