A Structural Model of Entry and Location Choice: The Differentiation–Agglomeration Trade-Off

Extant models of entry and location choices by competing retailers focus on the benefits of differentiation, derived from locating far apart, and therefore cannot explain high degrees of store agglomeration. Unlike extant models that treat firm profits in reduced form, this paper decomposes firm profit as a function of customer choice (to allow for consumer utility from agglomeration) and competition; thus, the authors disentangle the differentiation–agglomeration trade-off that firms face. The findings reveal that (1) consumers value both format and store agglomeration; (2) consumers have high travel costs, and competition among stores decreases dramatically with distance, but ignoring agglomeration benefits biases these estimates substantially; and (3) intraformat competition reduces profitability at roughly twice the rate as interformat competition. Policy simulations demonstrate the importance of modeling the differentiation–agglomeration trade-off to arrive at correct entry and location decisions.