The expectations for growth of private labels in Asian food retailing are high.

At the moment, Asian food retailers may not need to or be able to fully commit to private labels.

But that is about to change.

Lessons from Eastern Europe show that private-label growth is likely to accelerate when the market share of private labels enters a 5 percent to 8 percent threshold bracket. Countries such as China and particularly India are nearing that threshold.

The consolidation of brands and distribution would help brand owners stay ahead of food retailers by locking up consumer loyalty.

It took 50 to 60 years for private labels to reach a market share of over 40 percent in, for example, the United Kingdom and Switzerland. Central and Eastern European countries, such as the Czech Republic and Hungary, took only about 20 years to reach half that level.

The history and outlook of private labeling in Europe provides valuable lessons about what to expect in places such as India and China. The question is whether private labeling in Asia will need 5 years or 50 years to catch up with European levels.

Consumers are not asking for private-label products; food retailers are putting them on the shelves. Why?

Knowing the rationale allows us to identify both the bottlenecks and the catalysts to private-label growth.

Even more important than higher gross margins or an increase in customer loyalty, the introduction of private-label products is intended to support food retailers in price negotiations with branded suppliers.

China bottleneck

Private labels are not new to consumers in China’s top-tier cities, such as Shanghai and Beijing, but they may be less familiar in lower-tier cities. Private labels have an estimated market share of 3 percent in modern retailing nationwide, mainly concentrated in leading retailers in top-tier cities.

Among the 65 leading supermarkets and hypermarkets — which hold a combined 25 percent market share — 39 have their own private-label products, accounting for 4 percent of total store sales, according to a survey by the China Retailers Association.

Private labels in China are mostly found in multinational retailers and in leading local retailers like Lianhua and CR Vanguard.

Private-label penetration varies significantly among product categories. Some Western processed foods, such as pasta and ready meals, already have relatively large market shares under private labels, thanks to a lack of local competition.

But there are bottlenecks to private-label growth in China.

First, modern retailing accounts for 60 percent of total food retail value, compared with more than 80 percent in Europe and North America. Retailing in China is highly fragmented, with the top three modern chains alone covering only 10 percent of the market. Food retailers lack the scale necessary to make private-label production economically viable.

Second, a brand dominance of any significance has been observed only in the instant noodles category. Market fragmentation prods food retailers to exercise their negotiating power through means other than expanding their private-label offerings.

A clear example of this is the reliance on entrance fees, which form one of the chief bottlenecks to developing private labels in China. These fees represent a significant part of total costs for suppliers. Manufacturers of leading brands generally pay fees of around 5 percent to 10 percent to get their products on the shelves. But for small and mid-sized brands, the fees can potentially go over 20 percent of sales. The entrance fees can contribute to as much as 50 percent of retailers’gross margins.

Abandoning the entrance fee policy in favor of private labels would thus be a costly exercise for many food retailers. The profit margin expansion from the introduction of private labels may not be sufficient to cover the loss of gross margins from entrance fees.

Furthermore, a high level of brand fragmentation further pushes bargaining power toward retailers. In China, more than 600,000 products in the “fast moving consumer goods” category are being offered, while a typical hypermarket stocks about 12,000 products. 

Food quality

Food safety concerns are also holding consumers back.

Quality issues surrounding branded food products in China are not uncommon and frequently make newspaper headlines. In general, consumers perceive private labels as less reliable, viewing them as poor quality because of low prices and unknown production sources. To make things worse, leading retail brands have also had recent quality issues. For instance, excessive amounts of bacteria were found in Carrefour meat products and mineral water and excessive levels of mercury were detected in Walmart’s jasmine tea. These scares have not helped private-label acceptance and have made food retailers more wary of the reputation risks that can affect any brand repositioning.

Food retailers will continue to rely on entrance fees in China, although various levels of government have been taking steps to try to abolish them. 

However, retailers are facing issues of losing suppliers to competitors or traditional retailers due to the market saturation of modern retailing in top-tier cities.

At the same time, leading brands are consolidating, which will likely exert a negative impact on the negotiating position of food retailers. Therefore, retailers will have to differentiate themselves to seek growth in the future.

Perceptions about food quality will gradually improve as governments step up food safety standards through harsher punishments for violators and investment in food monitoring. As branded companies enhance food quality, retailers will continuously upgrade their manufacturing partners. Confidence in the quality of private label food will be developed first in megacities, while lower tier consumers will stick to familiar branded products in the next 10 to 20 years.

The saturated Chinese food retail market is characterized by heavy price competition. Expanding geographically has meant more business in the past, but in recent years, we have observed increasing numbers of food retail store closing or being acquired. That will boost the concentration levels by eliminating small players. The market concentration ratio among the top three retails is expected to double from the current 10 percent to about 20 percent by 2025.

Sebastiaan Schreijen, Shiva Mudgil, and Ivan Choi are researchers with Rabobank International, a Netherland-based bank focusing on serving food and agribusiness companies. The opinions expressed are their own.