The effect of competition on retail price and assortment size decisions: Theory and evidence

Abstract

We investigate how competition shapes firms’ pricing and product assortment size decisions through both theoretical modeling and empirical analysis. Our focus is on the grocery retail sector, where assortment holds particular significance for consumer choice.

By analyzing a large number of markets, we find that the presence of two competing stores — as opposed to a single monopolistic store — is associated with both higher prices and a larger product assortment. This relationship holds even after accounting for both observable and unobservable differences across stores.

We provide a theoretical model that explains these patterns based on two main forces. First, competitive pressure amplifies firms’ incentives to expand product assortment due to a business-stealing effect — broadening assortment becomes a strategy to attract customers away from rivals. Second, a more extensive product range improves the firm’s ability to screen consumers with heterogeneous preferences, thereby enabling strategic price increases in more competitive environments.

The findings offer valuable guidance for retail managers in making strategic decisions about pricing, product assortment, and store placement. They also highlight considerations for policymakers, who must be mindful of the potential unintended consequences of zoning laws and antitrust regulations that affect competition between stores.