By Nathaniel Luce
Store brands — products manufactured and branded by retailers — are big business, generating over $100 billion in sales for supermarkets and mass merchandisers in the U.S. Retailers use them to attract budget-conscious shoppers, increase consumer loyalty, and build brand equity across multiple categories. Kroger, for example, generated 26% of its 2016 sales revenue from store brands like Simple Truth and Private Selection.
These brands can also have a big impact across product categories, according to new research by Yasin Alan, Assistant Professor of Operations Management, Mumin Kurtulus, Associate Professor of Operations Management, and Chunlin Wang, Postdoctoral Scholar.
In the study, to be published in Manufacturing & Service Operations Management, the authors examined the effects of “store brand spillover,” a phenomenon whereby a brand’s market share in a principal category (e.g., soup) creates demand in others (canned vegetables).
“Our study sheds light on how (store brand) spillover affects the retailer’s assortment and pricing decisions and demonstrates the impact of such decisions on the retailer, the focal category, and (national brands),” the authors write.
Retail category managers, responsible for the pricing and assortment of all brands on the shelves, are normally charged with maximizing profits for a particular category. This objective, however, overlooks the cross-category effects and can erode store-wide profits.
Using a game-theoretic model with a store brand-offering retailer and two national brands, the authors analyze how following a traditional category profit maximization objective (and thereby overlooking store brand spillover) affects a retailer’s performance. The study generated three significant findings regarding store brand spillover.
First, retailers that overlook store brand spillover can incur financial losses through suboptimal assortment and pricing decisions. The magnitude of this financial loss is relatively small when the retailer offers the right assortment but fails to adjust its prices to take store brand spillover into account. The financial loss is much larger when the retailer fails to carry the right assortment.
On the positive side, the study also found that when the degree of store brand spillover is low, a retailer can simultaneously increase its category profits and store brand market share. Conversely, if the degree of spillover is high, the retailer favors steep price reductions that may significantly lower category profits.
The authors note that “these findings suggest that retailers need to set the right performance targets for their category managers to reap the full benefits of store brand spillover. For example, rewarding a category manager based on her assigned category’s profit may incentivize her to overlook store brand spillover to keep her assigned category’s profit high at the expense of lower profits in other categories.
“In other words, when there is store brand spillover, incorporating the store brand market share into the category manager’s performance targets may be necessary to align the category manager’s incentives with the retailer’s objective of maximizing store profitability.”
Lastly, store brand spillover never benefits low-quality national brands, but it can increase high-quality national brand profits when the retailer drops low-quality national brands from their assortments. This finding suggests that differentiating their products from store brands may help the national brand manufacturers mitigate the adverse consequences of store brand spillover.
The authors conclude by writing, “we hope that our research will generate further interest in understanding the operational implications of store brands.”