The Role of Spatial Demand on Outlet Location and Pricing

52 Pages Posted: 4 May 2006

See all articles by Jason A. Duan

Jason A. Duan

University of Texas at Austin

Carl F. Mela

Duke University - Fuqua School of Business

Date Written: November 21, 2006

Abstract

In this paper we consider the problem of outlet pricing and location in the context of unobserved spatial demand. Our analysis constitutes a scenario wherein capacity-constrained firms set prices conditioned on their location, demand and costs. This enables firms to develop maps of latent demand patterns across the market in which they compete. The analysis further suggests locations for additional outlets and the resulting equilibrium effect on profits and prices.

Using Bayesian spatial statistics, we apply our model to seven years of data regarding apartment location and prices in Roanoke, Virginia. We find spatial covariation in demand to be material in outlet choice; the 95% spatial decay in demand extends 7.5 miles in a region measuring slightly over 9.5 miles. We further find that capacity constraints can cost complexes upwards of $193 per apartment. As predicted, price elasticities and costs are biased downward when spatial covariance in demand is ignored. Using our analysis to suggest locations for entry, we find that a proper accounting of spatial effects and capacity constraints leads to an entry recommendation that improves profitability by 66% over a model that ignores these effects.

Keywords: Outlet Location, Pricing, Spatial Statistics, Structural Models, Competition

JEL Classification: L1, R3, C5, D4

Suggested Citation

Duan, Jason A. and Mela, Carl F., The Role of Spatial Demand on Outlet Location and Pricing (November 21, 2006). Available at SSRN: https://ssrn.com/abstract=899312 or http://dx.doi.org/10.2139/ssrn.899312

Jason A. Duan

University of Texas at Austin ( email )

2317 Speedway
Austin, TX 78712
United States

Carl F. Mela (Contact Author)

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7767 (Phone)

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