Why do competitors open their stores next to one another? - Jac de Haan

Summary

The video script explores the phenomenon of businesses clustering together using Hotelling's Model of Spatial Competition. It narrates a story of two ice cream vendors on a beach, illustrating how they initially split the beach to minimize customer walking distance. However, as competition intensifies, they both end up in the center, creating a Nash Equilibrium where neither can improve their position by moving. This results in a less socially optimal solution, as customers at the ends have to walk further. The script highlights how in real-world scenarios, businesses often cluster to stay competitive, even if it's not the most customer-friendly distribution.

Takeaways

• 🏪 Clustering of businesses is a common phenomenon that can be explained by Hotelling's Model of Spatial Competition.
• 📍 The model begins with a single business serving a market with no competition, ideally placed in the center to serve the most customers.
• 👬 When competition enters, businesses tend to locate near each other to minimize customer walking distance and maximize their customer base.
• 🔄 In the ice cream example, two vendors initially split the market but eventually converge to the center to compete for the majority of customers.
• 🤝 The initial agreement to split the market equally is disrupted as vendors seek to capture more customers by moving closer to each other.
• 🔄 The 'ice cream wars' illustrate a dynamic where vendors continuously adjust their positions to capture a larger share of the market.
• 🔄 The process of moving closer to the center is driven by the desire to not lose customers to the competitor, leading to a convergence at the midpoint.
• 🔄 The final positioning at the beach's center represents a Nash Equilibrium, where neither vendor can improve their position by changing their strategy unilaterally.
• 📉 The Nash Equilibrium results in a less socially optimal solution, as customers at the ends of the beach must walk further to reach a vendor.
• 🛒 The concept applies to various real-world scenarios, such as fast food chains, clothing stores, and mobile phone kiosks, which often cluster to compete effectively.
• 💡 Businesses may choose to cluster not only to serve customers better but also to protect themselves from aggressive competition and to leverage marketing and differentiation strategies.

Q & A

What is Hotelling's Model of Spatial Competition?

Hotelling's Model of Spatial Competition is a simple story used to explain why similar businesses often cluster together rather than being evenly distributed across a community. It illustrates this through the example of ice cream sellers on a beach.

Why would an ice cream seller place their cart in the middle of a one-mile beach with no competition?

The seller would place their cart in the middle to serve as many people as possible, minimizing the walking distance for beachgoers at both ends of the beach.

What happens when a second ice cream seller, Teddy, enters the beach market?

Teddy and the original seller agree to split the beach in half and place their carts a quarter mile from the center, serving their respective territories and sharing the customers in the middle.

What is the outcome when Teddy moves his cart to the center of the beach?

Teddy captures more of the market by being closer to the majority of the customers, forcing the original seller to move back to gain the customers to the south of the beach.

What is the Nash Equilibrium in the context of the ice cream sellers' story?

The Nash Equilibrium is reached when both sellers end up at the center of the beach, back to back, each serving 50% of the customers. Neither can improve their position by changing their strategy alone.

Why is the original strategy of being a quarter mile from the center not a Nash Equilibrium?

The original strategy is not a Nash Equilibrium because either seller could improve their sales by moving closer to the other, thus capturing more customers.

What does the term 'socially optimal solution' refer to in Hotelling's Model?

A socially optimal solution minimizes the maximum number of steps any customer must take to reach a seller, ensuring the least inconvenience for the customers.

How do the ice cream sellers' actions reflect real-world business strategies?

In the real world, businesses often cluster to be close to their competition, using marketing strategies, product differentiation, and price cuts to compete, rather than spreading out to serve customers more evenly.

Why might customers at the ends of the beach have to walk further in the end?

When both sellers converge at the center, customers at the ends of the beach have to walk further than necessary to get ice cream, as the sellers are no longer optimally distributed.

What can businesses learn from Hotelling's Model about competition and customer service?

Businesses can learn that while clustering near competitors may improve their sales, it may not always lead to the best customer service, as it can increase the distance some customers have to travel.

How does Hotelling's Model apply to businesses other than ice cream sellers, such as fast food chains or clothing boutiques?

The model applies to any business where the location can significantly affect customer reach and sales. It shows how businesses may choose to locate close to each other to capture more of the market, even if it's not the most efficient distribution for customers.