Defensive Strategies Against a Private Label: Price Cut vs. Brand Building

Abstract

Private labels have become a major force in retail marketing posing a great threat to national brands. In many product categories, they are among the best-selling brands. Understanding the nature of competition from private labels is essential in designing defensive strategies for the national brands. To a national brand manufacturer, a retailer who sells the private label is both a channel partner and a competitor at the same time. However, this competitor also controls the retail price of the national brand, which gives the retailer a greater pricing power. Hence, it is important for the national brand to formulate a defensive strategy that is consistent with the retailer’s interest. In this paper, we examine two major defensive strategies for a manufacturer facing a private label competition: price cutting and brand-equity building. A game theoretic model is employed to examine these strategies in a competitive scenario. We build our demand model by mixing a consumer reservation price distribution and a brand equity distribution. The existing literature generally indicates that the national brand manufacturer’s best reaction to an introduction of private label is to simply cut its wholesale price in the hope to lower its equilibrium retail price. On the contrary, however, our model shows that the national brand’s retail price tends to increase despite the lower wholesale price. That is because the retailer has an incentive to amplify the price gap between the two products in order to make room for his own private label. Moreover, a wholesale price cut tends to decrease the retailer’s total profit by cutting the private brand’s price further. Thus, a national brand manufacturer is unlikely to find the retailer cooperation when cutting its wholesale price. This implies that, if the national brand manufacturer relies solely on price competition as a defensive strategy, a significant wholesale price cut is necessary. Even so, its retail price would barely decrease if at all. On the other hand, we also show that a manufacturer who focuses more on building brand equity by various marketing efforts can expect a full cooperation from the retailer. This is because the retailer also benefits from the increased brand equity of the national brand: i.e., the retailer’s total profit increases, although his profit from the private label decreases. As a result, the retailer has a smaller incentive to aggressively push his private label at the expense of the national brand. This implies that brand building should be the first line of defense instead of aggressively cutting the wholesale price. The benefit to the retailer could even justify cost sharing of brand-building efforts with the retailer.