Private Label vs. Brands

An Inseparable Combination

Rabobank InternationalFood & Agribusiness Research and Advisory

Author: Sebastiaan SchreijenTelephone: +31 30 71 23831E-mail: Sebastiaan.Schreijen@rabobank.com

far@rabobank.comwww.rabobank.com/far

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Disclaimer Neither Rabobank nor other legal entities in the group to which it belongs, acceptany liability whatsoever for any direct or consequential loss howsoever arising fromany use of this document or its contents or otherwise arising in connection herewith.

This report has been published in line with Rabobank’s long-term commitment to the international food and agribusiness. It is one of a series of publications undertaken by the global department of Food & Agribusiness Research and Advisory. ©2011 All Rights Reserved.

Private Label vs. Brands

An Inseparable Combination

Contents | i

ContentsPage

Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

The Raison d’être for Private Label in a Nutshell . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Are Brands Winning Back Market Share? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

More Growth in Private Label to Come . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Section 1

Private Label Today — Economic Recession to Fuel Growth in Years Ahead . . . . . . . . . . . . . . . . . . . 5

Private Label: a Push Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

The Lasting Impact of the Economic Recession . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Push Factors for Private-label Penetration by 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Private Label Over Time — Lessons for Developing Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Section 2

Private Label Tomorrow — Market Share to Reach 50 Percent by 2025 . . . . . . . . . . . . . . . . . . . . . . . 9

Not all Private-label Products Serve Similar Needs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Private-label Share to Double to 50 Percent by 2025 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Long-term Growth Drivers of Private Label . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Section 3

The Role of A-brands Gains Importance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

A-brands Expected to at Least Hold on to Their Market Share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Price — The Marriage Between Private Label and A-brands . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Retailers Need the A-brand as the Category Price/Quality Anchor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Consumers Want to Find A-brands in Their Supermarkets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

Function and Emotion Drive Brand Success . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

Section 4

Challenging Times for B-brands . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

B-brands in the Squeeze . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Pick Your Battle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Price Competition Flares Up — The Emergence of Private-label Specialists . . . . . . . . . . . . . . . . . . . . . . . . 18

Consolidation in Private-label Supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Empty Quadrant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Chicken or Egg? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

Executive Summary | 1

The conclusion that private label is expectedto expand market share in the coming yearswill not come as a surprise to anyone.However, private-label growth only forms the starting point of this analysis.

Whether private-label growth is anopportunity, a challenge, or perhaps both for an individual food supplier depends on the supplier’s market position. Only byassessing the impact of private-label growthon the supply structure can the strategicimplications for food processors be identified.In addition, the relationship between brandsand private label needs to be addressed. Afterall, in the zero-sum game of the food market,the fate of A and B-brand suppliers is tiedclosely to the developments in private label.This impact becomes more tangible once weput numbers to the growth outlook. In orderto sketch the growth path of private label forthe coming 5 to 15 years, we’ve examined the ‘raison d’être’ of private label and reached the following six conclusions:

I. Private-label Share is Expected toDouble to 50 Percent by 2025

Private label is a push market. It ispredominantly driven by food retailers. Themain bottleneck for growth has been theeconomies of scale required for economicallyviable production levels. Private-label share ispositively correlated to concentration levels in food retail. On the basis of assumptions for autonomous growth and consolidation infood retail by 2015 and 2025, we come to anestimated share for private label of 50 percent

by 2025. Compared to the current level of 25 percent, this entails that private labelmarket share is set to double in the coming 15 years.

II. The Role of A-brands Gains ImportanceA-brands are expected to hold on to theirmarket position. Neither retailers norconsumers can do without these referenceproducts. Consumers need brands tobenchmark the price competitiveness of theirsupermarket. Food retailers need the A-brandas the price and quality anchor for eachproduct category. Competing fiercely with A-brands on price would result in lower retailselling prices for private label and would cut into the overall category profitability.Moreover, without A-brands, the productcategory could become trapped in adownward price/quality spiral.

III. Challenging Times for B-brands The combination of A-brands holding on to their share and the expected growth inprivate label means that the pressure willmount on the smaller, often local, B-brands.The private label and A-brand competitionwill likely result in volume pressure anddelistings for B-brands. Additionally, giventhat many product categories are alreadycharacterised by overcapacity and thatproduction utilisation rates are key to stayingout of the red, sales volume declines are likelyto trigger heavy price competition betweenB-brand suppliers.

Executive Summary

2 | Rabobank Private Label vs. Brands

IV. The Emergence of Private-labelSpecialists

The battered B-brand suppliers have twostrategic options: find market niches(innovation) or go for cost leadership (scale).The former is not a feasible option for manysuppliers, so the main focus will be on thelatter. Volume growth is key to achieving costleadership, so B-brand suppliers will want totap into the strong growth outlook for privatelabel by becoming private-label specialists.Private-label specialists strive to increase thescale of their production and service levels,lower their client dependency and improvetheir negotiating position on the sourcingside. Trying to attain these scale advantagesby means of hybrid production (producingthe B-brand and private-label productssimultaneously) is seldom a win-win strategyand often accelerates the deterioration of the B-brand.

V. Consolidation in Private-label SupplyAcquisitive growth is an important buildingblock for private-label specialists. Expandingprivate-label production capacity by means of a takeover avoids adding even moreproduction overcapacity to the market,possibly eliminates a competing B-brand, and improves the chances of attainingrelative cost leadership. Any merger andacquisition (M&A) steps are likely to triggerreactions by other players. Notably, private equity involvement and A-brandconsolidation are catalysing the consolidationprocess in private-label supply.

VI. Professionalisation of Supply FuelsAdditional Private-label Growth

Intense price competition and the emergenceof private-label specialists are likely to lead tohigher quality private-label products at lowerprices. Private-label specialists that have aninternational presence could leverage theirbest practices and new product developmentacross countries. The resulting scaleadvantages in production would reducecosts, while the economies of scale intraceability and quality control wouldimprove product offerings. This should bemusic to the ears of food retailers. Thisprofessionalisation of supply is expected to give another push to the private-labelsuccess story.

Introduction | 3

Private label accounts for about a quarter ofthe food that is sold through modern foodretail outlets worldwide. However, eachsubmarket (one product category in onecountry) has its own battle between brandsand private label. A very rough calculationalready points to over 100,000 differentsubmarkets, each with their own dynamics.

The products that are made exclusively for a particular food retailer are referred to asown brands, store brands, retailers’ brands,private label, etc. For the sake of simplicity,‘private label’ is used throughout this report.This report adheres to the Private LabelManufacturers Association (PLMA) definition,according to which, private-label products‘encompass all merchandise sold under aretailer’s brand’. That brand can be theretailer’s own name, e.g., Tesco or Carrefour, or a name created exclusively by anassociated purchasing desk, e.g., Euroshopperor First Choice Cola, or by the retailer itself,e.g., Perla (Albert Heijn) or 365 (Delhaize). The‘fancy’ labels (unmarketed brand names) soldby hard discounters, such as Lidl and Aldi, alsofall into the latter category. Commondenominators for any private-label productare that the supplier is not actively marketingthe brand/product directly to the consumerand the ultimate control over the product is exercised by the retailer. A and B-brands are defined as any products that are notprivate label.

Generalising about private label is potentiallyproblematic. Fortunately, the outlook for eachof the thousands of submarkets can be traced

back to a couple of common denominators.Foremost among them is that the private-label market is a typical push market. Foodretailers have been involved with private label since its inception and will beinstrumental in boosting its growth in the coming 5 to15 years.

The Raison d’être for Private Label in a NutshellIn essence, food retail is an efficient way ofdistributing food products from numeroussuppliers to a broad consumer base. Over the years, as brands gained strength throughadvertising and promotional efforts, brandsuppliers were able to grab a larger share ofthe profit pool, often at the expense of foodretailers’ margins. Once retailers began torealise that consumer access is a very valuableasset, they started looking for ways to take a larger piece of the margin pie.

In addition to increasing negotiation powervis-à-vis suppliers by increasing scale(industry consolidation), retailers begantaking advantage of consumer intelligenceand consumer access by offering their ownprivate-label products. The introduction of such in-store competition has first and foremost helped retailers in pricenegotiations with branded product suppliers.In addition, offering their own products allows retailers to hold on to a higher share of the manufacturing margin. Finally, theintroduction of private-label products helpsbuild consumer loyalty and differentiatesfood retail formulas.

Introduction

4 | Rabobank Private Label vs. Brands

Are Brands Winning Back Market Share?Judging by the benefits for food retailers, the sky should be the limit for private label.However, recent newspaper headlinessuggest that the growth of private label has come to a halt. Have brands found a way to successfully combat private-labelcompetition?

Not really. The revival of brands may well be temporary. Consumers may have tradeddown on quality a bit too fanatically when therecession hit in 2009 and are returning to thecomfort of their favourite brands again. Brandsuppliers themselves are trying to fend off the negative volume impact of the recessionby investing in promotions. And retailersgratefully use the suppliers’ promotionalefforts to signal their ‘lowest price’ image to their clientele.

Overall, the impact of the recession has givenprivate label an enormous boost. However,empirical research shows that private labelwill be forfeiting part of its share wins whenthe economic recovery kicks in, althoughhistorically brands have never been able to fully recoup share losses. And this is onlythe direct impact.

More Growth in Private Label to ComeIndirectly, the effects of the recession will fuel further private-label expansion across the globe for years to come. It has raisedconsumer awareness, prompted furtherexpansion of the hard discount format, and increased the competitive pressure onservice-oriented supermarkets for lower pricepoints and differentiation. All of these factorsand the professionalisation of private-labelsupply are expected to double private-labelmarket share in the coming 15 years.

Private label’s market share gains will affectbrands in one of two ways. A-brands areessential to retailers, so these brands willmaintain market share. The squeeze will befelt by the suppliers of the weaker B-brands.These producers will have to make difficultstrategic choices if they are to retain orstrengthen their market positions. Forced toact by competitive pressure, more B-brandsuppliers will specialise in private-labelproduction, which will likely lead them down a path to consolidation.

Section 1 Private Label Today — Economic Recession to Fuel Growth in Years Ahead | 5

The economic recovery may be slowlygaining traction, but the recent recession will put its stamp on private-label demand in the coming years. The economic dip easedsome of the main limitations to private-labelgrowth as increased price sensitivity drewconsumers to private-label alternatives.

Increased inter-store competition is fuellingthe need for food retailers to pursue bothprivate-label segmentation and economies of scale more vigorously. Economies of scalewill be the main driver of private-label growthuntil 2015. Given the close link betweenconcentration levels in food retail and private-label share, the ongoing consolidation ofsupermarkets and the growing presence of hard discount stores are core to theexpectation that private-label market

share is set to increase by between 3 and 5 percentage points in the coming five years.

Private Label: a Push MarketThe prime beneficiary of growth in private labelis the food retailer. The private-label market is a ‘push’ market, meaning that the width anddepth of the private-label offering is largelydetermined by the food retailer. Of course, theprivate-label opportunities for the food retailerhave limitations, which relate to supply,demand and competition (see Figure 1.1).

Supply — Necessity of Economies of Scalein ProductionTo overcome consumers’ negative perceptionof quality, private-label products are priced ata significant discount compared to brandedalternatives. However, the sales potential of a

1 Private Label Today — Economic Recessionto Fuel Growth in Years Ahead

SUPPLYRETAIL

CONCENTRATION

Differentiation

Market share RecessionPremiumExpansion

strategyShoppingfrequency

Qualityperception

ConsolidationScale International expansion

COMPETITION DEMAND

CONSUMERAWARENESS

Figure 1.1: Limitations and Opportunities in Private Label

Source: Rabobank, 2011

6 | Rabobank Private Label vs. Brands

private-label product is much smaller than for branded alternatives, as the prospectivemarket is capped to the consumers thatfrequent the retailer’s outlets. To source theprivate-label product at a competitive priceand make production economically viable,retailers’ sales volumes must meet a minimalthreshold. This means that the size anddiversity of a retailer’s private-label offering isa function of its market share. Consolidationin food retail is therefore the prime driver ofprivate-label growth.

Demand — The Slow Process of GainingConsumer AcceptanceBrand suppliers invest heavily in building a positive quality image for their productsamong consumers. Retailers can sometimesovercome this perceived quality gap byoffering the private-label alternatives at a significant price discount, but typicallyconsumers remain hesitant towards switching to private-label products. Furthercomplicating the matter is the fact that the price difference could be seen as anindication of lower product quality. Asconsumers gradually become more aware of the comparable quality of private-labelproducts, their willingness to buy private label in other product categories will increase.In this respect, the fairly recent introduction of premium private-label alternatives will helpto raise the overall quality perception ofprivate label.

Competition — Muscle Power from True A-brands and the Expansion of Hard DiscountAlthough in-store competition may be alimiting factor to introducing private-labelproducts, the presence of strong incumbentbrands in itself begs for a private-labelalternative as a negotiating tool for theretailer. However, if brand suppliers hold the majority of the market and defend theirshare vigorously with a well-executed brandportfolio strategy, the prospective market for launching a private-label alternative maywell be too small to be economically viable.

On the other hand, inter-store competitioncould be a catalyst for private-label adoption.The competitive threat of hard discountretailers to traditional service-oriented foodretailers is forcing the latter to introducesimilarly priced products. The service-orientedretailers often rely on private label to offerthose competitively priced products. Inaddition, the rapid expansion of harddiscount retailers in itself raises private-label penetration rates (as the ‘fancy’

brands of hard discounters are included in theprivate-label definition).

It is the supply limitation which is playing thedominant role in the development of private-label penetration. Countries with traditionallyhigh concentration rates in food retail, such as the United Kingdom and Switzerland, orwhere concentration rates increased rapidlyin recent years, i.e., Spain, score high in termsof private-label adoption. So do countrieswith above-average hard discounterpresence, i.e., Germany. (see Figure 1.2).

The Lasting Impact of the Economic Recession The recent economic crisis neatly shows how the limitations — supply, demand andcompetition — tie into retailers’ decision-making processes and often interact.Undoubtedly, the recession has had a directpositive contribution to private-labeladoption worldwide. But the indirect effectsmay be of even more importance for private-label growth in the long term.

An economic recession triggers priceconsciousness among consumers. As peopleattach greater importance to lower prices,they attach less priority to perceived quality.Consumers therefore become more willing to try unfamiliar brands and/or private label if this enables them to reduce their foodexpenses. The recent recession has opened up the ‘demand’ side for private label. Foodretailers are catering to this increased interestby expanding their private-label assortment.Drawn into private-label consumption byfinancial circumstances, consumers may findthat the actual quality gap between brandsand private label is less than they hadoriginally anticipated. Once they growaccustomed to buying private-label products,the barrier to trying other private-labelproducts is significantly reduced.

In their search for cheaper products,consumers will shop at various food retailformats. Notably, the hard discount format is benefitting from the increased pricesensitivity and lower banner loyalty amongconsumers, which gives another short-termboost to private-label penetration rates. Inturn, the real and potential share wins of harddiscount retailers prompt the service-orientedfood retailers to shore up their value private-label lines.

As hard discounters gain share, volumes comeunder pressure and price competition flares,making it more difficult for service-orientedfood retailers to differentiate themselves and

Section 1 Private Label Today – Economic Recession to Fuel Growth in Years Ahead | 7

maintain profitability. The economic recessionhas accelerated the shake-out in the foodretail industry. Ailing smaller food retailformulas are being acquired and thelandscape is consolidating — mostly on acountry-by-country basis. This consolidationwave increases retail concentration levels. As the big get bigger, so do their respectiveclient bases and their sales volumes, wearingdown the ‘supply’ limitations on their private-label offerings.

Push Factors for Private-labelPenetration by 2015Regardless of the economic climate, the limitations of supply, demand andcompetition are expected to ease evenfurther, providing food retailers with moreroom to push and expand their private-labelstrategies. It is estimated that by 2015 theoverall private-label value share1 will hover ataround 30 percent of global food retail sales.It currently accounts for about 25 percent ofthe market.

Market data for 2004 and 2009 clearly reflectthat changes in food retail concentration rates and/or hard discount market shares areclosely correlated to market share wins ofprivate label (see Figure 1.3). An anticipatedconsolidation amongst the larger retailersand continued growth of hard discount in the coming five years provides a sound basisto make a country-by-country prediction forthe position of private label by 2015.

The underlying growth outlook is not equallydistributed over all regions/countries. The

largest growth potential for private label inthe coming five years is found in countrieswhere consolidation ranks high on the foodretailers’ agendas: Germany, the Netherlands,Spain, Russia and Poland. A second growthdriver will be hard discount expansion. This is expected to support private-label growth in Russia, Poland and Italy.

Other push factors are more difficult totranslate into numbers. For example, severaltop-three food retailers in Germany and theUnited States (US) have only recently madeprivate label the spearhead of their growthstrategies. Their current private-label share isaround 15 percent to 25 percent. Comparedto their British peers that generate half oftheir revenues through private label, theGerman, US and many continental Europeanfood retailers still have plenty of room forgrowth. Note that private-label growth is notnecessarily solely driven by the top-threeretailers. Notably in Spain, Italy and Poland,second-tier food retailers are also cooperatingclosely to expand their private-label offering.

Private Label Over Time — Lessons for Developing CountriesIt has taken between 50 and 60 years forprivate label to reach a penetration level of over 40 percent in the United Kingdom.Central and eastern European countries like the Czech Republic and Hungary areprogressing much faster, taking about 20 years to reach half of that level. Growth in private label seems to accelerate oncepenetration rates reach between 5 percentand 10 percent, e.g., Russia and Turkey.

1 Throughout the report ‘market share’

is defined as share by value unless

otherwise stated.

CEE 04

CEE 09

CEE 15e WE 04WE 09

WE 15e

US 04

US 09

US 15eAus 04

Aus 09Aus 15e

Mex 04Mex 09Mex 15e

Rus 04Rus 09

Rus 15e

2025e

0

10

20

30

40

50

60

0 10 20 30 40 50 60 70 80 90 100

Figure 1.2: Private-label Share vs. Food Retail Concentration

private-label market share (percent)

e=estimate

Source: IGD, Euromonitor, Nielsen, PLMA, Rabobank, 2011

Food retail top-three + hard discount market share (percent)

Fr 04

Fr 09

Fr 15e

Ger 04 Ger 09

Ger 15e

It 09

It 04

It 15e

Nl 04

Nl 09 Nl 15e

Sp 04

Sp 09

Sp 15e

Ch 04 Ch 09 Ch 15e

UK 04

UK 09

UK 15e

WE avg 04

WE avg 09

WE avg 15e

0

10

20

30

40

50

0 10 20 30 40 50 60 70 80 90

Food retail top-three + hard discount market share (percent)

Global Western Europe

8 | Rabobank Private Label vs. Brands

Given the surge that modern retail andnotably hard discount are making, and thepresence of international retailers, mosteastern European countries are likely to catchup with ‘developed’ markets within one ortwo decades. But, what can be expected fromprivate label in countries that are still in the earliest start-up phase like Mexico, China and India? Private-label penetration in these countries is still well below the 5 percent threshold.

In these rapidly developing countries, faith in private label will be tied closely to theexpansion of modern retail. International foodretailers are paving the way for a smooth roll-out of private label once modern retail gets a foot on the ground — thanks to their brandimage, best practices and professionalpurchasing organisation. The likelihood that,in time, these food retail markets will alsoconsolidate is already leading to speculativeM&A activity.

In the 1950s and 1960s modern retail andbrand suppliers shared the same goals,making entry to developing countries mucheasier than it is today. In developed countries,

brands started off by gaining the loyalty ofconsumers that had been reserved for thetraditional ‘mom and pop’ shops. Thanks to brands, consumer trust was placed in the product not the seller, and modern retailgained traction. The supermarket banner has become a brand of its own and consumerloyalty is shifting back to the retailer again ―creating an ideal platform for private label(see Figure 1.4).

In developing countries, brand suppliers still have a reputation to build on their own.Rather than focusing solely on modern foodretail, brand suppliers are also supporting thefragmented traditional ‘mom and pop’ outletsby tackling important consumer issues suchas food safety and convenience. The brandsuppliers may therefore be able to delay theconsolidation in food retail. This will buy themtime to build enough brand loyalty before the retailers get the upper hand at thenegotiation table and before private labelreally takes off. By 2025, the developingcountries are expected to have reachedpenetration levels similar to where centraland eastern European countries are now —between 10 percent and 25 percent.

Figure 1.3: Largest Private-label Share Gains, 2010-2015 (in percentage points)

Poland 11

Russia 9

Turkey 8

Italy 8

Netherlands 4

Spain 4

Germany 3

Source: PLMA, IGD, Euromonitor, Rabobank, 2011

high

low

time and/or market maturity

Loyalty to retailer

‘Mom and pop’ shops and live markets selling artisanal products

Cash and carry shops and modern retail selling branded products

Service retailers increasingly selling private-labels products

Figure 1.4: Loyalty Curves — Ranking Regions According to Food Retail Market Maturity

Source: Euromonitor, Eurostat, Rabobank, 2011

Africa

SE Asia

India

China

Turkey

South America

Russia CE Europe

US

NW Europe

Loyalty to brand of food processor

Section 2 Private Label Tomorrow — Market Share to Reach 50 Percent by 2025 | 9

Consolidation levels in modern food retailand rising share of hard discount are a goodbasis for quantifying the private-label growthoutlook in the short to medium term. But forthe long-term outlook an important element is missing: the role of private label for the food retailer.

Many, if not all, retailers are active in privatelabel, albeit at very different levels of intensity.The use of copycat products to build pressureon the brand supplier is quite common.British supermarkets in particular take theirprivate-label strategies a couple of stepsfurther. By segmenting the private-labelmarket, they are turning their products into a differentiating factor and reputation builderall in one. The retail banner is becoming a brand in its own right.

The food retailers that adopt a proactiveprivate-label strategy will still have plenty togain. By 2025, private label will have doubledits share to at least 50 percent of global foodretail consumption.

Not all Private-label Products ServeSimilar NeedsThe prime reason for retailers to introduceprivate label has been to keep pressure on price negotiations with brand suppliersand to demand a larger share of themanufacturing margin. To reach a 50 percentpenetration level, retailers cannot rely onmimicking strong brands alone. A more

proactive private-label strategy is required in which consumer loyalty and differentiationplay more important roles. This warrants acloser analysis of the drivers of the differentstages of private label.

Mainstream Private LabelThe copycat stage is the starting point for private label. The prime motive forintroducing private label is to strengthen the food retailer’s position at the negotiationtable. By introducing a 1:1 copy of a brandedproduct at a 20 percent to 30 percent cheaperretail price, the retailer is able to demand alarger share of the profit pool. To put pressureon the brand supplier in the negotiationprocess and convince the consumer that theprivate-label product is a suitable substitutefor the brand, the copycat or mainstreamprivate-label product needs to stay close tothe looks and product characteristics of itsbranded counterpart.

The first financial win for food retailers stemsfrom price concessions that the brandsupplier makes in the negotiations on thebranded product — higher gross margins,larger promotion budgets, etc. However,retailers generally make better margins ontheir private-label products as well, despitethe lower retail price (see Figure 2.1). Strippedof typical ‘brand’ costs like marketing andinnovation, the sourcing costs of private-labelproducts could be some 30 percent belowtheir branded counterparts.

2 Private Label Tomorrow — Market Share to Reach 50 Percent by 2025

10 | Rabobank Private Label vs. Brands

Although in general the retailers’ operatingmargins on private label will be higher thanon brands, it is uncertain whether the retaileractually earns more money in absolute terms.The higher retail price and often higher shelf turnover of brands support absoluteprofitability for the retailer. Although margin-wise, the private-label product looks moreprofitable, the profit on A-brands will not bevery different from the copycat private-labelalternative, especially once the priceconcessions that retailers negotiate from A-brands by having private-label products on their shelves are factored in.

Recent empirical research has indicated that once the food retailer has established astrong reputation for its private-label product,consumers tend to take offence to purecopycat products2.

Value Private LabelCopycat products that compete with brands(in-store) are the mainstream in private label.However, private label is also used to positionthe retailer vis-à-vis other food retail formulas(inter-store).

To fend off competition from hard discounters,service-oriented supermarkets haveintroduced generic, basic food products at adeep price discount of between 40 percentand 60 percent compared to brands. Thesevalue private-label products are meant tosignal the retailers’ price competitiveness and to prevent consumers from defecting to hard discount food retail formulas.

Offered at a lower price/quality level, the look-and-feel of the entry-priced valueprivate-label products needs to be distinctly

different from the mainstream private-labelrange in order not to dilute the quality imageof the mainstream offering.

A separate range that largely falls in the valueprivate-label category is fancy labels. Fancylabels are brand names that are exclusivelyused in one store and are not supported bymarketing. They are typically found in thehard discount channels. During the economicrecession, some service-oriented retailersused fancy labels as a temporary extension of their value private-label offering. As thesefancy labels could cannibalise the mainstreamoffering during the economic recovery, theyare expected to be quietly phased out againin the coming years.

Premium Private LabelAnother way of using private label to positionthe retailer is on the opposite side of theprice/quality spectrum. Premium private label is placed at or above the price points of brands.

Keeping the consumer on board is theleading driver at this stage as well. By offeringhigh-end product ranges that, for example,outperform in terms of quality, are regional or have a seasonal nature, the retailer is ableto differentiate not only from brands, butnotably from other food retail formulas.

The higher price level may allow highermargins, but this is not the prime focus. The premium private-label range first andforemost builds consumer loyalty. In addition,it can strengthen the retailers’ quality imageamong consumers, which can benefit itsentire private-label offering.

2 Breaking the mould on copycats:

what makes product imitation

strategies successful.

Femke van Horen. 2010

Figure 2.1: Simplified Food Retail Profit and Loss Account — Mainstream Private Label

Brand Private label

Retail selling price (RSP) 100 80

Cogs 80 57

Staff 8 8

Housing 5 5

G&A 3 3

Handling/sourcing costs* 3

Operating profit 4 4

Gross margin 20% 29%

Operating margin 4% 5%

*Generally private-label products will generate higher gross margins for the retailer than branded alternatives. The gross margin does nothowever, cover all costs associated with private-label products. The retailer will need to invest in market intelligence, in-house marketingexpertise, product innovation, purchasing, tracing/tracking the supply chain and knowledge of raw material. In addition, not all private-labelproduct introductions will be successful; start-up costs are not always recovered in the gross margin.

Source: Private label, brands and competition policy, 2009; Rabobank, 2011

Section 2 Private Label Tomorrow — Market Share to Reach 50 Percent by 2025 | 11

Private-label Portfolio Management — A Brand Called Private LabelThe success of private label has an importantside effect for the retailer. Consumers nolonger only see the supermarket as the placeto buy food products, but also as a trusted‘food processor’. In this stage, the retail bannerbecomes a food brand on its own. Typicalbrand characteristics such as image,marketing, reputation and consumerrecognition start playing a role.

The segmentation into value and premiumprivate label is a prelude to a true brandportfolio. It is difficult to use one brand acrossso many different product categories, so sub-branding is a quite common private-labelstrategy. The retail banner becomes anumbrella brand under which retailers candeploy sub-brands to address or even createniche markets.

A full-fledged private-label segmentationstrategy allows retailers to address severalobjectives in one go. Mainstream private labelprovides a counterbalance to the negotiationpower of the brand supplier, while private-label differentiation generates higherconsumer loyalty. Premium private label and sub-branding reinforce the quality imageof the retailer, which rubs off on the entireprivate-label portfolio. Meanwhile, the valuerange retains the most price-sensitiveconsumers. Finally, if executed correctly, anactive private-label strategy should generatehigher margins as well.

Private-label Share to Double to 50 Percent by 2025The food retailers who have been mostproactive on the private-label front have been able to boost private-label share in theiroutlets to some 50 percent to 55 percent. This provides a good basis for a long-termprediction of private-label share. It seems fair to assume that the top-three retailers in developed markets (western Europe, the US and, to a lesser extent, Australia) or incountries where modern retail is gainingtraction (central and eastern Europe, Russiaand Turkey) will start — or have alreadystarted — to copy the successful private-labelstrategies from peers such as Tesco, Asda, AH or Mercadona. Second-tier supermarketsalso require private-label offerings, usuallyconsisting of niche and regional products, in order to differentiate themselves from the top-three. However, their lack of scale isexpected to cap their private-label exposureto about 30 percent of sales. Hard discountersare expected to stay true to their roots and

will focus predominantly on private label,which constitutes roughly 80 percent of their sales.

Our estimate of overall private-label adoptionby 2025 is closely linked to forecasts fordevelopments in the food retail structure overthe coming 15 years. Looking at the marketstructure in mature countries in westernEurope, and the ongoing consolidation trend,the top-three are expected to account for an approximate share of between 60 percentand 70 percent in each country by 2025. Theshare of hard discount is expected to grow to about 10 percent to 15 percent — leaving a 20 percent to 25 percent share for thesecond-tier supermarkets. The weightedaverage of private-label penetration bymarket segment and the anticipated foodretail structure point to a private-label shareof at least 50 percent of global food retailsales by 2025, which is double the currentshare of 25 percent (see Figure 2.2).

Mainstream private label will see somegrowth leaking away to the value andpremium segments, but as mainstream stillrepresents the majority of the category, it isexpected to grow about twice as fast as theoverall food retail market.

The growth outlook until 2025 differs fromsegment to segment since many service-oriented supermarkets in continental Europeand the US only fairly recently started to focus on a segmented private-label strategy.Notably the premium private-labelpropositions are expected to show stronggrowth. Roughly based on the currentsituation in the United Kingdom, premiumprivate label is expected to account for 8 percent of the market in 15 years. As theshare of premium private label currentlystands at 2 percent, the expected growth rate is nearly four-times that of the overallmarket growth.

Long-term Growth Drivers of Private LabelThe conclusion that private-label penetrationwill have reached 50 percent by 2025 is basedon assumptions about food retail marketstructure. The underlying drivers for private-label growth are scattered over a number oftrends/strategies. To complicate matters, thereis a strong interdependency between thegrowth factors. The 11 arguments for private-label growth are summarised below.

• Consumer acceptance levels are rising. The acceptance of private label is not onlystrengthened through increased price

12 | Rabobank Private Label vs. Brands

sensitivity (economic recession or harddiscount competition). The introduction of premium private-label products is havinga positive effect on consumer perceptions of private-label quality.

• Continued industry consolidation indeveloped food retail markets (westernEurope, the US and Australia). Economies of scale in logistics, procurement, marketing,store opening strategies and private labelwill continue to fuel sector consolidation.Larger operating scale provides moreopportunities to launch private label.

• Adoption of modern retail in developingmarkets (central and eastern Europe, Russiaand Turkey). Retail chains are winning shareat the expense of traditional retail. Moreprofessional and larger scaled procurementorganisations are prerequisites forexpanding the private-label offering.

• Growing share of hard discount. Share gains are expected for hard discounters on the back of increased price awareness, a consumer trend toward demandpolarisation (indulgence versus value for money) and ongoing expansion indeveloping countries.

• Hard discount competition is driving valueprivate-label growth. Service-orientedsupermarkets are expanding their valueprivate-label offering, aiming to retain traffic and prevent customers defecting to hard discounters.

• Need for diversification among service-oriented supermarkets. The ongoingconvergence of service and price-oriented

business models is driving the need for service-oriented supermarkets todifferentiate through premium private label.

• More comprehensive private-label strategiesof larger retailers. Many top-three retailers indeveloped countries are still in the earlystages of private-label adoption and haveonly recently started to look at private labelas one of the pillars for growth.

• Need for diversification among smallersupermarkets. Smaller, regional food retailersneed private label to help them carve out a niche position in a rapidly consolidatingmarket.

• Increased professionalism of private-labelsuppliers. The emergence of specialistprivate-label suppliers is increasingprofessionalism and quality levels, thusimproving the ‘image’ of private label among retailers and consumers.

• Consolidation among A-brands underminesretailers’ negotiation positions. Larger A-brand suppliers drive the need for foodretailers to reinforce their position at thenegotiation table by expanding theirprivate-label offering.

• Price competition in private-label supply is expected to heat up. As private label andA-brands are winning share, producers ofdelisted B-brands are looking for alternativeproducts/markets to safeguard theirproduction capacity utilisation rates (andprofitability). This is expected to fuel pricecompetition in private-label supply.

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2025f201020092008200720062005200420032002200120001999

Figure 2.2: Brand/Private-label Market Shares, 1999-2025f

percent

f=forecast

Source: Euromonitor, PLMA, Rabobank, 2010

Super premium A-brand B-brand Premium PL Mainstream PL Value PL & HD

Section 3 The Role of A-brands Gains Importance | 13

In developed countries, the majority of foodreaches consumers via modern food retail.The food retailers control the main route to market. What if these retailers decided tobar brands from their shelves? Withoutcompeting brands, private label would beheading for a golden future.

The title of this report ‘Private Label vs. Brands;An Inseparable Combination’ already impliesthe answer to this question. After all, theconclusion that private label will double itsshare to 50 percent by 2025 also means thathalf of the market will still be buying brandedfood products.

Many of those surviving brands will by nomeans be passive bystanders. Strong brands— so-called A-brands — are expected tomaintain their current market share. Neitherconsumers nor retailers can do withoutstrong A-brands. Consumers value in-storecompetition and retailers would chase theirclientele out of the shop if they reducedconsumers’ choices to private label only.Perhaps retailers need A-brands even morethan consumers, as they form the priceanchor of the category as a whole.

A-brands Expected to at Least Hold on to Their Market Share Looking back at the past five years, the impactof private-label growth on A-brands’ marketshare has been limited. A-brands have beenable to keep up with or outpace marketgrowth in more than half of the categories(see Figure 3.1). Notably, B-brands havesuffered the consequences. As B-brand

suppliers lack the financial firepower to keepup with the innovation and marketing pace of their bigger competitors and as retailersreorganise their shelves — to make room for the expanded private-label offering — B-brands are the first to be delisted. Foodretailers need the A-brand both from aprofitability (price/quality anchor) andvolume (consumers’ price benchmark) point of view.

The market share expansion of A-brands incategories such as beer, margarine and frozenpizza may look counterintuitive. Autonomousgrowth will be difficult for A-brands toachieve in such mature product categories.However, in less developed regions such as central and eastern Europe, A-brands stillhave plenty of share to win or to acquire. Over the past years, larger food multinationalshave been actively targeting the top-threepositions in selected product categories,partly by acquiring local heroes or non-corebrands of fellow-multinationals. This trend isexpected to continue. Moreover, the buy-and-build strategies of private equity-held brandsuppliers support the outlook for A-brandconsolidation. Consequently, A-brandsuppliers as a group are expected to hold on to or possibly even enlarge their marketshare in the years to come.

Price — The Marriage Between PrivateLabel and A-brandsA brand is the unique identity of a specificproduct, service or business. Brands aim tomeet identified consumer needs and have

3 The Role of A-brands Gains Importance

14 | Rabobank Private Label vs. Brands

both a reputation (goodwill/loyalty) andrecognition function, on which consumersbase their choices. A brand can have manyidentifying markers, including a name, sign,symbol, colour combination or slogan. Wehave defined brands as anything that is notprivate label. A distinction can be madebetween strong brands — so-called A-brands— and weaker B-brands.

The strength of a brand is determined by its reputation among consumers. Consumersare willing to pay a substantial premium for a strong brand and, perhaps just asimportantly, consumers are willing to accept more inconvenience in order to obtain a strong brand.

As mainstream private-label products aremarketed primarily as the budget alternativeto A-brands, their retail price tends to be tiedto the pricing of their branded counterparts(see Figure 3.2). The price discount is afunction of the brand image, perceivedquality differential and the food retailer’spricing/portfolio strategy. Depending on thecountry and category, mainstream privatelabel is on average between 20 percent and30 percent cheaper than A-brands. Value orgeneric private-label products are typicallypriced at a discount of roughly 40 percent to 60 percent in order to compete with harddiscounters. Premium private label, on theother hand, can be just as or even more

expensive than the A-brand on the basis of the quality of ingredients.

Competitive considerations are not the onlyfactors influencing private-label pricing. Otherfactors that play a role are the anchor role of the A-brand — absolute price level percategory and price volatility — and retailers’attempts to manage consumer perception(portfolio segmentation strategies). A strongA-brand is in the interest of both retailers and consumers.

Retailers Need the A-brand as theCategory Price/Quality AnchorMainstream private-label retail prices areoften directly linked to the prices of the A-brand. This means that the A-brand price level is a key factor in the retailers’ profitmargins on their private-label offering. Giventhe interdependency of the two, any priceadjustment in the A-brand (upward ordownward) is likely to filter down into theprivate-label price as well. Consequently,retailers will not be inclined to undermine the position of the A-brand completely, as this will cut into their own profitability.

In addition, the A-brand is instrumental incommunicating bad news, i.e., price hikes, to the consumer. In inflationary times, such as 2007/08, retailers actually welcomed the retail price increases implemented by the A-brand suppliers. The impact of raw

Beer Spirits

Baby food

Biscuits

Cereals

Canned vegetables

Chilled pizza

Chilled ready meals

Chocolate tablets

Chewing gum

Pastilles

Milk

Yogurt

Rice

Frozen pizza

Frozen vegetables

Frozen ready meals

Ice cream TH

Margarine

Spreadables Ketchup

Mayonnaise

Pasta sauces

Table sauces

Chips/crisps Cola Orange carbonated

100% juice

-6

-4

-2

0

2

4

6

8

exce

ss v

alu

e g

row

th p

riva

te la

bel

-4 -2 excess value growth top-three brands

0 2 4 6 8

Figure 3.1: A-brand Growth and Consolidation

Note: Excess value growth is defined as value growth of top-three brands/private label minus market growth

Source: Euromonitor, Rabobank, 2011

percent

Section 3 The Role of A-brands Gains Importance | 15

material or packaging cost inflation weighsconsiderably more on private-label productsthan brands, as it represents a substantiallylarger proportion of the product’s cost price.Without the A-brand suppliers raising theirprices, it is more difficult for food retailers to recoup higher raw material and packaging costs.

Last but not least, an A-brand often serves as the quality benchmark of the category. The quality of the A-brand product and themarketing around it determine the absoluteprice level that the consumer is willing to pay.Without the A-brand and the associatedmarketing, the price premium of the categorywould fade and competition could draw theretailers into a negative quality/price spiral.The absence of a strong A-brand can bedetrimental to the overall profit pool in thecategory, including the retailer’s share.

Consumers Want to Find A-brands in Their SupermarketsIt’s not only the retailers who want to see A-brands on their shelves. The availability ofA-brands provides consumers with a sense offamiliarity and choice. An over-representationof private label evens out the differencebetween full-service formulas and harddiscounters. There is no magic number for theoptimal private-label share. Among retailers,the most active private-label proponents —some of which paid the price for private labelover-representation — seem to settle atabout a 50 percent to 60 percent share.

The A-brand is also the price benchmark for the consumer. It allows the consumer to compare supermarkets on priceattractiveness. By definition, a private-labelproduct of one supermarket will not be foundon the shelves of its largest competitor. Thatmakes fair comparisons much more difficult.On the other hand, A-brand stock keepingunits (SKUs) tend to be similar from onesupermarket to the next. Typically, retailersplace more emphasis on promoting A-brandsduring a price war, as witnessed during the recent economic recession. Althoughprivate label may address the rising priceconsciousness of the consumers, the A-brandpromotions help the retailers to signal their‘lowest price’ image to the consumer, and thatsupports traffic even better.

Function and Emotion Drive Brand Success The share of A-brands can differ greatlybetween different food categories. Categoriesin which product characteristics or marketingplay important roles typically have a higherbrand share (see Figure 3.3). Private label ishigher in categories in which differentiation is more difficult to establish, such as frozenvegetables or ‘need-to-have’ products. Eachcategory will have its own dynamics.

We have concluded that private label is set to double its share to 50 percent. Themarket share of private label is likely to rise in many categories, but it should be clear that 50 percent is an average. The main differences

Price

A-brand

Fancy label

Value private label

Mainstreamprivate label

B-brand

Premium private label

Super premiumbrands

Perc

eive

d q

ual

ity

Figure: 3.2: Price Segmentation

Source: Rabobank, 2011

16 | Rabobank Private Label vs. Brands

are not likely to level out in the coming years.Some convergence is likely, but A-brands willalways have product categories which theycan dominate.

This dominance is supported by the two main roles of A-brands: meeting identifiedconsumer needs, and enhancing reputationand recognition. Meeting consumer needsrepresents a functional role where theemphasis is on product characteristics.Reputation and recognition relate toemotions and explain the importance of marketing to raise brand value.

There is no ‘one size fits all’ answer, but thesefunctional and emotional roles do give brandsuppliers two important levers to successfullyfend off private-label competition andmaintain market share.

1. Functional benefits are prettystraightforward. Generic formulations tend to fall prey to private-label suppliers.Standard ingredient lists leave little room for brand suppliers to differentiate. A-brands will have to stay ahead of thecrowd in terms of taste, texture, healthbenefits, nutritional values, packaging, etc.Innovation is a key requirement for brandsuppliers to maintain a premium consumerperception. The competition with privatelabel is fought out at the product level through:

• Innovation — developing taste, texture,ingredients or packaging to improveconvenience, indulgence or healthperception among consumers

• Patents/trade marks — impose structuralbarriers to prevent copying and defend

this competitive advantage in court if necessary

2. Emotions are less tangible. The reputationof a brand can overcome uncertainty orsignal status. Uncertainty makes consumersembrace safe and reputable brands;notably in categories like baby and petfood ‘only the best is good enough’. Theultimate example of a food brand as astatus symbol is, of course, Coca-Cola. Theaspirational value that is attached to thebrand goes beyond marketing and allowsfor premium pricing.

Cultivating an image by means ofadvertising and marketing plays animportant role in creating and maintaininga brand reputation. But investing in otheraspects of the brand can build emotionalvalue as well. These alternative strategiesare all geared to fight the ‘brand values’ of private label.

• Traceability/food safety — backwardintegration and leveraging scale

• Sustainability/social issues — globalsustainability themes like water supply,hygiene, hunger or animal welfare

• Regionalisation — targeted markets toosmall for the retailer

• ‘Race on Sunday, sell on Monday’ —indirect brand aspiration throughfoodservice, music and track record

• Personalisation — customer engagementon a one-to-one basis

• Distribution — other routes to market(foodservice, internet, cobranding)

Figure 3.3: Private-label Penetration Differs per Category

Source: Rabobank, 2011

<10%Cola; beer; spiritsbaby; pet food;confectionery

(insecticides)

>60%Chilled food;

spreads;dairy products

(kitchen towels)

Priv

ate-

lab

el p

enet

rati

on

Marketing;functional ingredients;

health;indulgence

Value-for-money;generic;

fresh supply;‘need-to-have’

Section 4 Challenging Times for B-brands | 17

Certainly in developed countries the foodmarket is mature. Demographic changes andincreased demand for convenience will drivelow single-digit volume growth over the next15 years. That makes the food market virtuallya zero-sum game. For private-label suppliersto double their market share, otherparticipants must lose out. As the role of A-brands will only gain in importance, it will be mainly B-brands that fall victim to the increased competition.

The business models of private label andbrand suppliers are worlds apart. The best bet for B-brand producers is either to carveout a niche product/market combination, or to embrace private label and use theirproduction capacity to leverage theanticipated volume growth in this segment.

Heated price competition in the B-brand and private-label supply markets is expectedto trigger the emergence of private-labelspecialists. The scale advantages that these‘specialists’ are going after are not only to be found in establishing cost leadership;professionalising their offering and reducingtheir risk profile are equally important. Given the importance of scale, consolidation among private-label specialists is only a matter of time.

B-brands in the SqueezeThe private-label growth trend and the steadyA-brand market share will have repercussionson the product offering of food retailers. If food retailers are serious about pushingprivate label, more shelf space will need to

be allocated to these products. With fewermetres available for brands, retailers will be inclined to reduce the number of brandsand simplify their offering. A process referredto as ROB+1 (the offering will be reduced to retailers’ own brands, i.e., private label, + 1 strong A-brand). In mature productcategories, such as frozen vegetables orfrozen snacks, ROB+1 is pretty much commonpractice already.

At the same time, consolidating A-brands will focus on introducing more innovativeproducts in order to defend their preferredlocation on the shelf. Given the sheer amountof money spent by these A-brands on R&Dand marketing, it will become increasinglydifficult for B-brand suppliers to differentiate.Not only will it be hard for consumers to seedifferentiation, for the retailer the added valueof the B-brands will also be jeopardised. B-brand market share is therefore expected to decline steadily (see Figure 4.1).

However, the fiercest competition will takeplace between the B-brand suppliersthemselves. The preference among retailersfor ROB+1 has been pressurising the B-brandsegment for some time. In many productsegments, the supply side is alreadycharacterised by over capacity. The loss offurther market share to private label and/or A-brands is putting more pressure on theproduction utilisation rates of the smallersuppliers. Maintaining production volumes is of the utmost importance for B-brandsuppliers as this determines the contributionmargin and, ultimately, operating profitability.

4 Challenging Times for B-brands

18 | Rabobank Private Label vs. Brands

To retain volumes, manufacturing pricescould be dropped as low as the variable costlevel. So, apart from the share wins of privatelabel and A-brands (impacting volumes), theB-brand market itself is turning into a buyer’smarket (price concessions).

Pick Your BattleIn order to cushion the negative impact on operating profitability, the pressurised B-brand supplier basically has two optionsleft: raising sales levels or lowering the costbase. The top line is a multiplication of priceand volumes sold. Given the importance ofeconomies of scale in food production, thecost base is largely volume-driven as well.

Given that the B-brand supplier finds itself inthis challenging position due to the presenceof A-brands and private-label competition,the option of higher volumes at similar orhigher prices is unavailable. Engaging in afight with an A-brand requires massivemarketing investments. Regardless ofwhether this marketing battle will be won or lost in the long run, the necessaryinvestments behind the brand are likely to push the B-brand supplier into instantoperating losses. Competing for volumes with a private-label supplier will require pricereductions, so this will not result in a win-winsituation for the B-brand supplier.

The strategic options for the B-brand supplierare limited. The B-brand’s volumes are notlarge enough to enable cost leadership, whileits brand image is not convincing enough for the consumer to pay a premium for itsproducts (see Figure 4.2). The challenge foreach B-brand supplier will be to pick its battle

carefully. The suppliers either want to move‘up’ to a higher price level or move ‘right’towards lower costs. Trying to do both at thesame time would be counterproductive ineach direction.

Price Competition Flares Up — TheEmergence of Private-label SpecialistsThe inflow of more B-brand producers andmore production capacity will also fuel pricecompetition on the supply side of privatelabel. Given the strong negotiation position ofthe food retailers and the fragmented supplystructure, the food retailer’s purchasing priceshould evolve to the variable cost level of thecheapest producer. This provides a strongincentive among private-label suppliers toproduce ‘more of the same’, in order to dilutethe fixed costs base (overhead) and raise thegross margin on the product by increasingasset utilisation (leveraging fixed productioncosts), and by reducing waste levels andswitching/cleaning time.

The need for scale in private-label productionis not only dictated by the price negotiationswith food retailers. The food retailers are alsobecoming more demanding with regard tothe professionalisation of their supply chain.As private label is set to gain a larger share ofthe retailer’s wallet, the requirements will riseas well. Factors such as traceability, health,quality control, out of stock, new productdevelopment, internationalisation, etc., arelikely to drive a quest for economies of scaleamong private-label suppliers.

Apart from price and service levels, risk factorsare also an important driver for private-labelsuppliers to pursue scale. The business model

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2025f201020092008200720062005200420032002200120001999

Figure 4.1: The Squeeze, 1999-2025f

market share (percent)

f=forecast

Source: Euromonitor, PLMA, Rabobank, 2010

Super premium A-brand B-brand Premium PL Mainstream PL Value PL & HD

Section 4 Challenging Times for B-brands | 19

of a private-label supplier focuses onproduction processes, customer intimacy,flexibility and contract wins. Scale shouldreduce production risk by allowing longerruns with less switching and give suppliersthe ability to leverage specific client requestsin an international context. Finally, scale andinternationalisation strengthen the suppliers’position in sourcing negotiations and reduce client dependency by broadening the client base.

Consolidation in Private-label SupplyAcquisitive growth is an important means forprivate-label specialists to attain relative costleadership. Key to this strategy is the ‘relative’position, since we concluded earlier that thepurchase price of private label evolves to thevariable cost base of the cheapest competitor.The advantage of expanding productioncapacity by virtue of acquisitions is that it a) does not add to potential productionovercapacity in the industry overall and b) possibly eliminates one of the competingB-brands. Any M&A steps are likely to triggerreactions by other players.

The synergies for these private-labelspecialists are found on the process side(rationalising production capacity) and/or on the customer side (adding new clientrelationships, offering existing clients aninroad into new markets and reducing client dependency).

The consolidation wave is accelerated byprivate equity involvement and A-brands.Consolidation, leveraging scale and increasingasset utilisation are the levers typically pulledby private equity to enhance the value oftheir investments. However counter-intuitiveit may seem, the fierce battle between A-brand food multinationals for the top-two positions is also accelerating theconsolidation process in private-label supply.Stronger A-brands make it even more difficultfor B-brands to differentiate themselves.Private label is set to benefit, as the retailerrequires the mainstream private-labelsupplier to pick up on innovation trends and be able to translate them into volumeproduction within the shortest time possible.Scale and international presence allow these

Figure 4.2: The Strategic Challenge for B-brand Suppliers

Source: Rabobank, 2010

Relative cost advantage

‘Up’ — The supplier improves its relative market position by focusing on the uniqueness of the product, the targeted market and/or the associated service level. Usually, the supplier will try to find a niche product/market combination for which it can create a defendable market proposition. Typical examples of such niches include premium beer, single-serve packaging, regional or seasonal products, convenient distribution (meals on wheels, hospitals), etc.

‘Right’ — The supplier improves its relative cost level by focusing on volume growth. Additional volumes could help the producer to exploit economies of scale and lower the cost price per unit. Since growing branded sales is a very challenging option for the B-brand supplier, volume growth can be achieved by looking at the B2B market. Spare capacity can be used to produce products for A-brand manufacturers or for private label. When taking the B2B-route, producers have the option of continuing production of the B-brand (hybrid production) or abandoning the B-brand entirely to focus exclusively on producing products on contract.

Perc

eive

d v

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Niche brandsPremium private label

A-brands

Mainstreamprivate Label

B-brands

?

20 | Rabobank Private Label vs. Brands

private-label suppliers to react quickly andgear up to economically viable productionquantities immediately.

Empty QuadrantAs concluded earlier, no single marketsegment is alike. Depending on the presenceof brands, the availability of raw materials,barriers to entry, regulation, potentialeconomies of scale, food miles, retailattention, etc., each food segment has its own supply structure. The maturity level andtiming may differ, but all segments seem tofollow a roughly similar consolidation process.

Young market segments contain manyentrepreneurs and a scattered supply base.The most appealing and/or efficientcompanies come to the surface as so-calledlocal heroes. These local brands startleveraging their competitive advantageabroad and start to become true A-brands. A-brands only work if they have the top-twopositions, so the brand space is likely toconsolidate quickly. In a broad sense, this iswhat we have witnessed over the past yearswith major portfolio reshuffling of A-brandpowerhouses like Unilever, Nestlé, Danone,Kraft, etc. The smaller companies left in thebottom-left strategic quadrant are nowlooking for ways to survive in a morecompetitive market. Specialisation in nichemarkets or private label could help thesecompanies to raise returns. This specialisationstrategy is turning into a consolidation drivedue to the severe price competition in privatelabel. In the most mature market segments,

the bottom left quadrant will be virtuallyempty. The market is then divided between A-brands, niche brands and a couple of largeprivate-label producers.

As young markets mature, brands and privatelabels go through several predictable stagesof development (see Figure 4.3).

Chicken or Egg?Once the wheel starts turning, it will not onlybe the retailers that are pushing private label.Many B-brand suppliers will be eyeingprivate-label production, hoping to use theirincreasingly under-utilised machine parks. As private-label production capacityincreases, suppliers will start to push privatelabel as well. Suppliers that have started tospecialise in private-label production willhave all the more reason to encourageprivate-label adoption. Once private-labelsuppliers go international, they will help best practices and new product developmentspread across countries. The resultingeconomies of scale in traceability and quality control will improve product offerings. This consistent high quality andprofessionalisation of their services willencourage retailers to push private label,since the surest way to consumers’ hearts is to deliver private-label products that match or outcompete their brandedalternatives at a lower price.

3 In defined cases, even a private-label

specialist can support a ‘fancy brand’,

if this facilitates the need of a

specific customer/customer group.

Is Hybrid Production a Valid Option to Go After Scale?

It is debatable whether scale advantages can be achieved by combining B-brand and private-labelproduction. The business models of brands and private-label suppliers differ greatly. Unlike private-labelsupply, brand production is about product, image, differentiation and market share. The brand supplierassumes more risk by investing in innovation and marketing. This higher risk needs to be rewarded by a price premium. The main risk of combining the two business models is that the price premium is forfeited. The ability to demand a price premium can be lost on both the consumer and the foodretailer’s side.

Once the consumer comes to believe that both the brand and the private-label alternative areproduced in the same factory and there is no longer any perceived quality difference, the pricepremium fades overnight. In-house availability of a private-label alternative also undermines thenegotiation position of the brand towards the food retailer. The pressure of the retailer may result in:

1. Convergence of product quality – eliminating any product differential of the B-brand2. Convergence of product innovation – reducing time to recoup R&D investments 3. Convergence of accounting – cross subsidising private-label production with brand premium

Hybrid production is often used as a last line of defence. If the private-label business cannot survive on a stand-alone basis, it is likely to accelerate the deterioration of the B-brand. It can work as long as thesupplier stays out of the food retailer’s reach, i.e., using completely independent sales teams, splittingthe branded and private-label business geographically and/or by using spare production capacity on a temporary basis only. In the occasional situation that the branded supplier can raise the barriers toentry for competitors by exclusively supplying the retailer with brand and private-label products, ahybrid production model may work as well. Not many B-brands will be in this luxury position, though3.

Section 4 Challenging Times for B-brands | 21

Source: Rabobank, 2010

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Relative cost advantage Relative cost advantage Relative cost advantage

Relative cost advantage Relative cost advantage Relative cost advantage

1. Fragmented Market

6. Private-label Consolidation

3. Internationalisation

2. Local Heroes

5. Specialisation

4. A-brand Consolidation

Figure 4.3: Supply Structure Changes Over Time

Conclusions | 23

By drilling down to the core — its raison d’êtreand the added value it brings for food retailers— we have been able to sketch an outlook forprivate-label growth. For the time being,private label remains a push market. The mainlimitation for food retailers to fill their shelveswith private-label products is size. The marketpotential needs to be large enough to viablyproduce and sell private labels.

There is a strong correlation between the top-three retailers and hard discount banners’market shares in a country, and the adoptionof private label. Based on the outlook for foodretail consolidation and continued harddiscount growth, private label is expected todouble its current market share to 50 percentby 2025.

This outlook is underpinned by the proactiveprivate-label strategies that many food retailersin continental Europe, the US and Australia areadopting. The multiples in the UK clearly act as role models for food retailers worldwide.

The substantial market share gain of privatelabel by 2025 prompts the question: wheredoes this leave the brands? After all, the foodretail market is virtually a zero-sum game. The answer is two-fold. The stronger A-brandscan rely on the important roles they play for consumers (price benchmark) and foodretailers (price anchor, quality benchmark). A-brands are expected to retain or perhapseven win some market share. The pain will be felt by the smaller, weaker B-brands.

Squeezed between the A-brands and thegrowing private-label share, B-brand supplierswill be faced with a substantial loss of market

volumes. As production utilisation rates arekey to staying out of the red, the volume lossis likely to trigger heavy price competition in both B-brand and private-label supply.

B-brand suppliers will be looking for a wayout before getting stuck between a rock and a hard place. The growth expectation for private label is the most obvious strategictarget. The competitive pressure among many suppliers is expected to trigger theemergence of suppliers that focus exclusivelyon the production of private-label products.We refer to them as private-label specialists.

These private-label specialists will be pursuingscale on three fronts. As cost leadership is key for any private-label supplier, assetrationalisation and production efficiency will be at the top of the agenda. But theeconomies of scale are also important withregard to servicing clients’ needs (leveragingon innovation and international presence) and lowering the private-label specialists’ riskprofile (lowering client dependency). The needfor scale is expected to lead to a consolidationspree among private-label specialists in thecoming 5 to10 years.

Last but not least, the private-label specialistswill bring production quality and innovationin private label to a higher level. At the sametime, the consolidation of production assetsshould warrant lower prices for private-labelproducts. This professionalisation of private-label supply supports both the food retailersin their ambition to grow private label, andour 2025 projection that private label willaccount for half of the food retail market.

Conclusions

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