Yale School of Management

Center for Customer Insights

Advancing the frontiers of consumer understanding

The Invisible Effect of Zoning on Store Formats

September 24, 2014

Cities are resurgent. On any given block in the heart of a lively downtown you might find restaurants, retail outlets, apartments, a public transportation terminal, and the classroom building of an urban university. Drive out to some mid-distance suburb and the results of your observation will be markedly different: a row of houses, perhaps; or a box store. What encourages so much variety in some locations rather than others?

For many stores, decisions on whether or not to enter a market stem not only from surrounding demographics, but also the presence of particular zoning policies, which separate land uses through permitting—residential from industrial or commercial uses, for instance. Zoning also sets guidelines on the types of residential, industrial, or commercial ventures allowed on particular parcels of land. As such, zoning regulations would appear to be an essential determinant of retail locations and formats.

And yet the influence of zoning on a store’s choice to enter a market remains a surprisingly understudied subject. Marketing professors K. Sudhir and Sumon Datta, from Yale and Purdue respectively, probed this issue in a recent article for Quantitative Marketing and Economics. They revealed that, as one might assume, zoning powerfully affects outcomes of storefront diversity; failing to incorporate this effect distorts the current understanding of retail market entry.

For instance, it is quite possible that locations with higher incomes have tougher zoning rules that restrict entry. Absent consideration of zoning, fewer stores in these areas would imply that income does not have a big impact on entry and profits. However, recognizing that the lack of entry is due to zoning could imply the opposite: income does, indeed, have a large, positive impact on store profits. Or take the case of commercially zoned locations: these would have dense populations with more retailers. This retail presence might be attributable to the effect of population, but equally probable is the effect of favorable zoning laws.

To untangle this problem, the authors compiled zoning data using the National Land Cover Dataset (NLCD), then stitched it together using GIS. They used 100 sample markets covering a total of 751 big-box grocery stores. The market boundaries were constructed using NLCD data; each market could be divided into one-square-mile grids. After that, the commercial pixel data was used to obtain the central commercial location and the extent of commercial activity. Google Earth was then used to identify the location of big-box retailers. Finally, a game theory model estimated retail entry, location, and format choices.

The paper empirically validates that zoning restrictions do reduce entry, but that firms also shift their formats to avoid compromising entry. Ever wonder why the retail giant Walmart has six different store types? Or what motivated Nordstrom in New York to open a retail branch with 11,000 square feet, a store about one-tenth the size of an average retail location? It’s because firms respond to controlled spatial differentiation—that is, zoning—by adjusting basic statistics like square footage.

“Ignoring spatial zoning regulations underestimates retailers’ willingness to enter a market and their propensity to differentiate on formats,” conclude Sudhir and Datta.

To extend their findings, the authors also tested how certain “prototype” zoning approaches such as “centralized” (retail in the center), “neighborhood” (distributed retail), or “outskirt” (retail on the fringes) affect entry. Their key finding is that these different zoning arrangements lead to different retail structures and formats: outskirt zoning leads to greater homogeneity, while centralized zoning leads to more variety. This insight is imperative for city planners who aim to encourage retail format variety through zoning policy. As towns open up their locations to big-box retailers, and as the global population becomes increasingly urban, these results will provide valuable information for the planning debates to come.

Contributed by Nirajana Mishra, freelance writer