Executive Summary
Wal-Mart’s remarkable operational efficiencies give it an advantage over competing chains, such as Kmart and Target. This advantage enables Wal-Mart to offer famously lower retail prices and generate higher sales volumes of many products. Wal-Mart is the principal buyer from many manufacturers, including Disney, Procter & Gamble, and Revlon, among others. With such high volumes, Wal-Mart is able to command concessions from its suppliers through reduced prices or quantity discounts.
This provokes some suppliers to complain that Wal-Mart is using its buying advantage to reap a higher share of channel profits at their expense, but have manufacturers necessarily suffered in terms of profits as a result of Wal-Mart’s growing channel power? The authors illustrate that such complaints might be unsupported. Specifically, using a formalized economic model, the authors investigate the impact of retail efficiency gains on manufacturer profits. The model shows that, indeed, suppliers can be more profitable when an advantaged retailer gains a buying advantage over its retail competitors through efficiency gains.
The Wal-Mart story belongs to a recent trend in the retail industry, which has seen the growth of “power retailers” and “category killers,” such as Best Buy, Home Depot, and PetSmart. The analysis in this article suggests that manufacturers of certain products should appreciate their relationships with large-volume retailers that are able to lower their retailing costs. To understand why, consider a retailer that is faced with one high-cost and one low-cost retailer. For a fixed amount of products sold, there are potential efficiency gains from exploiting a low-cost retailer because channel margins are higher. Wholesale prices that favor the low-cost retailer serve to transfer market share through the more efficient channel. For each additional sale shifted from a high-cost channel to a low-cost channel, the manufacturer can negotiate with the retailer for a portion of the added channel profit.
It is key that manufacturers not view channel relationships as a zero-sum game. By recognizing this, manufacturers can direct their resources toward productive endeavors (e.g., product development) rather than wrestle with retailers for channel power. In the Wal-Mart case, for example, several manufacturers have decided to devote a large portion of their marketing resources to serve Wal-Mart and to consult with its buyers on new product designs. Not only does Wal-Mart get a say in the design of the new products, but it also gets the best wholesale prices, which suggests that other retailers get a higher price.
Lower wholesale prices might mean lower margins for these suppliers, but combined with Wal-Mart’s low retailing costs, it also means a higher volume. Furthermore, a shift in the distribution of a supplier’s product from traditional retail channels to a more efficient one makes other channels relatively less important. Suppliers can then negotiate for better terms with those other retailers. In summary, the research presented in this article challenges the notion that the emergence of dominant retailers is necessarily bad news for manufacturers.
Biography
Bios Anthony J. Dukes is an assistant professor in the School of Economics and Management at the University of Aarhus in Denmark. His current research is focused on marketing channels and retail competition. His previous work has appeared in Marketing Science, Journal of Industrial Economics, and Journal of Economics and Management Strategy.
Esther Gal-Or is Glenn E. Stinson Chair in Competitiveness and Associate Dean for Research in the Katz Graduate School of Business at the University of Pittsburgh. She has also taught as a visiting professor at the Technion-Israel Institute of Technology and at the Kellogg Graduate School of Management at Northwestern University. Professor Gal-Or’s research and teaching interests are in microeconomics, industrial organization, game theory, and the industrial structure of the health care and media markets. Her work has been sponsored by the National Science Foundation and other government agencies. It has been published in economics and management journals, such as Econometrica, Review of Economic Studies, Journal of Economic Theory, Bell (Rand) Journal of Economics, Journal of Economics and Management Strategy, Journal of Business, Management Science, and Marketing Science. She also serves on the editorial boards of various economics and management journals.
Kannan Srinivasan is H.J. Heinz II Professor of Management, Marketing and Information Systems in the Tepper School of Business at Carnegie Mellon University. His research interests are in dynamic structural models, analytical models of competitive behavior, and the marketing–operations interface. His prior work has appeared in journals such as Marketing Science, Management Science, Journal of the American Statistical Association, Journal of Marketing Research, Journal of Marketing, Marketing Letters, Journal of Retailing, Accounting Review, and Journal of Business. He is an area editor of Marketing Science, an associate editor of Management Science, and an associate editor of Quantitative Marketing and Economics.
J Marketing Research, Volume 43, Number 1, February 2006
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