Ville Aalto-Setala

Two parallel concentration trends in grocery retailing have been discernible in all Western countries over recent decades. Firstly, grocery retailing has become more concentrated among stores as the size of establishments has grown and their numbers have decreased. Secondly, grocery retailing has also become more concentrated among firms: the combined market share of the three biggest grocery-retailing firms exceeds 50 percent in most West-European countries. Although nationwide concentration of grocery retailing in the U.S. is not high, the industry is highly concentrated at the local level as well.

The reason for these trends in concentration derives from the scale economies in grocery retailing. From the consumer's point of view, scale economies and concentration in retailing bring along benefits as well as costs. On one hand, scale economies enable low-cost distribution of products, but on the other hand, they may drive firms out of market and cause high mark-ups through lack of competition. High mark-ups are not only a problem of a concentrated market structure. At worst, the decreasing number of stores causes long shopping trips and fewer alternatives for purchasing daily necessities. The impact of scale economies and concentration on the welfare of consumers and the society as a whole, thus, is twofold. The nature of this tradeoff is especially important in grocery retailing because of its local competitive character.

Despite the presence of many empirical studies dealing with the relationship between concentration and price level in grocery retailing, these studies have only considered local concentration. This research examines both local and industry-wide concentration (which can be interpreted as a multimarket contact) among grocery retailers. Moreover, not only investigates price levels, but also the costs and the mark-ups of stores.

The data are drawn from grocery retailing in Finland with an individual store as the unit of observation. The Finnish grocery retailing industry is concentrated in the hands of four leading retailing firms. This makes the data ideal for an empirical analysis of the effects of concentration and market power.

The analysis shows that the size of the retail firm does not affect the costs of retail firm's stores. However, stores belonging to large retail firms take higher mark-ups than those of smaller competitors. Consequently, this results in higher prices than the smaller grocery firms. At the same time, the data also show that despite higher prices in stores of large retail firms than in those of small firms, large stores have lower prices than small stores, holding firm size constant. This is due to substantial store-level scale economies in grocery retailing. Hence, even though large stores have higher mark-ups than small stores, the reduction in costs is greater than the increase in the mark-ups.

From a policy perspective, the results show that there is no need to restrict the size of the stores to protect competition unless growth in store size serves to increase the market shares of the retail firms. At the same time, the data show that a high market share of a retail firm is detrimental to a competitive market. In other words, larger stores pass part of their lower costs to consumers as long as competitive setting among firms does not change. Market regulators (which often may be municipal governments) should, therefore, ensure that there are enough independent market participants in all local markets to ensure a competitive market structure. Further, the key result of the study showing the non-existence of firm-level scale economies, importantly suggests that the most important reason for mergers among grocery retailers is the desire to gain market power, not to achieve lower costs.