Strategic effects of private labels

This paper presents a model of retailer-manufacturer interaction that focus es on retail competition between national brands and private labels positio ned by retailers to compete with them. The final demand side involves verti cal differentiation between the private label (low quality) and the nationa l brand (high quality). It is assumed that production costs for the nationa l brand and the private label differ not only by sunk costs (advertising) b ut also by marginal costs, and that the marginal cost function is increasin g and convex in quality. We study equilibrium price strategies for both age nts when the quality of the private label varies and we compute the optimal private label quality from the retailer's point of view. We also determine the effect of the private label on the agents' profits. Our results sugges t that the wholesale price of the branded good may increase as the private label good becomes a closer substitute for it. Moreover, introducing a priv ate label reduces the double marginalisation problem in the vertical struct ure.