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HotellingsLaw

ByDavidB.Ridley

February2011draftpreparedforthePalgraveEncyclopediaofStrategicManagement,editedbyDavid

TeeceandMieAugier

Abstract(

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AtthetimeHotellingintroducedhismodel,theprevailingeconomicthoughtwasthatduopolywas

fragile,becauseasmallpricecutbyonefirmwouldcapturetheentiremarket.However,thisthought

wasinconsistentwithreality,accordingtoHotelling,becausesomebuyfromoneseller,somefrom

another,inspiteofmoderatedifferencesofprice(Hotelling1929,page41).

Hotellingmodeledthewayinwhichfirmssharethemarket.Heusedasimplemodelinwhich

consumersareevenlydispersedalongalineandbuyfromthenearestfirm.Thetwofirmschooseto

locateatthemidpointoftheline.Afirmthatunilaterallymovesawayfromthemidpointloses

marketshareandprofit.

However,whenathirdfirmisaddedtothemodelthereisnoequilibrium(Chamberlin1933).Ifthere

arethreefirmsclusteredatthemidpoint,thefirminthemiddlehasanincentivetomovetothe

outside.Thesimplemodelalsofailstoaccountforstrategicpricing.Whenfirmschoosebothpriceand

location,firmsmoveaparttodecreasepricecompetition(D'Aspremontetal.,1979).

Hotellingsmodelhasbeenenhancedbytheinclusionofpricecompetition.Whilepricecompetition

intensifieswhenfirmscolocate,theintensitycanbediminishedbydifferentiationofproduct

characteristics(Piconeetal.2009).Infact,itmaybesufficienttodifferentiateinonlyonedimensionof

productspace.Newhotelsoftenenteratsimilarpricepointsbutdifferentsizesrelativetothose

aroundthem(Baum1997).

WhileinHotellingsmodelfirmscolocatetoattractconsumerswithtransportationcosts,competing

explanationsemphasizespilloversandotherfactorsdrivingcolocation.Onthesupplyside,firmsco

locatetodecreaselaborandotherinputcosts(Marshall1920),learnfromotherfirmshowtoimprove

productivity(ShaverandFlyer2000),learnaboutdemandfromotherfirms(Ridley2008),andbecause

spinoffssometimeslocatenearparentfirms.Onthedemandside,firmscolocatetoattractconsumers

searchingforoptimalproductcharacteristics,toprovideacrediblecommitmenttolowprices,to

locatenearconsumersattractedbythemarketingorreputationofcompetitors,toconferlegitimacy

(Deephouse1999),andbecauseconsumersareconcentrated.Foraliteraturereviewofagglomeration

economies,seeRosenthalandStrange(2004).

Despitesomeshortcomingsoftheoriginalmodel,Hotellingskeyinsightsendure.First,businesses

tendtolocatenearrivals,despitepricepressures.Second,inmanysectors,competitionislocaland

smallpricechangesdonotnecessarilycauseadramaticmovementofconsumersfromonefirmto

another.

References:

Baum,J.A.andH.A.Haveman.1997.Lovethyneighbor?Differentiationandagglomerationinthe

Manhattanhotelindustry,18981990.AdministrativeScienceQuarterly42(2),304339.

Chamberlin,E.H.1933.Thetheoryofmonopolisticcompetition:areorientationofthetheoryofvalue.

Cambridge,MA:HarvardUniversityPress.

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D'Aspremont,C.,J.J.Gabszewicz,andJ.F.Thisse.1979.OnHotelling'sstabilityincompetition.

Econometrica47(5),11451150.

Deephouse,D.L.1999.Tobedifferent,ortobethesame?Itsaquestion(andtheory)ofstrategic

balance.StrategicManagementJournal20(2),147166.

Hotelling,H.1929.Stabilityincompetition.EconomicJournal39(153),4157.

Marshall,A.1920.PrinciplesofEconomics.London:Macmillan.

Picone,G.A.,D.B.Ridley,andP.A.Zandbergen.2009.Distancedecreaseswithdifferentiation:strategic

agglomerationbyretailers.InternationalJournalofIndustrialOrganization27(3),463473.

Ridley,D.B.2008.HerdingversusHotelling:marketentrywithcostlyinformation.JournalofEconomics

andManagementStrategy17(3),607631.

Rosenthal,S.S.andW.C.Strange.2004.Evidenceonthenatureandsourcesofagglomeration

economies.InHandbookofRegionalandUrbanEconomics,vol.4,editedbyJ.Vernon

HendersonandJacquesFranoisThisse,chap.49.Amsterdam:Elsevier,21192167.

Shaver,M.J.andF.Flyer.2000.Agglomerationeconomies,firmheterogeneity,andforeigndirect

investmentintheUnitedStates.StrategicManagementJournal21(12),11751193.