Quality competition in retailing


Quality competition in retailing

Quality competition in retailing

In many retail industries, the most successful firms are the ones that offer the widest selection. For example, Wal-Mart rose to the top of the Fortune 500 by offering consumers a vast array of products at very competitive prices. The emphasis on product variety is particularly strong in the supermarket industry, where the introduction of computerized logistical and inventory management systems in the 1980s allowed firms to stock an ever expanding array of products. The explosion in both product variety and store size in the supermarket industry is striking.

According to the Food Marketing Institute, the number of products offered per store increased from about 14,000 in 1980 to over 30,000 by 2004. To accommodate the greater selection, store size has increased an average of convert|1000|sqft|m2|-2|abbr=on per year for the past three decades. Maintaining this variety requires substantial firm level investments. Every major supermarket firm invests in proprietary information technology and logistical systems aimed at increasing variety while minimizing storage and transportation costs. The emphasis on variety and the requisite fixed investments yield tightly contested markets among a handful of rival chains, a pattern that is repeated throughout much of retail.

Competition in the retail food industry

The retail food industry is composed of two relatively distinct submarkets: supermarkets and grocery stores. Although chain grocery stores date back to the early 1900s, the supermarket format was not introduced until the 1950s, when the rise of nationally branded products and the diffusion of the automobile created a natural incentive to build larger, less centrally located stores. Situated in the suburbs to economize on land costs, supermarkets were 5 times larger than their rival grocery stores, carried far more products, and advertised heavily. Distinguished by the variety of products they carried, supermarkets and grocery stores were vertically differentiated: if they charged the same prices, consumers would choose the store with a wider selection. While supermarkets quickly captured the bulk of sales, grocery firms maintained a foothold by serving the remote locations and niche consumer markets that the supermarket firms ignored.

By the 1980s, supermarket firms realized that maximizing product variety meant building their own distribution networks. While grocery firms were mostly supplied by independent wholesalers, supermarket firms vertically integrated into distribution. The computerized logistical and inventory management systems introduced by mass-merchandisers like Wal-Mart required a degree of coordination, both in terms of scheduling and technology adoption, that was difficult to achieve through an arm’s length contract. For example, even getting independent grocers to implement a standardized scanner system proved to be a major hurdle for third party wholesalers.

By 1998, 49 of the top 50 supermarket firms were vertically integrated into distribution, operating state of the art, climate controlled warehouses and specialized trucking fleets. The savings from integration are significant: according to a 1997 report by the Food Marketing Institute, operating costs are 25% to 60% lower for selfdistributing chains. Although grocery firms (and third-party wholesalers) continue to capture around 25% of overall food sales, they do not compete directly with the dominant supermarket chains, focusing instead on smaller niches like ethnic foods and rural towns.

References

*Berry, S., Waldfogel, J., 2003. Product Quality and Market Size. NBER Working Paper, vol. 9675.

*Bonano, G., 1987. Location choice, product proliferation, and entry deterrence. Review of Economic Studies 54, 37–46.

*Dick, A., 2003. Market Structure and Quality: an Application to the Banking Industry. Finance and EconomicsDiscussion Series, vol. 2003-14. Board of Governors of the Federal Reserve System, Washington.

*Eaton, B.C., Lipsey, R.G., 1979. The theory of market preemption: the persistence of excess capacity and monopoly ingrowing spatial markets. Econometrica 47, 149–158.

*Ellickson, P., 2002. Does Sutton Apply to Supermarkets? Duke University Working Paper, vol. 05-05.

*Ellison, G., Glaeser, E., 1997. Geographic concentration in U.S. manufacturing industries: a dartboard approach. Journalof Political Economy 105 (5), 889–927.

*Gibrat, R., 1931. Les Inegalities Economiques. Applications: Aux Inegalities des Richesses, a la Concentration desEntreprises, Aux Populations des Villes, Aux Statistiques des Familles, etc., d’une Loi Nouvelle: La Loi de L’EffetProportionnel. Librairie du Recueil Sirey, Paris.

*Kochersperger, R.H., 1997. Food Industry Distribution Center Benchmark Report. The Food Marketing Institute andFood Distributors International, Washington D.C.

*Latcovich, S., Smith, H., 2001. Pricing, sunk costs, and market structure online: evidence from book retailing. OxfordReview of Economic Policy 17 (2), 217–234.

*Prescott, E., Visscher, M., 1977. Sequential location among firms with foresight. Bell Journal of Economics 8, 378–393.Progressive grocer, Annual report of the supermarket industry, selected April issues.

*Reynolds, S., 1987. Capacity investment, preemption and commitment in an infinite horizon model. InternationalEconomic Review 28, 69–88.


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