Spatial Competition and Preemptive Entry in the Discount Retail Industry∗

Big box retail stores have large impact on local economies and receive large subsidies from local governments. Hence it is important to understand how discount retail chains choose store locations. In this paper, I study the entry decisions of those firms, examine the role of preemptive incentives, and evaluate the impact of government subsidies on those decisions. To quantify preemptive incentives, I model firms’ entry decisions using a dynamic duopoly location game. Stores compete over the shopping-dollars of close-by consumers, making store profitability spatially interdependent. I use separability and two-stage budgeting to reduce the state space of the game and make the model tractable. Instead of adopting census geographic units, I infer market divisions from data using a clustering algorithm built on separability conditions. I introduce a ‘rolling window’ approximation to compute the value function and estimate the parameters of the game. The results suggest that preemptive incentives are important in chain stores’ location decisions and that they lead to loss of production efficiency. On average, the combined sum of current and future profits of the two firms is lowered by 1 million dollars per store. Finally, I assess the impact of government subsidies to encourage entry when one retailer exits, as happened in the recent crisis. I find that although the welfare loss such exits cause on local economies can be substantial, the average size of observed subsidies is not enough to affect firms’ entry decisions.