Retail Clusters in Developing Economies

We develop a game-theoretic model to explore why retail clusters are so popular in developing economies and when governments should facilitate the formation of retail clusters to improve social welfare. First, we find two determinants of retailer clusters: the valuation-cost ratio (consumers’ maximum valuation over retailers’ production cost) and retailer density (the number of retailers over unit transportation cost). The valuation-cost ratio and retailer density indicate retailers’ profit potential and competition intensity, respectively. Second, the equilibrium cluster size increases in the valuation-cost ratio. This finding explains the phenomenon that clusters are usually larger in developing economies (where numerous retailers sell unrecognized brands with low profit potential) than in developed economies. Third, when the retailer density of a product market exceeds a certain threshold, the market coverages of clusters overlap with each other (i.e., the overlapping case). Furthermore, when compared with the nonoverlapping case, the equilibrium cluster size in the overlapping case is larger for low-profit-potential products but smaller for high-profit-potential products. Together, valuation-cost ratio and retailer density define four types of clusters: overlapping massive clusters, nonoverlapping large clusters, nonoverlapping small clusters, and overlapping mini-clusters. Finally, the socially optimal cluster size is larger than the equilibrium cluster size, and the gap between these two cluster sizes decreases in the valuation-cost ratio. The online appendix is available at https://doi.org/10.1287/msom.2017.0663 . This paper has been accepted for the Manufacturing & Service Operations Management Special Issue on Value Chain Innovations in Developing Economies.