You’ve probably noticed many stores tend to cluster in one specific spot, with similar product and service offerings. While it might seem more logical for similar businesses to be far away from one another, two business theories show that it may not be efficient for competitors to go that route.
Hotelling’s Location Model
One reason why you come across similar businesses appearing in groups instead of being spread evenly in a specific community can be explained with a theory known as Hotelling’s Model of Spatial Competition.
In the late 1920’s, Harold Hotelling, an American mathematical statistician and influential economic theorist analyzed a model of spatial competition, the location of different businesses in a similar market in respect to one another.
According to Hotelling, “when competing on location, each business wants the central point as it is the most strategic spot that allows it to be as close to as many customers as possible. Since every business has the same mindset, they will be competing with one another which eventually causes similar businesses to end up in a cluster focused on one specific point.”
In September 2015, US-based retail influencer Marc Smookler conducted an experiment in his hometown of Austin, Texas. Using his home address just northwest of the city proper, he concluded that:
- CVS and Walgreens pharmacies were, on average, 0.958 miles (1.54 kilometres) apart, with an average drive time of 3 minutes to the nearest competitor.
- Walmart and HEB (a major Texas-based grocery chain) were, on average, 0.633 miles (1.01 kilometres) apart, with an average drive time of 3.33 minutes to the nearest competitor.
- Home improvement supplies stores Home Depot and Lowe’s were, on average, 3.46 miles (5.56 kilometres) apart with an average drive time of 8 minutes to the nearest competitor.
The Nash Equilibrium
In the early 1950’s, John Forbes Nash Jr., an American mathematician introduced the Nash Equilibrium: a concept within game theory where the optimal outcome of a game is where there is no incentive to deviate from their initial strategy. The optimal outcome of a game is “one where no player has an incentive to deviate from his chosen strategy after considering an opponent’s choice. Overall, an individual can receive no incremental benefit from changing actions, assuming other players remain constant in their strategies”.
Take two competing retail stores which are now in close proximity and unable to benefit from relocating, they will therefore need to rely on marketing strategies to gain an advantage over the other by differentiating their product offering, give promotions and creating publicity. This is one of the reasons why you notice that similar businesses tend to have promotions that resemble competitors’.
For example, a Starbucks store within a given Canadian postal code offers a new coffee and muffin combo for $2. Through bench-marking techniques, Dunkin’ Donuts finds that the strategy has increased Starbucks’ customer base, and then decides to implement a similar strategy by introducing a coffee and muffin combo of their own.
Does the lack of physical location in e-commerce invalidates the theories previously stated? What about the availability of vast information about other sellers consumers possess?
In this case, consider the retailer and the consumer as the two players in the game theory. In a blog post published in September 2017, Cornell University instructors stated that a game theory graph would illustrate a company’s best response to the consumer’s willingness to pay and the consumer’s response to the retail price the company is offering for the product. Either party can stop pursuing this transaction and just find another customer/company to sell/buy to/from.
This can be illustrated with the given example of how Amazon dropped prices on Black Friday of a Samsung TV from $350 to $250 and decided on this final price using collected data, which allowed them to surpass the competition.
Amazon took this a step further by hiking the price of HDMI cables, a complementary product, knowing based on consumer data that people are less likely to shop around in pursuit of the lowest prices for smaller items than bigger ticket items. The customers’ willingness to pay for the Samsung TV was any price lower than what the competitors were offering, which turned out to be $250.
Thinking outside of the box can be beneficial, however being close to your competitors is a tested and proven strategy for retailers. As they say: “keep your friends close and your enemies closer”.
By Phil Siarri