by John M. Jennings | May 30, 2018
Hmm – which pharmacy should I go to?
This weekend we decided to buy a new patio umbrella. As we drove down Hanley Rd. in St. Louis we had a few options: Home Depot, Menard’s (right across the street) and Lowe’s (less than 1/4 mile down the road). This a common phenomenon: competing firms locating their stores in close proximity to each other. It is very common with fast food stores, gas stations, banks, mattress stores, coffee shops, pharmacies, large retailers, etc.
It seems to make no sense, but its so common there must be a good reason for it.
When competing firms are located close together it is called clustering. Clustering can be explained by game theory and specifically by “Hotelling’s Model of Spatial Competition.”
Here’s the theory in a nutshell: businesses want to locate themselves near the center of their potential customer population to attract the greatest amount of customers. When multiple competitors exist it would make sense, if they were working together, to spread out so that each competitor would have a share of the customer population. But competitors don’t work together, so this sort of arrangement will not work (or, in game theory parlance, it hasn’t reached “Nash Equilibrium”). So, each competitor will simultaneously make the same decision to move to the best location.Nash Equilibrium occurs at “the point where neither of you can improve your position by deviating from your current strategy.” Nash Equilibrium will occur when all competitors have moved to the optimal location in terms of potential customers. Basically, for various population density areas there are only a few (maybe only one) optimal locations and the mathematics of competition drive all competitors to the optimal location.
As explained by Jonathan Becher of SAP:
If a retailer opens a new location away from the current clustering, there are two potential results:
1. It will fail to capture enough consumers and eventually close.
2. It will become successful causing competitive stores to locate nearby.
Either way, clustering remains the norm.
Here’s a great, but short, animated video explaining Hotelling’s Model of Spatial Competition and why clustering occurs (well worth watching IMO):
Alvaro Diazon October 7, 2023 at 4:33 am
Margarita. Yes, that is exactly what you should do, group them, classified them by activity.
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Margaritaon September 6, 2021 at 10:33 pm
More than a comment is a question.
I am the organizer of a art and craft out door market. Now we have all the vendors mixed. I am proposing that we should have all the painters, ceramist, jewelers, etc clustered, not mixed. My intention is to attract buyers from wealth neighborhoods interested in fine art at low prices. I believe that someone who is interested in fine art will not want to waste hus* time roaming looking at stickers, or jewelry, until he finds a painter. Please give me your opinion.
*hus-his/hers from HUmanLoading...
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I'm an enthusiast with a deep understanding of the concept of clustering in business, particularly as explained by Hotelling's Model of Spatial Competition. My expertise is grounded in game theory and its application to real-world scenarios, such as the strategic location decisions made by competing firms.
Hotelling's Model of Spatial Competition, named after economist Harold Hotelling, provides a theoretical framework for understanding why businesses tend to cluster in close proximity to each other. The essence of this model lies in the pursuit of businesses to position themselves near the center of their potential customer population, aiming to attract the maximum number of customers.
In the case of the article by John M. Jennings, the phenomenon of clustering is observed among various types of businesses, including fast food stores, gas stations, banks, mattress stores, coffee shops, pharmacies, and large retailers. The article highlights the seemingly counterintuitive nature of businesses locating near each other and explains this behavior through the lens of game theory.
The Nash Equilibrium, a concept within game theory, is crucial to understanding the rationale behind clustering. In the context of Hotelling's Model, Nash Equilibrium is reached when all competitors have moved to the optimal location in terms of potential customers. It is the point where none of the competitors can improve their position by deviating from their current strategy, leading to a stable state of spatial competition.
Jonathan Becher of SAP is cited in the article, emphasizing that deviating from clustering may result in unfavorable outcomes for a retailer. Opening a new location away from the existing cluster can either lead to failure due to the inability to capture enough consumers or success, prompting competitive stores to relocate nearby. This reinforces the idea that clustering is a dominant and persistent strategy in spatial competition.
The article also alludes to the practical implications of Hotelling's Model for businesses. For instance, it suggests that businesses have a limited number of optimal locations in areas with varying population densities. Additionally, the mention of a short animated video provides an extra resource for a visual understanding of Hotelling's Model and the dynamics of clustering.
In the comments section, there's a question posed by Margarita, the organizer of an art and craft outdoor market, seeking advice on whether to cluster vendors by activity (painters, ceramists, jewelers, etc.) to attract buyers interested in fine art. This question aligns with the principles of clustering discussed in the article, emphasizing the importance of grouping similar businesses to cater to specific consumer interests and enhance the overall shopping experience.
In conclusion, my expertise lies in understanding the intricacies of Hotelling's Model of Spatial Competition and its application to real-world scenarios, as exemplified by the clustering phenomenon observed among competing businesses.
