A while back, I was having an argument with a friend over how Walmart sells products cheaper than its competitors. Someone had told him that the quality of Tide that you buy from Kroger is better than what you'd buy from Walmart. I tried to convince him unsuccessfully, that something like this is impossible since companies like Consumer Reports thrive on this kind of news. If this was true, then somebody would have tested the difference in quality and reported it long ago. Besides, a company size of Walmart cannot tolerate that one of its supplier would give it an inferior product, because it will literally bring down the whole business. Imagine if you find out that the Tide you are getting from Walmart is lower quality. Are you going to buy Tropicana from Walmart anymore? How about M&M's? Doritos? Gillete shaving foam? Over the counter medicine? At the end of the day, it's not only Tide that's cheaper at Walmart but pretty much everything. Although, I have seen lately that Meijers and Target are catching up (competition always catches up) and for most of the similar items you can get prices similar to what you would pay at Walmart.
That being said how is it that Walmart is able to get lower costs from its suppliers. If you are running a small grocery store in your neighborhood (aka mom and pop store) then your cost of Tide or other products sold at Walmart is probably close to Walmart's prices. A simple answer that everyone knows is that this happens because of huge buying power that comes from buying in bulk quantitites. When Walmart buys products from its suppliers, it reduces bulk of their shipping and handling costs, thereby reducing the cost of product for Walmart. But what else happens? There is something called search cost which is the cost of finding a buyer. I'll try to explain here what search cost is and how it affects the price you pay at the counter.
Imagine you are a farmer who grows corn. Now you have a harvest season and you started harvesting corn. You have ten thousand bushels of corn to sell (in real world its a lot more). Also assume that there are no commodity markets. Now you started selling your corn right outside your farm. You have distributed flyers in your neighborhood and people you know and posted flyers around the city that you are selling corn at $5 a bushel. Some customer came and bought two bushels. Another bought five and another one and so on. You estimate that at this speed you will sell your corn in 4 months. During this four month you will accrue storage cost and your money will be tied up in that corn on which you can start earning interest (assuming you invest your savings) if you can get that cash today. Let's assume that a buyer stops by at your farm one day and offers to buy all remaining 8000 bushels of corn. But he says he is not going to pay you $5. Instead he will offer $3 per bushel and starting next year he will buy all your harvest.So you don't have to spend your money searching for a buyer. This reduces your search cost significantly. It will get you your money early, some of which you can use to buy bonds and earn interest. Commodity markets play the role of this person. A farmer does not decide the price of corn. He just takes his corn to the market and he has to take whatever the price is offered at the market, or he can just take his corn back. These markets are called price taker markets. These markets reduce his search cost significantly, however the price he is offered is not the same anymore.
This is exactly what happens when P&G sells its Tide to Walmart. Walmart has reduced P&G's cost of selling Tide. It has reduced the cost associated with finding a buyer. Yes P&G still has to market the product and run ad's on TV. But it has to do that even when Kroger or other mom and pop stores are selling it. But Walmart has reduced the cost of distribuing the product. Through Walmart, P&G can reach millions of customers. In the absence of Walmart, P&G will have to spend a significant amount of money to be able to reach all these customers and that will be reflected in the price you pay at the counter. So why can't P&G sell Tide to Kroger at the same price as Walmart? Well, first of all Kroger does not reduce the search cost for P&G as Walmart. And we don't know if Kroger is getting the same deal as Walmart. May be it is getting the same deal as Walmart but it may have other overheads that are higher than Walmart which increases the cost for you when you buy products from Kroger. May be you get better service at Kroger than Walmart which is reflected in higher prices than Walmart.
Search cost is one of the main reasons why we are able to buy cheap products at Walmart. Internet has redcued our search cost. Imagine what you'd have to do if there was no craigslist, no product reviews, no ebay and no amazon and of course no Google. By reducing our search cost, Internet has reduced the over all cost of the products for us. We can compare prices and reviews for products and services by just typing few words on Google. Imagine what you'd have to do for similar information if there was no Internet.
I don't need to give more examples but search cost is significant and it has a huge affect on the prices we pay. If a particular retailer can figure out a way to reduce search cost then it doesn't mean that the product he is selling with same labels is inferior.
That being said how is it that Walmart is able to get lower costs from its suppliers. If you are running a small grocery store in your neighborhood (aka mom and pop store) then your cost of Tide or other products sold at Walmart is probably close to Walmart's prices. A simple answer that everyone knows is that this happens because of huge buying power that comes from buying in bulk quantitites. When Walmart buys products from its suppliers, it reduces bulk of their shipping and handling costs, thereby reducing the cost of product for Walmart. But what else happens? There is something called search cost which is the cost of finding a buyer. I'll try to explain here what search cost is and how it affects the price you pay at the counter.
Imagine you are a farmer who grows corn. Now you have a harvest season and you started harvesting corn. You have ten thousand bushels of corn to sell (in real world its a lot more). Also assume that there are no commodity markets. Now you started selling your corn right outside your farm. You have distributed flyers in your neighborhood and people you know and posted flyers around the city that you are selling corn at $5 a bushel. Some customer came and bought two bushels. Another bought five and another one and so on. You estimate that at this speed you will sell your corn in 4 months. During this four month you will accrue storage cost and your money will be tied up in that corn on which you can start earning interest (assuming you invest your savings) if you can get that cash today. Let's assume that a buyer stops by at your farm one day and offers to buy all remaining 8000 bushels of corn. But he says he is not going to pay you $5. Instead he will offer $3 per bushel and starting next year he will buy all your harvest.So you don't have to spend your money searching for a buyer. This reduces your search cost significantly. It will get you your money early, some of which you can use to buy bonds and earn interest. Commodity markets play the role of this person. A farmer does not decide the price of corn. He just takes his corn to the market and he has to take whatever the price is offered at the market, or he can just take his corn back. These markets are called price taker markets. These markets reduce his search cost significantly, however the price he is offered is not the same anymore.
This is exactly what happens when P&G sells its Tide to Walmart. Walmart has reduced P&G's cost of selling Tide. It has reduced the cost associated with finding a buyer. Yes P&G still has to market the product and run ad's on TV. But it has to do that even when Kroger or other mom and pop stores are selling it. But Walmart has reduced the cost of distribuing the product. Through Walmart, P&G can reach millions of customers. In the absence of Walmart, P&G will have to spend a significant amount of money to be able to reach all these customers and that will be reflected in the price you pay at the counter. So why can't P&G sell Tide to Kroger at the same price as Walmart? Well, first of all Kroger does not reduce the search cost for P&G as Walmart. And we don't know if Kroger is getting the same deal as Walmart. May be it is getting the same deal as Walmart but it may have other overheads that are higher than Walmart which increases the cost for you when you buy products from Kroger. May be you get better service at Kroger than Walmart which is reflected in higher prices than Walmart.
Search cost is one of the main reasons why we are able to buy cheap products at Walmart. Internet has redcued our search cost. Imagine what you'd have to do if there was no craigslist, no product reviews, no ebay and no amazon and of course no Google. By reducing our search cost, Internet has reduced the over all cost of the products for us. We can compare prices and reviews for products and services by just typing few words on Google. Imagine what you'd have to do for similar information if there was no Internet.
I don't need to give more examples but search cost is significant and it has a huge affect on the prices we pay. If a particular retailer can figure out a way to reduce search cost then it doesn't mean that the product he is selling with same labels is inferior.
