Retail Clusters in Developing Countries

Abstract

A retail cluster refers to a collection of horizontally differentiated retailers of a particular business sector locating in close proximity. Retail clusters are commonly seen in developing countries. In this paper, we develop a game-theoretic model to explore why the retail cluster phenomenon is so popular in developing countries and how the governments in these countries can foster retail clusters and leverage them to improve social welfare. Our model captures two salient characteristics of developing countries – product fit uncertainty and transportation cost. We classify retailers into two types (mainstream and niche retailers) and study their incentives to join a cluster. We find that there are only two types of retail clusters possible in equilibrium: a grand cluster where all retailers locate together or a niche-only cluster where only niche retailers locate together. More importantly, we show that the government can improve social welfare through mandating the physical location of the cluster. Our findings suggest that when the unit misfit cost or the unit transportation cost is medium, the preferences of retailers and the government are misaligned and thus government intervention is necessary. Specifically, retail clusters are preferred under a larger range of market conditions under such government intervention.