Business Cluster

A business cluster is a geographic concentration of interconnected firms, specialized suppliers, service providers, universities and related institutions in a particular field, which both compete and cooperate with one another. Well-known examples include technology in Silicon Valley, finance in the City of London, film in Hollywood, information-technology services in Bengaluru, electronics in Shenzhen and sports goods and surgical instruments in Sialkot, Pakistan. The term was popularized by Harvard Business School professor Michael Porter in The Competitive Advantage of Nations (1990) and a 1998 article on "clusters and the new economics of competition".

The underlying idea is older. Alfred Marshall described "industrial districts" in his Principles of Economics (1890), and economists today speak of agglomeration economies, a kind of external economies of scale that benefit every firm in a place rather than one firm's own size. Paul Krugman's "new economic geography", recognized in his 2008 Nobel prize, modelled how such concentrations form. Clusters are a common target of industrial policy and regional development programs.

Think of a city street lined with furniture shops. Buyers go there because they can compare many shops in one trip. Sellers open there because that is where the buyers are. Upholsterers, delivery drivers and wood suppliers set up nearby because they have plenty of customers within walking distance.

Being next to rivals sounds like a disadvantage, but every shop on the street gains from the crowd the street attracts. A business cluster is the same effect at the scale of a city or region, built around an industry instead of a single street.

Marshall identified three main forces, and Porter and later writers added more:

• A shared pool of skilled workers. Firms can hire people with the right skills quickly, and workers can change employers without moving home, which makes the local market for labor deeper and less risky for both sides.
• Specialized suppliers. A large local industry supports suppliers of parts, equipment, legal advice and finance that no single firm could sustain, deepening specialization and the division of labor.
• Knowledge spillovers. Ideas travel through informal contact, job moves and imitation, a positive externality that is strongest over short distances.
• Rivalry and demanding customers. Porter stressed that intense local competition and sophisticated buyers push firms to improve.
• Trust and networks. Repeated dealings build trust, which lowers the cost of doing business, and investors such as venture capital firms prefer to back companies they can visit.

Silicon Valley grew from defense electronics and Stanford University research into the world's best-known technology cluster, supported by a dense network of investors and lawyers. London's financial district combines banks, insurers, exchanges, law firms and regulators, and in recent years has developed a large fintech community; Singapore, New York and Bengaluru host others. Sialkot has supplied footballs and surgical instruments to world markets for decades through networks of small family firms. Detroit shows the other side: once the center of the US car industry, it suffered decades of decline as production moved and the cluster shrank.

Many governments try to create or strengthen clusters through science parks, special economic zones, research grants, transport infrastructure and tax breaks. The European Union runs the European Cluster Collaboration Platform, and in the United States the Cluster Mapping Project, a collaboration between Harvard Business School and the Economic Development Administration, publishes data on cluster strength by region.

The evidence on cluster policy is mixed. Clusters tend to grow out of local history, universities and chance, and few successful ones were planned from scratch. Subsidies to attract firms can trigger costly bidding wars between regions, a form of tax competition, and may reward firms that would have come anyway.

Clusters can become victims of their own success. Office and housing rents rise, congestion worsens, and high costs push out lower-paid workers and young firms, adding to regional economic inequality. A region tied to one industry is exposed when that industry declines or new technology moves activity elsewhere. Economic geographers Ron Martin and Peter Sunley (2003) criticized the cluster idea as loosely defined, saying it was used so widely that it lost precision.

The rise of the internet economy and remote work led some to predict that location would stop mattering. So far, leading clusters have kept much of their pull, and in fields with strong network effects the gains have often concentrated further in a few places, echoing patterns seen in winner-takes-all markets. New firms in clusters also benefit from the presence of other entrepreneurs, which makes it easier to learn, hire and raise money.

• US Cluster Mapping Project
• European Cluster Collaboration Platform