brand leaders dilemma

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The brand leader’s dilemmaThe growing appeal of private label in many product categories poses adifficult choice for today’s brand leaders.

May 1993 • FRANÇOIS GLÉMET AND RAFAEL MIRA

During the past few years , private label goods have enjoyed steady

growth in an increasing number of food and non-food categories. Many

suppliers outside the ranks of the first-tier branders have exploited this

growth to achieve significant volumes. Conversely, the share and price

premium of traditional brand leaders has been eroded. Many of them are

now faced, as Exhibit 1 suggests, with a crucial strategic issue: should they

—or should they not—begin to produce private label products themselvesfor their large trade clients?

However pressing now, this issue can only intensify during the next few

years. Leading producers of fast-moving consumer products will be unable

to avoid it; they will have to make a choice. How can they best weigh up all

the facets of the question? And how can they look beyond short-term

considerations of marginal cost and marginal volume, reject simplistic

gaming behavior ("if we don't do it, our competitors will"), and make a

reliable decision based on a long-term vision of product category evolution?

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Here, we lay out an approach, based on a McKinsey study of private label

experience in Europe, that may help brand leaders frame the private label

dilemma as it applies to their individual businesses. Because the choice is so

complex and depends on so many different factors, the right decision will

vary from situation to situation. In a future article, we will describe a

tested, step-by-step process for actually making that choice. In this first

discussion, however, we concentrate on getting it into proper focus—and on

making clear the key factors on which it depends.

A strategy in gray

Whenever a brand leader faces the private label issue, there are strong

arguments in favor of going ahead:

Private label represents a large (and usually growing) market segment

Economies of scale at each step in the business system (manufacturingcapacity, distribution, merchandising, and so on) justify the search foradditional volume

Supplying private label will improve relationships with a powerfulorganized trade

Control over technology and raw materials reduces the risk

There is a clear consumer segmentation between branded and unbrandedgoods that supports providing private label

Private label helps to eliminate small, local competitors Private label offers

an opportunity to compete on price against other branded products

Private label increases share of shelf space—a critical factor in motivatingimpulse purchases.

But there are also strong arguments against:

Market share growth through private label supply always happens at theexpense of profitability, as price sensitivity rises and margins fall

Disclosing cost information to the trade—usually essential for a privatelabel supplier—can threaten a firm's branded products

In order to displace existing private label suppliers, new entrants have toundercut current prices, and thus risk starting a price war—in anenvironment where trade loyalty offers little protection

In young, growing markets, it is the brand leaders, not the private labelsuppliers, that influence whether the market will develop toward brandedor commodity goods

Private label is inconsistent with a leader's global brand and productstrategy—it raises questions about quality standards, dilutes management





The private label decision is not a

simple either/or choice; no single,

generic private label strategy exists.

There are many nuances and many

variations

attention, and affects consumers' perception of the main branded business.

Faced with these arguments,

manufacturers commonly take a

"black or white" approach. Either

they never produce private label, or

they always do. As Exhibit 2

suggests, however, the private label decision is not a simple either/or

choice; no single, generic private label strategy exists. There are many

nuances and many variations. The strategic ground is neither black nor

white, but gray.





Understanding private label

Evidence suggests that private label will continue to grow. To date, it has

achieved a significant level of penetration in some countries, but remains

marginal in others (Exhibit 3).





As both the grocery trade and consumers become more sophisticated,

private label's market share in these countries is likely to reach those in the

United Kingdom and Germany (Exhibit 4).

Even in countries where private label has already achieved a respectable

level of penetration, further growth is likely. The dynamics of market

development follow a reasonably predictable course. Exhibit 5 and Exhibit

6 describe this general pattern of evolution.





Today, different product markets in different countries are, obviously, at

different stages of evolutionary development. But they are all moving in

the same general direction—driven, in part, by the self-interest of retailers,

which view private label as a strong contributor to profitability, as

measured in terms of return on sales (Exhibit 7).

Nevertheless, as Exhibit 8 indicates, the level of penetration by private label

will continue to vary by country and product category. This reflects





Variations in consumer perception

reflect an underlying segmentation

of consumer attitudes toward

private label purchases

underlying variations in both consumer perception and the behavior of

leading branders.

These variations in consumer

perception reflect, in turn, an

underlying segmentation of

consumer attitudes toward private

label purchases (Exhibit 9 and Exhibit 10).





And, as Exhibit 11 and Exhibit 12 illustrate, this pervasive segmentation of

attitude implies that some product categories offer considerably more

potential for private label than others.





From the manufacturer's viewpoint, similarly, some product categories are

intrinsically more attractive candidates for private label than others. For





example, categories with higher levels of product innovation tend to have a

lower level of private label penetration (Exhibit 13).

So, in general, do categories that require significant investments in brand

support (Exhibit 14).

Where such investments lead to unusually high prices for branded goods,

penetration of private label is likely to be higher, since—as Exhibit 15 and

Exhibit 16 indicate—price differentials are often the basis of private label's

appeal.





In summary, then, there is a reasonably common set of factors that

explains why some categories and countries have higher levels of private

label penetration than others (Exhibit 17).





Although some of these factors are difficult for the manufacturers of fast-

moving branded foods to affect, others lie well within their—and especially

a brand leader's—range of control (Exhibit 18).

For individual retailers, private label's appeal will depend on w hat it mightcontribute to—and how it might "fit" with—their distinctive strategies

(Exhibit 19).





Such strategies are shaped by differences not only in the objectives of

individual retailers, but also in manufacturers' behavior, consumer

perception, and the extent of trade development in each country. Within

their different strategies, retailers continue to search for the best way to

manage private label marketing. Four common approaches can be

distinguished, as Exhibit 20 indicates.





Basic beliefs

Whatever their ultimate resolution of the private label dilemma, leading

producers of branded goods should approach the decision with this simple

set of experience-based beliefs in mind:

For new entrants, private label may be the only way to gain access to anew market; for followers or marginal players, the sole means of survival

in the face of increasing competition and trade pressure. For most leaders,however, private label is a real threat to market share and profitability inthe medium and long term. Some limited opportunity may exist, but only in specific situations where:

The branded segment is securely protected both from competitorsand from cannibalization by private label

New needs emerge that cannot be satisfied via existing leading brands

There are high entry barriers.

Private label is not a new segment; it does not create innovative productsthat generate new users and new occasions of consumption. Rather, itrepresents a "me-too" brand or set of brands that grow only at theexpense of others. Total market volume may well increase in the shortterm, but on a longer view the risks are real. Though the threat of cannibalization is greater for followers and marginal players, it can also be significant for a leader's branded business, causing:

Deterioration of relative price position

Decrease in share of shelf space

Growth in both the number and the weighted distribution of competitors' private label products.

Private label development is likely to lower overall category profitability,especially for leading manufacturers. In fact, the marginal profits fromprivate label usually do not compensate for the losses from declining sales,lower unit prices, and reduced margins in the branded business.

Redefining marketing's role

From an academ ic or theoretical perspective, the relatively narrow conceptualization ofmarketing as a profit-maximization problem, focused on m arket transactions or aseries of transactions, seems increasingly out of touch with an emphas is on long-term customer relationships and the formation and m anagement of strategicalliances. The intellectual core of marketing m anagement needs to be expandedbeyond the conceptual framework of microeconomics in order to address more fullythe set of organizational and s trategic issues inherent in relationships and alliances. [.. .] The focus shifts from products and firms as units of analysis to people,





organizations, and the social processes that bind actors together in ongoingrelationships . [. . .]

In the new organization environment, the marketing function as we know it isundergoing radical transformation and, in som e cases , has disappeared altogetheras a distinct management function at the corporate level. Just as the distinctionbetween the firm and its market environment (both suppliers and customers)becomes blurred in network organizations built around long-term strategicpartnerships , so do traditional functional boundaries within the firm become lessdistinct.

Notes

From Frederick E. Webster, Jr, "The Changing Role of Marketing in the Corporation,"Journal of Marketing , October 1992, Vol. 56, pp. 1–17. Reprinted by specialpermission of the American Marketing Association.

About the Authors

François Glémet is a director and Rafael Mira is a consultant in McKinsey's Madrid office.

© Copyright 1992-2011 McKinsey & Company


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