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Exploring retail clusters

August 03, 2012


ENTER the Azam Cloth Market in Lahore and you find there are thousands, quite literally, of small shops selling very similar kinds of cloth.

Add the two other similar markets from the vicinity and you have some 15,000-odd shops, all selling similar products, sourced from similar suppliers.

Some of the other retail clusters in Lahore are not as big, but they are not organised differently: Urdu Bazaar for books/stationery, Hall Road for electronics, Hafeez Centre for mobiles. The traditional notion of a market was indeed of a central place where all suppliers and buyers would congregate and then prices would be set that would clear the market. And a lot of our mandis still work on the principle.

But the market for cloth, clothing, electronics and other durables, for which we have retail clusters as well, are not like the mandis for commodities. Yet retail clusters still thrive today. This raises interesting concerns and questions for our market development. Given that the new growth framework of the Planning Commission emphasises the growth of cities and commerce, the connections between the two are worth exploring.

When person number 501 or 5001 is thinking of opening a cloth shop, what makes the choice of locating it in a cluster more beneficial? More customers come to the cluster and so shops getting free advertising. There might be advantages in common sourcing or the sharing of inventories. Informal financial arrangements such as committees within markets also encourage within-cluster expansion. The disadvantage is being one shop in thousands.

A significant percentage of the new shops opened in clusters tend to be by people who have already had long-standing connections with the business and the cluster. Sons of a father who had a business open their own shops, or other relatives do, or it might be people who have apprenticed for many years at one of the shops. These people have strong connections with the market and also with the business. For them opening a shop in the cluster is definitely more advantageous than going for a standalone option or to a different cluster.

But this leads to another interesting question. Why do we have thousands of shops and not a few hundred much bigger ones? If bigger firms enjoy economies of scale through sourcing, inventory-management, storage and in raising capital, why do people still prefer to set up smaller shops, divide business inherited from their parents and rely mostly on sole proprietorship as the model for retail in these businesses? This seems to have a lot to do with the insecure property rights regime that we have in Pakistan. A number of retailers pointed out that they wanted to divide their business between their children in their lifetimes so that the children don’t fight over it after their demise. Some said that they decided to separate each son as the son got married and started his own family. Meanwhile, a number of younger people pointed out that though they had received their initial capital from the larger joint family, they had been given this funding to start their own independent business, in some cases even when the father or some brothers had similar businesses in the same market.

This seems to be a strange model for growth. But it could be driven by the lack of property rights that make it difficult to go into partnerships, as most of these businesses are not formal companies, or create other legally recognised structures for having joint ownership. This question is definitely worth exploring from a policy point of view.

With hundreds or thousands of shops retailing similar products/services, located in the same area, the search cost for customers trying to get better deals are low. This implies stiff competition. Do all these businesses only make zero profits? Does price get competed down to covering costs only in an effort to get customers in a competitive environment? Theoretically, it should: what could be a more competitive environment than hundreds of shops selling similar products in the same area?

Yet there must be positive returns to be made or we would not see expansion in these markets. How does that happen? This should be an important question for the Competition Commission of Pakistan (CCP).

A recent CCP judgment disallowed different medical laboratories from dividing the market between them through agreements and fixing the prices of the services provided. In many of the markets mentioned above there are strong market bodies that sometimes set prices. Even if prices are not set explicitly, price-posting in shops can lead to implicit price setting. And if there is an expectation that shopkeepers will abide by set or posted prices, and there is some mechanism where the market can deter or punish transgression, we have collusive arrangements in place. These are anti-competitive and illegal. It would be the worth CCP’s while to explore whether any explicit or implicit agreements work in these markets: would be surprising if hundreds of shops are making some positive profits with no collusive agreements on dividing customers or setting prices.

Sometimes when you are bargaining for better prices in these markets and you go from one shop to another, shopkeepers do inquire about the best offer made by the last shopkeeper. It is an effort to keep a check on each other. But on some products there is room for bargaining also. An investigation into the pricing practices of clusters would definitely be of value from a policy perspective and for ensuring that the interests of the customer are not being contravened.

Trade and commerce can and do create a lot of value addition for the economy. The sectors are an important part of the growth framework that has been put together by the Planning Commission recently. But for this to pan out we need to ensure that micro issues, within markets, have also been looked at in detail. Within large retail clusters that exist across Pakistan there are interesting issues related to property rights as well as price determination that are worth examining from this perspective.

The writer is senior adviser, Pakistan, at Open Society Foundations, associate professor of economics, LUMS, and a visiting fellow at IDEAS, Lahore.