Politics from the Palouse to Puget Sound

Monday, March 10, 2008

Hotelling and Hawkins

In his Town Crier column last Wednesday, Chris Lupke wrote that:
A mall on the Idaho border with no promise of tax revenue won't help our parks or police and won't pave our streets. But what it will do is permanently situate the retail center in and near Moscow, miles from Pullman. Better negotiators could have insisted it be sited closer to our retail base.
Lu Laoshi may be a "national expert" in Chinese and Chinese culture, but he doesn't know jack about the economics of retail.

Some 80 years ago, economist Harold Hotelling devised an analogy to explain the spatial functioning of the marketplace.

His analogy became known as "Hotelling's Model":


Suppose there is a beach which is 100 yards long. Assume beachgoers are spread evenly across the length of the beach. Along come two ice cream vendors. The vendors are selling product of similar quality and price (ceteris paribus.) Logically, the layman would expect the vendors to place their carts at the 25 and 75 yard lines of the beach, thus allowing for an equal division of profits and providing the greatest convenience to beachgoers, as no one would be more than 25 yards from an ice cream cart.

However, one vendor will recognize that by relocating closer to the midpoint of the beach he can achieve an increase in market share. So, on the illustration above, the vendor at Position A will move his cart to the 30 yard line, increasing his market share to 52 1/2 %. The vendor at Position C will compensate by moving his cart to the 70 yard line. This continues as both vendors move incrementally towards the middle of the beach. Eventually, both vendors' carts are at Position B, right next to each other. They have achieved economic equilibrium, with each having a 50% market share.

Hotelling's Model, as you might guess, is very sensitive to cost assumption. There must be some cost to traveling because customers prefer the closest vendor. But these costs must be small, because the people at the end of the beach continue to buy the same amount no matter how far they are from the nearest vendor. If traveling costs are less, then people might not care whether they go to the nearest vendor. If they are greater, so that when the vendor gets far away, people do not bother to go, the vendors will no longer cluster at the middle.

Pullman residents, being six miles away from Hawkins, have negligible traveling costs. Travel costs for Moscow residents are even less. Put the shop in the middle, the customers will come, especially if there is already other retail clustered there. That explains why Hawkins chose the location it did. All very logical and very much in accord with economic principles. That is why the Pullman/Moscow corridor is a potential gold mine.

14 comments:

Scott M. said...

Fantastic job, Tom! You really nailed it. Where do you get this stuff?

My only question/concern is if this model is true, why doesn't Wal Mart locate at Hawkins?

April E. Coggins said...

Scott, Wal-Mart could easily locate in the corridor AND in Pullman. A Wal-Mart Supercenter near their current location, but on the Washington side of the border, would make perfect sense. Plus they have already made the commitment to their Pullman location so I don't believe they would start over at this late date.

Some people think that our current population can't support two Supercenters. But big retailers don't build for current retail needs. They build for future/projected needs. If they wait until the market is mature, it is too late. Which makes all this growth in Pullman and Whitman county very exciting. The large national retailers see some very big growth coming and they want to be out in front.

Tom Forbes said...

The Hawkins site would be quite logical for a Wal-Mart. Look at their existing store. It's as close to the ID/WA border as they could get back in 1992.

However, the tremendous infrastructure challenges Hawkins has faced would have been greatly multiplied had Wal-Mart instead of Lowe's been the anchor. There would have been much more opposition. I'm sure Wal-Mart was looking for something that was more of a sure thing with regards to water and stormwater, hence, luckily for Pullman, the Bishop Blvd. location.

But using the Hotelling Model, I think you can make a couple of other points about Wal-Mart in Pullman:

1. The Hotelling Model assumes that travel costs for the customer are minimal. For many of Wal-Mart's target demographics, that is not true. Wal-Mart has seen sales slip as gas prices rise. It is only natural that they would want to be as close to the customer as possible.

2. The Hotelling Model also assumes that selection and prices are the same between vendors. Again, in the case of a Wal-Mart Supercenter, that is not the case. Wal-Mart leads in low prices and has a wide selection of goods literally from soup to nuts and bolts. That affects how far customers are willing to travel. A perfect example in our own region is Costco in Clarkston, which regularly brings in customers from a 50-75 miles radius. So a Pullman location really doesn't make a difference to customers (but it does to our tax base.)

Scott M. said...

Good stuff guys! How come you never read or hear about this in the local media?

And when are you running for the city council Tom?

Tom Forbes said...

Never. Other than two U.S. senators, I am completely satisfied with every elected representative I have from city council through president.

As far as the local media goes, I think its partially bias and partially low-paid, high-turnover, inexperienced reporters.

liam said...

Your argument appears to explain how to maximize the vendors benefit by locating at point B. However, the point of the newspaper article was to maximize the benefit of consumers at point A (Pullman?) and not the vendor at B (Hawkins).
Simply, your argument says nothing about how beachgoers benefit, only the vendor.

In addition, you violate the first assumption of the model, that mobile consumers are spread evenly across the length of the beach,
which is clearly not the case with Pullman and Moscow at the present time.

This brings up a further problem with this model, as it would ultimately lead to a redistribution of beachgoers to point B, in order to minimize their travel costs.
However, this cannot happen here on the Palouse, at least in the forseeable future, as the population centers of Pullman and Moscow are fixed at points A and C.

It is difficult to apply a model to a particular situation, violate it's only assumption, and then state it's usefulness in explaining your argument.

To rebut the argument of the article the required economic model would need to explain how locating a business at a distant point B, rather than point A, is better for
consumers that are fixed at point A. This is difficult as the benefits to the consumer, as defined by the article, are parks, police and paved roads. These benefits are usually paid for by property/sales tax dollars; in this case these are unattainable for Pullman, at least directly, if the business is located outside the city limits.

While the business will attract new employees to the region, I don't know if this indirect increase in tax revenue will offset the direct loss of property/sales taxes
which fund Pullman parks, police etc, which I guess was the point of the article.

Tom Forbes said...

"liam," or I should say Bryan Burke, there is no need to be shy.

Thanks for an evidently well-thought out point. I have to disagree, however.

The area population, while perhaps not evenly spread out through the corridor, is still evenly distributed between Pullman and Moscow, which in my mind makes Hotelling's Model even more applicable.

A word about the corridor. It is the logical location for residential and commerical growth on the Palouse, situated as it is between two major employers and two population centers. The Palouse Mall and Wal-Mart were located as close to the corridor as they could get at the time. Remember, Moscow's population base is on the east side of town. If thos retailers had been strictly targeting Moscow consumers, they would have located by the Eastside Marketplace. Hawkins' choice of locations is not the geographical center between the two towns because they want to be close to this existing retail center and close to the nearest municipal water and sewer service, which is in Moscow.

The only reasons the corridor has not been developed before now are land-use regulations and lack of infrastructure, both of which are changing. In the next 50 years, the corridor will become a population and commercial hub.

As to what is best for the consumer, the Model explains that as long as the travel expenses are minimal, the customers will come. When the travel expenses become too great, they will stop coming. Simple. Customers, in any economic equation, always look out for their own best interest.

But in any case, short of continental drift between Washington and Idaho, travel expenses will remain small unless gas hits $20 or $30 a gallon. 6 miles is hardly "distant" as you claim. PARD members, including Chris Lupke, have repeatedly made this point about the Wal-Mart in Moscow.

I understand you attempting to defend your political ally Chris Lupke, but the point of Lupke's column was not to maximize the benefits to consumers or to Pullman parks, police, etc. Lupke is apparently opposed to all national retailers, despite his claims to the contrary, and was reduced to using our arguments for Wal-Mart in Pullman to oppose Hawkins. It is completely and thoroughly disingenous. See my reponse here. If he (and you for that matter) is so concerned about closeness to consumers and Pullman's sales and property tax base, then he should support a Wal-Mart Supercenter. Of course, he has taken the completely opposite position. I can only imagine what gyrations Lupke will perform should Target or Costco, PARD's red herrings, announce plans to locate at Hawkins. And as always, Lupke and PARD are free to build their own shopping center is they has a better location in mind.

The other question, of course, is if PARD and others were so opposed to Hakwins, where were the petitions, the press conferences, and the legal appeals? Could it be the United Food and Commerical Workers union has no interest in stopping Lowe's and other stores? Lupke is punching at the wind and attempting to appear pithy and relevant (he is neither.) It is too late for him or anyone else to stop Hawkins now.

Interestingly, Hotelling's Model is frequently used in politics to explain why candidates move to the middle in elections to attract voters. Something perhaps you might consider.

Tom Forbes said...

Sorry, my response to Lupke is here.

April E. Coggins said...

I would enjoy "Liam" explaining how Pullman would suffer a "direct loss" of tax revenue because of Hawkins. And keep in mind your implication of consumers free choice also being compromised because of distance to Hawkins and Pullman's shopping area which includes Spokane, Seattle and the Internet. How can shopping in our own county harm us?

April E. Coggins said...

I've exlained this before on this blog but let me do it again.

In the past two years our county has raised sales tax by six-tenths of a percent. If Whitman County wasn't so starved for tax revenue, Pullman's sales tax rate would be 7.2%, instead of 7.8%. That difference makes Pullman retailers less competive. Inflation and new government mandates continue to escalate the we must either raise tax rates or increase the tax base. If we don't start feeding our county, the tax rate will increase, which will make Pullman retailers even less competive. We need to increase our tax base to help the retailer, the consumer and the citizen tax payer.

There are other reasons to welcome large retailers, including more retail traffic equals more sales, but that's a different post.

Tom Forbes said...

Thanks April. That was the point I was going to make. And it is an outright LIE to say that Pullman will get nothing from Hawkins property taxes. We will receive:

$4,207,500 for the Pullman School Distict over the next 20 years. That's hardly chump change, particularly as I heard on KQQQ this morning that a new high school will cost $58 million and we are 3-6 years away from even thinking about that due to our limited tax base and current bond obligations.

$2,174,001 for Whitcom emergency communications over the next 20 years. That's who answers the phone when you dial 911 in Pullman.

$2,050,115 for Washington State schools over the next 20 years. The state pays the Pullman School District $5,000 for each student enrolled.

$1,190,000 for Rural Fire District 12 over the next 20 years. They provide fire and emergency services in rural Pullman, as well as helping out with fires in Pullman like last November 15.

$350,370 for the Port of Whitman County over the next 20 years. The Port Industrial Park in Pullman provides hundreds of living wage jobs for Pullman residents.

You know, Hotelling's Model is jus that. A model. I offered as an explnation as to why retail stores tend to cluster together and why they pick the locations that they do.

In the real world, location decisions depend on retailers' assessment of sales potential, the location of competitors, and the availability of land for development, which depends of land use regulations and landowners being will to sell.

April E. Coggins said...

It's strange to me that people view themselves as residents and taxpayers of Pullman, but not Whitman county. Pullman is every bit a part of Whitman county as the smallest, rural town. Just like Pullman is every bit a part of Washington state as Seattle. We can't seperate ourselves, no matter how hard people try.

The leftists can try to claim that they support the poor of Whitman county, but their posture of anti-commerce reveals the truth. It takes money to lift people out of poverty, not more regulation.

Bryan E. Burke said...

I suspect that "Liam" is a nice person, but I assure you that I am not he or she.

Sincerely,

Bryan E. Burke

P.S. I have always blogged and authored using my real name.

Tom Forbes said...

I'm sure "liam" is a nice guy too...

Anyway, nice column in the Daily News Friday Bryan. I'd like to hear more about taxpayer-funded elections.