THREATS AND OPPORTUNITIES OF PRIVATE LABELS

Asist. univ. drd. Pavel Camelia Dimitrie Cantemir Christian University Faculty of Tourism and Commercial Management e-mail: 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 retailers 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 retailers 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 retailers brand. That brand can be the retailers 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 worlds 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, the consumers. The focus of this paper is to explore the retailers 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--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 manufacturers sales force and distribution channels are not used, the retailers buying price can be reduced;

if the retailer has enough (marginal) buying power, it might be able to negotiate a reduction in the manufacturers profit margin. The following example illustrates how a retailers 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 9 5 3 4 9 5 10 8 100 Private label 35 12 9 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 competitions 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. 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--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. 3. REFERENCES Ac Nielsen (2005), The power of private label 2005. A review og growth trends around the world, http://www2.acnielsen.com/reports/documents/2005_private label Ailawadi, K.L., Harlam, B. (2001), The effects of store brands on retailer profitability: an empirical analysis, working paper, Tuck Business School, Dartmouth College, Hannover, NH. Ailawadi, K.L., Scott, N., Gedenk, K., (2001), Pursuing the value conscious consumers: Store brands versus national brand promotions, Journal of Marketing, 65: 71-89. Bontems, P., (2005). On the welfare impacts of store brands, Toulouse, INRA Eds. Boyd, H.W. Jr., Frank R.E., (1966), The Importance of Private Labels in Food Retailing, Business Horizons, 2: 81-90.

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