Why Retailers Love Their Private Labels

January 1, 2011

It’s clear why shoppers like store brands. Private labels are cheaper than their name brand counterparts, and in categories where the store brand and name brand are virtually identical, buying private label is a way to save pennies without sacrificing too much. And during these recessionary times, those pennies are worth a lot to many consumers.

But why do retailers like store brands? The first answer is pretty straightforward: private label brands offer higher margins than national brands: Walmart makes more money selling “Great Value” paper towels than Bounty. But are there other explanations as well? Research from YCCI Fellow and Yale School of Management Professor  K. Sudhir and Professor Sergio Meza of the Rotman School of Management asks “Do private labels increase retailer bargaining power?”  The short answer to their question is yes.

Looking at the grocery store shelf, whenever a new product comes in (private label or name brand), competition increases and wholesale prices (those charged to the grocer by the manufacturer) go down. However, wholesale prices go down more when a private label product comes in than they would if a name brand product came in, meaning that private labels give retailers more bargaining power with their other suppliers. However, a store’s gain in bargaining power isn’t the same across the board. Store brands give retailers more bargaining power over “niche” categories with limited capacity to “pull” shoppers into stores (think healthy cereals like Special K) than they do with “mass market” categories  that appeal to a broader audience (think family cereals like Frosted Flakes).

Given that private labels have higher margins than national brands, it seems logical that retailers might raise the prices they offer shoppers on national brands when a new “imitator” store brand rolls out on to shelves. After all, this should help nudge their shoppers to the private label “copycat.” Sudhir and Meza’s research offers evidence that retailers do strategically alter the prices of goods to build market share for the private label, but usually only for mass market brands. The idea is that the payoff is large enough to justify some lost sales in the short term to build market share for the long term in the larger category. Usually, they make such sacrifices only during an introductory period of about six months after a copycat product is introduced, to give consumers a push to trade down to the private label.

The kicker: If shoppers see a price hike for national brands to nudge them to private labels, it will just be during that introductory period. But, the retailer can leverage its increased bargaining power with the name brand manufacturer to win lower wholesale prices on that brand for a very long time.

What do you think?

Have you seen retailers adjust prices to push shoppers to store brands?

How have you seen new private labels impact categories that they enter?

 

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