I have recently re-read my post "Shops shut down but rents still stand firm?". Suddenly, I realize that I may have established a framework for analyzing retail property values based on the economics concept of externality. This framework is not limited to the retail shops on streets like what has been analyzed in the above blog. It is also applicable to all retail shops. Be it located in a shopping mail or on streets.
First, let's revisit the analysis done in the above blog post: "The value of a retail property ... depends crucially on the business revenue that can be generated from the shop. ... rarely do we observe that next to a coffee shop is also a coffee shop though it may be a restaurant. The reason should be clear: a new coffee shop owner doesn't want to open a shop so close to an existing coffee shop such that potential clients are spread. ...
"In fact, the situation is even more complicated and the logic is not strict. Unlike coffee shops, sometimes we find bubble tea shops are clustered together on the same street or even next to each other. Why don't they fear that each shop steals business from each other?
"On the one hand, clients come and go quickly for bubble teas. Seats are not offered while the consumers also don't need seats. As such, each bubble tea shop will not occupy their clients for long. The clients actually flow in from everywhere nearby. A coffee shop will fear that their clients will be occupied by another shop next to them. But bubble tea shops won't fear because the former type of shops occupies the limited number of clients for quite a while but the second type won't.
"On the other hand, clustering may generate a promotion effect that attracts clients wanting bubble teas to come to a specific area, which bring more clients than without clustering.
"Now, you can see: the values of retail properties depend on many factors and can't be easily assessed. It is much more complicated to evaluate a retail property..."
In the analysis above, externality is the key factor involved. Externality is not explicitly mentioned above but it is implicitly used.
What is externality? It refers to situations where a party takes certain actions that affect another party. The affected party does not take the action to affect oneself. It is another party that takes the action. So, from the affected party's perspective, the effect is out of control. It is external to this party.
Now, in above, the coffee shop 1's business is affected coffee shop 2's business. Coffee shop 1 can't affect coffee shop 2's actions. In this, the externality is negative as each affects another's business negatively. In the example of bubble tea shops, the effect may be positive if a cluster of bubble tea shops in the same area attracts more people to come. There is a positive externality in this case.
When we mention externalities, normally the example used is pollution, etc. But my analysis above shows that retail shops also create externalities to each other.
Yet, the externality is not limited to shops on the streets. Think about a large shopping mall. There are some shops in a mall that is normally considered to be anchor tenants. For example, a big ice rink can attract a lot of players to go skating on it. Perhaps a 3D movie theater can also attract a lot of visitors. For local shopping mall, perhaps a huge supermarket can have the same influence: people go to the mall because this store is located there.
The point is: while anchor tenants attract visitors to go the mall, these visitors will not simply visit the anchor stores only; they will also visit other stores in the same mall, such as its restaurants, fashion shops, etc. The anchor tenants bring more clients to other stores in the same mall. They generate positive externalities.
Meanwhile, if there are too many restaurants of the same type in the same shopping mall, they may simply compete for the same pool of clients. Each restaurant can't have much business. This is a negative externality case.
So far, it looks not so different from what we have described about street shops: both involves shops affecting each other's businesses. But there is a big difference.
There is a "central planner" in the shopping mall while there is none for street shops. The landlord owns all shopping spaces in a mall and so can decide to incorporate anchor tenants into the mall, and avoid renting spaces to shops selling too similar products. This can help the whole mall earn a maximum amount of businesses and rents.
Street shops are separately owned by different landlords, however. Each landlord decides which tenant can rent the shop. There is normally not a single landlord to own all shops along the same street and so no "central planner". In this situation, deliberately introducing an anchor tenant to a street will not be done. Yes, when coffee shop 1 is already located, coffee shop 2 will not come to the same street, avoiding the negative externality. But perhaps coffee shop 2 is more suitable for this street. But it will be scared off by the early arrival of coffee shop 1. There is no "central planner" who will coordinate and choose the most valuable shop for a street.
Hence, in a shopping mall, the landlord makes use of the externalities generated between the stores in the same mall to decide a mix of stores so as to maximize the benefit. On a street, the externalities just happen. No design, no coordination, no organization. The retail value of the whole street can't be expected to be maximized.
Of course, I won't say street shops are worse than mall stores. The advantages of street shops are convenience. People just pass. They don't need to enter a covered space with doors. Passenger flows are normally higher on popular streets than popular malls. Hence, street shops can survive and even thrive. The point is: the retail value on the whole may not be maximized. Of course, no one cares as each landlord will care only about the value for one's own shop, not the value on the whole.
Economists care about value on the whole. They say it is inefficient if the value on whole is not maximized. Though inefficient, we also may not need to worry about the situation of street shops. The inefficiency is a static phenomenon, or the situation for a point of time. Sometimes we may wish to take a dynamic perspective.
Street shop ownership is not concentrated. Each landlord decides which tenants can rent. As such, it is closer to a free entry situation than shopping mall, whose landlords have a much tighter control for which tenants can come. Therefore, street shops have more diversity and can catch up with market changes more easily.
Yes, what people want may change over time. It may need to be discovered by entrepreneurs. It is not a fixed list simply awaiting for retailers to supply. From this perspective, we should value the mechanisms that are more flexible and responsive to market changes.
Shopping mall landlords may be smart and can be responsive to market changes quickly. But they cannot be more market-responsive than millions of the individual landlords of street shops taken together, with each having one's own market shrewdness. That's a notable advantage of free market. But of course mall owners will also learn from the streets. When what are popular become clear on the streets, shopping malls sooner or later will also introduce them into the malls.
So, you can see: the efficiency and inefficiency of mall versus street in static and dynamic aspect are actually complementary to each other.
