Positioning of Store Brands

We consider the retailer’s store brand (SB) positioning problem in a market with two national brand (NB) competitors. In the context of our model, two brands are assumed to be positioned close to each other if the “perceptual” distance between the two brands is small, and positioning affects the degree of price competition. Our game-theoretic model indicates that the optimal strategy for the retailer is to position the store brand as close as possible to the leading national brand (brand with the highest base level of demand) unless the cost of doing so is beyond a critical level. Even when facing two equally strong brands, the retailer is better off targeting one of the national brands rather than adopting a mid-point positioning where the store brand competes “equally” with the two national brands. Positioning the store brand closer to the leading national brand increases the cross price sensitivity between the two, and leads to (a) lower wholesale prices from both the leading (NB1) and secondary (NB2) national brands; (b) higher margins for the retailer; and (c) increased category demand --all of which adds up to increased category profit relative to other positioning strategies. We test the implications of our analysis in three empirical studies. In a field study in two U.S. supermarket chains, observational data (labeling, package design, color, shelf placement, etc.) showed that the probability of a national brand being targeted by the store brand is an increasing function of its relative market share. In a second study we estimated cross price elasticity in 19 categories as a means of assessing inter-brand competition. In categories with high quality SB’s, the cross-price effects do suggest that the SB and NB1 compete more intensely with each other than with NB2. In categories with low quality store brands, however, the cross-effects are more inline with the asymmetries in cross-price elasticity reported in previous price/quality tier research. In a third product perception study, we found that although explicit targeting by store brands influenced consumer perceptions of physical similarity, it had no influence on consumers’ perceptions of overall or product quality similarity. In fact, the SB was rated as more similar to the lower share national brands. And so while it appears that retailers do follow a positioning strategy consistent with our model, it meets with more limited success in changing consumer perceptions and demand side behavior. 1 1. Positioning of Store Brands Store brands (SB’s) or private labels are created and controlled by retailers. In aggregate they constitute about 20% of unit sales (IRI 1998) and are among the top three brands in 70% of supermarket product categories (Quelch and Harding 1996). As is true for any brand, positioning of the store brand can have an important influence on its performance. Unlike the manufacturers of the national brands (NB’s), however, the downstream retailer has a different objective function. Whereas national brand manufacturers position their products to maximize the profits from their own products, the retailer focuses on maximizing profits from the entire product category, including profit from store and national brands (Hoch and Lodish 1998). We model how the retailer should position the store brand to maximize category profits within the context of a category with two national brands, one of which is stronger. Positioning is operationalized as the perceptual distance between two brands. Brands positioned closer exhibit a higher cross-price elasticity. We focus on: (a) whether the store brand should target a specific national brand or follow an “in the middle” positioning and compete to a lesser degree with both NB’s; and (b) if targeting is better, which NB should be targeted. Although we take the retailer’s perspective, a better understanding of store brand positioning strategy is also important to NB manufacturers who must coexist with store brands. Schmalensee (1978) noted that store brands often imitate the category leader, presumably to signal comparable quality at a lower price. Although the demand for the store brand may increase, the downside is that the demand for the targeted leading national brand may also decrease. Since the retailer also makes money by selling the national brands, it may not be optimal to have the store brand specifically compete against the national brand with the largest customer base and higher margins (Corstjens and Lal 2000). Instead of targeting a 2 national brand that generates substantial profit, adopting a mid-point position where the store brand competes to a lesser extent with both NB’s may be better. Yet, we often observe retailers targeting leading national brands. We believe that the answer to this puzzle lies in a better understanding of how the retailer’s objectives drives the store brand positioning decision. The product positioning literature usually ignores the retailer. To the best of our knowledge, there is only one study incorporating the difference in the objectives of the retailer and the national brand manufacturers into the positioning problem. Tyagi and Raju (1998) examine the pre-emptive positioning strategies of national brands when there is a national brand versus a store brand entrant. We focus on the store brand’s positioning problem and attempt to find the exact optimal location in both the symmetric case, where both NB’s are equally strong, and the asymmetric case, where one NB is stronger than the other. We adopt a game theoretic approach and examine a market with two incumbent national brands one of which is stronger, and a store brand entrant. SB positioning essentially involves choosing the appropriate perceptual distance between the SB and the NB’s. This distance in turn determines the degree of price competition between the store brand and each of the national brands. As such, positioning the store brand closer to one national brand results in a higher cross price sensitivity between the two. Our analysis suggests that the retailer should position the store brand close to the stronger national brand unless the cost of doing so is beyond a critical level. Further, compared to other prospective strategies, this strategy is more profitable in categories where the leading national brand is stronger. Our results also reveal that SB targeting of the leading national brand leads to: (a) lower wholesale prices from both the leading national brand (NB1) and to a lesser extent the secondary brand (NB2); (b) higher margins for the retailer on national brands; 3 (c) higher profits from the store brand; and (d) increased category demand --all of which adds up to increased category profit relative to other positioning strategies. We test the implications of our analysis in three empirical studies. In a field study in two U.S. supermarket chains, we gathered observational data (labeling, package design and color, shelf placement, etc.) regarding the targeting strategies of store brands in various categories. We found that if the store brand follows a targeting strategy, the category leader invariably is the target. Further, the probability of a national brand being targeted by the store brand is an increasing function of its market share relative to its competitors. In a second study we used store-level data from A.C. Nielsen to examine demand−price relationships in 19 categories and estimate cross-price effects as a means of assessing inter-brand competition. In categories with high quality SB’s, the cross-price effects do suggest that the SB and NB1 compete more intensely with each other than with NB2 (Bronnenberg and Wathieu 1996). In categories with low quality store brands, however, the cross-effects are more in line with the asymmetries observed in price/quality tier research (Blattberg and Wisniewski 1989). In a third study we collected product perception data. We found that consumers could detect when store brands targeted a national brand; consumers rated the physical similarity of the store brand and the national brand to be much higher when the targeting was explicit rather than ambiguous. However, explicit targeting had no influence on consumers’ perceptions of the overall similarity or product quality similarity of the SB and NB1. In fact, the store brand was rated as more similar to the lower share national brands (NB2 and NB3). And so while it appears that retailers do follow a positioning strategy consistent with our model, it meets with more limited success in changing consumer perceptions and demand side behavior. 4 2. The Model We consider a market consisting of two NB’s, each offering one brand sold through a common retailer. The retailer can introduce a store brand if it results in higher total category profits for the retailer. Our model extends previous work in this area by allowing the retailer to also decide how the store brand is positioned relative to the two national brands. For example, the retailer may choose to position the store brand "in-between" the two national brands, or may decide to target a particular national brand. Before describing the model in detail, we discuss why we have chosen this particular modelling approach. Previous studies of brand competition where there is heterogeneity in consumer preferences has, by and large, used two distinct modelling approaches. 1. Models such as DEFENDER (Hauser and Shugan 1983) allow for horizontal differentiation. No brand is uniformly better than the other brands; different consumers buy different brands because of differences in tastes. Difference in tastes are often modelled by allowing for different consumer ideal points in a Hotelling type framework (Hotelling,1929). Competition amongst NB’s can be construed as competition among horizontally differentiated brands. 2. Moorthy (1985) studies differences among vertically differentiated brands. In this context, if prices are the same, all consumers prefer the brand with higher quality. Competition between a SB and a NB is more like competition between vertically differentiated brands. Our positioning problem requires us to simultaneously model the competition among NB’s, as well as the competition between a SB and NB’s. The problem is further complicated by the fact that the competitive parties reside at two different levels of the distribution channel, with each 5 party maximizing its respective profits. To tackle this complex problem, we utilize a reduced form modelling approach where heterogeneity in tastes and differences among brands are captured through a parsimonious demand model well grounded in utility theory. 2.1. Demand Structure without the Store Brand. The demand for national brand i, denoted by qi, i = 1, 2, is assumed to be as follows: [ ] ) ( 1 1 2 1 1 2 1 1 p p p a a a q − + − + = θ (1) [ ] ) ( 1 2 1 2 2 2 1 2 p p p a a a q − + − + = θ (2) where pi is the price of national brand i, ai ∈ (0, 1) is the base level of demand of national brand i, and θ ∈ (0, 1) is the cross-price sensitivity representing the degree of price competition between the two national brands. The proposed linear demand function is consistent with utility maximizing consumers with quadratic utility functions (see Shubik and Levitan 1980). A different utility function could lead to another demand function; however, market data seems to be consistent with linear demand (e.g., Brodie and de Kluvyer 1984, Bolton 1989). The demand structure outlined in (1) and (2) generalizes the demand model used in Raju, Sethuraman, and Dhar (1995) as it allows the base level of demand of the two national brands to be different. Overall category demand equals 1 when p1 = p2 = 0 implying that there is a bound on how much consumers will buy. We also assume that the marginal cost of NB’s to the manufacturers is 0; so, prices are additional to the marginal cost. 2.2. Demand Structure with the Store Brand. In addition to the two national brands, we now include the store brand denoted by the subscript s in (3)-(5).