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As Small as a Man's Hand

After several years of extreme drought in Israel, the prophet Elijah sent his servant to look on the horizon for a cloud. The servant returned to say that he had seen a cloud on the horizon but it was as small as a man’s hand. However, in short order, that little cloud turned into a deluge and ended the drought in Israel. This story had a happy ending. There is a small cloud on the horizon for consumer goods that may not have such a happy ending. The retail market share of consumer goods is falling, while that of private labels is growing.

Consumer goods are a special case when we look at low-end, Price Leader, competitors (see Audio Tip #83: Price Leader Products and Companies on StrategyStreet.com). On average, private labels sell at a 25% discount to branded consumer goods. At the same time, these private label products offer their retailers better margins than do consumer goods. You may be asking yourself, how can the private label producers charge 25% less and still offer better margins to the channel of distribution. The answer lies in the cost of goods sold.

In consumer goods, the cost of goods sold represent a smaller percentage of total revenues than in most other industries. On the other hand, the cost of the marketing and the sales of consumer goods is high. Private label suppliers turn over most of the cost of marketing and sales to the retailers. They have to worry primarily about their cost of producing and delivering the products.

For the last several years, branded consumer goods suppliers have been able to raise prices at will. The branded consumer goods manufacturers needed part of these price increases to cover escalating commodity costs. But another part increased their profit margins. Private label suppliers have been able to compete underneath this price umbrella (see Audio Tip #119: A Price Umbrella on StrategyStreet.com) in ways that should frighten the branded consumer goods manufacturers.

The private label suppliers have kept their pricing and margins attractive for their retail channels of distributions. At the same time, though, they have reinvested in the quality of their products under the price umbrella provided by the branded manufacturers. It is getting increasingly difficult for a consumer to tell the difference between private label and its branded competitor.

This difficulty in differentiation is showing up in market shares. Today, private label consumer goods have as much as 20% market share in Wal-Mart, where branded consumer goods carry low prices already. In retailers with higher branded consumer goods prices, private labels have an even higher market share. They control about 35% of the sales at Kroger.

Since these market shares for Price Leader products are very high, you might assume that they are unlikely to go higher. That may not be the case. In Germany, private labels now account for nearly 40% of consumer goods. That’s up from about 20% ten years ago.

A small part of this share shift may be that consumers are shifting their purchases downscale in this tough economy. But that is only a small part of the story. This market share shift to private label products has gone hand in hand with the rise in real prices of the branded consumer goods.

Today, many of the branded consumer goods producers are cutting their prices and increasing their product sizes in order to compete with the private labels. But these branded consumer goods companies may need to go much further (see Audio Tip #105: What is the Effect of a Price on StrategyStreet.com). They may need to reduce prices low enough to force private label suppliers to reduce the content and quality of their products so that the differences between their products and the branded products are clear to the consumer. If the branded producers leave their prices high enough to be comfortable for these private label suppliers, these Price Leaders will continue improving their quality and taking market share from these branded industry Standard Leaders.

Posted 9/21/09

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