HotellingsLaw ByDavidB.Ridley February2011draftpreparedforthePalgraveEncyclopediaofStrategicManagement,editedbyDavid TeeceandMieAugier Abstract(<100words): AccordingtoHotellingsLaw,competitorstendtoimitateeachotherinbusinesslocation,product characteristics,andotherways.HotellingsLawisillustratedwithtwofirmscolocatingatthemid pointofaline.Thecolocationmaybeintermsofbusinesslocationorproductcharacteristics.A commoncritiqueofHotellingsmodelisthatitomitsstrategicpricingwhichpushesfirmsapart. Nevertheless,Hotellingskeyinsightsremain:firmsfrequentlychoosetolocatenearcompetitors,and smallpricechangesdonotdriveallconsumerstoonefirm. Definition(<60words): AccordingtoaseminalpaperbyHaroldHotelling(1929),themostprofitablelocationisinthemiddle nexttoacompetitor.

Crossreferences: differentiation industrialeconomics

Keywords(indexterms): agglomeration linearcity location principleofminimumdifferentiation

AccordingtoHotellingsLaw,thereisanunduetendencyforcompetitorstoimitateeachotherin qualityofgoods,inlocation,andinotheressentialways(Hotelling1929).Thelawisnamedafter HaroldHotelling(18951973)whodescribedtheideainStabilityinCompetition.Hotelling'sLawis alsoreferredtoastheprincipleofminimumdifferentiationorHotelling'slinearcitymodel. HotellingsLawexplainswhyretailersandrestaurantssooftenlocatenearoneanother.Theclassic exampleisicecreamvendorslocatingnearoneanotheronabeach. Notonlyarebusinesslocationsminimallydifferentiated,butsotooareproductsandpoliticians.In twopartyelections,eachpartystrivestomakeitsplatformasmuchliketheothersaspossible (Hotelling1929,page54).

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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