Too often corporations decide to locate facilities based solely on cost savings. And that's shortsighted, argues Harvard Business School professor Michael Porter. Instead, business leaders should look for locations that gather industry-specific resources together in one "cluster" (think Silicon Valley or the Napa wine country) that can lead to competitive advantage.
Porter's Institute for Strategy and Competitiveness has just introduced a new database tool to help corporations and policy makers pinpoint these clusters, which number forty-one in the United States. The tool, called the Cluster Mapping Project, uses statistical techniques to profile the performance over time of regional economies in the U.S., with a special focus on clusters. Clusters are geographically concentrated groups of interconnected companies, universities, and related institutions that arise out of linkages or externalities across industries. Regional economies and clusters are analyzed at various geographic levels including states, economic areas, and metropolitan areas. Access to top-level data on the CMP is free; more in-depth information is available for a modest charge.
In an e-mail interview with HBS Working Knowledge editor, Sean Silverthorne, Porter discusses the importance of cluster research and the value of the CMP.
Silverthorne: How can data from the Cluster Mapping Project help corporations make better location decisions?
Porter: The competitiveness of a company is strongly influenced not just by the decisions it makes and the assets inside the company, but also by the surrounding business environment in the locations at which the company operates. The business environment shapes the skills, knowledge, and technology available as well as the productivity with which a company can operate.
At the core of the business environment is the cluster, or the group of interconnected firms, industries, and institutions present in a particular field. Examples of clusters include Silicon Valley, Boston in asset management, and Houston in energy. Being a part of a cluster allows a company to be more competitive because it is easier to source skilled people, access suppliers efficiently, and operate productively. In money management, for example, every road show comes to Boston because there is a cluster of major investors there, making it easier for Boston money managers to conduct research and gain access to company managements. Clusters allow companies to operate more productively than where they must do things themselves (vertical integration) or where they must outsource goods and ideas from distant locations.
Since the existence and depth of clusters affects productivity and competitiveness, a company needs to understand where the clusters are in its business. It must understand the competitive position of its cluster versus other locations. This is important not only to inform location decisions, but also to inform how a company should direct its energy towards enhancing its cluster, both individually and collectively through trade organizations.
The Cluster Mapping Project reveals the detailed patterns of cluster location across the United States. It allows an evaluation of whether a cluster is growing or shrinking in a particular region, where it is gaining or losing national share, and whether it is getting broader or narrower in depth. The data covers not only the overall cluster but also segments or "subclusters." These further reveal the cluster's strengths and weaknesses. The data is a powerful new tool to take location and economic development decisions to a new level of sophistication.
In a cluster, a company can draw on a local supplier base of skilled people, specialized service providers, and local institutions that can provide training and perform research.
— Michael E. Porter
Q: Many U.S. companies over the last twenty years, particularly in high tech, made the decision to move manufacturing offshore where costs are lower. You have argued that the location decision should involve much more than simple financial savings. What have these companies missed out on in terms of benefits not realized? Are they less competitive today?
A: There has been a tendency to look too narrowly at location decisions, focusing just on labor cost, electricity costs, tax breaks, etc. But input costs are not what matters. What matters is total cost, which depends on the quality of inputs and, most importantly, the productivity with which they can be used. Cheap labor is not really cheap if workers are unproductive. Input costs can be overshadowed by logistical costs, delays, and inefficiencies.
There are hidden costs of outsourcing. The most obvious is the cost of management and coordination required to supervise disparate sites, transfer new product lines, update technologies, etc. Another cost of outsourcing is the cost of inventory. A part might be manufactured cheaply in Mexico, but shipping the part involves inventory, not to mention delays and risks.
Another growing cost of outsourcing is lead time. Sourcing from Asia, for example, requires weeks for transit alone, not even considering coordination time. Product cycles are shortening, and less lead time allows companies to wait longer to make decisions on quantity, features, style, and fashion.
The data is a powerful new tool to take location and economic development decisions to a new level of sophistication.
— Michael E. Porter
A final hidden cost of outsourcing is slower innovation. Changing products and processes is more complex and time consuming across separated sites. Knowledge and technology are fragmented and dispersed. All these costs decline markedly within a cluster. Inventory largely disappears, and lead time falls sharply. In a cluster, a company can draw on a local supplier base, skilled people, specialized service providers, and local institutions that can provide training and perform research. Moreover, within a cluster there are many companies with which to partner. Being part of a cluster facilitates change and speeds innovation—both fundamental to modern, knowledge-based competition.
Q: Over the next ten or twenty years, what new clusters do you think will emerge that are not now represented in the forty-one competitive clusters covered in your research?
A: One of the major trends in the world economy is the aging of populations, which will create the need for retirement living, health services, and no doubt many other goods and services. This may create an entirely new cluster. We are also witnesses to substantial breakthroughs in life sciences technologies and continued breakthroughs in information technology. While there is no entirely new technology cluster evident on the horizon, new segments will be added to existing clusters such as genomics and proteomics in biopharmaceuticals. Economies are remarkably dynamic, however, and some entirely new clusters may emerge out of existing ones and become clusters in their own right.
Q: One area companies seem not to consider in their expansion or moving plans is the inner city. But your work with, among others, the Initiative for a Competitive Inner City (www.icic.org), has shown that inner cities have advantages in terms of proximity to transportation infrastructure, unmet market needs, lower employee turnover and much more. Have you seen a growing awareness of the potential of urban areas, or is corporate America still bypassing a huge opportunity?
A: There is some heartening progress. The word is out among retailers about the under-served market in inner cities. Drug chains, such as Walgreen's, and many other retailers, such as Home Depot, are pursuing this opportunity to good results. There is also beginning to be an awareness of the inner city opportunity in services. For example, there is a trend to locate call centers in central cities, to access a loyal and available labor force and strong telecommunications infrastructure.
What is not yet recognized is that inner cities mirror the future of the U.S. economy.
— Michael Porter
The corporate sector is starting to wake up to the opportunity, but there is still much to be done. Perceptions are slow to change. Many business people still view inner cities as areas where there are no businesses, no workers to hold jobs, and rampant crime.
The Initiative for a Competitive Inner City is working to change these perceptions and document inner city business opportunities. In partnership with Inc. magazine, the ICIC scours America each year looking for the most rapidly growing private companies based in inner city areas. The Inner City 100, as we call them, were selected this year from more than 4,000 nominations. The Inner City 100 companies, and hundreds that do not quite make the list, are proof that there are opportunities to take advantage of the inherent competitive advantages of an inner city location. As the number of nominees for the list goes up and the size of our annual awards dinner grows, the word is starting to get out.
What is not yet recognized is that inner cities mirror the future of the U.S. economy. Inner cities are disproportionately populated by minority groups, which reflects the growing consumer market. The workforce is also becoming increasingly diverse, making inner cities a window into the workforce of the future. The logistical efficiencies of inner cities—just-in-time, rapid response, rapid servicing—are metaphors for where the economy is going.
Inner cities are not only important for social or equity reasons, but for economic reasons. As companies understand this better, they will come to view inner cities as a more strategic location than they can imagine today.