Strategic multi-store opening under financial constraint

Abstract

This paper analyzes strategic store openings in a situation in which firms can open multiple stores depending on the financial constraints of the firm. Specifically, given any upper limit of the number of store openings that two potentially symmetric firms can open, they sequentially determine the number of store openings, including their locations, to maximize their profits. As a result of our analysis in a microeconomic framework, we show that the equilibrium strategy can be wholly classified into only two following opposite strategies according to the level of their financial constraints involved. When firms can afford to invest significant amounts of money in the market, the leader chooses “segmentation strategy,” in which a part of the market can be monopolized by opening a chain of multiple stores and deterring the follower’s entry. In contrast, when the leader has a severe financial constraint so that it can only monopolize less than half of the market, the leader chooses “minimum differentiation strategy,” where firms open each of their stores at exactly the same point as the rival’s. Under this strategy, the leader necessarily captures just half of the market. Furthermore, we show that regardless of potential symmetry between firms, both first and second mover advantages in terms of profit can occur in the equilibrium.

Introduction

This paper analyzes strategic store openings in a situation where two potentially symmetric firms, depending on their financial constraints, can open multiple stores. Consumers visit only one of the stores in consideration of the attractiveness of the store and the distance they must travel to the store. On the other hand, each firm faces its financial constraint that is given as the upper limit of the number of its store openings. Under this structure, we consider a leader–follower game where two firms sequentially determine the number of store openings, including their locations, to maximize their profits. The purpose of this paper is to provide managerial insights into competitive short-run strategies of store openings by analyzing the equilibrium of this game.

One of the location strategies possible when opening multiple stores in a short time frame is that a firm only concentrates its investment effort on particular geographical areas. In fact, this strategy can easily be observed in various industries and countries. For example, as introduced by Dasci and Laporte (2005), seven eleven Japan, the leading convenience store in Japan, opened about 11,000 stores in only 28 of the 47 prefectures in Japan (Seven eleven Japan, 2001). Another example is Starbucks Coffee, the world’s leading specialty-coffee chain, which announced that it would open around 50–75 coffee stores in the province of Quebec in the following four years (Dasci and Laporte, 2005). Also, in the apparel industry, aggressive store openings can be readily seen. For instance, in the fashion district of London, many traditional and new fashion retailers have recently opened their chain stores in competition with each other. In addition, while major global companies such as H&M, MANGO and ZARA entered and expanded their chains, Oasis, a major fashion retailer in UK, rapidly opened more than 20 stores, which are located so closely that they seem to cannibalize each other (Oasis, 2008). Furthermore, by taking an in-depth look at Starbucks’s store openings in Japan, we can see that the company opens multiple stores even within the same shopping mall as it did in Sano premium outlet and around a stadium such as Nagoya dome (Starbucks Coffee Japan, 2006), an action that definitely has the entry deterrence effect on the competitors. As seen in these examples, the practice of using such a segmentation strategy² has been frequently examined in the real-world.

However, it is important to note that we can also observe another type of location strategy: for example, in some areas Japanese Starbucks chooses to open each of its stores in close proximity to Tully’s Coffee, the strongest competitor of Starbucks in Japan (see Starbucks Coffee Japan, 2008; Tully’s Coffee Japan, 2008). A similar example can be seen in London, where H&M, MANGO and ZARA opened several stores on Oxford St. and Regent St. in close proximity to their rivals (see H&M official site, 2008, MANGO, 2008, ZARA, 2008).

While the segmentation strategy can be considered as a kind of maximum differentiation strategy in the sense that firms try to maximally differentiate their store locations with each other, on the other hand, the latter type of strategy is a minimum differentiation strategy, since it reflects firms’ behavior to minimally differentiate their store locations with each other. As introduced in Shy (1995) and Tirol (1988), these two strategies are frequently referred to in the economic (Industrial Organization) literature.

These discussions would also be applicable to the issue of product-line extension. In fact, Kotler (2000) says that “After creating a market for a particular use, Nike then expands the niche by designing different versions and brands within that shoe category, such as Nike Air Jordans or Nike Airwalkers.” This would be an instance of the segmentation strategy introduced above. On the other hand, Kotler (2000) also said that “The cloner emulates the leader’s products, name, and packaging, with slight variations. For example, Rolcorp Holding Inc. sells imitations of name-brand cereals in lookalike boxes.” Thus, some firms strategically offer similar products as those of their rivals in competition with each other.

Regarding the maximum and minimum differentiation strategies discussed above, in particular, it is interesting to note that as in the example of Starbucks, one company often carries out both of these opposite strategies with respect to expanding its store openings. How can both of the opposite strategies be optimal with respect to multiple store openings in a short term? To clarify a behavioral principle of firms underlying such outcomes, we consider that brand power and fixed cost as well as financial constraint mentioned above are the key factors of this issue and analyze how the relation between them affects firms’ location strategies. The term “brand power” specifically means the degree of firm’s attractiveness for consumers to visit its store. The term “fixed cost” means the cost necessary for opening a store, such as land price and a rent, etc. In the context of product line extension, it would correspond to investments for a plant construction and a product design, etc. On the other hand, in this study we suppose that each firm does not compete in determining their prices of products. This is consistent with settings in some of the existing related literature. However, we should note that all products are in fact sold at regular prices in chain stores such as 7-Eleven and Starbucks Coffee in some countries like Japan, which implies that pricing decisions are out of the scope of such firms with regard to their store openings.

We develop our analysis in a microeconomic framework. Our location model in this paper is based on the famous linear city model presented by Hotelling (1929), which is widely used in economics literature. Specifically, consumers are uniformly distributed on a unit segment and decide their purchase in consideration of the attractiveness of a store and the distance to the store. For this market, each firm sequentially opens its chain of stores within the upper limit of the number of its store openings. An identical fixed cost must be incurred for the establishment of each store. We formulate a strategic decision-making in this situation as a leader–follower game (Stackelberg game): two firms sequentially determine the number of store openings, including their locations, to maximize their profits. We characterize the equilibrium (Stackelberg equilibrium) of this game.

As a result of our analysis, we find that by the level of financial constraint, the equilibrium location strategy is wholly classified into just two situations. When firms can afford to invest a significant amount of money in the market, the leader chooses the segmentation strategy in which it differentiates maximally with the follower even if it suffers from severe cannibalization. In contrast, when financial constraint faced by firms is relatively severe, the leader chooses minimum differentiation strategy in which firms open each of their stores at just the same point as that of the rival. In general, it is well known that in the absence of price competition, firms choose minimum differentiation strategy since they simply try to maximize their market share in competition with each other (Gabszewicz and Thisse, 1992), while in the presence of price competition, firms choose maximum differentiation strategy because of the effect of relaxing the price competition between nearby stores (Tyagi, 2000, Gabszewicz and Thisse, 1992). However, in spite of assuming the absence of price competition, it is interesting to note that in our game, a variation of maximum differentiation strategy can also be beneficial. Furthermore, as a result of a comparison between the equilibrium profits of both firms, we obtain another interesting finding that both the first and second mover advantages may occur even if firms are potentially symmetric. This is quite different from the result of Tyagi (2000) and Peng and Tabuchi (2007), where the second mover advantage cannot occur.

The remainder of this paper is organized as follows. Section 2 reviews the literature related to our study. Section 3 introduces our proposed model and formulates a location competition between two firms as a Stackelberg game. In Section 4, we analyze the equilibrium strategy first in a financially unconstrained case as a benchmark and then in a constrained case. Section 5 discusses assumptions of our model. Section 6 summarizes our findings. The proof of our theorem is given in the Appendix.