Solving the brand leader's dilemma.
GIVEN THE CURRENT size and growth rate of the private label segment -- in some categories and countries, at least -- there are many appealing arguments for jumping in. The prospect of generating immediate additional volume is high on the list.(*) There is also, of course, the perennial and worn-out, "If we don't do it, our competitors will." Less threadbare are the opportunities to "improve our relationship" with the distributor for which the private label will be produced, to cut costs through higher capacity utilization, and to develop a better understanding of the consumers who are regular users of private label.
Even so, the decision to enter the segment inevitably creates an awkward predicament for a brand leader. It is tantamount to dedicating, long term, a significant part of a company's resources to products that, by definition, will neither benefit from nor reinforce the characteristics that allowed its brands to achieve their current dominance. In effect, it means a high-stakes commitment to achieving a real level of differentiation -- whether through innovation or a better understanding of consumer needs -- and to maintaining it through continual investment in communication.
This is not a commitment to be undertaken lightly. Consequently, any brand leader thinking seriously about entering the private label arena should be fully aware of the four main dangers that the company, its brands, and its products will have to face.
Loss of power
Supplying private label to a distributor may well result -- once the honeymoon is over -- in a long-term deterioration of the overall relationship and a loss of bargaining power. The reason is that many retailers, especially in southern Europe, require a tremendous amount of detailed information -- such as technical specifications and cost data -- from their private label suppliers.
When a retailer has a confrontational rather than collaborative relationship with its suppliers, access to such information will normally give it a significant bargaining advantage during annual negotiations of trade terms for those suppliers' branded products. This is particularly likely to happen when a manufacturer makes its private label products in the same plant as its own brands, but the organizational responsibility for marketing, especially pricing and setting trade terms, does not lie in the same hands (or at least is not strictly coordinated).
Launching a private label can easily trigger a price war that will ultimately result in lower prices for the whole product category -- without improving the instigator's market share.(*) Indeed, price wars often break out when most brand leaders in a particular category do not yet provide private label products, and when competition comes mostly from smaller companies with lower cost structures. Since private labels are often the major source of revenue and profit for these companies, they are not shy about protecting their turf.
A brand leader must understand that a move to displace smaller manufacturers of private label may erupt in a fierce price war. Moreover, since distributors are hardly likely to switch suppliers unless a new entrant's price is significantly lower, the decision to enter private label can easily become a strategy based purely on price. This is not to say that brand leaders cannot win such wars. They frequently do, especially in categories where the scale of production or purchasing strongly influences cost. Brand leaders must, however, realize that smaller manufacturers will fight to the death to preserve their current private label contracts. Losing them is tantamount to closing up shop.
The inevitable result of price wars like these is a permanent reduction in the price level of the product category, impairing the profitability not only of the private label goods but also of the leader's brands, which may well be unable to recover their traditional price levels. Price wars can be even more unpleasant if established private label manufacturers also supply private label goods in other categories in which the brand leader competes, but with products and brands that are not particularly strong. The risk of igniting a price war across several categories is real, and its consequences can be devastating.
Brand manufacturers may be tempted to fill up their production capacity by offering private label products to distributors at the same time as developing their own branded articles. The result -- early "commoditization" of a category -- can mean surrendering levels of margins and re-investment that would otherwise have been achievable. In categories where this has happened, initial growth rates are high, but total volumes are limited.
This strategy has another major drawback. As soon as consumers notice that an important part of the product offering at retail level consists of private label goods, they may lose interest in branded items. They may conclude, in effect, that the category is much less innovative than they had originally assumed. If they then try out private label products and judge them little different from the brands, the category is likely to "age" prematurely. Typically the brand leader -- the company that developed the market or segment in the first place -- will suffer most.
Producing and marketing branded and private label products simultaneously may set up internal conflicts and contradictions that create havoc in a manufacturer's organization. Leading brand manufacturers usually achieve their status by focusing on strategies that revolve around innovation, superior quality and service, and the development of differentiated value propositions for their products. Their culture, systems, and resources are geared to the superb and relentless execution of such strategies. Private label products, however, often require strategies that are totally at odds with these traditional values.
The resulting division of focus may, in turn, not only endanger the successful development of private label products, but also -- and more importantly -- jeopardize the health of existing brands. The risk is most acute when a private label adventure assumes such proportions that substantial quantities of a company's management resources are diverted to it, rather than devoted to the historical source of the company's success: innovation and differentiation.
Despite all these dangers, private label products are growing in importance, and manufacturers of leading brands continue to enter the arena. Such trends are likely to continue and even intensify in the future. To avoid the risks that entry poses without losing lucrative opportunities to their competitors, brand leaders can adopt a simple decision-making framework. There are two main steps: developing an understanding of the forces underlying private label growth, and assessing the risks and rewards inherent in each category- and country-specific decision.
In order to understand the forces underlying the growth of private label in a particular category, brand leaders need to examine four key issues:
TABULAR DATA OMITTED
The role of private label within the trade. How, for example, does each distributor use private label products in its assortment? What is its strategy for private label, as distinct from that for brands? Answering questions like these requires detailed knowledge of private label's role in each market and product category. Vague generalizations will not do. Moreover, when a manufacturer operates internationally, it must take into account country-specific variations in retailing and in the use of private label.
In Europe, for instance, we have found at least three different models of retailing behavior. The extremes, we believe, are represented by the United Kingdom's "cooperative" model and France's "confrontational" stance. The major characteristics of each are outlined in Exhibit 4.
No branded goods manufacturer can afford to ignore these differences, whether between countries or between individual retailers at national level. In France, for example, the private label strategy of a distributor such as Carrefour has little in common with that of Leclerc. A distributor may also change its strategy over time: Carrefour has moved away from its initial "produits libres" strategy (low prices and pared-down packaging) to its current "quasi-brand" approach (more sophisticated packaging, better quality, and prices well above those of budget brands, though lower than leading brands). This kind of change may, of course, radically affect the attractiveness of supplying private label.
Consumer perceptions and attitudes toward unbranded as well as branded products. It is natural to assume that leading branded goods manufacturers excel at understanding consumers, but not all do. In fact, few leading branders have the same detailed information on consumers of private label as they do on branded goods consumers. Nor do product and brand managers feel especially pressed to obtain such data. Nor do most store and consumer audit panels regularly report the performance of individual distributor brands to manufacturers.
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An in-depth study of consumers of a given product category may well reveal that private label users are really asking for a branded product at a more moderate price and with fewer frills, not for a store's own-brand product. A realization of this kind has recently convinced the managing director of Nestle France to announce that his company will focus on developing a new range of moderately priced products ("produits a positionnement economique") rather than agonize about the private label decision.
The intrinsic potential for private label development in the product category under review. The marketing teams of leading brand manufacturers have ample skill and resources to come up with the right answers so long as they refrain from taking findings that apply to one market and generalizing them to all. It can be tempting to assume that if a private label decision is successful in, say, the UK, it will also work in France. But the enormous differences that exist between markets (particularly geographic markets) in trade structure, trade behavior, and consumer attitudes render such assumptions lethal.
Equally dangerous is research that is not periodically repeated. As categories mature, especially if there is no significant product innovation, they may become increasingly open to private label even if they were unreceptive at the beginning.
The impact that a brand leader's behavior can have on the development of private label. Clearly, this is the trickiest part of understanding the forces at work in a particular category, involving as it does strategic thinking and game-theory type assessments. We believe that private label is not always "bound to grow," and that a brand manufacturer with solid market leadership can influence the way a market develops in terms of pricing, innovation, and, of course, communication about product values. By taking a hard look at its current practices, such a leader can often find ways not only to improve the performance of its brands but also to limit the threat of private label competitors.
An example can be seen in Procter & Gamble's approach to the disposable diaper market in some parts of Europe. Its strategy has combined frequent innovation with "reasonable premium" pricing in a product category where scale has a definite impact on cost. As a consequence, private label manufacturers have so far been relegated to late followers.
By the time the product category has developed to the point where manufacturing private label can provide sufficient volume to be cost competitive and offer prices that undercut the leading brand, the brand leader's market position is strong enough to allow it to launch a new product with improved performance. The competitive game shifts away from the "cheaper with same performance" proposition of private label to the "superior benefits at a reasonable price premium" promise of the brand leader.
Assessing risks and rewards is the final component in the private label decision. It involves three separate analytical steps. Most brand leaders are skilled at carrying out the necessary analyses, but a few common pitfalls are worth mentioning:
Scenario development and analysis. This first step carries two classic risks. The more obvious is that of developing "straw man" scenarios that implicitly tip the balance one way or another even before they are analyzed in depth. To avoid this, top management must take a hard look at the basic assumptions underlying each scenario and make sound judgments about their validity.
The second risk, which concerns the internal consistency of a scenario, is much more insidious. It may be true that a brand leader can manufacture and distribute a large volume of low-cost private label products and, at the same time, maintain the price premium of its brands without suffering a loss of market share. But it has to be proven. The assumption typically falls apart at the critical point of documenting likely price evolution in the category.
Take, for example, a manufacturer of branded salted peanuts that typically sell at $1 a pack. When it decides to enter private label in force, providing several competing chains with distributor brands that will sell at 60|cents~, it should ask its brand manager for convincing answers to these questions:
* How can we persuade consumers in stores where the private label sells alongside our brand to pay -- and carry on paying -- a 70 percent price premium?
* If we cannot, why will we be able to do so in other stores?
* How can we persuade purchasing managers in retail chains to pay a significant price premium for a product differentiated only by its packaging?
* What will happen to the product category's overall price level, and how will this affect the profitability and market share of our main brand?
This stage of the analysis entails investment by a brand leader of significant time and resources to understand how the decision to manufacture private label will affect the long-term price levels of the category as a whole, as well as of the company's leading brand.
Private label costs. The danger here is forming an excessively self-centered view of the world. A brand leader about to embark on a major private label program should not focus just on how this will help improve its own manufacturing, distribution, and (possibly) sourcing costs. It should also adopt the point of view of its competitors, understand their cost structures (with and without private label), and make sure that its proposed actions will not accidentally trigger a price war.
Strategic consistency. This final step should be carried out at the highest possible organizational level. It may even demand cross-border coordination if international retailer buying groups operate in the relevant product category. The task here is to analyze the ways in which a brand leader's chosen modes of response to a rapidly changing business environment are compatible -- or in conflict -- with its decision to supply private label. Exhibit 7 indicates the areas in which some form of strategic cross-checking may be especially valuable.
No branded goods manufacturer can avoid exploring private label. Regardless of the final decision, the kind of preparation described here will almost TABULAR DATA OMITTED certainly create a fund of valuable new knowledge about the consumer, the trade, and the economics of the product category.
If, for instance, a brand leader chooses not to supply private label products, it must still anticipate what will happen if and when other important manufacturers choose otherwise. Reinforcing the strength of its leading brands then becomes a strategic priority, demanding action on several fronts at the same time: cost reduction (in R&D, supply, production, logistics, sales, marketing, and overheads); increasing consumer benefits (by improving brand image and price positioning, for example); and increasing retailer benefits (by creating retailer-specific promotions, or integrating retailers in product development).
If the decision is, conversely, to enter private label production, serious consideration must be given to organizational issues so as to avoid the risk of corporate schizophrenia described earlier. Among the key issues to be resolved will be whether to dedicate separate manufacturing and commercial resources to the new private label business.
Finally, brand leaders active in several product categories and geographical markets should always remember that the best answer for a given category in a given country may well be completely inappropriate elsewhere. Within the same country and product category, similarly, what works for one retail chain will not necessarily be right for another. Even when private label is a sound decision in a specific segment and country, the brand leader still faces the question of whether to produce for all retailers, or only a carefully selected few.
It is irresponsible to adopt or eschew private label across the board. What is needed is a thoughtful choice between options within each segment -- a portfolio approach which can be based on a framework like that illustrated in Exhibit 8. In short, the challenge in private label is to take separate decisions, case by case.
* See Francois Glemet and Rafael Mira, "The brand leader's dilemma," The McKinsey Quarterly, 1993 Number 2, pp. 3-15.
* Editors note: See Robert A. Garda and Michael V. Marn, "Price wars," The McKinsey Quarterly, 1993 Number 3, pp. 87-100.
Francois Glemet is a director and Rafael Mira a consultant in McKinsey's Madrid office.
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|Author:||Glemet, Francois; Mira, Rafael|
|Publication:||The McKinsey Quarterly|
|Date:||Sep 22, 1993|
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