Private Label dillema for the CPG firms in US

Background:
As the retailers are getting bigger and more powerful, they are gradually extending their portfolio of private label lines. CPG firms are continuously trying to out-manoeuvre this by differentiating their product range with new features and encouraging customers to "brand loyalty" which would motivate them to pay the premium. However retailers are shamelessly copying the products and stacking them next in the isle to their branded counterparts to gain maximum visibility. In 2008, Kellogg launched a new breakfast cereal Raisin Bran Crunch and supported it with an interesting advertisement in the TV. When I went to a local Kroger, I was amazed to notice a Kroger Crunch placed strategically next to the Kellogg. Kroger priced it at $1.99 per box, beating the promotional price of 3 for $8 from Kellogg. I also noticed that the ingredients and the Nutrition Facts on both the products are very similar.

Alternatives:
Now the following two questions came to my mind:

(1) How Kroger is able to bring a very similar product at a lower price?
(2) What Kellogg can do to continue consumers interested in its product line?

The answer to the first question is rather simple to analyze. Kroger need not spend anything in Sales/Marketing and R&D and hence it's operating expenses are practically zero. Once they notice the success of a new brand (in this case Kellogg crunch), they ask their contract manufacturer to reverse engineer and come up with a comparable product (i.e. Kroger crunch) having very similar food value and taste. Additionally Kellogg spent money in TV attracting customers to the isle where Kroger stacked it's range adjacent to the branded product, but at an attractively lower price. Hence for all practical purpose, Kellogg is spending the advertisement and marketing dollars and Kroger Crunch is reaping the benefit of it. Obviously this is a very profitable model for Kroger which must be keeping the larger chunk of the margin leaving very little for the contract manufacturer. Also customers are getting what I would call a "duplicate" at a lower price point; a win-win situation for both. But why Kellogg is still tolerating this? Probably because it has very little bargaining power vis-a-vis it's key channel partner Kroger. In case of a severed relationship, Kellogg is going to loose much more than Kroger and hence the former has very little choice to raise the voice.

What Kellogg can do is the million dollar question here? Innovation, product differentiation etc. are unlikely to work in this commoditized business where something like a "copy-right" protections are practically unavailable to the CPG players. How they can continue to attract customers is a very difficult long-term challenge for every CPG player. Kroger would probably expand this profitable "private label" route without explicitly killing Kellogg. Because for the private label business to succeed, there has to be a brand available to absorb the R&D and Marketing expenses. But what are the options left for Kellogg?

Note: Click here for a good discussion on what is a private label brand, at Wikipedia.

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