Should name brands discount prices to combat private labels in the recession economy?

The Atlanta Journal-Constitution reported yesterday that customers are increasingly buying private label store brands due to the poor economy (click here). The article quotes research from Nielsen that shows that private label sales grew 10% YTD whereas name brands grew by 3.5% only over the same period.

Earlier research from Nielsen (click here) shows that consumers increasingly think that store brands are a good alternative to name brands and have a comparable quality. Fewer people (24%) think that name brands are worth the extra price. More people now feel that store brands are not only for consumers on a tight budget.

Category managers must ask themselves: Should I discount my name brand to compete against the store private label?

The answer may be different for different product categories and even for different store formats.

The share of private label products varies across categories (click here). It is high for pet food, frozen/refrigerated food and plastic/paper products. It is very low for beverages, home care, baby food, cosmetics, snacks/ confectionery, and hygiene products.

Surprisingly price differentials between private labels and name brands are lowest in categories where the share of private labels is high (around 20%). Price differentials in some categories where store brands have low share are as high as 40%.

This suggests that the price sensitivity and the importance of brand is different in each category. Name brands should use pricing analytics to understand the share and volume impact of various pricing differentials in the specific category.

For some categories (e.g. bottled water), it may make sense for the name brand to focus on low unit-count packs rather than focusing on the bulk-use packs. Consumers who buy bulk-use packs are more likely to be price sensitive.

It is also important to understand that private label receptiveness is much lower in convenience stores than in grocery chains (click here). It is important for category managers to analyze price sensitivity (by share and volume)for their brand for each retail chain separately. Discounting products in a convenience store chain may yield little/ no benefit whereas it may be a good decision at a wholesale chain.

Should Abercrombie discount its wares?

The Wall Street Journal reported earlier this week that Abercrombie & Fitch is pursuing a strategy of not discounting its apparel (fashion brands targeted at young people) during the current recession (click here). The article mentions that their competitors (American Eagle Outfitters, Aeropostale, QuikSilver, Pacific Sunwear) have discounted their apparel significantly.

While competition has seen same-store sales decline by 10-11%, Abercrombie's November same-store sales fell by 28%. However Abercrombie enjoys the highest gross margins (66%) compared to competitors who have much lower margins (AEO:41%; Gap:38%; J Crew:43%, Pacific sunwear:29%). The management insists that discounting will lead to long-term erosion of brand value.

I can't help but ask myself: Should Abercrombie discount its wares?

I think there is a strong case for Abercrombie to consider pricing lower selectively. Here's why:

• Abercrombie's target population has been hit hard by the recession due to potentially reduced pocket money from parents (for younger teens) to bleaker job prospects (for recent graduates) to higher tuitions and costlier student loans (for college students). Clearly, the target customers will cut back on apparel spending, especially on premium brands.
• Abercrombie has a 66% gross margin (Yep, you read that right: their average cost of goods sold is only a third of the average price). However its fixed costs (marketing and distribution expenses) run to more than $450 MM per quarter (~54% of sales in the Nov'08 quarter). This is much higher than the comparables for most competitors.
• Assuming that marketing and distribution costs remain largely fixed, Abercrombie will make a loss if its sales decline a further 15% from Nov'08 quarter levels.
• Based on current sales and inventory numbers, Abercrombie is carrying more than 50 days of inventory. This is a fairly high level in Abercrombie's history. Inventory pile-up could force it to discount later(as winter-wear will need to be sold off before spring).
  
• Although there is a strong case for brand equity dilution, Abercrombie could consider structuring the discount selectively on products that are slow-moving. Also it can be relatively discreet about its discounts so that it does not impact brand image.

Let me know what you think....