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A recently released report by Deloitte called “The Battle for Brands in a World of Private Labels” could not have come out at a better time. The fight for market share between private label and national brands for consumer dollars has heated up as consumers collectively tightened their wallets. Looking forward, there are signs that this trend is not only here to stay, but is growing, much to the dislike of senior leaders and investors in consumer products companies.

As noted in the Deloitte article, “only 22 percent of participating consumer product executives agreed or strongly agreed that a majority of the consumers who switched to store brands in recent years will switch back to national brands.” Part of the issue is increased promotions, which has decreased consumers’ reference price points (exactly what has happened with General Mills (NYSE:GIS) and Kellogg (NYSE:K)). As noted by Professor Carl Mela in an article about store brands featured in the Harvard Business Review, “In the battle for the customer, store brands are winning.

Unless manufacturers can create a clear reason in the consumer’s mind that the brand is more important than the store when making their choices, the manufacturers are bound to lose margin to the store. Discounts do not do this. Coherent branding strategies do.” Has this period signaled the decline of strong brand equity in the grocery store? And if it has, what will consumer product companies need to do in the future to win back their customers?

The reason that private labels have become competitive is the closing gap between the perception of quality in national brands and private label brands. In a recent study by Consumer Reports, 29 store and national brand products were tested; only 6 of the winners were national brands. On top of that, in those same 29 product lines, the store brand cost 27% less than the national brand on average. But customers aren’t the only people who have a reason to trade down to store brands.

As noted by Treehouse Foods (NYSE:THS) CFO Dennis Riordan, retailers generate roughly 20% higher gross profits on private label, and have a clear incentive to drive their continued success. Retailers nationwide are seeing the potential demand, and are looking to capitalize. A popular promotion is “buy theirs, get ours,” where retailers will give you the store brand for free when you purchase the national brand. If the Consumer Reports results accurately portray your average American consumer, this could spell trouble for the national brands.

The question consumer product companies need to ask themselves is, “What can we do to widen the gap between us and private label imitators?” One way is to associate the brand with a cause/purpose that can attract consumers beyond cost or product performance. A good example, as noted by Deloitte, is Proctor and Gamble (NYSE:PG), which donates one dose of vaccine for each pack of Pampers that is purchased as part of the “One Pack = One Vaccine” campaign. This strategy pulls on consumers’ emotions, and can cause them to overlook key factors that normally drive purchasing decisions in exchange for the feeling of “giving back” and supporting a brand that cares about community service and involvement.

Another strategy that national brands must use to effectively differentiate themselves is product innovation. The national brands need to avoid private label competitors from freely imitating their products. Some ways they could mitigate the replication by store brands is continuous packaging refreshments, a pipeline of R&D with rapid new product launches, and strong defense on product claims that store brands may not be able to imitate.

In all three of these areas, national brands would be forcing retailers to invest in playing catch up, while hopefully being able to differentiate their brands during the lag periods. Strong innovation also helps brands stay at the top of their respective categories, which is important in the fight for share. As noted by Dennis Riordan (CFO of private label manufacturer Treehouse Foods), “We don’t see the big brands as our competitors. Private label growth hasn’t come at the expense of #1 and #2 brands (lead brands have consistently held roughly 26% of market); it has come at the expense of the 4, 5, and 6 brands.” As private label has continued to grow, many of these 4, 5, and 6 brands have been removed from the shelves to make way for store brands.

These strategies suggest that consumer product companies need to keep doing what they have always done (but in a new way): focus on what the consumer wants. In the past, this often meant advertising and parading product quality/taste as a way to build brand equity. But the increase in transparent information and private label investment has made product quality between competitors less differentiated and the premium pricing of national brands a point of concern for consumers.

In my mind, these companies need to learn to differentiate based on what they stand for and what they do for the world around us while still offering a high quality product (i.e. Starbucks (NASDAQ:SBUX)). Advertising dollars used to draw an emotional connection between the consumer and the product/brand would be money well spent in the future. For investors, I would suggest looking into private label; as noted in the article, the ways to fight against imitators is becoming increasingly difficult. An investment in a strongly positioned private label manufacturer could act as a hedge against continued growth in store brands.

Disclosure: No positions

Source: Maintaining Food Brand Equity: Fighting Store Brands