The vulnerability of brand equity.

Are U.S. consumers unwilling to continue to pay a "brand tax" on food and other products? In line with trends in Britain and Canada, some anticipate a revolution that will rock the marketing and distribution infrastructure.

A brand is a tax paid by the consumer. The amount of the tax varies from product to product. For example, in April 1992, a case of 24 Coca-Colas retailed in Toronto for a regular price of Canadian $6.99 to C$7.99 ($5.07). Enter the Loblaw Cos.' President's Choice Cola (an upscale retail brand), which retailed at C$3.99 a case. Simple arithmetic shows the average price difference between the products is a whopping C$3.50 per case, equivalent to a brand tax of 90 percent. A recent survey of The Kroger Co.'s stores by J.P. Morgan Securities revealed that the "tax rate" on items sold side-by-side, under both traditional and retail brands, varied from 15 percent on peanut butter to 170 percent on skin-care lotion. Are the two identical products? No, but they are similar and, in many cases, preferred in blind tests.

Most observers define brands in a way that is simultaneously warm and fuzzy, and balance-sheet specific. A brand, they say, is the net present value of the goodwill consumers feel toward a product. In the 1980s, billions were paid for companies with powerhouse brands, because investors reasoned that valuable goodwill wasn't on the balance sheet. These days, that logic has become ever-less compelling. In the new millennium, a brand will be regarded as a tax, and many consumers will revolt.

Because of the bottom-line reasoning outlined below, retailing patterns in the U.S. will follow those in Canada and Britain. In Canada, retail-brand sales are twice the American level, while in Britain, they are two-and-a-half times as great.

BEAR MARKET

Of course, consumers get something for the tax they pay. Perhaps some are wedded to the taste of Coke and find Loblaw's President's Choice Cola a letdown. Perhaps some enjoy the polar bear ads and want to help pay for them. In Canada, 26.5 percent of consumers choose not to pay the tax on colas. In the province of Ontario, that number is 36 percent for take-home sales, and in the Loblaw chain, over 50 percent. Coke still loses money in Canada.

A recent Canadian example is Loblaw's introduction of a premium retail-brand ketchup. This 32-ounce product retails for C$1.51 and handily outsells the regular Heinz 28-ounce squeeze bottle priced at C$1.60. The price per unit for the store brand is 4.7 cents per ounce, compared with 5.7 cents per ounce on the Heinz product. After only 12 months in the marketplace, the premium retail brand controls the category.

How is this possible? Manufacturing and distribution costs of the premium retail "brand killer," including those related to raw materials, processing, distribution, advertising and marketing, and profit margin, have been compressed dramatically. This generally enables wholesalers and retailers to take a higher margin on such products and still sell them at a discount to national brands.

Retail-brand ketchup and hundreds of other products fit this model, which is a harbinger of additional success for upscale private-label goods. Products under the President's Choice label have been designed and tested to ensure that they meet consumer needs at prices at least 20 percent below the brand leader's price. Prerequisite to a formal launch, any product must be "significantly" preferred in a blind taste test to the national brand leader.

Better ingredients, preferred taste, lower prices--together these comprise a superior price/value package for a consumer courageous enough to take a chance on something new. Americans have always been risk takers, and it is to be expected that this frontier spirit will sweep supermarket shelves.

DISTRIBUTION TRENDS

According to market research firm Information Resources Inc., the penetration of private-label goods didn't grow much year-on-year in 1993. In total, the dollar value of private-label sales rose from 17.2 percent of total sales to 17.3 percent. In terms of volume, only 7 percent of sales were private label. Does this mean consumers are happy to pay any and all brand taxes?

Hardly. The future is divined not from the average figures but from the leading, trendsetting retailers. And these companies are basing their commitment to retail brands on a commitment to the bottom line and shareholder value. Wal-Mart has established its Sam's American Choice label in its 2,000-plus stores. The Sam's cola, apple juice, cranberry cocktails, peanut butter melts, and chocolate chip cookies are all examples of products now available at the world's largest retailer.

On the same wavelength as Wal-Mart in terms of commitment to President's Choice is American Stores, a chain with $20 billion a year in annual sales. In addition, Safeway ($15 billion) is committed to its emerging Safeway Select program, and The Great A&P Tea Co. ($12 billion) is pushing its Master's Choice brands. For these retailers, retail branding offers a way to set themselves apart from their competitors and, at the same time, to provide outstanding customer value.

Across the board, U.S. packaged-food manufacturers are finding their margins squeezed and their price/value assumptions tested. Since so-called Marlboro Friday, when Philip Morris announced a 20 percent cut per pack in the price of cigarettes--initiated because of private-label competition--the company's capitalization has dwindled by some $14 billion. Since then, the top 35 U.S. food and beverage advertisers have lost over $50 billion in market value.

Historically, U.S. food processors regarded their retail counterparts as no more than providers of shelf space. Power in the nation's largest, $650 billion industry was almost totally on the side of packaged-goods, branded manufacturers. But the tectonic plates are shifting, and power is consolidating in retailers' hands.

To survive this consolidation, U.S. retailers have to offer customers something unique. If Heinz ketchup is on sale in one chain one week, and in another the next, consumers looking for bargains will move around like line dancers. David A. Nichol, former president of Toronto-based Loblaw International Merchants, describes this as "ping-pong" marketing. While confused customers shift from store to store, the price/value equation of brands is destroyed. That hurts both retailers and packaged-goods manufacturers.

But what if the retailer had its own brand of condiments, which was unavailable elsewhere? What if that same retailer had Heinz ketchup on sale all the time at cost? What if that same retailer still had a combined condiment-category margin of 25 percent, as calculated by a point-of-sale scanning system and software? With a retail-brand ketchup in the lineup, it is possible to sell the branded product at a severely depressed margin--every day--and still make money on the category overall.

This is possible under a revolutionary marketing concept called category management. Under this strategy, the retailer controls the mix of every category, such that it has a large-enough portion of the category's total sales in high-margin, retailer-controlled brands (so-called brand busters and national brand equivalents). Here's an example. For the nine months ended last September 30, at 43 of Loblaw's "No Frills" stores in the province of Ontario, national brand sales captured 54.1 percent of the bathroom tissue category, the 23rd largest as measured by A.C. Nielsen. Such brands sold at a negative 2.5 percent gross margin, although the entire category grossed out at a positive 12.2 percent. The reason? Some 45.9 percent of the category's sales consisted of Loblaw's retailer-controlled brands, generating a gross margin of 29.6 percent.

In simple terms, what all these numbers mean is that for the nine-month period, "No Frills" stores sold the national brands of bathroom tissue below cost and still generated a gross margin twice as large as that required to run even the most efficient club store. Similar examples abound in peanut butter, barbecue sauce, pet food, laundry detergent, and colas.

Offer something unique to the customer and make a high gross on it. Meanwhile, ensure that consumers who want the "national brand"--and are prepared to pay the tax--can always find that brand at or close to cost. That kind of marketing would give retailers a unique, competitive advantage. Such a retailer would prosper and grow, while its competitor across the street awaited the next coupon blizzard in the cereal section.

SURVIVAL OF THE FITTEST

For the retailers of America, retail brands offer the best hope for survival since the scanner. For the consumers of America, retail brands offer the best price/value relationship in decades.

For the packaged-goods manufacturer, however, there is a challenge.

Obviously, the manufacturer should examine his fiscal policy or his tax regime. What tax rate is being charged? What alternatives are available in retail brands? What tax avoidance is occurring? Having digested these facts, the manufacturer can look at his manufacturing and distribution costs--along with those for marketing and overhead--and strip out the waste.

Externally, the classic and most effective response is to innovate--to bring something new to the consumer. A case in point: Nabisco has been wonderfully successful with its SnackWell's line of low-fat and fat-free cookies and crackers. Its share and tonnage are on the rise. Second place is no place in this category; either you're gold or you're gone. Keebler lost share points last year in cookies, as did Peppridge Farms and Sunshine. Private-label sales jumped more than 25 percent. But every trend brings a counter trend. Thus Coke and Pepsi are fighting back in Canada with lower prices, new packaging, and new products.

John A. Quelch, the Sebastian S. Kresge Professor of Marketing at the Harvard Business School, advises consumer-goods manufacturers to avoid using excess capacity for private-label entries. His recommendation: View private label as a serious competitor and focus on polishing the marketing effort to justify the brand tax to consumers.

Repeated for emphasis: The tectonic plates of the world's largest industry, food retailing, are moving. Watch out for the fault lines and the quakes. The landscape will never be the same.

David R. Beatty is president of Weston Foods Ltd., the $1.8 billion food-processing unit of Toronto-based food-processor George Weston Ltd. Weston's Loblaw Cos. Ltd. subsidiary is the largest food distributor in Canada.