Can your industry cluster?

One of the key concepts in strategy is that of the Industry Cluster, and the underlying economics of agglomeration. Broadly, a cluster is a geographic concentration of interconnected businesses, suppliers, and associated institutions in a particular field. In theory a business that is situated next to its suppliers and across the road from its customers benefits from dramatically reduced transport costs, and almost certainly from far more immediate sharing of information and shorter feedback cycles. The same goes for competitive businesses that are closely clustered – they share suppliers – for example several automotive manufacturers would share the same suppliers of steel, tyres, energy, labour and expertise. Clusters are a core part of industrial policy at a national level, and therefore the analysis around which to support and how to support them has made some consultants very wealthy. The success of Silicon Valley is around the clustering of venture capital and the entrepreneurs in which the capital is invested. Las Vegas is a cluster of hotels and casinos. London is a cluster of financial services. Johannesburg began as a cluster of mining related businesses situated right on top of the reef that they mined.

Done properly, clusters provide a long-term economic advantage to their members. An article in the BBC earlier this year illustrated just that: in the small town of Markneukirchen in Germany, the musical instrument making industry is 400 years old and still going strong. The story is one of survival – of how skills are passed down to the next generation who then adapt further to stay alive. The idea of an industry cluster wasn’t formalised when the makers of Violins set up their shop next to the makers of the bows needed to play them in the 1700’s, it was just the way things made sense. By the early 1900’s the town accounted for over 80% of musical instrument production around the globe. Being in the former East Germany, the town survived communism too: in fact the musical instruments were a prized source of foreign exchange for the East German government and the industry was actively supported. Today the town has over 100 different businesses all involved in making traditional musical instruments, yet using all the modern ways to connect to distant global markets.

Most of the businesses are very small, family owned workshops where skills are passed from grandfather to grandson and both tradition and quality matter. Musical instruments are increasingly mass produced or even digital. So how do the Markneukirchen manufacturers compete with low-cost competitors in China? The answer is the quality of the product and the ability to offer something that meets the exact needs of a highly trained musician playing in an orchestra somewhere. Their instruments have a reputation for durability, for consistency and this means that their customers (who are by nature self-referencing markets) are willing to pay for the quality of the European instrument rather than a cheaper Chinese generic. Their long-lasting profits mostly depend on quality – yes they use new manufacturing techniques where possible – and on selling the market that appreciates the difference they bring. They make sure that if a classical musician wants a particular part on his/her instrument, then they provide exactly that and at top quality too.

In our modern, globalised world clusters are no less relevant especially in manufacturing industries. It’s the service businesses where the walls have come down – modern information systems and telecommunications allow customer support to be outsourced to India, programming to the Ukraine, and design to California. The high quality, non-digital stuff is harder to commoditise, and here clustering may well still have major benefits.

Clustering should be something you think about in the strategy of your business, particularly those involved in manufacture or anything where transport or energy costs are significant. These costs are only going to go up in the future, and the more they do so then the more it will make sense to be very close to your suppliers or your customers, and if it makes sense for you then it will probably make sense for your competitors. Where can you cluster? Can this be a source of long-term profit for your business? How will rising energy costs affect these decisions?