Keep this in mind when looking for stocks to buy…

Every time I go to a Mc Donald’s to eat my favorite burger, I always see a Burger King outlet next door or within 50 yards of it.

I can understand if it’s in a mall as all major stores have retail space in a mall’s food court, but these are open space stores.

This also applies to car dealers and gas pumps. I’m sure you’ve seen a group of car dealers. Also many fuel pumps are next to each other.

To curb my curiosity, I did a Google search for why rival brands are side by side? I mean, isn’t it counterintuitive?

A gentleman on twitter had posted a thread about the same question.

Let’s take the example of two gas pumps located next to each other, say BPCL and IOC.

Imagine there is a 1km section at the end of a highway where BPCL and IOC are thinking of setting up gas stations.

Logically, they could divide the 1km stretch equally and place themselves right in the middle of their respective half.

In this case, IOC could be at 250 meters (m), while BPCL could place the petrol pump at 750 m on the 1 km trajectory.

For example, the customers coming from the right go to BPCL and the customers coming from the left go to IOC. Also, the center’s customers will be indifferent if they go to either one

the petrol pumps as the distance from the center will be the same. In this way, the market share becomes 50:50.

This is also ideal for consumers, as they can all fill their tank by covering less than 250 meters in the 1 km stretch. That is why game theorists call this situation a ‘socially optimal solution’.

However, the world is dominated by greed and animal spirits. In a jungle, the lion and the tiger should logically be friends. That way, both will not go hungry and go hunting together.

However, there is only one king in the jungle and that is the lion.

So to return to our example, suppose BPCL gets greedy and wants to make more money and decides to snatch the IOC’s customers by simply moving to the middle of the 1km road.

Now the IOC is at 250m on the 1km road and the BPCL moves to the middle of the 1km stretch and is at 500m. BPCL is gaining market share as it now serves everyone from the right half and also gets some demand which used to belong to Indian Oil.

Of course, Indian Oil would not stand for this. It will also move to the center, resulting in clustering.

We also see this when we look at McDonald’s and Burger King. This case where both are next to each other in the middle is what game theorists call the Nash equilibrium. This competition lesson is useful for investors as we select stocks to buy.

In the gas pump example, the most important factor was the convenience of location. This is because the product being sold was a commodity. The fuel quality is the same in both places.

Hence, there was a fight for customer convenience when it came to distance and things like driving on the other side of the road in the case of the gas pump.

Let’s take movie theaters for example.

If we compare two luxury theater chains, namely PVR and Inox, both have the same quality of comfort and pricing. I’m sure the distance from the theater to your home or office would be one of the most important factors in your decision.

Location is most important when setting up a theater. That’s why financially stronger multiplex chains like Inox and PVR have an edge over small theaters.

However, the story is not the same for fast food restaurants such as McDonalds, Burger King, Dominos and Pizza Hut.

People’s preferences are an important factor because taste plays a role. Someone who enjoys McDonalds burgers won’t mind taking a detour or traveling a fair distance to satisfy their taste buds, even if a Burger King is close to their home.

When selecting stocks, there will be certain industries where competitive intensity in the form of geographical advantage will determine market share and company performance. In other cases, such as strong brands, geographic location will be of little relevance.

Keep this in mind when looking for your next stock to buy.

This article is from Equitymaster.com

Disclaimer: This article is for informational purposes only. It is not a stock recommendation and should not be treated as such.