PRIVATE LABELS PRODUCTION BY NATIONAL BRAND MANUFACTURERS: THREATS OR OPPORTUNITIES?

Pavel Camelia, Faculty of Tourism and Commercial Management, Bucharest, Dimitrie Cantemir Christian University, Romania, camipavel2003@yahoo.com
Abstract: All over the world, consumers are being exposed to a proliferation of private labels or store brands, which have been embraced by retailers as a key differentiator in an effort to win and retain consumers. But most private labels are not actually produced by the retailers; they are produced by national brand manufacturers. The purpose of this paper is to examine the reasons of national brand manufacturers to produce or not private labels. The article considers the aria of private labels utilizing a theoretical perspective and suggests practical implications. The paper is organized as follows: the first section of this paper clarifies the private label concept and provides some statistics about the development of private labels for different countries from Europe; in the second section were discussed the key factors that facilitated the growth of private label (i.e. retail concentration and the growth of hard discounters); in the third section were analyzed the reasons of national brand manufacturers to produce or not private labels (i.e. economic-financial objectives, strategic objectives, relational objectives and market objectives). In the last section, we draw some conclusions about the production of private labels by national brand manufacturers. Maybe the most important conclusion is that the manufacturers certainly cannot ignore private labels, especially not in economically tight times.The results presented in this paper may help managers to identify key variables that may affect the profitability of producing private labels. Keywords: private labels, national brand manufacturers JEL Classification: M31 Theme: Tourism and Sustainable Economic Development: Macro and Micro Economic Issues 1. Introduction

All over the world, consumers are being exposed to a proliferation of private labels or store brands, which have been embraced by retailers as a key differentiator in an effort to win and retain consumers. But what is private label? Because in the literature, there are various definitions of private label, in this section we provide some definition discussed in marketing literature. American Marketing Association defines a private label as a brand name or label name attached to or used in the marketing of a product other than by the product manufacturers; usually by a retailer. According to the Private Label Manufacturers Association (PLMA 2005) 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. AcNiesen (2003) defines a private label as follows: any brand that is sold exclusively by a specific retailer or chain. In general private labels are defined as those products owned, controlled and sold exclusively by a retailer and for what the retailers must accept all responsibility from developing, sourcing, warehousing and merchandising to marketing such as branding, packaging, promoting and even advertising (Dhar and Hoch, 1997; Steenkamp and Dekimpe, 1997). According to Berges-Sennou al. (2003), these definitions bring out two main ideas. First, it is the retailer who owns and controls the brand whereas this was traditionally the role of the producer. Second, the retailer has exclusive rights to the product. This means that different retailers do not sell identical private labels, which is not the case when retailers sell manufacturers brands. Thus the development of private labels does not only change the relations between producers and retailers (because of the retailer has a new role), but also affects competition between retailers, because private labels are an additional way of differentiating between retailers. In the marketing literature besides various definitions there are many different terms used to describe this concept. While some authors use the terms private brands, store brands or own labels, others prefer words like house brands, private label brands, dealer brands and retailer brands etc. used for the same meaning. By and large, it can be assumed that the definition of private labels in one country or context is the same as in another (Burt, 2000). To avoid any confusion, we will use the term private label throughout the article. Private labels have had an impressive growth in the past few decades in many countries and product categories (Staahl and Sorgard, 2000; Dobson and Waterson, 1998). Today private labels continue to make impressive gains across Europe. Analysis of the secondary data showed that private label product sales varying by country retailer strategy and product. Switzerland is the country where private labels have the highest market share by volume, of 54%, followed by the United Kingdom, which has a share of 43%. In other countries, private labels reaching 40% or more, such as Belgium (42%) and Germany (40%) and over 30% in Spain, France and Portugal. Moreover, market shares in Central and Eastern Europe are climbing at an even faster rate. (PLMA 2008). Since 2000, private label market share in

countries such as Hungary, the Czech Republic, Slovakia and Poland has increased by between 60 and 150 percent (PLMA 2005, GFK 2005). Part of the reason for this is the push of Western European companies who wanting to take advantage of new growth opportunities by moving into these developing economies. This is shown by the private label origin data provided by the PLMA, which shows that products from Western EU countries account for 61% of the food products and 49% of the non-food products being sold under private labels in this region (PLMA 2005). For example, private labels are already well established in Slovakia with 62% of shoppers saying that they bought private labels on a regular basis. This figure increases to 75% in the Czech Republic (PLMA 2005). The penetration rate is lower in Poland and is still very low in Ukraine (11%), mainly due to the lack of western retailers in these countries. In Romania, private labels have attracted attention primarily only in the last decade. Food retailers have successfully acquired the strategy of private label and the concept is present in Romania for a decade with a particularly rapid growth during the last five years. As against to other European countries, the market share of private labels remains small (13%). This may be linked to the fact that retail market concentration is quite low 15,4% (GfK, 2007) in Romania. As a general observation, the level of concentration of the retail industry and the market share of private labels are positively correlated (Bontemps, Orozco, Requillart 2005). 2. Key factors that have contributed to the growth of private labels

The presence of private labels products in the retailing has been facilitated by a number of key factors, which have contributed to the significant growth of private label. Among them are: Retail concentration Berges-Sennou et al. (2004) provide empirical evidence of a positive correlation between the concentration of retail market and the market share of private labels. The higher shares of total market share the top five retailers got, the higher the concentration is. In most countries, the higher the retailer concentration is the higher amount of private labels sold; on the other side, with higher trade concentration, retailers need to differentiate and leverage greater consumer focus to drive growth and share gains. As the gain in operational efficiency and the effects of a change in private label quality on manufacturers profits may depend on the concentration of the retail market (e.g. through the quantity sold of each product), it is important to assess the effect of this concentration on the national brand manufacturers incentives to produce private labels. Channel blurring consumers worldwide are evolving shopping habits and responding to retailer offerings to shop more for different occasions than for different product needs seeking the same products in different outlets depending on the need. With common products available across multiple channels, channel definition based on product characteristics had diminished. Retailer growth goals private labels higher margin and ability to make a quality and value statement to consumers is a way for the retailer to build a unique relationship with the consumer at a higher profit level than branded goods. For retailers, besides higher chain profitability, promoting PLBs can also be beneficial in that they can generate store loyalty and improve bargaining power with manufacturers The growth of hard discounters which selling almost exclusively private labels products at a very low price. The more the hard discounters expand and start new stores, the more private labels were been launched in retailer stores in order to meet the competition and customer needs. Consumer acceptance of private label has grown considerably globally. Mature, slow growth categories and markets are more predisposed to private label development. Supply Chain global direct sourcing of private and non-brand products has substantially reduced costs by eliminating intermediaries, and improved supply chain flows. Retailer Marketing Skill Development as retailers develop their overall branding capability and extend that in to private Label marketing and product development, their ability to motivate consumer purchase and loyalty increases. Many retailers are adding marketing resources against this objective. Trade internationalization in some cases private labels are produced abroad to a lower cost than in country where are sold, which leads to increased competition. Retailers are forced to keep costs down because of the internationalization and because new foreign retailer chains. Hoch and Banerji (1993) state that consumers, retailers and manufacturers are three sets of players whose expectations and actions interact to influence the success of private labels. The presence of private labels nowadays is increasing rapidly and they are becoming one of the major factors in the developed food market from one side, and from the other are considered as a significant threat to producers brands and manufacturers profitability (Baltas, 1997; Guerrero et al., 2000). In the next sections was analyzed the reasons to produce or not private labels from brand manufactures perspective and implications that arise from private labels production. 3. Manufacturers reasons to produce private labels

Because of increasing private label share, national brand manufacturers are tempted to become private label producers. There are two alternative strategies for manufacturers to pursue with respect to private label production (Kumar and Steenkamp, 2007): first, a dual strategy, where the large manufactures produce both their own manufacturer brands and private labels for retailers. Alternatively, small and medium size manufacturers can become dedicated private label producers that are specialized in particular product lines and concentrate on producing private

label almost exclusively. Another kind of manufactures is major retailers and wholesalers that operate their own manufacturing plants and provide private label products for their own stores (PLMA), but them are not the subject of our paper. Private label production by national brand manufacturers is a ubiquitous phenomenon. There are national brand manufactures who want to engage and other that they will not engage in private label production. As interest in private labelling heats up, the question arises, Is private labelling an opportunity or a threat for a national brand manufacturer? Existing surveys indicate that for some manufacturers the answer is, it depends, and for many others its, I just dont know. The decision of whether or not a brand manufacturer should engage in private label production is not an easy one, since several considerations come into play. It is not a simple black-or-white decision but requires a careful tradeoff of the pros and cons. In general, private labels represent a considerable threat to manufacturer brands. However, there are a considerable number of producers that have opted to manufacture them as away to achieve the following objectives: Economic-financial objectives. The first objective is related to the fact that national brand manufacturers have excess capacity or idle capacity and the production of private labels allows them to use this excess production capacity. Studies have found that it is more difficult to generate profits when production capacity utilization is below 80 percent. Private label production might also lead to better overall corporate margins, take advantage of economies of scale, and reduce costs. Because advertising represents a significant portion of a manufacturer's budget, private labels have appeal because the costs of advertising are essentially shifted to the retailer. The producers do not pay for the communication and marketing costs of these products and are also to reduce their manufacturing costs and overheads. Thanks to large production volume and the intensive utilisation of product equipment, they operate on net margins that are lower than those of the leading brands but, due to the high turnover of investments, their profitability remains perfectly satisfactory. Strategic objectives. To benefit leading manufacturer brands, given that store brands compete with lesser brands; also they want to prevent other manufacturers from producing store brands. In fact they will produce a good that will compete with their own, but if they refuse to produce it, others will do so and the extra revenues from the production of the private labels will then go to other firms, whoever these may be: big competing manufacturers or small companies. Occasionally, manufacturers choose to produce these brands as a means of exercising their control. Relational objectives. The third objective deals with the fact that the production of private labels can improve relationships with the retailer in the short term, which can contribute positively to the merchandising of manufacturer brands. Retailers receive information referring to the purchasing habits of consumers via bar-code readers, and they often require the co-operation of manufacturers in order to analyze this information. Manufacturers will not only be able to have access to the data, but they will also be able to advise the distributor about the shelf space management and promotion policy (Dunne and Narasimhan, 1999). On the other hand Kalwani and Narayandas (1995) showed that longterm relationships with retailers can be more profitable and lead to a sustainable competitive advantage by creating a win-win situation. Market objectives. The fourth objective concerns the fact that producing private labels can be an opportunity to capture additional market share for a particular product, a chance to take sales from a competitor. It also concerns the production of private labels as a reaction to the production of private labels by competitors. The production of store brands allows manufacturers to enter the market, without having to assume high advertising and sales promotion costs. This objective is especially important for producers of non-leading brands and small producers, for whom the manufacture of store brands, due to the lesser number of references in the shelf space, constitutes an opportunity to remain in the market and even an opportunity to enter new markets and subsequently develop their manufacturer brands (Dunne and Narasimhan, 1999). The production of store brands may bring about a growth in the manufacturers market share. However, this growth may mean lower manufacturers profitability due to an increase in the price awareness of the consumer. This will be further enhanced if the consumer is able to identify the producer of the manufacturer brand as the producer of the store brand. Moreover, if the store brand is considered to have a similar quality than that of the manufacturer brand, but a better price, the so-called cannibalisation of the manufacturer brand could take place. Puelles (1995) and Dunne and Narasimhan (1999) dissuade manufacturers of leading brands from producing store brands. These latter authors notice that a manufacturers profit derived from the production of a store brand could turn out to be scarce or null if its manufacturer brands have a competitive advantage in costs or differentiation with respect to the brands of the competition, if they have high salience or equity or if they are protected by a patent. A store brand producer with recognized manufacturer brands must differentiate its manufacturer brands from the store brands that they produce, giving up a part of the market, the low-price part, and increasing the distance of its manufacturer brands from the store brands (Hoch, 1996; Dunne and Narasimhan, 1999). In order to prevent the price competition involved with the store brand, the producer can offer new or improved products, thereby preventing the consumer from perceiving its manufacturer brand as similar to the store brand in quality or from perceiving its manufacturer brand unfavourable as a result of the price. A manufacturer has to invest in the value of its brand, in obtaining the desired positioning, in increasing the imitation costs, etc. Only by this way, the manufacturer will achieve that the store brand not be able to resemble its manufacturer brand in quality and not be perceived as an attractive brand for the consumer (Simmons and Meredith, 1983).

According to Dunne and Narasimhan (1999), the production of a store brand may turn out to be advantageous for manufacturers when: there are substantial economies of cost; the manufacturer brand is an unrecognized brand, since the manufacturer may opt to produce a store brand in order to increase its market share; the store brand is a premium brand, since, the potential profits, the improvement of relations with distributors and the growth of the store brand can be significantly higher than those obtained by manufacturers with their brands, and in a market where there is low barriers to entry and where new competitors can launch brands that are similar to those of the manufacturers already installed. 4. Manufacturers reasons to not produce private labels

Despite these opportunities, a number of authors suggest that manufacturers should be reluctant to produce private labels, as the advantages are generally overestimated (Quelch and Harding, 1996). From the manufacturer's perspective, there are several reasons for not getting involved in any private label business. First, in time a manufacturer can be confronted with both price competition and a profit squeeze. In order to maintain a private label business when this occurs, the manufacturer usually decreases the quality of the product to meet the price competition of others. If the private label has become a substantial part of a manufacturer's business, not meeting price competition and still maintaining volume can result in severe financial problems, even bankruptcy. Second, a manufacturer has no control over certain key aspects of marketing such as advertising, retailer deals, package design, and brands in the private label business. Third, private label merchandising means tying up additional money as separate inventories must be carried in both packaging materials and finished goods. Separate inventories must often be kept for several private label customers, thereby substantially decreasing money turnover. At the same time, the manufacturer's branded product is being purchased by the consumer at a higher price, a practice that usually results in lower brand name volume. Another potential threat is that the private labels may also increase difficulties for manufacturers negotiating with retailers on both wholesale and retail prices of their national brands or even the loss of negotiation power with retailers in the national brand due to the production of a private label that may be perceived as having better quality than a private label manufactured by independent firms. When consumers lack the time, opportunity, or ability to inspect alternatives at the point of sale, they rely on any available evidence of quality to help them make a purchase decision. As such, they may perceive the private label produced by the branded manufacturer as a closer substitute to the national brand, for instance, for reputational effects. Moreover private labels may create greater pressure on national brands to retain value conscious consumers (Ailawadi 2001). A major concern for manufacturers is that private labels could be regarded by consumers as being equal to the national brands. Burt (2000) claims that consumers in the UK and the US accept private labels as a clear brand alternative offering similar or identical levels of quality assurance and production innovation as do leading national branded products. When consumers perceive private labels to be of equal quality to national brands, they may be more prone to buying a lower price alternative. Quelch and Harding (1996) recommend that companies with wellknown brands should not produce private labels because the cost of cannibalizing the national brand is generally larger that the contribution of the private label to the companys financial results. The presence of private labels in supermarkets may have limited the shelf space for national brands manufacturer and prevented more-than-modest price increases of their branded products (Narasimhan and Wilcox, 1998). For the producers private labels represent a threat not only because they substitute their own brand but also because they are competing with them in-store. The most vulnerable producers are minor ones, as the retail chains need the strong international or national brands in their assortment and shelves. Some minor producers find themselves omitted from a number of retail chains. Their only way to stay in the market is perhaps to win procurements on private label production. But, the competition to get the private labels orders can be hard too, as producers with strong market position also participate. On the other hand, the retail chains have very low cost on marketing their private labels, while the suppliers not only must market their brands so the consumers can identify them, they must also pay to be part of the retail chains' marketing including marketing of private brands. In addition, buyer power may be stronger for private labels, as the potential sourcing market may be wider. Moreover, retailers decide the price both for their private brands and for the producer's. Thus, prices for private labels are generally set lower, than manufacturing brands. Conclusions For national brand manufacturers the advantages of producing private label products for retail companies is less visible but still present. First, they get rid of most of the entry barriers of producer usually face as they try entering a market because they're supplying directly to the retailer itself. Secondly, for cash-strapped suppliers, manufacturing private label products will let them enter the bigger and higher end markets. The downside of all these of course is when a product does not perform as expected. The production of private labels involves several risks, such as: a loss of power; the danger of the product category becoming a commodity; low profit could then affect the relationship between the supplier and retailer. On the orher hand, the production of store brands can represent an alternative to be considered for manufacturers of products with high fixed costs but low variable costs. Store brands would allow these manufacturers to earn additional income with a low increase in the investment.

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