Market Areas Analysis

Author: Dr. Jean-Paul Rodrigue

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1. Market Size and Shape

Each economic activity possesses a location, but the various demands (raw materials, labor, parts, services, etc.) and flows it generates also have a spatial dimension called a market area.

A market area is the surface over which a demand or supply offered at a specific location is expressed. For a factory it includes the areas to where its products are shipped; for a retail store it is the tributary area from which it draws its customers.

Transportation is particularly important in market area analysis because it impacts on the location of the activities as well as their accessibility. The size of a market area is a function of its threshold and range:

• Market threshold. Minimum demand necessary to support an economic activity such as a service. Since each demand has a distinct location, a threshold has a direct spatial dimension. The size of a market has a direct relationship with its threshold.
• Market range. The maximum distance each unit of demand is willing to travel to reach a service or the maximum distance a product can be shipped to a customer. The range is a function of transport costs, time or convenience in view of intervening opportunities. To be profitable, a market must have a range higher than its threshold.

In the case of a single market area its shape in an isotropic plain is a simple concentric circle having the market range as radius. Since the purpose of commercial activities is to service all the available demand, when possible, and that the range of many activities is limited, more than one location is required to service an area. For such a purpose, an hexagonal-shaped structure of market areas represents the optimal market shape under a condition of isotropy. This shape can be modified by non-isotropic conditions mainly related to variations in density and accessibility.

2. Economic Definition of a Market Area

A market depends on the relationship between supply and demand. It acts as a price fixing mechanism for goods and services. Demand is the quantity of a good or service that consumers are willing to buy at a given price. It is high if the price of a commodity is low, while in the opposite situation - a high price - demand would be low. Outside market price, demand can generally be influenced by the following factors:

• Utility. While goods and services that are necessities (such as food) do not see much fluctuation in the demand, the demand for items deemed of lesser utility (even frivolous) would vary according to income and economic cycles.
• Income level. Income, especially disposable income, is directly proportional with consumption. A population with a high income level has much more purchasing power than a population with a low income.
• Inflation. Involves an increase in the money supply in relation to the availability of assets, commodities, goods and services. Commonly the outcome of an indirect confiscation of wealth through an over-issuance of currency ("money printing") by central banks and governments. Although it directly influences prices, inflation is outside the supply-demand relationship and decreases the purchasing power, if wages are not increased accordingly.
• Taxation. Sale and value added taxes can have an inhibiting effect on sales of goods and services as they add to the production costs and claim a share of consumer's income.
• Savings. The quantity of capital available in savings can provide a potential to acquire consumption goods. Also, people may restrain from consuming if saving is a priority, namely in periods of economic hardship. The wide availability of credit in a fiat currency system has considerably skewed the relationships between savings and consumption as it promotes current consumption levels, but at the expense of future consumption.

Supply is the amount of goods or services, which firms or individuals are able to produce taking account of a selling price. Outside price, supply can generally influenced by the following factors:

• Profits. Even if the sales of a product are limited, if profits are high an activity providing goods or services may be satisfied with this situation. This is particularly the case for luxury goods. If profits are low, an activity can cease, thus lowering the supply.
• Competition. Competition is one of the most important mechanisms for establishing prices. Where competition is absent (an oligopoly), or where there is too much (over-competition), prices artificially influence supply and demand.

According to the market principle, supply and demand are determined by the price, which is an equilibrium between both. It is often called equilibrium price or market price. This price is a compromise between the desire of firms to sell their goods and services at the highest price possible and the desire of consumers to buy goods and services at the lowest possible price.

For many economists, the market is a point where goods and services are exchanged and does not have a specific location, since it is simply an abstraction of the relationships between supply and demand. It is important to nuance in this reasoning since most of the time consumers must move in order to acquire a good or service. The producer must also ship a commodity to a place where the consumer can buy it, be at the store or at his/her residence (in the case of online shopping). The concept of distance thus must be considered concomitantly with the concept of market. In those conditions, the real price includes the market price plus the transport price from the market to the location of final consumption.

3. Competition over Market Areas

Competition involves similar activities trying to attract customers. Although the core foundation of competition for a comparable good or service is price, there are several spatial strategies that impact the price element. The two most common are:

• Market coverage. Activities offering the same service will occupy locations in view to offer goods or services to the whole area. This aspect is well explained by the central place theory and applies well for sectors where spatial market saturation is a growth strategy (fast food, coffee shops, etc.). The range of each location will be a function of customer density, transport costs and the location of other competitors.
• Range expansion. Existing locations try to expand their ranges in order to attract more customers. Economies of scale resulting in larger retail activities are a trend in that direction, namely the emergence of shopping malls. Taken individually, each store would have a limited range. However, as a group they tend to attract additional customers from wider ranges for many reasons. First, a complementarity of goods or services is offered. A customer would thus find it convenient to be able to buy clothes, shoes and personal care products at the same location. Second, a diversity of the same goods or services is offered even if they compete between one other. Third, other related amenities are provided such as safety, food, indoor walking space, entertainment and also parking space.

Making market area competition models operational has been the object of numerous approaches. The early work of Hotelling (1929) with his principle of market competition, created the foundations of market area analysis by considering factors such as retail location and distance decay. Later, factors such as market size were taken into consideration (Reilly's law) permitting to build complex market areas. Since market areas are often non-monopolistic, this factor was included with market areas becoming ranges of probabilities that customers will attend specific locations (Huff's law). Although market areas are particularly relevant for retail analysis, the methodology also applies to time dependant activities, such as freight distribution.

4. GIS and Market Areas Analysis

GIS have become useful tools to evaluate market areas, especially in retailing. With basic data, such as a list of customers and their addresses (or ZIP codes) it is relatively easy to evaluate market areas with a reasonable level of accuracy, a task that would have been much more complex beforehand. With GIS, market area analysis left the realm of abstraction to become a practical tool used by retailers and service providers. The market area is a polygon which can be measured and used to perform operations such as intersection (zones of spatial competition) or union (area serviced). Among the major methods a GIS can be used to evaluate market areas are:

• Concentric circles. The simplest method since it assumes an isotropic effect of distance in all directions. The radius represents the maximum distance a customer is willing to travel. It is useful to have a rough overview of the situation when limited information is available.
• Share by polygon. When data is available at the zonal level, such as the ZIP code the market area can be expressed as a share of the market for each zone.
• Star map. Composed of straight lines between each customer and locations. It is an indication of the extent and the shape of the market area and particularly relevant for distribution systems where relationships between distribution centers and their customers is shown.
• Spatial smoothing. A trend surface based on the location of actual customers. The higher the density of customers (the importance of each customer can be weighted), the higher the membership to a market area.
• Transport distance. Particularly useful for retailing or any activity that depend upon consumer accessibility or timed deliveries. A measure of transport distance, often driving time in minutes, is calculated on road segments radiating from the facility location.
• Manual polygon. Based on the local knowledge, common sense and judgment. It may implicitly consider other methods.