QuestionQuestion

MARKET STRUCTURE ANALYSIS AT WICHITA DRUGSTORES, INC.

Background:
Demonstrating the tools and techniques of market structure analysis is made difficult by the fact that a firm’s competitive strategy is largely based upon proprietary data. Firms jealously guard price, market share, and profit information for individual markets. No one should expect Target, for example, to disclose profit-and-loss statements for various regional markets or on a store-by-store basis. Competitors like Wal-Mart would love to have such information available. It would provide a guide for their own profitable market entry and store expansion decisions.

To see the process that might be undertaken to develop a better understanding of product demand conditions, consider the hypothetical example of Wichita Drugstores, Inc., based in Hartford, Connecticut. Assume Wichita operates a chain of 30 drugstores in the Northeast. During recent years, the company has become increasingly concerned with the long- run implications of competition from a new type of competitor, the so-called superstore.

To measure the effects of superstore competition on current profitability, Wichita asked you to conduct a statistical analysis of the company’s profitability in its various markets. To net out size-related influences, profitability was measured by Wichita’s gross profit margin, or earnings before interest and taxes divided by sales. Wichita provided you with proprietary company profit, advertising, and sales data covering the last year for its 30 stores, along with public trade association and Census Bureau data concerning the number and relative size distribution of competitors in each market, among other market characteristics.

You have decided to conduct a regression-based analysis of the various factors thought to affect Wichita’s profitability. To aid you in this process, Wichita created the accompanying spreadsheet entitled “Case_Data.xlsx/a specific version of the data will be emailed to you.” The data contained in this spreadsheet are described as follows, where the variable name (as it appears in the spreadsheet) is in italics.

The variable Store Number identifies a particular Wichita drugstore. The dependent variable is Profit Margin, which as stated before, is Wichita’s gross profit margin. The following independent variables are thought to affect Wichita’s profitability. The variable Market Share is the relative size of leading competitors in a store’s market, measured at the Standard Metropolitan Statistical Area (SMSA) level. Wichita’s market share in each area is expected to have a positive effect on profitability. The Market Concentration Ratio, measured as the combined market share of the four largest competitors in any given market, is expected to have a negative effect on Wichita’s profitability given the stiff competition from large, well-financed rivals. Both Capital Intensity, measured by the ratio of the book value of assets to sales, and Advertising Intensity, measured by the advertising-to-sales ratio, are expected to exert positive influences on profitability. Growth, measured by the geometric mean rate of change in total disposable income in each market, is expected to have a positive influence on Wichita’s profitability, because some disequilibrium in industry demand and supply conditions is often observed in rapidly growing areas. Finally, to gauge the profit implications of superstore competition, the variable Superstore Dummy takes the value of ‘1’ if Wichita faced superstore competition in a particular store’s market and ‘0’ otherwise.

Assignment:
In five-to-seven pages of double-spaced writing in a Word document, answer the following questions:
1. Based on the text above, build a multiple linear regression population model to analyze the impact of the preceding determinants on Wichita’s profitability. What is the multiple linear regression population equation? What are the assumptions underlying the model?

2. Using Excel and the accompanying dataset, estimate the population model. Copy and paste your Excel output into your Word document.

3. Based on the Excel output, what is the estimated regression equation?

4. Interpret all coefficient estimates. Identify the significance level for all of these estimates. Are any of the independent variables likely to actually influence Wichita’s profitability? Are your estimates consistent or inconsistent with the a priori conjunctures found in the article? (E.g., advertising intensity is thought, a priori, to increase profit margin. Does your coefficient on advertising intensity and its associated p-value suggest that it is directly correlated with profit margin?)

5. What portion of the variability in profit margin is explained by variability in the independent variables? Is the estimated regression equation a good fit for explaining profit margin?

6. Based on the estimate of the coefficient on Superstore Dummy and its associated p-value, do you believe that superstores pose a threat to Wichita’s profitability? Expand on the theoretical foundation for this conclusion, i.e., why would the existence of competitor superstores affect Wichita’s profitability?

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1. Based on the coefficients for Independent variable, the multiple linear regression population equation for Wichita Drugstores, Inc. is:
Y = 6.15486 + 0.18892*X1 - 0.15603*X2 + 0.33716*X3 + 0.61866*X4 + 0.85354*X5 - 2.46046*X6
Where;
Y = Profit Margin, X1 = Market Share, X2 = Market Concentration Ratio, X3 = Capital Intensity, X4 = Advertising Intensity, X5= Growth, and X6 = Superstore Dummy
The assumptions underlying the model are:
(a) Linear relationship – profit margin, market share, market concentration ratio, capital intensity, advertising intensity, growth and superstore dummy have a linear relationship
(b) Multivariate normality – market share, market concentration ratio, capital intensity, advertising intensity, growth and superstore dummy are normally distributed
(c) No multicollinearity - market share, market concentration ratio, capital intensity, advertising intensity, growth and superstore dummy are not related to each other, and lastly
(d) Homoscedasticity – that the variance of error terms are similar across the independent variables (market share, market concentration ratio, capital intensity, advertising intensity, growth and superstore dummy)...

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