Wal-Mart is a company that polarises. While there is much to be said about the low prices and extensive selection Wal-Mart offers its customers, its business model can be controversial (LA Times 2011). The US Supreme court has just heard a major sex discrimination lawsuit against the firm, and Wal-Mart is frequently in the news for its anti-union policies, its use of “sweatshop” suppliers abroad, and its impact on smaller retailers. Such controversies are not limited to the United States. In Mexico, Wal-Mart’s plans to open a store in Teotihuacan, an important historical location and a sacred Aztec site, drew massive criticism. And yet consumers kept coming.
Today Wal-Mart is one of the largest companies in Mexico, and its influence extends far beyond the retail sector. As we discuss below and show in more detail in our recent study (Iacovone et al 2011), Wal-Mart has had a polarising effect on Mexican suppliers of consumer goods, enabling strong firms to flourish while squeezing the profits of others.1
Mexico’s liberalisation and the arrival of Wal-Mart
Wal-Mart’s entry into Mexico was a response to several forces.
- First, beginning in the mid-1980s, Mexico systematically dismantled its barriers to trade and relaxed restrictions on foreign investment. This dramatic shift away from populist, inward-looking policies was locked in place when the country joined the General Agreement on Tariffs and Trade (GATT) in 1986 and signed the North American Free Trade Agreement (NAFTA) in 1994.
- Second, over the same period, Mexico’s population of 100 million people grew increasingly affluent, driving up demand for consumer goods. Enticed by these developments, and by the proximity of these consumers to the United States, Wal-Mart entered Mexico in 1991 by investing in a joint venture with an important Mexican retailer, Aurrera. A period of explosive growth followed. In 1997 Wal-Mart took majority control of Aurrera and became Wal-Mart de Mexico (henceforth Wal-Mex). By 2001 it controlled nearly half of the Mexican retail market, and by 2003 Wal-Mex became Mexico’s largest private employer.
The Wal-Mart system in action…
The entry of Wal-Mex has profoundly changed the Mexican retail sector and its supplying industries. Practices introduced by the retailing giant include centralised distribution systems, the use of standardised pallets, rigorous delivery schedules, and computerised tracking, which allows suppliers to obtain real-time information on sales and inventories at the level of individual stores. These innovations, together with Wal-Mex’s scale, have reduced distribution costs and enabled local suppliers to reach a national customer base – either under their own brands or as producers of Wal-Mex store brands. In exchange for these benefits, Wal-Mex has asked for, and given its size, typically received, exceptionally low wholesale prices from its suppliers. In fact, according to the Mexican manufacturing firms interviewed, Wal-Mex routinely demands price reductions from suppliers that do not come up with a product innovation in a given year.2
… and its effect on suppliers
In essence, selling through Wal-Mex allows Mexican suppliers to reach a larger market without having to make investments in distribution and logistics on their own. But this scale effect is traded off against lower quality-adjusted prices and the need to continually innovate. Thus the option of retailing through Wal-Mex affects not only the volume of sales but also the incentives of producers to engage in innovation and investments.
Not all suppliers benefit from the Wal-Mex option. According to the firms we interviewed, only relatively strong performers can achieve sufficiently large sales to break even at the retail prices dictated by Wal-Mex while investing enough in innovation to avoid further price cuts.
In Iacovone et al (2011) we develop a dynamic industry model which formalises this impact of the entry of Wal-Mex on upstream suppliers. The model is characterised by heterogeneous firms – some selling products with higher intrinsic appeal than others. Firms choose in every period whether to sell through Wal-Mex or through traditional retailers, where choosing Wal-Mex implies larger sales through national distribution but a quality-dependent ceiling on price. The suppliers also choose how much to invest in product-enhancing innovation, and whether to stay in the market or not. The arrival of Wal-Mex can therefore influence entry and exit decisions, shift market shares across firms, and change firm characteristics themselves by affecting patterns of investment. Simulations of the model suggest that Wal-Mart’s entry into Mexico might have had a major impact on upstream supplying industries as they self-select into one of two groups, those firms that retail through Wal-Mex versus those that choose not to do so, and that sales, investment, and productivity of the former go up while those of the latter go down relative to the no-Wal-Mex scenario.
Figure 1. Innovation and product appeal
Figure 1 shows the optimal innovation rates of firms with different levels of product appeal for a particular parameterisation of our model. The green line corresponds to the market equilibrium when firms have the option to reach consumers through Wal-Mex, provided they meet Wal-Mex’s pricing conditions. The blue line represents equilibrium in the absence of a Wal-Mex option. Note that firms with higher product appeal innovate at a higher rate, regardless of whether the Wal-Mex option is available. But the arrival of Wal-Mex lowers innovation rates among low-appeal firms while increasing these rates at the upper end of the appeal distribution. Further, some low-appeal firms drop out of the market altogether. These adjustments occur both because Wal-Mex allows high-appeal firms to gain market share, and because, given market shares, lower price-cost mark-ups reduce the incentive to innovate for Schumpeterian reasons. In short, the arrival of Wal-Mex sharpens the difference in firms’ static and dynamic choices, which is the key message emerging from the firm interviews we conducted.
To see whether these predictions are borne out for Mexican suppliers in general, we employ plant-level data from the Mexican Institute of Statistics (INEGI) covering 85% of Mexican manufacturing output. Using a differences-in-differences approach, we exploit the geographical patterns of Wal-Mex’ expansion as well as the fact that only some suppliers produce the types of processed food and consumers goods that are potentially carried by Wal-Mex. This analysis provides more support for our argument.
Figure 2. Supplier responses to Wal-Mex
Figure 2 plots the supplier responses to Wal-Mex in terms of sales, R&D, and total factor productivity. The horizontal axis measures the product appeal of firms (proxied by the firm’s initial sales), which is increasing from left to right. The striking pattern of Figure 2 is that weak firms – in Quartile 1 – reduce not only their sales but also their R&D whereas strong firms, in the fourth quartile, increase their sales and their R&D.3 As a consequence, the productivity of weak firms declines while strong firms exhibit higher productivity as a result of Wal-Mex entry. Overall, our micro data results provide support for the adjustments predicted by the model. Wal-Mex has sharpened the difference between weak and strong firms for Mexican manufacturing as a whole.
Wal-Mart’s entry into Mexico has had a polarising effect on the Mexican manufacturing sector. Wal-Mex was beneficial to some but detrimental to other Mexican producers. This may not be so surprising after all: the structural changes brought about by intensified competition typically involve winners and losers, and Wal-Mex has simply been acting as an agent of structural change in Mexico. Our analysis indicates that trade and foreign direct investment deregulation might have important effects that are transmitted through the vertical structure of production.
Bustos, P (2011), "Trade Liberalisation, Exports, and Technology Upgrading: Evidence on the Impact of MERCOSUR on Argentinian Firms”, American Economic Review, 101(1):304-340.
Iacovone, L, B Javorcik, W Keller, and J Tybout (2011), “Supplier Responses to Wal-Mart’s Invasion of Mexico”, NBER Working Paper No. 17204.
Javorcik, B, W Keller, and J Tybout (2008), “Openness and Industrial Response in a Wal-Mart World: A Case Study of Mexican Soaps, Detergents and Surfactant Producers”, World Economy, 31(12):1558-1580.
LA Times (2011), “Residents fighting against Wal-Mart store in Burbank”, Los Angeles Times, 14 August.
Lileeva, A, and D Trefler (2010), “Improved Access to Foreign Markets Raises Plant-Level Productivity … for Some Plants”, Quarterly Journal of Economics, 125(3):1051-1099.
1 Our conclusions are in line with other recent work showing that policy changes in the presence of heterogeneous firms are likely to trigger heterogeneous responses (Lileeva and Trefler 2010, Bustos 2011).
2 Based on firm interviews conducted in Mexico and summarised in Iacovone et al. (2011) and especially in Javorcik et al.(2008). Research support from the World Bank is gratefully acknowledged.
3 Figure 2 shows normalised coefficients on an interaction term that isolates the effects of Wal-Mex ‘s regional presence on local producers of food and consumer goods of the type Wal-Mex carries. Characteristics of the regional economy are controlled for, and Wal-Mex’s presence is treated as endogenous. See Iacovone et al. (2011) for further details.