The Main Features of Porters Cluster Model - Essay Example

Michael Porters (1998) work on industrial clusters has been seen as a new and potentially fruitful way of understanding how innovation can be stimulated in particular regions and firms. What are the main features of Porters cluster model and what advantages does it bring for business and society? Introduction Today, competition is more dynamic, as organisations enjoy the opportunities of global sourcing and have many new insights for creating and maintaining competitive advantages. Porter (1998a: 78) states “the enduring competitive advantages in a global economy lie increasingly in local things – knowledge, relationships, motivation – that distant rivals cannot match”. Thus, the author highlights the role of local factors and concentration of critical masses in one location. While location is one of the critical competitive factors, it plays a different role than it did a generation ago (Porter, 1998a). The quality of the local business environment is very important for clusters’ development. Companies can hardly operate efficiently if there are tough government regulations, lack of qualified personnel, lack of high-quality transportation infrastructure or other barriers/inefficiencies reducing firm’s productivity (Porter, 1998a). Michael Porter has introduced the ideas of industrial clusters, which he believes is a new and potentially fruitful way of understanding how innovation can be stimulated in particular regions and firms. The aim of this paper is to provide a brief overview of Porters’ cluster concept and its main features, and to discuss what advantages it brings for businesses and society. Definition of Industrial Clusters The history dating back to the earliest urban developments illustrates how economic agents (both firms and individuals) concentrated in close geographic proximity and established/developed business relationships in order to gain greater economic output and maximize the benefits of cooperation (Morosini, 2004). This tendency of forming economic agglomerates is also known under the concept of industrial clusters. While the concept of economic agglomeration exists for a long period of time, Michael Porter was the first one who proposed a formal term of the industrial cluster (Belso-Martinez, 2015). Clusters are defined by Porter (1998a: 78) as “geographic concentrations of interconnected companies and institutions in a particular field”. In terms of geographical scope, clusters have no specific limits and can range from a city to country or a network of neighbouring countries (Porter, 1998b). According to Porter, clusters are common for any type of economy at national, regional, metropolitan and state levels (Porter, 1998). Clusters can vary in size, scope, depth, sophistication, and nature (Porter, 1998) and can be established in a wide array of linked industries. These industries may vary by type and size, ranging from national to local businesses. Despite the numerous linkages and flexibility, well-developed industrial clusters usually have the following features: common customers, common service providers and suppliers, common pool of human resources, common infrastructure (including transportation, utilities, etc), common risk capital markets, common university, institutes or research center, common training and educational facilities for employees (Morosini, 2004). Industrial clusters can be a concentration of suppliers of specialised inputs such as components and services, concentration of channels, concentration of customers, concentration of manufacturers of complementary goods and services, or concentration of various institutions such as trade associations, universities, think tanks, standard-setting agencies, etc. (Porter, 1998). Some of the real life examples of clusters are: entertainment in Hollywood, consumer electronics in Japan, IT in Silicon Valley, finance on Wall Street, etc. (Porter, 1998). While clusters can be developed in different types of economies, the countries with advanced economies usually have better developed clusters (Porter, 1998). Moreover, there are no fixed boundaries of clusters as they continually evolve with the emergence of new industries/players, and development/decline of existing industries. Advantages of clusters Industrial clusters have several advantages as they promote both cooperation and rivalry. Competition and cooperation coexist as they occur among different market players and on different dimensions. On the one hand, clusters increase the potential for growth and development as it involves companies in related industries, leading to increased output due to complementarities across industries and organisations (Porter, 1998). On the other hand, clusters reinforce competition among rivals who fight intensely for customers. Vigorous competition is an important element of cluster’s existence, as lack of competition will cause cluster’s failure (Porter, 1998). Porter (1998) differentiates three ways of how clusters affect competition. First of all, it helps companies based in the location or in the area to increase the productivity. Secondly, it drives the pace and direction of innovations, which is crucial for future growth of productivity and efficiency. Thirdly, it stimulates and encourages the formation of new businesses and directions, supplementing and strengthening the cluster (Porter, 1998). A more detailed overview of advantages of clusters for business and society is presented below. Efficiency, flexibility, and productivity of business operations While there exist many different explanations of the benefits of industrial clustering, positive agglomeration externalities is recognized to be the most popular one (Iammarino and McCann, 2006). More specifically, three elements including local information and knowledge spillovers, a pool of skilled local labour, and local supply of non-traded inputs make up favourable business environment (Iammarino and McCann, 2006). As companies and institutions are based in one location or in proximity to each other, the market transactions are more coordinated and trusted due to repeated exchanges among buyers and sellers (Porter, 1998). Organisations do not need to bother about creating and maintaining formal structures such as partnerships, networks, and alliances (Porter, 1998). Businesses can operate more productively in accessing information, needed institutions/partners and technology; sourcing inputs; driving and measuring improvement. Thus, companies and institutions benefit from a robust organizational form, which is more effective, efficient, and flexible (Porter, 1998). Access to specialized information The organizational design of clusters contributes to the formation and accumulation of extensive market, competitive, and technical information. All participants of the market in cluster have a greater access to valuable information, which pose them in relatively unique and advanced position (Porter, 1998). Moreover, due to a proximity factor, there are increased opportunities for community ties and personal communication contributing to greater access to specialized information (Porter, 1998). This aspect enables firms to make more efficient and effective decisions, staying ahead of distant competitors. Better Access to Employees Clusters imply a concentration of not only organisations and various institutions but also professional specialists and experienced employees. Professional and qualified individuals seek for/strive to work in clusters and this behavior enables firms to reduce both search efforts and recruitment transaction costs (Porter, 1998). Moreover, companies have greater opportunities to attract and employ talented employees from different locations, developing such a sustainable competitive advantage (especially valuable for service industries) (Porter, 1998). Better Access to Suppliers In addition to better access to employees, clusters enable the firms to gain better access to suppliers. Due to the organizational feature of clusters, companies benefit from access to a deep and specialized base of suppliers. By having an opportunity to source inputs from local suppliers, firms are enabled to lower transaction costs (on inventory, importing costs, etc.) and to establish strong formal relationships with suppliers. Moreover, clusters offer firms an alternative to vertical integration, as outside contractors and partners are often more responsive and cost effective than in-house departments/divisions (Porter, 1998). Clusters are beneficial for suppliers as well, as they gain an opportunity to develop their customer’s base and to achieve economics of scales by targeting well-established organisations. By pursuing this strategy, suppliers are more likely to focus on aggressive growth by offering lower/more loyal prices in order to capture new and retain existing clients. Complementarities Complementarity is an important advantage of industrial clusters as members (both sellers and buyers) gain better experience due to complex approach. For example, in a tourism industry tourists will enjoy not only the nature, beauty and/or historical value of the primary attraction but also the availability and quality of relevant infrastructure, including: hotels, shops, transportation, entertainment, restaurants, etc. (Porter, 1998). Another example is healthcare industry, whereas patients can receive necessary help in the most efficient, fast, and comfortable way, rather than travel through different clinical facilities spread across the country or even abroad. Moreover, complementarity effect of clusters also perform a positive marketing function, as clusters often become “centers of excellence” with overall positive reputation. Innovation Another important advantage of clusters is its effect on innovation stimulation. Due to a high concentration of leading market players, companies operating within clusters usually have better understanding of market trends and customer needs than the companies, operating in isolated markets. Moreover, the ongoing relationships and interactions with other market players within the cluster help firms to be aware of evolving technologies, marketing concepts, strategic innovations, etc. In addition to stimulating innovation in terms of ideas, clusters enable firms to implement these innovations in more rapid and efficient due to easy access to necessary sources and supplies (Porter, 1998). As competition within a cluster is fiercer and more intensive, companies are more focused on innovation in order to be ahead. All these factors contribute to innovation stimulation and make clusters “the centers of innovation” (Porter, 1998: 83). More detailed overview of how clusters drive innovation is discussed further in the report. Formation of new businesses Another advantage of clusters is its driving force to stimulate new business development. Due to a concentration of market players in specialised industry, the firms have a better understanding of market needs and the gaps existing in the loop. Lower business risks and entry barriers also stimulate development of new businesses and directions. Advantages for society As it has been already identified, clusters stimulate competition, drive innovation and contribute to economic development. All these factors have positive impact on society as people get better products and offers, and due to increased economic input their income levels and general welfare is improving. Disadvantages of industrial clusters While there are so many different benefits and advantages of industrial clusters, there are also many disadvantages and pitfalls of clusters. Some of these disadvantages are: increased competition (which might be significant risk for some players), shared market intelligence, poaching of skilled/specialized employees among firms, faster imitation of product innovations and technology on behalf of competitors, etc. (Morosini, 2004). Industrial clusters and innovation The above listed disadvantages and threats of industrial clusters indicate that industrial clusters are driven by competition. While for some players industrial clusters can support and develop business, for others it can be quite disadvantageous. This asymmetrical distribution of benefits and disadvantages is an important element of industrial clusters as it drives and improves innovation performance (Belso-Martinez, 2015). Belso-Martinez (2015:206) explains “if innovation derives from new exploitations of resources or new ways of exchanging and combining resources, then external knowledge favours innovation performance”. Innovative performance of a firm in cluster depends on many different factors varying from a type of industry to the type of network in the industry and the type of knowledge/information transfer (Casanueva, Castro and Galan, 2013). Due to numerous networks and strong ties among cluster members, firms and other institutions have more opportunities for exchanges of high-quality information and knowledge (Belso-Martinez, 2015). Cheng, Niu and Niu (2014) have developed a model of the influence of cluster involvement on learning and adaptation (see Figure 1). This model illustrates how dense networks in clusters contribute to a decentralised process of experimentation, learning, and innovation. The authors differentiate two types of competitive characteristics that the firm/institution/other players can further transfer into competitive advantage. The first type is referred to traded interdependencies and the second type - to non-traded interdependencies (Niu, 2010). Traded interdependencies imply “formal exchanges of value for value” and can be expressed through acquisitions, strategic alliances or technological know-how. Non-traded interdependencies are “based on shared knowledge for which no or limited market mechanisms exist” (Storper, 1997 cited in Niu, 2010: 143). Figure 1. Model of the influence of cluster involvement on learning and adaptation (Source: Cheng, Niu and Niu 2014: 976). Due to geographical proximity, knowledge acquisition/creation and information exchange is much easier within the industrial cluster, which makes the environment especially favourable for innovations (Casanueva, Castro and Galan, 2013). As it has been already mentioned, presence of common research centers, educational facilities and cluster institutions is one of the features of a well-developed cluster (Belso-Martinez, 2015). These institutions usually accumulate and catalyse new knowledge and provide this external knowledge at moderate cost to other cluster embers (Belso-Martinez, 2015: 206). Due to knowledge transfer, firms can build innovations more easily upon the pool of knowledge, attained from outside sources (Belso-Martinez, 2015). In addition to knowledge sharing factor, clusters usually are highly competitive location, which stimulates new business venturing activities and thus contributes to innovation development. The industrial atmosphere forces the companies to develop new products, services, new processes and approaches in order to stay competitive. All these aspects inevitably add to the innovative capacity of industrial clusters and offer its members greater opportunities for innovations’ development. Conclusion Industrial clusters are broadly discussed and analysed by different researchers. Michael Porter also has made a substantial contribution to analysing the nature of industrial clusters, offering formal definition of this concept, developing a model of industrial clusters and explaining various advantages of economic/geographical agglomerates. Despite the variances in size, scope, depth, sophistication, and nature of industrial cluster, there is a number of advantages, which firms, institution and other agents gain. Some of these advantages include the following: efficiency, flexibility, and productivity of business operations; access to specialized information, better access to employees, better access to suppliers, complementarities, formation of new businesses and ventures, etc. While there are so many different benefits and advantages of industrial clusters, there also were identified some disadvantages and pitfalls of clusters, namely: increased competition (which might be significant risk for some players), shared market intelligence, poaching of skilled/specialized employees among firms, faster imitation of product innovations and technology on behalf of competitors, etc. Advantages and disadvantages of industrial clusters are asymmetrically distributed among various players, which in turn, drives firms to attain sustainable competitive advantages through innovations. Due to numerous networks and strong ties among cluster members, firms and other institutions have more opportunities for exchanges of high-quality information and knowledge. At the same time, due to geographical proximity, knowledge acquisition/creation and information exchange is much easier within the industrial cluster, which makes the environment especially favourable for innovations. This major feature of industrial clusters can be helpful and useful for stimulating development and growth in many different regions and sectors. Firms and other organisations willing to grow business and increase innovation performance might consider the option of industrial cluster as part of their strategies. References: Belso-Martinez, J. 2015. ‘Resources, governance, and knowledge transfer in Spanish Footwear Clusters can local firms be locked out by their crucial partner?’, International Regional Science Review, 38 (2), pp. 202-231. Casanueva, C., Castro, I., and Galan, J., 2013, ‘Informational networks and innovation in mature industrial clusters’, Journal of Business Research, 66, pp. 603-613. Cheng, H., Niu, M and Niu, K. 2014. ‘Industrial cluster involvement, organizational learning, and organizational adaptation: an exploratory study in high technology industrial districts’, Journal of Knowledge Management, vol. 18 (5), pp. 971-990. Iammarino, S. and McCann, P. 2006 ‘The structure and evolution of industrial clusters: Transactions, technology and knowledge spillovers’, Research Policy 35, pp.1018-1036. Morosini, P. 2004, ‘Industrial Clusters, Knowledge Integration and Performance’, World Development, vol. 32 (2), pp. 305-326. Niu, K., 2010 ‘Organizational trust and knowledge obtaining in industrial clusters’, Journal of Knowledge Management, vol 14 (1), pp. 141-155. Porter, M.E. 1998, Clusters and the new economics of competition’, Harvard Business Review, 76, 6, pp. 77-90, Business Source Complete, EBSCOhost, viewed 2 April 2015. Porter, M. E. 1998, ‘Clusters and Competition: New Agendas for Companies, Governments, and Institutions’, Harvard Business School Working Paper, No. 98-080. Available at: http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.199.4104&rep=rep1&type=pdf Porter, M.E. 1990, The Competitive Advantage of Nations. (cover story), Harvard Business Review, 68, 2, pp. 73-93, Business Source Complete, EBSCOhost, viewed 28 March 2015. Read More