Home Depot/Lowes, Bloomingdales/Neiman Marcus/Nordstrom, Honda/Toyota/Nissan, CVS/Rite Aid/Walgreens, Best Buy/Circuit City (awww).  You’ve seen this.  When one pops up, a competitor is just down the road within a few hours, at most.

How can this make sense?  I recall dozens of conversations with my father as a child while driving through town on the way to church.  Whether it was fast food, grocery, or one of the stores above, it made no sense to us that a competitor would open next door.  Why go through all the effort to steal customers from your competitor when you could just open in a virgin location and tap the new market?

To the average consumer, this is simply convenient and they don’t care.  To the savvy consumer, they question the logic of the business.  This was me and pops.  But even savviest consumers aren’t all that smart.  We’re both smart enough to know there has to be a good reason for it, we just didn’t know what it was.

Well, would you like to know why?  Go back to the average consumer.  The average consumer doesn’t know what they want.  They know they want to buy some tools, they know they need to get a prescription filled, they know they want to buy a car.  They just don’t know what to buy or where to buy it.

Imagine that you’re in the market for a car.  You want a Honda Accord, Toyota Camry, Nissan Altima, or a Ford Fusion but you aren’t sure what you want to buy.  You want to buy a car today but the dealerships are spread across town and you only have time to drive to one location.  At one individual dealership, your odds of finding the right car are 1/4.  This means your odds of not finding the right car are 3/4.  This means there is a 75% chance that no one will get a sale.  Now imagine two of the dealerships were located together and you have time to visit both since they’re so close.  Now there is a 50% chance that someone will get a sale.  Follow the logic and if all 4 dealerships are located together there is a 100% chance that someone will get a sale, meaning each dealership has a 25% chance of landing the sale when they are located together.  If the Nissan (or any other) dealership were alone, then it would only have a 25% chance of being selected, and then a 25% chance of being the right car for the customer.  These probabilities are multiplied and therefore each dealership, located separately, only has a 6.25% chance of landing a sale from you, the shopper with the time to only go to one part of time.

I’ll warn you that the last paragraph is a dramatic oversimplification of the math behind the logic.  It serves its purpose though in illustrating that when competing companies are located together, they all increase their chances of getting a sale.

Locating near each other does more than increase chances of a sale, it increases foot traffic.  This is why malls are so popular.  We go there because we can go to a bunch of places at once.  We can comparison shop, check out a number of similar or exact products, or just get a variety of grub.

Counter-intuition this is not.  It’s an exact science.  Lowes and Home Depot would rather be located together at a hardware epicenter than on opposite sides of town.  To a certain degree, they need each other.

If you’re a big numbers geek, you can read an academic paper on the subject that dives much deeper than Weakonomics is designed for.

Photo: f33

categories: business, economics