Nation of Beancounters

Threatening to wallop every single person who comes along won’t help Wal-Mart one bit

Posted in Uncategorized by Navin Kumar on October 23, 2012

UPDATE: Okay, this is NOT my strongest post. It lacks rigour-of-thought and clarity of writing. I wrote it at 2 am and at some point I think I nearly became rude. I apologize to Adi if I have. Please read this post instead.

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I’ve said before that FDI in retail won’t lead to monopolization and underscored the importance of free entry. My friend and former roommate Aditya disagrees with me. He says:

my friend wants me to believe that a small kirana store owner who has been kicked out of business and forced to take up another vocation(possibly at a much lower income) will drop whatever he is doing and somehow get the initial capital and procure the product(assuming he would be able to, given his small scale of procurement) and then set up a store…

…Lets assume there is free entry that once the prices are raised the small retailer comes back, Walmart will drop prices to drive him out. The prior knowledge that the small retailer has, that if he tries to enter the market, he will be forced out, will act as a credible threat, thus no small retailer will ever enter as long as this threat exists.

The kirana-owner returning to his business was a metaphor; in reality anyone can compete with WalMart, provided it has set it’s prices high enough, including a duo of economics graduates. So I propose this to Adi: if WalMart does indeed drive all the Kirana store out of business and drive the price of toothpaste to double what it is, he and I can pool in our savings, buy Colgate wholesale from P&G and set up a stand near a railway station (I’ll pay the hafta). If WalMart, frightened by these uncouth revolutionary youths (we’ll wear Che t-shirts), lowers it’s price to below ours, I’ll buy you out and pay you a 15% profit. If WalMart doesn’t, the profits we make by undermining WalMart will be a good deal more than 15%.

Less facetiously, prices are at least mildly rigid. You ask why we’d enter if WalMart will discover us and cut its prices immediately and drive us out? I reply that WalMart won’t discover us and cut its price immediately. By the time it realizes what we’re up to, we’ll have sold out for a tidy profit and heading back to the warehouse for more. Sooner or later WalMart will have dropped it’s price to below ours and we’ll have to pack up and go home but the profits we earn in the interim will more than cover that slow day. And when Sam Walton raises his prices again, we’ll just pull the cartons of toothpaste out from under my bed, take it to the station and start flogging it again. We’ll be rich!

Low barriers to entry means that it costs me nothing to “set up a store”. More broadly,  how can WalMart enjoy months of uninterrupted supernormal profits if it has to engage in a price war with every Tom, Dick and Harry that comes along? Most models of predation involve one firm and one entrant, not one firm and several thousand heterogeneous agents. Just tweak the above model so that once WalMart sets a price, it is committed to that price for at least a day. Adi can then walk in, observe the price and decide whether to take that carton of toothpaste he has tucked under my bed to the Dadar or not. The only scenario that he isn’t going to is the one where WalMart has set the price so low that it isn’t worth his time. That’s a good outcome, no? The game theoretic model that Adi uses is fragile: any number of small tweak would cause its conclusion to be invalid.

Incidentally, I’ve seen everything from books to deodorants to watches to vegetables being sold on a railway platform, so I’m not spinning an idle yarn here.

Question: This idea – threatening to cut prices the moment someone steps on your turf – is hardly one that can be only be implemented in India. WalMart and it’s like are present in dozens of countries. Where has it followed this practice successfully? Even in the US all reports claim that it delivers on it’s promise of “low prices every day”; complaints are usually regarding it’s impact on Mom & Pop stores, an impact no different from technological progress.

It is true that unemployment has always fallen, but this does not mean all the people displaced by all the policies implemented in the last two decades are better off. Whenever people have been displaced they have been pushed to the marginal unorganized sector, the proportion of the unorganized sector in total employment of the labour force has been rising.

And yet poverty is declining like never before, which suggests that shifting labour from the organised sector, where it enjoys productivity- and investment- destroying levels of protection to the unorganised sector may actually help the poor who were previously locked out of manufacturing jobs by labour unions.

More broadly, high growth has been very beneficial to the poor and high growth is based on reforms that eliminate inefficiency.

(Also, WalMart would come under the formal sector while the current system is in the informal sector – so what is there to complain about?)

Let me conclude by scolding Aditya, who I fear has fallen into bad intellectual habits. No-one has “infallible trust in the market mechanism” and no-one is “treating it as sacrosanct” – the argument was merely that retail markets have low barriers to entry.  And no-one is “sticking to textbook neo-classical economics”. Free entry is hardly a neoclassical concept and you don’t need to subscribe to it in order to see that barriers to entry are low in this sector. Although he’s been much politer than is the norm, this is an instance of attacking strawmen and using pejoratives which he no doubt did not intend to do, but which he should watch out for in the future

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  1. […] earlier wrote an uncharacteristically narrative post in which I attempted to counter his  model with temporary price rigidity. But this is […]


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