Tuesday, July 26, 2011

Price effects of WalMarts versus Sam's Clubs

An interesting discussion on Freakonomics. Basically, what is happening is that when a WalMart enters a market, existing retailers compete, and prices fall; when a Sam's (or Costco) enters the same market, prices rise. Why?
Phillips makes the argument that it's a mostly a product differentiation issue, i.e. that the monopolistically-competitive retailers are competing by distinguishing on variables like appearance, cleanliness, service, and convenience. I don't buy it, because they already do that with a WalMart around.
Instead I think it has to do with the pricing strategy of the club stores vis-a-vis non-club stores, and which consumers are attracted to each (and revealed as such to the competitors). Club stores price discriminate. They charge a membership fee, and then charge lower prices on marginal purchases. Smaller grocers don't have the size or clout to charge membership fees. Thus, they attract much more price-elastic consumers. The remaining consumers are considerably less responsive to price. At the same time, these leftover consumers are revealed to value the intangibles like service and appearance more. Small stores are free-riding on the informative role of the membership fees.

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