The Economics of Everyday Things - 34. Store-Brand Products

Episode Date: January 29, 2024

Those low-priced staples on grocery-store shelves — where do they come from? Zachary Crockett finds out at a national convention for private-label manufacturers. SOURCES:Kusum Ailawadi, professor of marketing at the Tuck School of Business at Dartmouth College.Eric Beringause, C.E.O. of Winland Foods.Ryan Boyle, vice president of sales at Kitchen Innovations.Samantha Burd, co-owner of Lady Burd Cosmetics.Dean Erstad, senior vice president of sales at Seneca.Harry Overly, president and C.E.O. of Flagstone Foods. RESOURCES:"The Backlash to Price Hikes Is Building," by Julia Waldow (Modern Retail, 2024)."For U.S. Consumers, It’s a Matter of ‘And’ — Not ‘Or,'" by Kari Alldredge and Warren Teichner (McKinsey & Company, 2023)."Those Doritos Too Expensive? More Stores Offer Their Own Alternatives," by Julie Creswell (The New York Times, 2023)."Why Private Label Brands Are Having Their Moment," by Errol Schweizer (Forbes, 2022)."The Hidden Makers of Costco’s Kirkland Signature and Trader Joe’s O’s," by Nathaniel Meyersohn (CNN Business, 2022)."Pursuing the Value-Conscious Consumer: Store Brands versus National Brand Promotions," by Kusum Ailawadi, Scott A. Neslin, and Karen Gedenk (Journal of Marketing, 2001)."The Effect of Generic Products on Consumer Perceptions and Brand Choice," by John J. Wheatley (NA - Advances in Consumer Research, 1981). EXTRAS:"Should America Be Run by … Trader Joe’s?" by Freakonomics Radio (2018)."How to Save $1 Billion Without Even Trying," by Freakonomics Radio (2014).

Every November, thousands of people in the grocery business gather at a convention center in Chicago. Inside, there are booths set up as far as the eye can see. Sales representatives are showcasing just about anything you can find in the aisles of a supermarket. We make baby diapers. We have lipsticks, foundations, mascaras, concealers, cleansers, moisturizers. Plastic trash bags, plastic drustering bags, handle bags. You'll find foods from all over the country.

Canned vegetables. Cut green beans, sweet peas, carrots, potatoes, cookies, we've got sandwich creams, we've got ginger snaps, even bacon-wrapped quail meat. We farm-raised quail and we produce fresh quail eggs for consumers across the country. It's unlikely that you'd recognize any of these companies by name. They're not household brands like Frito-Lay or General Mills, but there's a very good chance that you've purchased some of their products without even knowing it. Because this is the annual trade show for the Private Label Manufacturers Association,

or PLMA for short. It's an organization that represents companies that make the store brand products for major retailers. The peanut butter that's sold under the Trader Joe's label, the batteries for CVS, the granola bars for Albertsons. Store brand products are ubiquitous on grocery shelves, and more people are buying them than ever before. But it's an industry that, by by nature stays out of the spotlight.

So we went to Chicago to figure out where exactly all those products come from and why stores carry them in the first place. Retailers always look at what is selling in their stores and what isn't. Their goal is going to be to get a private label product that is as close in quality to some of the high demand national brand products and to sell it successfully at a lower price. For the Freakonomics Radio Network, this is the economics of everyday things. I'm Zachary Crockett. Today, store brand products. When you go shopping at your typical grocery store, you'll see a lot of the big name brands, Tide Detergent, Keyblur Cookies, Kellogg's Cereals.

But sitting right next to those brands, you're likely to also see the store's own version of the same products. And perhaps nobody understands those private label products better than this woman. My name is Kusum Elawadi and I'm a professor of marketing at the Tuxedo Business Adatmot College. Elawadi has spent her career studying store brands. She says these products really began to take off in the 1970s when inflation was straining the economy and shoppers had tighter wallets. In those days, they were called generics.

They were generally kind of acceptable quality but known to not be anything outstanding. No name at all, very plain packaging. They were really, really attractively priced for price sensitive consumers. If you were buying beans, the generic would just be a giant white or yellow can with beans written on it. In commercials, the stores touted these products as cheaper alternatives to name brands. Alternatives that cut out the marketing and advertising and passed the savings on to consumers. A new no frills value choice. Just look for the plain yellow and black generic labels

and save even more on nutritious food and serviceable household products. So now the choice is yours. Brand names or generics. By the 90s, retail chains ditched the generic packaging and created their own simple branding for their affordably priced products. Today, most of the major retailers have store brands.

Sometimes they use the name of the store like at Trader Joe's. Other times, the retailer might create a brand name of its own like Kirkland at Costco or Signature Select at Albertsons. With rising prices at grocery stores, these more affordable store brands are in high demand. Last year, Americans bought more than $230 billion worth of private label products, and they now account for around one in every five products on store shelves.

For us shoppers, they present a tantalizing value proposition. You know, I can go and buy a box of Kellogg's cereal and look for coupons or look for a deal in the grocery store and then get it for, you know, like a 20% off or whatever. But I have to search for that. Private label is consistently priced lower than the national branded products. So that's always been the big driver of private label purchases. Retailers have their own incentive for selling store brands. They're a way to build loyalty with customers. And as it turns out, they're a lot more profitable than the name brands.

Typical gross margins for retailers in the grocery industry are around the 20 to 25% point on national branded products. Their gross margins on private label products are in the 30 to 35% range, sometimes even higher. Despite the names you see on those products, most retailers don't actually make them. I mean, some grocery chains like Safeway and Kger, have their own dairy farms, bakeries, and meat processing plants. But for the most part, retailers outsource the manufacturing of these products to other

companies and just slap their brand on it. Those Trader Joe's peanut butter cups and tortilla chips, they're not actually made in some magical Trader Joe's factory. Elawadi says that some store brand products are actually made by the same companies that produce the name brand versions of those products. Take for instance Costco. Some of the Kirkland brand coffee blends are made by Starbucks. Kirkland batteries, Duracell.

And Kirkland diapers, those come from Kimberly Clark, the company that makes huggies. I have my plant running. If I have some excess capacity, why not just also manufacture the private label after all someone else is going to do it if we don't do it? When nationally recognized brands do make private label products, they're usually tight lipped about it. Obviously, it is not in the national brand manufacturers' interest to loudly proclaim

that they also supply private label, right? The consumers then thinking, well, why am I paying 25, 35, 40% more for, you know, a Heinz ketchup if the private label ketchup was also made by Heinz. So it's a very, very well kept secret. But most of the store brand products you see on shelves come from dedicated private label manufacturers. These companies specialize in manufacturing certain products in very large volumes. Instead of creating their own brands

and marketing their products to consumers, most of them prefer to stay behind the scenes. To find them, retailers go to trade shows like PLMA. At last year's event, representatives from Kroger, Family Dollar and Costco roamed the halls looking for capable partners. And there were more than 1600 companies from 60 different countries to pick from. Our company is based in the state of Vitaly, Calabria.

We do mainly ready meals and fruits and vegetables. We are the Ukrainian producer of sunflower oil, soybean oil, rapeseed oil, mayonnaise and tomato sauces. This is company Flora from Serbia and we do some gems for international products. So how do these retailers decide which products to replicate? And just how close can they get? That's coming up. Bringing a store brand product to market usually starts like this. A national retailer like Albertsons has category managers who are in charge of specific kinds

of goods. They might see that a certain name brand tomato sauce is selling in big numbers, but it's a little expensive, which means there's an opportunity for a more affordably priced store brand version. So they turn to a company like Winland Foods. We're a little bit of a stealth business. That's Eric Behringaus. He's the CEO of Winland Foods. That company isn't a household name, but their products are all over the grocery landscape. Albany isn't a household name, but their products are all over the grocery landscape. So we manufacture private-label foods for all the major retailers in the world.

We make 30 different types of pasta, 20 different types of salad dressings, various sauces, chocolate sauces, strawberry sauces, we make barbecue sauces, pita chips, and the list goes on and on. Retailers ask Wynland Foods to reverse engineer, name brand products, and create a new version. Some emulations require less reverse engineering than others. Under FDA regulations, peanut butter, for instance, has to be composed of at least 90% roasted peanuts. Things like mayonnaise, salt, milk, they're usually pretty similar. Something like pasta sauce requires

a little more work, but Wynland can get pretty close. If you looked at the ingredient declaration on it, it would be identical to the brand, the nutritional labeling would be identical. And if you were to put it into a consumer test, it's indistinguishable from the brand. Wynland will run what's called the Triangle Test on the product. They'll set up a blind tasting of three sauce samples. One of them them their own formulation, the other two the name brand they're trying to emulate. If testers can't pick out which one is different, Winland knows they've done a good job. But that's the easy part. The bigger

challenge is mass producing that new recipe at a significantly lower cost than the national brand. Private label is a highly competitive business and unless you can actually sell at a pretty low cost, you're not going to be able to make much margin. Marketing professor Kasum Alawadi says that private label manufacturers don't have much bargaining power when it comes to negotiating with retailers. Because nobody knows who the supplier is, the consumer doesn't, so the supplier doesn't have much leverage.

So when you go into a proger, when you go into a Walmart, pick up great value or you go to all the, or whoever you might go to, a lot of times that product is ours. That's Dean Ersted. He's the vice president of sales at Seneca, one of the largest private label manufacturers of canned vegetables.

We met him at the trade show while standing in front of a giant wall of his company's corn. He says that because the margins are so slim, private label firms often have to get creative to keep production costs down. Sometimes, that means offering a slightly different product than the name brands. Take for instance canned peas. The real small ones, they're called petite peas, and you run them separately for store brands because they're about the only ones that really want that, where national brand, they just blend them all together, you know, in the whole scheme

of things. So there's little nuances within the product. Many companies we talked to said they had to make concessions on their products to make the costs work. Here's Harry Overly, the CEO of Flagstone Foods. They make trail mixes for major retailers. There is a bit of a science in terms of ratio of almonds, peanuts, raisins, and chocolate-covered candies is the most common one. So yeah, there's a bit of a science to that. And then if you

get really fancy, you know, you throw some cashews in there. If you go the other way, just say, hey, I'm really trying to give a value product, no almonds. So it's all peanuts, raisins, and M&M-type products. Once these products are on the shelf, retailers have to make sure they're priced far enough below the name brand to entice shoppers. The consumer still today thinks of private label as an acceptable quality, but reliably lower price product.

So if your private label product gets priced too close to well-known national brands, the consumer's going to say, oh, why should I buy this? I'll just buy the national branded product. National brands often don't take kindly to the retailers that make store brand versions of their products.

It's with good reason. I mean, retailers will often have little signs there saying, try our product compared with the national brand, buy it for 40% less. For consumers, this competition is more than welcome. Since the pandemic, some big brands have increased pricing on their products by percentages in the double digits, while reaping record-setting profits. A McKinsey survey found that nearly 8 in 10 grocery shoppers are now trading down to

save money. And when they trade down, they're putting a lot more store brands in their carts. Of course, private-label products aren't just cheaper imitations of name brands. As retailers look to reduce dependence on national brands, they're also in the market for new stuff. Stuff that can only be found at their stores. So my dream outcome is maybe hitting on two to three good US or international retailers

and working with them on an innovative gadget or tool, a private label program. That's Ryan Boyle, vice president of sales at a company called Kitchen Innovations. At PLMA, his booth had all kinds of weird gadgets on display, garlic presses, potato mashers, tongs with rubber hands, and a cheese grater that kind of looked like a little medieval torture device. We're trying to add some uniqueness, some creativity, as well as focusing on the design aspect, which sometime is missing as well with private label, like researching colors and pantones and things like that, where you know, outside of the norm that you'd see traditionally on a private label shelf, we wanna show that we can be the ones

who are innovative for you. We can work alongside you, and we can present you with innovation for your own private label and your own brand. Just down the hall from Kitchen Innovations, we found another entrepreneur who shared a similar philosophy. I'm Samantha Bird.

I'm one of the co-owners of Lady Bird Cosmetics. I'm a third generation owner of the company. Lady Bird Cosmetics makes private label beauty products for retailers and celebrities who want to create their own makeup lines. The company's clients don't just want imitations of existing products. There's the second type of customer who wants to do everything custom. They have a dream, they have a vision, and they work one-on-one with our lab to create exactly what they want.

Whether they're tasked with making a can of corn or a new color of lipstick, there's one thing private label companies often can't do. Take credit for their work. After the development, the planning, and the manufacturing is done, their goods become a part of the retailer's identity. And for shoppers like you and me, the origin of any given store brand product remains a mystery. It's really cool to walk into some of these stores that I personally love shopping in and see things on the shelf and I know it's ours, but it pains me to not be able to post it to our Instagram.

People always look, oh, who do you manufacture for when they find out that we do this? And I'm like, I'm sure that you've seen them. I'm sure you've used them, but I can't tell you, but I know that you like our stuff. For the economics of everyday things, I'm Zachary Crockett. This episode was produced by Sarah Lilly and mixed by Jeremy Johnston. We had additional help from Daniel Moritz Rapson. Parmilla Creamery is the leader in vegan cheese. Can we call you the cheese marketing officer? You can call me the cheese marketing officer. The Freakonomics Radio Network.

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