Watson 2009

THE JOURNAL OF INDUSTRIAL ECONOMICS
Volume LVII
June 2009
0022-1821
No. 2
PRODUCT VARIETY AND COMPETITION IN THE RETAIL

MARKET FOR EYEGLASSES
RandalWatson w
I use original data on eyewear retailers in a cross-section of U.S. markets
to study how rms product range choices vary with the degree of local
competition. Market level regressions show average per rm variety
declining in the number of rivals. In regressions at the rm level, taking
account of spatial differentiation within each market, a non-monotonic
relationship between product ranges and competition is apparent. As
the number of nearby rivals increases, per rm variety may rst rise
before eventually declining. Explanations for this pattern are offered, in
terms of a tradeoff between business stealing and clustering effects.
I. INTRODUCTION
in the variety
of products that they offer to consumers. Consider a retail market in which
each store sells many horizontally differentiated varieties of a single class of
good, for example, music CDs, books, clothes, or video rentals. Consumers
in such markets typically have idiosyncratic preferences over the different
available styles of the good. They may need to search across multiple
retailers to nd the outlet that sells their preferred combination of style and
price, in which case they are naturally drawn to sellers with a broader range
of available varieties. A stores choice of product variety is then a strategic
variable, depending endogenously on the variety choices of its competitors.
Thus a music store manager choosing whether to add CDs to his stock
weighs the costs of additional inventory and display space against the
increased probability that customers nd a good match for their musical
tastes there, rather than at a rival outlet elsewhere.
THIS PAPER IS AN EMPIRICAL EXAMINATION OF HOW FIRMS COMPETE

This paper is based on chapter 3 of my doctoral dissertation. For advice and guidance at
various stages of this project I am grateful to Michael Mazzeo, Robert Porter and Asher
Wolinsky. Thanks for comments are also due to David Barth, Avi Goldfarb, Shane Greenstein,
Ithai Lurie, Brian Viard and Robert Vigfusson, to the Editor and anonymous referees, and to
seminar participants at Northwestern, Kyoto IER, Tokyo, Texas, Melbourne, Analysis Group
and the 2004 IIOC and NASMES conferences. Financial support is gratefully acknowledged
from a Northwestern University Graduate School Graduate Research Grant and from the
Universitys Centre for the Study of Industrial Organization. All errors herein are my
responsibility.
w
Authors afliation: Department of Economics, University of Texas at Austin,
1 University Station C3100, Austin, Texas, 78712 U.S.A.
e-mail: watson@eco.utexas.edu
r 2009 The Authors. Journal compilation r 2009 Blackwell Publishing Ltd. and the Editorial Board of The Journal of Industrial
Economics. Published by Blackwell Publishing, 9600 Garsington Road, Oxford OX4 2DQ, UK, and 350 Main Street, Malden, MA
02148, USA.
217
218
RANDAL WATSON
When consumer preferences are not directly observable, the choice of

optimal inventory size in such situations may become a matter of (costly)
speculation. For example the Blockbuster video rental chain reportedly
spent 50 million dollars in the late 1990s on a marketing experiment that
drastically increased inventories at outlets in six test markets. Management
guessed that they could raise revenues by improving the store-level
availability of popular movie titles.1 While in that particular case the depth
of retail inventory may have been the key variable of interest, no doubt the
breadth of inventory is also an important element in such calculations.
Throughout this paper I focus on this breadth variable, measured as the
number of different styles of a good on display at each outlet. I use the terms
product variety and product range to denote this measure of inventory
coverage.2
How then does a retail manager adjust his product range if a new rival
opens next door? What if the rival is three miles away? Does the incumbents
response depend upon the number of other competitors already in place
nearby? I aim to provide answers to these questions in a particular context:
the retailing of eyeglasses. This business was chosen for analysis rstly
because eyeglasses are usually (but not always) sold at businesses dedicated
to eyecare. The potential statistical interference from a stores other lines of
business is thereby minimized; this interference could be a problem if, for
example, books or CDs were under study. Second, eyewear sellers typically
stock hundreds of different styles of spectacle frames, reecting heterogeneity in consumer tastes for colour, shape and construction. A measure of
the number of different frame styles in a sellers display inventory can then be
used as an indicator of product variety.3
My original dataset records this measure of per-rm product variety at
each of several hundred sellers in a cross-section of 44 small to medium sized
markets in the Midwestern U.S. I run market and rm level regressions of
this measure on location characteristics and competition indicators, and
interpret the results in terms of oligopoly theories of horizontally
differentiated multiproduct rms (e.g., Anderson and De Palma [1992]).
Regressions at the market level indicate a strong tendency for average perrm variety to decline with increases in competition (i.e., with increases in
the number of rivals). This may be interpreted as representing the effects of
1
Redstone [2001]. Results from the experiment encouraged Blockbuster to implement a new
business model based on expanded retail inventories and revenue sharing with movie studios.
2
Note that terms like product range are not meant to connote distances in an explicit space of
product characteristics. Rather they refer to the number of different product lines carried by a
retailer.
3
Previous empirical studies which analyze other aspects of the eyecare industry include
Benham [1972], Kwoka [1984], Haas-Wilson [1989], and Parker [1995]. The Federal Trade
Commission has had a longstanding interest in the effects of state regulations on the practice of
optometry see, e.g., FTC [2003].
Economics.
VARIETY AND COMPETITION IN RETAILING EYEGLASSES
219
business stealing: all else equal, having more rivals in a market reduces the
marginal revenue (i.e., the probability of sale) associated with each item in a
sellers inventory, and equilibrium product ranges therefore fall.
A more complicated picture emerges when I move to rm level
regressions, taking into account the spatial differentiation between sellers
in a market. If a seller already has more than a few rivals nearby, then more
competition still has a baseline negative effect: per-rm variety falls when the
number of rivals increases, or when the distance to these rivals is reduced.
However this response is signicantly less negative when the incumbent
faces relatively little local competition, with few or no proximate
competitors. Suppose for example that a certain seller X initially operates
alone at a particular site, or with just one or two nearby rivals. Then the
empirical results indicate that shifting a rival to join X from elsewhere in the
market is more likely to lead to an expansion in Xs product range than to a
contraction.
Theories of agglomeration behaviour (or clustering) might explain this
nding. Models in this literature show how clusters of independent sellers
(e.g., shopping malls) attract more business by allowing consumers to
economize on search costs.4 In the present context a positive response of perrm variety to nearby competition is consistent with this behavior. Holding
xed a rms cost of stocking inventory, such a response suggests an increase
in the marginal revenue of the items initially held in stock. If price-cost
margins do not increase in response to more competition, then the increased
marginal revenue of an inventory item must reect an expectation of higher
quantities sold. With unit-demand consumers, this implies the attraction of
shoppers away from other locations in the market.
This evidence is circumstantial rather than direct; hence I consider an
additional test for clustering effects. If consumers plan shopping trips to
economize on search costs, then the different rm locations within a market
are effectively in competition with each other. All else equal, a cluster with
more sellers should attract more shoppers. When a new cluster forms
(because one rm moved to join another) it is then less likely to attract
business from other rms in the market if those other rms are themselves
concentrated at, e.g., a mall. To examine this effect in the empirical analysis I
construct a measure of the dispersion of rms elsewhere in the market, and
interact it with the response of a rms variety to more nearby competition. I
nd that the interaction is indeed signicantly positive. That is, a rm is more
likely to raise variety in response to more competition when other rms are
less concentrated, which is again suggestive of the existence of clustering
effects in these markets.
4
For theoretical analyses of clustering by single-variety rms see, e.g., Wolinsky [1983],
Dudey [1990], Konishi [2005], and Fujita and Thisse [2002, Ch. 7]. I am not aware of any
equivalent spatial analyses for multi-variety rms.
Economics.
220
RANDAL WATSON
Since these inferences are based on the estimated effects of the competition
measures, it is important to control in the empirical analysis for any
endogeneity in these measures. My initial approach to this problem is similar
to the selection-correction methodology employed in Mazzeo [2002]. I apply
a two-stage model of competition to the markets in my data. In the rst
stage, the entry behavior of sellers in each market is modelled using Seims
[2006] framework for endogenous location choice. That incompleteinformation entry framework is particularly suited to the analysis of spatial
differentiation, since it admits a relatively rich set of potential product
locations. From the entry model I generate selection corrections to be
incorporated into the second-stage regressions of product ranges on the
congurations of competitors. To check the sensitivity of this approach to
particular assumptions used in the rst-stage entry model, I also employ a
traditional instrumental-variables methodology. Neither approach produces results that contradict my earlier inferences.
The existing empirical literature on product-variety competition is fairly
sparse. Berry and Waldfogel [2001] study the relationship between per-rm
variety and market concentration in U.S. radio broadcasting, focusing on
the impacts of recent regulatory changes. They nd that greater concentration of ownership in a market raises variety per rm, where variety is
measured by the number of different programming formats on air.5
Alexander [1997] looks at the variety-concentration relationship in the U.S.
recorded-music market. Working with a measure of aggregate (i.e., marketwide) variety in popular songs, he nds a non-monotonic trend over several
decades, with aggregate variety reaching a maximum at medium levels of
concentration and declining thereafter. This non-monotonic pattern is
similar to the results presented below. However Alexanders focus is
somewhat different to that of the present analysis, since he uses market-level
measures of variety and concentration. I aim at deriving a richer picture of
the competitive effects by eliciting the relationship between rm-level
product ranges and differentiation from rivals. My results suggest that this
differentiation is indeed an important element of variety competition.
Somewhat closer to the present work is the study of Olivares and Cachon
[2007], who examine the relationship between sales, inventory and
competition at auto dealerships in a cross-section of small U.S. markets.
Among other results they nd a non-linear increasing relationship between
dealer inventories and competition the concave shape of this relationship is
again consistent with the patterns observed in my data.6
5
Related studies of product variety in media markets may be found in George and Waldfogel
[2003] and George [2002].
6
A marketing study looking at the retailing of yoghurt is Draganska and Jain [2005], who use
supermarket scanner data to incorporate consumers tastes for greater variety (number of
avors) into a differentiated-goods model of interrm competition. See also Bayus and Putsis
Economics.
221
The next section introduces an intuitive analysis of the behavior of rms

and consumers in a theoretical eyewear market. Some informal propositions
are derived; these are intended as useful reference points for guiding the
subsequent product-variety regressions. The data are introduced in section 3
and section 4 outlines an empirical model. The issue of endogenous rm
locations is addressed in section 5. Section 6 presents the results, including
various robustness checks and a brief discussion of the role of chain retailers.
Section 7 concludes. An appendix posted on the Journals website contains
some details of the generation of selection corrections from a two-stage
econometric approach.
II. THEORETICAL PREDICTIONS
In the following I assume that different varieties of eyeglasses are a

horizontally differentiated good, in the sense that unit-demand consumers
have an i.i.d. idiosyncratic taste for each frame style on display at a seller.
Models of variety competition with horizontally differentiated goods
include Anderson and de Palma [1992] and Cachon, Terwiesch and Xu
[2006], both of which use a logit framework to capture consumers
idiosyncratic tastes for the available styles.7 An alternative approach might
assume that eyeglasses are a vertically differentiated product and that the
proliferation of different styles of eyeglasses arises from sellers incentives to
engage in quality discrimination. The theoretical relationships conjectured
below may still hold in this type of framework. However in this market it is
fairly clear from the wide product ranges stocked by each seller that the
horizontal element in tastes is a principal inuence on rms inventory
choices. Therefore I assume in this section that there is no qualitydiscrimination aspect to interrm competition.
On the cost side I assume that all retailers face the same marginal cost
(uniform across all varieties) of buying extra frames of a given style from
manufacturers. One potential shortcoming of this assumption lies in its
treatment of vertically integrated chain retailers. Some chains have vertical
links with manufacturers. For example the Lenscrafters chain is operated by
Luxottica, a major eyewear manufacturer. It is possible that such chains face
lower procurement costs than their non-chain rivals. However if unintegrated retailers can procure frames from a number of competing
[2000] and Israilevich [2004], who respectively study product-line extensions in the personal
computer and bath tissue markets. A simulation approach based on data from a small crosssection of video rental stores is de Palma et al. [1994]. There is also a body of empirical work
studying product variety in an international trade context: see, e.g., Hummels and Klenow
[2002], Brambilla [2006].
7
See also Judd [1985], Bagwell and Ramey [1994]. The literature on competition in product
availability is closely related see, e.g., Aguirregabiria [2005], Carlton and Dana [2006]. There
is also a large marketing literature on the topic, e.g., van Ryzin and Mahajan [1999].
Economics.
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RANDAL WATSON
manufacturers then it is plausible that they may be able to bargain the

wholesale price down to manufacturers marginal costs. Forming buying
groups is one way for unintegrated retailers to gain leverage in such
bargaining see, e.g., Morgan [2007]. Since there are many manufacturers
of eyeglasses presently supplying U.S. retailers, I assume in this section that
such bargaining is in operation, and that retailers costs are therefore
unaffected by their chain afliation.8
Added to this per-pair purchase cost is a per-style xed cost, assumed
constant across styles. This xed cost could include components from two
different sources. First there is the inventory cost of stocking the necessary
extra frames when a seller adds a style to its line-up. To sell the new style the
retailer needs to have one or more pairs of that frame in stock.9 The second
component pertains to the retail space required to display additional
varieties. If rms plan their product ranges at the same time that they choose
their retail premises then this is the rental cost of the necessary extra space.
No doubt some rms also adjust their product ranges ex post, taking as given
their current premises. Sellers in this situation may expand their display area
by, e.g., taking space away from customer waiting areas. Or they may just
cram more frames into an existing display area. In either case, one cost of the
product-range expansion is then an opportunity cost of reduced consumer
amenity. For example, due to more congested premises, more staff time may
be required to provide a given level of customer service.
In the empirical analysis to follow, a market corresponds to a mediumsized town comprising a nite number of spatially distinct retail locations.
Consider then a setting in which the sellers of eyeglasses in a market are
distributed in asymmetric clusters across the available locations. Suppose
that a seller X initially has sole occupancy of one these locations and that it is
now joined by seller Y, a new entrant to the market. What change would we
expect in seller Xs equilibrium product range?
Suppose rst that the number of consumers visiting Xs location is xed.
Models such as Anderson and de Palma [1992] predict that Xs product
variety would then fall. With xed prices, the intuition is easy to see more
rms selling to a xed number of visitors reduces the probability of sale (and
therefore the marginal revenue) of any given variety in a rms inventory.
This tendency is only reinforced if prices fall as a result of the new entry.10
8
The industry wholesale catalogue Frames Data (Jobson Medical Information) reports
specications for eyeglass frames from more than 100 different manufacturers.
9
My survey data indicate that an eyeglasses seller implementing a one-standard-deviation
increase in its product range would need to stock around 300 extra styles. If the seller carries two
pairs in each style and the wholesale cost per pair is $60, then the additional inventory costs are
the interest costs on $36,000, a non-trivial burden for a small business.
10
Starting with Rosenthal [1980], various models have shown that price-cost margins in
oligopoly can increase in the number of competitors. Bagwell and Ramey [1994] and Watson
Economics.
223
Now allow the number of consumers visiting the location to change in

response to Ys entry. The increased competition may make the location a
more attractive shopping destination through its effect on the overall variety
of products available there. That is, a group of two or more sellers at a single
location may form a cluster or agglomeration that enables consumers to
economize on search costs, raising the probability that they nd a good
match to their tastes without having to visit multiple locations. In that case,
new entry might be expected to raise the number of visitors to a location. All
else equal, such an expansion in the customer base could lead rms to
broaden their product ranges, again through its effect on the marginal
revenue of each item held in stock.
Whether the business-stealing effect dominates this market-expansion
effect is an empirical question to be resolved by the data. There are however
two situations in which we might expect the latter effect to be at its strongest.
The rst is when the new entrant at a location is joining a relatively small
number of rms (e.g., just one). Many models of oligopoly predict that an
additional rival has its greatest effect on outcomes such as prices and prots
when there are few incumbents already in operation. Empirical support for
this idea may be found in, e.g., Bresnahan and Reiss [1991]. In the present
context, this means that a signicant expansion in visitor numbers at a
location may be more likely after the entry of the second or third rm than
after the sixth or seventh entrant.
The other situation in which variety-enhancing agglomeration effects are
most likely to dominate is when sellers elsewhere in the market are relatively
dispersed. Different locations in a market form competing clusters of sellers
(even if all sellers behave non-cooperatively). Agglomeration effects mean
that, all else equal, a cluster of N sellers (e.g., a shopping mall) should
provide relatively stronger competition than the same number of sellers
dispersed across N separate locations. That is, if the other sellers in a market
are already clustered in just one or two groups, the entry of Y at Xs location
may only have a small impact on overall visitor numbers to that site. Such
entry might attract a larger number of shoppers from elsewhere if the other
sellers are more dispersed.
To summarize these ideas, let A1 denote the number of a given rms
nearby rivals and let A2 denote the number of distant rivals, i.e., those
elsewhere in the market. My data are deliberately drawn from relatively
isolated markets. I expect increases in the number of distant rivals to
therefore produce few agglomeration effects for the rm in question. Such
rivals by denition are not in a position to form local clusters with the given
rm, and any agglomeration effects they produce for the whole market are
[2006] show how this effect can arise in models with multiproduct rms however the increase
in margins in those models only obtains if rms product ranges simultaneously fall.
Economics.
224
RANDAL WATSON
likely to be limited by the construction of my data. With no agglomeration

effects for distant rivals we then have:
Conjecture 1. All else equal, per-rm variety should decrease in the
number of distant rivals A2.
The predicted net impact of an increase in the number of nearby rivals A1
is of indeterminate sign. Instead we have a predicted sign for the interaction
between A1 and the geographic conguration of a rms rivals:
Conjecture 2. All else equal, per-rm product variety is more likely to
increase in the number of nearby rivals A1 when:
a. rms elsewhere in the market are relatively dispersed; and
b. A1 is small.
In the empirical analysis, this proposition is tested by including among the
competition effects an interaction between the slope of a rms variety in A1
and a measure of the dispersion of rms elsewhere in the market.
Although there is no predicted sign for the coefcient on A1, observe that a
positive value for this coefcient would imply the presence of agglomeration
effects in some degree. We have a better chance of observing this effect if we
hold the total number of rms in the market xed when we raise A1. That is,
consider the rms variety response to relocating a rival from far away to
nearby. This is a true ceteris paribus test of how a change in the spatial
conguration of a rms rivals may affect the shopping patterns of
consumers in the whole market:
Observation 1. If the relocation of a distant competitor to a site nearby
raises a rms product variety, then agglomeration effects are present.
The intuition here is that given previously: with horizontally differentiated products, a rise in per-rm variety is attributed to increasing marginal
revenue, which in turn must reect increased quantities sold per variety. If
consumers have unit demands and quantities rise when nearby competition
increases, then agglomeration effects must be present.11
III. DATA
The geographic markets in this study are M 5 44 medium-sized towns (or

groups of adjacent towns) in six Midwestern states.12 Similar criteria to those
11
A counter-argument to the assumption of unit demands arises from the use of two-forone deals by some eyeglass sellers. But giving consumers a free second pair of eyeglasses will, if
anything, reduce the marginal revenue of any given style currently held in stock. Thus it is not
clear how the use of such deals by prot-maximizing rms could explain an increase in product
ranges in response to more competition.
12
Illinois, Indiana, Iowa, Michigan, Minnesota, Ohio. These states were chosen for
convenience of access, rather than as a random sample. The econometric inferences below are
conned to the behaviour of businesses in these states only.
Economics.
225
Table I
List of Markets in Sample
State
Illinois
Indiana
Iowa
Michigan
Minnesota
Ohio
Markets
Bloomington, Carbondale, Danville, Decatur, De Kalb, Freeport, Galesburg,
Kankakee, Quincy, Springeld, Urbana
Bloomington, Columbus, Kokomo, Lafayette, Marion, Richmond, Terre Haute
Ames, Burlington, Cedar Rapids, Clinton, Dubuque, Fort Dodge, Iowa City, Mason
City, Waterloo
Battle Creek, Benton Harbor, Holland, Jackson, Muskegon
Mankato, Rochester, St. Cloud
Ashtabula, Findlay, Lancaster, Lima, Manseld, Marion, Newark, Sandusky,
Zanesville.
Table II
Market Characteristics
Description
No. of Census tracts in market
No. of eyeglass sellers in market
Population of market (in 1,000s)
Proportion black (%)
Log (per capita income in $1,000)
Weighted average of median age (years)
Weighted average of median rent ($)
No. of malls in market with area 150,000 sq. ft.
No. of hospitals
No. of ophthalmology (MDs) practices
No. of interstates
Mean
StDev
Min
Max
22
13
86
6.5
3.0
35.6
500
1.3
1.8
2.6
0.9
9.5
4.3
36
5.5
0.1
2.9
58
0.6
0.7
1.5
0.7
8
4
31
0.4
2.8
30.0
401
0
1
0
0
48
23
170
27.6
3.2
39.9
610
2
3
6
2.5
Note: Counts of eyeglass sellers, MDs, and hospitals are from directories and a telephone survey. Demographic
data are from the 2000 Census: population is non-institutionalized population; black population is persons
reporting African-American race only; age and rent measures are market averages of tract-level medians,
weighted by tract population. Shopping centre data are from National Research Bureau [1998] areas for malls
are gross leasable areas. The interstate measure is the number of interstate highways passing through the market
an interstate that terminates in a market counts for an increment of one half.
in Seim [2006] are used to dene the set of markets. A town or group of towns
was initially included in the sample if it comprised a continuous built-up area
with total population in the range 25,000200,000, located entirely within (one
or more of) the six states under study. I dropped a market from this set if any
one of its principal business centers was less than 20 miles from a business
center in a separate built-up area of population 25,000 or greater. Thus the
sample excludes markets close to big metropolises in favour of regional centers
at least 20 miles from the next major town.13 Table I lists all the markets in
the study area and Table II summarizes some of their characteristics.
Column 1 of panel I in Table III classies the 571 sellers of eyeglasses in the
44 sample markets by type of outlet.14 Most (465) are specialist sellers,
13
The Rand McNally Marketing Atlas [2001] was used to dene built-up areas and locate
business centers.
14
Sellers were initially located from listings in telephone directories (American Business Disc,
www.yahoo.yp.com), and were then telephoned to conrm location and current operation.
Economics.
226
RANDAL WATSON
Table III
Sellers of Eyeglasses
Number of sellers
Category/sub-category
I. By type
(A) Eyecare specialists:
Comprising:
Optician
Optometrist
Ophthalmologist
(B) Dept.-store sellers
Total of (A) and (B)
II. By afliation (eyecare specialists only)
Lenscrafters, Pearle Vision
Other wide-area chain
Local chain or unafliated
Total
(1) Overall
(2) In frames subsample
465
277
19
358
88
106
571
10
212
55
64
341
40
55
370
465
22
25
230
277
Note: The frames subsample has 100% of sellers in IL, 50% elsewhere. All department store sellers provide
eyecare through an optometrist. Wide-area means operating in more than three markets in the sample.
operating out of premises dedicated to eyecare, i.e., in their own shopfront or

professional ofce, but about 19% are located inside large department stores
(or discount stores).15 A small number (19) of the specialist sellers are
opticians; a somewhat larger number (88) operate out of the ofces of
ophthalmologists (MDs). The remaining specialist outlets have optometrists
as the principal on-site eyecare provider. All premises inside department
stores also provide eyecare through optometrists. Thus optometrists
altogether account for 464, or about 80%, of all sellers in the data.
Panel II of Table III shows the chain afliations of the specialist eyewear
sellers, where a chain is dened as an operation appearing in more than three
of the 44 markets in the sample. Column 1 of that panel shows that around
20% of the specialist sellers are linked by their chain identity (Lenscrafters,
Pearle Vision, etc.) to outlets in other markets. Not shown in panel II are the
department store optical shops, all of whom also share their store identity
with some sellers in other markets in the data. Less common are instances of
sister outlets operating in the same market. About 90% of all 571 shops in the
whole sample have no sister operations in the same market.16
Over the summer of 2001 I visited each market to conduct an in-person
survey of the variety of spectacle frames stocked by sellers. This survey
concentrated on obtaining inventory data from a randomly chosen 50% of
the sellers in each market. In the 11 Illinois markets the survey aimed for
100% coverage, resulting in a target subsample of 341 out of 571 total sellers.
15
There are six such stores: Sears, JC Penney, Shop Ko, Super Target, and two kinds of
Walmart: ordinary Walmart and Walmart Supercenter.
16
At the time the data in this study were collected, Lenscrafters and Pearle Vision were under
separate ownership. In October, 2004, Cole National, the parent corporation of Pearle Vision,
was acquired by Luxottica, the owner of Lenscrafters.
Economics.
227
The second column of Table III categorizes this subsample into the different
classes of seller dened above. At each of these businesses the measure of
product variety is a simple count (usually done by me) of the number of
different frames on display for adult prescription lenses (excluding sunglasses
and safety glasses). About 5% of the observations in the frames subsample
are missing due to seller non-response. For any such outlet, the number of
frames is imputed to be the average for similar sellers in the same town.
Table IV and Figure 1 summarize the numbers of eyeglass frames stocked
by each kind of seller in the subsample. From the gure, the distribution of
Table IV
Number of Eyeglass Frames
No. of frames per seller
Category/sub-category
Mean
I. By type
(A) Eyecare specialists:
661
Comprising:
Optician
510
Optometrist
676
Ophthalmologist
631
(B) Dept.-store sellers
471
All in (A) and (B)
625
II. By afliation (eyecare specialists only)
Lenscrafters, Pearle Vision
1142
Other wide-area chain
718
Local chain or unafliated
604
Median
Std. dev.
1st quartile
3rd quartile
600
326
438
793
503
603
612
434
537
166
340
285
138
309
410
451
396
385
411
613
807
793
499
749
1055
670
551
423
206
270
825
587
410
1420
815
738
Note: Frames data are for the subsample with 100% of sellers in Illinois, 50% elsewhere.
See notes for Table III.
Figure 1
. Distribution of Sellers, by Type and Number of Frames
Economics.
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RANDAL WATSON
frame counts appears to be approximately log normal. An average seller has

625 different styles of eyeglasses on display. Specialist eyecare chain stores
have the broadest product variety, while department stores typically have
low variety. The main distinction in specialists qualications, between
optometrists and ophthalmologists, does not produce major differences in
the variety distribution. Independent opticians have relatively low variety,
but they are few in number relative to the other two types of specialist seller.
Department store sellers exhibit not only low variety in absolute terms,
but also low variation in display inventories from store to store. The
interquartile range in the product variety of department stores as a group is
about 27% of their median, compared with 60% for the specialist eyecare
outlets. Moreover department store inventories are even more tightly
distributed when viewed at the individual brand level: the two most
widespread sellers, Sears and Walmart Supercenter, respectively have
proportional interquartile ranges of 20% and 10%. This suggests that
department stores, whether for reasons of marketing or cost control, value
uniformity of content in their optical shops.
In addition to prescription spectacles, eyewear shops also sell eye
examinations, contact lenses and sunglasses (plus other less signicant
items like non-prescription reading glasses). I have little information about
the marketing of these goods. To abstract away from competition in eye
examinations, I assume that they, are sold in xed proportions to eyeglasses,
with no variation in quality across sellers. The latter assumption is
somewhat restrictive, although the former may not be far from the truth.
Competition in sales of contact lenses and sunglasses is similarly ignored.
Contact lenses might be regarded as a homogeneous good sold under
conditions of perfect competition, perhaps reecting the fact that this good
can also be purchased through the Internet. Sunglasses were specically
excluded from the inventory survey because they are carried not just by
eyecare specialists but also by kiosks in malls, clothing shops, sellers of
sporting goods, and so on. Accounting for (and locating) this variety of retail
outlets would complicate the analysis considerably.17
IV. AN EMPIRICAL MODEL
In each market m 5 1, . . ., M there are Nm sellers of eyeglasses and Km

possible retail locations. As in Seim [2006], census tracts are used to dene
17
In the course of the eyeglasses survey I also collected data on sellers Yellow Pages
advertising for 25 of the 44 markets in the sample. Comparing these data with my frames
counts, I found a statistically (and quantitatively) signicant positive correlation between my
variety measure and the frequency with which a seller mentions a wide selection in its
advertising. This suggests that my chosen index of product variety is indeed related to a realworld quantity of strategic interest to managers. Further details may be found in Watson [2003,
ch. 3].
Economics.
229
the set of locations (or cells) in each market.18 Within each market a census
tract is counted in the set of possible seller locations if its populationweighted centroid is within ten miles of the center of the markets main urban
area. For simplicity, all stores and other features of a tract are assumed to be
located at its population-weighted centroid, and the distance between tracts
is taken to be the distance between these centroids.
Let Vmki denote the equilibrium number of varieties sold by the i-th rm,
i 5 1, . . ., Nm, when it is located in cell k 5 1, . . ., Km of market m. Here Vmki
is measured as the number of different styles of spectacle frames on display at
an eyewear seller. It is assumed that the logarithm of Vmki is determined by
the following reduced-form relationship:
1
lnVmki Zmk c gAmk ; a tm umki :
The vector Zmk contains exogenous demographic and location characteristics of cell mk, including both tract-specic characteristics (e.g., median age
of residents, population within one mile) and market-level variables (e.g.,
state dummies). Some specications could add to Zmk characteristics of rm
i such as chain afliation, but my baseline model avoids this because of the
potential for endogeneity between such rm-specic attributes and a rms
location.
Effects of competition on rm is product range are captured by the
function g(Amk, a). Here a is a vector of parameters and the vector Amk
classies rm is rivals according to their distance from cell mk. Section II
discussed the competing roles of agglomeration and business stealing in
determining the effects of competition on a rms equilibrium product
variety. To allow for these opposing effects, my specication of g(.) admits
non-monotonic effects of nearby rivals. For simplicity I use just two distance
classications (or bands), with A1mk representing the number of nearby
rival sellers within one mile (including rivals in the same tract), and A2mk
representing the number of distant rivals more than a mile away. I also
let Admk represent the presence of the rst three nearby rivals, i.e.,
Admk 1A1mk > 0 1A1mk > 1 1A1mk > 2, where 1(.) represents the
indicator function. Then Amk A1mk ; A2mk ; Admk , and g(.) is:
2
g A1mk a1 A2mk a2 Admk ad :
Parameters a1 and a2 respectively measure the baseline effects of an extra

nearby or distant rival on a rms product variety. Non-monotonic
responses to the number of nearby competitors are allowed for in the term
ad, which shows the extra effect exerted on Vmki by the rms rst, second and
18
Census tracts are non-overlapping irregular polygons dened to correspond roughly to a
neighborhood or locale. Each tract usually contains three to ve thousand inhabitants. The
markets in the present data each contain 22 tracts on average.
Economics.
230
RANDAL WATSON
third-closest rivals. In other words, (2) is piecewise linear in A1mk with slope of
a1 ad for A1mk 3 and a1 for A1mk 4.19
With this specication of g(.), Conjecture 1 in section II corresponds to a
test of H0: a2 5 0. If a2 is signicantly negative, then the conjecture is
conrmed: competition from distant rivals reduces per-rm variety.
Conjecture 2 indicates that the agglomeration effects of nearby competition
should be more pronounced when distant rivals are more dispersed, and
when there are relatively few incumbent rms at a site, e.g., for A1mk 3. To
test this conjecture, I include in the regression an interaction between Admk
the sum of the indicators for the presence of the rst three nearby rivals and
a measure of the dispersion among distant competitors.
This measure is constructed by determining, for each cell mk in a market,
the set Dmk of distant rivals for that cell, i.e., the set of rms in tracts more
than a mile away from the given tract. Thus Dmk has A2mk elements. For each
rm j in Dmk, I count sjmk, the number of distant rivals in the same set, i.e., the
number of other rms in Dmk in tracts that are themselves more than a mile
away from js tract. I set smk to be the average across all j in Dmk of sjmk and
dene DISPERSmk smk =A2mk 1. (If A2mk 1 then I arbitrarily set
DISPERSmk to one. In the present application there are very few rms with
A2mk 1, and changing DISPERSmk to zero for these rms would not make
any great difference to the results.)
To interpret DISPERS, say, for example, that all A2mk distant rivals are
clustered at a single location. Then we have DISPERSmk 5 0, since sjmk 5 0
for all j in Dmk. On the other hand if the distant rivals all operate at separate
locations, each a mile away from the other, then we have DISPERSmk 5 1,
since sjmk A2mk 1 for all j in Dmk. Thus, DISPERSmk is a number between
zero and one, with higher values representing increases in the overall
dispersion of rivals. Conjecture 2 then corresponds to a test of the
signicance of a coefcient on DISPERSmk Admk .
Observation 1 may be applied to the data by testing H0 : a1 ad a2 5 0
and H0 : a1 a2 5 0. The former hypothesis represents the effect of
relocating a distant rival nearby, when a rm already has two or fewer
competitors in close competition. The latter represents the effect of such a
relocation when the rm has three or more rivals nearby. In the absence of
any theoretical structure, rejection of either hypothesis simply indicates that
spatial differentiation matters in variety competition. If the informal
structure of section II is taken on board then the rejection of either
hypothesis in favor of a positive response is interpreted as evidence for the
presence of agglomeration effects.
19
It can be seen that (2) may equivalently be written as: g 1A1mk 3A1mk aa
1A1mk 43aa A1mk 3ab A2mk a2 , where a1 ab and ad aa ab.
Economics.
231
Unobserved market-level effects in equation (1) are represented by tm:

these will be folded into a full set of market dummies, when such are included
in the regression. These dummies would also absorb the effects of any
market-level observables, and also the sums of some tract-level variables.
For example the elements of the competition measure Amk sum to the same
number Nm 1 at all tracts k in each market. (Some of the elements of Zmk
will be seen to have the same property.) Then with market dummies included
and g as in (2), the parameters a1 and a2 are not separately identied. Instead
their difference is identied, by rewriting A1mk a1 A2mk a2 as
A1mk a1 a2 a2 Nm 1:
Note that ad will be identied whether or not market dummies are
included.
The term umki is an unobserved error component specic to the seller. This
error is potentially correlated with factors determining the location of the
rm, in particular with elements of Zmk and Amk. Methods of dealing with
this endogeneity problem are discussed in the next section.
To test the robustness of (2), I consider alternative specications of the
competition effects. First, I vary the cutoff distance that separates nearby
(band 1) rivals from distant (band 2) rivals. I estimate versions of equation
(1) (with g as in (2)) with the cutoff distance set to 0.5 miles and 1.5 miles.
These estimates are then subjected to a test of non-nested hypotheses against
the baseline model, where the cutoff is one mile.
Second, I consider measuring spatial differentiation in terms of average
distances between rms, rather than as counts of nearby and distant rivals.
Let nrm A1mk A2mk be the number of rivals faced by any rm in market m.
Replace the function in (2) with
3
far far
near near
gm on dmk
a
1nrm > 3dmk
a ;
where n nrm , m 5 1, . . ., M. The rst term on the RHS of (3) is a dummy for
the observed outcome of nrm in market m. Spatial differentiation is captured
far
near
by the second and third terms, in which dmk
and dmk
respectively represent
the average distance from the rm to its three closest rivals, and to all other
rivals. (Once again distances are measured in miles between tract centroids.)
Thus anear shows the notional effect on a rms variety, for a given total
number of rivals, of a marginal increase in the average distance to its three
closest rivals. A similar interpretation applies to afar
mk , for a marginal increase
in the average distance to all the rms more distant rivals.20
Interpretation of the parameters in (3) is not always straightforward. In
far
near
particular, the average distances dmk
and dmk
are each functions of the
20
The third term in (3) is preceded by the indicator 1nrm > 3 to allow for the possibility that a
market only has nrm 3 rivals in total.
Economics.
232
RANDAL WATSON
locations of all rms in the market. As a result, certain ceteris paribus

near
are sometimes not possible. The most obvious (extreme)
changes in dmk
example is when the rst-through-fourth-closest rivals are all located, e.g.,
one mile from tract k. Then it is not possible to raise the average distance to
the three closest rivals without also changing the distance to the fourth
closest rival. To avoid a tedious digression into the analysis of this problem,
the distance-band specication in (2) is maintained as the preferred
approach, and (3) is used as an example of a plausible alternative.
As noted in section III, the product ranges of eyeglass sellers in
department stores show relatively little within-chain variation. Furthermore, four out of the six department store brands (Sears, Walmart
Supercenter, Super Target, Shop Ko) have optical shops in almost all
(95%) of their outlets. Thus the product ranges of these optical shops are
almost perfectly explained by the fact of their location in a particular
department store, and moreover the locations of these parent stores are held
to be exogenously xed throughout the analysis. For this reason I exclude
sellers in this group of four from the sample for the regressions. I collectively
refer to these sellers as group B to distinguish them from group A,
representing all other sellers in the study. Optical shops in JC Penney and
ordinary Walmart stores are included in the regression sample because only
about half of the outlets of these stores contain optical shops. The potential
endogeneity in the locations of these shops leads me to group them with the
non-department-store (group-A) sellers, for whom the issue of endogenous
locations is addressed in the next section.
Locations of group B sellers still enter the regressions as explanators of
other rms product ranges, but I divide the RHS competition measures,
showing numbers of nearby and distant rivals, into two categories, for
groups A and B. Let the variables A1mk , A2mk ; Admk now represent competition
just from group A rivals, and let B1mk ; B2mk represent counts of nearby and
distant group B rivals. Furthermore let Bdmk 1B1mk 1 be a dummy for
the presence of the rst nearby group B rival. Then the effects of competition
from group A rivals are represented by the function in (2), while competition
from group B rivals is represented by
4
gB B1mk b1 B2mk b2 Bdmk bd :
The function in (4) is again piecewise linear in the number of nearby rivals,
but because of the small numbers in group B, I assume that the kink occurs
between B1mk 1 and B2mk 2. Thus bd, the coefcient on Bdmk , is the extra
slope coefcient for the rst nearby group B rival.
V. ACCOUNTING FOR THE ENDOGENEITY OF LOCATIONS
The potential endogeneity of product locations is a well known problem in

the empirical analysis of differentiated products oligopoly. Firms observed
Economics.
233
locations reect joint prot-maximizing choices which may induce a

correlation between the error terms tm and umki and the other RHS variables
in (1). In an oligopoly context, this endogeneity problem may be thought of
in two parts: a problem of sample selection, arising from the own rms
choice of location, and a problem of endogenous competition effects, arising
from the rivals location choices.
For illustration, suppose that strategic interactions were entirely absent
from this industry, which implies g 0 in (1). Then any endogeneity in the
competition measures in g may be ignored, but we are still left with a
selection problem in the own rms location choice. This stems from prot
components which are unobserved by the econometrician but which affect
the location choice and which are correlated with tm umki. The solution in
this case is fairly straightforward: standard Heckman-type two-stage
methods (for example) can be used to construct sample selection corrections
for inclusion on the RHS of the regression.
New problems arise when strategic effects are present, i.e., when g60 in
(1). First, rms observed locations will now reect the expected location
choices of their rivals. Any method using sample-selection corrections needs
to take these expectations into account. Second, all rms in a market m may
base their location choices in part on a set of shared prot effects
fymk gk1;...;Km which are correlated with fumki g for each rm i, but which
are unobserved by the econometrician. Then each umki would be correlated
with, e.g., the number of other rms in the same tract mk (and hence with
A1mk ), through the shared unobservable ymk.
I use two approaches to handle these problems. In the rst I use sampleselection corrections similar to those introduced to the entry literature by
Mazzeo [2002], borrowing the framework of Seim [2006] to model a
preliminary entry stage, in which rms locations arise from the symmetric
equilibrium of a game of simultaneous moves under incomplete information. Under certain assumptions, this rst-stage model yields a parametric
form in each tract k for the conditional expectation
5
Etm umki jfZmk ; Amk gk1;...;km ; i chose k;
i.e., for the expected value of the error given the observed location choices of
all rms in the market. These conditional expectations (which are linear in
parameters) can be added to the RHS of (1) in the same manner as ordinary
sample-selection corrections.
Further explanation of this entry model and the associated selection
corrections appears in the online appendix. For present purposes it should
be noted that this approach uses a particular assumption to deal with the
potential endogeneity in the competition measures in Amk. The Seim model
assumes for identication purposes that rms do not see any shared
location-specic unobservables when simultaneously choosing locations.
Economics.
234
RANDAL WATSON
That is, rms private information about their potential protability at each
tract is independent of their rivals information. Hence, conditional on the
observables, rms actual location choices are by assumption independent of
each other. In (1) this implies that, after conditioning on Zmk and any
additional observables from the rst stage, the indicators of rivals locations
in Amk are uncorrelated with umki. Thus, while the sample-selection
corrections employed in this approach allow for strategic interactions in
the rst-stage actions, they assume away some types of second-stage
endogeneity.
To deal with this issue, I consider also an instrumental-variables
approach, to control for any conditional correlation between the competition measures in Amk and the errors tm and umki. In this approach, the
sample-selection corrections used previously are retained, to control as
before for any endogeneity in the regressors in Zmk. As instruments for the
competition measures in Amk, I use four variables: a dummy indicator of a
tracts proximity to major arterial roads, an interaction of this dummy with
the tracts population density, a measure of the tracts distance from the
geographic centre of the market, and a count of the number of interstate
highways passing through the market.
Instruments are required to be conditionally correlated with rivals
location decisions but uncorrelated with the unobserved component in a
rms product range equation. Thus they should be factors affecting costs or
revenues that are unrelated to product range choices. Indicators of zoning
restrictions would be good candidates. Since direct observation of such
restrictions is difcult, I instead use a tracts proximity to major roads as a
proxy. It seems likely that tracts containing such roads would be zoned for
commercial use (at least in part). From the Census TIGER/Line les, I
constructed a dummy variable equal to one if a tract contains (or directly
abuts) a U.S. highway or interstate highway. About two thirds of all tracts
(whether or not they contain eyewear sellers) in all 44 markets contain such
thoroughfares. To control for rural tracts on the outskirts of a market
(through which an interstate might pass) I also include the interaction of this
major road dummy with the logarithm of a tracts population density.
Justication for the third instrument arises from the fact that rival rms in
the sample seem to be located closer to a markets centre than would be
predicted by its observed locational characteristics. That is, A1mk , the number
of nearby rivals, has a strong negative correlation with the distance from a
rms location to the geographic centre of its market, even after controlling
for demographics such as population density and proximity to malls and
large stores. This may reect persistence in rms location choices and the
migration over time of commercial activity out of a towns downtown area.
Casual observation suggests that eyewear sellers in these downtowns are
mainly older establishments. Proximity to the centre of a town may thus be a
proxy for a sellers date of entry into a market. If enough present-day
Economics.
235
locational characteristics are included as regressors, capturing nearby

demographics and business activity, it could be argued that the age of an
eyewear outlet may be uncorrelated with its choice of product range.
Whereas the preceding three instruments all control for endogeneity in the
tract-level competition measures, the interstate-highways instrument covers
endogeneity in Nm, the total number of sellers in a market. This number
could be correlated with unobserved factors that affect overall demand, and
which therefore affect rms product ranges. (In section VI I include market
dummies as one way of dealing with this problem however that approach
does not separately identify a1 and a2.) The argument here is that access to
interstates might affect a sellers entry costs via delivery times for suppliers,
commute times for employees, and so on. If interstate access does not affect
the demand for eyeglasses other than through variables already on the RHS
of the regression, such as shopping-mall indicators, then it can serve as an
instrument for Nm.
VI. RESULTS
VI(i).
Market-Level Regressions
To highlight what is to be gained from the subsequent rm-level regressions,

it is useful to start with an analysis at the market level. Four models
regressing variety on market characteristics are shown in Table V. In each
model, the dependent variable is the market mean logarithm of the product
range of each seller in the frames subsample. For the reasons outlined in the
previous section, the group B sellers are excluded from this mean the
analysis only seeks to explain product variety at the group A sellers.21
Explanatory variables for these regressions include market demographics
and other characteristics, for which summary statistics may be found in table
2. Also included are competition effects in various forms, including levels
and logs of the number of group A and group B rms in the market, and two
measures of the average distance between rms in each market: from all
group A to all group B, and from all group A to all group A. The former
distance measure is interacted with a dummy accounting for the two markets
which have no group B entrants. In each market there are on average 11
group A sellers (st. dev. 5 3.9) and 2 group B sellers (st. dev. 5 1.0). Across
all markets, the mean of the in-market average distance from a group A seller
to its rivals is (coincidentally) the same for both group A and group B rivals:
2.3 miles with a standard deviation of 1.0.
Competition effects in model 1 in Table V are counts of each type of rival
rm. Model 2 uses the same counts in log form. In both regressions there is a
21
The calculation of mean log(frames) also excludes any group-A sellers for whom a frames
observation is missing.
Economics.
236
RANDAL WATSON
TableV
OLS Regressions of AverageVariety at the Market Level, for Group-A
Sellers
Dependent variable: mean of log(number of frames) in market. N 5 44.
RHS variable
Constant
No. of malls
No. of hospitals
No. of ophthalmologists
Population (10,000s)
Propn. black (%)
Log(per capita income)
Weighted ave. of median age (years)
Weighted ave. of median rents ($100)
No. of interstates
No. of group-B rivals
No. of group-A rivals
(1)
(2)
(3)
(4)
7.1
(1.1)
0.056
(0.057)
0.063
(0.046)
0.0061
(0.019)
0.0011
(0.014)
0.0071
(0.0059)
0.047
(0.51)
0.018
(0.014)
0.0072
(0.11)
0.035
(0.048)
0.059z
(0.034)
0.027
(0.010)
7.4
(0.95)
0.066
(0.053)
0.070z
(0.041)
0.0057
(0.018)
0.00025
(0.012)
0.0056
(0.0055)
0.15
(0.46)
0.014
(0.013)
0.052
(0.098)
0.030
(0.044)
7.1
(1.2)
0.053
(0.063)
0.062
(0.050)
0.0072
(0.020)
0.0042
(0.015)
0.0086
(0.0068)
0.053
(0.55)
0.018
(0.015)
0.0052
(0.11)
0.045
(0.052)
0.063
(0.042)
0.027
(0.011)
7.6
(1.1)
0.079
(0.058)
0.060
(0.045)
0.0033
(0.019)
0.0044
(0.013)
0.0083
(0.0062)
0.25
(0.51)
0.012
(0.014)
0.061
(0.11)
0.040
(0.047)
Log(no. of group-B rivals 1)

Log(no. of group-A rivals 1)
0.19
(0.085)
0.34
(0.095)
Dummy: 1 or more sellers in group B

(DUMGPB)
(Ave. dist. to group-B rivals)
DUMGPB (miles)
Ave. dist. to group-A rivals (miles)
R2
Signicance of regressors (Pr[ 4 F ])
0.38
0.11
0.47
0.02
0.087
(0.21)
0.030
(0.056)
0.0083
(0.053)
0.26
(0.12)
0.36
(0.10)
0.021
(0.20)
0.050
(0.051)
0.032
(0.049)
0.39
0.26
0.49
0.05
()
signicant at 1% level.
(z)
Note: Group B is a group of four department stores which have optical shops in almost all their outlets see
section IV. Average frames counts are taken over all group-A sellers with a non-missing observation in the
frames subsample. Average distances are calculated from all group-A sellers, regardless of missing frames
observations.
Standard errors (in brackets) are robust to heteroskedasticity.
()
striking distinction between the competitive effects of group A and group B

rivals. Whereas competition from the latter type of rival has a signicantly
positive effect on average product variety, competition from group A rivals
has a signicantly negative effect. For example in model 1, an extra rival of
the group A (respectively, group B) type is estimated to reduce (respectively,
raise) product variety by 2.7% (resp. 5.9%).
Economics.
237
A plausible explanation for this difference in competitive effects lies in the

fact that all group B rms are attached to department stores entry by a
group B seller thus entails entry by an entire big store. It is perhaps not
surprising that, because of the wide range of products stocked by such stores,
this type of entry might bring with it new consumers in numbers large
enough to lead incumbent eyeglass sellers to expand their product ranges.
On the other hand entry by a group A rm just represents the direct
competitive effect of an extra eyeglasses seller. The markets in my data are by
construction relatively geographically isolated, and on average each market
already has at least ten incumbent group A sellers. Therefore the marginal
group A entrant is unlikely to have much impact on the overall number of
consumers shopping for eyeglasses in the whole market. At the market level,
the competitive effect of such entry thus consists mainly of a businessstealing effect, and is consequently estimated to be negative.
The competition effects t better in logs than in levels compare the R2 of
0.47 in model 2 with 0.38 in model 1. For the group A rivals, the better t of
the log form is consistent with business-stealing effects that diminish in the
number of entrants. Among the market characteristics, only the coefcient
on the number of hospitals is statistically signicant at the 10% level it is
positive, suggesting that people seeking medical care form part of an
eyeglass sellers customer base. While not statistically signicant, the
coefcient on the proportion of African-Americans in the population is also
positive, which is consistent with the idea that the aggregate taste for variety
in a market is related to its ethnic diversity (George and Waldfogel [2003],
George [2002).
Columns 3 and 4 in Table V add measures of average interrm distance to
the competition effects of models 1 and 2. The estimated coefcients on the
distance measures are not statistically signicant, and in both models the
other coefcients show little difference with their values in columns 1 and 2.
Although the distance coefcients are not signicant, note that their signs
are consistent with the inferences from models 1 and 2. That is, at the market
level, reducing the average distance to rival rms raises per-rm product
variety for group B rivals, and reduces it for group A rivals.22
Using numbers of rivals (in logs or levels) as a competition measure is
subject to endogeneity, due to unobservable market factors that affect rms
entry propensities. In regressions of product variety like those in Table V,
one would expect the resulting bias in the estimated coefcient to be positive,
since factors that raise the protability of entry (such as unobserved demand
effects) would also give rms an incentive to expand their product ranges.
Thus, if anything, the true values of the coefcients on the number of group
22
I also estimated versions of models 3 and 4 allowing for non-monotonic distance effects.
However the non-monotonicities were not statistically signicant.
Economics.
238
RANDAL WATSON
TableVI
Summary Statistics for Firm-level Regressions
Description
Mean
Market-level variables
3.0
9.5
35.2
Tract-level variables
Median rent in tract, 2000 ($100)
5.1
No. of hospital beds in band 1
83
Black popn. in band 1 (10,000s)
0.08
0.61
Dummy for mall in band 1
0.37
Area of malls in band 1 (100,000 sq. ft.)
6.1
No. of malls in band 2
0.97
1
No. of group-B sellers in band 1 Bmk
0.5
No. of group-B sellers in band 2 B2mk
1.4
d
Bmk
0.35
1
2.3
No. of group-A sellers in band 1 Amk
No. of group-A sellers in band 2 A2mk
8.9
d
1.8
Amk
Dist. to closest group-B rival (miles)
1.9
Ave. dist to other group-B rivals (miles)
3.0
Ave. dist. to 3 closest group-A rivals (miles)
0.9
Ave. dist. to other group-A rivals (miles)
3.1
Dispersion in distant rivals (DISPERS)
0.75
Log (per capita income in $1,000)
Population (10,000s)
Weighted ave. of median age (years)
StDev
Min
Max
0.1
3.7
3.0
2.8
3.1
30.0
3.2
17.0
39.9
1.1
206
0.12
0.57
0.48
2.1
0.66
0.7
1.1
0.48
2.0
3.9
1.2
1.9
1.8
1.1
1.5
0.19
2.2
0
0.00
0.02
0
1.6
0
0
0
0
0
1
0
0
0
0
0.7
0
8.3
1195
0.80
2.19
1
11
2
3
5
1
7
19
3
11.2
8.1
7.7
10.8
1
Note: See notes to Tables II and V. Variables are averaged over the 301 sellers in the variety regression
subsample. See text for denitions of Admk , Bdmk , DISPERS. Band 1 refers to the band 0-1 miles, band 2 to
anything further. Mall areas averaged only over those sellers with a mall in band 1.
A rivals in Table V are likely to be even more negative than the values
reported. The overall conclusion then is that at the market level, the
dominant effect of competition between non-big-store eyeglass sellers is one
of business stealing. From columns 3 and 4 of the table, one might be
tempted to venture the further conclusion that interrm distance is a
statistically irrelevant factor in competition in these markets. However the
following analysis of competition at the tract level shows this conclusion to
be misleading.
VI(ii).
Firm-Level Regressions
Table VI reports summary statistics for the explanatory variables in the rmlevel regressions. These statistics are calculated over the set of 301 group A
sellers included in these regressions. This set represents a random 50%
(100% in Illinois) of the group A sellers in each market. Equivalent statistics
for the set of all 571 sellers are quite similar to those in the table.23 In addition
23
There is a difference between this regression subsample and the set of sellers upon which
the summary variety statistics in Tables III and IV are based. The former comprises a random
50% of the group-A sellers in each market (100% in IL), rather than 50% of all sellers in each
market. However the differences in the summary statistics will be relatively small because
group B only accounts for around 13% of all sellers.
Economics.
239
to demographic variables measured at the tract and market levels (income,

population, black population, age), the regressors include indicators of local
rents, number of hospital beds, and presence and size of shopping malls.
Proximity to a shopping mall is likely to be positively correlated with a
sellers product range, since malls are prime locations for the specialist
chains. Thirty-seven per cent of sellers in the variety regressions are within a
mile of an enclosed shopping mall; for these sellers, the average size of such
malls is 610,000 square feet.
Competition measures are divided into two categories, for groups A and
B. On average a seller in the regression subsample faces 2.3 group A rivals in
band 1 (i.e., within one mile) and 8.9 group A rivals in band 2. With respect to
group B rivals, the corresponding averages are 0.5 and 1.4. About 80% of
sellers in the regressions have at least one group A rival in band 1; 60% have
at least two; and 40% have three or more (not shown in Table VI).
In the baseline model, I measure competition with the piecewise linear
specications in (2) and (4). An alternative measure uses distances from a
rm to its rivals. Average distances to the nearest three rivals (for group A)
and the nearest single rival (for group B) are calculated separately from the
average distances to all other rivals. Table VI shows that on average a rms
three closest group A rivals are 0.9 miles away, and the closest group B rival
is 1.9 miles away.
The table shows the mean of DISPERS in the regression subsample to be
0.75. Note that this variable is here constructed just with respect to the set of
distant group A rivals relative to any given tract distant group B rivals are
excluded. In auxiliary regressions I also try equivalent measures which
include the group B rivals.
Table VII shows results for rm-level OLS regressions of log(frames) on
the explanatory variables. Column 1 shows the baseline specication,
columns 3 and 4 show alternatives, while column 2 adds DISPERS to the
baseline model in order to test Conjecture 2. In each regression, standard
errors are robust to heteroskedasticity and correlation within tracts
(Wooldridge, p. 152). State dummies (or market dummies, in column 3)
account for any bias due to the oversampling in Illinois.
Among the exogenous location and market characteristics in model 1,
only the mall indicators and the measures of black population have
statistically signicant impacts. (None of the state dummies are statistically
signicant.) Sellers near a medium-sized mall of 500,000 square feet are
estimated to have about 17% more variety than if they were near a small mall
of 200,000 square feet (signicant at the 10% level). Distant malls also raise
variety, by 16% per mall (signicant at the 5% level). By attracting more
consumers, shopping malls seem to benet all sellers in a market, not just
those in the immediate vicinity. Measures of nearby and distant black
population are not statistically signicant on their own; however their
difference is statistically signicant at the 10% level. All else equal, if a group
Economics.
240
RANDAL WATSON
TableVII
Firm-level OLS Variety Regressions, for Group-A Sellers
Dependent variable: log(number of frames). N 5 301.
RHS variable
Log (per capita income in market)
Market popn. (10,000s)
Weighted market ave. of median age (years)
Median rent in tract ($100)
No. of hospital beds in band 1 (100s)
Black popn. in band 1 (10,000s)w

Area of malls in band 1 (100K sq.ft.)

No. of group-B rivals in band 1 B1mk
Bdmk
No. of group-A rivals in band 1 A1mk w
Admk
Admk DISPERS
No. of group-A rivals in band 2 A2mk
(1)
(2)
0.17
(0.36)
0.012
(0.014)
0.021
(0.013)
0.041
(0.032)
0.024
(0.016)
0.34
(0.22)
0.056
(0.059)
0.15
(0.17)
0.055z
(0.028)
0.16
(0.065)
0.032
(0.088)
0.25
(0.12)
0.099
(0.047)
0.095
(0.032)
0.090z
(0.047)
0.043
(0.016)
0.12
(0.37)
0.024
(0.015)
0.026
(0.013)
0.044
(0.033)
0.024
(0.016)
0.21
(0.25)
0.095
(0.060)
0.19
(0.16)
0.060
(0.026)
0.16
(0.066)
0.043
(0.091)
0.26
(0.12)
0.11
(0.047)
0.095
(0.029)
0.040
(0.064)
0.17
(0.067)
0.042
(0.016)
YES
NO
0.17/0.00
YES
NO
0.18/0.00
(3)
0.016
(0.036)
0.032
(0.016)
0.48
(0.34)
0.14
(0.36)
0.056z
(0.030)
0.45
(0.31)
0.052
(0.10)
0.28
(0.14)
0.22
(0.61)
0.0094
(0.018)
0.0062
(0.021)
0.024
(0.034)
0.032
(0.015)
0.30
(0.27)
0.24
(0.15)
0.24
(0.18)
0.059
(0.025)
0.068
(0.12)
0.10
(0.05)
0.17
(0.076)
Dist. to closest group-B rival (mi)

Ave. dist. to other group-B rivals (mi)
Ave. dist. to 3 closest group-A rivals (mi)
Ave. dist. to other group-A rivals (mi)
State dummies
Market dummies
R2/P-val for F test
(4)
YES
0.26/0.00
0.054
(0.022)
0.0016
(0.030)
0.042
(0.037)
0.061
(0.030)
YES
NO
0.22/0.00
()
(z)
Note: See notes to Tables II, V, VI. In (2), coefcients on variables marked
(w)
show the effect of moving one unit from band 2 to band 1. Model 4 contains a full set of dummies for each
possible value of the numbers of group-A rivals, and of group-B rivals, in the whole market.
S.e.s (in brackets) robust to heteroskedasticity and within-tract correlation. Constant not shown.
()
Economics.
241
of 1,000 African-American residents were to be shifted from far away to

nearby then a sellers product variety is estimated to fall by 0.056 0.34
4%.24
As a group, the independent variables in model 1 are signicant at the 1%
level. It will be noted that some of the locational characteristics enter as
tract-level measures, while others (age, income, population) enter as market
averages. For each of the three market-level measures, I tried re-running the
regression with the measure split into nearby and distant averages instead
in each case I could not reject the null hypothesis that the spatial distinction
was irrelevant for that variable. Therefore for parsimony these variables are
measured at the market level only. On the other hand this null hypothesis
was rejected for the black population hence a spatial categorization is
retained for that variable.25
In model 1, the coefcients a1 and a2 on the variables A1mk and A2mk measure
the baseline variety effects of nearby and distant group A competition, and
ad on Admk measures the difference in slope between the rst three, and later,
nearby rivals. All three coefcient estimates are statistically signicant, the
former two at the 1% level, and the latter at the 10% level. An extra
competitor gives rise to baseline variety reductions of ^
a1 9:5% for a nearby
rival and ^
a2 4:3% for a distant rival. Thus Conjecture 1 is conrmed:
competition from rivals elsewhere in the market creates business-stealing
effects. The same is true for nearby competition, when there are already at
least three such rivals in place. Furthermore, the difference between ^
a1 and ^
a2
is signicant at the 10% level, indicating that spatial differentiation matters
in variety competition.
Since ^
ad is positive, the negative effects of business stealing are
ameliorated when nearby rivals form a cluster of just a few sellers. For the
rst three nearby rivals, the slope â1 âd is not signicantly different from
zero. This may reect limited agglomeration effects consumers respond to
the formation of a cluster of rms by switching their search activity to this
neighbourhood from elsewhere, and this encourages sellers to expand (or
not reduce) their product ranges. To see this more clearly, consider the
relocation of a rival seller from elsewhere in the market to a site near a rm.
24
This result seems to stand in contradiction to the market-level regressions in Table V,
where black population was seen to have a positive (albeit statistically insignicant) impact on
average product variety. An apparent explanation for this discrepancy may be found by
replacing the black population counts in model 1 with an interaction between the proportion
black in a market and an indicator for location inside a shopping mall. The coefcient on this
interaction is positive and signicant at the 10% level thus it is sellers inside shopping malls
whose product ranges respond most strongly to more ethnic diversity in a market.
25
Rents are measured just in the sellers own tract because there is no obvious reason why the
cost of rental space elsewhere in a market should have a direct effect on a sellers product range.
I also ran the model with indicators for: number of hospital beds in distant tracts, number of
ophthalmologists, density of other (non-eyecare) businesses, population density, and number
of open-air shopping plazas. None of these additional variables was statistically signicant.
Economics.
242
RANDAL WATSON
As suggested in Observation 1, the response to this ceteris paribus change is

an appropriate test for the existence of agglomeration effects, since it holds
xed the total number of rms in the market. Each of the rst three such
a2 3:8%. With a prelocations induces a variety response of â1 âd ^
value of 0.17, this response only has marginal statistical signicance. Further
relocations (bringing the fourth, fth, etc., rivals nearer the rm) each induce
a signicantly negative variety response of 5.2%.
On this basis, there is some support for the existence of agglomeration
effects in groups of up to four rms, but it is not conclusive in statistical
terms. For stronger evidence, consider column 2 in Table VII, which
introduces into the regression an interaction between Admk and DISPERS,
the measure of the dispersion of distant rivals dened in section IV. The table
shows that, as predicted by Conjecture 2, this interaction is indeed positive,
signicant at the 5% level. Consider then the effect of relocating a rival on a
rm for which the numbers of nearby and distant group A competitors are
A1mk 2 and A2mk 9 (which are values close to the means in the data). Take
in particular two cases where the congurations of the rms distant rivals
are such that: (I) DISPERS 5 0.56, and (II) DISPERS 5 0.875 (which are
respectively the 14% and 80% quantiles for this variable). In case I, the
distant rivals are clustered, and moving one of them closer to the present rm
ad ^
a2 0:56 0:17
has a statistically insignicant effect of â1 ^
0:4% on the rms variety. On the other hand in case II the distant rivals are
more dispersed, and the same move then has an effect of ^
a1 ^
ad ^
a2
0:875 0:17 6% on variety, signicant at the 5% level.26 Thus the
positive effect of such relocations on a rms product range is reinforced in a
manner consistent with agglomeration effects.27
Estimated effects of group B competitors in model 1 are consistent with
their status as tenants of big stores. Extra big stores serve to attract new
consumers to an area their effects on a rms variety of eyeglasses thus
represent a tradeoff between market expansion and business stealing. The
results in Table VII show that the former effect tends to dominate here. In
contrast with the competition effects for group A rivals, all three coefcients
are estimated to be positive. Two are statistically signicant at the 5% level
those on the number of distant rivals and on the dummy for the rst nearby
rival. An initial nearby group B rival has a net effect on a rms product
range of 0.25 0.032 25%, signicant at the 1% level. Consistent with
the evidence for distant shopping malls, distant big stores in this group also
26
Removing one rival from the distant set will affect the value of DISPERS. When there are
nine distant rivals this effect is small, and may be ignored for present purposes.
27
There are various ways to construct DISPERS, depending on how one treats the group-A
and group-B rivals. In Table VII DISPERS is constructed just w.r.t. group-A rms. An
alternative construction measures the dispersion in all distant rivals, regardless of type. Using
this measure gives similar results to those in Table VII.
Economics.
243
raise product ranges, indicating that their market expansion effects are not
conned to a single location, but are spread across the whole market.
Model 3 in table 9 adds market dummies to the model of column 1.
Coefcients on market-level variables will no longer be identied. Variables
which are measured as counts over nearby tracts (number of hospital beds,
black population, area of malls, numbers of group A and group B rivals)
may now be interpreted as the effect of moving a unit of that variable from
band 2 to band 1. Thus, as mentioned in section IV, the coefcient on A1mk ,
for example, is now a1 a2, the baseline effect of bringing a distant group A
rival closer. Note that the piecewise linear specication of the competition
effects is still retained, through the dummies Admk and Bdmk . The coefcients
on those dummies are still ad and bd, and the sum of the coefcients on Admk
and A1mk , for example, gives a1 ad a2, the effect of relocating one of the
rst three group A rivals nearby from far away.
Effects of exogenous location characteristics and of competition from
group B rivals show similar estimates both with and without market
dummies. Estimated effects of spatial differentiation between group A rivals
are of the same sign in both models, but are somewhat more pronounced in
model 3 than in model 1. Thus the baseline effect of moving a group A rival
closer is estimated to be 10% in model 3 (signicant at the 5% level),
compared with 5.2% previously. However if the relocation involves one
of the rst three nearby group A rivals then the variety effect is reversed, to
become 0.17 0.10 7.1%. Furthermore this effect now becomes signicant at the 5% level previously this effect was a marginally signicant
3.8%. The null hypothesis of linear competition effects (H0: ad 5 0) is
rejected with 95% condence. Overall the inferences drawn from model 1
still apply, but if anything with more force: the underlying effect of more
competition is one of business stealing, but this seems to be tempered by
agglomeration effects in small groups of rms.
Clearly the preceding inferences rely on a fairly simple specication for the
form of the competition effects g(.). I tested the robustness of this
specication in two ways. First, I ran two alternative versions of model 1,
redening the cutoff distance between bands 1 and 2 to be 0.5 miles, or 1.5
miles, instead of one mile.28 Using a Davidson-McKinnon J test of nonnested hypotheses (Greene [1997], p. 366) I tested the null that model 1 alone
explains the data against each of the alternatives. In each case H0 was
rejected, but only at the 10% signicance level. I also ran the tests in reverse,
with the 0.5 mile and 1.5 mile models as the nulls and model 1 as the
alternative in each case. Again H0 was rejected, but much more strongly, at
the 0.1% level in each case. On this basis it seems clear that the one-mile
cutoff is the preferred specication among the three models.
28
Regression results for these models are omitted for brevity.
Economics.
244
RANDAL WATSON
My second test replaces the two-band distance characterization with

measures of the average distance from a rm to its closest and furthest sets of
rivals, as outlined in (3). Results for this model are in column 4 of Table VII.
Note that with this specication of the competition effects, a full set of
dummies for all possible numbers of group B and group A rivals is included
in the model.29 Then the coefcients on the distance measures represent the
ceteris paribus effects of rearranging a given number of rivals.
Two distance measures are included for each of the types of rival.
The estimated coefcicents on the average distances to the closest group
B rival, and to all other such rivals, are both negative, and the former is
signicant at the 5% level. These ndings are consistent with the inferences
from the baseline model in column 1. In particular, when the nearest group
B rival is moved closer to a rm there is a statistically signicant rise in
the rms product range, of 5.4% for every mile. Compare this with the
^ b
^ b
^ 18%, signicant at the 5% level, in
estimated effect of b
1
d
2
model 1 when the rst distant group B rival is moved close to an isolated
rm.30
For group A rivals, the estimated distance effects are non-monotonic,
being negative for the closest three rivals and positive for the others. Recall
the prediction from model 1 of a 3.8% rise in variety when each of the rst
three distant group A rivals is relocated near the rm, and a 5.2% fall for
each further such relocation. The estimated distance effects in model 4 are
consistent with these predictions. When the average distance to one of the
rms three closest group A rivals is reduced, product variety is estimated to
rise (albeit without signicance), by 4.2% for every mile. When the average
distance to the other group A rivals is reduced, variety will fall by 6.1% for
every mile, signicant at the 5% level.
Model 4 ts the data somewhat better than model 1 compare the R2 of
0.22 with 0.17. When the models are compared using the DavidsonMcKinnon J test, each model is rejected in favor of the other; however model
1 is rejected more strongly. Nevertheless I retain model 1 as my preferred
specication for its ease of interpretation. The key point is that both models
are approximations to a true reduced form that would in practice be very
complicated. They provide similar insights, but model 1 is easier to interpret.
For example, it is straightforward to interpret the relocation of rivals in
model 1 in model 4 it is more complicated, requiring consideration of not
29
Furthermore, the distance measures are interacted with dummies so that, e.g., average
distance to 4th-closest-and-further group-A rivals only switches on if the rm actually has four
or more such rivals.
30
Model 4 predicts a rise of 0.16% for every mile when the average distance to other
^ b
^ 6:7% for the similar experiment
group-B rivals is reduced. Model 1 predicts a fall of b
1
2
of relocating a second-or-later distant rival near a rm. Since neither effect is statistically
signicant these results are not necessarily in contradiction.
Economics.
245
just the effects on the sets of closest and furthest rivals, but also the effects on
the average distances to these rivals.31
VI(iii).
Two-Stage and IV Approaches
The analysis so far assumes that the competition measures A1mk , Admk , and A2mk
may be taken as exogenous, i.e., that the spatial conguration of rms in each
market is well explained by the exogenous location characteristics included in
each regression. As discussed in section V, in practice rms location choices
may be affected by unobservable factors which cause the competition measures
to be endogenous. To account for this possibility, I model rms observed
locations as arising from a rst-stage entry game, deriving from this game a
selection correction to be included in the second-stage variety regression. This
correction is of the form in (5): a conditional expectation of the composite error
tm umki. It is itself the weighted sum of two subsidiary conditional
expectations: one for a tract and rm-specic unobserved prot effect, and
one for a prot effect shared by all rms in a market.
Model 2 in Table VIII includes these selection corrections among the
regressors from the baseline model 1 of Table VII. For ease of comparison,
the estimates for that earlier regression are repeated as model 1 in Table VIII.
The table shows that when the selection corrections are included, they are
not statistically signicant, and the estimated coefcients and standard
errors for the other explanatory variables are essentially unchanged.
(Standard errors are corrected for the sampling error in the two new
generated regressors an explanation of how to correct the standard errors
is in the online appendix.) On this basis there is no apparent problem of
selection-induced endogeneity in the RHS variables. However, as explained
in section V, the entry model on which the selection corrections are based
assumes that there are no tract-specic prot unobservables common to all
potential entrants. If such unobservables are in fact present, then the
competition measures in Amk might still be correlated with tm and umki, even
after the inclusion of the selection corrections.
To address this problem I turn to an instrumental variables technique,
using as instruments for the competition measures the four variables for
which summary statistics are shown in Table IX. That table also shows
estimated coefcients on these instruments from rst-stage regressions in a
2SLS IV procedure. (Coefcients on the other exogenous variables are
omitted for brevity.) Note in particular the strong correlation between
31
I also estimated a version of model 1 in which a rms closest rival can have an effect on
variety that differs from the effects of its second and third nearby rivals. That is, in place of (2)
I estimated a specication where g A1mk a1 A2mk a2 a0 d 1A1mk > 0 a00d 1A1mk > 1
a0d 0:110 (s.e. 5 0.085) and ^
a00d 0:076 (s.e. 5 0.075).
1A1mk > 2g. This regression yielded ^
Since H0:a 0 d 5 a00 d cannot be rejected (p-value 5 0.79), the use of this restriction in model 1
seems a reasonable abstraction.
Economics.
246
RANDAL WATSON
TableVIII
Variety Regressions Allowing for Endogenous Competition Measures
Dependent variable: log(number of frames). N 5 301.
RHS variable
(1) OLS
(2) OLS
(3) 2SLS
Log(per capita income in market)
0.17
(0.36)
0.012
(0.014)
0.021
(0.013)
0.041
(0.032)
0.024
(0.016)
0.34
(0.22)
0.056
(0.059)
0.15
(0.17)
0.055z
(0.028)
0.16
(0.065)
0.032
(0.088)
0.25
(0.12)
0.099
(0.047)
0.095
(0.032)
0.090z
(0.047)
0.043
(0.016)
0.16
(0.37)
0.011
(0.015)
0.023z
(0.013)
0.041
(0.032)
0.025
(0.016)
0.36
(0.24)
0.058
(0.062)
0.15
(0.17)
0.058
(0.028)
0.17
(0.067)
0.038
(0.091)
0.25
(0.12)
0.10
(0.047)
0.099
(0.031)
0.092z
(0.049)
0.048
(0.017)
0.0097
(0.035)
0.032
(0.089)
YES
NO
0.20
(0.49)
0.038
(0.18)
0.064
(0.30)
0.046
(0.67)
0.024
(4.4)
0.63
(0.54)
0.033
(0.18)
0.20
(0.27)
0.076
(0.20)
0.28
(0.17)
0.14
(0.17)
0.30z
(0.17)
0.23
(0.20)
0.26
(2.2)
0.24
(0.65)
0.17
(0.21)
0.073
(0.11)
0.38
(0.55)
YES
NO
Market popn. (10,000s)

Weighted market ave. of median age (years)
Median rent in tract ($100)
No. of hospital beds in band 1 (100s)
Area of malls in band 1 (100K sq.ft.)
Bdmk
Admk
Selection correction (tract-level)
Selection correction (market-level)
State dummies
Market dummies
YES
NO
()
(z)
Note: See notes to Tables II, V, VI, VII. Model (1) repeats (1) from Table VII.
Instruments for (3) are in Table IX. See appendix for explanation of the selection corrections. S.e.s (in brackets)
robust to heteroskedasticity and within-tract correlation, and in (2) and (3) are corrected for sampling error in
generated regressors. Constant not shown.
()
distance-to-market-center and the competition effects. Results for the IV

regression itself are in column 3 of Table VIII.32 The estimates are seen to be
fairly noisy (as is typical in IV analysis), and in fact the dummy for the rst
nearby group B rival is the only statistically signicant variable, at the 10%
32
In this regression the selection corrections described above are retained among the RHS
variables.
Economics.
247
Table IX
Instruments for 2SLS Regression
I. Summary Statistics
StDev
Min
Instrument
Mean
Max
Dist. from tract to

market centre (mi)
Dummy: hwy or
interstate passes
thru tract

Above dummy
log(pop. density)
(persons/ha)
No. of interstates
passing through
market
2.1
1.3
0.056
8.0
0.72
0.45
1.3
1.2
1.9
1.1
0.72
II. Coefcients In First-Stage

Regressions (N 5 301, s.e.s
in brackets)
Dependent Variable:
1
Amk
Admk
A2mk
0.28
(0.091)
0.074
(0.33)
0.19
(0.054)
0.073
(0.19)
0.17
(0.12)
0.51
(0.42)
4.3
0.18
(0.14)
0.12
(0.081)
0.088
(0.18)
2.5
0.024
(0.19)
0.12
(0.12)
0.031
(0.25)
Note: Estimated coefcients in panel II are from regressions of the endogenous variables on the instruments and
all other exogenous variables in Table VIII. (Other coefcients not shown.) S.e.s are robust to
heteroskedasticity and within-tract correlation, but are not corrected for the sampling error in the generated
regressors.
()
Mean and s.d. calculated over tracts where the dummy is not zero.
level. Note however that the pattern of signs on the estimated effects of
group A competition is the same as in model 1. That is, the baseline effect of
such competition on per-rm product variety is negative, and is more
negative for nearby competitors. (Compare â1 0:26 and ^
a2 0:17.) In
a small cluster of rms, however, the effect of new entry by such competitors
is less negative, and if the rival is relocating from elsewhere in the market
then the net effect on variety is positive, since ^
a1 ^
ad ^
a2 0:15 > 0.
A test of overidentifying restrictions does not reject the exogeneity of the
instruments in this procedure. Nor does a Hausman-type test reject the
exogeneity of the competition effects in Amk.33 Overall, the results of the IV
analysis thus do not contradict the previous inferences from model 1. Of
course, the validity of this conclusion rests on the suitability of the
instruments. In particular, the number of freeways is potentially problematic as an instrument. Since it is a market-level variable, it might be
correlated with unobserved market-level effects which are in turn correlated
with umki. To deal with this issue, I re-ran the 2SLS model with market
dummies, thus dispensing with the need for an instrument for the number of
33
To implement these tests, the model was estimated by efcient two-step GMM, using a
weighting matrix robust to both heteroskedasticity and clustering in the errors. (The Stata
procedure ivreg28 (Baum, Schaffer and Stillman [2007]) is very useful for this purpose.) The
efcient GMM estimates are very close to the 2SLS estimates. I did a limited investigation of the
effects on these tests of correcting for the sampling error in the generated regressors (i.e., in the
selection corrections). The p-values for the tests seemed if anything to increase, which is
consistent with the idea that (in cross-section analysis) standard errors on individual
coefcients are always underestimated if such sampling error is ignored.
Economics.
248
RANDAL WATSON
entrants Nm. The results are again noisy, but the pattern of signs on the
estimated competition effects supports the inferences from Table VII.
Finally, since I could not observe zoning regulations, I included in the entry
stage of my two-stage approach a measure of the density of local businesses as a
proxy.34 It was highly signicant, indicating that it is at least a reasonable proxy
for the unobserved regulations. However when this measure is included in the
second-stage variety regression, it is not signicant, and furthermore the
coefcients and standard errors on the other RHS variables (in particular, on
the competition effects) are more or less unchanged. I conclude that the
inuence of zoning on product variety seems to be captured by the other
locational characteristics already included in the model.
VI(iv).
Chain Stores and Variety Competition
The summary statistics on product ranges in Table IV point to signicant

behavioural disparities between specialist chains and other eyewear
retailers. Further evidence presented in Watson [2003, chapter 3] indicates
that, relative to other specialist sellers, eyewear chains choose prime retail
locations, have bigger stores, are open longer, charge lower prices for eye
exams, advertise more, and emphasize distinctive features in their
advertising. To analyze these differences in a structural manner is beyond
the scope of the present model. Indeed, the framework here abstracts away
from cross-market links between rms, and therefore ignores the dening
feature of chain retailing. Nevertheless I ran some exploratory regressions to
gain an initial indication of whether chain identity explains the pattern of
competition effects seen above.
I added dummies for chain afliation to model 1 in Table VII, and broke
down the response to competition (for rms in the regression sample) into
effects for chains and non-chains. Thus chains and non-chains each have a
separate pair of competition response functions gA and gB. With respect to
group A rivals, the pattern of estimated competition effects is broadly the
same for both chains and non-chains, and the signs and relative magnitudes
of the coefcients echo those in the baseline model. The joint hypothesis that
each non-chain response to a group A competitor is equal to the equivalent
effect for a chain seller cannot be rejected at ordinary signicance levels. On
the other hand, the same hypothesis is rejected, with 90% condence, when
competition with the group B rivals is considered. In particular, variety at
non-chain sellers shows a relatively stronger positive response to distant
group B rivals than variety at chain outlets. An explanation for this
discrepancy is not immediately clear. While the results for competition from
the big stores in group B are thus ambiguous, with respect to the group
A rivals, it appears that the preceding inferences on competition and product
34
This measure was a count of the number of chain fast-food outlets in band 1.
Economics.
249
variety might still hold in a model which endogenizes, or instruments for,

sellers chain afliation.
VII. CONCLUSIONS
Estimation results presented above suggest rst that geographic differentiation

matters in competition between eyewear sellers. Moving rival sellers closer to a
given rm has statistically signicant effects on that rms product range.
These effects are non-uniform in that their directions depend on the current
conguration of sellers in a market. The baseline effect is for a new entrant (or a
relocating rm) to steal business from nearby sellers, who therefore reduce
their product ranges. However a relocating rm (or group of rms) which joins
with a previously isolated seller may cause that incumbent to raise product
variety. Circumstantial evidence suggests that this reects in part the attraction
of customers away from other locations in the market.
Because of the difculty of obtaining objective measures of eyewear
quality, the preceding discussion abstracts away from the issue of vertical
product differentiation. However the interpretations presented above would
not necessarily stand in contradiction to the predictions of a model where
rms choose an average quality level for their inventory, as well as a product
range. As long as my variety counts measure the number of distinct styles of
eyewear on display (where distinctions in style include quality differences),
changes in product range could in part reect shifts in the average quality
of rms inventory. Thus for example the nding that product ranges
eventually decline in response to more competition could reect rms
specialization into different quality levels. What is missing from the present
analysis is an indication of the signicance of such common quality rankings
relative to the horizontal dimension in consumers tastes for different styles.
Gathering the data needed to address this issue would also be an interesting
topic for further research.
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Supporting Information
Additional supporting information may be found in the online version of
this article:
APPENDIX
A(i). Generating selection corrections.
A(ii). Correcting the standard errors.
Please note: Wiley-Blackwell is not responsible for the content or
functionality of any supporting materials supplied by the authors. Any
queries (other than missing material) should be directed to the corresponding author for the article.
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THE JOURNAL OF INDUSTRIAL ECONOMICS

PRODUCT VARIETY AND COMPETITION IN THE RETAIL

THIS PAPER IS AN EMPIRICAL EXAMINATION OF HOW FIRMS COMPETE

When consumer preferences are not directly observable, the choice of

VARIETY AND COMPETITION IN RETAILING EYEGLASSES

VARIETY AND COMPETITION IN RETAILING EYEGLASSES

The next section introduces an intuitive analysis of the behavior of rms

II. THEORETICAL PREDICTIONS

In the following I assume that different varieties of eyeglasses are a

manufacturers then it is plausible that they may be able to bargain the

VARIETY AND COMPETITION IN RETAILING EYEGLASSES

Now allow the number of consumers visiting the location to change in

likely to be limited by the construction of my data. With no agglomeration

The geographic markets in this study are M 5 44 medium-sized towns (or

VARIETY AND COMPETITION IN RETAILING EYEGLASSES

(2) In frames subsample

operating out of premises dedicated to eyecare, i.e., in their own shopfront or

VARIETY AND COMPETITION IN RETAILING EYEGLASSES

frame counts appears to be approximately log normal. An average seller has

In each market m 5 1, . . ., M there are Nm sellers of eyeglasses and Km

VARIETY AND COMPETITION IN RETAILING EYEGLASSES

lnVmki Zmk c gAmk ; a tm umki :

g A1mk a1 A2mk a2 Admk ad :

Parameters a1 and a2 respectively measure the baseline effects of an extra

VARIETY AND COMPETITION IN RETAILING EYEGLASSES

Unobserved market-level effects in equation (1) are represented by tm:

locations of all rms in the market. As a result, certain ceteris paribus

gB B1mk b1 B2mk b2 Bdmk bd :

The potential endogeneity of product locations is a well known problem in

VARIETY AND COMPETITION IN RETAILING EYEGLASSES

locations reect joint prot-maximizing choices which may induce a

Etm umki jfZmk ; Amk gk1;...;km ; i chose k;

VARIETY AND COMPETITION IN RETAILING EYEGLASSES

locational characteristics are included as regressors, capturing nearby

To highlight what is to be gained from the subsequent rm-level regressions,

Log(no. of group-B rivals 1)

Dummy: 1 or more sellers in group B

striking distinction between the competitive effects of group A and group B

VARIETY AND COMPETITION IN RETAILING EYEGLASSES

A plausible explanation for this difference in competitive effects lies in the

VARIETY AND COMPETITION IN RETAILING EYEGLASSES

to demographic variables measured at the tract and market levels (income,

Black popn. in band 1 (10,000s)w

No. of malls in band 2

Dist. to closest group-B rival (mi)

VARIETY AND COMPETITION IN RETAILING EYEGLASSES

of 1,000 African-American residents were to be shifted from far away to

As suggested in Observation 1, the response to this ceteris paribus change is

VARIETY AND COMPETITION IN RETAILING EYEGLASSES

Regression results for these models are omitted for brevity.

My second test replaces the two-band distance characterization with

VARIETY AND COMPETITION IN RETAILING EYEGLASSES

Two-Stage and IV Approaches

Log(per capita income in market)

Market popn. (10,000s)

distance-to-market-center and the competition effects. Results for the IV

VARIETY AND COMPETITION IN RETAILING EYEGLASSES

Dist. from tract to

II. Coefcients In First-Stage

Chain Stores and Variety Competition

The summary statistics on product ranges in Table IV point to signicant

VARIETY AND COMPETITION IN RETAILING EYEGLASSES

Etm umki jfZmk ; Amk gk1;...;km ; i chose k;