Industrial Clusters
A Solution to Distance-Related Costs
LOCATION of your venture is one of the first business decisions you will have to make. Location affects distance-related costs. Major distance-related costs are related to sourcing your inputs and marketing your products.
Compare the following:
Cost of transporting inputs from their sources, and
Cost of transporting your products to their markets.
Which of these will be higher on an average?
If sourcing costs are significantly higher, you will benefit by locating your venture near the input sources. If product distribution costs are higher, a location near the markets will be better.
Actually, there is another option, industrial clusters. These can bring input suppliers and product buyers to you, instead of you having to go to them. You can collapse input and outpur transport costs simultaneously by pulling suppliers and buyers into a single geographic hub.
What are Industrial Clusters?
The most visible aspect of an industrial cluster is the existence of many production units engaged in the same industry in a specific locality. The density generates several benefits:
A pool of workers skilled in the industry's operations become available in that locality
The intense competition among the different units leads to faster innovations; competitors are watching each other and if one unit gains a cost benefit through an innovation others will be quick to follow
Ancillary units providing support services are attracted to the neighborhood, leading to lower maintenance, logistic and other support costs
It becomes possible to establish common facility centers that individual units cannot afford owing to the heavy costs involved.
Attracted by the concentration of the industry, buyers are attracted to the locality, opening up markets for individual units
Together these factors reduce costs and improve quality in a significant way. Both of these enhance marketing effectiveness.
Tapping the Industrial Cluster Solution
You can tap the industrial cluster solution in two ways:
Join an existing cluster engaged in the industry you are interested in, or
Organize currently unorganized units engaged in the industry into a cluster.
The first of these options will require some investment on your part as you are starting a venture of your own. You will also have to work under the rules applicable to cluster members. The plus point is that you can be operational in a short time by tapping the facilities of the cluster. You can choose to focus on an area you are strong in, such as production, marketing or distribution.
The second option requires political skill rather than investment. You will have to work with the owners of existing ventures, and sell your idea to them. You will also have to organize funding to add elements that make the cluster attractive, such as common facility centers that make costly equipment or services available to cluster members. This option is likely to need a significant amount of time before the cluster is up and operational.
What Goes into a Successful Cluster?
A key requirement for a successful cluster is a willingness to work together. While cluster members engaged in the same activity might be competing against each other, they should also be willing to work cooperatively in some areas.
The cluster should deliver real value to members, a value that will not be available to members if they work alone. Examples include expensive equipment needed for testing or quality improvement, and infrastructure like reliable transport and high-speed digital networks.
An ideal cluster will provide support in all key business result areas such as cost-effective operations, quality testing and marketing support.
Availability of VC funding and collaboration with universities for R&D add to the value and attractiveness of the cluster.
Case Study: The Silicon Valley Tech Cluster
In the 1940s and 50s, Frederick Terman, the Dean of Engineering at Stanford University, noticed that his best graduates were leaving California for East Coast jobs. He leased vacant Stanford land to high-tech firms, creating the Stanford Industrial Park. He encouraged faculty and graduates to start companies rather than just publish papers.
The industrial park had some major advantages:
1. Favorable Factors:
Top engineers available on a continuing basis from Stanford and UC Berkeley
Availability of early-stage, make-or-break venture capital from top VC firms like Kleiner-Perkins, Sequoia Capital, Andreessen Horowitz and others located along Sandhill Road nearby.
2. Demand Conditions:
In its infancy, the primary buyer was the US Department of Defense, which demanded highly sophisticated, zero-failure semiconductors for the Cold War aerospace race. This strict, deep-pocketed client forced local firms to perfect high-quality manufacturing rapidly.
3. Ancillary Industries:
As chipmakers grew, a dense secondary web emerged. Specialized intellectual property lawyers, tech-focused PR firms, precision machine shops, and component suppliers set up offices within miles of each other, slashing friction and transaction costs.
4. Competition and Knowledge Spread:
Silicon Valley’s culture thrived on hyper-intense local rivalry combined with unprecedented knowledge spillover. California law historically refused to enforce non-compete clauses. This meant engineers constantly hopped from one company to another, carrying ideas, failing fast, and cross-pollinating innovation across the entire ecosystem.
5. Self-Sustaining:
Successful founders like the "PayPal Mafia," became the next generation’s angel investors and mentors, feeding capital back into the ecosystem.
Summary
By funding the culture of innovation and providing the anchor infrastructure, the market grew organically to create an iconic example of an industrial cluster, Silicon Valley.
Governments worldwide have spent billions trying to build artificial "Silicon Deserts" or "Silicon Forests" from scratch using top-down master plans, and most have failed. Often, these become real-estate projects offering just buildings instead of an organically growing ecosystem. Industrial clusters need sustained attention to spot and remedy problem areas.
Conclusion
Distance is a major cost factor. Industrial clusters are one solution for the distance cost. Actually, clustering generates additional benefits like faster innovation, a pool of skilled labor and attracting buyers to the locality.
You can tap the cluster solution in two ways. The first option is to join an existing cluster. The second option is to organize a cluster by assembling disorganized units in an industry, and working to set up facilities that enhance the quality of their products and marketing effectiveness. The first option requires investment on your part but can produce quicker results. The second option will need significant time.
To succeed, clusters must meet certain requirements, such as a willingness to work together and availability of capital and infrastructure.
We conclude with a look at an iconic industrial cluster, the Silicon Valley.