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How does private label impact retail & manufacturer profit?

Globally retail chains run on razor-thin margins competing brutally on price to get the customer through the doors. The ones that have emerged winners in the battle have found innovative ways to thrive, like CostCo which uses a combination of its loss leaders (rotisserie chicken) and membership fees to win and Walmart that thrives on the back of its scale and every day low pricing consistency. A new tool these players are now honing is their own private labels - basically developing their own brand for regular staples they sell in their stores.

In this piece, we discuss what private labels are, analyze the impact of private labels on the volumes and bargaining power and consequently margins of food companies, and end with why the long term implication of this trend on FMCG, retail, and consumers.

What is Private label:

When they started, private labels were positioned as low-cost alternatives to regular purchases people make in stores. Introduced mostly by large discount chains, these products got the benefit of scale as well as no middlemen to split the margin between, allowing retail chains to price them attractively. Kirkland is one of the most popular private label brands selling everything from tissue paper to petfoods. Closer home, the Future group seems quite intent on developing and growing its own private labels.

The battle for margins between producers and retailers is as old as time itself. What private labels have done is give the retailers an extra edge in this battle. In the next segment, we look at the key benefits this gives them.

How does it help retailers:

Just two in the store - One tactic that a lot of retail chains who have gone the private label route have adopted is just having two brands in their store - 1. Their own, 2. The largest, or a large player who can outbid the largest. Having two brands, one of which is fairly well known satisfies most customers except in niche categories, but what it allows retailers is an opportunity to start a bidding war between the manufacturers. Getting rack space on one of these larger retail chains can move sales numbers by a few percentage points and margin numbers by even more, which motivates a lot of players to participate in this, leading to the retailers getting a lot better deal than they earlier did.

Turns and margins - In an industry that runs on margins anywhere between 1% and 3%, the way to maximize the returns you make is to maximize how fast you are able to move stuff out of your store. This figure often known as asset turns, is a measure of how much revenue you can generate relative to your assets, and is often the deciding factor between a hugely successful retail chain and a failed one. Managing inventory better due to a lower number of brands kept, also help firms grow their turns. The added margin benefit that these private label brands provide help grow the returns futher.

What's the end game?

In this game of tug of war both parties will continue to pull using any leverage they have. The manufacturers respond to the threat from large retail by diversifying the channels they sell through and strengthening the weaker channels. In India, this will likely take the form on trying to strengthen mom and pop retail, while also diversifying through online. The best weapons manufacturers have in this war though is the power of brand. Being so good and differentiated, that the customer walks out without the category if he doesn't find it in a store. As the large players grow, it would be fair to expect marketing intensity to grow rapidly.

Customers face a mixed set of results here. On one hand the goods they get from large retail will be priced quite attractively as these players are able to squeeze out manufacturers. On the other, their will likely be a lot less variety, and the possibility of not finding the brand you love on your next trip to the store. Exciting times ahead, and we will track the space closely, to see how this dynamic plays out.

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About the Author: The post is written by Ganesh Nagarsekar. Ganesh is a graduate from IIM Calcutta and has worked with J.P. Morgan and Goldman Sachs, before founding GSN Invest.


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