Market Structure and Competition in the Retail Discount Industry

The views expressed here are those of the authors and do not necessarily reflect the views of the Board of Governors of the Federal Reserve System or its staff. We examine competition between the three major firms in the retail discount industry, Wal-Mart, Kmart and Target, using two distinct, but related, approaches. We first consider a model that examines the determinants of store presence for the three chains in local markets. For each local market, we assume that each chain chooses whether to operate a store and, if so, which store format. These decisions are based on the evaluation of underlying payoffs which depend on observable and unobservable market characteristics including the presence of competing firms. Notably, we allow for substantial asymmetries across firms in terms of their preferred characteristics and the impact of competition. Since each firm’s decision depends on the decisions of its rivals, the model involves a discrete game between the chains, the outcome of which determines the realized market structure. We use numerical techniques to characterize the equilibrium in each market and estimate the model by simulated maximum likelihood using data on market characteristics and structures for a cross-section of local markets. Hence, eve