Why Do Competitors Open Their Stores Next To One Another?
Source video: https://www.youtube.com/watch?v=jILgxeNBK_8
This very informative and interactive Ted-Ed video uses the principles of game theory and Nash equilibrium to help explain why competitors often open their stores next to one another. Many people do not understand how this decision can possibly benefit both parties. Ultimately, Hotelling’s Model of Spatial Competition and the principles behind Nash equilibrium can explain the existence of clusters of similar companies.
The example that was provided in the video was of two cousins who sell the same type of ice cream on a 1-mile beach. At first, only one of the cousins sells ice cream on the beach. In order to maximize his sales potential, he sets up right in the middle of the beach so that the maximum a customer would need to walk is .5 miles. The next day, the second cousin arrives at the beach hoping to sell ice cream. The two cousins agree to split the beach in half. To ensure that customers do not need to walk too far, one cousin sets up .25 miles north of the middle point of the beach and the other cousin sets up .25 miles south of the middle point of the beach. They each have their own .25-mile zone where the customers belong only to them. Together they share the area between the two shops, which is .5 miles. Game theorists consider this a socially optimal solution because it minimizes the amount customers must walk to buy the product. In an ideal world, this would be how companies would decide to choose the locations of their store. We will see why this arrangement does not usually occur in the real world.
While this situation is socially optimal, it is not sustainable because it is not a Nash equilibrium. Imagine that the next day, one of the cousins sets up shop at the halfway point instead of .25 miles away from the halfway point. If this happens, one cousin serves .5 miles plus half of .25 miles while the other serves .25 miles + half of .25 miles. We can imagine that the cousin would respond the next day by moving his shop to the halfway point of beach, back-to-back to his cousin’s shop. At that point, both cousins will serve 50% of beach goers and Nash equilibrium will have been reached. This means that neither cousin will stand to benefit from changing their current strategy. This situation is no longer a socially optimal solution because customers on the far ends of beach will have to travel far distances for ice cream.
The cousins-ice cream example was able to demonstrate how game theory and Nash equilibrium explain why large corporations like Shell and Mobil open locations next door to one another. While we can understand why it makes business sense for companies to do this, there are many situations where clustering competitors really hurt society. For example, food deserts are areas that have limited access to affordable and nutritious food. One of the main reasons food deserts exist is because supermarkets are often located very close to each other. Certain areas are left without sources for healthy food because they do not meet the demand for multiple supermarkets. While it may make more business sense to open supermarkets in areas that are densely populated with other supermarkets, I believe that large supermarkets like Wegmans and Shoprite need to make more of an effort to provide low-income Americans with access to healthy food. I don’t think that principles from game theory can be used to justify the decisions to cluster supermarkets in one area if it has such negative effects on our society.