Spatial Economics- Why trade area’s will get smaller and Walmart might miss out.

The idea behind this post originally came from the question of how important gas stations and convenience stores were to small towns. And if the proximity to highways had the same impact in the 21st century as it did in the 20th. Anyways, those are questions that I shall address in a later post.

First up, a definition on spatial economics from Professor Gilles Duranton, “In a nutshell, spatial economics is concerned with the allocation of (scarce) resources over space and the location of economic activity. Depending on how this definition is read, the realm of spatial economics may be either extremely broad or rather narrow. On the one hand, economic activity has to take place somewhere so that spatial economics maybe concerned with anything that economics is concerned about. On the other hand, location analysis focuses mostly on one economic question, namely, location choice. This is only one decision among a large number of economic decisions.”

National retailers had a simple structure when it came to expanding in the 50’s and early 60’s- don’t go into towns with a population less than 10,000. National retailers back then couldn’t fathom how they could make profits in smaller towns and decided the best approach would be to franchise out, but then something or rather someone changed that. When Sam Walton decided to upend the traditional thought and open a Walmart in a town in Arkansas that had a population of 5,000. Walmart seemed to get, what most companies at the time didn’t. If you built up the right balance between convenience, loyalty and prices you could be profitable in even the smallest of towns. True, when President Eisenhower’s dream since he was Captain Eisenhower to get the government to increase spending on roadways was realized with the passing of the federal aid highway act, it helped reduce transportation costs (by how much is unclear). Since the 60’s Walmart started opening up stores closer to one another to cut down on transportation costs from distribution centers, which had the added benefit of fostering a company culture that was easy to spread. But Lately Walmart has gone on to close down 154 stores, most of them in low density and lower income areas. This isn’t a critique of Walmart’s approach but to draw comparison to how things have changed since the 60’s when these are exactly the kind of areas Walmart would look at when chalking out its expansion plans. So how does this relate to Walgreens and rapid technological progress (mainly 3-D printers)?

If one were to believe that the potential of 3-D printers would be realized, it would lead to a drastic change in the current supply chains. A Bain & Company report argues the same. While I don’t imagine the current population clusters to change as drastically as the report suggests. I do find myself agreeing on how the growth in 3-D printing and other platforms could change supply chains massively. Highways didn’t stop the positive trend in urbanization even though they did reduce transportation costs and make it much more easier to stay put. Similarly, new technologies won’t cause the trend of aggregating in high density areas to stop. Supply chains might change drastically, but residual demand and value chains still prefer larger population clusters. If 3-D printing could bring manufacturing units closer to customers as they are projected to, they could not only change current supply chains, but also reduce the benefit of rent seeking when it comes economies of scale. Which brings us back to the title and why I think trade area’s in the future might be getting smaller. If transportation costs decline and distribution networks continue to rapidly evolve, it would lead to a situation where trade areas might get smaller. Stores such as HEB (Texas) and Walgreens are better suited to adapt to the new technological growth even as many brick and mortar stores are closing down.

A typical Walmart draws its customers from a 15 mile radius compared to a Walgreens or CVS which tend to draw customers from a smaller radius; on average around 5 miles. What HEB/Walgreens/CVS have going for it is convenience. Winning in the future would most likely relate to speed. The speed of a retailer to change its products to meet customers ever changing taste. The smaller stores like Walgreens have a distinct advantage here with their smaller trade area and the ability to cater to their distinct and smaller customer base. The only drawback one might have with stores like Walgreens and CVS would be that their front end’s rely heaving on big boxers like Walmart for supply. Around 80% by certain estimates. Their back end (prescriptions) aren’t as vulnerable, but Walmart is slowly catching up to the point where it’s third in prescriptions filled. A grocery chain like HEB is perfectly suited to weather the storm that new technological growth might bring. Its trade radius is significantly smaller than Walmart or any other grocery chain in Texas. HEB stores are also smaller and hence better able to tailor their stores to the needs of their customers. Regardless of how much distribution networks change there will always be a demand for traditional brick and mortar stores, especially when it comes to groceries. Technological growth and its possibilities have had unexpected results, but I don’t see traditional grocery chains going out of business any time soon. I just don’t see a future where there will still be a need for the scale of stores that retailers like Walmart operate.

Next up: will a reduction in production costs due to technological growth translate to greater investment in R&D?

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