Private Labels and supermarket competition
Many Australian branded goods FMCG manufacturers are nervous about the proposed increase of private labels on the shelves of the two large supermarket chains. In some comments, this is linked to the 80% market share of the Coles and Woolworths. Other approaches are even more defensive and futile, such as trying to prevent "copying" of branded-product packaging.
I have a strong FMCG manufacturing background. I'm not anti-FMCG. But I don't believe in trying to hold back the tide. Change is coming. It's overdue. There are ways to respond which are based on getting ready for the future. Trying to erect barriers in the face of this change will fail, and distract FMCG manufacturers from adapting. So not only is it a waste of money and effort, it is worst of all a waste of time. If manufacturers try to solve this by going to war with the big supermarkets, they will lose, and deserve to lose. Instead, they need to offer products that consumers want to pay for. Since their customers are committed to making private labels a bigger, it's time for the manufacturers to look for opportunities in this change.
The first futile complaint is blaming the Coles/Woolworths virtual duopoly. The ACCC has taken a keen interest in this market dominance, thinking of the potential harm to consumer interests.
Many look to Aldi, a new entrant, to improve competition. Aldi is well resourced, highly professional and offers a new concept which is strongly pro-consumer.
The problem for the FMCG brand-owners is that Aldi succeeds with a revolutionary approach to branding: nearly everything is a house brand: a well packaged, high-spec house brand. In fact, the cosy duopoly probably suited brand owners, although they may only just be realising how lucky they were.
Aldi has a small market share, but that's due to lack of stores, not due to poor consumer acceptance of its offer. There is no doubt that Aldi has huge market share potential, and I'm sure that the Aldi threat is driving increased private-label use at the big two.
The ACCC is a fan of Aldi, which means it's committed to private labels
Aldi has some implicit endorsement from the ACCC, which has made specific changes to shopping centre anchor-tennant leasing rules to prevent Coles and Woolworths from banning Aldi. So the FMCG brand-owners are not going to get much joy from the ACCC, since the ACCC sees Aldi as a key driver of increased competition.
If the FMCG manufacturers rely too much on colors and appearance to extract premium from consumers, they are ripe for attack. Instead of adding value, it smells like rent-seeking: trying to get revenue just for being there. The ACCC is unlikely to be a big fan of rent-seeking.
The opportunities and threats of change
The big supermakets don't have anything against branded products; they sell for more money which means a high dollar margin, broadly speaking. Coles and Woolworths have had private label products for years. Mostly, they've been deliberately ugly and literally bottom of the shelf.
But now, Aldi is forcing a response with its innovative approach delivering substantially better value. The big two have decided they need to meet fire with fire.
For MFCG manufacturers, there are two opportunities. Firstly, as Aldi gets bigger, branded products should be a way for Coles and Woolworths to differentiate. Smart FMCG manufacturers should be supporting the private label push, trying to lock in the production volumes, while making sure they can show the supermarkets an innovative roadmap for the branded products. Both have a mutual enemy.
Secondly, becoming good at private label supply is getting more attractive, driven by Aldi's market share increase and the push to more private label sales by the 80% of the market held by Coles and Woolworths. That volume is going to need production somewhere.
To take advantage, manufacturers should expect lower margins (from a higher mix of private label sales) or lower contribution margins (from lost volume), and start adjusting R&D, marketing and other costs (to avoid the nasty experience of of Lion's milk business). They need to communicate innovative roadmaps. They need cost-models which allow them to bid for private label with good understanding of cash costs and how they plan to fund innovation and brand support (simply averaging these costs across all products will lead to uncompetitive private label pricing). They also need to become very strong at managing a combined shelf of private label and branded products to the mutual benefit of supermarkets and themselves.
This is a time for initiative.
The trap of underestimating private labels
A trap is to underestimate the potential of private labels. The brand owners complaining about copying should prepare themselves for some nasty surprises.
Private labels have a reputation for being followers. This is not always true. An interesting tale of private label packaging innovation comes from the Dutch premium supermarket chain, Albert Heijn. Philips had a smash hit with the Senseo coffee maker, which was a pad-based coffee maker. Unlike high-end pad-based coffee makers, the Senseo pads are ground coffee encapsulated in filter paper not dissimilar to tea bags. For the pads, Philips took a JV approach with a prominent coffee brand. Making the pads required investments in production equipment, but eventually Albert Heijn introduced a private label product.
The Philips/Douwe Egberts Senseo brand sold the pads in bags of ten but not individually wrapped. The Albert Heijn private label individually wrapped them, keeping the coffee fresher ... a powerful innovation.
I was closely involved with Philips Consumer Lighting and our brand managers were puzzled at the free pass given to the private label by our colleagues in Domestic Appliances.
The Philips Lighting approach to private labels
At Lighting we recognised the importance of private labels and we were always keen to be a private label supplier. Where we had the A brand contract as well: it was a chance to manage the price ladder to mutual benefit. Where we did not have the A brand contract, it was a chance to prove our credentials as a reliable and flexible supplier, by out-perfoming our competitor who held the brand contract. It also kept us in touch with low-cost operations, and forced us to be very focused on the added-value of the Philips brand.
We had quite sophisticated approaches to factoring R&D costs into product cost pricing to make sure we had good visibility of the need to fund R&D from our contribution margin from all activity, private label and A brand. It's not easy winning low-cost volumes and keeping overall margins high enough to fund R&D. But it's a lot harder without the private label manfacturing load.
Is this the end to high/low pricing in Australia?
Aldi's other innovation is its variation to high/low pricing strategy. Traditionally, Coles and Woolworths have high prices and attractive specials (which the manfuacturers pay to participate in). Aldi takes the "everyday low price" approach. However, they have stunt offers, a bit like Catch-of-the-day.
Since private labels don't have high-margin manufacturers behind them, it seems unlikely that Coles and Woolworths will be able to adopt a high/low pricing policy with these products. I wonder where this will leave the premium brands.