Walmart Merger - Case Study Example

Walmart Merger WALMART MERGER For a couple of decades now, Wal-Mart has been characterized as being the leader, the dominant firm and the Big One Retail Company, all relatively smaller firms look up to. The main reasons behind this are multifarious, with the consumers benefitting the most among them. This paper attempts to focus and analyze the impact of the merger of the smaller firms in the Retail Industry, with the Major leader – Wal-Mart. The effects of the merger on consumers, other retail companies and on society are presented, with the major attention on Wal-Mart, its emergence as a threat, and the profits, consumers gain from it. The paper has been divided into two main parts: the first part mainly dealing with the Retail Industry, the major players, their production schemes, and their impact on the consumers and society overall. The second part deals with the advantages and disadvantages the firms might have because of the merger. PART I: INTRODUCTION Oligopoly is characterized as consisting of a small number of large sellers, being called the ‘Competitive Fringe’, with a few big firms dominating the entire industry’s production (Lipsey, 2004). These big firms, act as the trend-setters in terms of price and output, and are a major reflection of the entire Market. In this instance, the Retail market, is characterized by one big firm – Wal-Mart, with smaller firms either adhering to an acquisition or a merger, for their benefit. For example, in the United Kingdom, the Big Five Banks – Barclays, Lloyds TSB, Royal Bank of Scotland, HSBC and HBOS - dominate the Banking Sector. Similarly, there are many small departmental stores, selling retail products, but a dominant few, like Sainsbury, Asda and Tesco, taking over the entire nation. The small firms, then, sometimes, find it profitable to merge, consolidate, co-operate or be purchased by the Big One. SALES, OPERATIONS AND FIRMS IN THE MERGER According to Forbes Global 2000 list, Wal-Mart is the world’s 18th largest public corporation, and the world’s largest corporation when it comes to annual revenue ($421.849 billion), with its international operations accounting for 26.1 % of its total sales, and a gross profit margin of 24.7%, running chains of discounted departmental stores and warehouse stores. With a total of 8500 stores in 15 different countries, with 55 different names, Wal-Mart extends its operations in nine different retail formats, including general merchandise, food and drugs, Super Center, small markets, cash and carry stores, membership warehouse clubs, apparel stores, discount stores and restaurants (Holdings, 2011). VERTICAL INTEGRATION: REASONS TO CONSOLIDATE A lot of consolidation has been seen among retailers and retails chains, over the past couple of decades, with 40,788 mergers & acquisitions having been announced only between 1988 and 2010. The main reasons behind the consolidation of firms in the industry may be due to: 1. Economies of Scale: This refers to a significant decrease in the fixed cost of the merging firms by the removal of duplicate or extensive operations; 2. Economies of Scope: Economies of scope exist due to the alteration of method of the distribution and the marketing of products. For instance, two homogeneous products may have been advertised in a similar way previously, but now they are not; 3. Vertical Integration: This primarily means the merging of two or more firms from the same industry results in increasing profits and a larger consumer surplus than before, implying a decrease in the deadweight loss. This is done by the firms deciding on a particular amount of output, and then sticking to that output level; 4. Investment benefits: The merged firms have higher chances of receiving greater benefits when it comes to Investment, because of the name of the big firm attached to it. Sensing financial stability, the smaller firms, once a part of the big firm, are viewed as being stable, and thus attract a larger number of investors. There are many other reasons due to which firms might want to collude or merge with other firms. These refer to the social and economic impact the merger has on the a) political scenario and b) the social sector of the economy in general. For instance, in the case of Walmart-Massmart Merger (Lubin, 2011), the authorities will be able to create new jobs in South Africa, increase its exports, reduce prices, and provide customers with an increased access to their desired products, thus increasing financial stability in the Country. FIRMS IN THE INDUSTRY The Retail Industry is categorized by all the characteristics of an oligopoly, meaning that there exist a large number of small sellers. Some of the major names in this Industry include Tesco, The Home Depot, Target, Kmart and Sears. The difference in these firms can be judged from the size and extent of the operations of the one major firm: Wal-Mart. It is four times the size of The Home Depot, the second largest retailer in the United States, and twice the size of Target, Costco, and Sears (including Kmart) combined (Wilbert, 2006), implying that the company puts a certain amount of pressure on the Retail sector to act as the Dominant firm. SCALES OF PRODUCTION AND TECHNOLOGY The products Wal-Mart offers range in the general category of Retail products, utilizing no raw materials, since it does not manufacture goods. The scale of production is large, since it has to cater to the needs of a common man, but the best thing that keeps Wal-Mart going is its pricing strategy: it has the minimum price that is available in the world. Even more useful, is the technology of the Universal Bar code, and the Radio Frequency Identification Technology, Wal-Mart is supposed to be a pioneer of (Daniel, 2010). Wal-Mart merger takes place due to the increased incentives being offered to the smaller firms in the industry, in the form of logistics expenses, inventory management, and improvements in the Supply chain. COMPETITIVE ENVIRONMENT WITHIN THE INDUSTRY In 2004, had Wal-Mart been a country, it would have China’s 8th largest trade partner, with a GDP larger than 75 % of all the countries in the world. With these figures, Wal-Mart has given a tough competition to other firms in the Retail industry, triggering changes in the structure of the firms. (Basker, Klimek, Hoang Van, 2008). This same competition motivates the firms towards growth, and constant improvements in the retail sector, with an upward trend in productivity and the rate of innovation. The competitive environment within the industry is very unique, with the main competition coming to Wal-Mart from general merchandise, warehouse and supermarket retailers competing with it both, at a national and international level, in the form of pricing, location, technology and innovation. Characterized by economies of scale, Wal-Mart is home to comparative advantage in terms of cost and general store layout. The chief competitors of Wal-Mart include Target and Kmart, Circuit Sity and Bed, Bath and Beyond, among others. The competitive benefits that Wal-Mart brings to its consumers include value and substandard exchanges amongst the commodities that individual consumers require. Wal-Mart merger, tends to highlight these very things in the industry, and drives the competition up, so that smaller firms, in order to at least be receptive to the output effect of an oligopoly, propose mergers with it. CONCENTRATION RATIO AND HERFINDAHL HERSCHLER INDEX 12.3, 17The concentration ratio is the measurement of the total production, by a set number of firms in the industry and basically gives the percentage of total market sales or the market share that is attributed to the largest firms in an industry. In the Retail Industry, Wal-Mart takes the lead in the four-firm concentration ratio (CR4), which measures the percent of total market sales accounted for by the top four firms in the market, as well as the eight-firm concentration ratio, measuring the total sales of the top eight firms in the market. The CR4 of the top four firms in the Retail Industry is 12.3 %, and the CR8 is 17.5 % (U.S. Census Bureau, 2010). These figures indicate, that the top leading firms in the retail industry, have a market share equivalent to 12.3 % (in the case of top four firms), and 17.5 % (in the case of top eight firms. The Herfindahl Herschler Index (HHI), which basically denotes the competition between the firms, in relation to their sizes in the industry, marks Wal-Mart as having a share of 72.51 % in the Market, clearly indicating a high level of competition. The HHI, unlike the CR4 and the CR8, indicates the allocation of the share of the top four firms in the industry, and simultaneously, gives the constitution of it outside the sphere of the top four firms. HHI is a useful technique for calculating the opportunity cost of any merger to take place, because, the firms, before the merger find their share to be a total of the summed squares of their individual market share [(a)2 + (b)2], while, after the merger, they can find their market share as a total of the summed squares of the market shares of their total products [a2 + 2ab + b2].Thus, a share of 72.51 %, by Wal-mart, would induce a smaller firm to have almost double the value of their individual market shares, since, Wal-Mart, being a very large firm, has the ability to effect the HHI significantly, as compared to a small firm. CONCLUSION The first part of this paper basically presents the setting of an oligopoly model, with Wal-Mart acting as the Dominant firm, as has been shown by the huge market share it possesses in the Retail Industry. As can be seen, Wal-Mart is a leading Retail firm, and firms want to consolidate with it for a better output and a better overall standing, otherwise they need to move their operations out of town. PART II: THE MERGER Merger refers to a consolidation between one or more firms, from either the same industry, with a homogeneous product, or between some firm, wanting to take up the manufacturing of other firms. There have been many mergers in the past, amongst different sectors of the economy, all with their positive and negative externalities. Mergers usually arise due to competition, which is able to either drive out some firms from the market to another location, or sometimes, is able to shut down the operations of certain firms. ARGUMENTS FOR THE MERGER The competition in the Retail industry has a beneficial impact on its consumers, through the implementation of low prices (Jamieson, 2011), which simultaneously results in the expansion of the company. Competition is an advantage to firms, since it enhances their ability to expand their operations, by driving the levels of innovation up. Similarly, competition is beneficial for consumers, in that, it enables them to become loyal to a certain brand or a seller of consumer goods. The benefits that the merger offers to society include an increased market share over the input suppliers (Lynn, 2006), as well as the workers in the company (Bonanno and Lopez, 2008). As has already been mentioned, the benefits to society from mergers are numerous, since eventually, it is the consumers who have to buy products. Extremely low-priced products act as an incentive for consumers, to broaden the customer base at any given retail outlet. Similarly, according to the Circular Flow diagram in economics, the consumers have chances of high employment, when firms merge into a consolidated unit. A high degree of market concentration leads to a close debate as to whether Wal-Mart is good overall for the society as a whole, or not. The main reasons for its proponents arguing for it include the fact that it provides its customer base with the lowest prices, and experts against it, to pin down the fact that it drives the other retailers out of the market. The impact Wal-Mart has on the other firms, extends beyond anything else. So much so, it was able to alter the distribution and the marketing of major companies like Coca-Cola and Pepsico (Frank, 2006). ARGUMENTS AGAINST THE MERGER Mergers are generally seen as being positive indicators for economies. However, they can prove to be disadvantageous for certain firms as well. For instance, competition can be considered as a threat to some smaller firms operating in the same business. In this case, let us take the example of Massmart. Massmart, a smaller firm as compared to Wal-Mart, is under threat of an acquisition by the same (Lubin, 2011). This is being seen as a threat by the South African Authorities, due to the fact that it would cut down profits to a great extent. Hence, mergers cause a disadvantage as well, to firms, since it eliminates the entities, which are unable to keep up with the changing innovation and technology. A merger can be a disadvantage to consumers for some reasons, the main ones being a clash of culture building up between consumers in a homogeneous product market. It could also be due to a conflict of objectives amongst the merging partners, and due to diseconomies of scale, meaning that the firms have expanded so much, that it is almost impossible to cater to its needs. OLIGOPOLY MARKET STRUCTURE: BENEFITS TO CONSUMERS AND FIRMS Wal-Mart, being the dominant firm in the Retail Industry, has the ability of influencing the market, the way any big-sized oligopoly would do: By using either the Output effect or the Price Effect. But, since the price effect becomes absent, due to the increasing number of sellers, the Oligopolistic firms act as a price taker, and simply operate under the principle of the Output effect (Mankiw, 2003). Allocative efficiency deteriorates when it comes to oligopolies, primarily due to the inability of the firms to be conducive to market signals for effective resource allocation. However, dynamic efficiency is somewhat achieved, due to the span of time these same firms have, to dedicate to research, gaining huge profits, and proving to be beneficial to the economy in the Long run. CONCLUSION The main arguments presented for and against the mergers, clearly indicate that if, on the one hand, a merger is not beneficial to the society, and it is however, a source of profits for the smaller firms who propose to merge in the first place. REFERENCES Bonanno, A. (2008) “An Empirical Investigation of Walmart’s expansion into food retailing”. University of Connecticut. Food marketing policy Center Research Report No. 105. Bonanno, A. 2009. Wal-Mart, Oligopsony Power and Entry: an Analysis of Local Labour Markets. July 2009. Basker. E,, S. Klimek and P. Hoang Van (2008) “Supersize It: The Growth of Retail Chains and the Rise of the “Big Box” Retail Format” University of Missouri Department of Economics Working Paper. Daniel, Fran (2010-09-29). "Head of Wal-Mart tells WFU audience of plans for growth over next 20 years". Winston-Salem Journal. Retrieved 2011-09-21. Frank, T.A. "A Brief History of Wal-Mart." The Washington Monthly. April 1, 2006. Retrieved July 24, 2011 Holdings. (2011) Retrieved September 22, 2011, from http://www.texglobe.com/content/2011-6/20116116552.html Jamieson, D. (2011). “Walmart in South Africa: Retail Giant may acquiesce to workers, suppliers”. Retrieved September 22, 2011, from http://www.huffingtonpost.com/2011/05/18/walmart-in-south-africa_n_863655.html Lipsey, R. & Chrystal, A. (2004) Economics. pp. 199 - 201 Lynn, B. C. 2006. “Breaking the Chain: The Antitrust Case Against Wal-Mart”. Harper’s Magazine. July 2006. 29-36. Available at www.harpers.org. Accessed 11/12/2007 Lubin, G. (2011). “ South Africa tells exactly why it is terrified of a Walmart-Massmart Merger”. Retrieved September 22, 2011, from http://www.businessinsider.com/south-africa-walmart-massmart-merger-terrified-2011-8 U.S. Census Bureau. (2010). Retail Trade: Subject Series – Estab & Firm size: Summary statistics by Concentration of Largest Firms for the United States: 2007. Retrieved September 23, 2011, from http://factfinder.census.gov/servlet/IBQTable?_bm=y&-ds_name=EC0744SSSZ6 Wilbert, C. (2006). “How Wal-Mart works”. Retrieved September 22, 2011, from http://money.howstuffworks.com/wal-mart1.htm Read More