Supplier Responses To Wal-Mart S Invasion Of Mexico

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Supplier Responses to Wal-Mart’s Invasion of MexicoLeonardo Iacovone (The World Bank)Beata Javorcik (University of Oxford and CEPR)Wolfgang Keller (University of Colorado, NBER, and CEPR)James Tybout (Penn State University and NBER)June 2009()Wal-Mart’s Invasion of MexicoJune 20091 / 42

Equilibrium price setting when products di er in quality()Wal-Mart’s Invasion of MexicoJune 20092 / 42

Mexico: a globalization shock()Wal-Mart’s Invasion of MexicoJune 20093 / 42

Wal-Mart o ers its retailing services to Mexican rms()Wal-Mart’s Invasion of MexicoJune 20094 / 42

Wal-Mart’s Invasion of Mexico: the argumentWal-Mart enters after NAFTA and Mexico’s joining the GATT in 1985Wal-Mart brings its business practices to MexicoThe FDI triggers massive reshu- ing among Mexican producersIWal-Mart increases their market size (national distribution)FHeterogeneous rms: strong rms gain, weak rms loseWal-Mart’s FDI gives incentives to innovate and upgradeIUpgrading required to ensure compatibility w/ Wal-MartF()Heterogeneous rms: strong rms upgrade, weak rms do notWal-Mart’s Invasion of MexicoJune 20095 / 42

Overview1Firm interviews in Mexico as input for modeling the impact ofWal-Mart on Mexican suppliers (summarized in Javorcik, Keller, andTybout 2008)2Simulation of sales, upgrading, pricing and other rm responses3Regression evidence on the same variables using Mexican micro data()Wal-Mart’s Invasion of MexicoJune 20096 / 42

The InvasionWal-Mart entered Mexico viajoint venture with BodegasAurrera in 1992IBought controlling interestin 1997 and becameWal-Mart de México(Walmex)Walmex is Mexico’s largestprivate employer since 2003()Wal-Mart’s Invasion of MexicoJune 20097 / 42

Walmex store formats()Wal-Mart’s Invasion of MexicoJune 20098 / 42

Regional Distribution CentersWalmex stores are supplied by regional distribution centers (CEDIS),as well as direct deliveries from producers30 percent of perishable goods are bought locally directly fromsuppliersSupplying a single CEDIS gives a producer access to the entirenetwork()Wal-Mart’s Invasion of MexicoJune 20099 / 42

Walmex’geographic expansion patterns: summaryWalmex started out in the most populated area–partly becauseAurrera was already thereWalmex expanded by adding stores throughout Mexico, rather thangradually radiating out from the centerIIn contrast to Wal-Mart’s strategy in the United States (Holmes 2007)Distribution centers followed stores, so suppliers’proximity to storesmeans they have good access to Walmex()Wal-Mart’s Invasion of MexicoJune 200910 / 42

Becoming a Walmex supplier: the prosSubstantial increase in market size()Wal-Mart’s Invasion of MexicoJune 200911 / 42

Becoming a Walmex supplier: the prosSubstantial increase in market sizeBene ting from Walmex innovative business methods()Wal-Mart’s Invasion of MexicoJune 200911 / 42

Becoming a Walmex supplier: the prosSubstantial increase in market sizeBene ting from Walmex innovative business methodsIModernized IT-based system of channeling deliveries from suppliersthrough centralized warehouses()Wal-Mart’s Invasion of MexicoJune 200911 / 42

Becoming a Walmex supplier: the prosSubstantial increase in market sizeBene ting from Walmex innovative business methodsIIModernized IT-based system of channeling deliveries from suppliersthrough centralized warehousesWalmex requires on-time deliveries ( ned if not) and drivers must carryidenti cation cards()Wal-Mart’s Invasion of MexicoJune 200911 / 42

Becoming a Walmex supplier: the prosSubstantial increase in market sizeBene ting from Walmex innovative business methodsIIIModernized IT-based system of channeling deliveries from suppliersthrough centralized warehousesWalmex requires on-time deliveries ( ned if not) and drivers must carryidenti cation cardsShipments must be on standardized corner-protected palettes (rentablefrom Walmex), subject to third-party quality audits()Wal-Mart’s Invasion of MexicoJune 200911 / 42

Becoming a Walmex supplier: the prosSubstantial increase in market sizeBene ting from Walmex innovative business methodsIIIModernized IT-based system of channeling deliveries from suppliersthrough centralized warehousesWalmex requires on-time deliveries ( ned if not) and drivers must carryidenti cation cardsShipments must be on standardized corner-protected palettes (rentablefrom Walmex), subject to third-party quality auditsGetting ready for Wal-Mart()Wal-Mart’s Invasion of MexicoJune 200911 / 42

Becoming a Walmex supplier: the prosSubstantial increase in market sizeBene ting from Walmex innovative business methodsIIIModernized IT-based system of channeling deliveries from suppliersthrough centralized warehousesWalmex requires on-time deliveries ( ned if not) and drivers must carryidenti cation cardsShipments must be on standardized corner-protected palettes (rentablefrom Walmex), subject to third-party quality auditsGetting ready for Wal-MartIis like "getting into a company version of basic training with animplacable Army drill sergeant"()Wal-Mart’s Invasion of MexicoJune 200911 / 42

Becoming a Walmex supplier: the prosSubstantial increase in market sizeBene ting from Walmex innovative business methodsIIIModernized IT-based system of channeling deliveries from suppliersthrough centralized warehousesWalmex requires on-time deliveries ( ned if not) and drivers must carryidenti cation cardsShipments must be on standardized corner-protected palettes (rentablefrom Walmex), subject to third-party quality auditsGetting ready for Wal-MartIIis like "getting into a company version of basic training with animplacable Army drill sergeant""helps everything: customer focus, inventory management, speed tomarket" (Fishman 2003)()Wal-Mart’s Invasion of MexicoJune 200911 / 42

Becoming a Walmex supplier: the consWalmex keeps negotiations with its suppliers as stark aspossible— both the bargaining environment and the number ofnegotiable contract features (price, quality, quantity)()Wal-Mart’s Invasion of MexicoJune 200912 / 42

Becoming a Walmex supplier: the consWalmex keeps negotiations with its suppliers as stark aspossible— both the bargaining environment and the number ofnegotiable contract features (price, quality, quantity)IOften makes a take-it-or-leave-it o er()Wal-Mart’s Invasion of MexicoJune 200912 / 42

Becoming a Walmex supplier: the consWalmex keeps negotiations with its suppliers as stark aspossible— both the bargaining environment and the number ofnegotiable contract features (price, quality, quantity)IIOften makes a take-it-or-leave-it o erExpects product innovation or annual price concessions()Wal-Mart’s Invasion of MexicoJune 200912 / 42

Becoming a Walmex supplier: the consWalmex keeps negotiations with its suppliers as stark aspossible— both the bargaining environment and the number ofnegotiable contract features (price, quality, quantity)IIIOften makes a take-it-or-leave-it o erExpects product innovation or annual price concessionsUses store brands to create competition()Wal-Mart’s Invasion of MexicoJune 200912 / 42

Becoming a Walmex supplier: the consWalmex keeps negotiations with its suppliers as stark aspossible— both the bargaining environment and the number ofnegotiable contract features (price, quality, quantity)IIIOften makes a take-it-or-leave-it o erExpects product innovation or annual price concessionsUses store brands to create competitionFor a supplier to complain about Wal-Mart’s approach()Wal-Mart’s Invasion of MexicoJune 200912 / 42

Becoming a Walmex supplier: the consWalmex keeps negotiations with its suppliers as stark aspossible— both the bargaining environment and the number ofnegotiable contract features (price, quality, quantity)IIIOften makes a take-it-or-leave-it o erExpects product innovation or annual price concessionsUses store brands to create competitionFor a supplier to complain about Wal-Mart’s approachI"would be committing suicide. If Wal-Mart takes something the wrongway, it’s like Saddam Hussein. You just don’t want to p them o "(Paul Kelly, business consultant; Javorcik, Keller, and Tybout 2008)()Wal-Mart’s Invasion of MexicoJune 200912 / 42

A simple model of Walmex’upstream industryIndirect utility from a unit of product j for consumer i:Uij θ 1 ln(ξ j ) βw wj θ 2 ln (YPj ) eijdef U ij eij .ξj :Pj :Y :wj :eij :Quality of good supplied by rm jPrice of good jIncome of representative consumer 1 if j retails through Walmex, 0 otherwiseType 1 extreme value, iid across consumers and goodsIf rm j sells through Walmex, it makes its product more accessible toconsumers, so more consumers choose it()Wal-Mart’s Invasion of MexicoJune 200913 / 42

Static and dynamic rm heterogeneityFirms’products di er in terms of their current quality, ξ jAt the beginning each period, each type of rm decides whether toexit for scrap value or continue operatingPotential entrants decide whether to create new rmsThose that continue choose a level of investment in innovationIInvestment increases the probability of quality improvement()Wal-Mart’s Invasion of MexicoJune 200914 / 42

The choice of retailingEach incumbent rm decides whether to sell through Walmex(wj 1 or wj 0)IIThe bene t: Access to Walmex consumer baseThe cost: Walmex dictates a low pricePure Bertrand product market competition for rms not sellingthrough Walmex()Wal-Mart’s Invasion of MexicoJune 200915 / 42

Nash EquilibriumIn equilibriumIIIThe transition density for the industry states is correctly understood byall agentsSpot markets clear at optimal price (Pj ) and retail (wj ) choicesOptimal investments towards quality improvements are madeGiven parameters, we solve for the oblivious equilibrium numericallyIOblivious equilibrium: approximation technique introduced byWeintraub, Benkard and Roy (2007)()Wal-Mart’s Invasion of MexicoJune 200916 / 42

Optimal price settingFirms selling through Walmex must meet a minimum quality leveland price at:P j P0 θ 3 ln(ξ j ), θ 3 0The remaining rms do best to price at:Pj Y θ 2 Cj (1 hj ), j 2I1 θ 2 (1 hj )wherehj h(j jw, P, ξ ) ()exp U ij exp U i 1Wal-Mart’s Invasion of MexicoJune 200917 / 42

Equilibrium retailing choiceFirms anticipate second stage equilibrium prices for each quality levelGiven the decisions of their competitors (w j ), they make thepro t-maximizing Walmex choice by comparingπ j π (j, wj 0jw j , ξ ) (PjC ) hj Mandπ j π (j, wj 1jw j , ξ ) P jChj MEquilibria in retailing choices obtain when:[π j (j, wj [π j (j, wj() 1jw j , ξ ) 0jw j , ξ )π j (j, wj 0jw j , ξ )] wjπ j (j, wj 1jw j , ξ )] (1Wal-Mart’s Invasion of Mexicowj )June 20090 8 j.18 / 42

Product quality investmentsrj is the current level of R&D of the j th producer in order to in‡uenceits product quality next period, hereafter denoted ξ j0Product quality realizations are elements of a discrete ordered setQuality moves at most one position for each rm per period()Wal-Mart’s Invasion of MexicoJune 200919 / 42

The evolution of product quality over timeWith R&D e ort r , a rm’s probability of success isar1 arFirms lose a quality step with exogenous probability δThe quality transition probabilities arehiarUp:Pr ξ j0 ξ i 1 jξ j ξ i 1 arj j (1 δ)hiarConstant:Pr ξ j0 ξ i jξ j ξ i 1 1 arj j (1 δ) hiarDown:Pr ξ j0 ξ i 1 jξ j ξ i 1 1 arj j δ()Wal-Mart’s Invasion of Mexicoarj1 arjJune 2009δ20 / 42

Bellman equationLet the i th element of s (s1 , s2 , ., sK ) be the number of rms inthe industry at quality level ξ iLet scountjbe the same vector, except in that it leaves rm j out of theLet π ξ j , , s j be the pro ts of rm j when it is at quality ξ j , andthe remainder of the industry is at s jThen optimal decisions are characterized by:V ξ j ,, sj max φs , max πrj()ξ j ,, sjcr r βEΩj V . ξ j0 , , s0Wal-Mart’s Invasion of MexicojJune 200921 / 42

Entry and exitFirms enter at some common initial quality level when the expectedpro ts exceeds the (exogenous) cost of creating a new rmFirms exit when the scrap value φs exceeds its continuation value()Wal-Mart’s Invasion of MexicoJune 200922 / 42

Simulations: main parametersWithoutWalmexWithWalmex optionC:Marginal costs1.51.5βw:Walmex boost1.01.0ξ̄:Min. Walmex qualityn.a.2.0θ3:Quality-price rel’nn.a.0.4()Wal-Mart’s Invasion of MexicoJune 200923 / 42

Price setting in the Walmex world()Wal-Mart’s Invasion of MexicoJune 200924 / 42

R&D investmentBlue line: No Walmex()Green line: Walmex is presentWal-Mart’s Invasion of MexicoJune 200925 / 42

Product quality upgradingBlue line: No Walmex()Green line: Walmex is presentWal-Mart’s Invasion of MexicoJune 200926 / 42

The number of rmsBlue line: No Walmex()Green line: Walmex is presentWal-Mart’s Invasion of MexicoJune 200927 / 42

Key model implicationBoth static and dynamic responses to Walmex vary across the qualitydistribution:LowMediumHighSales *Innovation &Upgrading * Price()Wal-Mart’s Invasion of MexicoJune 200928 / 42

Simulations: speci c results1Net exit occurs (39 rms ! 20 rms)2Operating pro ts increase by 23%3Exit and entry rates fall (3.5% ! 1.8%)4Consumer surplus rises by 2%()Wal-Mart’s Invasion of MexicoJune 200929 / 42

Regression evidence: key dataPanel data on Mexican manufacturing establishments (1993 to 2002)IIAlmost 7,000 establishments ( plants) across 205 industry groupsSource: INEGINumber of Walmex stores, by state and over timeInformation on whether products are carried by Walmex, or notControl variables: State GDPs, US and Mexican tari levels, and xede ects()Wal-Mart’s Invasion of MexicoJune 200930 / 42

EstimationIdenti cation: Are establishments that sell a Walmex-type producta ected di erently when Walmex’regional presence increases,compared to establishments that do not sell Walmex-type products?Use simultaneous quintile regressions:YitY jt βq1 ln(Nst ) βq2 WMXj βq3 ln(Nst ) WMXj βq4 ln(GDPst ) βq5 ln(GDPst ) WMXj βq6 TARjtMEX βq7 TARjtUS αqt εqit ,where i 2 state s, industry j; e.g., in the rst results, dependentvariable Yit is domestic sales of establishment i in year tq is the quintile of the sales distribution (generally, the Yit variabledist’n)()Wal-Mart’s Invasion of MexicoJune 200931 / 42

Summary statistics()Wal-Mart’s Invasion of MexicoJune 200932 / 42

Walmex and changes in sales for small versus large rmsln(#WalMartStores)WalMartProductln GDP)WalMartProduct20th 7(0.020)0.316(0.053)80th 0(0.023)0.059(0.059)Number of obs: 52,861; regression also includes constant, tari levels, and time xed e ects; bootstrapped standard errors inparentheses()Wal-Mart’s Invasion of MexicoJune 200933 / 42

Changes in sales across quintilesCoefficient on ln(#WalmexStores) art’s Invasion of Mexicoq80June 200934 / 42

Changes in R&D spending across art’s Invasion of Mexicoq80June 200935 / 42

Skill composition as another indicator of t’s Invasion of Mexicoq80June 200936 / 42

Importing intermediate inputs from abroad3210-1-2-3-4q20()q40q60Wal-Mart’s Invasion of Mexicoq80June 200937 / 42

Walmex and labor productivity ’s Invasion of Mexicoq80June 200938 / 42

The change in prices charged across level prices incorporate product-level information; index 100 in 1994, no time xed e ects()Wal-Mart’s Invasion of MexicoJune 200939 / 42

Supplier response: Model versus dataSalesLowqualityMediumqualityHighquality *LowqualityMediumqualityHighquality *LowqualityMediumqualityHighqualityUpgradingPrice ()Wal-Mart’s Invasion of MexicoJune 200940 / 42

SummaryWal-Mart’s entry had a major impact on Mexico’s manufacturingindustryWe nd static reallocation (between- rm) and dynamic (within- rm)e ectsThe industry evolution model matches the interview and quantitativeevidence well()Wal-Mart’s Invasion of MexicoJune 200941 / 42

ImplicationsEmpirical analysis ought to bring possible heterogeneous responsesmore into focusIIIMarket share gains versus lossesMore technology spending versus lessFirm- and labor force upgrading versus downgradingUpstream-downstream relations appear to be important for assessingthe impact of trade and FDI liberalization on market size,technological change, and welfare()Wal-Mart’s Invasion of MexicoJune 200942 / 42

Wal-Mart s Invasion of Mexico: the argument Wal-Mart enters after NAFTA and Mexico s joining the GATT in 1985 Wal-Mart brings its business practices to Mexico The FDI triggers massive reshu› ing among Mexican producers I Wal-Mart increases their market size (national distribution) F Heterogeneous -rms: strong -rms gain, weak -rms lose

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