Solving the Brand Leader's Dilemma

A decision maker's guide to the risks and rewards of private label 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. Risks 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). Price wars 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. …