Competition among food and beverage retailers in Mexico

06/11/2020

The remarkable expansion of food and beverage marketing through the modern channel has raised some concerns about competition. The United Nations (2016) has noted that, in most countries, retail markets are concentrated in a few supermarket chains that could have considerable market power, in addition to the presence of significant economic, strategic, and legal barriers to entry.

The OECD (2019) finds that the concentration in the Mexican retail sector is greater than in other countries, including some in Latin America, which has generated some concerns about the purchasing power of retailers, in addition to the excess of regulations affecting the intensity of competition.

The most relevant transformation of the modern channel has been the modernization of the supply chain. The regional deployment of goods distribution centers and logistics networks, both supply and distribution to stores, determines the ability of chains to consolidate and exert competitive pressure on local markets. The high investments made by large chains to modernize their supply chain are difficult to replicate, which can make the small stores already established unable to challenge the position of the larger chains.

On the other hand, established chains that already have infrastructure are in a better position to meet increases in demand, since the investments they need for these peaks are smaller and more quickly enforceable than those that would be required by entrants or small stores, as will be seen later.

Concentration on local markets

Competition in food and beverage retail is local. Consumers minimize travel time and costs by going to the stores closest to their homes and only going to the next closest store when they believe they will get better prices, a greater variety of products, or some other benefit in services that will offset the increased time and cost of travel. Thus, the establishments attract customers from an area around them called the area of influence.

In the absence of barriers to entry for potential competitors, an establishment cannot continuously increase its prices, since it will either cause consumers to seek alternative sources of supply or encourage a competitor to move in nearby, causing a drop in prices. Consequently, both the geographical proximity of the establishments in the modern channel and the similarity of their formats determine the competitive pressure they exert on each other.

To approximate the level of concentration that exists in the markets, the area of influence defined in this study is a circle in whose center is a store of the format warehouses, supermarkets, hypermarkets, and megamarkets of the modern channel. These areas of influence are classified into four types of locations, according to their average urban density:

Metropolitan Zone of the Valley of Mexico, the radius of 2.5 kilometers;

Urban areas with a higher than average population density, 4.98 kilometers;

Urban areas with lower than average population density, 7.41 kilometers;

Rest of the country, 18.61 kilometers.

The radius of the areas of influence represents the kilometers that people can travel by vehicle in a time of fifteen minutes, with this transfer being smaller as one is in a more densely populated area. For example, in the Valley of Mexico Metropolitan Area, the average distance traveled in a fifteen-minute trip is 2.5 kilometers; while in Monterrey, located in an urban area with a population density greater than average, is 4.98 kilometers. These thresholds are similar to those adopted by other competition authorities in market studies of this type and in resolutions on concentrations in retail trade issued by the Federal Economic Competition Commission.

The definition of the areas of influence that was made in this study is only a rough approximation to the real areas of influence, since it does not consider that consumers' travel times to stores can vary due to various factors such as traffic, urban and topographic barriers. Nor does it consider that the area of influence for non-perishable products could be greater than that of perishable ones; since the latter must arrive earlier at their destination to preserve their quality.

Based on this analysis, it can be concluded that 10% of the areas of influence of large retail formats are monopolistic; that is, there is only one agent (with at least one store) and in 15% there are only two competitors.

Likewise, the economic agents that operate department store formats in the areas of influence of the Valley of Mexico Metropolitan Area tend to face fewer competitors than in urban areas with a higher than average population density and urban areas with a lower than average population density. average.

The presence of areas of influence with more competitors in urban areas with a higher than average population density and urban areas with a lower than average population density may be a result of the way in which the areas of influence were built (their radius is greater than in the Valley of Mexico Metropolitan Area, but it is also noteworthy that some chains that are only present in one region also participate in them, and they have also managed to form networks of stores and distribution centers.

The scarcity of land, at least in the Mexico City Metropolitan Area, is a major barrier to entry. Such barriers may be less strong in non-metropolitan municipalities (called "rest of the country"), but in these municipalities, areas with one or two players predominate, which may be due to the fact that the small size of the market imposes a limit on the installation of more stores.

Walmart does not face competition in almost half of the areas of influence of its large stores established in these areas, which are characterized by being located in generally undeveloped and sparsely populated municipalities. In general, Walmart does not face competition in 21% of all the areas of influence in which it is present with its department store format at the national level.

A total of 87% of the areas of influence with a single competitor correspond to Walmart. Most of Walmart's stores that do not have competition belong to the warehouse, supermarket, hypermarket, and megamarket formats with an average sales floor of approximately 1,500 m2, generally located outside metropolitan areas). More than half of the areas of influence with a single competitor are in the State of Mexico (48%), Jalisco (28%), Chiapas (22%), Puebla (19%), Guanajuato (16%), Michoacán (14%) and Veracruz (14%).

In the case of land scarcity as a barrier to competition, some alternatives for economic agents to operate in these areas could be to enter into smaller formats (discount stores and express stores) or to expand through e-commerce. Smaller formats, although they imply a smaller supply of products and services for clients, facilitate participation in markets that would otherwise be more difficult to enter. Entering the electronic channel provides the opportunity to increase the service alternatives available to consumers -such as initiating a multi-channel or omnichannel strategy- and to increase the geographic reach of a physical store.

Distribution in the modern channel

Although competition is local, decisions taken at the regional level affect the dynamics of competition. It is at the regional level that retail chains make the decision to establish their distribution networks, which in turn makes it possible to form networks of stores to expand into the local markets of that region.

As they grow, retail chains acquire cost advantages, which can become an obstacle to the entry or expansion of their competitors by limiting the profitability of the potential entrant. One of the most important cost advantages is that which arises as a result of establishing an efficient logistical supply network. Large retailers have transformed their logistics chains through technological innovation, organizational improvement, infrastructure building, and partial elimination of intermediaries.

Goods arrive at modern channel stores through three channels:

Directly from suppliers or "on foot". It generally occurs when suppliers have an extensive logistic chain.

Through the distribution centers. This is the most common means of distribution of goods to stores and the epicenter of the main technological and organizational transformation of large supply chains.

From another nearby store of the same chain in the region, called "mother store", which transfers inventories to other smaller stores, because it has surpluses or greater infrastructure.

The distribution centers are warehouses or collection centers that distribute the goods to the stores, whose purpose is to improve the internal processes of the supply chain, through the distribution with quality - that the product arrives at each store without shortages or surpluses - and productivity - to meet the objectives of moving boxes or pallets in a given time. Distribution centers have increased operational efficiency in storage, distribution, inventory management, and logistics.

Gasca and Torres (2014) indicate that distribution centers allow direct links between stores and their suppliers, displacing intermediaries. For example, Lugo Morín (2013) shows that in Acatzingo, Puebla, Walmart established direct commercial relations with small producers, reducing the ones it had with marketing companies and the Huixcolotla supply center in Puebla. The elimination of intermediaries is a global trend that is not exclusive to Mexico. Michelson et al. (2018) document that in China, Walmart has reduced the purchase of fresh fruits and vegetables from supply markets to supply agricultural communities. Gale and Hu (2011) emphasize the global trend in the modern channel to generate efficiencies by eliminating intermediaries.

The number of distribution centers per chain depends on the size of its network of stores, the volume of products collected and channeled, the centralization of the logistics operation, and the type of products handled in each one (dry, perishable, or mixed) because they require different temperatures. Most of the retail chains own their distribution centers, although some contract them with specialized companies or lease them. Walmart introduced distribution centers to Mexico and is the chain with the most of these facilities.

The distribution centers and physical store networks are a significant barrier to the entry of new chains and the expansion of smaller chains. Established chains can cover the increase in demand at a lower cost and immediately because they would only have to increase investment in supply and inventory rotation with the infrastructure they have, instead of building a new store and distribution centers, as a new entrant or small store would have to do. Consequently, the structure of the modern channel is characterized by the predominance of a small number of participants. This is a phenomenon that is observed around the world and not only in Mexico.

Distribution centers are more important for larger formats, such as stores, supermarkets, hypermarkets, and megamarkets, since they make it easier to handle a larger assortment. Larger formats are cheaper to supply per unit of product, because they can be supplied by complete trucks in a single delivery - known as economies of scale. Also, at the store level, profitability per square meter increases when a cost advantage is achieved by selling a greater variety of goods in the same store (economies of scale).

The importance of economies of scale and scope can limit the possibility that small store formats, less than 500 m2, will exert some degree of competitive pressure on larger ones. It is more expensive to supply a network of small stores than a large format retail store per unit of product delivered. The way small stores compete is by differentiating themselves by their location, offering different quality products or different services. In the latter case, income from payment of services such as water, electricity, or telephone has become an important source of income for convenience stores.

Since distribution centers favor chains to agglomerate their stores in a geographic area, sharing costs among them by optimizing distribution routes, the decision to expand must weigh the fact of taking advantage of density economies - favoring growth towards adjacent markets - against the option of establishing in more attractive, but more distant, locations. Foster, Haltiwanger, Klimeck, Krizan, and Ohlmacher (2016) find evidence that chain stores selling food and beverages tend to expand more through the first option. For example, in the United States, Walmart started in Bentonville, Arkansas, and from there expanded to the local market, then to the regional market, and finally to the national market.

In this sense, regionally established distribution networks largely determine the local dynamics of competition, since high distribution capacity facilitates entry into local markets and greater competitive pressure. In addition, the increase in the number of stores allows them to share operating costs as administrative employees of the chain and advertising spending.

In some regions, the chains that install more distribution centers surfaces than their competitors are also usually the ones that accumulate more surfaces or the number of stores. The large national chains face previously established regional chains that are smaller and well-positioned, but because they cannot replicate their distribution networks in other regions, they have difficulty expanding to the rest of the country.

Finally, some regional chains that specialize in discount stores and express stores or convenience stores do not use distribution centers, but rather their suppliers distribute directly to the stores, which may help explain why they have not expanded beyond their region. In some convenience store chains, their distribution centers are used to bring their beer production to the stores, with the franchisees having to negotiate with other suppliers for the supply of other products. This situation shows that the development of logistics chains by food and beverage suppliers could be used to enter the retail trade.

Pricing considerations

In principle, the efficiencies of the modern channel should translate into lower prices. The greater capacity of retail chains to obtain from their suppliers better prices, qualities, or other contractual conditions, plus savings from logistics costs and technological improvements, are benefits that can be transferred to consumers.

Previously, the Federal Economic Competition Commission (2015) had indicated that even with the efficiency gains of the modern channel, it is not possible to assert that prices in that channel are lower than those of the traditional channel for all products, but only for some.

Some authors have found higher prices in the modern channel, which could be explained, in part, by the differences in quality and variety of the products offered. For example, Atkin et al. (2018) observe that in products such as fresh fruits and vegetables, milk products, cold cuts, dried meats, and sausages, modern channel chains have requirements for selection, packaging, presentation, and refrigeration that imply higher quality, but also higher prices. Also, in the modern channel, some products such as dairy and meat products have to comply with standards, such as NOM, NMX, and TIF certification, as well as strict compliance with the cold chain; while in the traditional channel, compliance is less strict or not at all.

In this regard, Atkin et al. (2018) show that when a store of a modern channel transnational chain enters a jurisdiction, prices drop by 12% when comparing products at the barcode level (i.e., the same product and presentation), but when comparing product groups (e.g., "soft drinks"), the entry of foreign supermarkets raise prices by 25%.

These authors believe that this is due to the introduction of products that belong to the same product group already offered by established national chains, but that are of higher quality or have larger presentations and consequently higher prices. They also point out that transnational chains offer five times more products at the barcode level than national chains. 

Some authors have found evidence that the entry of stores in the modern channel generates benefits for consumers. Busso and Galiani (2019) show that the entry of new chains has positive effects for consumers by lowering the prices of competing chains and also improves the shopping experience.

Arcidiacono et al. (2019) point out that Walmart's entry into U.S. markets generates a decrease in prices and income for established chains. In Mexico, Atkin et al. (2018) warn that the entry of transnational retail chains disciplines prices not only of established chains, but also of traditional channel stores; that is, in order not to lose customers, traditional channel stores are forced to reduce their prices.

Source: Cofece