Local Competition and Impact of Entry by a Dominant Retailer

This paper analyzes the competition between two spatially differentiated multi-product retailers who encounter entry from a dominant discount retailer. Our primary objective is to determine how entry affects the pricing and relative profits of the incumbent stores and the role played by the location of the entrant. The new entrant has partial overlap in product assortment with the incumbents and is assumed to have lower procurement costs for the common goods. Consumers are heterogeneous in their location, economic status (shopping costs and valuations), as well as purchase basket or the types of products demanded. Results show that in the post entry equilibrium, the prices for the products not offered by the discounter are higher than the pre entry prices. More interestingly, contrary to the conventional wisdom we find that the store that is closer to the new entrant is better off compared to the incumbent located further away. The intuition for these results is that the discounter with its low price draws away the poor consumers – the price sensitive segment – out of the market for the items it carries. This in turn softens price competition between the incumbents for these items. Furthermore, the new entrant’s unique product offering attracts more consumers to visit the location it occupies, which introduces positive demand externalities to the neighboring retailer, leading to an increase in sales for the non-competing products. We provide empirical evidence for our results and discuss implications for retailers facing competition from large discount stores.