In 2021, we asked whether the private-brand trend would last. At the time, consumers were eagerly snapping up retailers’ owned brands, which were lower-priced and more readily available than similar products from many national brands. Fast-forward to today: our research clearly shows that consumers are continuing to opt for private brands.
The trend is continuing in both Europe and the United States. McKinsey’s latest consumer sentiment research shows that nearly 75 percent of US consumers and almost 85 percent of European consumers indicate that they are “trading down” when shopping—and switching to private-label brands accounts for a quarter of this trade-down behavior. Furthermore, the continued strong performance of mass retailers and the club channel in the United States, as well as the discount channel in Europe, makes it clear that customers are willing to change their buying behavior and shop at different retailers in search of value.
What’s more, private brands are appealing to customers not just because of price and affordability; these brands are now also becoming known for their quality. Sophisticated retailers are using private brands to differentiate themselves in the market and build customer loyalty, not only to improve margins and penny profit. We see this as a turning point in private brands.
But not all retailers will benefit. Retailers that are intentional about their private-brand portfolio—by providing both affordability and differentiation while shifting their mindset to think more like consumer-packaged-goods (CPG) players—will be better positioned to boost margins, consumer loyalty, and market share.
In this article, we outline a recipe for excelling in private brands. It encompasses three core capabilities—namely, merchandising and brand building, insights-led product development, and next-generation sourcing—and two organizational enablers that are fundamental to success.
No longer just a value play
Historically, US retailers have positioned private brands as affordable consumer options. As a result, private brands have not always had an advantageous penny profit position and have thus been treated as a low-priority part of the business. Retailers in Europe, by contrast, have been ahead of the curve in private-brand penetration, born out of the rise of discounters—and the resulting fight for market share against them. In Europe, private-brand penetration in 2023 was 38 percent, compared with only 19 percent in the United States.1
While US consumers typically opt for private brands only when their wallets are squeezed (see: the 2001 dot-com bust and the 2008 global financial crisis), the tides are changing. Our recent research shows that more than 80 percent of US consumers rate the quality of private-brand food products the same or better than national brands, and nearly 90 percent feel that private brands offer similar or better value (Exhibit 1). US consumers now regard private brands similarly to how their European counterparts do; in Europe, more than 80 percent of consumers perceive the quality of private-brand offerings as equal or superior to branded products.
This is no accident. Leading retailers have made tremendous investments in private-brand capabilities and offerings and have shown that private brands can propel both margin rate and penny profit, in addition to improved customer loyalty. These retailers have borrowed best practices from the world of CPG manufacturing and have become “CPG-like” in how they think about quality, value, innovation, and, ultimately, margin delivery.
The recipe for private-brand excellence: Three ingredients
While there are of course nuances between the North American and European markets, retailers around the world with successful private brands typically demonstrate strength in three capability areas: merchandising and brand building, insights-led product development, and next-generation sourcing. These capabilities, which are core competencies for CPG manufacturers, are redefining retailers’ private-brand offerings.
Merchandising and brand building
The appeal of private brands used to be all about price and affordability. But today’s private brands play multiple roles, from offering affordable quality to differentiation to tapping new growth opportunities. Creating the right private-brand offering thus requires new merchandising and branding capabilities, linked to the retailer’s value proposition and supported by advanced technologies such as AI. Specifically, retailers need to be much more intentional about their private-brand portfolio and architecture. They need to ensure sufficient scale by SKU to manage complexity and value, and they need to leverage digital channels, loyalty programs, and personalization.
Over the past few decades, European discounters like Aldi and Lidl have invested in private brands as a lower-cost alternative to national brands, using high volumes on a limited SKU base to lower costs and streamline consumer choice. Players such as the Spanish supermarket chain Mercadona have continually invested in private-brand quality, communicating both the value and quality of their products to consumers. The mix of merchandising strategies has differed by player. Some have built a frequently rotating product offer to spur traffic, while others have introduced weekly in-out nonfood products (or seasonal products that are not replenished once they sell out) at competitive prices. These actions have helped these companies elevate their private-brand products above those of national brands and, over time, rival supermarkets, which has helped them win market share. In response, supermarkets have moved from a three-tiered “good, better, best” structure to a two-tiered structure (for example, Tesco eliminated Tesco Value, and Albert Heijn did the same with AH Basic) and have made consistent price and quality investments.
In addition, European retailers have made big investments in private-brand innovation and differentiation. Consider Mercadona, which has introduced in-store customer feedback loops and highly iterative test cycles. In 2023, Mercadona’s 23 “co-innovation centers” conducted 11,000 consumer testing sessions, which led to 500 product improvements and 314 new products.2 Today, leading European private-brand players launch more new products per year than US players, including large ones. And private-brand success matters: we see a correlation between overall private-brand share and market share gains, with market leaders typically having high private-brand penetration. A similar trend is emerging in North America, where leading retailers are more consistently treating what were previously known as “private labels” as “private (or owned) brands.” This change in mentality from labels to brands has been critical: it means retailers now purposefully develop private-brand offerings that have a clear customer value proposition and a set of differentiators from national-brand alternatives. For example, Albertsons and Walmart recently launched a line of private brands that promise higher quality compared with their existing value-focused private-brand offerings. Target, meanwhile, has introduced more than 40 private brands across categories.
Insights-led product development
With private brands playing both a value-for-money and differentiation role for retailers, advanced product development skills have become more important. Product development can be a powerful driver of both revenue and margin growth when informed by deep consumer insights. Today, generating consumer insights has become much easier and faster, thanks in large part to digital tools and AI.
The internet, for one, is a treasure trove of consumer insights. Online ratings and reviews, which took on outsize importance during pandemic lockdowns, still heavily influence consumer purchase decisions: products with star ratings between 3.5 to 5 (on a five-point scale) capture 95 percent of market share. Companies can now quickly analyze online consumer sentiment using AI, web-scraping technologies, and natural-language processing (NLP)—which can aggregate reams of free-text comments and social media posts, organize them into themes, and reveal valuable, actionable insights that retailers can use to develop new products and improve existing ones.
Develop new products. Retailers have direct control over what products to stock on their shelves, which gives them an advantage over CPG players when it comes to new product releases. Retailers can therefore win in the marketplace by developing “first to market” products. One way to generate ideas for new products is to conduct ethnographic research, which can surface unmet consumer needs. In the past, this qualitative-research approach would have required in-person observations of consumer habits and behaviors. Today, this research can be done much faster and less expensively using digital-video diaries, in which consumers record themselves using a product or going about their daily lives. Consumer-backed insights, in combination with product expertise (from food scientists or packaging experts, for instance) and agile processes, can dramatically accelerate innovation: in grocery, for example, the product development cycle can take a mere six to 12 weeks, compared with 12 to 18 months at traditional CPG players.
Optimize existing products. Consumer comments and reviews can also highlight the ways in which product development could better align with the role the product plays in the category. Based in part on an analysis of online consumer comments, one retailer added truffle oil to one of its frozen-dinner products and priced the product higher, putting it in a premium bracket, which attracted a new consumer segment to the brand.
Whether a retailer decides to launch a new private-brand item or reformulate an existing product, it can’t afford to compromise on quality. Consumers, faced with an abundance of choice, may not give a private brand another chance if they think a product’s quality is subpar or has diminished over time.
Next-generation sourcing
The third ingredient in the recipe for private-brand excellence is taking sourcing to the next level. Getting to the right cost is critical to making the penny profit equation work. Depending on the category and the role of the private brand, retailers can often offer value to consumers without eroding margins—but this is no easy task, given that merchants and sourcing managers deal with thousands of SKUs, each of which requires component-level cost management. One way that retailers can address this significant challenge is through a digitally enabled next-generation sourcing model. The following actions have helped retailers expand their private-brand margins by 400 to 600 basis points.
Create real-time visibility into input costs. Over the past few years, retailers have faced dramatic increases in the costs of commodities and other inputs. Using automated tools, merchants and sourcing managers can now access a real-time view of input costs, including raw materials, the foreign exchange market, and labor, allowing them to identify cost reduction opportunities and cost-increase risks and equipping them to enter negotiations with their vendors with a clearer picture of the market.
A leading retailer identified a 24 percent cost reduction opportunity by gaining transparency into the impact of cost changes in rice, sugar, cocoa, and packaging on the cost of its cereal. After deploying an input cost monitoring tool across hundreds of food SKUs, the retailer found that over the past two and a half years, its supplier had increased prices by around 50 percent, but raw materials costs did not rise nearly as much (Exhibit 2).
Adopt an at-scale, ‘should cost’ approach to costing. It’s not uncommon for sourcing managers and merchants to use a “margin back” approach to set the target cost of private-brand goods—that is, they work backward from a retail price to hit a target margin. This leaves plenty of value on the table. Retailers can capture significant value by switching to a “cost forward” approach: establishing a target cost based on the best price a supplier can offer while still earning a fair margin. This approach, used extensively in contract manufacturing in the automotive and electronics industries, requires retailers to develop the capabilities for building detailed bottom-up value stream mapping and costing of the end-to-end manufacturing process (Exhibit 3).
Digital tools, such as parametric should-cost software, allow a retailer to quickly build should-cost models across thousands of SKUs. One retailer used a parametric cleansheet approach to determine how costs would be affected by adjusting the format or paper grade of a base toilet paper, which then informed its entire portfolio of toilet paper SKUs (Exhibit 4).
Drive supplier competition at the cost component level. Data analytics are helpful to retailers when setting target costs. However, to achieve better target costing over the long term, it’s critical to build negotiation leverage. Supplier competition at the cost-component level is crucial to closing the gap to what appears in should-cost models.
Digital request-for-quotation (RFQ) tools allow retailers to run RFQ processes and provide granular feedback to vendors, particularly on the components that cost more than expected. Retailers can compare bids from multiple vendors at the cost-component level and overlay information from parametric should-cost models to further calibrate bids.
Retailers can go a step further to bolster their sourcing approach: they can foster vendor competition by using AI-enabled tools that identify new vendors in both newer and established categories. These advanced supplier-discovery tools can help retailers cast a wider net for product sources, run rigorous analysis on supplier bids, and diversify their supplier base, thus ensuring business continuity even in the face of supply shocks.
Two enablers: Centers of excellence and strategic partnerships
How can retailers best operationalize the three ingredients discussed above? Where should those capabilities reside in their organizational structure? For leading retailers, a critical success factor in their private-brand journey has been the creation of a centralized team of specialists: the private-brand center of excellence (COE).
A private-brand COE is composed of experts in product development, nutrition, packaging, sustainability, and sourcing-related activities such as analytics or vendor negotiations—and can perform these functions faster, more rigorously, and in a more standardized way than if the retailer operated without a private-brand COE. It can support merchant teams, coordinate cross-functional collaboration, and disseminate best-in-class practices across the organization. On the analytics front, for example, a private-brand COE can deploy some of the tools described in this article, such as should-cost models and star rating analysis. It can also work with merchants to develop supplier-specific negotiation strategies incorporating insights from should-cost models and electronic RFQs. A COE’s size and specific responsibilities will vary from one retailer to another, depending on a variety of factors such as product portfolio complexity, the number of annual competitive sourcing events, and the capabilities of merchants and sourcing managers outside the COE.
To date, few retailers have successfully created private-brand COEs. Retail leaders say the lack of consistent processes or shared analytics on product development, sourcing events, or negotiations poses difficulties in setting up a COE (even though establishing a COE can help standardize those very processes). A bigger obstacle to establishing a COE may be the difficulty of demonstrating the ROI of a centralized team.
To overcome these challenges, a retailer can standardize the work within one of its private-brand functions. Once that process starts showing success, retail leaders can establish a COE to replicate the process across the remaining categories, which in turn can help scale the impact of the COE across the retailer’s entire private-brands business.
Another critical enabler of excelling in private brands, in both Europe and North America, is deep manufacturing expertise and reliable access to high-quality production capacity. Some retailers, such as Lidl, have their own manufacturing facilities; other retailers are forming long-term strategic partnerships with vendors. In North America in particular, competition for production capacity is intense, with some categories—such as pet food—having limited spare capacity for private brands. Some CPG players that are experiencing volume declines are starting to take on private-brand manufacturing. In all categories, retailers can seek to understand where, how, and with whom to form strategic partnerships. A purely transactional approach to vendor relationships likely won’t work; retailers need strategic partnerships to secure innovation and continuous quality improvements.
In light of favorable consumer sentiment toward private brands, and given the continued growth of the discount, mass, and club channels, stepping up private-brand capabilities is now an urgent matter for retailers. The leaders in this new era—specifically, those retailers that deploy CPG-like capabilities to achieve private-brand excellence—will be better positioned to boost revenue and margins while also attracting more satisfied and more loyal customers.
