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Retailers have extended the concept of private label to identify a brand with a store, a concept
known as the store brand. This can be a far more profitable business than selling nationally
advertised brands. A Food Marketing Institute study in the U.S. found that retailers earn a 35
percent gross margin on store-branded products compared to 25.9 percent on comparable
nationally advertised brands. [5]

Use of Private Label goes well beyond the Store Brands, though certainly this is the most
frequent situation in which a customer will have contact with one.

Several corporations source an extremely wide range of products from specialized

manufacturers, which may or may not own their brand. The reasons for this business practice
are several. A company, having identified a business opportunity in a new product or groups
of products, may assess that setting up their own production line or facility may require a
substantial investment in equipment, human resources, patents and so forth. In many cases, a
viable alternative is to source from a specialized company that has already made such
investments and that has spare production capacity. If the two companies find that the market
situation allows to avoid or minimize direct competition without stealing each other's market
share (cannibalization), then both companies may find an agreement whereby the specialized
manufacturer supplies the goods to the other. The methods to reduce 'cannibalization' are
general marketing practices such as: dedicated distribution channels, different image and
customer perception of the brands, pricing, separate regional presence etc.

This applies, with basically the same basic concepts, to the service industry (for example,
customer services help-lines).

Private Label may be behind the decision of some companies to enter the market with
products that are quite different, but somehow associable, to those that have made them
famous (apparel companies launching perfumes; car companies launching watches and so
on). Private Label may be an extremely profitable business for companies or corporations
commanding an important share of the market with certain products that enjoy a high
customer recognition.

As sophisticated technologies become widespread, and even subsidized, in emerging

countries (generally with export-driven economies), sourcing of a wide range of products can
be made at very low cost. These same products may have prices that allow for net margins to
account up to several times the cost of the goods sold. Customers may be unaware of this
business practice and be paying higher prices for products that differ little from others with
less famous brands. On the other hand, some companies do provide additional guarantees to
these products offering better quality, customer support, additional services.
Customers should know about this business practice and avoid paying high prices unless a
real advantage on other products is clearly identifiable.

For the past several decades, manufacturers have been the key creators and builders of
branded consumer products. However, this situation has changed more recently as retailers
have begun to play a key role in branding. Although aggregate private label share never
exceeded 17% before 1993 (Hoch, 1996), it went up to 20% of unit sales in aggregate in
1998; that same year, private labels were among the top three brands in 70% of supermarket
product categories (Sayman et al., 2002). In food and drug stores, unit sales of private label
goods increased 8.6% during 2002±2003, compared with 1.5% for national brands, and in
the apparel market, private labels represented 36% of the US$163 billion spent in 2002.
These figures together imply that private labels have assumed a more prominent position in
the market.
Much marketing literature discusses various issues surrounding private labels, including
the advantages for a retailer to have its own store brand (e.g., Corstjen and Lal, 2000;
pCorresponding author.
144 WU AND WANG
Narasimhan andWilcox, 1998; Chintagunta et al., 2002), the optimal quality level of private
labels (Dunne and Narasimhan, 1999;Winningham, 1999; Apelbaum et al., 2003), and how
national brands should confront private labels (Hoch, 1996; Quelch and Harding, 1996; Kim
and Parker, 1999; Rao, 1991; Mills, 1999; Lal, 1990). From the manufacturer¶s standpoint
in the literature, private labels appear as competitors for national brands, which me ans
national brands must fight against those private labels. More interestingly, however, some
national brand manufacturers actually provide retailers with private labels (Quelch and
Harding, 1996; Dunne and Narasimhan, 1999). Despite the prevalence of this practice, little
literature has discussed the reason national brand manufacturers might do so. 1
In this article, we offer some reasons for why a manufacturer, which has its own national
brands, provides private labels that compete against its own products. We build a gametheoretic
model to show that private labels can mitigate the promotion competition between
national brand manufacturers; thus, providing private labels to the common retailer can be
beneficial for all the members in the channel.
The logic for this claim is as follows: Consider a channel in which two national brand
manufacturers (hereafter denoted NB) sell their products through a monopolistic common
retailer. Each national brand manufacturer constantly has an incentive to promote to gain
more market share. When the promotion expense is not very large (in comparison with the
gain from promotion), both NBs will engage in promotion and thus get caught in a prisoners¶
dilemma, because both NBs pay the promotion expense but their promotion effects are
neutralized. However, when one of the national brands introduces a lower -quality product
as the retailer¶s private label (hereafter denoted PL), the NB¶s subsequent promotion has two
effects: It grabs market share from the other NB, and it reduces t he retailer¶s persuasiveness
in terms of switching consumers to buy the PL. Therefore, the NB that provides the PL will
have less incentive to engage in a promotion than will the other NB. 2 Even the NB that does
not provide the PL has less incentive to promote because the cost of promotion remains
the same, but the gain from promotion is lessened. 3 Therefore, as long as the promotion
expense is greater than a certain critical point, both NBs might avoid promotions when one
supplies a PL to the retailer.
There are some indirectly empirical evidences supporting this concept. 4 For example,
Ward et al. (2002) find that private label entry is correlated with reduced NBs¶ promotional
activities in processed food and beverage industries; Chintagunta, Bonfrer, and Song (2002)
find similar phenomenon in their dataset about oats and frozen pasta categories.
In addition, in terms of equilibrium, the quality of the PL plays an important role in the
game. The literature about PL (e.g., Mills, 1995; Sayman et al., 2002) u sually suggests that
it is to the retailer¶s best benefit to obtain the highest -quality PL as possible to be competitive
and comparable with the leading national brand and thereby obtain terms of trade. Does this
suggestion imply that NBs should suppress the PL quality as much as they can?We conclude
that when the other NB is involved in an interaction relationship between an NB and its
retailer, this scenario is not the case. Because the NBs¶ incentive for engaging in promotion
decreases with the quality of the PL, in some circumstances, the NB that provides the PL
will sacrifice some of its benefits to elevate the quality to soften the promotion competition.
We organize the rest of the article as follows: In Section 1, we review the literature,
then in Section 2, we lay out the model. In Section 3, we analyze the equilibrium of
The literature devoted to PLs tends to discuss the reasons retailers introduce private labels,
the factors that favor the development of private labels, and the consequences of their
development for the relationship between the manufacturer of a national brand and its
retailer. For the retailer, introducing a quality PL successfully not only increases its total
profit but also provides it some strategic advantages. For example, it can distinguish itself
from other competing retailers and cultivate the store loyalty of consumers (Corstjen and
Lal, 2000); obtain an improved position for getting better terms of trade from the NBs
against which the PL competes (Narasimhan and Wilcox, 1998; Chintagunta et al., 2002);
and employ the PL, when it is carried by competing retailers, as an implicit coordination
mechanism (Chintagunta et al., 2002). Therefore, there are significant incentives for retailers
to introduce PLs as much as possible.
How do NBs deal with this strong inclination? In recent years, retailers have tended
to elevate their PL quality (Dunne and Narasimhan, 1999; Winningham, 1999; Marketing
Week, 2000; Apelbaum et al., 2003), and in turn, PLs have attained greater market share
(Hoch and Banerji, 1993). If NBs do nothing but justwait and see, they will suffer decreasing
profits and lose market share as the PL quality continues to get higher (Sayman et al., 2002;
Ailawadi and Harlam, 2004). The literature has suggested several ways manufacturers can
cope with these trends, which can be categorized into three types of strategies.
First, by refusing to supply the retailer with a PL, the manufacturer can fight against PLs
by itself, for example by introducing a value flanker (Hoch, 1996; Quelch and Harding,
1996; Mills, 1999), distancing itself through quality innovations (Hoch, 1996; Quelch and
Harding, 1996; Mills, 1999), managing the price gaps (Hoch, 1996; Quelch and Harding,
1996), investing in brand equities (Quelch and Harding, 1996; Kim and Parker, 1999), or
exploiting sales promotion tactics (Rao, 1991; Quelch and Harding, 1996; Mills, 1999).
However, these options fail to consider competition or the implicit collaboration between
NBs, as though there were only one NB in the market. Second, if NBs decide to alternate
their promotion occurrences, they can achieve an implicit collusion that enables them to
defend their market shares from possible encroachments by a PL(Lal, 1990). In this scenario,
however, though they limit further invasion by the PL, they lose profits because of promotion
expenses. Third, as suggested by Dunne and Narasimhan (1999), an NB can join the game
and supply the retailer with a PL as a substitute for its own brand, in which case the supply of
the PL functions as a strategic role. That is, the PL provides economic protection to the NB
when the NB wants to raise the price on its brand, because the NB does not have to worry
about the loss of its customers to another national brand rival. In addition, supplyin g the
PL can keep pure PL manufacturers from entering the category, capturing price-sensitive
shoppers, and gradually growing. Furthermore, the NB can use the PL to attack leading
competitors. Dunne and Narasimhan (1999) similarly suggest a switch from competing
with a PL to co-opting the PL as a strategic tool to fight against national brand rivals and
146 WU AND WANG
pure PL manufacturers. Supplying the retailer with a PL solely as a strategic function is
attractive, but we propose that the NB also can use the PL to mitigate competition rather
than to compete with its national-brand rival. Furthermore, we extend the strategic role of
PL as a commitment not to promote, which offers a way out of the prisoners¶ dilemma
created by NBs¶ promotion competitions, in addition to that proposed by Lal (1990).
In light of the ideas suggested by Dunne and Narasimhan (1999), we propose that the NB
should consider the broader competitive environment, which includes interactions among
another national brand competitor, the common retailer, and itself, when thinking about PL
issues. In addition to the competitive perspectives just described, whether competing with
a PL or other NBs, supplying the private label also might be considered as a co mmitment
to relieve the often harsh promotion battles between national brands. In this study, we show
that in certain circumstances, the NB can mitigate the competition and benefit all firms in
the game by supplying the PL in the context of a category with two national brand rivals of
equal strength that have a common retailer.

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