Does Sutton apply to supermarkets?

Abstract

This paper presents empirical evidence that endogenous fixed costs play a central role in determining the equilibrium structure of the supermarket industry. Using the framework developed in Sutton (1991), I construct a model of supermarket competition where escalating investment in firm level distribution systems is driven by the incentive to produce a greater variety of products in every store. Using the observed networks of store and warehouse locations, I identify 51 distinct geographic markets covering nearly the entire United States and empirically verify their relative independence. Employing a store level census, I demonstrate that the industrial organization of these markets is a natural oligopoly in which a small number of firms (between 4 and 6) capture the majority of sales, regardless of market size. While the total number of firms does scale up with the size of the market, the expansion is limited to a competitive fringe of low quality stores.

Supermarkets as a Natural Oligopoly

“…club cards), its importance has declined in recent years. 1 0 The speci…c details of how these markets were constructed are described in Ellickson (2007), which also establishes the relatively high degree of independence between these markets by matching each store to its primary distribution center and measuring the degree of spillover across markets. In particular, I …nd that stores supplied by an out of market distribution facility owned by the parent …rm account for, on average, less than 10% of total sales.…”

“…To do so, I rely on prior empirical results presented in two previous papers. In Ellickson (2007), I empirically established the relevance of natural oligopoly at the market level. In particular, I demonstrated that, across the full set of distribution markets, between 4 and 6 …rms capture 60 to 70% of sales.…”

“…The model was developed in Ellickson (2007), but is reviewed in some detail here in order to 1) highlight the focal comparative static regarding quality escalation and 2) motivate several new results concerning the nature of strategic interaction. In particular, after establishing that Sutton's model implies that competing investments are strategic substitutes (and is equivalent to a model of cost-reducing investment), I introduce an alternative speci…cation in which these investments are instead complements.…”

“…This is the third in a series of three complementary papers that apply the EFC framework to supermarket competition. In Ellickson (2007), I develop a formal model of supermarket competition, based on Sutton (1991), in which …rms compete for customers by o¤ering a greater variety of products in every store. As markets grow in size, existing …rms must incur higher costs if they are to remain in the industry, and this escalation in costs discourages entry by other …rms.…”

Brand History, Geography, and the Persistence of Brand Shares

“…11281986. The geographic areas encompassed by a Scantrack are also roughly consistent with the supermarket distribution regions designated in Ellickson (2007). in the "processed canned/bottled foods" group, and dinner sausages are contained in the "refrigerated meats" group.…”