1. The Locational Aspects of Business There are 3 theoretical constructions used by business professionals to analyze, explain & predict the location and market areas of businesses 1. Central Place Theory which explains the geographical extent (the boundaries) of businesses’ market areas and the spacing of businesses

2. The Locational Aspects of Business … 3 theoretical constructions … 1. Central Place Theory -- which 2. Reilly’s Law of Retail Gravitation -- which provides a model for calculating the geographical boundaries of businesses’ market areas between/among competing businesses

3. The Locational Aspects of Business … 3 theoretical constructions … 1. Central Place Theory -- which … 2. Reillly’s Law of Retail Gravitation -- which … 3. the Huff Model -- which provides a model for calculating the probability that shoppers in a market area will patronize a particular store given that there are competing stores in the area We will consider each in turn over the next few lectures

4. Central Place Theory What does it do? Explains (and can predict): 1. the locations of businesses 2. the geographic extent (the size) of their market areas 3. the geographic arrangement (a hierarchical pattern) of various businesses’ market areas.

5. Central Place Theory The Central Place: Definition: the Central Place is a market center for the exchange of goods and services by/among people from the surrounding area. This market center is called a central place because it is centrally located in the area … … in order to maximize the accessibility of customers (to the central place) from the surrounding area

6. Central Place Theory The Central Place: Maximizing accessibility is based on the Principle of Minimizing Transportation Costs A matter of minimizing transportation costs for the maximum number of customers coming to the market center Thus, the “best” location for businesses is at the center of the market (all roads lead to the village: the “central place”) more about this later

7. Central Place Theory Minimizing transportation costs is the feature that defines the geographical extent (the size) of a central place’s market area Customers who come from greater distances incur greater transportation costs Thus, as transportation costs increase, demand for the product decreases (because total costs for the good = product price + transportation price)

8. Central Place Theory Minimizing transportation costs … defines the … market area … greater distances … greater transportation costs … transportation cost increases, demand for the product decreases … The geographical extent (size) of the market area is the point at which total price cancels out demand (where demand is reduced to 0 because of the increased price of the good (product price + transportation price)

9. The next few slides demonstrate, graphically, the method – and the economic foundations- used by Central Place Theory to determine the geographical extent of the central place’s market area Later, we’ll see how this is extended to determine the spacing of businesses

10. Price Demand Price Supply P1 P2 Q1Q2 Q1Q2 P1 P2 D S Price Quantity Pe Qe DS Supply, Demand and Equilibrium Price Demand Curve Supply Curve Equilibrium Price The supply/demand equilibrium without transportation costs The familiar treatment of price/demand relationships

11. Deriving the geographical extent (size) of the Market Area from the Supply/Demand Equilibrium Quantity P1 Q1 P2 Q20 P3 Distance Quantity Q1 P1 Q2 P2 P3 P1 P2P2 P3 Distance 0 A B C Price On the Left: transportation costs increase the price (P1 to P2) and reduce quantity demanded (Q1 to Q2)

12. Deriving the Market Area from the Supply/Demand Equilibrium Quantity P1 Q1 P2 Q20 P3 Distance Quantity Q1 P1 Q2 P2 P3 P1 P2P2 P3 Distance 0 A B C Price In the center, take the reduction in quantity demanded associated with the increased costs (from the graph on the left) and plot them (on the X Axis) against increments of price increases (due to distance from the market center) until quantity = 0

13. Deriving the Market Area from the Supply/Demand Equilibrium Quantity P1 Q1 P2 Q20 P3 Distance Quantity Q1 P1 Q2 P2 P3 P1 P2P2 P3 Distance 0 A B C Price On the right, rotate the graph 90 degrees so that you are looking down on the Y-axis, and you now have a view of the geographical extent of the market area

14. This is another view (all in one step) of deriving the geographical extent of the market area Distance Quantity Q1 P1 Q2 P2 P3 0

15. Having determined the geographical extent of the market area, we can now turn to the spacing of businesses. This draws upon the same principles we just used. We will have to return to this geographical extent exercise a bit later (once we have the spacing established, and can consider multiple –competing- businesses) in order to rectify some problems with the circular shape in systems of market areas

16. The spacing of businesses is determined by the geographical extent (size) of the market area a.k.a. the “range” of a good)

17. The geographical limit one business’ market area is the boundary of an adjacent market area in which some competing business has a price advantage

18. Since the competing business faces the same production and transportation costs, it has a geographical extent to its market area that is equal to that of the first business

19. Thus, the spacing of competing businesses, who do not share a market area, is … twice the range of the good divided by 2

20. Having determined the market areas and the spacing of businesses, … … we now turn to rectifying the problem of circular shape of market areas in a system having multiple – competing- businesses

21. the circular form of businesses’ market areas derived above are not geographically optimal because … … a system of circular market areas leaves some “gaps” (some customers/areas are “unserved”)

22. The gaps in a system of circular market areas (diagram on the left) can be removed by reducing the distance (spacing) between businesses, but this results in an overlap of businesses’ market areas (diagram on the right)

23. The overlap in circular market areas yields to the principle of minimizing total costs to the customer (as above), thus, the market is “divided” at the circles’ intersections, and the optimal (“least cost to the most customers, with all customers served”) market area is a HEXAGON” Note: marketing and management professionals commonly use circular market areas when conducting analysis without customer location data … the problems noted here can be avoided by geocoding (lecture/lab 2) customers to produce “actual” market areas

24. Since there area many goods, and many businesses, there area many market areas, and since...... each good has its own range (the geographical extent of its market area – the distance that a customer will travel to purchaes it), thus....... goods, and businesses, have multiple market areas, and...

25. ... many goods... many businesses...many market areas,...... each... its own range (... geographical extent...), thus....... businesses... multiple market areas, and... thus market areas for inexpensive goods (“low order”) goods are “nested” within the market areas of expenisve (“high order”) goods thus, the business landscape is characterized by market areas that are intermingled hierarchically, at multiple scales, with multiple - but regular - patterns of spatial organization

26. The Nested Hierarchy of Market Areas

27. The analysis of business’ market areas, then, must be sensitive to the price/quantity relationships of the mix of goods, and to … … the ranges of the mix of goods (their differences in the geographical extent of the market area(s)), … … both of which are peculiar/particular to the geodemographic characteristics of customers residing within the (complex, nested) market area(s) end

29. Central Place Theory The Market Area: Definition: The market area of the central place is that area surrounding the central place from which people come to exchange goods and services (a.k.a. the “hinterlands” or the “trade area”)

30. Central Place Theory The Market Area: The area surrounding the central place is its market area (a.k.a. the “hinterlands” or the “trade area”) The geographical extent (size) of the market is determined by the range of the business’ product Range = the maximum distance customers will travel to purchase the business’ product customers are not willing to travel long distances for everyday products customers are willing to travel long distances for specialty products