The Agglomeration-Differentiation Tradeoff in Spatial Location Choice

Retailers often co-locate spatially to draw consumers, even though it increases price competition. The paper develops a structural model of entry and location choice that isolates the agglomeration benefit of co-location, after controlling for pure differentiation rationales for colocation such as (1) high demand and/or low cost at the location; (2) zoning restrictions and (3) format differentiation that minimizes the need for spatial differentiation. We augment entry and location choice data used in the literature with revenue and price data to help identify the agglomeration effect. We introduce a new approach to obtain zoning data across a large number of markets that should be of general interest for a large stream of spatial location applications. We find that agglomeration benefits explain a significant fraction of observed co-location. While zoning restrictions have little direct impact on co-location, in combination with the agglomeration benefit, they explain a surprisingly large fraction of observed co-location.