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Location, Location, Location

8/20/2010 --

New research can help guide franchisors on where and when to open or close stores.

ANN ARBOR, Mich. — One of the biggest decisions facing managers of franchise chains – especially those in the fast food segment – is where and when to open new locations or close existing ones.

A prime example would be Starbucks, the ubiquitous coffee shop chain that grew incredibly fast only to find that too much growth in individual stores came at the expense of other nearby locations.

Just using sales data from incumbent and newly opened stores to infer the effect of future outlets often can be misleading, says S. Sriram, assistant professor of marketing at Ross. If the chain is growing overall, it can be tough to tell if a new store is cannibalizing an existing location. The same holds true when a chain is shrinking — it can be difficult to determine which stores are the right ones to close.

Sriram’s new paper, "Investigating the Effect of New Store Openings on Chain and Store Performance in a Dynamic Environment," delivers a model that takes into account evolving consumer brand preferences, store geography, time-varying competition, and customer satisfaction. The more complete picture gives franchise executives a better idea of where stores should be located so the effect on existing outlets is minimal.

"What makes this model unique is that it works in a dynamic scenario," Sriram says. "It controls for dynamics that can cloud the picture if you’re just using average sales. It’s not always clear where a sales increase comes from."

Sriram and co-authors Joseph Pancras of the University of Connecticut and V. Kumar of Georgia State University collected data from a fast-food chain experiencing significant growth. The data includes the chain’s geographic configuration of stores over time, monthly sales numbers from individual stores, and time-varying customer satisfaction scores at the store level. Their findings revealed in the paper were aided by the ability to access this hard-to-obtain data.

To make a good decision on where or when to open new stores, managers require answers to several questions. First, how much would a new store draw current customers of the chain from nearby stores? Second, how much would this cannibalization affect the existing stores? Third, what is really driving consumers to act? A sales increase could be driven by new store openings or an increase in brand awareness, which is common during a heavy advertising campaign.

The chain studied by Sriram showed that only eight to 18 percent of sales at new locations came from customers of existing locations. Likewise, this cannibalization affected sales at existing stores by only one to three percent. Instead, it was the chain’s increasing popularity, driven in part by an advertising campaign, that drove overall chain sales – more than opening new stores.

By studying those dynamics, along with the other data, Sriram and the co-authors built a mathematical model managers can use to determine the right location for a new store. During times of contraction, the model also can be used to determine which stores would be the best to close.

"If you have three locations to choose from when opening a store, you can use this model to simulate what sales would be at the chain level and at nearby stores," Sriram says. "The firm we worked with seems to be very interested in this question. There’s a lot of interest among managers in the fast-food industry on how to locate without cannibalizing existing stores."

—Terry Kosdrosky



For more information, contact:
Bernie DeGroat, (734) 936-1015 or 647-1847, bernied@umich.edu