Assessing the impact of manufacturer power on private label market share in an equilibrium framework
Introduction
The rise in private label market shares in emerging economies has not kept pace with growth elsewhere. While private label shares in the U.K., Canada, the U.S., and Switzerland are 43 %, 28 %, 25 % and 54 %, respectively, penetration rates in emerging economies average 3 %.1 In this paper, we seek to explain the gap in private label market shares between developed and emerging economies by examining the unique structure of manufacturer-retailer relationships in emerging economies. In most emerging economies, national brand manufacturers tend to be the sole producers of private labels. Therefore, we investigate whether they possess bargaining power relative to retailers and, if so, how this impacts private label market shares.
There has been a limited amount of effort to understand variation in private label penetration rates across geographical markets. Erdem and Chang (2012) show that variation in private label market shares among the U. S., Spain, and the U. K. is partly due to variation in consumers’ private label quality expectations, quality uncertainty, and risk perceptions. However, their comparison does not include any emerging economies. In contrast, Cuneo et al. (2015) attempt to explain private label market share variability across a sample of markets that includes some emerging economies, arguing that private label market shares vary because of logistical challenges faced by retailers. Specifically, they contend that in markets where private labels underperform, supply chain networks are underdeveloped, inefficient, uncompetitive, and unreliable. However, they fail to explain how national brand manufacturers in these economies thrive under the same conditions. Moreover, similar to Sebri and Zaccour (2017) they also argue that retailers in emerging economies lack both the technical and financial capability required to run successful private label programs. Yet, in a number of these markets there is a strong presence of not only large local retailers, but also divisions of large, well-capitalized, multinational retailers.
What is different in the structure of retailing between developing and developed countries that may help explain why private label market shares are low in emerging economies? Retailers in both regions are highly sophisticated, often multi-national, and sell groceries through hundreds of individual locations. Consumers in emerging economies have less disposable income, but that would argue for higher private label shares, not lower. Perhaps the most striking difference lies in the upstream relationships between retailers and suppliers. In developed economies, retailers have the option to choose among different types of private label suppliers. For example, they can source private labels from national brand manufacturers, and an assortment of dedicated contract-manufacturers who only supply private labels (Milberg et al., 2019). On the other hand, national brand manufacturers are largely responsible for supplying private labels in most emerging economies (Beneke 2009; Euromonitor International, 2014; Song, 2011, Van Wyk, 2013). This raises the question of how this supply arrangement impacts private label market shares.
We address this question using a two-step approach. First, we develop a theoretical framework outlining the role of national brand manufacturers in private label sourcing. This framework implies that in emerging economies where national brand manufacturers are the sole producers of private labels, relative to retailers, they possess bargaining power which allows them to set wholesale prices on private labels that directly impact their retail prices and market shares. Second, using retail specialty bread sales data from a major South African retail market we estimate a structural econometric model to test whether in fact national brand manufacturers in emerging economies possess bargaining power and, if they do, whether the wholesale prices they set for private labels are nearer the competitive or non-competitive benchmarks. We then use counterfactual simulations to determine whether higher levels of manufacturer bargaining power affect private label wholesale prices, and consequently private label market shares.
Our results show that manufacturers generally price in excess of purely competitive levels, which implies that they exercise a measure of upstream bargaining power. Importantly, we find that in equilibrium, national brand manufacturers set relatively high wholesale prices on private labels, resulting in high private label retail prices, and low private label market shares. Furthermore, our results also show that retail prices of both national brands and private labels are highest when manufacturers’ bargaining power is relatively high. This suggests that the economic welfare of a nation’s consumers is lower when national brand manufacturers are responsible for producing both private labels and national brands.
These results contribute to the marketing literature in the following fashion. While the stream of research on private labels is far-reaching, only a few studies investigate why private label market shares are low in emerging economies. However, these studies do not consider how private label sourcing impacts private label market shares. Our study is the first to empirically investigate how the private-label supply chain impacts retailers and manufacturers specifically in emerging economies. Importantly, we are the first to show that manufacturer bargaining power impacts private label market shares. From this viewpoint, we provide further empirical evidence as to why private label market shares are lower in emerging economies and augment findings in this area. Furthermore, extant research on private label sourcing finds that national brand manufacturers supply private labels when they have excess capacity (Chen and (Xinlei), 2010, Quelch and Harding, 1996, Soberman and Parker, 2006); when they produce premium private labels (Kumar et al., 2010, Milberg et al., 2019); when there are contract manufacturers who are willing supply private labels (Berges and Bouamra-Mechemache, 2011, Dunne and Narasimhan, 1999); when they want to build goodwill with the retailers in their supply chain (Braak et al., 2013); and when they want and to signal to other manufacturers that they do not intend to engage in price promotions (Wu and Wang 2005). We add to this stream of literature by showing that national manufacturers also produce private labels when they want to deter retailers and contract manufacturers from entering the private label market. Moreover, private label production increases manufacturers’ bargaining power over retailers which results in higher margins and market shares for their national brands, outlining another reason why national brand manufacturers should supply private labels.
The remainder of this paper is organized as follows. In the next section, we develop our theoretical framework and explain in detail the effects of manufacturers’ bargaining power on both the manufacturer-retailer relationship and consumer welfare. The third section presents the structural econometric model of retail bread demand and manufacturer supply. We then describe our data and provide some descriptive statistics that highlight key price and market share trends. In this section, we also explain how our model was estimated. In the fifth section we present and summarize our results. Last, we offer managerial implications and formulate the conclusions of our study.
Section snippets
Theory and hypotheses
Unlike in western markets, where retailers can acquire private labels from multiple suppliers at wholesale prices that are close to marginal cost, retailers in most emerging economies procure private labels solely from national brand manufacturers. In this supply arrangement, both retailers and manufacturers derive mutual benefits. Retailers procure private labels from national brand manufacturers for quality and cost assurances and better category management (Hoch 1996). On the other hand,
Model specification
Our model is structural as we specify private label demand, supply, and equilibrium pricing models under the assumption that both retailers and manufacturers operate in imperfectly competitive markets. On the demand side, we model consumers’ discrete purchasing choices, using a random parameter logit model. On the supply side, we assume Bertrand-Nash competition between manufacturers and retailers (Villas-Boas and Zhao 2005). We then estimate the extent of deviation from Bertrand-Nash margins
Consumer demand
We model consumer demand at the household level assuming preferences for differentiated products are randomly distributed among consuming households. Households make discrete choices among brands each week, choosing one brand from among several other brands. Utility depends on random elements, product attributes, and observed heterogeneity. Formally, we assume that consumers choose one unit of the brand that offers the highest utility, and they choose only one brand during each shopping trip.
Manufacturer and retailer conduct
In order to estimate the degree of manufacturers’ bargaining power, we develop a model of the private label supply chain and derive equilibrium wholesale and retail margins under the maintained assumption of Bertrand-Nash manufacturer conduct. The nature of the vertical game is such that we assume the manufacturers play a Stackelberg pricing game. In this channel structure, the manufacturers are the first movers; they set the prices paid by the retailers, who then, in turn, set prices to
Counterfactual simulations
Estimating bargaining power, however, merely establishes the extent of imperfection in either the wholesale or retail market. How this is manifest in private label shares requires simulating outcomes under alternative behavioral assumptions. Therefore, to determine the effects of bargaining power, we use counterfactual simulations to calculate changes in private label market shares, prices and consumer welfare under a variety of alternative assumptions.
The simulation is intended to determine
Data
To test our hypotheses, we use a nationally representative panel data set gathered by Nielsen (Homescan). The data includes a comprehensive set of retailers and brands and tracks South African households between August 2013 and June 2014. Consistent with household-panel data sets elsewhere, households in the panel keep shopping diaries in which they record their biweekly purchases of all grocery items. The data describes the main characteristics of their purchases: quantity, brand, retail
Results
In this section, we first present the demand-system estimates, followed by specification tests of the pricing model, and estimates from the preferred pricing model. Specifically, for the pricing model, we present estimates from a number of variants of the model in order to examine the robustness of our specification and estimation method. As a specification test for the supply-side model, we first present a model that only includes retailer margins, followed by a second model that includes both
Discussion and implications
This study examines why private label market shares are growing at lower rates in emerging economies than developed economies. In particular, we investigate the possibility that low private label market shares may be due to manufacturer bargaining power. Because manufacturers produce both national brands and private labels, there are fundamental economic incentives that prevent retailers from expanding the role of private labels as they do in markets with relatively less-powerful manufacturers.
Limitations and future research
As with most research, our research is also subject to limitations despite its contribution to some noteworthy findings. The primary limitation of our research is that we use data from the South African market only. Although there are overt similarities in the private label markets among South Africa and most emerging economies, examination of data from several other countries will improve the generalizability of our findings. This is an area that future studies can explore. We also implore
CRediT authorship contribution statement
Simbarashe Pasirayi: Writing – review & editing, Writing – original draft, Formal analysis, Data curation, Conceptualization. Timothy J. Richards: Methodology, Supervision.
Declaration of Competing Interest
The authors declare that they have no known competing financial interests or personal relationships that could have appeared to influence the work reported in this paper.
Simbarashe Pasirayi is an Assistant Professor of Marketing at the Franklin P. Perdue School of Business, Salisbury University. He received his Ph.D. from Arizona State University. As an academic, Professor Pasirayi’s primary research interests include the impact of marketing decisions on firm performance. His work has been published in a variety of academic journals.
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Simbarashe Pasirayi is an Assistant Professor of Marketing at the Franklin P. Perdue School of Business, Salisbury University. He received his Ph.D. from Arizona State University. As an academic, Professor Pasirayi’s primary research interests include the impact of marketing decisions on firm performance. His work has been published in a variety of academic journals.
Timothy J. Richards is the Morrison Chair of Agribusiness in the W. P. Carey School of Business at Arizona State University. He holds an undergraduate business degree from the University of British Columbia, where he majored in Economics and Finance, and a Ph.D. in Agricultural Economics from Stanford University. He has published articles in top economics, marketing, and agricultural economics journals, including the Review of Economics and Statistics, Management Science, the Journal of Retailing, the American Journal of Agricultural Economics, and several others.