Quality competition in retailing: A structural analysis

Abstract

This paper presents empirical evidence that endogenous fixed costs play a central role in determining the equilibrium structure of the retail food industry. Using the framework developed in Sutton [Sutton, J. (1991). Sunk Cost and Market Structure: Price Competition, Advertising, and the Evolution of Concentration (MIT Press, Cambridge).], I construct a structural model of retail competition in which escalating investment in firm level distribution systems yields a natural oligopoly of high quality supermarkets, while a low quality fringe of grocery stores serves consumers who do not value quality. Using a full census of the retail food industry to evaluate the model, I construct a structural prediction for the limiting number of supermarket firms and identify the quality escalation mechanism that sustains this oligopoly. Apart from the specific setting analyzed here, this model can help explain why certain retail industries remain highly concentrated as markets grow, while others quickly fragment.