Liz Claiborne, Jones Apparel, Apple Computers, and other manufacturers have opened successful stores that compete with their brands on the shelves of traditional retailers. Retailers are creating their own house brands. The two sides have blurred the neat distinctions — suppliers and shelves — that once defined the roles of manufacturers and retailers.

"Manufacturers and retailers share the same pie, and there is always competition about how the pie is divided up," said Stephen Hoch, John J. Pomerantz Professor of Marketing and director of Wharton's Jay H. Baker Retailing Initiative. He draws on his retail research in a number of executive education programs in marketing, including Essentials of Marketing and Competitive Marketing Strategy.

While all of these changes are part of the eternal dance between retailers and manufacturers, the intensity of the dance is picking up. "The watershed event was the introduction of bar code scanning at the checkout in 1974," said William Cody, managing director of the Baker Retailing Initiative, and academic director of a custom program on channel strategy that Wharton developed for a major packaged goods manufacturer. "Before that, the manufacturer understood the consumer. The retailer was just offering shelves where the consumer picked up the manufacturer's product. With scanners, retailers were getting all this information about what was being bought. Widespread adoption took place in the mid-1980s, and the balance of power shifted."

Private Labels

Consolidation gave large retailers more scope, scale, and power. In the 1990s, the big box just kept getting bigger. Wal-Mart moved into groceries, sparking a wave of consolidation in supermarkets. The wave swept through drug stores and department stores. In February, Federated Department Stores announced plans to acquire Mays, giving the retailing giant more than 1,000 stores.

The industry consolidations gave retailers the scale to better support private labels. Retailers are expanding their use of private labels, such as Home Depot's Hampton Bay brand, Target's Archer Farms brand, and Federated's INC brand. These brands, if handled effectively, can help to differentiate stores and attract customers.

Still, private labels have not penetrated as far as most observers had expected. "I've been studying private labels for more than 15 years, and over that period — despite a lot of predictions that private labels were going to take over the world — they have only grown modestly in the grocery sector," Hoch said. While private labels offer retailers higher margins, the retailer has to bear the cost of promotion and product launch and the risk of failure.

As evidence of the power of national brands, private labels still account for only about 20 percent of retail sales of packaged goods in the United States. This means that some 80 percent of sales are still dominated by major national brands. (Private labels sales are higher in the UK, about 40 percent, which may be due to the higher density of population and higher cost of living.)

Although private labels account for a relatively small percentage of sales, they play a significant strategic role in the balance of power between retailers and manufacturers. "It softens up the manufacturer so retailers might get better terms in the negotiating process," Hoch said. "Where the big impact has happened, however, is in the secondary brands that don't have much brand equity."

Three Strategies

Retailers tend to follow three types of strategies with private label brands, Hoch said:

• Low cost, OK quality: These private label brands are the successors to the old black-and-white labeled generic brands. They provide the consumer with rock-bottom prices for mediocre goods. "Not many retailers are pursuing this strategy because there is not much money in it, and there is the risk of customers buying lousy quality in the store and blaming the retailer for it."
  
  
• Parity quality at a lower price: This strategy is the most common one. "Everyone uses this," Hoch said. "They exploit the installed base, bringing in the customer with the national brand, and offering a compelling ‘compare and save' proposition in the store. Some 90 percent of retailers today use this strategy."
  
  
• Differentiate through private brand: Some stores are also using high-end private label brands to offer brands that can only be found in the retailer's store. These brands themselves are so distinctive that they become a draw for customers.

More Polygamous Relationships

Manufacturers are also setting up their own stores, which gives them more control over how consumers interact with their brands. "A lot of brands, particularly luxury brands, have their own stores now," said Hoch. "One of the big success stories is Apple Computers, with one fifth of their sales now coming through their own retail stores, up from zero a few years ago." While the first manufacturer's stores may have raised concerns about channel conflict, they are now accepted as part of the landscape.

Private labels will continue to change and gain ground. "Things will change a bit," said Hoch. "Right now private labels have greater acceptance by consumers. People have more experience with them and know that in a lot of situations they can be just as good or better than national brands. Clearly, retailers have to be in this game — both because of the economics of it and to distinguish themselves from competitors."

There appears to be a natural upper limit on how far retailers can go with private labels, about 40 percent of sales. "Once you start going over that level, the risk to the retailers is that if they don't sell the stuff they are on the hook," said Hoch. There are some chains of smaller stores that sell 100 percent private label, such as The Gap, Victoria Secret, and innovative grocery retailer Trader Joe's, where the store is the brand. But most retailers don't have the expertise in product R&D, branding, advertising, and other activities needed to support private brands. "It is hard to do and expensive to do," said Hoch. "Retail is a very competitive business, and if you start putting a lot of money into private label brands, you might be more vulnerable to day-to-day competition. Most retailers are going to be better off working with national brands."

The relationships between manufacturers and retailers will also continue to shift. Liz Claiborne, for example, is working with Kohl's to develop new private label lines for the retailer. "The standard distinctions between customers and competitors is blurring in all sorts of business," Hoch said. "We are seeing much more polygamous sorts of relationships. At the end of the day, manufacturers and retailers need to cooperate."

Related Courses

• Essentials of Marketing
• Competitive Marketing Strategy

Related Links

• Jay H. Baker Retailing Initiative
• Executive Education Custom Programs
• Wharton Marketing Department
• Wharton Marketing Programs

• Wharton Executive Education
• The Wharton School

This month's articles:

• Thought Leaders
  Leaders of Wharton's Baker Retail Initiative discuss transformations in retail.
  
  
• Fellows
  How does Alessi turn household utensils into objects of art?
  
  
• Conferences
  How can you make better decisions under uncertainty? A Wharton conference offers insights.
  
  
• Advanced Management Program
  What does poetry have to do with business? A lot more than you may think.
  
  
• Education à la Carte
  Improve your own shelf life.