Private label products have become an increasingly important tool in the retailer’s arsenal; by 1999, private label products (or equivalently, store brands) accounted for over 20 percent of supermarket unit sales and 15.7 percent of dollar sales.  Among other retailer benefits, private labels add diversity to the product line in a retail category.  This product differentiation can reflect quality differences or just differences in features. How to position a private label product in competition with national brands is clearly an extremely important managerial question.   However, it is still not well understood how the probable relationship between quality and feature positioning affects the profitability of private labels, nor how varying degrees of feature differentiation between national brands affect the optimal positioning of the private label.  We attack these questions in the present research and show that enriching our analytic understanding of these issues affects the predictions about how retailers can optimally position their private labels in competition with national brands.

Quality differentiation is based on the notion that the characteristic on which differentiation occurs is one for which all consumers value the highest possible level (all else held constant – such as price).  In contrast, feature differentiation refers to the degree to which products have different forms, sizes, or packaging.  Unlike a “quality” characteristic, a “feature” characteristic of a product is one for which “more” is not always “better,” and can include characteristics where variety is valued by the consumer.  This suggests that in many real-world cases, the retailer’s positioning of the private label inherently involves both feature and quality positioning messages to its consumers.  The concept of differentiation of the private label from the national brand is thus not a unidimensional concept.  The overall interchangeability or substitutability between them is a function of both quality and feature differences across products, and the retailer’s positioning choice for its private label will naturally reflect both dimensions.  Our model investigates the nature of national brand-private label competition in a market characterized by both quality and feature differentiation.

This paper moves beyond the existing literature in several dimensions.  It allows for the purchase of multiple brands within a product category, a phenomenon that is seen in many commonly purchased categories but not explicitly considered in the modeling literature.  It allows the degree of feature differentiation between the private label and competing national brands to vary, and the results show that this has a substantive effect on the private label’s optimal position in the marketplace.  It examines the interaction between feature and quality differentiation, considering that one may be correlated with the other, and shows that this affects the profitability of optimal positioning of the private label.  And finally, this work is grounded in consumer utility theory, and does not rely on ad hoc specifications of the demand function; we show that this affects the interpretation of the effect of demand parameters on optimal positioning of the private label in a way that prior work has not done.

We consider a stylized model of two competing national brands and one private label, and allow the retailer to control both the retail prices of all three products, and the positioning of the private label relative to the two national brands.  National-brand manufacturers set the wholesale prices of their products to the retailer.  The model shows optimal pricing and positioning decisions by the players and can be used to calculate how these optimal decisions depend on exogenous parameters of the model.  One of our key findings is that, when the two national brands are significantly differentiated in their features, the private label’s optimal strategy is to minimize feature differentiation from one of the national brands.  Further, its target brand to imitate depends on its own quality level: when its quality is high, the private label should imitate the stronger brand; otherwise, the weaker one.  But when two incumbent national brands are feature-undifferentiated (e.g., offer similar flavors and packaging), the retailer is better off maximally differentiating her private label from the national brands in the feature dimension.  In addition, we investigate the impact of private label positioning on national brand profits, and show that depending on the brand strength of the private label, a national brand manufacturer may be better off occupying the position of second-quality brand, rather than the top quality position.

In sum, the paper’s approach (grounded in economic theory) allows us not only to predict the relative levels of prices and of positions in the market, but also to examine the effects of changes in underlying characteristics of consumer utility on these optimal positions, and on their implications for retailing and manufacturing profitability.  The model’s predictions expand our insight into private label positioning and suggest conditional avenues for action, depending on the strength and characteristics of the private label product.