COMPETITION AND LOCATION DECISIONS The preceding discussion of market areas and spatial pricing policies has described

the behavior of sellers at given locations. We have recognized one important dimension of competition in a spatial context: the ability of locational units to absorb transfer costs. Thus spatial pricing policies serve as one mechanism by which firms may seek to gain competitive advantage. We now proceed by recognizing that the choice of location may itself be part of a competitive strategy. In order to establish a simple framework for exposing the essential character of this aspect of spatial 12 competition, we draw on a model developed by Harold Hotelling. Our attention will be focused on two competitors who confront a linear-bounded market. It is assumed that production costs are zero for each locational unit. Identical buyers are evenly distributed over this market. Their demand for the good in question is not sensitive to price differences (the elasticity of demand is zero). One unit of the good is consumed by each individual per period of time, and each buyer prefers to purchase from the nearest seller. This situation is depicted in Figure 4-13. In panel (a), the linear market, l, is segmented into two protected or uncontested parts, a and b, and one contested part, x + y, that is shared equally by the sellers. The two sellers, A and B, can move to any location on the line that will maximize their profit, and they do so believing that the rival will not change its location in response to their competitive action. We will assume that these moves are costless, in the sense that the sellers confront neither moving costs nor costs associated with disposing of fixed assets that might be associated with a given location. In the restricted environment established by these assumptions, profits are always enhanced if a seller increases its market area. Since production is costless, larger market areas imply greater sales and, therefore, greater profits. If each seller believed that the others location was fixed, the first seller to act, say A, would move to a position adjacent to its rival, ensuring itself the largest possible market area. If the initial positions are as depicted in panel (a), the first seller to move would seek to eliminate the contested portion of the market and maximize its protected portion. Thus panel (b) would represent such a move. The second seller is similarly motivated, however, and would leapfrog its rival to obtain competitive advantage. This type of movement would continue until neither seller stood to gain from further action. Such a situation would prevail if both sellers assumed central locations, each sharing one-half of the market. These results demonstrate that some aspects of spatial competition may actually lead to the mutual attraction of sellers. In Chapter 5, other factors that might encourage clustering of this sort are examined in depth. Some individuals have claimed great generality for Hotellings model, suggesting that it explains a good deal about spatial groupings of activity. This suggestion is difficult to justify, however, when one recognizes that attempts to move the model closer to reality by relaxing one or more assumptions 13 have consequences that are very much at odds with Hotellings results. The validity of this point is apparent if one explores the implications that follow when one assumes that the demand elasticity is non-zero and also allows for the possibility that sellers may act in light of a belief that rivals will react by competitive pricing or location decisions. In earlier sections of this chapter, we have recognized that if the quantity demanded by individuals is sensitive to price, a seller that offers its goods for sale at a lower delivered price may be able to extend its market to include customers who are physically closer to competing establishments. Thus both price and location decisions can enter competitive strategy. In Hotellings model, not only was the demand elasticity equal to zero, but each sellers expectation about the behavior of its competitor was naive; no change in the rivals location was assumed. Now we wish to admit price responsiveness and somewhat more realistic expectations about competitive reactions in order to appreciate more fully the complexity of related problems.

While many possibilities might be examined that would serve to expose the character of decisions in 14 this context, we choose to concentrate on two examples: (a) each seller assumes that any competitive price or location action that it takes will be matched by its rival, or (b) each seller assumes that its price changes will be met but that the rivals location is fixed. We continue to assume that there is a bounded linear market with uniformly distributed, identical buyers. Now, however, we also assume that they have negatively inclined linear demand functions. As with the Hotelling model, the sellers can move without cost and their marginal costs of production are zero; but we extend our assumptions concerning the sellers to include f.o.b. pricing with freight rates that are uniform over the market. The sellers are also profit maximizers. Under these conditions, in situation (a), where each seller believes that price and location changes will be matched, neither seller can expect to gain from competitive behavior. Each believes that any attempt to lower the f.o.b. price in order to invade the rivals market will be met and that the original boundary between the two sellers will be reestablished at that lower price. Similarly, each seller expects that any relocation aimed at invading the rivals market will be matched and that the boundary separating the rivals will be maintained. Further, movements toward the rival inevitably imply movements away from buyers in the sellers uncontested market segment. The associated increases in delivered price will affect demand. There is pressure to avoid competition because of these circumstances. In fact, it has been suggested that a possible outcome in this situation would be for the sellers to cooperate and share 15 the market equally, to their mutual advantage. In situation (b), price competition is eliminated. However, since each seller believes that the others location is fixed, both will move toward a central location. These moves are again at the cost of sales in the uncontested market segments as delivered prices rise for more distant consumers. Further, as in situation (a), there is no gain in the contested market segment. As both sellers approach the center, the interior boundary is unchanged. Here, after their initial move toward the center, both sellers would realize that further movement in that direction would result only in additional losses. The tendency toward central locations has been checked as a result of competitive pressure and decreased sales to more distant customers. Thus we find that Hotellings results are very sensitive to assumptions concerning the nature of demand. Specifically, the elasticity of demand (which determines the extent of lost sales to the more distant customers) can be a factor in encouraging dispersed patterns of economic activity. Once we admit possibilities of the sort just described, it is easy to recognize the complexity of the decisions faced by the firm. It must develop expectations about the behavior of competitors before choosing an initial location or deciding to relocate. Further, its pricing and location decisions are undertaken with the risk of retaliation. Any seller is likely to have little or no solid information on which to make the sort of judgments that are required. Thus in addition to the substantial risks that may exist in any location or production decision because 16 of uncertainty concerning market conditions, competition also implies uncertainty. The costs of guessing incorrectly may be substantial, and location decisions are undoubtedly influenced by this reality. In reacting to increases in uncertainty, firms will make more conservative production and location decisions: Their location choices, it has been suggested, are likely to reflect relatively smaller commitments of physical capital, and they will seek the security of locations with a variety of supply 17 sources and good access to alternative markets). 4.5 MARKET AREAS AND THE CHOICE OF LOCATIONS 4.5.1 The Location Pattern of a Transfer-Oriented Activity In light of considerations thus far discussed, we can now formulate some general propositions about the locational preferences of a transfer-oriented activity.

Regardless of the price strategy involved, an output-oriented seller will still try to find the most rewarding location in terms of access to markets. It will not simply be comparing individual markets nor, as a rule, access to all markets wherever situated. Rather, it will have to evaluate the advantage of any location on the basis of how much demand there will be within the market area that it could expect to command from that location. Each location that it might choose entails a market area and a 18 sales potential determined by where the buyers are and where the competition is. The best location from this viewpoint is one where demand for the sellers kind of output is large relative to the nearby supply. This suggests that the seller will look for a deficit area, one into which the output in question is flowing, in preference to a surplus area, one out of which it is flowing. The direction of flow is "uphill," in the sense of an increasing price of the output; thus the seller will be attracted toward peaks in the pattern of prices, rather than toward low points. In other words, it will try to find the largest gap in the pattern of already established units of its activity as the most promising location for itself. If demand for the outputs of its activity were distributed evenly, the seller would simply look for the location farthest from any competition: that is, the center of the largest hole in the pattern. Since any new unit will aim to fill gaps in this way, the tendency will be toward an equal spacing of units of the activity, with market areas of approximately equal size and shape. Analogously, input-oriented location units will look for surplus areas for that input; and if the supply curve for the input is the same over a large area, the units will tend to distribute themselves equidistantly, with supply areas identical. In the real world, of course, no such regularity is found. Neither demand nor supply is spread evenly, competitors and sites are not identical, transfer costs are not the only factor of location, and transfer costs do not rise regularly with distance in all directions.