Retailer Price Competition and Assortment Differentiation: Evidence from Entry Lotteries

Abstract

This paper studies the relationship between the degree of local competition and retail markups as well as retailer product selection decisions. We leverage a unique circumstance in the context of the legalized cannabis industry in Washington, where a lottery system to allocate licenses to retailers generated random variation in local competition. This natural experiment helps address the endogeneity issues commonly encountered in causal analyses of competitive effects. Additionally, our access to detailed retail and wholesale pricing enables the direct assessment of markups, a measure often unavailable to researchers. The analyses yield three key findings: first, an increase in the number of nearby competitors is associated with lower retailer markups, although the marginal effect decreases as competition intensifies. Second, retailers respond to greater competition by differentiating their assortments. Third, this differentiation strategy helps mitigate the intensity of price competition among retailers.

Keywords: Retail competition, markups, firm differentiation, product variety, legal marijuana