The Economics of Private Label Pricing and Channel Coordination

Abstract

The marketing of products in developed economies relies primarily upon the sale of branded products rather than commodities. Companies that manufacture such products go to great lengths to differentiate specific products from close substitutes, and use real or perceived differences to do so. The resulting product differentiation is an important feature of market structure in mature industries that tend to have high seller concentration and high brand promotion budgets. Those budgets typically include advertising, direct consumer promotion activities such as manufacturer coupons or rebates, and trade promotion activities that provide retailers incentives to display the brand at a special (lower) price. Consequently the price of the prototype branded product is significantly higher than the direct manufacturing cost and the resulting price-cost margin is used to cover marketing costs and generate a profit. Ultimately the amount spent on marketing and the level of profitability depends upon the brands elasticity of demand. A firm can unilaterally develop inelastic demand brand level conditions through its differentiation efforts, and it can possibly do the same by tacitly colluding with other sellers (Levy and Reitzes, 1993; Deneckere and Davidson, 1985).