In a globalized economy, companies can access capital, goods, information and technology from all parts of the world. Thanks to faster methods of transportation and communication, physical location has become less important. Yet, there are geographic concentrations of industrial activities. For example, Silicon Valley in California is reputed for its cluster of computer hardware and software companies. Even though it is a very expensive location, many tech companies continue to perform their key value adding activities in this region.
Michael Porter uses the term “clusters” to describe geographical concentrations of interconnected companies and institutions in a particular business. Business clusters include suppliers of components, machinery, services and institutions which provide specialized infrastructure. Sophisticated, demanding customers who keep companies on their toes can also be considered a part of the cluster. So can the local government, universities, research centers and think-tanks who play a vital role in encouraging innovation and creating suitable conditions for more efficient value addition.
Firms within a cluster exhibit strong inter-relationships. The flow of goods and services between geographically concentrated industries in a cluster is stronger than the flow linking them to the rest of the economy. Business clusters are different from the classic definition of business sectors because it represents the entire value chain of a broadly defined business from suppliers to end products, including supporting services and specialized infrastructure.
Business clusters help in improving productivity, due to the superior quality of the local infrastructure. Other aspects which give a location a head start over other centers include a high quality transportation network, which facilitates fast and efficient movement of goods, availability of skilled, educated and trained manpower, a sound legal system and favorable tax rates.
Many leather goods, footwear, apparel and accessories companies operate out of Italy because of the country’s reputation for fashion and design. France is an important country for cosmetics, since it has highly sophisticated customers. In a location with well-established marketing networks, companies can also take advantage of referrals. Clusters help companies to improve as competition with rivals keeps them on their toes. The presence of companies engaged in related value chain activities, downstream and upstream, facilitates effective coordination even without vertical integration. Proximity also builds a greater degree of trust among the various players.
The presence of demanding customers in a cluster motivates companies to innovate, while the presence of competent suppliers and partners helps in bringing innovations to the market faster. A company within a cluster can source what it needs much faster, closely involve suppliers and partners in the product development process and obtain relevant technical and service support.