Intra- and Inter-Format Competition in Grocery Retailing

1. Intra- and Inter-Format Competition in Grocery Retailing Catherine Ball ESRC Centre for Competition Policy University of East Anglia 20/02/09

2. Outline of Presentation • Introduction • Research questions • Literature • Econometric model • Methodology • Data • Results • Conclusions • Further work

3. Research Questions/Literature • How effective are small supermarkets and specialist stores at providing a competitive constraint to large supermarkets? • Several CC/OFT studies make the assumption that ‘larger’ supermarkets constrain ‘smaller’ supermarkets but not vice versa. • Cleeren et al (2008) show that discounters can constrain supermarkets in Germany. • Which type of supermarkets (small, urban or large,out-of-town) are the most ‘harmful’ to the existence of specialist stores? • Smaller, town-centre supermarkets might be less ‘harmful’ to specialist stores – increase footfall. • Is it useful to measure variation in product range, both in terms of range of product categories and range within categories, in a two dimensional product space? • Increased scope for product differentiation decreases competitive pressure in a market Seim (2006) – could this extend to differentiation in product range carried?

4. Market Summary • Large supermarkets • 4 major players • Tesco (supermarket and Extra formats) (27.6% all formats) • ASDA (14.1%) • Sainsbury (supermarket format) (13.8% all formats) • Morrisons (9.9%)

5. Market Summary Large supermarkets 4 major players Tesco (44,000) ASDA (65,000) Sainsbury (26,000) Morrisons

6. Market Summary • Smaller supermarkets/convenience stores • Main players • CGL/Somerfield (3.8 and 3.9% respectively 2007) • Waitrose (3.3%) • M&S (3.8%) • Tesco (Express and Metro formats) (27.6% all formats) • Sainsbury (Local and Central formats) (13.8% all formats) • Budgens • Iceland (1.5%) • Aldi/Lidl (2.8% combined) • Others (15.5%)

7. Market Summary Smaller supermarkets/convenience stores Main players CGL/Somerfield (15,201 – CGL only) Waitrose (24,500) M&S (5,000 – food only) Tesco (Express and Metro formats) Sainsbury (Local and Central formats) Budgens (6,600) Iceland (3,420) Aldi/Lidl Others

8. Market Summary • Specialist stores • Main types: • Fishmongers • Greengrocers • Butchers • Bakers • Off-licences

9. Multiproduct Firms • Most retailers are multiproduct firms: • Two issues- • Internalisation of agglomeration effects (Shaked and Sutton, 1990) • Expansion effect • Lower for specialist stores • Product differentiation in range? • Reduces competitive pressure

10. Large vs. Small Supermarkets • One-stop vs. Top-up shopping • Out-of-town vs. Town centre location • Large supermarkets have a wider range both within and across(?) categories than a smaller supermarket. • Parking, other facilities • Price flexing and “PQRS”

11. Supermarkets vs. Specialists • Supermarkets internalise agglomeration effects of providing a range of products, a group of independent specialists does not (Hay and Smith, 2005) • Specialists offer expert advice • Specialists have a wider within category range(?) • Supermarkets have more categories • Perceived higher quality

12. Methodology • Multiple-entrant qualitative response model • Cross-sectional data • Limited to pairwise comparisons • At present limited to comparisons where dependency between firms is only in one direction • Eg small supermarkets profits depend on number of large supermarkets but not vice-versa

13. Methodology • The profits of a particular type of supermarket, k where k = 1, 2 are given by: • Where S is market size (population and nearby population), X is a vector of demand/cost variables that affect firm profitability within a market.

14. Methodology • Assuming that large supermarkets constrain small supermarkets (but not vice versa). The latent profits are given by: • A firm of a particular type will enter market i when:

15. Methodology • Latent profits are unobserved, but if ε are i.i.d. bivariate normal, the observed number of stores of each type, Nk (k=L,S) can be estimated using a simultaneous equation bivariate ordered probit model. • NL and NS are observed such that:

16. Methodology • Therefore the probability of observing NL=j and NS=k in market i is: • Assuming ε are bivariate standard normal with correlation parameter ρ, this corresponds to a simultaneous equation bivariate probit model with one endogenous regressor.

17. Note: • There are several special cases nested within this model: • γ=0 (coefficient on endogenous regressor) – seemingly unrelated model • ρ=0, univariate probit model

18. Sample Markets • Aggregate postcode districts (e.g. NR1, NR2) into postal towns (e.g. Norwich). • Vary in population from 142 (St. Martin’s, Isle of Scilly) to 1,015,043 (Birmingham). • Each London borough is classified as a separate postal town. • 1239 postal town markets

19. Sample Markets - filtering • Why filter? • Isolated markets • Partial and sub-markets • Categorisation of number of firms • Cleeren et al (2007) filtering rule: • Exclude markets where pop<3,000 or pop>25,000 • Bresnahan and Reiss (1991) filtering rule: • Exclude markets within 20miles of a town with pop>1,000 • Exclude markets within 100miles of a town/city with pop>100,000 • My filtering rule: • Exclude markets within 20miles of a town/city with pop>150,000 • Exclude markets where pop<3,000 or pop>75,000

20. Sample Markets - filtering

21. Large supermarkets • Defined as the following fascias of the “big four” • Tesco (Supermarket and Extra formats) • ASDA (All stores) • Sainsbury (Supermarket format) • Morrisons (All stores) • Counted in a postal town if it is within 15mins drive of the centre.

22. Small supermarkets • Defined as: • All non-”big four” supermarkets • I.e. Somerfield/Co-op, M&S, Waitrose, Budgens • All non-”big four” convenience stores • Tesco (Express and Metro formats), Sainsbury (Local and Central formats) • Counted in a postal town if in one of the postcode districts that comprise the postal town.

23. Specialists • Specialist stores included: • Butchers (5449) • Bakers (5505) • Offlicences (5539) • Greengrocers (1733) • Fishmongers (790) • Counted in a postal town if in one of the postcode districts that comprise the postal town.

24. Other Data • Market size given by population • Control variables – percentage employed, age • Instruments • For “large” supermarkets – percentage of car owners

25. Final specification Profits of a large supermarket are given by: Profits of a small supermarket are given by:

26. Red, orange and yellow indicate significance at the 1%,5% and 10% level respectively. Red indicates significant difference to the preceding cut-point at 1% level.

27. Conclusions • Evidence that large and small supermarket’s entry decisions are strategically linked and jointly determined. • Some weak evidence that, for large supermarket, competitive pressure increases with additional entry. • Some weak evidence that an agglomeration of three different types of specialists has an impact on the profitability of small supermarkets but no effect on large supermarkets.

28. Extensions • Jointly determine whether small and large supermarkets are strategically dependent (two endogenous regressors) • Endogenise specialist entry • Analyse affect of barriers to entry affecting large supermarkets • Model product range as two-dimensional product differentiation. Change order of game.

29. Extensions Model product range as two-dimensional product differentiation. Large supermarkets Specialists Range within categories Small supermarkets Range across categories