08 Jun 2012  Working Papers

Location Choices Under Strategic Interactions

Executive Summary — How do firms decide their location when expanding geographically? This paper explores how strategic interaction among competitors affects firms' geographic expansion across time and markets. HBS professor Juan Alcacer builds a model in which two firms that differ in their capabilities enter sequentially into two markets with different potentials for profit. The model is solved using game theory under three learning scenarios that capture the ability of a firm to transfer its capabilities across markets: no learning, local learning, and global learning. Three equilibrium strategies emerge: accommodate, marginalize, and collocate. Alcacer identifies how these strategies are more or less likely to emerge depending on three parameters: initial relative firm capabilities, relative market profitability, and learning rates. For managers, the paper illustrates different ways that firms can use location choices across time and geographic markets as a tool to enhance or preserve their competitive position within an industry. Key concepts include:

  • Strategic interaction affects how firms locate. It is crucial to look beyond location traits and firm traits to consider the complex and critical influence of strategic interaction.
  • The lens of strategic interaction helps explain not only one location decision at a point in time, but also a set of location decisions across time.
  • A firm's operations abroad are an important source of sustainable competitive advantage in oligopolistic competition.
  • This paper also provides a theoretical framework for understanding the mechanisms and constraints emerging from competition in product markets that regulate the number of contacts between firms across markets.

 

Author Abstract

The literature on location choices has mostly emphasized the impact of location and firm characteristics. However, most industries with a significant presence of multi-location firms are oligopolistic in nature, which suggests that strategic interaction among firms plays an important role in firms' decision-making processes. This paper explores how strategic interaction among competitors affects firms' geographic expansion across time and markets. Specifically, we build a model in which two firms that differ in their capabilities enter sequentially into two markets with different potentials for profit. The model is solved using game theory under three learning scenarios that capture the ability of a firm to transfer its capabilities across markets: no learning, local learning, and global learning. Three equilibrium strategies arise: accommodate, marginalize, and collocate. We identify how these strategies emerge depending on the tradeoff between the opportunity costs of absence (giving competitors a lead in a market) and the entrenchment benefits (the cost advantage firms develop through learning-by-doing when they enter early). Both the opportunity costs of absence and the entrenchment benefits vary according to initial relative firm capabilities, relative market profitability, and learning rates. Our model offers a comprehensive approach to understanding the drivers of firm location choices by modeling not only the impact of location and firm heterogeneity, but also the strategic interaction among firms.

Paper Information