The retail sector accounts for 20 percent of global GDP. In developing countries, mostly small independent stores and small wholesalers that capture almost 60 percent of the sector’s revenue populate the sector. A large body of empirical literature analyzes the effect of competition on prices and quality in the sector. This literature has focused primarily on market responses to the entry of modern, large “big box” retailers. In a new paper, we provide the first experimental evidence on the effect of competition on prices and quality (Busso and Galiani 2019). We do this by assessing the effect of the entry of small retail shops rather than large retailers.

The experiment was part of an attempt to improve the operation of a conditional cash transfer (CCT) program in the Dominican Republic. This program provides monetary transfers to poor families that can only be used, by means of a debit card, in grocery stores affiliated with the program. Because entry into this market was restricted by program design, these stores could potentially wield market power. Our paper assesses the effect on product prices and quality of a relaxation of those entry restrictions. At the outset of the CCT program, the Dominican Republic’s government was grappling with the problem of how to deliver basic consumption goods to the poor sectors of its population. It had potentially three alternative strategies for controlling the prices and quality of those goods: directly selling these goods to the program beneficiaries; outsourcing the provision of such goods to the private sector and regulating their prices; or outsourcing to the private sector and ensuring competition in the market. In the end, the government chose the last of these three policy options. Our paper contributes to the literature by providing new evidence that governments can contract out public services and achieve lower prices without sacrificing quality if they can ensure that there is enough competition among potential providers.

The Experiment

We carried out a randomized control trial in 72 districts. Each district is considered a market. In these markets, program beneficiaries represent a large share of the customers and sales. The intervention consisted of an exogenous randomized increase in the number of retailers. The design allowed anywhere from zero to three new stores to begin operating in each market. 61 new grocery stores entered these markets, for a 26 percent increase in the number of stores in the treated areas. It is important to note that, in our setting, the stores referred to as “incumbents” are the ones that were already operating in the program network before the intervention took place; market entry is considered to have occurred when a store is approved by the CCT executing agency to sell its products to program beneficiaries. We refer to the retailers who are entering the program network as “entrants”.

We collected data on both retail stores and households (i.e. consumers) before and six months after the intervention took place. Our data includes information on product attributes (units, price, variety, and brand) that allows us to assess changes in the characteristics of the goods sold by retailers. As is also true of other papers that have contributed to the literature on this subject, we focus on the effect of competition on a relatively small set of goods. For each of those goods, we used the reported information on product, brand, variety, and measurement unit to build barcode-equivalent observations. Based on the retailer and household data, we built two independent measures of prices that proved to be very closely correlated. In addition, the surveys included measures of consumers’ self-reported shopping experiences, which we use to measure quality.

We estimate average treatment effects using the randomization assignment as an instrument for the potentially endogenous entry of new stores induced by non-compliance with randomization.

Results

Theoretical models of imperfect competition make various predictions about the competitive effects of market entry. Firms with market power may exploit their position to reduce quality, just as they may raise prices (Tirole 1988). In most models, the entry of new competitors leads to price reductions by putting more competitive pressure on market incumbents. This is a prediction of standard imperfect-competition models, such as differentiated-product Bertrand competition and spatial-competition models, as well as of many models with equilibrium price dispersion (such as that of Reinganum 1979). By contrast, the effect of competition on quality has been less clear-cut across the various models. Ultimately, it appears that the effect that competition has on quality depends on the extent to which consumers perceive and value quality.

We find that entry into the market led to reductions in prices ranging from 2 to 6 percent and to a statistically significant improvement in self-reported service quality. Since, owing to the increased competition that they faced, stores did not change the varieties or brands of the goods that they sold, our point estimates do not change significantly when we restrict the estimation sample to the set of stores and goods that sold products with the same barcodes before and after treatment. We also find that prices dropped more in areas where the number of entrants was larger. Competition seems to have driven part of the clientele away from incumbent retailers, since the entry of new stores increased the probability that consumers would switch to an entrant retailer.

Relative to the existing literature we show that entry of small retailers causes price effects of similar magnitudes as those observed when entrants are large retail chains. The existing literature found that objective measures of quality (e.g., reduced product shortfalls) improved after entry. Our paper shows that consumers perceive that quality improves. As in Bresnahan and Reiss (1991) we show that competition is effective even when there are as many as four to five incumbent retailers already operating in the market.

Conclusion

Relying on a field experiment, we studied the effect of market entry on prices and quality. We found a significant and very robust reduction in prices that ranges from two to six percent because of the increase in competition and some evidence that quality of the service provided to consumers improved six months after the intervention. We find these results to be economically large.

Our paper also contributes to the public finance literature by presenting experimental evidence suggesting that governments that choose to outsource to the private sector the delivery of services, can use competition to achieve lower prices without scarifying quality. In our setting competition also matters for incidence. The benefits of social programs that subsidize consumers (via monetary or in-kind transfers) can potentially leak into the profits of the private providers that are serving them if the supply side does not operate in a competitive environment. Our findings indicate that introducing competition, when that is possible, provides an effective means of avoiding rent capture by suppliers.

References:

Busso, Matias and Sebatian Galiani. 2019. “The causal effect of competition on prices and quality: Field experimental evidence.” American Economic Journal: Applied Economics, Volume 11, 2019, pages 33-56  

Bresnahan, T. and P. Reiss. 1991. “Entry and competition in concentrated markets.” Journal of Political Economy 99(5): 977-1009.

Reinganum, Jennifer F. 1979. “A simple model of equilibrium price dispersion.” Journal of Political Economy 87(4): 851-858.

Tirole, Jean. 1988. The Theory of Industrial Organization. Cambridge, MA: MIT Press.