Externalities are present in all economic interactions, from apiaries to factories, and vary in that some have are positive and others a negative economic impact. Apiaries produce honey for bee keepers as an economic activity, the bees in turn pollinate crops to generate higher agricultural yields. The same applies to nitrogen-based fertilisers, which drive up crop yields but adversely impact fish populations in local streams. Ronald Coase posited that when transaction costs are close to zero and information is perfect, money transfers can attain an equilibrium in which one party is no better off at the expense of another, and vice versa.

Retail has become increasingly aware of the importance of footfall as an indirect generator of revenues. Footfall is created by consumers gravitating to areas to acquire various resources. Agglomeration of retailers in one location creates an environment which incentivises consumers to converge. Footfall is driven by the presence of retailers or amenities in an area, be it food and beverage or clothing retailers.

In much the same way as bees pollinate the crops of surrounding agricultural land so too does footfall generated by retailers and amenities bring consumers to shopping destinations. A retailer that generates footfall produces a positive externality which can then be parasitized. We must be careful, though, not to understate the fact that increased competition within a retail location might produce negative externality, depending on the environment.

Externalities are difficult to measure. Farmers are unable to determine the degree to which a local apiary assists in the production of agricultural goods. In retail, a lack of information impacts the capability to directly determine the source of the footfall generated and its associated impact on revenues. However, technology is presently developing to more accurately determine footfall levels in specific locales. Where transaction costs are low, and when information is available and externalities are present, we can engineer equilibrium to achieve a higher level of economic efficiency than the status quo. This model could be utilised to drive revenue for economic actors within the retail industry. Two examples could be the provision of useful services like Doddle and Collect+ or anchor tenants which drive footfall in retail environments.

This is already accounted for to some degree within shopping centres, which rely on anchor tenants to drive footfall. Often, centres are required by anchor retailers to provide lower or fixed rents due to the benefits that these anchors confer upon centres. Shopping centres and high streets differ in that the number of economic actors supplying retail space on a high street is numerous rather than singular. This key difference makes transacting more challenging as interactions between two actors are always simpler than transactions between many.

The role of competition and the impact of ‘local charm’
However, we must consider that the presence of a Primark would be to the disadvantage of some other retailers in terms of increased competition. Those which directly compete with Primark in the sale of home wares or value clothing would see their local market share impacted, thus creating a negative externality. This would also be the case for many anchor retailers that each retain economies of scale far above that of local independents, which could force many away from high street locations as consumers move to shop at larger retailers. Sapping the high streets of retailers means a loss of business, vacant units, and reduced rents across the board, which will damage income of landlords. This would be considered as a substantial negative externality, as it results in reduced local labour requirements and impacts local disposable incomes. In this sense, we must assert that, for some retailers and landlords, the externalities will in no way be positive and will negatively impact high streets. A particularly effective example is the proliferation of ‘pound shops’ across the UK, forcing local merchants out of business with low prices driven by economies of scale unavailable to smaller retailers. Further, much of what makes some high streets popular is the concentration of independents with ‘character’. We must be careful not to overstate the benefit of large multinational retailers to a local retail environment.

Research at the University of Loughborough has shown the way people choose a shopping destination is based on several factors: consumers value function in the form of car parks, easy access, retail mix and the availability of products at competitive prices. Consumers also value softer, experience-based attributes including personal services, outdoor events and leisure opportunities. This highlights a change in how consumers shop in different areas. Smaller shopping locations perform better in terms of ‘soft’ experiential factors; larger town centre environments provide more functional shopping environments and so perform better in ‘functional’ experiential factors. One finding showed that ‘functional touch points’ equate to a more positive shopping experience in a larger town and ‘experiential touch points’ equate to a more positive shopping experience in smaller towns (Hart et al., 2014). Anchors, for example, contribute more towards function-based shopping areas and detract from experiential areas.

Elimination of the free rider problem
Utilising subsidies to increase the provision of positive externalities can eliminate the free rider problem. Generally, if activities produce positive externalities then a more efficient social equilibrium occurs with a greater level of provision. The supply of anchors should be at the point where the marginal social benefit of the anchor is equal to the marginal social cost; i.e., the price paid by landlords should equal the extra benefit enjoyed in terms of footfall generated by the anchor. Local retailers and landlords capable of paying more can indicate the locations where the degree of positive externality will be highest and thus, most socially efficient; these areas will most likely be in functional environments with specific retail mixes.

One issue is reluctance from the perspective of individual landlords to part with their cash. As individual landlords wish to maximise rents, they would likely not be happy to pay for other retailers’ presence in an area they cannot directly benefit from. This is where a lack of information and understanding about the degree and value of externality can block efforts. For high streets without subsidy, there will be an under provision of these footfall generators. Landlords should agree to commit to subsidise specific retailers in an area where many will benefit. This might drive some revival of the high streets as retailers are incentivised to locate back instead of staying within shopping centres, which have the capacity to subsidise space for footfall generators. The conditions for the effective application of Coase Theorem, as explored above, is predicated on perfect information and low transaction costs. At present, neither condition is met; footfall and direct competition are hard to formally value and landlords will incur costs if they transact collectively with anchors.

By Alasdair Pocock, Retail Research Analyst at Bayfield Training