In recent years, most European retailers have been working to develop their distributor own brand (DOB) product lines, sometimes by extending own brand into new categories, sometimes by widening the assortment in categories where it is already present. While the latter option is motivated by strategic image considerations, the decision to enter new categories is based on the popular belief that introducing own brand improves a category’s overall profitability for the retailer. However, experience suggests that this belief may not always be justified, and that European retailers seldom have the necessary information systems to monitor product profitability in an accurate and timely manner.

Profitability varies by category

When DOB is introduced in a new category, the expectation is that it will improve overall category profitability by: (1) increasing the number of units sold by improving perceived value; (2) reducing average buying costs and, since the reduction is only partly passed on to the consumer, raising the retailer’s absolute margin; and (3) increasing other revenues such as promotional investments paid by manufacturers to counterbalance the additional threat of this "new" in-store competition (Exhibit 1). However, an exhaustive analysis indicates that the impact on profits varies widely: the "best" category shows a profitability improvement of over 80 percent, the "worst" a decline of 1 percent.

Brand leaders are often more profitable

This unexpected finding is partly explained by the fact that DOB products often turn out to be less profitable than branded equivalents when all cost and revenue items are taken into account. Although DOB margins (that is, selling price minus buying cost) are always more attractive for the retailer than those of leading brands, this advantage can be offset by the heavy investments made by manufacturers to promote their products in stores (shelf rental, use of special displays, promotional leaflets, and so on). Moreover, DOB products are often allocated an excessive amount of space in relation to brand leaders, which means they generate lower ratios of profit per cubic meter. When 60 food categories were analyzed, almost half of the DOB products produced less profit per cubic meter than brand leader counterparts (Exhibit 2).

Retailers lack critical information

These profitability problems will probably surprise most European retailers, for two reasons: (1) their information systems do not allow them to monitor real product profitability—important components such as commercial investments, financial terms, and logistics costs are normally left out; and (2) data relating to space allocation, although available, are rarely linked with profitability—current space allocation software still seems to be a long way from making this possible.