FOOD 1NDUSTR% MERGERS :

ANKU LOOK

Chairperson: Bill Lesser, Cornell University

The Structural and Performance Effects

Of Retail Mergers

by

Bruce W. Marion Agricultural Economist Economic Research Service, USDA and Professor University of Wisconsin, Madison

We are in the midst of a tidal wav’e , the number five chain of mergers. The distinctive feature of in Minneapolis , acquired Applebaums, the the present merger wave is the large number three chain-- resulting in a number involving huge corporations. merged market share about equal to the Observers of the food manufacturing and leading chain. I opposed the merger food distribution industries have not because Applebaums was one of the strong- previously seen mergers on the scale of est competitors in and Nation- Nabisco-Standard Brands, Beatrice’s acqui- al Tea had a proven ability to turn sition of Esmark which had not yet diges- “silk purses into sow’s ears.” I was ted Norton Simon, Nestle’s acquisition of afraid National would do the same with Carnation, R. J. Reynold’s acquisition of Applebaums, a rather unusual basis for Heublein, Grand Union’s acquisition of opposing a merger. The merger was al- , ’s acquisition of lowed and National Tea began to work Dillon, and most recently, American its magic. By 1983--four short. years Store’s acquisition of Cos., the later-- the Applebaum and National Tea biggest in the history of food retailing. stores were sold to Gateway Foods (the And this is far from a complete list. Applebaum family was also involved). The market share of the merged company I have been asked to talk about the had plunged to about.one-third the level effects of retail mergers. As some of at.the time of the merger. Even econom- you may know, I was a pro bono economist ists are right once in a while. for the government in challenging Nation- al Tea’s acquisition of Applebaums and Little did I know that. a similar Grand Union’s acquisition of Colonial. scenario would be played out in the Both mergers occurred in late 1978 or Grand Union case. There were 13 SMSAS early 1979. The National Tea-Applebaums involved in that case--one of which merger was horizontal; Grand Union-Colon- Colonial had exited by the time of the ial was a market extension merger. case. Of the remaining 12, Grand Union

Journal of Food Distribution Research February 85/page 79 has since withdrawn from seven, includ- following ten-year period was one of ing two where they were the leading firm tough enforcement of the merger laws by (Norfolk and Newport News) and another the antitrust agencies. Overall merger where they were second . In the five activity increased during this period; SMSAS in which Grand Union still oper- however, the mergers were channeled to ates, their market share has dropped by smaller companies. From 1975 through more than half in two and by nearly 25 1978, the top 20 chains were once again percent in Atlanta, the most important the major acquirers. Possibly because market in the acquisition. Only in Fay- the Grand Union-Colonial merger was etteville and Raleigh-Durham has Grand challenged and initially found illegal, Union been able to hang onto the market large chains cooled their merger appe- share it bought. From the tradespeople tites somewhat in the next four years, I talk with, it. t30und8 like Grand Union and especially during 1981 and 1982. In raided the assets of Colonial, It may 1983, the large chains jumped back into have been a profitable investment for Sir the merger arena with enthusiasm. And, James Goldsmith and Cavenham--I don’t large chain mergers in 1984 may even know--but it has been devastating for surpass those in 1983. Colonial as a chain. Antitrust enforcement. today is very What has been the effect on competi- selective; there is little interest in tion? It really depends on who took over challenging mergers. Thus, evidence con- the Grand Union stores and market share, cerning the effects of mergers during an which I have not attempted to track. If earlier period may provide no basis for they went to fringe companies so as to judging the effects of the present wave weaken the oligopolistic core in these of mergers. Because of this, I want to markets, competition may have been spend some time discussing the changes strengthened. If the stores and sales in antitrust enforcement and the key went to the market leaders, competition factors that may influence future merger may have been weakened. It is clear that enforcement act.ivit.ies. a viable competitor has been lost in at least six SMSAS. Since the mid 1970s, the antitrust agencies have increasingly turned their It is difficult to evaluate the ef- backs on mergers, large and small. In fects of retail mergers, in part because the last two or three years, even sub- this depends upon the number and type of stantial horizontal mergers have been mergers that are allowed by the antitrust ignored. In my home town of Madison, laws and the agencies responsible for Wisconsin, the number one chain, Eagle, enforcing those laws. Since the Clayton was recently acquired by the number two Act was amended by the Cellar-Kefauver chain, Kohls (which was acquired by A&P Act in 1950, there has been market varia- in 1983). The estimated market shares tions in the int.erpretat.ionand enforce- of these chains in 1983 were 21.5 and ment of this law. Acquisitions of food 17.4 percent (Metro Market Studies, retailing stores and companies from 1949 1984). Although their combined market to 1983 are shown in Figure 1 and Appen- share is probably something less than 39 dix Table A. The retail sales (in 1967 percent because of the sales gains of dollars) acquired through mergers peaked warehouse stores and one or two store in 1967-68 and has had a series of peaks closings, the merged chain clearly domin- from 1978 to the present. ates the market. Sentry is the only other market-wide operator of convention- The retail sales acquired by the top al and superstores is a 10 and top 20 grocery chains are also voluntary group. plotted on Figure 1. Whereas these chains accounted for a high percentage In California, Lucky recently ac- of the sales acquired from 1949-1964, the quired Smith Food King with no response

February 85/page 80 Journal of Food Distribution Research from antitrust agencies. The two were was number one (17.8%) and Smith Food competitors in four SMSAS; of particular King number two (15.0%) in 1983 accord- concern is Santa Barbara where Lucky ing to Metro Market Studies.

Figure 1. Acquisitions of Food Retailers, 1949-83 (amounts in millions of 1967 dollars)

4000 4

3600 I I i ,3200 I 2800

2400 A, 2000 t ~1600 i I o 1200

800 I 400 k II

(1

Journal of Food Distribution Research February 85/page 81 In Birmingham, Alabama, Brunos, the ler) . This argument was reinforced by number one chain with 22 percent of the William Baumol’s new theory of contest- market was allowed to acquire ten A&P able markets, which emphasizes that stores in 1979. A&P ranked fifth in the concentration has no effect if there is market according to Metro with a 7 per- completely free entry and exit into an cent share. The list goes on. Clearly, industry. In spite of its extreme and the precedent established by the Von’s simplistic assumptions (see Shepherd’s case has been abandoned. Since the Feder- critique), contestable market theory al Trade Commission has been primarily has attracted followers in part because responsible for antitrust enforcement in of its mathematical elegance. the food distribution industries, it is primarily this agency that must be credi- This debate will not soon end. The ted with opening the merger flood gates. stakes are too high. Perhaps the most Although the Commission largely endorsed telling evidence comes from studies of the Merger Guidelines issued by the Jus- concentration-price relationships. If tice Department in 1982, it has subse- the revisionists are right, prices in quently ignored horizontal mergers that concentrated markets should not be high- seriously violated the Guidelines. er and might be lower than prices in unconcentrated markets. Either a nega- What do we make of this? Is the tive or no relationship between concen- recent lapse in enforcement simply a tration and prices would be expected. reflection of the political philosophy of this administrat.ion or are there legal or Roughly twenty studies have exam- economic explanations? Although one can ined concentration-price relationships chalk up the FTC’s paralysis to politics, across local markets for gasoline, of equal importance is the economic Welt- drugs, groceries, bread, beer, business anschaung held by Chairman Miller and his loans, life insurance, auto loans and economist colleague, Commissioner Doug- other product-services. After reviewing las. This is the first time an economist these studies, Greer (1984) concludes, has served on the Commission; now we have II.*. prices and concentration are two in extremely powerful positions. As positively related” (p. 296). F.~ a result, economic doctrine probably has Scherer agrees. In the 1980 edition more influence over the present Commis- of his highly respected book, Scherer sion than anytime in history. Armed with comments on the various studies relating the new theories and empirical evidence prices to concentration: of “revisionist” industrial organization economists, the Commission has charted a Although one can, as always, new course for ant.it.rustenforcement. quarrel with the particular samples, controls, and methods Let me depart for a moment to com- employed in these studies, ment. on the debate between traditionali- their overall thrust is unam- sts and revisionists within the field biguous. Prices do tend to be of industrial organization. During the higher when markets are highly last decade or so, a reinterpretat.ion of concentrated than when they the concentration-profitability litera- are not. ture has been gaining adherents. The traditional monopoly power explanation Thus , to date, the evidence supports for the positive concentration-profits the traditional point of view that con- relationship found in many empirical centration conveys market power and studies was challenged by Brozen, Dem- results in supra-competitive prices. setz, Peltzman and others, who argued that efficiency and lower costs in con- Perhaps because of the debate con- centrated industries accounted for the cerning the effects of market concen- relationship --not higher prices (Paut- tration, the FTC currently places heavy

February 85/page 82 Journal of Food Distribution Research emphasis on entry barriers and the effi- cern, for it firms try to elevate ciencies th’at may be gained in concen- prices, new firms will enter. If firms trated markets. One also senses that try to collude, new firms will seize the Commission has a strong faith that that opportunity to enter the market. businessmen and consumers are rational, Thus, the extent to which entry barriers and that competition is generally effec- exist in food retailing is the key issue tive-- particularly when left alone. with the present Commission- There is a pervasive laissez faire men- tality. 1s the Commission correct? Are entry barriers low? If so, mergers can This is reflected in the Grand Union be expected to have little if any effect decision. The Commission’s decision in on competition. What are the important that case rested on the following logic. factors to consider? Since entry barri- ers can only be ascertained once the - The relevant product market involved relevant product and geographic markets in the merger was all grocery have been properly defined, I will exam- storea, including supermarkets, ine this subject next, followed by a warehouse stores, box stores and discussion of entry conditions. convenience stores. Strategic Groups and - During the 1970s, there was some Submarkets in Food Retailing type of grocery store entry into nearly all of the 13 SMSAS involved Those that labor on the marketing in the case. faculties of our schools of business have long recognized that businesses - Several firms already in these mar- “segment” their markets and attempt to kets expanded in number of stores “position” their product-service-price or market share during the 1970s. offers so as to appeal to certain market. segments. In recent years, academicians - Therefore, entry barriers into gro- interested in business strategic plan- cery retailing must be low. The ning or in industrial organizat.ion have Administrative Law Judge’s decision attempted to develop a more comprehen- finding the acquisition illegal sive theoretical framework. Michael was reversed. Porter has written extensively on the theory of strategic groups and mobility One of the key statements in Chair- barriers. Porter’s basic notion is man Millers’ decision is: relatively simple. In any given indus- try, there is a continuum of firms with Indeed, this consistent pattern different strategies regarding products, of recent entry and expansion prices and services. Some may appeal in these numerous markets may to customers desiring low prices; others indicate that barriers to enter- may appeal to customers seeking high ing the retail grocery industry quality or services. In addition, firms are often clustered in groups along the *PE:S ‘X::;:lY s continuum of strategies, hence the term 1983, p. 49) strategic groups. Firms compete most directly with other firms in their “stra- Although this conclusion was based upon tegic group,” and less directly with startlingly skimpy evidence, it accurate- firms in other strategic groups. Stra- ly foretold subsequent FTC actions. If tegic groups that are sufficiently “dis- an industry has low entry barriers, anti- tant” from one another are only indirect trust has little role. Predation is competitors; for antitrust. purposes, irrational and unlikely if there are no they are in separate product markets. entry barriers. Mergers are of no con- Porter and his colleagues also propose

Journal of Food Distribution Research February 85/page 83 the notion of mobility barriers--that is The Department of Justice has pro- the extent to which barriers prevent the posed procedures for identifying rele- movement of firms from one strategic vant product markets in its 1982 Merger group to another. He argues that all Guidelines.1 The latter states: firms strive to drive other firms out of their strategic territory and to create ..* the Department seeks to sustainable mobility barriers. Where identify a group of products there exist strategic groups with high such that a hypothetical firm mobility barriers, indust-ry st.ruct.ure that was the only present and may be misleading. As Porter states: future seller of those prod- “An industry need not be concentrated ucts could raise price profit- for a particular strategic group to have ably. Dept. of Jus- . (Us. enormous market power” (1981, p. 455-56). tlce$ p. 5)

Strategic Groups Thus, the Department.ts approach attempts In Food Retailins! to include all close substitutes within its market boundaries, but to exclude For illustrative purposes, I have all poor substitutes. identified eight retail store formats in Figure 2, classified by price and service In the case of food retailing, the levels and by breadth of product assort- “product” is the product-service-price ment. While stores might be classified bundle provided by various retail by other attributes, these three are stores. Thus , the question becomes probably the most important in trying to whether consumers perceive the “bundles” visualize the “space” between different of various types of stores as close store formats. In general, low price substitutes. For consumers, are conven- stores have low service and vice versa, ience stores or meat markets close sub- but this is not always the case. Includ- stitutes for supermarkets? Are ware- ed in “service” is the pleasantness of house stores close subst.itut.esfor super- the shopping environment as well as cus- st.ores? tomer services such as carry-out, check cashing, special departments, etc. 1 believe most people would agree that specialty meat., bakery or confec- Each store format can be viewed as tionery stores are in separate markets a strategic group. For each to survive from the remaining store formats in in a market, there must be a segment Figure 2. I suspect that there would of customers who prefer that cluster of also be general agreement that combina- products, services and prices. For exam- tion stores and super stores belong in ple, box stores have met with limited the same product market. At least for success in most markets and may not sur- now, I will argue that all five store vive as a strategic group. formats on or above the horizontal line in Figure 2 compete directly enough t.o All these strategic groups compete be placed in the same product market. to some degree with each other if they All provide the breadth of assortment are located in the same geographic mar- and price levels to compete for the ket. 1 can buy ground coffee at a conven- major shopping trips of consumers. tional , a warehouse store, a All would be classified by the trade convenience store, or at a specialized under the general umbrella of “supermar- coffee-tea shop. However, does that.mean kets.” they are in the same product market for economic analysis or for antitrust In my judgment., however, conveni- purposes? ence stores (and other small grocery stores) are in a distinct product submar- ket and do not compete directly with the

February 85/page 84 Journal of Food Distribution Research Figure 2. Retail Food Store Formats

Broad Aaaortments, One-Stop Shopping,

4 Gmbination Storeu o Super Stores o 0 Supez Ihwehouse Stores

Conventional )Supermarkets

Warehouse Stores Price High Price / SSigh Servic8

o Convenience Storeio

0 Box Stores ~“ Specialty Markets (-t, Produco, etc.) 9 Limited Assortment, Fill-in and Specialty Shopping

February 85/page 85 Journal of Food I)istribut.ionResearch five formats classified as supermarkets. tor of conventional supermarkets, super The Administrative Law Judge in the Grand stores, warehouse stores, etc. in Madi- Union case (Federal Trade Commission, son, Wisconsin or Washington, D.C., 1981c) concluded: could that firm profitably increase its prices? For example, could that firm The record in this case is raise prices by 2 or 3 percent and in- replete with evidence that crease profits? Or, would customers supermarkets, by and large, transfer enough patronage to convenience compete with other supermarkets stores, small grocery stores and special- .**. (p. 204) ty markets that the supermarket firm’s profits would decline? Assuming super- Convenience stores are not market gross margins of 20 percent of generally price-checked by sales, a 2 percent price increase would supermarket firm operators. represent a 10 percent increase in gross They carry little, if any, margins. Since there would be no appar- produce and meat, and indeed, ent change in costs, sales would have t.o average only 500-3000 items. decline by roughly 10 percent. for no Supermarkets stock from change to occur in profits. Given the 8-12,000 items. Convenience much higher gross margin of convenience stores generally have only one stores and the one-stop shopping appeal employee per shift and they of supermarkets, I doubt that the super- average sales of from $1-3 per market chain in this example would lose customer, as compared to the much sales as a result. of the price $11-15 average sale for super- increase. markets. Convenience stores are generally not considered in The correct definition of relevant supermarket expansions and product markets and submarkets is obvi- store location studies. Basi- ously critical in antitrust cases. It. cally, the only competition is also critical in attempting to study they offer to supermarkets is structure-performance relations. For in terms of hours of operation. example, entry into the convenience (p. 204) store submarket is much easier than into the supermarket submarket.. Compared to The record evidence shows that. supermarkets, desirable convenience the gross margins of supermar- store sites are more numerous, initial kets are 15-20% as opposed t.o investment is much less, advertising is 30% for non-supermarket grocery relatively unimportant, and zone pricing firms such as convenience by incumbent retailers to deter entry is stores. (p. 200) highly unlikely. In short.,entry condi- tions into the convenience store submar- Grand Union’s and Colonial’s ket provide no indication of entry condi- supermarkets averaged over $3 tions into the supermarket submarket, million dollars in annual sales and vice versa. per store, while convenience stores averaged from $140 thou- Entry Barriers sand t.o $325 thousand per Into Grocery Retailing store. (p. 201) Barriers t.o entry are the The Justice Department procedures sine ~ non of monopoly and can be used to help judge whether the mgopoly, ‘for sellers have supermarket submarket--as I have defined little or no enduring power it-- is an appropriate product market. over price when entry barriers Here we ask ourselves if one firm was are nonexistent. (Scherer, the only present (and potential) opera- 1971)

February 85/page 86 Journal of Food Distribution Research Recently, the theory of contestable to introduce non-trivial price competi- markets has placed great emphasis on tion. entry and exit conditions. If we could only do a better job of measuring entry Thus , warehouse stores and super barriers, I suspect we would see an out- warehouse stores represent a sufficient- pouring of Ph.D. dissertations on this ly better “mouse trap” that they have aspect of market structure. entered some markets with relative ease. For example, in ❑y home of Madi- The height. of entry barriers are son, Wisconsin, a new Cub super ware- measured in terms of the cost or selling house store reputedly garnered over 10 price advantages that established firms percent of grocery store sales in its have relative to the least disadvantaged first six months of operation. As the outside firms. The least disadvantaged first warehouse store on the west side “potential entrants” into the supermarket of Madison, it filled a market vacuum-- submarket of an SMSA are usually supermar- an unmet. consumer demand. During the ket chains that operate a warehouse with- last year, another super warehouse store in about 200 miles and are a “competitive (Woodmans) has been built near Cub. factor” in a nearby city. Whereas Cub found entry easy, Woodmans has found it difficult since a signifi- The ease of de novo entry into a cant portion of its sales had to be strategic group is likely to depend upon taken from Cub. With a new strategic the extent to which incumbent firms in group, there are important first mover that group have fully exploited the mar- advantages. ket potential. For older strategic groups, such a conventional supermarkets, Let me turn my attention now to they have probably gained about as much entry conditions into the supermarket of the market as they can in most. SMSAS. submarket, I will comment particularly There may lit.t.le easily gained sales on the barriers to de novo entry by for a new conventional supermarket. conventional supermarkets, superstores and combination stores. The barriers By contrast, the warehouse and super- faced by these firms may be similar warehouse store strategic groups are far to the barriers faced by warehouse short of their market potential in many stores in a few years as they approach SMSAS . Apparently a sizeable segment their potential. of consumers in some markets prefer these store formats. If allowed to enter, The Federal Trade Commission, in warehouse stores will attract this seg- reversing the Administrative Law Judge’s ment of consumers. At some point, these (ALJ’s) opinion in the Grand Union case, st.rat.egicgroups will also achieve their concluded that grocery retailing was market potential--at which point, new the relevant product market for that entry will be more difficult. case and that entry barriers into gro- cery retailing are low. As the above Significant new strategic groups discussion indicates, I believe the emerge only rarely in food retailing. ALJ in that case was correct in defining When they do--as in the case of warehouse the supermarket submarket as the rele- and super warehouse stores--de novo entry vant product market. Using this as into that strategic group may be easier the relevant market, what evidence would than it is into older strategic groups. we expect to find if entry barriers Where the new strategic group poses a are low? substantial threat to other strategic groups, entry deterring action can be If entry barriers are low into the expected. This is particularly likely supermarket submarket, there is no oppor- when the new strategic group is expected tunity for sustained monopoly prices or profits. We would expect to find no

Journal of Food Distribution Research February 85/page 87 relationship between market concentra- to deter entry, prices are normally tion and prices. We would expect. to eee dropped in the 2 or 3 stores closest few instances of predatory behavior; the to the new entrant while the remaining main incentive for predation is the expec- stores of the chain maintain normal tation of future supra competitive prices prices. Because it can be employed and profits. These are only possible very selectively against a firm entering where significant barriers exist. If with one, two or three stores, the incum- entry barriers are low, we would expect bent chain can cross-subsidize the loss- to observe new entry into large SMSAS es or lower profits from its atores a.s often (or more often) as into small near the new entrant by normal profits SMSAS . We also would expect to see all from its remaining stores. sizes of firms entering various SMSAS; with low barriers, there are many firms The long-run profit incentives for that can successfully hurdle the barri- a leading incumbent chain to employ ers. Finally, if entry barriers were zone pricing to deter new entry are low, we would expect to see no medium substantial if the new entry is likely or large SMSAS with persistently high to become a competitive “factor in the levels of concentration and profits. market.” In addition, firms with large Economies of scale do not require high market. shares have a much greater incen- levels of concentration except. in small tive to deter new entry than firms with markets. With low entry barriers, new a small market share. They also have a entrants would be expected t.oerode high greater capacity to use zone pricing concentration and profits in medium or and cross-subsidization to deter entry. large markets. The following example, based upon As I examine the facts, they don’t the regression results of the Marion, support the above scenario. First.--at Mueller, et al., study, illustrates the least. four different studies have found profit incentives for established firms a significant positive relationship be- to block a new entrant. from becoming tween retail food prices and supermar- est.abliahed. In the example the entrant ket (or grocery store) concentration is assumed to achieve a moderate 8 per- (Marion et al. 1979; Lamm 1981; Hall, cent market share in a market in which Schmitz and Cot.hern 1979; Cott.erill the top four firms have an initial 70 1984). The relationship holds both in percent combined share. It is assumed studies that have examined SMSAS and that the market share lost to a new studies that have examined small cities. entrant is proportional to the market The results are consistent with the grow- share of established firms. The size ing number of studies of concentration- of market assumed for the example is price relationships in other industries. $1,000,000,000 of annual grocery store The results of the price studies tell us sales which is about the size of Memphis that entry barriers exist in at least presently or Washington, D.C. in the some markets. early 1970s.

To what extent do we see predatory Under these assumptions, a firm behavior in food retailing? Without with a 10 percent initial share stands getting into the question of what consti- to lose $166,400 in profits per year if tutes predation, I do want to comment the new entrant gains an 8 percent mar- briefly on zone pricing. I believe there ket share. However, a firm with an is ample evidence that zone pricing is initial share of 30 percent would suffer widely used-- particularly by certain profit reductions nine times as great. chains-- to deter or limit the success of Although this illustration only holds a new entrant. The basic concept of zone under rather narrow assumptions, it does pricing means that it can only be em- indicate the strong incentive which an ployed by multi-store firms. When used established firm may have to prevent. the

February 85/page 88 Journal of Food Distribution Research Market Share of Established Chain Firm’s Profit Rate ------Annual Profit be fore after before after Reduction due entry entry entry entry change to entry

10% 9.2% 1.45% 1.39% -.06 $166,000 30% 27.6% 2.94% 2,76% -.18 $1,312,000

successful entry of a new firm. The The Court held in Marine Bancorporation stakes are particularly high for the (418 U.S. at 636-37) that for actual market leader. potential entrant analysis, the only entry that is significant is that which Thus, without. dealing with the ques- has a “realistic hope of ultimately tion of when zone pricing constitutes producing reconcentration” or of having predation, I conclude that there are a “meaningful effect on the economic strong incentives for the leading firms behavior” of the major market parti- in a market to deter new ent.rant.sthrough cipants. zone pricing (and possibly other actions such as increased advertising and promo- In most markets, a market. share of tions). In addition, zone pricing ap- 5 percent or more is needed to be a pears t.obe frequently used as a response competitive “factor,” although this may to a new entrant. not be true for particularly threatening entrants such as a warehouse store. A An additional piece of evidence major chain that is entering the market concerning barriers is the extent to may also be a factor. Eugene Walters, which entry is observed in large and President of Commonwealth Foods, testi- small SMSAS, and by large, medium, or fied: small firms. Independent operators may be satisfied to enter and operate one or Anybody the size of Winn Dixie two stores in certain trading areas. that. wants to come into a Their entry will affect competition in market, if you do not think those areas but. will affect. competition that they are a factor in the market-wide only in small cities. When a market., you are making a cru- supermarket chain enters a metropolitan cial mistake. They have the area, however, they are usually intere- assets and they have the re- sted in gradually penetrating all or sources the same as any other most of the market. If they are success- substantial company to come ful in entering and building market in. You better consider them, share, they influence competition first because they are not coming in in the trading areas directly affected there for one store. (Federal by their stores; at. some point as they Trade Commission, 1981b, p. expand, their competitive influence is 36) sufficient to affect competition at the market level. In the jargon of the Time does not permit a comprehen- trade, they have become a competitive sive analysis of “effective” entry activ- “factor” in the market.. ity. However, 1 have examined the 13 SMSAS included in the Grand Union case. Thus , de novo entry by supermarket Only de novo entry by supermarket chains chains is of particular interest.. In between 1975 and 1983 was considered. addition, the ent.ry must be “effective” Table 1 summarizes my findings. Using a in the sense of developing a sufficient 5 percent market share as the threshold, beachhead that it affects competition. there were seven cases of effective

Journal of Food Distribution Research February 85/page 89 ~;;i;diento the 13 SMSAS in the nine-year on five of the most important barriers Three firms accounted for the to effective entry, These are: 8even instances: (now ), A1.bertson and Kroger. All three 1. Economies of store size rank among the 30 largest supermarket chains. In these markets, large chains 2. Multi-store economies, including were clearly best able to overcome the advertising barriers to de novo entry. Only Fayette- ville, N.C. had two effective entrants. 3. Capital costs and risk Seven of the 13 SMSAR had no effective entrants during this period although all 4. Store sites but one had ineffective entry. The entry into the Atlanta SMSA is misleading since 5. Entry forestalling practices by it involved two BiLo stores on the fringe incumbent supermarket chains of this 13-count.y SMSA. There has been no effective entry into the Atlanta SMSA Economies of store size. Because since Winn Dixie in the late 1950s. of the sharp increase in the number of Given the relatively high concentration items carried and consumer preference of supermarket sales in this market for store features such as service deli- (SCR4=79 in 1977) and the frequent char- catessens and wide aisles, the minimum acterization of Atlanta as a soft market desired size of supermarkets has steadi- with high prices in the Grand Union case, ly increased. Larger stores require the lack of effective entry suggests that large capital expenditures and substan- some type of barrier exists. The Grand tial sales to break even. Union proceedings provide abundant evi- dence that entry barriers are particular- Supermarkets averaged $6 million ly high in a large SMSA such as Atlanta. in annual sales in 1981 (Progressive Grocer, 1982). A city of 25- Finally, if entry barriers are low, could support four supermarkets of this why has there been persistently high size; a small SMSA of 50,000 people levels of concentration in many markets? could support about eight. Thus, in Table 2 indicates the change in concen- small cities and SMSAS, a new entrant, tration that occurred between 1972 and faces the challenge of taking substan- 1977. Although the very highly concen- tial sales from existing firms (a “dis- trated SMSAS experienced a slight decline placement” effect). In general, the in supermarket four-firm concentration larger the displacement effect of a (SCR4), the vast majority of the SMSAS new entrant, the stronger the resistance had an increase in SCR4. from incumbent firms. Because the aver- age cost curve of supermarkets is sharp- Why is it that markets such as Wash- ly downward sloping at low volumes, new ington, D.C. and Denver have had very entrants are usually at a substantial high levels of concentration for years? cost disadvantage unless they are able Why is it that Kroger had dominated the to achieve the desired store volume. Cincinnati market for at least the last For the new entrant, sales volume is twenty years? Surely, if entry were the key to survival. easy, there must be other firms whose stores would catch the fancy of Cincin- Super warehouse stores, such as Cub nati, Washington and Denver consumers. and Edwards, are often very large (40,000 to 80,000 square feet). when So much for what I consider the these stores enter a market , the dis- “circumstantial” evidence that entry placement effect. is many times that barriers are significant. into the super- of a conventional supermarket entrant. market submarket. Let me now comment Whereas the latter may take $6 million per year in sales from incumbent firms,

February 85/page 90 Journal of Food Distribution Research Table 1. De novo Entry into 13 Southeastern SMSAS, 1975-1983

Census Supermarketa 1977 Salea as Effec- Grocery % of Groc. Market tive Store Sales Store Sales Sharec Entry SMSA (roil.$) 1972 Firms Enteringb Yearb 1983 (x)

Atlanta, GA 1,227 70 BiLo 1978 0.8

Augusta, GA 194 65 1977 0

Charlotte, NC 455 68 Kroger 1978 12 x

Fayetteville, NC 118 54 Food Lion 1975 15 x Kroger 1977 15 x

Gainesville, FL 102 72 Albertson 1975 10 x

Greenville-Spartan- burg, SC 397 73 Food Lion 1977 3

Jacksonville, FL 470 66 Albertson 1975 5 x

Macon, GA 165 60 None

Newport News-Hampton, VA228 69 Winn Dixie 1978 3

Norfolk, VA 481 71 Winn Dixie 1978 3

Orlando, FL 471 78 Albertson 1975 14 x

Raleigh-Durham, NC 366 65 Food Lion 1975 11 x Harris Teeter 1977 4 Food World 1975 2 Lyon ? 2

Richmond, VA 434 76 Winn Dixie 1978 4

4 a Provided by special tabulation of Bureau of Census and included in Marion et al, 1979, appendix D. b From Complaint Counsel’s Answering Brief, In the Matter of Grand Union et al, Atlanta Regional Office, Federal Trade Commission, March 12, 1982, p. 24-25, plus trade magazines, newspapers and directories. c Metro Market Studies, “1984 Grocery Distribution,Analysis and Guide,” Weston, MA, 1984.

Journal of Food Distribution Research February 85/page 91 Table 2. Comparison of Four-firm Grocery Store and Supermarket Concentration Figures, 240 SMSAS, 1972 and 1977

Grocery Store Grocery Store Cone. Supermarket Cone. Concentration Nr, of Mean CR4 Mean CR4 Mean CR4 Mean CR4 in 1972 (CR4) SMSAS in 1972 in 1977 in 1972 in 1977

< 30 5 27.86 32.20 38.40 41.42

30 < 40 17 35.07 40,02 48.65 51.51

40 < 50 81 44.90 49.71 61,84 64.87

50 < 60 77 54.69 58.05 72.12 73.30

6(3< 7(3 45 65.72 66.02 83.44 82.52

k 70 15 74.93 76.89 90.40 88.49

Total 240 52.58 56.09 69.55 70.93

Source: Marion, Parker and Handy. some super warehouse stores do $25 to sales dropped by about.one-half, resulti- $50 million in sales per year. ng in substantial losses. It. was on the verge of closing the store when The displacement effect of a new an FTC investigation led warehouse store in a relatively small to raise its prices. SMSA is documented in the Shoppin’ Bag v. Dillon Case (U.S. District Court for Mult.i-st.ore economies, including Colorado, No. 81-Z-1548 [1979]). In advertising. Industry witnesses in the March 1979, Shoppin’ Bag opened a ware- Grand Union case testified that multiple house store in Pueblo, Colorado. As store entry was necessary for a supermar- the first warehouse store in Pueblo, it ket chain that intended to become a had little difficulty attracting sales competitive “factor” in an SMSA. The with its substantially lower prices. size of the SMSA is positively related With annual sales of approximately $30 to the number of stores necessary for million, King Soopers was the market effective entry. William Stewart, a leader in the Pueblo SMSA with a 30 per- former president of Colonial and former cent market share. Safeway was number vice president of Grand Union, estimated two with 27 percent of the market. Assum- the number of conventional supermarkets ing no price response by incumbent firms, necessary for profitable entry ranged King Soopers estimated the Shoppin’ Bag from a low of two in Fayetteville, North store would take 14 percent of their Carolina, to a high of twelve in Atlan- sales, 11 percent of Safeway’s sales ta, Georgia (Federal Trade Commission, and 26 percent of Albert.son’s sales. 1981b). This proved to be a greater sales loss than King Soopers was willing to take. Multi-store economies accrue from Nine weeks after the Shoppin’ Bag store the costs and effects of advertising opened, King Soopers lowered prices on in medium and large SMSAS. In addition, thousands of grocery items to meet or the reactions of incumbents, such as beat Shoppin’ Bag prices. Shoppin’ Bag zone pricing, is better borne by stores

February 85/page 92 Journal of Food Distribution Research entering with multiple stores. In those lished (Federal Trade Commission, 1981b, cases where a new entrant provides a p. 41). combination of products, prices and ser- vices that fill an unmet need in the Capital costs and risk. In order market., it may have little difficulty to open a new 25,000 to 30,000 square attracting customers from established foot- supermarke-t in 1980, bet-ween stores. In the normal situation, how- $500,000 and $1 million was required ever, advertising is a major vehicle to equip and stock the store (Federal to attract the sales necessary for an Trade Commission, 1981c, p. 216). In entrant to operate its stores at low addition, supermarket firms must obli- unit costs. However, area wide newspaper gate themselves for leases on new advertising (or television) is very expen- stores; this liability is approximately sive, particularly in large metropolitan $3.0 to $3.5 million per store. Thus, areas. New entrants can expect t.ospend a total of roughly four million dollars as much as 5 percent of sales on advertisi- per new store is at risk. ng for their first year(s) in such a market, placing them at a substantial Drawing on the estimates of indus- cost disadvantage relative to established try members in the Grand Union case, firms, which are more likely to spend I will assume nine stores are necessary about one percent of sales on advertis- for effective de novo entry into the b ing. New entrants must rapidly increase Atlanta SMSA core; nine times $4 million store numbers and total sales if they is $36 million at risk. These are not are to eliminate this cost disadvantage. all sunk costs. If attempted entry is But , to do so requires taking sales from unsuccessful, these commitments have incumbent firms. Thus, economies of some salvage value. These figures do scale in advertising requires new en- not include advertising and promotional trants to have a significant displacement. expenditures incurred during entry,

effect, particularly in large SMSAS. which are sunken costs.

In addition, the leading firms in a The magnitude of capital costs and market can more fully take advantage of investment risk are generally a direct advertising allowances offered by manu- function of the SMSA size. Whereas facturers than fringe firms or new en- Atlanta may require an at risk commit- trants. This accentuates the advertising ment of $36 million +, Fayetteville or cost disadvantage faced by entering Gainesville may requi~e only $4 to $8 firms. Alternative advertising media, million for effective entry. such as hand bills and direct mail, can be used but are often considered t.ohave Store sites. A major element, in less consumer impact per dollar of cost. attracting sales to a store is a good location. Store sites for supermarkets The advertising costs and difficulty are mostly made available through devel- of quickly building a sufficient sales opers. The best sites are usually in or base over which to spread these costs adjacent. to shopping centers where cus- can be a major reason why regional chains tomer traffic is concentrated. It is will not. attempt to enter a large SMSA. a typical practice for developers to This was the main reason given by the sign a supermarket tenant. before they General Manager of Markets for attempt to recruit other tenants and not attempting to enter Atlanta (Federal often before obtaining financing. The Trade Commission, 1981b, p. 40). Grand supermarket may be used as a selling Union executives indicated that advertis- point. The leading chain in the market ing per dollar of sales in their expan- is the most proven traffic builder in sion areas (Baltimore and west coast of that area. New entrants are often uncer- Florida) were two and one-half times tain traffic builders and represent that in areas where Grand Union was estab- substantial risk. If a new ent.rant

Journal of Food Distribution Research February 85/page 93 faila, leaving its site in the shopping is aimed at all new entrants. The for- center closed for a time, the entire mer only takes place when a new entrant shopping center will be hurt. Because hae one or more sites and has taken of this risk, a new entrant able to get definite action to enter the market. a site in a shopping center is likely to pay higher rental costs than the lead- The action taken by incumbents ing chains in the market. Where the new depends upon the strategic group of entrant has something unique to offer which the entrant. is expected to be a that has proven highly successful in part . In some cases, incumbents may other markets, the above may not be true decide store remodellings are a better (e.g., a warehouse store in a market response than reducing prices. However, without. any). However, this is relative- increased advertising and promotions and ly rare. reduced prices are frequent tactics used to counter a new ent.ranto This is parti- Entry -forestalling practices of cularly likely in SMSAS with one or more established chains. Established firms dominant. chains. These chains have a lose sales and Profits if a new firm en- strong incentive to deter entry, and can ters the market and becomes established. employ zone pricing in stores near the The seriousness of the perceived threat new entrant to force the new entrant. to will largely determine how established carry low prices and sustain large loss- firms respond. If the new entrant fills es while it tries to attract. sales. a relatively small niche in the market Multi-store entry by large chains are and is not perceived as a major threat less likely to be subjected to zone to conventional supermarkets, the re- pricing by incumbents because the new sponse may be relatively mild. However, entrants have the financial resources to if established firms perceive the new withstand such actions; in addition, entrant. as a strong threat to their incumbents would have to drop prices sales, they may attempt to forestall its more broadly in the market and possibly successful entry or cause it. to incur trigger a price war. large costs, thereby impeding subsequent expansion. Anew entrant is particularly Occasionally, a price war results vulnerable to an aggressive competitive from new entry. Bill Saporito describes response during its entry phase because Kroger’s entry into the San Antonio its stores are on the sharply declining market : section of their average cost curves. If the established firms can successfully Like a thunderstorm off the limit an entrant’s sales growth in the Gulf of Mexico, it rolled in initial phase, they can impose heavy with 14 stores and a warehouse losses on the entrant. in two years. It was betting an estimated $100 million that The costs and benefits to the estab- it could take a big bite of lished firms of undertaking aggressive the market . . . . Lo and action are generally related to its mar- behold, H. E. Butt Grocery Co. ket position and the extent to which the then and present market the entrant is expected to affects its leader, knew how to play de- sales. There are two entry forestalling fense Kroger-st.yle. . . . [It.] practices that deserve comment. One is matched Kroger new store for zone pricing, increased advertising and new store, price for price, other t.act.ical responses immediately precipitating a price war the prior to or after a new entrant. opens like of which the city had its stores. The second is to prevent never seen. Two smaller access to preferred new sites by build- chains went to the bottom. ing stores ahead of sales. The latter (Saporito, p. 80) is a general preemptive strategy that

February 85/page 94 Journal of Food Distribution Research Importantly, four years later Kroger tion is often preferred by chains when only held 11 percent of this market com- antitrust laws and enforcement permit. pared to H. E. Butt’s market share of 26 percent (Metro Market Studies, 1984). The surest route around other San Antonios led to the acquis- Entry forestalling tactics of this ition of Dillon, the llt.h type raise the cost of entry and when largest U.S. chain, which has used against a less formidable entrant a lock on established markets, than Kroger, may very well prevent suc- much like Kroger’s own. At cessful entry (see earlier discussion some $600 million in Kroger of Shoppin’ Bag’s entry into Pueblo). stock, Dillon was the priciest. These tactics can also serve an important supermarket acquisition in strategic role in signaling other poten- history. But Everingham fig- tial entrants that the incumbent firm ures it was a bargain. To greets new entrants like a grizzly bear. crack Denver from scratch, as Thus , zone pricing, massive advertising it did in San Antonio, Kroger campaigns and other aggressive responses would have had to lay out $500 to new entrants may not only be aimed million, facing price wars and at the entrant in question but. intended no guarantee of market share. as warning to future potential entrants (Saporito, p. 80) (Spence 1981). Entry barriers are clearly higher Another tactic to forestall entry in large SMSAS. All else the same, in the supermarket industry is geographic entry barriers are also higher in SMSAS preemption (Mallen and Haberman). Simply in which: a) a high percentage of gro- put, this is building stores ahead of cery store sales are held by supermar- sales. Since the growing parts of metrop- kets indicating that there is little olitan areas are most susceptible to unmet demand for supermarkets; b) super- entry, it may be profitable in the long market sales are highly concentrated; run for a leading firm to build stores c) there is one or more dominant super- in prime locations in anticipation of market chain in the market.; d) there future population growth. Although sub- is little or no growth in SMSA grocery stantial losses may be incurred for a store sales. year or so, this practice makes new entry more difficult and enables a leading Taken in total, I believe there is firm t.oprotect its market position. relatively strong evidence that the barriers to effective entry into the Large chains can overcome all of supermarket submarket are substantial. these five barriers more easily than This is particularly true in large small . For example, “Grand Union manage- SMSAS . Entry forestalling behavior ment., in outlining a Florida West. Coast makes little sense if there are low Development Program for 1976-1980, anti- barriers; a firm would be unable to cipated operating their eighteen stores gain the benefits of entry deterrence on the West Coast of Florida at a sub- without. attracting new entry. The posi- stantial loss for at least five years” tive relationship between price and (Federal Trade Commission, 1981c, p. seller concentration found in several 216). Large chains can cross subsidize empirical studies is also difficult from other markets and have greater total to explain if there are low barriers. resources on which t.o rely during an entry attempt. Entry conditions vary for different strategic groups and different markets. Because de novo entry can be slow, As a new “mousetrap,” warehouse and costly and uncertain, entry via acquisi- super warehouse stores have enjoyed a welcome response by consumers in several

Journal of Food Distribution Research February 85/page 95 markets. As their share of the market and competition --has been used instead increases, entry by new warehouse stores to buy other companies. will become more difficult. For example, a new warehouse store entrant into Minnea- As sizeable companies are swallowed polis or Milwaukee will find it tougher up through mergers, the number of firms to attract sales than the first entrants. is reduced that have the resources to With nearly half of the sales in these enter large markets with high entry markets, warehouse type stores may be barriers. Small and medium companies, approaching their market potential. which from my experience are often the For at least some consumers, low prices best run and most aggressive competi- are not the primary criterion for select- tors, also are limited through a lax ing a store. For example, Byerly’s and merger policy, Applebaums, Altermans, Lund ‘s, operators of large, luxurious Star Marketa in Rochester, and Purity superstores in Minneapolis report. that Supreme are a few examples. their business has been unaffected by the growth of super warehouse stores Since the total financial strength in that market (Supermarket News, p. 32). of a chain definitely affects its abil- ity to overcome entry barriers, competi- Conclusions tion would probably be better served if mergers were channeled to small and So--what. does all this add up to? medium size companies. This was done If there are significant entry barriera, during 1965-74. Large chains were as I believe there are--particularly in forced to enter new markets whether de large SMSAs-- then mergers can have an novo or through toehold acquisitions, important effect on competition in food both of which tend t.o be pro competi- retailing. Significant. horizontal merg- tive. ers-- especially involving the top two or three firms-- are obviously of con- While I see no evidence that fur- cern. However, the FTC has to be con- ther consolidation among the largest vinced that entry barriers are signifi- supermarket chains will carry benefits cant in the supermarket industry before either to the public or to the U.S. food it is likely to take much action. marketing system, large mergers are unlikely to be challenged without a In addition, I believe we need to change in the law. This is unlikely at rethink the pros and cons of large market present.. Thus , until the pendulum extension mergers. As our present anti- swings back to a stronger role for anti- trust laws are written, such mergers are trust., perhaps the best that. can be illegal only when the effects “may be done is to develop more evidence on aubstant.ially to lessen competition, or the factors affecting the competitive to tend to create a monopoly.” There is performance of grocery retailing. no requirement that such mergers carry some social benefits. I see little re- References deeming social value from the Grand Union- Colonial, Kroger-Dillon or American Baumol, William J. (1982). “Contestable Stores-Jewel mergers. These mergers Markets: An Uprising in the Theory were not made to salvage a company in of Industry Structure,” Am. Econ. trouble. They are unlikely to improve Rev. 72:1-15, efficiency. If anything, inefficiency and unnecessary costs are likely to in- Caves, Richard E. and Michael E. Porter crease in larger organizations. Capital (1977). “From Entry Barriers to that. could have been used to build new Mobility Barriers,” Q. J. Econ. stores, install new equipment, and enter 91:241-61. new markets-- thereby enhancing efficiency

February 85/page 96 Journal of Food Distribution Research Cotter ill, Ronald, “Market Structure- Market Structure, Profits, and Price Relationships in Vermont Food Prices. New York: Praeger. Retailing Market s,” NC117 Working Paper, University of Wisconsin, Marion, B., R. Parker and C. Handy. forthcoming. “Organization and Performance of Food Distribution Industries,” Demsetz, Harold (1974). “Two Systems of chapter in The Organization and Belief About Monopoly,” in Industria- Performance of the U.S. Food 1 Concentration: The New Learning, =$ forthcoming. edited by Harvey J. Goldschmid, H. Michael Mann, and J. Fred Weston, Metro Market Studies (1984). 1984 Gro- 164-84. Boston: Little, Brown. cery Dist.ribut.ion Analysis and Guide. Weston, Mass. Federal Trade Commission (1981a). In the Matter of the Grand Union Co. et Mueller, Willard F. (1984). “Alleged al., FTC Docket No. 9121, Proposed Predatory Conduct in Food Retail- Findings of Fact, Conclusions of ing,” NC117 Working Paper 78, Uni- Law and Order, June 8, 1981, Atlant- versity of Wisconsin, September. a, Ga. Pautler, Paul A. (1983). “A Review of (1981 b). In the Matter the Economic Basis for Broad-Based of the Grand Union Co. et al., FTC Horizontal-Merger Policy,” The Docket No. 9121, Initial Deci_sion, Antitrust Bulletin, Fall 1983. — October 30, 1981, Washington, D.C. Peltzman, Sam (1977). “The Gains and (1983). In the Matter of Losses from Industrial Concentrat- the Grand Union co., FTC Docket ion,” J. L. & Econ. 20:229-64. No. 9121, Final Order, July 18, 1983, Washington, D.C. Porter, Michael E. (1976). Interbrand Choice, Strategy, and Bilateral Greer, Douglas F. (1984) . Industrial Market. Power, Harvard Univ. Press, Organization and Public Policv. Cambridge, Mass. 2nd Ed., Macmillan Publ. Co., N.Y.: pp. 294-321. (1979). “The Structure Within Industries and Companies’ Hall, Lana, Andrew Schmitz and James Performance,” Rev. Econ. & Stat. Cothern (1979). “Beef Wholesale- 61:214-27. Retail Marketing Margins and Concen- tration,” Econometrics 46:395-400. (1981). “Strategic Inter- action: Some Lessons from Industrv Lamm, McFall (1981). “Prices and Concen- Histories for Theory and Antitrus~ tration in the Food Retailing Indus- Policy,” in Strategy, Predation try,” J. Ind. Econ. 30:67-78. and Antitrust Analysis, ed. by Steven Salop; Federal Trade Commis- Mallen, Bruce and M. Haberman (1975). sion, Washington, D.C., pp. “Economies of Scale: A Determinant 449-506. of ‘Overst.oring and Superst.oring’?” in Canadian Assoc. of Administra- Progressive Grocer. “Annual Report of tive Sciences Conference Proceed- the Grocery Industry,” April 1982. ings, Edmonton, Alberta. Saparito, Bill (1983). “Kroger, The Marion, Bruce W., et al. (1979). The New King of Supermarketing,” Food Retailing Industry Indust~ Fortune, Feb. 21, 1983, pp. 74-80.

Journal of Food Distribution Research February 85/page 97 Scherer, F. M. (1971). Industrial Market Supermarket News (1984). “Market Pro- Structure and Economic Performance. files ‘84,” Section Two, July 30. , Ill.: Rand McNally. U.S. Dept. of Justice (1982). Merger Sheperd, William G. (1984). “Conteata- Guidelines, Washington, D.C., June bility vs. Competition,” Amer. 14. Econ. Rev., 74:572-587.

Spence, Michael (1981). “Competition, Entry and Antitrust. Policy,” in Strategy, Predation and Antit.rust. Analysis, ed. by Steven Salop; Fed- eral Trade Commission, Washington, D.C.

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