Location Strategies for Agglomeration Economies

by Juan Alcácer & Wilbur Chung

Overview — Locations thick with similar economic activity expose firms to pools of skilled labor, specialized suppliers, and potential inter-firm knowledge spillovers that can provide firms with opportunities for competitive advantage. While certainly attractive, the lure of these agglomeration economies varies. Some firms should be wary of aiding their competitors by co-locating with them, for example, because each "agglomeration economy" differs in how readily competitors can leverage contributions made by others. HBS professor Juan Alcácer and Wilbur Chung of the University of Maryland develop a framework to better understand how firms respond to agglomeration economies. Key concepts include:

  • Firms' location choices balance the perceived risk of aiding competitors with a recognition that some agglomeration economies will be of limited use to others.
  • Firms, on average, place more value on pools of skilled labor and specialized suppliers than on potential knowledge inflows from competitors.
  • The priority placed on labor and suppliers persists even for industries that are more R&D intensive.
  • Economically larger firms are less attracted to industry employment, but more attracted to industry supplier activity.

Author Abstract

Geographically concentrated industry activity creates pools of skilled labor and specialized suppliers, and increases opportunities for knowledge spillovers. The strategic value of these agglomeration economies may vary by firm, depending upon the relative value of each economy, and upon firm and agglomeration economy traits. To better determine when a firm will be attracted to agglomeration economies, we develop a three-layer framework. The first layer assesses the relative importance of skilled labor, suppliers, and knowledge spillovers. The second layer considers whether firms can benefit from geographic concentration without co-locating. The final layer examines why some firms are more inclined to co-locate than others based upon firm and agglomeration economy traits. We test our framework on the U.S. location choices of new manufacturing entrants between 1985 and 1994 and find that firms are far more attracted to skilled labor and specialized suppliers than they are to potential knowledge spillovers, even in R&D intensive industries. We also find that leading firms will be more attracted to pools of labor, suppliers, and potential knowledge spillovers when their own contributions are less fungible, and cannot be easily leveraged for strategic advantage by proximate competitors. Keywords: agglomeration economies, location choice, firm strategy. 38 pages.

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