Eric Beck April 28, 2009

1. EC 970FINAL PRESENTATIONDISCOUNT RETAILER RIVALRY IN KOREA:WHY THE WORLD’S LEADING SUPERMARKET LOST TO A KOREAN DOMESTIC WHOLESALER Eric Beck April 28, 2009

2. Quick Overview • During its international expansion, Wal-Mart entered South Korea with expectation to dominate its discount retailer market • However, Wal-Mart loses against its primary rival E-Mart and it soon exits the market after incurring millions of dollars in loss. • This paper takes a game theoretic approach to explain why the world’s leading supermarket failed to compete with a relatively small domestic wholesaler.

3. Questions to Consider: • What allows a multinational corporation to capture a foreign market when it enters and competes against the already established domestic firm? • In a free market, does the guarantee of low price necessarily attract more consumers, hence more profitable business overall?

4. Background – Understanding the Duopoly • Distinctive characteristics of the Korean retailer market • Describe how its consumers are strikingly different from the consumers in the United States • Strategies Wal-Mart implemented to attain its leader position in the U.S. market • Whether or not Wal-Mart used similar strategies in the Korean market • Comparison of Wal-Mart’s marketing strategy to that of already established domestic wholesaler, E-Mart.

5. DEMANDS OF SOUTH KOREAN CONSUMERS AND AMERICAN CONSUMERS • Value Difference • Korean: Frequent visits to the supermarket for fresh food products. • US: Willing to compromise quality for low price. • Proximity Factor • Korean: Prefers to walk to the store. (small quantity) • US: Drives in their large vehicles to shop large quantity. • Types of Products • Korean: Fresh food purchases, beverages, and other daily use items. • US: Food products to electronics and clothing.

6. IMPLEMENTING THE “WAL-MART WAY” IN E-MART’S TERRITORY • Wal-Mart: the “American” Way • “Every Day Low Price” (high quantity at low price) • Strategy of smaller city store build-up in the United States • All Types of Products Sold (Food products to electronics and clothing) • E-Mart: the Local Way • More Fresh Produce and Seafood • Launched stores in the most populated areas beginning in the early 1990s • Stores designed after conventional department stores rather than warehouses *** Wal-Mart, despite being the largest retailer in the world by its sheer revenue and size, has entered the Korean market at a heavily disadvantaged position against its primary rival, E-Mart.

7. Price Competition with Differentiated Goods • Model Simplification: • A total of 5 firms in the competition but focuses on two primary rivals. • Consumer’s unique preferences are measured by a single variable, D. • Think of Bertrand’s Duopoly • However, the products are no longer perfect substitutes

8. Understanding the Model • Assumptions: • Firms, Wal-Mart and E-Mart, are situated at either end of a line segment of length 1 • Potential customers uniformly distributed along the line. • Each customer is then at a position X: meaning X distance from Wal-Mart and (1–X) distance from E-Mart • Customer at position X on the line buys: • From Wal-Mart if: Pw + D(X)2 < PE + D(1–X)2 • From E-Mart if Pw + D(X)2 > PE + D(1–X)2 • D measures the level of product differentiation between the two firms • D x (distance)2 term simply measures the degree of inconvenience for a consumer to purchase a product that is away from his most desired point

9. Best Response Functions and the N.E. • Wal-Mart’s best response to E-Mart’s price: PW* = BRW(PE) = (PE + D + c) / 2 • E-Mart’s best response to Wal-Mart’s price: PE* = BRE(PW) = (PW + D + c) / 2 • Nash Equilibrium: NE ∈ [D + c, D + c]

10. PE 3D + C 2D + C D + C C C – T C – T C D + C 2D + C 3D + C PW The graph of Wal-Mart and E-Mart’s Best Response Functions Red: Wal-Mart’s best response to PE Blue: E-Mart’s best response to PW NE ∈ [D + c, D + c]

11. Implications • In repeated games, the price of both firms should reach the stable equilibrium at NE • Wal-Mart’s “Every Day Low Price” guarantee led the firm to set its price far below the NE • Pi = (c + ε) is optimal in Bertrand’s duopoly (US market) • Pi = (c + D) is optimal with product differentiation (Korea) • Wal-Mart should have localized to meet the unique demands of the Korean consumers • Selling smaller quantity of higher quality products at higher prices – Increase PW while decreasing D

12. Quantity Competition with Perfect Substitutes • Wal-Mart began to make changes to its business strategy • Merchandising, packaging, and store expansion. • Gradually diminishing the product differentiation. • Quantity competition is more realistic as prices of these firms are already close to c • Further price competition is undesirable. • As the incumbent of the competition, E-Mart is the “Stackelberg leader” and makes the first move.

13. Stackelberg’s Duopoly • Price and Profit Functions: • PW = a – b [QW+QE] • πW = [PW – c] x QW • PE = a – b [QE+QW] • πE = [PE – c] x QE • Optimal Level of Quantity Produced: • Using Backwards Induction • QE* = (a – c) / (2b) • QW* = (a – c) / (4b) • NE ∈ [(a – c) / (2b), (a – c) / (4b)]

14. Implications • Based on this model, E-Mart captures two-thirds of the market • In Cournot’s duopoly, it would have captured only half of the total market share. • E-Mart forced Wal-Mart to reduce its own production, or limit its opening of new stores • How? Credible Threats • In 2003, E-Mart = 53, Wal-Mart = 15 • In 2006, E-Mart = 102, Wal-Mart = 16 * First-Mover Advantage

15. Weakness • Simplicity of the model • In price competition, parameter D is rather vague • In quantity competition, the price functions should be more inelastic to the changes in the quantity produced • Because these firms are not manufacturers, but rather wholesalers. • Increase in quantity does not necessarily mean lower price

16. Conclusion • Wal-Mart should have foregone EDLP to actually earn more profit. • The challenger, Wal-Mart, should not have easily given up the “leader” position. • Planning for the future: • Demand of a typical Korean consumer is relatively price inelastic – lower cost does not necessarily win over the consumers • Rapidly open up new branches to secure market share.