Updated: Jun 29, 2020
I will never forget a conversation I had with the owner (I'll call him "Jean") of a local restaurant near my house several years ago. I was trying to be sympathetic (the longer you're an engineer, the harder you have to "try" to have certain emotions, they don't just "happen"). A chain restaurant had recently opened up just across the street, so I assumed Jean was feeling the added pressure from the nearby competition.
The new restaurant was just one store of a large chain in the exact same class as Jean's store (similar type of cuisine, quality, and price). Until now, Jean had the only restaurant of that type.
I asked Jean: "How have you been handling things since your competitor moved in? This must really take a toll on your business..."
Jean: "Actually, I'm really glad they're here. Things have been great!"
My first thoughts were: Wow I guess even Jean likes their food more than his own.
Befuddled, I asked: "Wait, what do you mean? Aren't they stealing your customers? Aren't you worried about losing business?"
Jean responded: "No, my business hasn't suffered at all. In fact, sales have gone UP since they moved in next door. We're thriving!"
This seemed paradoxical. Why would competition cause a restaurant to do better? I coach startups to find as powerful of a monopoly as they can (legally and ethically) in order to stand out from the competition—not fit in (1). This scenario, however, presents a somewhat unique phenomenon that occurs when competition actually drives up business for both neighboring firms.
After that encounter, I began to notice a trend everywhere I went. Almost every McDonald's is a one-minute drive from a Wendy's or Burger King, over 50% of criminal defense attorneys here in Albuquerque are located within the same 1-mile radius, there's a little thing called "the mall" in which dozens of clothing stores share a building, and every gas station I pass is just one out of two, three, or even four all at the same intersection. A real-life example is an intersection in northern New Mexico with a gas station on each of the four corners of an intersection, and due to the mergers and acquisitions, 3 of the 4 of stores are all owned and operated by ONE company, and they have been for years now (2). You'd think if any competition could hurt a gas station, it would be competition from the same brand, but apparently not.
Where else does this paradox exist?
We've discussed geographic/physical positioning by restaurants, retail clothing stores, and gas stations, but positioning can also be figurative, rather than literal (positioning in the market, positioning in technological capability, etc.). There are parallels reaching as far as the following topics:
Politics. Although I have never seen a political ad that says "my candidate is bland and in the middle", I've seen a plethora of ads that attack the opposing candidate for being "radical". If the goal is to appeal to the median voter, then the goal of attack ads would be to make the opponent appear as far to one side as possible. Come to think of it, I don't think it matters to which "side" you anchor the perception of your opponent in an attack ad, so long as it's the extreme.
Smartphones. I just switched to an iPhone from a Samsung because I was curious if there is even a noticeable difference between any two smartphones at this point in the lifecycle of these products. Save yourself the trouble: outside of a few minor features, there is no difference. All of the expensive smartphones do all of the same things, just in different ways.
Nightly news. I have to thank Presh Talwalkar of Mind Your Decisions for this one. I wouldn't have thought about this had I not read his book The Joy of Game Theory. Have you ever noticed similarities between two or three local news channels at night? Not only are the stories the same, but they are even often in the same order, and are comprised of the same details.
What is a business's incentive to copy the position of a competitor? Here are a few possible reasons for the phenomena:
1. Saving money on market research
Some companies (likely smaller businesses) may copy the competitor's homework. Managers might say something like this: "[Competitor] wouldn't have built there on a whim. They must have done the research to know that's where our target-demographic resides and shops!"
2. Higher demand can be created from higher supply
Until a market is fully saturated, the more stores there are in an area, the more crowds they draw. So even though the competing stores now have to "share the pie" (the pie being the total amount of buyers), the pie itself has grown at a rate that outpaces the diminishing portion sizes.
Even a 1/5th slice of a 12" pie is better than an entire 4" pie. Similarly, a 25% share of a $10,000 market is better than 100% of a $2,000 market. The market grows because the area now appears as a type of hotspot. People might say: "[X location] is THE place to go if you want [Y product], so let's go there first and we'll figure out which store we'll get it from when we get there!".
I have noticed higher demand as a result of higher supply firsthand in the car-sharing economy. I was one of the first 10 or so Turo hosts in my area (and proudly still have the only Porsche Cayman for rent in Albuquerque). I thought that by being one of only a few hosts, I would have a constant stream of renters. At the time, however, there was just not enough demand. Turo, as a platform, didn't yet appear as a viable option compared to traditional rent-a-centers. It lacked variety and a history of reliable service, both of which come with more cars, more hosts, and more competition. Over the following 2-3 years, the number of hosts in Albuquerque quintupled, and the number of available cars to rent increased tenfold. My own number of bookings has skyrocketed as well, correlating with the increase in competition. My theory is that customers can now rely on a quality vehicle's availability from a friendly Turo host in Albuquerque.
This is the type of virtuous cycle responsible for making cities grow: people move into an area to trade and utilize the services that already exist, then trade and the number of services increases since there are more people, then even more people are drawn to the area, and so on.
3. Game theory of "clustering" or Hotelling's Law
This is a more mathematical focused economic theory which illustrates the idea that the closer you are to your competitor (be it physically located, or in product similarity), the more of the market you capture, since you're "closer" to the entire market from one extreme end to where you're positioned. It looks something like this:
Hotelling might argue that the first priority is to get as close to the median as possible. Then, once a firm has occupied the middle, the other firm's best play in this game is to occupy a space as close to the existing firm. In the above illustration, this would mean attempting to minimize Δ. (3)
Hotelling's Law perfectly describes simpler scenarios such as in the game show "The Price is Right". Let's say I have the lowest guess so far of how much a set of golf clubs cost. If I guess $600, then some jerk will come along and guess $599, thereby stealing my whole range from $0-$600. Of course, it could backfire if another player guesses $598, sandwiching the $599. Then the $599 guess can only win if it's exactly right.
I tend to disagree with Hotelling's Law being the primary explanation of close-proximity between competitors. I do believe it has an effect, but it does not explain the increased total market being shared in certain situations. It also assumes buyers will choose which seller to patronize based solely on the seller's proximity to themselves, and not consider any other differentiating factors, which could make sense in theory, but even the most similar stores have minor differences. It also cannot explain why stores that are "sandwiched" between two other stores get any customers at all. Do underground tunnels lead directly to these stores? Not likely.
Another argument against Hotelling's Law is that although it can explain the case of where to buy gasoline – a commodity that most people consider completely identical between stations – if you want a Big Mac, you will drive past Wendy's to get to McDonald's even if it means driving further. I myself will certainly go out of my way to choose Jean's restaurant over the national chain.
How will you position your company in the market? Despite the counterintuitive outcomes presented here, I always prefer to work with companies who don't try to squish up against the competition, but rather defy it completely. If you set your goals low, then you run the risk of achieving them. Better to shoot for the moon and if you miss you'll land among the stars.
If you have any more explanations or have witnessed interesting situations like those mentioned in this article, I would love to hear from you.
(1) This will be covered more in another article, but for now, Peter Thiel covers the topic well in his book Zero to One. Check it out if you need inspiration to stand out from the pack rather than simply mold yourself in its image.
(2) Go to Google maps and count the Giant stores near the intersection of Highway 550 and West Broadway Ave in Bloomfield, NM.
(3) Δ is pronounced "delta" and is often used in mathematics to represent "difference".