EC 970FINAL PRESENTATION

DISCOUNT RETAILER RIVALRY IN KOREA:

WHY THE WORLD’S LEADING SUPERMARKET LOST TO A

KOREAN DOMESTIC WHOLESALER

Eric Beck

April 28, 2009

QUICK OVERVIEW

During its international expansion, Wal-Mart entered South Korea with expectation to dominate its discount retailer market

However, Wal-Mart loses against its primary rival E-Mart and it soon exits the market after incurring millions of dollars in loss.

This paper takes a game theoretic approach to explain why the world’s leading supermarket failed to compete with a relatively small domestic wholesaler.

QUESTIONS TO CONSIDER:

What allows a multinational corporation to capture a foreign market when it enters and competes against the already established domestic firm?

In a free market, does the guarantee of low price necessarily attract more consumers, hence more profitable business overall?

BACKGROUND – UNDERSTANDING THE DUOPOLY

Distinctive characteristics of the Korean retailer market Describe how its consumers are strikingly

different from the consumers in the United States

Strategies Wal-Mart implemented to attain its leader position in the U.S. market Whether or not Wal-Mart used similar strategies

in the Korean market Comparison of Wal-Mart’s marketing strategy

to that of already established domestic wholesaler, E-Mart.

DEMANDS OF SOUTH KOREAN CONSUMERS AND AMERICAN CONSUMERS Value Difference

Korean: Frequent visits to the supermarket for fresh food products.

US: Willing to compromise quality for low price. Proximity Factor

Korean: Prefers to walk to the store. (small quantity)

US: Drives in their large vehicles to shop large quantity.

Types of Products Korean: Fresh food purchases, beverages, and

other daily use items. US: Food products to electronics and clothing.

IMPLEMENTING THE “WAL-MART WAY” IN E-MART’S TERRITORY Wal-Mart: the “American” Way

“Every Day Low Price” (high quantity at low price) Strategy of smaller city store build-up in the United

States All Types of Products Sold

(Food products to electronics and clothing) E-Mart: the Local Way

More Fresh Produce and Seafood Launched stores in the most populated areas

beginning in the early 1990s Stores designed after conventional department

stores rather than warehouses*** Wal-Mart, despite being the largest retailer in the

world by its sheer revenue and size, has entered the Korean market at a heavily disadvantaged position against its primary rival, E-Mart.

PRICE COMPETITION WITH DIFFERENTIATED GOODS Model Simplification:

A total of 5 firms in the competition but focuses on two primary rivals.

Consumer’s unique preferences are measured by a single variable, D.

Think of Bertrand’s Duopoly However, the products are no longer perfect

substitutes

UNDERSTANDING THE MODEL Assumptions:

Firms, Wal-Mart and E-Mart, are situated at either end of a line segment of length 1

Potential customers uniformly distributed along the line.

Each customer is then at a position X: meaning X distance from Wal-Mart and (1–X) distance from E-Mart

Customer at position X on the line buys: From Wal-Mart if: Pw + D(X)2 < PE + D(1–X)2

From E-Mart if Pw + D(X)2 > PE + D(1–X)2

D measures the level of product differentiation between the two firms

D x (distance)2 term simply measures the degree of inconvenience for a consumer to purchase a product that is away from his most desired point

BEST RESPONSE FUNCTIONS AND THE N.E.

Wal-Mart’s best response to E-Mart’s price:

PW* = BRW(PE) = (PE + D + c) /

2 E-Mart’s best response to Wal-Mart’s price:

PE* = BRE(PW) = (PW + D + c) /

2 Nash Equilibrium:

NE ∈ [D + c, D + c]

THE GRAPH OF WAL-MART AND E-MART’S BEST RESPONSE FUNCTIONS

C – T

C – T

D + C

3D + C

3D + C

2D + C

C

C

D + C 2D + C

PE

PW

Red: Wal-Mart’s best response to PE

Blue: E-Mart’s best response to PW

NE ∈ [D + c, D + c]

IMPLICATIONS

In repeated games, the price of both firms should reach the stable equilibrium at NE

Wal-Mart’s “Every Day Low Price” guarantee led the firm to set its price far below the NE Pi = (c + ε) is optimal in Bertrand’s duopoly (US

market) Pi = (c + D) is optimal with product differentiation

(Korea) Wal-Mart should have localized to meet the

unique demands of the Korean consumers Selling smaller quantity of higher quality products

at higher prices – Increase PW while decreasing D

QUANTITY COMPETITION WITH PERFECT SUBSTITUTES

Wal-Mart began to make changes to its business strategy Merchandising, packaging, and store expansion. Gradually diminishing the product differentiation.

Quantity competition is more realistic as prices of these firms are already close to c Further price competition is undesirable. As the incumbent of the competition, E-Mart is

the “Stackelberg leader” and makes the first move.

STACKELBERG’S DUOPOLY

Price and Profit Functions: PW = a – b [QW+QE]

πW = [PW – c] x QW

PE = a – b [QE+QW]

πE = [PE – c] x QE

Optimal Level of Quantity Produced: Using Backwards Induction QE* = (a – c) / (2b)

QW* = (a – c) / (4b)

NE ∈ [(a – c) / (2b), (a – c) / (4b)]

IMPLICATIONS

Based on this model, E-Mart captures two-thirds of the market In Cournot’s duopoly, it would have captured

only half of the total market share. E-Mart forced Wal-Mart to reduce its own

production, or limit its opening of new stores How? Credible Threats In 2003, E-Mart = 53, Wal-Mart = 15 In 2006, E-Mart = 102, Wal-Mart = 16* First-Mover Advantage

WEAKNESS

Simplicity of the model In price competition, parameter D is rather

vague In quantity competition, the price functions

should be more inelastic to the changes in the quantity produced Because these firms are not manufacturers, but

rather wholesalers. Increase in quantity does not necessarily mean

lower price

CONCLUSION

Wal-Mart should have foregone EDLP to actually earn more profit.

The challenger, Wal-Mart, should not have easily given up the “leader” position.

Planning for the future: Demand of a typical Korean consumer is

relatively price inelastic – lower cost does not necessarily win over the consumers

Rapidly open up new branches to secure market share.