When I was still a student in Cape Town, I was intimately acquainted with the stretch of N1 highway between Cape Town and Johannesburg. Over the years, I’d spent a lot of time at roadworks, staring out at the Karoo, waiting. There was one memorable trip at the end of my first year where I was worried that I didn’t have enough money for both refuelling and eating. Which was horrifying because it was true – and that entire trip, I ate nothing but the sausage rolls that my friend’s mom had given me as padkos.

But that aside, the point is that I always stopped to refuel at the same places:

  1. The Shell Garage at Worcester
  2. The Total at Beaufort West
  3. The Engen at Colesburg
  4. The Caltex Star Stop at Bloemfontein
  5. And occasionally, the Star Stop at the Kroonvaal Plaza toll gate.

Here’s the thing though: in Beaufort West, there is also an Engen and a BP. In Bloemfontein, there’s also a Shell Ultra City and a Total.

In fact, almost every garage en route is surrounded by all the other brands of garages. And does that really make sense? Like, why aren’t they more spread out?

And that’s not unique to petrol stations:

  • Shopping centres often have two or three of the major supermarket chainstores.
  • There are roads that are filled with nothing but second-hand bookstores.
  • Places like London and New York have flower-selling districts, and shoe districts, and diamond districts – where all the sellers flock together and then bombard you with pleas and promises.
  • And then you get markets that are filled with stalls all selling the same varieties of spice.

Doesn’t it seem strange that this should happen? As in: surely it would be better if each store were far from the others, and could create their own mini-geography-monopolies…

Apparently not.

The Game Theory Approach

Some economists explain this thus:

  • All gas stations are out to capture the largest share of the market.
  • Any one gas station will try and find the best place to locate itself, so that it gets the largest possible number of cars coming to fill up.
  • All the other gas stations will try to do the same thing.
  • If one gas station finds a spot that drivers seem to like (Beaufort West, for example – where drivers are reaching the point of fuel desperation), then it will do well.
  • At which point, all the other gas stations will relocate nearby, because that’s where the customers are. Which results in all the gas stations in the same vicinity.
  • And if a petrol station does badly in a particular spot then it will close, and the other gas station-owners will celebrate their competitor’s foolishness by not moving nearby.

Which seems reasonable.

But there is another (possibly) more intuitive reason…

Why Being Close To Your Competition Is Often Good For Business

Let’s look at another example: shopping malls.

You might look at that concentrated mass of clothing stores and wonder whether they aren’t being unnecessarily competitive. But at the same time, you’d never expect a solitary clothing store in a small centre to do as well as a similar-sized store in a large mall.

The obvious reason: shopping malls get more traffic. That is, the clustering of competition makes sense because people know where to go.

If I want to buy clothing, I go to the mall. If I want to browse for something to read when I’m in London, I go to Tottenham Court Road. If you’re a wedding planner in New York arranging lilies for a bouquet, you go to the flower district.

Clustering of competition is good for volume business. You might be able to charge higher prices if you were a small jewellery store out in the suburbs; but the diamond seller in New York’s jewellery district is going to get plenty of traffic coming through his door.

And usually, it’s better to sell five necklaces at a $100 profit each, than one necklace at a $200 profit.

So now you know.

For more, listen to this Planet Money podcast: Episode 128: Friend or Foe?

And/or read this article: “Why Gas Stations Are So Close To Each Other

Rolling Alpha posts about finance, economics, and sometimes stuff that is only quite loosely related. Follow me on Twitter @RollingAlpha, or like my page on Facebook at www.facebook.com/rollingalpha. Or both.