The Imitation Games

Private Label Economics 101

Discontents: 1. The Imitation Games: Private Label 101.

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Confession. I have a fondness for sandwich cremes cookies. Now that my ageing metabolism can’t really handle much sugar or gluten (or really anything fun), I will only occasionally splurge on such treats. On a recent consulting trip to Seattle, I snagged a $3.99 box of Simple Truth Gluten Free sandwich cremes at a QFC. They were not too terrible.

Sometime afterwards, I was in a Walgreens somewhere else. Same size box, same cookie glamour shots, probably same ingredients. Gluten free sandwich cremes, for $3.99 under the “Nice” private label. And just the other day I was in Whole Foods. There they were, the same exact products on shelf under the 365 label, but for $4.79 (because Whole Foods). Sucker that I am, I bought a box.

But what is up with these incidents of look-alike cookies?

These are the imitation games, also known as the store brands or private label industry.

The Macroeconomics of Store Brands

What are store brands, also known as private labels? They are product lines wholly owned by the retailers, their service partners or their wholesalers. Great Value, Good & Gather, Field Day, 365, Simple Truth, Lucerne, Simple Nature, Hill Country’s Best, Cadia, etc. The packaging, the ingredients, the supply chain, the nutritional information, everything that makes up the product itself, is proprietary for the retailer or wholesaler. There is a whole industry of private label manufacturers with vast infrastructure, capabilities and expertise that make these products for grocery chains.

U.S. store brand sales are over $236 billion. Sales are up 4.7% over the past year.

This is an increase of over $10 billion in one year and over 34% or $60 billion since Covid-19 began. Over 22% of groceries sold in the U.S. are private label. Over 98% of U.S. households buy them, but this is probably an underestimate. Why? Well, first we should consider the economic context.

Grocery prices are up over 30% since 2019, and up over 40 or 50% in many key categories. Over 90% of consumers are concerned with high food costs. Over 70% are financially stressed, 58% living paycheck to paycheck. The share of income spent on food increased 13% to the highest rate in 30 years. Food insecurity rates rose 18% in the last 2 years, affecting 17% of households. Things are not pretty out there for consumers. Yet we all need and want to eat well. People still want healthy, sustainable, filling meals and obviously plenty of snacks and treats.

Store brands offer an easy personal choice for consumers to navigate these uncertainties.

Cost and value were the top reasons consumers are buying more private label. While name brands still have an edge when it comes to trustworthiness, variety and quality, over 55% of shoppers are now buying more store brands than last year. And 54% of shoppers plan to buy more store brands next year, even if food prices fall. Over 53% of consumers said that store brands are very important in determining where they shop. This is up 18% since 2016. Nearly 70% of consumers view store brands favorably. This ain’t your grandma’s stale, pale, generic brand cookies. Store brands are the future, at least for now.

Grocery retailers are jumping in with both feet to expand, reformulate, refresh and relaunch their store brands.  

More than half of retailers expect store brands to be their top growth driver this year. They are expanding product development, marketing and store placement priorities to favor these exclusive products. They are under pressure from institutional investors and asset managers to comply with new laws to disclose risks, reduce externalities and make their supply chains more transparent and sustainable (i.e., “ESG”). Developing and controlling their own proprietary brands solves for this. They also know that they can’t keep raising prices, but they need to stay profitable for shareholders. And they also know that their customers want better products at better price points, a seeming contradiction. And the biggest grocery chains are leading the charge.

Walmart does almost 30% of U.S. grocery sales. Walmart also owns the industry’s largest and most ubiquitous private label, Great Value. Over 26% of Walmart’s grocery sales are from this and other store brands, including pharmacy line Equate, wine brand Oak Leaf, fresh foods (Marketside) and sparkling waters (Clear American). Half of all customer baskets had a private label item in them. Store brands are a major growth engine for Walmart, as important to their business model as low wages, frequent layoffs or government benefits for their employees.

Now Walmart is launching bettergoods, a line over 300 items, mostly priced below $5. This is the retailer’s largest store brand launch in 20 years. Walmart describes bettergoods as “a new elevated experience that delivers quality, unique, chef-inspired food at an incredible value.”  bettergoods includes “culinary experiences” such as new rubs and seasonings, plant-based products such as chocolate almond milk, oat milk ice cream and dairy free mozzarella, and “made without” items tailored to specific dietary needs such as gluten free.

bettergoods is very obviously geared to compete with more of the premium-positioned store brands such as Simple Truth, 365 and Good&Gather. Is Walmart gentrifying its value image? Only just a bit. Market research firm Numerator found that “bettergoods is appealing to lower-income consumers who want to treat themselves while giving higher-income consumers a product that goes beyond base needs at an affordable price… Compared to its Great Value counterpart, the demographics of Walmart’s bettergoods ice cream buyers indicate a younger, more naturals-focused consumer who has dietary restrictions and cares about price and flavor.” Sound familiar?

This is also the “Better For You” (BFY) customer segment that so much of the emerging brands sector is aiming for. bettergoods will create more pressure on cash-strapped emerging brands that are scrambling to get on shelf, because Walmart is the center of gravity in the grocery industry. Everyone competes with Walmart.

Not to be outdone by the folks in Bentonville, Target is relaunching its Up&Up line of general merchandise.

Hundreds of these products are being reformulated based on new quality standards and consumer preferences. Up&Up generates over $3 billion in sales, or 10% of Target’s $30 billion private label business. Up&Up offers over 2,000 products under $15, across dozens of categories including oral care, food storage, pet products, protein powders, over the counter medications, cleaning and bath supplies and baby products.

In addition, Target is also launching Dealworthy, a low-price focused store brand with 400 products across paper towels and plates, body wash, cotton balls, apparel, beauty products and electronics. This will provide a counter measure to Great Value and Dollar General, while Up&Up gets upgraded to a less extreme value positioning. Target also recently launched Figmint, a kitchen products line with prices starting at $3. They also continue to add items to the popular Good& Gather and Favorite Day store brand lines that are well represented across the grocery sections.

Store brands continue to be a growth engine for Kroger.

Kroger’s CEO recently noted, “We continue to expand and diversify our brands portfolio at every price point”. The largest full service U.S. supermarket chain at 10% national market share, Kroger launched 346 new store brand items in the first quarter alone. Kroger store brands are among the largest and best known in the industry. They are represented in dozens of center store categories by ubiquitous labels such as their Kroger line, Simple Truth (as in the GF cookies that inspired this little thought bubble), Private Selection, and the recently introduced, deep value-oriented Smart Way. This breadth of assortment makes for good investor relations and media copy, but for a customer shopping any given grocery category in a Kroger (or it’s numerous banners such as Harris Teeter, Smith’s, Ralph’s or QFC) it means sorting through 2 or 3 different price, quality and formulation tiers of store brands, alongside numerous national brands. Sometimes too much feels like too much.

With Kroger, Target and Walmart adding up to over 45% of all U.S. grocery sales, it is no surprise that smaller chains are also chasing store brand sales and market share. More than 20% of Sprouts sales comes from its store brands. This is double the share of 2017. The mid-market chain has been adding 3-400 items a year to its store brands portfolio, including replacing or reformulating over 100 items a year. Sprouts has also been consolidating its lines under its own brand name instead of category specific lines such as “Butcher Shop”, “Fish Market”, the less obvious “Market Corner” and “Sprouts Essentials” or wholesaler-owned brands such as Cadia. Their store brands re-boot is expected to be completed in 2024.

Grocery cooperatives are even taking advantage of these opportunities to stay competitive.

Customer transactions at co-op’s were up over 5% in 2023, along with the strongest same store sales growth since 2015. CE Pugh, CEO of National Cooperative Grocers (NCG) credits some of this stickiness to the success of UNFI-owned Field Day, which grew 31% year over year at NCG stores. Field Day offers products at similar quality and price points to 365 and Simple Truth but is mainly sold to cooperatives and independents.

And it is not just the supermarket and mass market channels that are pushing store brands. Discount leader Dollar General is expanding its store brands assortment with its OhGood! Supplement line, which includes non-GMO and gluten free options. The nation’s fastest growing grocery chain is also expanding its Clover Valley packaged food line and Nature’s Menu pet food line. And CVS has a new line of snack, beverage and grocery products called Well Market geared towards the “BFY” shopper, with vegan, gluten free and keto items formulated with no artificial colors, sweeteners or preservatives. These will most likely stack up “well” to competitor Walgreen’s private label brand “Nice”. How… creative.

And even truck stops and convenience stores are seeing the private label opportunity. Buc-ee’s gargantuan snack and beverage assortment is mainly private labeled. Competitors Love’s and TXB each take a tiered approach to store brands based on customer “need states”, so that their “value proposition centers around total value, not just price points”. Quality and innovation are big factors even for customers cruising through gas stations and travel stops.

The Microeconomics of Store Brands.

What are the merchandising operations that happen back of house to make this all hum? What stunning feats of analysis,logistics and inspiration enabled at least three far flung retailers across three time zones to merchandise literally the same gluten free sandwich cremes?

There are a lot of highly skilled retail workers involved, motivated mainly by financial targets but in many cases also sincerely wanting to make better products for consumers. Category managers are one such group of retail workers. They decide what to merchandise in stores and are responsible for the financial performance of their categories. A category is any group of products under a similar purchase occasion. Categories are generally classified as such by the industry and data providers, with some small variances: milk, eggs, cheese, cheese analogues, butter, cookies, etc. And category attributes are descriptors or certifications that flow across categories, such as organic, non-GMO, gluten free, etc. Syndicated data aggregators such as NIQ, Circana, SPINS and Numerator roll up and sell category data back to participating retailers and brands, so category managers can drill down to category, brand or attribute by year, month, week, by state, city, region, store. And at some point, by looking at all this data, someone smart realized that a lot of somebodies like me really wanted a reasonably priced box of gluten free sandwich crème cookies. How thoughtful!

Category managers review dozens of categories annually.

They meet and negotiate with suppliers. They go to trade shows. They see what is and isn’t selling well, and what may be needed to improve the various performance metrics that they are accountable for, including sales, gross margins, unit volumes and basket sizes. They will then work with an in-house or outsourced store brands team to determine what items need to be developed. This is probably how the imitation games starts.

Maybe someone saw that Kinnikinnick, Glutino or Catalina cookies were growing fast in the data. Maybe a co-packer displayed their new gluten free cookie mock-up’s at a private label trade show and category managers from a half a dozen grocers tripped over themselves to launch it first. It is all possible. Costco buyers used to literally follow my team around trade shows. The private label industry is vast but is also really tight knit. Everyone knows each other. There are a lot of suppliers out there. But for certain categories, only a few big ones can supply particular products at the large volumes that such national retailers need. Hence, essentially the same cookies at three different chains, with the same box, pack size, ingredients and nutrition profiles.

Category managers will try to make sure that they have value-priced options for the best-selling items in a category.

They make sure they are on trend with popular items, like probiotic soft drinks, regeneratively sourced whole milk ice cream or guacamole flavored tortilla chips (why?!). The customer data may say that they need multiple price tiers in a category to fulfill varying customer needs, including value priced or more premium products, like the various store brands displayed at Kroger. Or they may want to use the store brand as a competitive lever against some of the name brand items that are being sold for less at competitors, as a way to pressure these name brands for lower costs. Things also get dicey here with retailers exploiting and even ripping off innovation from emerging brands. Smaller brands will do almost anything to get on shelf at national chains and category managers can easily take advantage of them. If the company direction is to push out innovation or trendy culinary items through store brands, the watch out.

Emerging brands can end up as incubation test subjects for the retailer’s private label.

They may then be excluded from the grocer’s supply chains or category plannograms if they can’t meet the food safety, inventory requirements and low cost needs of a store brand, even though they had the good idea in the first place.

Once a product decision is made by the category manager, the retailer’s private brand team works with a co-manufacturer to formulate and produce these items at scale. This private label team looks at the formula, ingredients, taste and organoleptic qualities of the name brand items they have identified as the most compelling equivalents. Their food scientists and product formulation experts dissect the product down to its core components so they can get as close as possible to what's on shelf. Imitation is not just flattery. It is a $236 billion grocery behemoth.

The next step is the financial model. The category manager and store brands team will build a cost structure of their product. They will compare the national brand equivalent and the private label item and make sure that the store brand formulation is more cost effective. And this is where they have to be careful because some customers will look and see if the name brand item has the same cost per ounce, ingredients, and nutritional content as the private label version. The imitation can't be made too differently. The formulators have to pull as many elements of cost out of the equation so that they can have a much cheaper price on shelf.

One way they do this is by negotiating dead net pricing. CPG brands have trade spend built into their cost structure, which they use to fund markdowns and promotions.

Trade spend in and of itself is also a vast business, with over $250 billion in annual transactions. Trade monies translate to between 10-30% of an item’s wholesale cost.

These trade dollars are accrued at an item level and are used to fund promotional and marketing programs, including slotting fees or free fills, wholesaler monies (like UNFI’s controversial SSA,) display fees, BOGOs, sale markdowns, coupons, circulars and digital ads. So when you see something on sale at 2/$5 and it's $0.50 off, that $0.50 was paid for by the brand, and most of the time the retailer is just passing that discount through from the brand to the wholesaler to you. 

In this case, the store brand will instead be at dead net pricing. This means the lowest possible cost with all the trade and marketing dollars pulled out. This is also known as EDLP, or everyday low price. Some retailers like Walmart, Aldi or Trader Joe’s are always EDLP. Most grocers are instead “high-low”, where they frequently use sale pricing to keep customers happy and just use EDLP selectively in store brands or in value strategies such as NCG’s Co-op Basics. The Whole Foods EDLP program was over 10% of our grocery sales during my tenure there. Pulling trade spend out can also be a big gamble, because sales and promotions drive customer loyalty, basket sizes and transactions. The store brand at an everyday low price must be on the money to make up for this investment.

And like almost all food companies, grocers’ store brands do not factor in externalities into their cost structure.

Wage theft, heart disease, cancer, child labor, prison labor, soil loss, herbicide contamination, animal cruelty, that dead zone in the Gulf of Mexico the size of New Jersey. These are real cost factors not included in the balance sheets. Nor are they in the shelf prices. The recent expose of immigrant child labor in private label cereal and granola was a wake-up call for many grocers. Some are trying harder now. The growth of “better for you” products and product attributes like plant-based, organic, Fair Food, non-GMO or animal welfare signal that retailers are starting to respond to consumer demands for good food.

Consumers, especially younger cohorts want true cost accounting. Whether or not they will pay the higher mark ups is another story. For grocers, cheap and cheerful means ignoring what you can’t charge more for.

After all this is finalized and approved by the category manager, they will work with the supplier to forecast large quantities of private label inventory so that the logistics and handling costs are lower per item. This means that the retailer must sell high volumes of these items to justify the inventory exposure. The retailer owns it all and the category managers and other staff are typically responsible for this inventory. This is also one of the reasons why private label-focused chains like Trader Joe’s or Aldi are so cheap. They each have highly centralized supply chains that support a much smaller number of SKUs than their competitors. Instead of buying a few pallets worth of many different products from many brands via wholesalers, they are buying multiple container loads of a select few items from a much smaller group of suppliers, vastly lowering their item level costs. These are actual efficiencies of scale, at the expense of choice and variety.

In terms of setting retail price points, there is a process to get there. The category manager will assess the regular price point and gross margins, and the promotional price points and gross margins of the national brand equivalents against their projected store brand price point. They will also look at what competitors are selling the same products for. The goal here is to make the retail price points as sharp as possible while trying to preserve as much of the item’s penny profit. If they're going to supplement or replace the national brand equivalent with the store brand, they have to make sure that it doesn't hemorrhage gross margin. As we say in the industry, “it needs to pencil out”.

An important point for store brand items is their financial performance. Besides whether or not it sells well, success also hinges on whether the gross margins on an item level basis match up or exceed what the gross margin targets are for that particular category. A retailer’s financial performance is highly determined by the blended average of the gross margins of the millions of products it sells daily, weekly, annually. This can vary by retailer. A retailer like Kroger or Walmartwill have most category gross margins in the 20-30% range because their margins for food are all in that range. This will differ from a Whole Foods or Sprouts, where the enterprise level gross margins will be in the 35-40% range, meaning most of their categories must be in that range as well. That milk being sold at cost must be balanced out by yogurts or kefirs at 45% margins. And that .80 cent variance on my gluten free cookies was probably a roll of the dice by Whole Foods to make a higher margin, while assuming that customers wouldn’t care if this obscure product was a little more expensive. Private label items are supposed to compete on price and there is usually little variance in private label pricing on identical items like milk, salt, butter, pasta or ketchup, even if the retailer’s business models are so vastly different. Once you are in the imitation games you can’t get out.

But this also means that mass market retailers are able to achieve relatively better gross margins in store brands.

The mantra that store brands are more profitable deserves an asterisk. It really depends.

If Kroger is at a 23% gross margin enterprise wide and they are making 28% on cookies, they are very happy. But if Whole Foods is at a 38% gross margin enterprise wide, and they are making 35% on the same item even with their higher price, they are still below their target margins. They will make up those pennies elsewhere, likely through higher prices on innovative, small and emerging brands that aren’t subject to as much price comparison scrutiny. These hundreds upon thousands of small and emerging producers are not only inspiring store brand innovation, but they are subsidizing the margins on the value priced items with the capital from their promotions and slotting fees, their digital ads and BOGOs.

Every day in every grocery chain, the new and emerging brands, built by the many people that work for them, made from the resources nature provides, carry the grocery industry.

Store brands may be hot, but they can’t exist in a vaccum.

At the end of the day, this whole analysis, formulation, logistics and merchandising of store brands is geared towards providing the shopper with the best bang for their buck. The $236 billion in annual sales seems to indicate the imitation games are winning. I will now enjoy my cookies.

peace.