Location, location: the geography of industry clusters

Location, location: the geography of industry clusters Holger Schiele

Holger Schiele is an associate lecturer at Leibniz University Hanover, Institute of Management and Organisation. He is also project manager with h&z business consulting in Duesseldorf, Germany.

lusters are a fashionable topic. The theory has been refined and hundreds of such regional-sectoral agglomerations have been ‘‘discovered’’ during the last decade and their functionality studied. It seems to be a characteristic of modern economies that successful industrial activities cluster in a few regions:

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Every third brush sold in the world is manufactured in Bechhofen in Franconia; the Italian region of Friaul holds about one third of the world’s chair manufacturers, half of the world’s tiles are produced in two regions in Italy and Spain, and the region of Yiwu in China controls about half of the market for Christmas decorations (Schiele, 2003). These are only a few striking examples. A meta-study counted more than 800 documented clusters around the world (van der Linde, 2003).

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Most of China’s export success is driven by firms located in ‘‘one-product towns’’ where hundreds of firms agglomerate along a single value chain (Sim, 2006).

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In Germany, every second manufacturing sector hosts clusters (Brenner, 2004), including paper manufacturing, watches, the optical industry and foundries. Clusters also exist in some service sectors, such as media and finance.

The clustering of entire value chains in single locations has considerable consequences for firms. For instance, Nokia officials explained that they closed the last mobile phone factory in Germany because they had failed to attract a cluster of suppliers near the factory. Most suppliers are located in Asia and even though transport costs are negligible, the distance to the industry centre and the resulting long lead times prevented Nokia from achieving the necessary flexibility to react quickly to market changes. Of course, clusters do not form in every industry (Steinle and Schiele, 2002), but ‘‘in industries characterized by dominant regional clusters, membership in a cluster is essential for sustained strategic equality’’ (Tallman et al., 2004, p. 268). Recently, a new school in strategic thinking has started to consider clusters. The ‘‘ecosystem theory’’ not only attributes the success of firms to their presence in attractive markets or to the availability of superior resources for production, but also offers a new perspective, arguing that the entire value-creating system of a firm contributes to its success. This explicitly includes its network of business partners and the relationship towards them (Jarzabkowski and Wilson, 2006). One of the ecosystem theories is the cluster approach, which attaches a geographic dimension to a value-creating system. The cluster approach has been extensively applied in the marketing of regions and regional development, but not in corporate management. While theoretically compelling, what have largely been missing are answers to the questions of what the clustering phenomenon really means for firms and how management can actively seize the opportunities arising from this trend.

DOI 10.1108/02756660810873191

VOL. 29 NO. 3 2008, pp. 29-36, Q Emerald Group Publishing Limited, ISSN 0275-6668

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Addressing these two issues, we will briefly explain the concept of clusters. Then, two pairs of case studies illustrate clusters’ vital relevance for management. Each pair contrasts a successful with an unsuccessful firm. The first two cases cover firms located within a cluster and the second two cases firms outside the strongest cluster of their industry.

Productivity benefits, innovation and higher profitability: competitive advantages of companies located within clusters In the 1990s, the century-old cluster concept was revitalised by the seminal work of Porter. He defines a cluster as a group of firms and institutions of one industrial sector that are complementing each other along a value chain and also overlapping in a limited geographical area (Porter, 1998). Several producers of a particular product, their specialised suppliers, customers who anticipate international trends and supporting organisations, such as educational institutions or associations, agglomerate on a national or even a regional basis within a country (see Figure 1). To fully describe a cluster, though, it is not sufficient to merely list the organisations present in a region. It is also necessary to consider how these firms and institutions behave towards each other. Is their behaviour towards cluster members different from their behaviour towards other firms? Are they aware of being located in a cluster? Take the example of a region that called itself ‘‘medical valley’’ yet almost half of firms surveyed indicated that they had never been aware of forming a cluster. Workshops have subsequently been conducted in the region to create awareness. In one workshop, for instance, a firm which was sending its samples to be tested overseas discovered that another firm, located almost next door, also had a testing facility. Firms in agglomerations can miss opportunities through not communicating with each other sufficiently. However, some agglomerations have developed an ‘‘innovative milieu’’ with intensive interaction which fosters collaboration while simultaneously maintaining competition (Crevoisier, 2004; Steinle et al., 2007). Firms located within such clusters have often been found to enjoy productivity, innovation and profitability advantages compared to their isolated competitors. British and American studies showed that almost double the density of employees in a specific sector within a region correlated with 7 per cent and 6 per cent higher productivity, respectively (Ciccone and Hall, 1996; Baptista, 2003). There are even more dramatic examples, such as that of the Flemish tufted carpet industry where the average productivity of the same machines – expressed in terms of the number of meters Figure 1 Elements of a cluster (the amplified Porterian diamond)

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produced by the plant – was 40 per cent higher in the cluster than in isolated companies (Vanhaverbeke, 1992). An explanation: in clusters, numerous specialised suppliers can emerge through spin-offs, which then start to compete intensively with one another. Owing to the presence of this supply base, producers located within clusters can more easily concentrate on their core competencies and increase productivity. Another form of specialisation found in agglomerations is a ‘‘labour-pool’’ of employees trained in specialties (Marshall, 1961). In clusters, it is easier for companies to recruit suitable employees and for employees to specialise in terms of their education. However, a wage-spiral may arise in a very dynamic cluster if employees frequently switch from one firm to another. The significance of employees moving from company to company becomes clearer still when viewed as a mechanism for knowledge exchange. People take their knowledge with them to their new jobs, combining it with the knowledge acquired at their new firms and thus developing the common knowledge base further. This provides an explanation for research findings showing that a few selected centres are host to most of the innovations in an industry (Feldman, 1999; Breschi and Lissoni, 2001). Higher productivity and innovative power result in companies within clusters tending to be, on average, more profitable than their isolated competitors: B

The Banca d’Italia analysed 64,000 balance sheets, which revealed that companies within clusters showed a return on investment of 10 per cent, whereas comparable but isolated companies achieved only 6 per cent (Fabiani and Pellegrini, 1998).

B

In another study with data from Mediobanca, there was a difference of at least 2 per cent between companies within clusters and isolated companies (Hermes Lab, 2000).

Conclusion Individual sectors within an economy form national or regional focal points. Companies anchored in such clusters can yield, on average, higher productivity than isolated companies and also benefit from greater innovative strength. Consequently, they are more profitable. The competitive success of a firm is thus influenced by location as well as such factors as wages paid or the quality of management. Although the cluster approach argues that the success of firms depends more strongly on their environment than commonly assumed, it does not imply the irrelevance of management action. Management decides how to address the opportunities and challenges clusters present. This point will be illustrated by the following case studies. The cases were developed over the past five years in several companies through research and participant observation and data analysis, which were supplemented by semi-structured interviews (Punch, 2005).

How to recognise a cluster Firms can use Porter’s ‘‘diamond of competitive advantage’’ to determine if they are members of any cluster (or if their competitors are). Managers may ask the following questions: B

Are our internationally successful competitors headquartered in the same region (as us)?

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Does our home country host innovation-oriented customers who tend to anticipate global trends?

B

Can we rely on a complete set of leading suppliers being present locally?

B

B

Is our sector characterised by an abundance of institutions in our region, such as associations, specialised educational institutions, research institutes and the like? Are there close ties among these organisations – ‘‘everyone knows each other’’? Does our cluster resemble a club?

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The cases do not aim to ‘‘prove’’ the theory, an objective for which larger-scale empirical studies may be more suitable, but rather to fill the application gap for management and provide evidence which may suggest a new focus in strategic management thinking.

Case study 1: anatomy of a vehicle cluster with intensive communication among players The first case study deals with a leading manufacturer of rail vehicles in one of the strongest German clusters. In this sector, the German export share of the world market was 25 per cent in 2003, larger than the average German world market share of this product (10.6 per cent) by a factor of 2.4. In terms of the four dimensions of Porter’s diamond – competitors of a company, customers, suppliers and institutions – until a short while ago, two global players and half a dozen smaller manufacturers located in Germany were producing the final product. On average, the German market alone has constituted about 20 per cent of overall global sales volume over the last few years. The industry is supported by at least 30 associations, institutes and technical training establishments. According to the cluster concept, it is not surprising that the supplier side is also very strongly represented. In this case, we studied the supply structure of the leading manufacturer in the cluster. We studied the 30 largest suppliers, who also supplied the three most important competitors of the firm. Twenty of these core suppliers were from Germany; five were from Austria or Switzerland and only five were not located in the German-speaking area. These suppliers, who sold their components to all the major players in this industry, were invited to participate in a ‘‘reverse rating’’. They were asked to evaluate their four most important customers with respect to ten dimensions. In six dimensions the suppliers rated their customers similarly. In four dimensions, though, significant deviations among them appeared. The German company located within the same cluster as most of the suppliers was evaluated more positively for the ‘‘communication with suppliers’’, ‘‘supplier development’’ and ‘‘knowledge about the supplier’’ dimensions than its international competitors located outside the cluster. The various suppliers’ evaluations of their international customers revealed only minimal deviation between these non-cluster firms. Conclusion A typical feature of a leading cluster is that the leading suppliers are also anchored in the cluster, such as in this case. There was good mutual knowledge and intensive communication within the cluster. However, in this case study, it is noteworthy that for the ‘‘cooperation/partnership’’ dimension no deviation was evident among the four companies assessed by their common suppliers. This shows that the company located within the cluster did not consistently exploit its advantage of having a better relationship with suppliers. Establishing personal contact through informal events is one technique used to make teams work well together, for instance in new product development projects. Typically, in a cluster, such ‘‘intimacy’’ already exists due to the employees sharing the same educational background, for instance. Thus, clusters create opportunities but these opportunities must be actively seized, which the firm in the case study above did not do. The case study below illustrates how a firm actively used its cluster location successfully.

Case study 2: cooperation with suppliers in a cluster leads to productivity gains The company in this second case, which has won many prizes for innovation, is located within a sectoral agglomeration. It is a manufacturer of milled metal products, a sector where Germany has a world market share of 12 per cent, hence holding third position according to the export statistics. This firm’s home region is in one of the clusters identified in the study by Brenner (2004). Case company 2 is the world market leader for a particular alloy and one of its largest competitors is located only 30 km away in the same cluster. The second largest manufacturer, an American company, had to apply for creditor protection under ‘‘Chapter

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11’’. The world market share of the company in the case was relatively stable at 11 per cent by the end of the 1990s, but rose sharply to 17 per cent between 1997 and 2002. Although global demand decreased by 15 per cent during the same period, this company was able to increase its production by a further 6 per cent against this market trend. If one observes the procurement structure of the company, it is striking that 85 per cent of its purchasing volume is sourced within a radius of 50 kilometres. Almost all of its machine equipment is manufactured in this region as well. The exceptions were two Italian machines, which had been purchased from the assets of a bankrupt French competitor. In the present case, the case study firm wanted to analyse how the costs for a specific production step could be reduced. In the context of global sourcing, the first consideration was to find economically viable suppliers for an important consumable, because it accounted for 70 per cent of costs. Six of the eight potential suppliers for this consumable were within the cluster. Testing the material of one of the non-local suppliers resulted in serious damage to the company’s equipment, and its engineers were reluctant to try out any more new suppliers. The firm decided on a specific, partner-oriented strategy of cooperation with its traditional supplier. Such a strategy can best be implemented in a cluster. A joint project was initiated among: B

the buyer, as the user of the consumable (the case company);

B

the manufacturer of the consumable whose costs should be reduced;

B

the manufacturer of the machine on which the material was used; and

B

a research institute, which would support the necessary tests.

The team formulated a target for reducing consumption and costs linked to the following agreement: if the productivity target was not reached, the supplier would have to lower its price. In the end, this constellation resulted in a win-win situation for the participants. The buyer reduced its costs while the manufacturer of the consumable gained, for the first time, an opportunity to use its own testing plant thanks to its cooperation with the machine manufacturer. The results underline the importance of several organisations, all of which are well integrated with one another, comprising one localised value chain. The cost-efficiency of the newly developed consumable is linked to the entire context, including the type of machine used. It is unlikely to perform in a similar way in a completely different (application) context, such as with a foreign competitor which uses different equipment. The literature refers to the ‘‘technology transfer paradox’’ (Gertler, 1993). Added to this is the need to conduct the tests on the same physical machine with all the parties working at the same geographical location, namely where the test unit is installed. Conclusion Within a cluster, forms of cooperation are possible which are not available to partners scattered far and wide without unduly taxing effort. Partner-oriented projects are a good example. Systematically searching for partnering opportunities within the cluster and implementing such cooperation agreements is at the core of a cluster strategy. The cases below consider two companies, which, unlike those in the first two case studies, do not belong to strong sector clusters.

Case study 3: risks to the competitive position of companies outside clusters Case 3 deals with a German oil-field equipment supplier and illustrates the problems that can arise due to remoteness from clusters. The strongest cluster, comprising well over 5,000 companies, is located in Houston, Texas. Aberdeen, Scotland, with over 1,000 companies, is second in importance and can be termed ‘‘the oil capital of Europe’’. The German agglomeration in Celle registers about 60 firms. The company in Case 3 has seven major competitors, among which the American firms are clearly dominant and include the world market leader. In terms of institutions, the American

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Petroleum Institute is the main standardisation body. On the demand side, the firm in Case 3 has a very close relationship with one customer, from whose repair department the firm originated in the first place. Meanwhile, both companies have been taken over by a foreign group. Remoteness from the main clusters and the consequences of this can be clearly demonstrated by analysis of the sourcing structure: 55 per cent of goods purchased by the Case 3 company were classified as highly specialised, including, for instance, pumps that are made just for the oil industry. Only a single home supplier, which accounted for about 3 per cent of purchasing volume, was supplying this strategic category of goods. The remaining 97 per cent of the externally-sourced specially-made parts came from abroad, primarily from the strongest cluster in the United States. An ‘‘inverse supply structure’’ is present, which is exactly the opposite of Cases 1 and 2, where almost all specialised suppliers were located in the home cluster. In the present case there were supply problems, including delays and non-adherence to the specifications established at the time of ordering. Repeated trips to the cluster in the United States did not improve the situation. Even delegating a permanent agent to the cluster in Houston failed to solve the problem.

Conclusion Companies anchored outside strong sector clusters must be regarded as marginal firms. It may be possible for such marginal firms to exist in niches. However, it may be difficult for peripheral companies to obtain a leading position in terms of technology or a significant world market share when their most important competitors are the ‘‘preferred customers’’ of the core suppliers located in a foreign cluster.

Case study 4: sales growth after joining a cluster The company in Case 4 may be described as a mixture of trading house and technical services provider, providing end customers with sophisticated products as well as on-site installation. The steel parts are used in industrial buildings. After changing over to sourcing its main product from a cluster-based firm rather than from an isolated manufacturer, the company was able to increase sales by 30 per cent. This increase was not due only to the cluster effect – an increase in sales staff also played a role. However, successfully tapping the cluster provided the basic prerequisites for this improvement. When the case study 4 company signed a new contract, the new partner was a company which focuses on its core competencies and was anchored in a cluster. Importantly, instead of the end product, only an intermediate product is made by the large core firm. The intermediate product is then further refined by small suppliers. Six companies, all of which are located in the immediate vicinity of the main factory, qualified for this processing work. Owing to the high transportation costs of this steel product, it is only possible to allocate this work among companies located in a small area. Sourcing the products from a regional network of suppliers rather than from an integrated company created many advantages for the buyer. First, the processing companies are largely interchangeable and hence have to compete for orders. Cost and efficiency advantages are thus transferred quickly. Secondly, the competitive situation led to differentiation efforts on the part of the small processing companies, even in the first year of the new model being put into practice. Thus, for instance, one company offered a surface treatment which made it possible to use the product under unfavourable environmental conditions with high humidity. This is a typical example of innovative force created through competition in a cluster, which in turn leads to an expansion of the market and therefore to a win-win situation for all participants.

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Conclusion Within the cluster, the value chain is more strongly differentiated and is characterised by companies which compete with one another. Such a competitive structure can contribute to lower costs and higher innovative force. From this perspective, it is advisable to procure products from a cluster-based supplier instead of from an isolated company, all other things being equal.

Implications of clusters for management The four case studies illustrate various aspects of the practical relevance of a cluster perspective for companies. The spatial concentration of competitive suppliers has repeatedly become evident. This finding may also alert strategists to the necessity of closely monitoring supply markets as a factor in strategic decisions. Further, it has been possible to observe that cooperation as well as productivity and innovation advantages have emerged in clusters. Clearly, the cluster phenomenon deserves a space in managers’ decision-making. Managers need to ascertain whether their firms are located in a cluster or not. Firms located outside a strong industry cluster may need to link up with the cluster. Avoiding the home market of the company’s strongest competitors would be the wrong approach. Another option would be to find a niche. From a portfolio perspective, firms outside a cluster may be candidates for divestiture.

Keywords: Strategic management, Sourcing, Cluster analysis, Innovation, Productivity rate

Firms anchored in strong industry clusters must take advantage of their location. Rather than ignoring their cluster through undifferentiated global sourcing, for instance, firms should actively search for partnering opportunities with local firms (Steinle and Schiele, 2008). Finally, the cluster approach has substantial implications for decisions regarding firm relocations. If a new location is needed, moving into a regional cluster in the host market may be the preferable option. Above all it is clear that, contrary to the prematurely proclaimed ‘‘death of distance’’, proximity matters and is a factor that deserves attention in strategic management. The cluster approach is one way to operationalise proximity.

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About the author Holger Schiele is an associate lecturer at Leibniz University Hanover, Institute of Management and Organisation. He is also project manager with h&z business consulting in Duesseldorf which specialises in strategy, purchasing and production consulting. In addition to three books, his previous work has included papers in Research Policy, European Planning Studies and Journal of Purchasing and Supply Management. He can be contacted at: [email protected]

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