Why do competitors open their stores next to one another? - Jac de Haan | Summary and Q&A

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October 1, 2012
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Why do competitors open their stores next to one another? - Jac de Haan

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Summary

This video explores the phenomenon of businesses clustering together instead of being spread evenly throughout a community. It introduces Hotelling's Model of Spatial Competition, which explains why businesses such as gas stations, coffee shops, and restaurants are often built next to each other. The model uses the example of two ice cream vendors on a beach to illustrate the concept of a Nash Equilibrium, where neither vendor can improve their position by deviating from their current strategy. The video suggests that while distributing services throughout a community may be more beneficial for customers, businesses prefer to keep their competition close.

Questions & Answers

Q: What is Hotelling's Model of Spatial Competition?

Hotelling's Model of Spatial Competition is a simple story that explains why businesses tend to cluster together instead of being evenly distributed. The model uses the example of two ice cream vendors on a beach to demonstrate how the location of businesses can impact their market share.

Q: How does the story of the ice cream vendors illustrate Hotelling's Model?

In the story, the beach is divided equally between two ice cream vendors, each setting up their cart either north or south of the beach center. This arrangement ensures that customers don't have to walk too far to buy ice cream. Initially, both vendors have equal market share, and this is considered a socially optimal solution.

Q: What happens when one vendor changes their location?

When one of the ice cream vendors decides to move their cart closer to the center of the beach, they gain an advantage by capturing more customers. The other vendor responds by moving their cart closer as well, leading to a cycle of competitive repositioning. This continues until both vendors end up at the center of the beach, each serving 50% of the customers. This is known as a Nash Equilibrium, where neither vendor can improve their position by deviating from their current strategy.

Q: Why is the Nash Equilibrium not a socially optimal solution?

While the Nash Equilibrium ensures that neither ice cream vendor can gain an advantage by moving their cart, it is not the most beneficial solution for customers. At the Nash Equilibrium point, customers at either end of the beach have to walk further than necessary to get ice cream. This means that the original socially optimal solution, where the vendors were each a quarter mile from the middle of the beach, is no longer achieved.

Q: How does this model apply to other businesses and industries?

The concept of businesses clustering together to be close to their competition applies to various industries. For example, fast food chains, clothing boutiques, and mobile phone kiosks in malls often locate themselves near their competitors. While customers may be better served by having services distributed throughout a community, businesses prefer to be in close proximity to their rivals to stay competitive.

Q: What strategies do businesses use to compete against each other?

In the real world, businesses have various strategies to compete with each other. They may employ marketing strategies, differentiate their product line, or engage in price cuts. These tactics allow businesses to gain an edge in the market and attract customers.

Q: Why do businesses choose to keep their competition close?

Despite the possibility of distributing services throughout a community, businesses prefer to keep their competition close for several reasons. Firstly, being in close proximity allows businesses to closely monitor and keep up with their competitors' activities. It also provides customers with a convenient and concentrated area to satisfy their needs, which helps attract a larger customer base.

Q: What are the drawbacks of businesses clustering together?

While clustering offers advantages, it also has disadvantages. Businesses located in clusters are more vulnerable to aggressive competition, as rivals can easily steal customers from nearby establishments. Furthermore, clustering can lead to saturation of the market in a particular area, making it difficult for new businesses to gain a foothold.

Q: How do businesses compete when customers come from more than one direction?

In scenarios where customers come from more than one direction, businesses adjust their strategies accordingly. They may focus on targeting specific customer segments or adopt different marketing approaches to attract customers from different directions. Additionally, businesses may offer different products or services to cater to the preferences of customers coming from different areas.

Q: Can businesses still compete even if they are not physically close to each other?

Yes, businesses can compete even if they are not physically close to each other. In today's digital age, online platforms have provided businesses with the means to reach customers regardless of their location. With effective online marketing and delivery systems, businesses can overcome the limitations of physical distance and still compete with each other.

Takeaways

Hotelling's Model of Spatial Competition explains why businesses tend to cluster together, even though it may not be the most beneficial arrangement for customers. The model demonstrates the concept of a Nash Equilibrium, where businesses reach a point where neither can improve their position by changing their current strategy. While keeping competition close allows businesses to closely monitor their rivals and provide customers with convenience, it also makes them more vulnerable to aggressive competition. However, with the rise of online platforms, businesses now have the ability to compete regardless of physical distance.

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