THE COEXISTENCE OF ORGANIZED AND UNORGANIZED RETAILING IN
EMERGING ECONOMIES
Grant proposal submitted to the Institute of Asian Consumer Insight
by
Kinshuk Jerath, S. Sajeesh, Z. John Zhang†
March 2012
Introduction and Problem Statement
The retailing sector contributes substantially to a country's gross domestic product (GDP). For example, an
estimated two-thirds of the United States GDP comes from retail consumption. The retailing landscape in
most developed countries is dominated in sales by organized retailing, characterized by supermarkets,
corporate-backed hypermarkets and retail chains, while in emerging economies the leading retailing format
is unorganized retailing, characterized by small neighborhood stores selling groceries (“mom and pop”
stores) and stalls selling fresh produces, typically run by individuals or small families.
The liberalization policies on foreign direct investments in developing economies coupled with huge
growth prospects has led retailing giants from developed economies, such as Wal-Mart and Carrefour, to
foray into emerging markets. In fact, since 1995 global retailers have entered more than 100 new markets
(A. T. Kearney 2006). The growth of organized retailing is changing the way the unorganized retailers are
competing in emerging economies. Organized retailers attenuate the role of location as a source of
enduring competitive advantage for unorganized retailers. But organized retail penetration seems to differ
substantially even among various emerging markets (McKinsey 2008). For example, the organized retail
penetration is about 36% in Brazil and 20% in China but only 15% in South Korea and 4% in India.
Unorganized retailers have also reacted differently in different countries. For example, in India, activists
along with local store owners have held numerous rallies to protest against entry by organized retailers
citing detrimental impact on unorganized retailers. In contrast, in China, the unorganized retailers have not
(or could not have) mounted persistent resistance to global retailers. In this research project, we aim to
conduct an in-depth study of the factors that drive the structure of retailing markets in emerging Asian
economies when unorganized and organized retailers coexist and interact, with specific focus on modeling
the differences in
the
consumer
purchasing
processes
at
these
two
types
of
retailers.
__________________________________________________________________________________
† Kinshuk Jerath is Assistant Professor of Marketing at the Tepper School of Business, Carnegie Mellon University (email:
kinshuk@cmu.edu). S. Sajeesh is Assistant Professor of Marketing at the Zicklin School of Business, Baruch College, City University of
New York (email: s.sajeesh@baruch.cuny.edu). Z. John Zhang is Murrel J. Ades Professor of Marketing at the Wharton School,
University of Pennsylvania (email: zjzhang@wharton.upenn.edu).
Organized and unorganized retailers serve consumers in very different ways, which need to be carefully
understood to develop insights into their coexistence in developing countries. Even in developing
countries, organized retailers operate large stores which are located further away on average (usually in
large shopping plazas), and each outlet serves several thousand households spread over a large area.
Customers typically make a few shopping trips per month, driving long distances, and purchase large
quantities of products at low prices which they store at home and consume over the next few weeks.
There is little personal interaction involved during purchasing and individual-level service is almost nonexistent. Purchasing from these stores involves various costs such as time-planning to visit the store, costs
of driving and parking, and other in-store costs. However, organized retailers often offer lower prices. In
contrast, a salient feature of the unorganized retailing environment is that family-run retailers operate on a
small scale, with each store serving only several hundred households that reside in the vicinity of the
store. The shopkeepers are closely familiar with the preferences of each household they serve and offer
highly personalized service; in turn, these households are regular customers of the neighborhood stores.
Due to budget and storage constraints, consumers purchase frequently and in small quantities (often
multiple times a week, as need arises for a product).
Under the coexistence of organized and unorganized retailers, a key trade-off for a consumer is purchasing
from a small neighborhood store multiple times as and when uncertain demand is realized, or incurring
larger transaction costs while making fewer trips and purchasing larger quantities from an organized
retailer. If a consumer purchases a larger quantity, she also runs the risk that she may not want the entire
purchase in the future because of uncertain demand, leading to either wastage or consumption with reduced
utility. In addition, factors such as better service at unorganized retailers and consumers’ ability (or
inability) to store products for future consumption also influence the choice of retailer and the quantity
purchased. These demand-side factors influence the market-entry and pricing decisions of both
unorganized and organized retailers. Most importantly, they determine how well unorganized and
organized retailers will fare and how consumer welfare is affected, which will ultimately frame and inform
policy debates in a country.
In addition to the above, the marketing strategies of retailers are also influenced by cost-side factors. More
specifically, the survival strategy of unorganized retailers will depend on nuances of the factors on the
demand as well as supply side. In a market with multiple unorganized retailers, each retailer serves a part
of the market and has to invest resources to maintain a store that has the capacity to serve all of its
clientele. Developing economies are characterized by high population density and scarcity of real estate
(especially in the urban areas where organized retailers are present). This makes it increasingly difficult
for a small, family-run unorganized retailer to set up and manage a larger store to serve more people. This
is because many of the recurrent costs of running a store, which act as fixed costs, are characterized by
quantity premia, i.e., increasing per-unit cost with increased consumption (e.g., real estate rents in
crowded urban areas and cost of electricity used).
Proposed Methodology and Expected Contributions
We construct a stylized mathematical model which captures the essential aspects of consumer behavior
in emerging markets. We assume that consumers and multiple unorganized retailers are spatially
distributed in a given geographical area. Each consumer considers purchasing from her nearest
unorganized retailer, but incurs a per-unit-distance disutility (or transportation cost) if this retailer is not
located at her ideal point. One organized retailer enters the market, and is located further away from the
nearest unorganized retailer for any consumer. When a consumer purchases from the organized retailer,
she incurs a constant and large disutility. This assumption reflects the fact that organized retailers have
stores located in a central shopping area, and visiting this store requires incurring costs associated with
advance planning, vehicular transportation, parking, and waiting in checkout lines. However, consumers
obtain lower prices at the organized retailer
To capture the phenomenon of bulk purchasing by consumers from the organized retailer, we consider a
two-period model for consumer demand. In Period 1, each consumer needs to consume exactly one unit of
the product. For Period 2, however, consumers are uncertain about their need, and a demand of one unit is
realized with some probability. Every consumer has to make a trip to a retail store to purchase the product
to be consumed in Period 1. For Period 2 consumption, she may make a second trip in Period 2 only if
demand is actually realized. On the other hand, to avoid travel costs in Period 2, she may purchase a
second unit for Period 2 consumption during her Period 1 trip (and risk letting this unit go to waste if need
doesn't arise subsequently). To reflect the reality in developing countries, we assume that only a fraction
of consumers in the market have the required storage/refrigeration capability and the budgetary capacity
to purchase in bulk; the remaining consumers do not have the ability to make bulk purchases and must
necessarily purchase as and when demand arises.
For an unorganized retailer, we assume that there are two costs: a constant marginal cost of goods sold,
and a fixed periodic cost (store rent, utility bills, payroll, etc.). The periodic cost increases with the market
coverage of the unorganized retailer since a store that serves a larger clientele has to be larger. We assume
that the fixed cost increases in a convex manner with the capacity of the store. This is an important and
careful assumption, invoked to model the fact that urban areas in emerging economies are heavily
congested and real-estate rental cost schedules and utility cost schedules are typically characterized by
quantity premia.
From this model, we investigate the factors that facilitate or hinder the growth of organized retailing in
emerging economies, and derive implications for the impact on market prices and the profitability of local
unorganized retailers. Our theoretical analysis will help us understand various substantive issues, such as:
1. What is the impact of organized retailing on unorganized retailers' profitability? Our model allows us to
understand the strategic incentives facing the organized retailer to enter a market as well as the strategic
incentives facing the unorganized retailers to resist entry. The conventional view is that the entry by the
organized retailer will lead to greater price competition. In contrast, our preliminary analysis suggests
that the entry by the organized retailer triggers the exit of a fraction of the unorganized retailers leading
to an increase in prices charged by the remaining unorganized retailers.
2. Why do organized retailers expand more rapidly in some emerging economies but less so in other
developing countries? Our objective in this research is to go beyond the usual explanation of countryspecific deregulation policies and look at the organized retailers’ strategic incentives to enter and
expand in a market based on factors such as differences in consumer characteristics, degree of retail
competition and infrastructure in the economy. Our preliminary results show that as the retail market
expands, unorganized retailers may gain a larger share in a growing market, while at the same time this
may not necessarily imply that organized retailers are not faring well. Note that this has been observed
in India (Kohli and Bhagwati 2012); this observation perplexed retail analysts and our model provides
an explanation.
3.
What actions can the unorganized retail sector as well as policy makers take to alleviate the possible
unfavorable impact of entry by organized retailers? Our model sheds light on the influence of
government policies on creating special economic zones for organized retail activities and the impact of
policies influencing growth of the retail sector on the coexistence of these two types of retail formats.
To empirically test our theoretical findings, we also plan to collect data (the specifics of which we will decide
based on our exact theoretical findings). Since the data required by us are unlikely to exist, we will have to
syndicate this data collection, which is an expensive and time-consuming task. At this time, we are considering
such data collection in India as well as China, and exploring avenues for the data collection.
References
•
A.T. Kearney Report. 2006. Selling the World on Modern Retail. Vol. IX (1) 63-66.
•
Kohli, Rajeev and Jagdish Bhagwati. 2012. Organized Retailing in India: Issues and Outlook. Working
paper, Columbia University.
•
McKinsey Global Institute 2008. India's urban awakening: building inclusive cities, sustaining economic
growth," April 2008.
THE COEXISTENCE OF ORGANIZED AND UNORGANIZED RETAILING
IN EMERGING ECONOMIES
Kinshuk Jerath, S. Sajeesh, Z. John Zhang
Update on the Research Project
1st Septemeber 2012
Our objective in this project has been to investigate factors that facilitate or hinder the growth of
organized retailing in emerging economies, and to examine how “local” unorganized retailers
can adapt to the changing retail environment. Over the past few months, we have constructed a
stylized mathematical model which captures the essential aspects of consumer behavior in
emerging markets and have written an initial draft of the paper. Our theoretical model provides a
number of interesting insights into the interplay between organized and unorganized retailing.
For instance, we find that when both types of retailing coexist and the retailing market grows, the
unorganized retailing sector may grow at a faster rate than the organized retailing sector (i.e.,
unorganized retailing will claim a larger share in a growing market). Furthermore, we find that as
a larger fraction of the population has the ability to purchase in bulk from the organized retailer
and store for future consumption, prices are higher not only at the organized retailer (which is
intuitive) but also at the unorganized retailers.
This research was presented at the INFORMS Marketing Science conference held at Boston
University in June 2012. In the next stage of the project, we propose to refine the findings of our
theoretical model to develop hypotheses for empirical testing using real-world data.