ANALYSTS SEE COMMUNICATION, INNOVATION AS KEYS TO PRIVATE LABEL

MARK HAMSTRA / Additional reporting: Elliot Zwiebach

Food retailers have significant opportunity to grow their private-label businesses, especially if they work on better communicating the benefits of those products to customers and expanding their offerings through innovation, analysts told SN.

U.S. supermarkets could potentially evolve their store-brand programs to rival those of such foreign private-label leaders as Loblaw's in Canada and Tesco in England, some analysts said, if the U.S. retailers are willing to invest in building that segment of their businesses.

Unit sales of private-label products account for about 15% to 20% of total product volume in U.S. supermarkets today, and growth has been increasing steadily as customers have discovered that the quality of private-label products rivals that of name brands.

"I think it has been growing in the low single digits, and that seems pretty reasonable going forward," said Marina Vendrova, analyst, Edward Jones, St. Louis.

One of the reasons she said she expects private label to continue to enjoy solid growth is the fact that retailers can obtain higher margins from those items, encouraging the retailers to add their labels to new products and expand into new categories. Private labels also allow supermarkets to differentiate themselves from competitors, creating unique offerings that can't be directly compared to price-oriented rivals like Wal-mart.

But to continue to be successful, retailers need to focus on maintaining high levels of quality in their private-label products and doing more to communicate that level of quality to their customers, analysts told SN.

"One potential obstacle to private-label growth is consumer education -- getting people to understand that the quality is there," said Chuck Cerankosky, analyst, McDonald Investments, Cleveland. "Especially if a chain hasn't used private label that way or it's used second-rate packaging or had inconsistent quality."

That failure to communicate was evident in Safeway's introduction of its Safeway Select products into the regional chains it has acquired in the past few years, according to Jonathan Ziegler, San Francisco-based managing director of Deutsche Banc Alex. Brown, New York.

"Safeway has had trouble with private-brand penetration at Genuardi's, Randalls and Dominick's because longtime customers at all three considered their stores more upscale, and private label still has an image to them that represents a compromise in quality," he said. "It's my belief that it's not the fault of the private-label product but Safeway's. It's the chain's execution in getting the message across."

One of the ways he suggested promoting private label was through the use of in-store sampling.

"All supermarkets should visit Costco more often because they sample the hell out of their private brands," he said. "Private brands are blind items, but if customers can taste a product and like it, they are more likely to buy it -- and that goodwill can transfer over to non-edible lines as well. So when a retailer does a private-label rollout, he should have an ongoing program of in-store sampling."

In addition to sampling, Ziegler said retailers could grow their private-label lines by focusing on high-quality products and strong packaging, in categories where it can be justified economically. Retailers also have the opportunity to use the packaging to advertise other products and services, he said. Safeway, for example, advertises its pharmacies on the backs of its private-label cereal boxes.

Cerankosky said lately he's seen more investment in the promotion of private-label products, including more advertising, couponing and placement on endcaps.

"But I wouldn't say it's approaching trade promotional levels," he added.

While the sluggish economy might be contributing to private-label growth in the near term as consumers seek to stretch their food budgets, analysts said retailers have other opportunities to grow that portion of their business by expanding their private-label products into the smaller, regional chains that they acquire and by expanding their private-label offerings into new product lines.

"The future of private brands is linked with the future of U.S. food retailing, and the future of U.S. food retailing involves consolidation," said Mark Husson, analyst, Merrill Lynch, New York. "The large food retailers that survive will want to explore the economies of scale they can achieve to the fullest possible extent, and as they buy more businesses, they will always be adding private brands at those companies, and that will increase the penetration of private brands."

He said he thinks that the largest U.S. retailers could achieve penetration as high as Loblaw's, which counts more than a third of its dollar sales in private-label products.

"Supermarket retailers today are doing a better job in private brands than they once did, but they have to start thinking of those lines as brands in their own right, rather than rip-offs of other, established brands," he said. "As private brands grow, the next step -- which we could see in the next two to three years, is to do a much more consistent job on chilled ready meals by working with local producers on a range of products that are tailored to the needs of the local market. All the major chains are working on getting that done, using their critical mass to contract with manufacturers.

"And the next step after that," he added, "will involve developing private-brand financial services, including banking and insurance, pending further liberalization of state banking laws."

He also said Kroger Co., Cincinnati, was considering developing a new private-label line of healthy living products, and he predicted that Albertsons, Boise, Idaho, would develop a premium private brand by the end of the year.

The challenge for retailers is to maintain a low cost structure so they can continue to reap the higher margins that private-label products yield. Branded companies not only have the marketing muscle to promote their products more heavily than store brands, but they also can devote more money to research and development and to superior packaging.

"The more innovation you see in branded packaged foods, the harder it is for private label to keep up," said Vendrova of Edward Jones. "You see branded companies spending a lot of money making their packaging convenient and so forth, and it's hard for private label to match that investment in their products and still keep a good price. It is harder for private-label manufacturers to imitate more sophisticated name brands with better packaging."

Analysts said retailers have largely avoided innovation in their private-label lines, instead settling for copycat products and packaging that mirror name-brand offerings.

"They are reluctant because it requires a whole new skills set and a whole expertise that the CPG companies have developed over years and years," said Meredith Adler, analyst, Lehman Bros., New York. "Do they want to go another step beyond what the manufacturers are doing and get new products out there?"

She cited Safeway as being aggressive in its development of the Primo Taglio private-label line of deli meats, but she said she's "not sure how much others want to do something similar" because of the additional investment that would require.

"I still think there are opportunities for general private-label growth," she said. "Retailers such as Safeway and Kroger understand the value of private label and how to market and display it and make volume grow. But others are just in their infancy, like Winn-Dixie, whose private-label program is not even in the 21st century, although the company is working to get there. So, the average growth for the industry will go up as the weakest players get better."

She also said electronic procurement services like the World Wide Retail Exchange and the Global Net Xchange are helping companies buy private label more efficiently, and she noted that retailers are translating those efficiencies into higher margins rather than trying to increase sales and market share by lowering prices.

To grow their private-label offerings, retailers also must continue to fight consumers' general preference for branded products, said Laura Ries, president of business consultancy Ries & Ries, Atlanta.

"People in general prefer brands," she said. "It's something they feel good about, they trust and understand. What's helped private label in the last few years is that they are no longer no-name brands. These are now more house brands. They have become a brand in and of themselves."

While retailers have been quick to spread their labels across a range of products and product categories, Ries cautioned that such a strategy could dilute the focus of the store brands.

"You see the private-label brands in every category in the supermarket, from soup and nuts to ice cream," she said. "People want to buy from the specialists, and those brands tend to be the most successful. It doesn't enable private label to ever build a very strong position in any one category."