********Low price is the hallmark of private labels Private labels are known for their low prices. There are two types of low prices: one is low quality, low price, which is what is commonly called cheap, focusing on quality at a low price. The other is high quality, low price, which is value for money, focusing on price while maintaining quality. Private labels fall into the latter category, targeting the middle class with high quality at low prices. So, how low are private label prices? Price comparisons must have a benchmark, and private labels benchmark against well-known brands of the same quality. Koen A.M de Jong, author of The Private Label Revolution, cites the example of Aldi, a famous German hard discount retailer: its private-label ketchup costs €0.95, while the benchmark Heinz ketchup costs €3.39, a price difference of 3.57 times. Recently, I asked a CEO who studied in Australia, and he said that in supermarkets, the price of one can of Coca-Cola could buy 10 cans of private-label cola. Of course, such a high price difference may be an extreme case, but the low price of private labels is widely recognized.
The Logic Behind Low Prices There are two main logics for retail low prices: First, retail gross margins are low, but purchase prices are not low. For example, some stores source "Oriental Leaf" tea from normal channels but sell it at a loss to attract customers. This practice is not suitable for most SKUs. It is commercially known as a "loss leader" to drive traffic. For instance, supermarkets often used low-priced eggs to attract customers. Retail gross margins vary significantly across different retail formats, such as grocery stores, department stores, supermarkets, KA stores, and discount stores, but gross margins within the same format are roughly similar. When discussing gross margins, one must benchmark against the same format. Loss leaders are just marketing gimmicks, not normal prices. Private labels typically have higher gross margins than well-known brands, so private labels do not engage in price wars by sacrificing gross margins. However, retail gross margins are related to the category; some small commodities sourced from Yiwu can have retail gross margins exceeding 100%. Second, retail gross margins are normal, but purchase prices are low. In this case, it depends on the purchase price the retailer gets. Private labels naturally have lower purchase prices. To understand why private labels are cheap, we need to analyze the different purchase prices retailers have and the cost structure of those prices.
Cost and Price Structure Why are private label prices so low? Is it because of cutting corners? Private labels, backed by the retailer's reputation, certainly do not have this issue, and their quality often benchmarks against well-known brands. The low prices in hard discount stores mainly come from procurement costs. Therefore, it is necessary to analyze the procurement costs of private labels versus well-known brands.
- Workshop cost = Workshop production cost (variable cost) + Workshop allocated fixed costs
- Company cost = Workshop cost + Company allocated fixed costs
- Company ex-factory price = Company cost + Company gross profit
- First-tier distributor price = Company ex-factory price + Distributor operating costs + Distributor gross profit
- Second-tier distributor price = First-tier distributor price + Second-tier operating costs + Second-tier gross profit
The above cost and price structure will be used later. Different companies may have different prices at each level.
How big is the difference from workshop cost to second-tier distributor price? More than 50%, or even larger.
Retailer Purchase Prices Retailers of different statuses get different purchase prices, roughly as follows: First, BC-class retail stores. Under China's current deep distribution system, the purchase price is the "second-tier distributor price." This is the highest price. Second, A-class retail stores. These include KA stores, chain supermarkets, and chain convenience stores. Because of their larger scale, they are directly supplied by the manufacturer's distributors, and the purchase price is the "first-tier distributor price." Third, super retailers. They are supplied directly by the brand owner (manufacturer) headquarters. However, under China's current distribution system, they typically sign cooperation agreements with headquarters, and local distributors provide services such as delivery. Therefore, the purchase price is between the "company ex-factory price" and the "first-tier distributor price." For example, Walmart has only one procurement center in its global supply system outside mainland China, but in China, each Walmart store can be considered a procurement center. Although super retailers may establish supply relationships with headquarters, local services are always provided by local distributors. Fourth, private label supply prices. This depends on the scale of the retailer's OEM. For example, current snack discount stores, due to limited store numbers, often still source from distributors and then burn money to attract traffic. Of course, these are not private labels. Private labels, simply put, mean the store connects directly with the factory, eliminating channel intermediaries. The purchase price for private labels depends on which type of manufacturer they source from. There are roughly three scenarios: First, sourcing from small manufacturers for white-labeling. Many people think this is cheap, and some small factories believe they can transition to private label white-labeling. But this approach has two major risks: one is the quality stability of small factories; the other is that small scale means higher costs. Cost is a typical concept of scale. Total cost leadership means scale leadership. Second, sourcing from large factories for white-labeling. There are two types of large factories for white-labeling: one is specialized white-label factories, which charge cost plus margin. The other is manufacturers that also do white-labeling; the purchase price is "company ex-factory price minus manufacturer's marketing costs." Because for private label OEM, the manufacturer does not need brand promotion fees or channel costs. With the same quality, the price is lower than the brand's ex-factory price, and this is where the price advantage comes from. Third, in rare cases, white-labeling can get prices lower than the factory price, even reaching "company cost" or "workshop cost." Why does this extreme situation occur? Because China is currently in an era of shrinking volume, with overall industry overcapacity. Even leading brands have significant excess capacity. For example, in recent years, leading brands have been continuously closing factories. Utilizing excess capacity is itself a way to increase revenue. Therefore, the OEM ex-factory price may not be the normal operating cost. For instance, a listed company might use OEM as an important revenue-increasing method to make its annual report look good. Some companies also use ultra-low-price OEM to increase revenue before going public. In such cases, the purchase price for private labels might be the workshop cost. Note that workshop cost is the lowest price for private labels. From "workshop cost" to "second-tier distributor price," the difference can be several times. The more well-known the brand, the larger the gap. Private label price comparisons are inherently benchmarked against well-known brands. Well-known brands may also be OEM, such as Nike and Apple, which is normal. The largest cost item for well-known brands is precisely marketing costs. Only high marketing costs can support the ultra-high premium of well-known brands. The low price of private labels is precisely because they save on marketing and channel distribution costs. This is the reason for the low price of private labels.
Scale is the Prerequisite for Low Prices The price system mentioned earlier is determined by retail scale. BC-class stores have the smallest scale and the highest purchase prices. The prerequisite for private labels is that the scale reaches the level where you can directly approach manufacturers for OEM; otherwise, don't talk about private labels. When it comes to scale, there are two scale logics: First, total scale. For example, if a retail store's total sales are large, it can get a larger discount ratio from comprehensive suppliers. Note that this is a scale discount obtained while the price system remains unchanged. Second, single SKU scale. Hard discount businesses have far fewer SKUs than ordinary stores of the same type. This model not only helps consumers choose but also helps expand the scale of individual SKUs. When sourcing from manufacturers for white-labeling, the price depends on the scale of individual SKUs. What determines the scale of individual SKUs? Given the same operating capability and store scale, it is, of course, the number of stores. In the past decade, the share of China's retail TOP 100 has halved, and concentration has severely declined. With the rise of private labels, retail concentration will correspondingly increase. For example, China has already seen vertical retail chains with over 10,000 stores, such as Mixue Bingcheng. I believe that snack discount stores may see brands with over 10,000 stores within a year. Private labels and hard discount are two typical phenomena of the supply chain revolution, and the low price of private labels is the prerequisite for hard discount, that is, super cost-effectiveness. Traditional retail stores compete on operating capability with the same products. Hard discount stores compete not only on operating capability but also on cost control of private labels. The cost of private labels is determined by scale.
The cost and scale of private labels are like the chicken and the egg, mutually causal. Because of scale, the cost of private labels is low. Because the cost of private labels is low, scale can continue to expand.