Elsevier

Omega

Volume 39, Issue 3, June 2011, Pages 283-292
Omega

Efficiency determinants in retail stores: a Bayesian framework

https://doi.org/10.1016/j.omega.2010.07.005Get rights and content

Abstract

This paper analyzes the impact of vertical integration, age, geographic expansion, and low price strategy on the cost efficiency of retail stores. We test our hypotheses using the innovative Bayesian frontier methodology. The data involve a sample of Spanish retail stores that operate in a highly competitive and dynamic environment. From the results, it is clear that cost efficiency is higher for stores that have: longer years in business, stronger geographical presence, and lower price offerings. Vertical integration, on the other hand, is negatively related to efficiency. Further discussions of these findings and related managerial implications are provided in the paper.

Introduction

The level of competition in the retail industry has intensified in recent years, driven by several factors such as the decline in household wealth, rising unemployment, tight credit conditions, rapid globalization, unclear economic picture, drop in consumers’ confidence index, and increase in merger and acquisition activity. In fact, it is very common today to find several retail stores competing for a slice of market pie that rarely varies in size and often saturated. Consumers have also become extremely price conscious, especially as retailers constantly fight for each dollar by offering substitutable products at lower prices [1], [2]. Weekly specials including catalogues and additional marketing are also used intensely to attract consumers and drive sales. While the winner of this price war is the consumer, retailers have to survive with lower profit margin which necessitates a stricter control of productivity and a decrease of operational wastages, especially as the industry is traditionally known to be labour intensive.

In the retail literature, the need for higher productivity has also been highlighted as one of the key issues for future survival. Numerous studies have recently appeared, addressing the performance challenges of several retail markets, such as Portugal, the US, and France [1], [2], [3], [4]. The key message from most of these studies is that efficiency measurement is of vital concern at both the store level and the strategic level, since it helps retailers differentiate themselves from other competitors. Studies dealing with some store-specific characteristics that affect retail performance have also appeared in the literature.

Within the growing importance of performance measurements in retail, more advanced methodologies have also been introduced. In contrast to the traditional literature where simple ratios were the most adopted productivity methods, significant volume of work currently exists in the area of measuring production efficiency by estimating an “efficient frontier” that serves as a benchmark for evaluating performance. The most adopted methods for that purpose include the stochastic frontier (SF) and data envelopment analysis (DEA) methods [5], [6], [7], [8], [9]. The advantage of both these methods is that they allow the use of multiple inputs and outputs in the measurement of performance, making them thus more suitable in the retail context. Although the DEA method is a nonparametric, deterministic approach that defines a relationship between multiple spending inputs and outputs by building an efficient frontier, it has been critiqued for not providing fit statistics such as r-square or p-value that can be used for statistical inferences [10]. The SF method, on the other hand, uses a parametric approach by explicitly taking into account the stochastic properties of the data [1], [19].

The aim of this study is driven by all of the above, and the motivation is to extend the existing literature by offering more accurate insights into the performance determinants of retail stores. Specifically, the study focuses on analyzing on the supermarket industry, which is traditionally known to be very competitive. Most supermarkets operate on a high inventory turnover usually with low profit margins, which suggests that retail mark up for each individual product is very low. In most countries, supermarkets compete against national, regional, local and independent supermarkets, specialty food stores, club stores, drug stores, convenience stores, discount merchandisers, and other local retailers. They compete on the basis of price, store location, product mix or types of products and brands and services. The industry’s small mark up price format indicates that price is extremely significant. In other words, supermarkets rely on low mark up and high sales volumes as opposed to higher mark up and lower volume of sales. Is this context, efficiency analysis constitute a useful and interesting tool to improve the profitability of supermarket chains.

Most existing studies in the literature have generally focused on the estimation of efficiency without providing an in-depth analysis to the factors that lead to efficiency variations between retail stores. The sole focus on efficiency makes the study also limited to one sample or one geographic area of analysis. However, as this study focuses on identifying the sources of efficiency, the results can be more applicable to other retail sectors, or even to the same retail sector in other countries. The methodology used in this study also provides an innovation to the existing literature. For the first time, we use the Bayesian methodology that has several advantages over the maximum likelihood (ML) traditionally used to estimate the SF approach. For instance a key advantage of the Bayesian approach is that it allows the inclusion of “prior” information about parameters in inferences. With Bayesian, the results are also usually presented in terms of probability density function (pdfs), making it thus possible to make probability statements about the model parameters.

In testing our hypotheses we use a sample of Spanish retail supermarkets. There are several interesting characteristics of the Spanish retail market that allow us to test our desired hypotheses. In the next section we provide a brief overview of the Spanish retail market. This is followed by the literature review, methodology, data characteristics/hypotheses, discussions, and concluding remarks.

Section snippets

Contextual setting

In recent years, the Spanish supermarket industry has been characterized by a series of changes that have affected its structure and performance [11]. Among them, four critical factors deserve special attention.

First, the significant growth of self-service establishments in comparison to traditional stores [12]. Specifically, supermarket chains have become one of the main players in grocery retailing in almost every Spanish city [13] and, in recent years, have earned significant market shares

Literature review

There are two competing scientific methods to analyze efficiency: the stochastic frontier (SF) and the DEA. Several papers exist in the retailing literature using either of these methods or a combination of two. In Table 1, we summarize these papers presenting the models and the inputs and outputs used.

We can observe that most authors have used the DEA method and that there are only few papers using the econometric models. Sellers and Mas [19] estimated a production function of Spanish

Stochastic frontier: the Bayesian framework

The stochastic frontier model used in this study can be simply expressed asCit=g(xit,β)+vit+zit,(i=1,...,N;t=1,...,T)where Cit is the natural logarithm of total cost for retail store i at time t, xit a vector of exogenous variables,ga known functional form, β a vector of unknown parameters which define the deterministic part of the frontier technology, and vitand zit are two random terms, one is symmetric around zero and represents measurement noise, and the other is non-negative and capture

Data

The sample is taken from Spanish self-service retail establishments in the general grocery retail sector, with retail selling areas of between 400 and 2500 square meters (supermarkets). The estimation of efficiency requires homogeneous units, so in order to guarantee the consistency of the companies analyzed, hypermarkets were excluded, because the assortment and services provided to consumers are quite different from supermarkets.

During the period considered there were a series of mergers and

Results

We estimate the Bayesian frontier model2 in this study using data on 74 retail stores over T=7 years. The functional form of the model is a restricted translog and can be expressed as follows3

Discussion and conclusions

Growing competitiveness among retail companies and the globalization of markets have given rise to an economic environment in which it is becoming increasingly difficult for companies to survive. In today’s extremely competitive environment, consumers are more demanding than ever as they constantly seek immediate access to products at lower prices. In this context, the analysis of efficiency has become an important issue in the retail sector [62]. Efficiency favors intermediary management,

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