Major coffee chains often move in to wall out competitors: study

When a major coffee chain opens a new location in an urban centre, one might assume the company’s main aim would be to sell as many drinks and food items as possible. But according to a new UBC Sauder School of Business study, sometimes they’re simply walling out the competition — and for some chains, it’s been a winning strategy.

But the study does much more than examine the behaviours of coffee chains: it offers a new measure for those “deterrence motives” that can be applied to other oligopolies.

Much of it boils down to pre-emption, says UBC Sauder Assistant Professor and study co-author Dr. Limin Fang (she/her/hers). When Starbucks first moved into the Canadian market in the 1980s and ‘90s, they opened many locations in close proximity — some even right across the street — which left little room for their competitors to enter the market. 

“Once they densely pack the area, they basically saturate the local market, so consumers don’t need to go to a competitor’s coffee shop or fast-food place,” says Dr. Fang, who used Toronto as the study’s sample market. “Also if you put several of your own stores on the same street, you can have one truck taking care of many deliveries. So there are economies of density in laying out this type of network.”

In the process, older coffee chains like Country Style and Coffee Time gradually got walled out, leaving chains like Starbucks and Tim Hortons to dominate — but that doesn’t mean deterrence-minded businesses are destined to stay in the top spot indefinitely. Stronger competitors who eventually move in can adopt the same winning strategy: pack their store network and push out the existing chains.

“As a business owner, I’m thinking about how my current behaviours would affect my opponents' behaviours in future,” says Dr. Fang. “But conversely, my opponents are also thinking about me as well, and looking at what I'm doing today, or thinking about what could be my strategy for the future. So this becomes the game.”

Titled Measuring Deterrence Motives in Dynamic Oligopoly Games, the study uses what’s called a decomposition approach to disentangle whether businesses are trying to directly compete — by lowering prices, for example — or whether they are aiming to block their competitors from future entry. The authors also developed a way to measure the intensity of the deterrence relative to that in other businesses. 

Interestingly, the use of deterrence strategies varies widely. On average, Starbucks’ deterrence motives accounted for roughly 24 per cent of all entry motives, and in some markets that number was as high as 43 per cent. By contrast, for the least aggressive chain, Country Style, deterrence motives accounted for just two percent of store openings. 

Meanwhile Tim Hortons proved to be an outlier, as it had a positive impact on all of the other chains’ profits — likely because the Canadian-born company has often been a pioneer in widening the scope of what coffee shops offer, explains Dr. Fang, and they broke ground in more suburban and highway areas. 

However other chains didn’t always return the favour: for example, while Tim Hortons has a positive impact on Country Style’s presence, Country Style has a negative effect on Tim Hortons.  

“So the conclusion is that Starbucks’ growth is motivated by deterrence, and Country Style’s decline is mostly driven by Starbucks' aggressive expansion. And Tim Hortons growth is facilitated by mostly economies of density,” says Dr. Fang. “And because Starbucks pushed out Country Style, it allowed room for Tim Hortons to penetrate.”

The researchers also did more than 1,000 simulations to predict what would likely happen if deterrence motives were removed from the market, and they showed the presence of Starbucks and Tim Hortons would shrink, while Country Style would grow rapidly. 

The study is the first of its kind to create a measure for deterrence motives, and that measure can be used in settings that go far beyond coffee shops; it could also help examine the link between entry deterrence and firm failures, and help assess whether certain sectors of the retail industry seem more likely to fail when deterrence-minded competitors move in. 

Dr. Fang says that for businesses, it’s a chess-like back-and-forth, with everyone trying to anticipate the competition’s next moves. 

“You're not reacting to today's situation: you're thinking several steps ahead,” explains Dr. Fang, who co-authored the study with Dr. Nathan Yang of Cornell University. “You think, ‘If I enter this location today, how would that affect my competitors' behaviour in the future? Would that reduce the likelihood of my competitor putting a store here? If it does, I'm going to do this.’” 

Dr. Fang, who has a background in urban planning, says most people don’t realize the complex strategies and counter-measures that are at play as they’re moving through their neighbourhoods — or simply grabbing a cup of coffee.

“We just walk around our cities, and don’t know the inner workings behind everything we see,” she says. “But there’s a lot of strategic behaviour at work.”

Interview language: English