Regulatory barriers to entry or expansion in the modern retail channel in Mexico

08/11/2020

This article identifies regulatory barriers to entry or expansion in the modern retail channel in Mexico, based on the OECD methodology, which consists of identifying whether the selected regulations at the state and municipal levels have any of the following effects on the competition: 1) limit the number of competitors; 2) restrict the capacity and incentives to compete; and 3) reduce the incentives to compete.

The analysis combines the information collected during the preparation of this study with data on regulatory failures collected by Conamer according to the World Bank's Markets and Competition Policy Assessment Tool (MCPAT) methodology.

The analysis includes laws and regulations at the state and municipal levels. At the municipal level, for this study, we reviewed provisions from 54 municipalities selected on a non-probabilistic basis from among the 2,465 in the country: 31 municipalities from 27 states are from the Conamer database, selected based on indications from the state governments. For this study, another 23 municipalities were added in order to have information on municipalities from all states. The selection criteria for the latter was that their population be greater than 40,000 inhabitants and that they have at least one convenience store.

The laws and regulations analyzed in this study are related to the functioning and operation of retail trade (commerce, health, construction, etc.), except for regulations on the sale of alcoholic beverages. Land use regulations were not analyzed, although they could establish barriers to the entry of new establishments. Earlier, COFECE (2015a) noted that permits that affect the land market - for example, land use and construction - exacerbate the shortage of available land, increasing the time for entrants to find optimal locations and the price of these lands.

Regional or local chains generally have fewer resources to overcome regulatory barriers than large national chains: Walmart and FEMSA, for example, have formed teams that can exceed 100 people.

Identification of regulatory barriers

In all the states there are laws and regulations that regulate retail trade and matters that affect it, such as environmental or health and safety at work. In several states, state regulation imposes requirements that hinder the entry or expansion of businesses, although with differences in the number and type of obstacles.

The economic agents consulted for this study indicated that they must accredit more procedures before municipal than state authorities. This is due to the fact that it is at the municipal level where the authority to regulate various matters related to commercial activity lies.

More relevant than the number of procedures, the heterogeneity of regulation between one municipality and another is an obstacle to the expansion of regional chains. Thus, the difficulties of dealing with this variety of regulations, procedures, and authorities stand as an obstacle to the entry and expansion of commercial chains.

In 39 of the 54 municipalities reviewed, regulatory obstacles to the opening and operation of modern channel stores were found.

In 19 municipalities there are requirements to issue or renew licenses and operating permits, such as neighborhood consent or the presentation of socio-economic and urban impact studies for new establishments which, lacking clear criteria, give local authorities a wide margin to act arbitrarily and thus unjustifiably hinder the entry and expansion of businesses.

Other regulations restrict the number of licenses and establish preferences for local merchants. In Campeche City, for example, the regulation states that the municipal authority may refuse to grant a license, authorization, or permit when, in its opinion, there is a "sufficient number of businesses to meet the demand" or if there is a "risk of creating conflicts with organized trade".

In four municipalities of different entities, there are requirements that give preference to local businesses to obtain the license or permit. These regulations do not indicate what criteria the authorities should use to determine the number of businesses, and in establishing the preference of local merchants, they limit the supply of consumers.

Other municipal requirements raise the cost of operating retail establishments. In nine of the municipalities studied, regulations require that commercial establishments must have parking, as well as other infrastructure requirements. When these minimum requirements are justified - by urban or safety objectives - the expected benefits must be balanced against their possible anti-competitive effects.

Sometimes, regulations set limits on advertising for commercial establishments. In six municipalities, there are restrictions on the content of business advertisements: language, use of names, colors, and advertising space on facades, among others. Advertising regulations reduce the intensity of competition, and may affect more small businesses that would opt for low-cost advertising, as well as new businesses that seek to create a presence but see their ability to expose their brand reduced.

These regulations may be justified, for example, to control visual pollution or safety, as well as to protect historical and cultural heritage; however, it was not found that the number of advertisements is regulated, but rather that rules on content are ambiguous and arbitrary. The regulations on advertising in the cities of Culiacán, Sinaloa, and Gómez Palacio, Durango, prohibit the granting of licenses to those advertisements that are contrary to "morals and good customs".

Costs of regulation

This section quantifies the costs of the procedures to open establishments in the modern canal. This analysis is elaborated based on information about the procedures managed by the agents required in this study before the authorities of the three areas of government.

The procedures have two costs: the administrative cost, which is paid for carrying them out, and the opportunity cost, which is what the agent loses by having its investment stopped while the procedures are being completed.

The average administrative cost of the procedures per establishment is higher as the sales area increases, except for price clubs. The average cost of opening a warehouse, supermarket, hypermarket, and megamarket is 6.9 times higher than that of a discount store and express store. This administrative cost was calculated by dividing the sum of the total cost reported by economic agents from 2014 to September 2019 of the procedures already completed in the three government areas, by the number of establishments in each format that began and completed their procedures.

Based on the analysis carried out in this study, the administrative cost of the procedures for the 1,591 establishments of the modern channel that opened in 2018 amounted, in total, to 300.8 million pesos. On average, the administrative cost of the procedures was approximately 1,860 pesos per day for each warehouse, supermarket, hypermarket, and megamarket establishment. This cost considers the chains that were required to provide information, which had 95% of the sales area of the modern channel establishments in 2018.

In some municipalities, the governments have little incentive to change the collection, since it can become an important source of their own income. For example, in the municipality of Los Cabos, Baja California Sur, the administrative costs for establishments that opened in 2018 were equivalent to 40% of the municipal government's approved payroll.

The costs of procedures to open establishments vary considerably among the states; in general, they are higher in the northwestern states.

In addition to administrative costs, the opportunity cost -what the agent loses by having his or her investment stopped while the procedures are finished- seems to be much more onerous than the monetary cost of the procedures, in the sense that the average duration of the procedures to open a store, warehouse, supermarket, hypermarket, and mega-market is almost a year.

In this study, average daily net sales per store were estimated considering the format of those stores that began operations in 2018. The procedure consisted of dividing the average net sales reported in the 2016, 2017 and 2018 income statements of the chains by the number of stores per format and 365 days, in order to obtain the net daily sales for each store according to its format.

As a result, warehouse, supermarket, hypermarket, and megamarket format agents lose approximately one million pesos per day for each day that it takes them to receive authorization to begin operations, a considerably higher figure than that for discount stores and express warehouses and convenience stores.

The above results show a regulatory bias that imposes a higher opportunity cost for opening a warehouse, supermarket, hypermarket and megamarket than for a discount store and express warehouse, by delaying the opening of larger stores. This can generate welfare losses for consumers, by preventing them from having greater access to a variety of products, and efficiency losses for chains because they open smaller stores than they would otherwise have.

Concluding comments

Some countries have established laws and regulations whose purpose has been to protect traditional businesses by imposing restrictions on the opening of stores in the modern channel. The international evidence concludes, in a convincing way, that these regulatory obstacles diminish competition and productivity, and increase the prices paid by consumers. The only thing they have achieved is to protect the modern channel stores that were already installed before the entry into force of such regulation.

For example, in France, the Royer Law of 1973 and the Raffarin Law of the same year established stricter and more discretionary criteria for the installation of large stores. These laws had the effect of blocking the entry of competitors from the large chains already established, which restricted employment and favored concentration and the maintenance of high prices.

In Spain, regulations imposed by the autonomous communities to protect established traditional retailers led to an increase in regional prices of approximately 20% and the departure of low-cost stores.

In contrast, the reduction of regulatory barriers to the establishment of stores benefits consumers. For example, in Okinawa, Japan, by removing land-use restrictions, the number of convenience stores grew by 10-14% in residential and industrial areas, and 2-3% in areas where local government permission was required. In Sweden, the adoption of less restrictive entry regulations increased productivity in retailing - measured as value-added per full-time worker - by 1.8% on average, and by up to 5% in local markets.

In Mexico, the World Bank (2018) found that the number of firms and sales in retail trade increase when the number of state regulatory barriers are reduced. Bruhn (2011) found that a simplification of regulation implemented in Mexico decreased prices by 0.6% and increased employment by 2.8%.

However, this study recognizes that some state and municipal regulations are justified by the achievement of other public interest objectives, such as the protection of health, the environment, urban image, or security; however, it is necessary that such concerns are addressed through regulations that limit as little as possible the efficient functioning of markets.

Therefore, state and municipal authorities should modify or eliminate provisions that limit the ability of businesses to compete or that limit the number and variety of competitors. In this regard, state and municipal authorities could establish one-stop stores to authorize the establishment and operation of self-service stores (warehouses, supermarkets, hypermarkets and megamarkets, discount stores and express stores and convenience stores), for which the Federal Executive could collaborate in their implementation by designing an assistance program or best practices.