Retailers once served mainly as carriers of products, while brand owners led product development and manufacturing. The result was severe product homogeneity in offline retail. Consumers could see little meaningful difference between the merchandise in one store and another.
Over the previous two years, however, New Distribution observed a change. Retailers represented by Pangdonglai, Sam's Club, and snack chains began actively experimenting with differentiated merchandise. New retail formats increasingly discussed product differentiation and co-created products with brand owners and upstream manufacturers.
Who should lead product differentiation in the future? What roles should brands and retailers play, and how should they divide the work?
This article is adapted from the roundtable “Who Should Lead Product Differentiation: Manufacturers or Retailers?” held at the third China FMCG Hard Discount Conference on August 21, 2024. Participants included Che Haiyan, vice president of Leerle Group; Yuan Ye, co-founder and vice president of Xunwushe; Zhang Huiying, national sales director of Oishi; Guan Xue, CEO of Gaosheng Liquor (Shanghai); consumer investor and industry consultant Qi Te; and Yuan Lai, chief content officer of New Distribution.
What Does Product Differentiation Mean?
Yuan Lai: Product differentiation has two dimensions.
The first is specification: is the product 300 grams or 500 grams? Those differences emerge from consumption occasions and channel requirements.
The second comes from consumer insight and differences in what consumers want.
How do brands, retailers, and investors understand product differentiation from their respective perspectives?
Che Haiyan: In Leerle's early years, we could say that price was our greatest differentiator. The market has changed. Price differentiation is now much smaller.
For a retailer, product differentiation determines how to become meaningfully different from competitors.
First, there is differentiation in the product itself. Function, price band, and specification can all differ.
Second, there is differentiation based on channel characteristics. A hypermarket and another retail format require different assortments and marketing approaches. The question is how to connect the characteristics of a channel with product differentiation.
Yuan Ye: Differentiation is extremely important to us. Price, packaging, function, and quality can all be differentiated. But I want to emphasize one phrase: products that are new, interesting, and unusual.
A popular format today is the “goods store,” which specializes in merchandise connected to entertainment intellectual property—cards, metal badges, acrylic displays, and other collectibles.
These products feel very fresh to consumers. We would not build an entire store format around them. Instead, we integrate them into Xunwushe's discount stores alongside snacks, designer toys, cosmetics, and skincare.
New, interesting, and unusual products depend heavily on differentiation. They attract more consumer groups, cultivate consumption habits, and occupy a distinctive position in the user's mind.
Zhang Huiying: Product differentiation began with specifications, sometimes reactively and sometimes proactively.
A reactive example is separating snack-channel pack sizes from those sold in the conventional market to prevent direct price conflicts.
A proactive example is responding to a channel request for a different specification, weight, or format.
Changing a specification is relatively easy. As consumer demand evolves, however, brands must also differentiate flavors and package design.
The more fragmented channels become, the more requests brands receive for differentiated products.
Guan Xue: This challenge affects every manufacturer.
For Gaosheng, product differentiation depends on several areas.
First, upgrade the raw materials. Alcoholic drinks provide emotional value. People drink when they are unhappy and when they are celebrating. We study the circumstances in which the consumer drinks and which kind of drink they select.
For a lightly sweet alcoholic beverage, for example, what alcohol content is appropriate? Which raw materials can create a differentiated value and taste for the distributor within that range?
Second, upgrade the process. Two drinks made with baijiu as the base can taste broadly similar. Gaosheng can use its global procurement capability to introduce other bases such as whisky or tequila, offering customers greater variety while continuously improving the product.
Third, make the product combination fit the retail channel more closely. Leerle and Xunwushe are completely different channels.
Leerle carries more than 70,000 SKUs. How should a new product connect with that existing assortment? Xunwushe wants products that feel new and unusual. How should we adapt to that requirement—perhaps by combining a drink with a collectible card?
The manufacturer must consider product attributes, marketing attributes, and the price range together.
Qi Te: Product differentiation can be considered at three levels.
At the micro level, a differentiated product is a recombination problem. Ingredients, formulation, innovation, and packaging determine the function and occasion. The value proposition must also create an emotional connection with consumers.
At a broader level, the company needs a systematic approach to communication and channels, matching different products to different channels.
From a retail perspective, product differentiation is assortment differentiation. Which categories should the store choose? How deep should it go in each category and SKU? Which products should be core products and which should generate profit?
Even the same merchandise displayed differently can create a different consumer experience.
The central question is assortment strategy: what share should come from mainstream products, distinctive local products, and private-label products? That is where retailer and brand capabilities combine.
Retailers are also moving upstream into some manufacturing activities. Their logic differs from that of a conventional brand owner, but both ultimately compete on two things: efficiency and product differentiation.
Should the Manufacturer or Retailer Lead?
Che Haiyan: The answer again has two dimensions.
From the product side, Apple in smartphones, Tesla in automobiles, and Coca-Cola in beverages have all created clear differentiation. Consumers regard those products as difficult to replace.
From the channel side, Sam's Club defines its assortment through large pack sizes and high-quality product selection. Consumers understand that channel positioning.
Miniso targets younger consumers and uses design and product innovation to define differentiation from the channel side. Watsons combined better service in beauty with product differentiation to build a channel-level identity.
Many strong examples come from cooperation between manufacturers and retailers. Procter & Gamble, a global leader in household and personal care, uses its brand portfolio, manufacturing capabilities, and research to offer consumers different functional benefits.
Walmart is a global offline retail leader. The two companies co-create deeply. Walmart can operate dedicated P&G sections with differentiated displays while the companies share data. Product feedback from Walmart enables rapid adjustment and helps both parties find a better fit with consumers.
Product differentiation is no longer optional; it is an unavoidable path in competition.
The best approach requires collaboration. Who leads? The party that moves first and wins a position in the consumer's mind will lead.
Yuan Ye: There is no universal answer. In the current market, most differentiation must be completed jointly by the manufacturer and retailer, depending on market conditions and company capabilities.
Manufacturers own technology and can innovate. Scale allows them to lower costs, and they control technical cost innovation.
Retailers have faster information feedback and channel sales data. They can lead private-label work, use merchandising as marketing, sell quickly, and return data to the manufacturer quickly.
Zhang Huiying: Neither side should lead entirely alone. Differentiation should result from collaborative innovation and mutual benefit.
If the brand acts alone, it can develop around brand, quality, and function, but then it has to find a suitable channel for the differentiated product. That is relatively inefficient.
Co-creation with a channel can take different forms. Some channels provide only basic requirements: a particular weight, package, or design direction, leaving the rest to the brand.
Other large retailers provide a much more complete concept. We cooperate wherever possible, while protecting the product's core process and our own brand. Different partnership forms can address different retail needs.
Guan Xue: Gaosheng is a manufacturing company. We provide channels with product recommendations based on channel needs, our capabilities, and retail research data.
Many customers come to us because they want to create a drink but do not know which type. They may have ideas only about package design.
We have industry data as well as import and export data. That information can guide domestic channels and brand owners in product and price design. We should not simply tell a retailer that every idea it has is correct.
If a customer wants an extremely low-priced product made with very expensive ingredients, we can manufacture it, but the result may not meet the actual business need.
Qi Te: My view is that the brand owner should lead at the most fundamental level.
The underlying reason is economic: a brand may operate at a 40 percent gross margin, while a distributor operates at 20 percent. Which party can invest more in product development?
Retail companies and FMCG companies can both make products, but they do different work.
The core private-label capability of a retailer is rapid replication: if a product sells well on the shelf, can the retailer reproduce a version quickly? That differs from a brand's product-development logic.
The market will likely separate into two groups. Strong brand companies will focus more energy on creating new categories that drive growth. Professional service companies will become specialized private-label providers for retailers.
This model is common overseas. I previously visited a European company that served traditional retailers including Aldi while maintaining its own R&D capabilities.
A service provider cannot wait until another company launches a new product before acting; by then it is already late. It must anticipate needs to serve a retailer's brand effectively.
The relationship remains collaborative. Retailers understand their customers and possess first-party data, but it is still early for most retailers to conduct R&D themselves. A better model is to cooperate with professional service organizations and allow brands and specialist companies to perform the appropriate work.
How Should Manufacturers and Retailers Collaborate?
Che Haiyan: Collaboration is exactly what retailers want. In a market saturated with brands, awareness of the problem is already widespread.
From the retailer's perspective, we hope every party becomes more proactive. Leerle will remain open to more innovation and use differentiation to build its competitive capabilities.
Yuan Ye: Manufacturers need technological and category innovation. Retailers need to strengthen their own channel brands.
Zhang Huiying: From a brand owner's perspective, innovation and R&D are the starting points of differentiation.
Process-chain innovation matters as well. Raw-material procurement and production cost affect both price and quality.
Brand building also needs differentiation.
Retail channels must provide more market insight. They meet consumers first and therefore understand how to attract consumers into a channel and satisfy their needs.
Differentiation must also continue through the sales channel and customer experience.
Guan Xue: Gaosheng will continue to use good materials to make good products for good channels and serve more consumers.
We hope retail executives and manufacturers will control food safety together, then pursue differentiation on top of that foundation.
Without food safety, consumers receive inferior products. A low price cannot compensate for poor service or poor quality. Manufacturers must examine their own responsibility.
Upgraded raw materials, improved technology, and greater scale should help channels lower selling costs and deliver better products to consumers, while allowing the industry to assume greater responsibility for food safety.
Qi Te: New Distribution has framed the challenge through two themes: core efficiency and product differentiation.
China's discount retail industry must move through two stages.
The first is a revolution in distribution. The second is a revolution in products and manufacturing.
The first stage moves quickly because it reduces high markups and shifts pricing power. The second stage moves much more slowly. The ability to do both well remains rare in China.
Why is the second stage slow?
First, the industry is still young, and many participants do not yet recognize that it requires an ecosystem.
Second, too few outstanding people have entered the industry.
More strong professionals are needed to build merchandise capabilities inside service providers. Those providers can then help brand owners improve efficiency. Brands and service providers can combine their insights to develop products that sell well and offer real value for money.
Yuan Lai: Product differentiation used to be discussed mainly at the product level, with manufacturers deciding what to sell and how to sell it.
Retail formats are now changing dramatically, and manufacturers—especially those accustomed to the old commercial distribution system—are struggling to adapt.
Retailers can conduct consumer research and plan store formats around specific consumption occasions.
Manufacturers have experienced such pressure in recent years because retailers are awakening. That awakening will inevitably challenge both commercial differentiation and distribution efficiency.