No Free Ride For Private Labels

By Jim Prevor, Editor-in-Chief, Produce Business

The future for private label is almost universally seen as bright. Yet the intrinsic logic of the interaction between private label and national brands makes the future for private label somewhat problematic, and the peculiarities of fresh produce marketing make private label produce unlikely to triumph.

The key thing to think about is why a retailer would want to sell private label product at all. The answer is generally better margins. How can a retailer get better margins through a private label? Well, in a few cases, retailers literally become manufacturers and own manufacturing plants. In these situations, retailers can combine both a manufacturer’s margin and a retailer’s margin to come up with a substantial margin number. But this path involves significant capital investment and risk, so it requires additional margin to compensate for that outlay.

So this leaves retailers with purchasing from co-packers or other manufacturers. Yet how will this increase supermarket margins? To a small degree, supermarkets can get super great prices by persuading manufacturers to sell based on marginal costs rather than fully loaded costs. In other words, a branded cookie company sells enough cookies to keep its plant working at 90 percent of capacity. Some lucky chain or chains may persuade the cookie manufacturer to accept a cheap price to fill its last 10 percent of capacity.

But the ability to get this big margin is limited. At a 90/10 ratio, the branded product can carry all the fixed costs, but if private label grows and the branded product gets kicked out of the stores, then the ratio may switch to 60/40 or the manufacturer may drop its brand altogether. At this point, it seems clear that the “free ride” for the private label will be over and the private label product will increasingly have to carry its fair share of the overhead and capital costs.

So how exactly will private label boost margins? Well, this still leaves reductions in advertising, marketing and sales costs that national brands have to absorb. This is a big chunk of money and seems to offer the potential for big savings.

Yet even this savings is somewhat problematic. First, on some products, such as fresh produce, these costs are minimal. Even the most heavily promoted produce items rarely spend more than a penny a pound on advertising and promotion. Second, where marketing expenditures are higher, a not-insignificant amount of these expenditures goes directly or indirectly to benefit the supermarket — it may be slotting fees or merchandising assistance, consumer research, demos, and sampling, etc. Zeroing these out of the product price will lead to a reduction in revenues or increases in expenses for supermarkets.

Third, many of the savings may be very short run. Yes, if consumers have been trained by Oscar Mayer to eat B-O-L-O-G-N-A or Hebrew National to eat Kosher food because the company “answers to a higher authority,” then offering private label products that can piggyback on these campaigns without paying for them will result in higher margins. But if national brands shrink, they won’t have the resources to do the kind of advertising and marketing that has built these categories. So the supermarket looking for high margins through private label will have little choice but to start spending money to build and market the category.

The comeuppance of all this is troublesome for those who advocate private label marketing: If retailers have to cover the whole nut of manufacturing and have to invest in marketing and product development to build the private label brands and the category, it is not clear there is any real lift in margins to be had from private label.

The sustainable gain in private label comes from something much more difficult to do than co-packing corn flakes. It involves the creation of unique foods or flavor profiles that will draw consumers back and turn the private label program into a customer draw. Trader Joe’s is exemplary in America with this approach, and we often hear of consumers overnighting a sauce or dressing that Trader Joe’s uniquely has.

In produce, what private label has mostly done is disappoint supermarket CEOs. They were able, at least in the short term, to get a margin boost in the grocery with a private label orientation, but produce producers never had such fat margins to cut, and so it never has worked out as well in produce as the retail CEO had expected.

The future for the private label may see some quick about-faces because a focus on limiting SKUs, although superficially appealing, may be incompatible with the trade’s existing real estate inventory. Limiting SKU count to reduce costs and complexity may be a dandy strategy for an Aldi, but it seems to belie the whole purpose of a 70,000-square-foot supermarket or a 200,000-square-foot supercenter. These concepts live on their promise to provide one-stop shopping. Wal-Mart has already announced it will return to its shelves some products eliminated during its rationalization process.

In produce, of course, most products carry no brand known to the consumers. In this sense, the produce brands are, and always have been, identified with the retailer carrying the items. The trend, though, is opposite from private labeling, which implies a closer connection between the producer and the “big business” supermarket; the trend is to allow consumers a closer connection to the producer of their food.

That means branding focused on the producer with the supermarket shifting to the background, in a sense, a plethora of brands — national, international, regional and local — which may overwhelm the idea of private labeling most produce.