Industry Clusters FAQ

Clusters illustrate why place still matters in the global economy. Businesses thrive in particular locations because their network of local connections to a specially skilled local workforce and the availability of strong local suppliers in proximity to one another generates business advantages that can not easily be imitated or competed away by low cost competitors.

Harvard Business School's Michael Porter, one of the most influential business scholars of the past decade, provides a new perspective on the determinants of regional competitive advantage. Traditionally, economic developers have thought that they can influence a region's economy by lowering the costs for doing business in their areas. Corporate incentives such as tax breaks for individual firms were the tools of choice. But cluster thinking goes beyond the narrow cost-based view of the business environment by focusing on an extended set of factors that influence the competitive advantage of a group of firms. Within this view, public policy efforts become more effective because they affect more than one individual company. The development of effective public policy instead benefits a number of interrelated firms within an industry cluster.

Industry clusters increase the capacity of firms to innovate and increase their productivity. A cluster enhances productivity by providing firms with the privilege of accessing specialized inputs and employees, as well as unique information and knowledge. Firms that are connected to other firms and whose employees are part of cluster networks will ultimately have an advantage because they are able to more rapidly respond to market needs. Firms that recognize the benefits of information and knowledge flows will benefit because they notice new technological or market possibilities faster than others.

The importance of clustering seems like a paradox in the age of the Internet. While many people have assumed that the emergence of the global economy has somehow diminished or reversed the importance of place –“in an information economy, anything can be anywhere,” it is asserted -- careful studies have shown the reverse is true. Harvard Business School's Michael Porter documented that the creation and maintenance of competitive advantage hinges most critically on clusters of highly competitive firms in a wide variety of industries in every developed country.

In his study of the competitive advantage of national economies, Porter found that location characteristics play an important role in the success of a region's industries (Porter, 1990). A company’s location had a huge impact on its global competitiveness. Instead of focusing on factors inside the company, the industry cluster approach suggests "that a good deal of competitive advantage lies outside companies and even outside their industries, residing instead in the locations at which their business units are based." (Porter, 2000, p.16).

A cluster approach can help firms to achieve a competitive advantage by promoting their common interests, and can make the public sector more effective in supporting the economy. Working with clusters can enable us to identify the most promising opportunities to encourage further innovation, develop particular worker skills, and address issues that affect productivity.

Clusters can be used in a number of different ways to organize our thinking about the economy, to network groups of private sector firms for their mutual advantage, to efficiently promote clear lines of communication between the public and private sectors, and as a vehicle for organizing public policy. Clusters are not the exclusive province of any one organization or agency—they are a way we can all better understand our economy and work together to promote the common economic good.

Harvard Business School’s Michael Porter's defines clusters as groups of similar and related firms concentrated in a small geographic area (Porter, 1998). A cluster must consist of interconnected firms in the same fields, specialized suppliers, service providers, firms in related industries, and associated institutions (such as trade associations, universities, technology transfer centers, etc.). Through their competitive and cooperative dynamics, industry clusters are successful in creating competitive advantages for their member firms.

Porter provides an industry cluster framework to explain the determinants of regional competitive advantage. This framework is summarized in the diamond of competitive advantage (Porter, 1990). The four components of the diamond are:

• Firm strategy and rivalry
• Demand conditions
• Related and supporting industries
• Factor conditions

If a region succeeds in developing an industry-specific diamond, then the region's industry cluster can be competitive in the global economy because individual firms belonging to the cluster can draw on specialized services, inputs, and related industries. Thus, Porter's diamond powerfully describes the mechanics of industry cluster competitiveness.

The four elements of Porter's diamond deserve highlighting because they are integral to understanding why industry clusters are more competitive than firms that are isolated from others.

Firm strategy and rivalry:

This aspect of the diamond refers to the conditions governing corporate organization and aspects of rivalry among firms in the same cluster. If cluster firms choose to continuously upgrade and invest, then they will remain competitive. Additionally, if these firms compete with others in the same industry cluster, they will be motivated to constantly innovate in order to differentiate themselves from their rivals. Both firm strategy and rivalry contribute to regional competitiveness drawing on regional innovation dynamics.

Demand conditions:

The presence of sophisticated and demanding local customers will force industry cluster firms to continuously innovate and stay on the leading edge. Cluster firms must cooperate with their customers in order to meet their needs. Additionally, meeting the demand of sophisticated local customers will help cluster firms to compete more successfully in global markets.

Related and supporting industries:

The third aspect of Porter's diamond refers to the presence of capable, locally-based suppliers and of competitive related industries. These supportive industries create a web of necessary providers on which firms can draw upon. Cooperation between firms and their suppliers creates innovation because it is vital to these firms to exchange information and knowledge about new processes and products.

Factor conditions:

These include factors of production such as a skilled labor force, specialized infrastructure, educational institutions that all firms in the cluster can draw on. Porter states that "to increase productivity, factor inputs must improve in efficiency, quality, and (ultimately) specialization to particular cluster areas." (Porter, 2000, p.20) Such specialization will contribute to increased productivity. And if specialized factor conditions are only available at one location, then it is less likely that the same set of conditions will be available elsewhere. Thus, demand for services and products from firms in this specific cluster will rise because no other location provides the same set of services and products.

Porter concludes that "the cluster is the manifestation of the diamond at work. Proximity, arising from the co-location of companies, customers, suppliers, and other institutions, amplifies all of the pressures to innovate and upgrade." (Porter, 2000, p.21)

The term clusters has come into common use in the last few years, and in many cases there is some confusion about what it does and doesn’t mean. Because clusters are often discussed as part of public sector-led economic development efforts, some people assume that clusters are just some new kind of government led economic development program, and one that might involve favoring some parts of the economy over others. There are four common misconceptions about clusters.

Not (Just) A Public Sector Activity

First and most importantly clusters don’t depend on the public sector. As our definition makes clear, clusters are about the relationships between private sector firms that share common inputs, similar technology, related markets or drawn on particular sets of worker skills. Ultimately, participating private sector firms decide whether there is a cluster and who its members are.

Not A Program

Does the importance of clusters mean that we ought to have a new “cluster” program for our state or for individual communities? To be effective, the public sector approach to clusters has to cut across programs, departments and levels of government. Clusters become a way for all government entities (as well as private firms) to think about the way their activities influence the private sector of the economy. The efforts to work with some clusters may be lead by particular arms of government with a special mission or competence (like the Film and Video Commission working with creative service firms, or the Department of Agriculture working with food processors), but clusters can’t be treated as a separate program or activity.

Not Creating Clusters or Picking Winners

While government policy can play an important supporting role, it is abundantly clear that government can’t create clusters where none exist. Some people fear that engaging in an effort to work with and develop industry clusters involves having government pick winners. But a cluster view doesn’t involve ranking or excluding any industry. We should view our entire economy as being composed of cluster and recognize that we can work with large, well-established and growing clusters, just as well as working with smaller, newer and even slow-growing clusters.

Not “One Size Fits All”

A final concern about clusters is that there is a single set of policies or activities that is required to be a successful cluster. In fact, clusters form a basis for systematically addressing the important differences among industries, and tailoring one’s thinking, conversations and actions to the particular challenges and characteristics of each industry. Some industry clusters may value a strong formal industry organization and cooperate very closely on issues of market development (like the nursery industry). Other industry clusters may have much less formal kinds of collaboration, and be concerned about energy policy, job training, or resource management. Too frequently, our economic development efforts present the private sector with a pre-determined array of programs and services; clusters give us a way of crafting our efforts to develop each industry to its most pressing concerns.

In its December 2003 Leadership Summit discussion paper, the Oregon Business Plan outlines three general recommendations for the improvement and development of Oregon’s clusters.

Deepen understanding of industry clusters

Define all of the state’s industry clusters, utilizing the existing base of statistical research, and validating it with industry supplied information about the connections and relationships among principal cluster firms, their suppliers, and related and supporting institutions.

Develop an ongoing method for quickly identifying the emergence of new industry clusters, and assuring that they are understood and appropriately supported.

Think about how clusters relate to our roles as citizens, consumers, workers and entrepreneurs. As consumers, some of the local demand we provide, particularly for Oregon food products, can help provide the basis for an industry that can develop international competitiveness. As workers, our particular skills, and those of our peers are a critical ingredient in the success of the clusters that form the Oregon economy. It can be particularly helpful in stimulating public knowledge about clusters if our state’s news media would discuss the economy not just in terms of the ups and downs of the stock market and individual companies, but in terms of the health of interrelated industry clusters.

Use cluster framework strategically

Integrate clusters into a wide range of economic development policy and planning efforts. Already a number of local and regional plans have developed cluster components, such as The Oregon Economic and Community Development Department. Other regional economic development agencies and planners should also include strong cluster elements in their work plans and strategies.

Align industry cluster development efforts throughout the state into a well coordinated network that widely shares information, pools resources, and minimizes duplication of effort (for both the public and private sectors.) OregonClusters.org helps keep track of cluster development efforts, opportunities for involvement, and the progress of Oregon’s clusters.

Build an explicit “community of practice” around clusters in Oregon, an ethic, a set of relationships and supporting mechanisms to develop the skills and understanding of all those working with industry clusters. The objective of this effort should be to steadily improve the skill, professionalism and effectiveness of all those involved in supporting clusters in Oregon, and to reinforce the seamless networking of all of the various parties involved in cluster development. The community of practice would expand and deepen the relationship of cluster efforts tracked in the cluster matrix, providing meetings to analyze and learn from best practices, training opportunities and information sharing.

Strengthen cluster firm relationships

Strengthening the relationships among the firms that compose industry clusters is one critical way to improve the competitiveness of the Oregon economy. The Cluster Working Group offers three recommendations to strengthen these relationships.

First, the public sector needs to recognize the key role that clusters play. All public sector entities involved with the economy and economic development need to recognize the existence of industry cluster organizations.

Second, the private sector needs to organize each cluster in a fashion appropriate to that cluster’s needs. In many cases, trade associations and similar industry organizations already exist, serving as forums for cluster related activity. Where organizations exist, the public sector role is to work with and through such organizations to support cluster development. Where such organizations do not exist, the public sector can encourage their creation.

Third, for each cluster, develop a competitiveness assessment, an analysis of its strategic strengths and weaknesses, and identify specific actions that can enable it to be a vital part of the Oregon economy in the years ahead. They recommend that each cluster develop and maintain a competitiveness assessment that examines key trends in the industry cluster, identifies public policies and other factors that affect Oregon firms’ competitiveness, and identify specific actions that firms and the public sector can take to promote the success of the cluster. These assessments should be developed according to a timetable appropriate to each industry cluster. Primary responsibility for developing these assessments would be in the hands of the appropriate cluster organizations, with support from public organizations where needed.

Actions can be purely industry-led and driven. Some actions will involve intermediaries, like community colleges and universities. Instead of developing training programs or conducting research on behalf of a single firm, educational institutions and work with a broad group of firms representing an entire cluster, multiplying the impact of the services they provide, and assuring that their efforts are relevant to a wide range of circumstances.

In addition, the Cluster Working Group has identified steps to promote cluster development in their three-part Action Plan. The plan’s goal is to coordinate and strengthen statewide efforts to make industry clusters the central organizing principal for improving Oregon’s economy. It calls for a wide range of actors in the public and private sectors in Oregon to work together in three ways: building know who, know how and know what.