Henry Bullock Professor of Finance & Real Estate; Director of the Guthrie Center for Real Estate Research
The global financial crisis of 2008 might not appear to have much in common with a derelict shopping mall in your neighborhood. But both are examples of how financial distress can spread through markets like a contagious disease.
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Unlike global financial markets, the retail stores in a mall are primarily connected via their physical proximity to one another—a phenomenon that economists call “retail agglomeration.” But the connections within these local, brick-and-mortar “networks” can propagate economic shocks just as powerfully as the virtual networks that connected Lehmann Brothers and Goldman Sachs. And just as the failure of one investment bank started a domino effect that threatened its peers and competitors around the globe, the bankruptcy of a large retail location in a mall or shopping center puts neighboring stores at increased risk of failure as well.
Even if the local economic conditions are otherwise good, the loss of a single retail tenant exposes every other store around it to a potential cascade of ill economic outcomes.
Safety in Numbers
This effect is identified by economist Efraim Benmelech in the paper “The Agglomeration of Bankruptcy.” Benmelech, who directs the Guthrie Center for Real Estate Research at Northwestern University’s Kellogg School of Management, acknowledges that so-called “agglomeration economies” have been a feature of retail markets since long before any shopping malls existed. “In the diamond district in New York City, stores sell almost exactly the same thing right next to each other. And in the Grand Bazaar in Istanbul, the spice and textile stores are all on the same streets,” he explains. “This is a very old phenomenon.”
For good reason: historically, customers rarely have perfect information about what is on offer in a market. So the purpose of a physical market is not just to retail goods to customers, but to provide a convenient context for customers to learn about what they can buy. “They want to shop from several stores to acquire this information in one trip,” Benmelech explains. “So it makes sense for specialized stores to colocate next to each other, even if they are competitors.”
The economic benefits of retailers’ physical agglomeration are obvious to anyone who has visited a shopping mall intending to purchase one item and found himself coming home with ten. But agglomeration economies are a double-edged sword.
“What are the negative consequences of breaking this link between stores? And what is happening to the neighboring stores when a store shuts down?” Benmelech says. “When several stores leave the mall, that makes it less attractive to consumers, which weakens the position of the remaining stores. It’s a domino effect, and basically the mall dies. We wanted to evaluate that.”
This mechanism for “mall death” appears straightforward, but empirically proving a causal link—that the bankruptcy of one store actually causes the financial distress of its neighbors, rather than merely coincides with it—has been difficult. For example, the deterioration of a shopping center could be caused by declining local economic conditions, which would affect all the “agglomerated” stores in a certain location.
“What we’ve shown is a nontrivial and nonintuitive lesson: it’s not always true that I would like my competitor to fail.” — Efraim Benmelech
Benmelech and his collaborators were able to rule out this possibility by focusing on national retail chains that went out of business between 2005 and 2010 (including Circuit City, The Sharper Image, and Linens ‘n Things). Because these firms closed all their store locations in the United States simultaneously, the researchers could reasonably assume that any failures of neighboring stores “had nothing to do with local conditions or declining demand,” Benmelech explains.
Instead, “we show a domino effect where a negative shock to a retail environment, driven by the fact that some players are leaving the area, is leading to further economic deterioriation in that area. Stores would like to be next to each other, and consumers would like to go to malls with high occupancy rates. When this breaks down, it means that more and more stores close, which leads to a local economic decline.”
In addition, as you might expect, the researchers find that, in the wake of a closing national chain store, neighboring stores are more affected by the negative shock if they are less profitable. For example, any store within 50 meters of a bankrupt chain location would be at a higher risk of closing its own doors—but if that neighboring store were in just the 25th percentile of profitability, its odds of closing increase by 16.9 to 22.2 percent.
Shoring Up Defenses
This analysis can make bankruptcy agglomeration sound like a force of nature, wrecking stores based on location and blind chance the same way a tornado or earthquake might. Benmelech does not disagree, but he adds that increased awareness of the risk can still empower retail real-estate players. Mall and shopping-center owners, for example, would do well to carefully examine the financial stability of their larger tenants, because the failure of one of these “anchors” could threaten everyone else.
Understanding how bankruptcy agglomeration works could also help those owners unlucky enough to experience it mitigate or even reverse its effects. “It may make sense to bring in a new tenant and offer him a very low lease, or even pay the tenant to come in order to stabilize the mall,” Benmelech says. “It may seem counterintuitive, but you will pay much more if you lose your other tenants.”
And as other sectors of the global economy become ever more integrated and networked, Benmelech adds, the lessons of bankruptcy agglomeration may apply far beyond the realm of retail. In a world of hyperconnected markets—both physically and virtually—some of our most basic business intuitions may need to be revised.
“You’d think that if your neighbor closes their store, that’s good news because you can get their business,” Benmelech says. “But what we’ve shown is a nontrivial and nonintuitive lesson: it’s not always true that I would like my competitor to fail.”
Editor’s Note: “The Agglomeration of Bankruptcy” will soon be published as part of the Guthrie Center for Real Estate Research Working Paper Series.
Artwork by Yevgenia Nayberg
Benmelech, Efraim, Nittai Bergman, Anna Milanez, and Vladimir Mukharlyamov. “The Agglomeration of Bankruptcy.” Working paper.
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