What Happens When Wal-Mart Comes to Town: An Empirical Analysis of the Discount Retailing Industry∗

In the past few decades multi-store retailers, especially those with a hundred or more stores, have experienced substantial growth. At the same time, there is widely reported public outcry over the impact of these chain stores on small retailers and local communities. This paper develops an empirical model to assess the impact of chain stores on the profitability and entry/exit decisions of small discount retailers and to quantify the size of the scale economies within a chain. The model has two key features. First, it allows for flexible competition patterns among all players. Second, for chains, it incorporates the scale economies that arise from operating multiple stores in nearby regions. In doing so, the model relaxes the commonly used assumption that entry in different markets is independent. The estimation exploits a unique data set that covers the discount retail industry from 1988 to 1997 and yields interesting results. First, Wal-Mart’s expansion from the late 1980s to the late 1990s explains about fifty to seventy percent of the net change in the number of small discount retailers. Failure to address the endogeneity of the firms’ entry decisions would result in underestimating this impact by fifty to sixty percent. Second, scale economies were important for both Kmart and Wal-Mart, but the magnitude did not grow proportionately with the chains’ sizes. Finally, direct government subsidies to either chains or small retailers are unlikely to be effective in increasing the number of firms or the level of employment.