January, 2011

Fruits of Thought

Is Private Label A Mistake For Fresh Produce?

Across the entire store, the problem with private label is obvious. Retailers are drawn to such programs because they can purchase products less expensively and thus realize higher margins. Only a small part of this lower price, though, is accounted for by reducing manufacturer profit. Most comes about by eliminating costs such as advertising and research and development.

Yet eliminating these costs is problematic. In the short run, the category may do well; in the long run, the absence of investment in R&D and marketing will prevent the category from achieving the growth it could have.

In other words, Chiquita’s marketing of bananas did not just help Chiquita. These efforts helped build the category. Today we see similar concerted efforts by companies such as Dole with its Dole Salad Guide to build the salad category.

In a sense, private label programs leach on the efforts of branded companies to develop the potential of the category. When such programs were small grocery-based programs and mostly focused on consumers who were highly price-focused, they didn’t matter much, and one could at least argue that by providing a low cost alternative, private label products could serve as a portal of entry into the category.

In produce, private label combines being of little value to the retailer with being particularly deadening to the future growth of the category. Many a supermarket CEO has demanded that his produce VP do a private label program in fresh produce so that the retailer can realize the additional margin. In virtually every case, those CEOs have been disappointed in the results… and they don’t know the half of it.

The problem is that, in other categories, there are fat expenditures on things such as marketing, and so a switch to private label can realize large savings. Marketing expenditures on produce, however, are thin, so it is simply not possible to realize the large margin boosts that grocery delivers. This is why the CEOs are inevitably disappointed with private label efforts in produce.

The other half of the matter is that the private label efforts disappoint consumers and deaden the categories on a totally different scale from their impact in grocery. The grocery aisles are filled with private label product, but only a few specialized stores sell private label product solely. At most supermarkets, private label is still just an option.

In fresh produce, it is typical to sell only one brand of each item, and the refrigerated shelf space is severely limited. So very often the decision to sell private label produce is not a decision to give consumers an additional option, but, rather, a decision to bump a branded supplier off the shelves and replace the facing with a private label product.

We’ve received many unsolicited letters from consumers here at Produce Business telling us they miss their favorite brands when this happens. They claim the quality is lower; they claim they miss out on various promotions that the branded players used to run, and some have told us they have switched stores to get the product they want. This makes one wonder if the use of private label in fresh produce is really driven by a focus on the consumer or by chains looking to boost their own margins or to maintain uniform presentations in the store.

Interestingly enough, the more extensive private label becomes, the less likely it is to contribute much to retail margins. If a producer has a fresh-cut factory, for example, and it is running at 90% of capacity, a retailer can often cut a great deal to do private label with that last 10% of capacity. Producers will be tempted to go for the boost in their short-term profits and offer a great price.

Whether this is wise is another question. After all, the retailer who gets this great private label price will be selling in direct competition with the retailers buying the branded product that supplies 90% of the volume and more than that of the dollar sales. For a producer to empower a competitor to its branded lines with marginal cost pricing may not be a brilliant business strategy.

In any case, this deep discount model can only work as long at the vast majority of the sales and production are branded and paying the overhead. As private label grows, increasingly private label will have to carry the overhead of the plant and the business. This means the savings from going the private label route can only be realized by not doing things such as R&D and marketing that branded marketers do.

Some facts speak to the truth of the matter. Although many older retailers own their own dairies or manufacturing facilities, it is notable that Wal-Mart, which can get money very cheaply, has eschewed investment in such facilities because its executives do not believe they can realize a desirable rate of return. This makes us suspect that much of the rush to private label is based on the fact that enormous retail buyers in a consolidating market can demand prices that are not sustainable. That is to say they can demand prices that do not provide a sufficient return to justify building food production facilities.

Doing this may goose this quarter’s numbers, maybe this year’s numbers, maybe even a few years’ numbers. Long term, though, retailers depend on a vibrant supply sector, a supply base willing and able to invest in new facilities, pour money into R&D to develop the products of the future and a supply base prepared to invest in marketing to persuade the consumer to engage with the category.

In an age where sustainability is all the rage, there is a real question as to whether today’s focus on private label isn’t just a manifestation of unsustainable thinking, where today’s profit margins are enjoyed by gutting the future potential of the category and the industry.             pb