The competitive potential of clusters

Keynote by Michael E. Porter, Bishop William Lawrence University Professor at The Institute for Strategy and Competitiveness, based at the Harvard Business School on the competitive potential of clusters, at the National Competitiveness Forum (NCF) and Porter Prize event held recently in Gurgaon 

“To have a successful economy one just can’t build companies. We must build clusters because isolated companies cannot become world-class.”

“Countries where customer demand is sophisticated and where customers put a lot of pressure on companies are the countries that do well.”

India’s journey to raise the competitiveness of its economy has been long and complicated because of her history, politics, philosophies, and deep-rooted ideas. Under the present government and Prime Minister Narendra Modi there has been an exciting discontinuity in thinking and approach. Make in India and similar initiatives by the government to boost employment and productivity are very much steps in the right direction.

To have a successful economy one just can’t build companies. We must build clusters because isolated companies cannot become world-class. Competitiveness plays a very significant role for the country, society and its businessmen. It is important to understand the impact of competitiveness in business as it would not only lead to progress but also drive the country forward. Business people think that their success depends on what they do and the competitive advantage in the company is primarily inside the company. It also means it is the people, technology, ways of operating, and strategy that drives the success of a company. Companies are successful if they make good choices internally and if they run their business well but what is going on outside the company matters a lot too. The competitive advantage of a company has a lot to do with the location in which it is operating, the surrounding environment in that location, and the cluster that it is in. In business, we have not been taught to think about our surrounding environment and about clusters. We’ve been taught to focus on our own company. The success of a business is also dependent on the surrounding environment.

The concept of competitiveness starts with the idea of what creates prosperity in a society or a country. There are huge differences in the levels of prosperity in OECD countries, in other emerging countries like BRICS, including India and in large developing countries even though there is large flow of information. We have countries that are much more prosperous, countries that are declining in their prosperity, and countries that are growing in their prosperity.  India fortunately has been growing significantly in its prosperity. There would be a greater surge in the growth as new policies are put into place. These differences in levels of prosperity amongst various countries are not temporary as they are baked into the fundamental competitiveness of that economy and a business environment.

What creates competitiveness? 

Competitiveness and productivity start with endowments. It starts with what we inherit as a society, natural resources, our location in the world, availability of good ports, proximity to markets, the number of citizens et al. We can develop a certain amount of prosperity just on endowments but to be prosperous, we should take advantage of the endowments. For example, we can have the greatest ports in the world but if we don’t invest in the ports and the ports are not efficient, then it is not going to be very useful.

The next layer of competitiveness is what we call macroeconomic competitiveness. This is the framework conditions in the economy and starts with monetary fiscal policy. Unless you have a stable macroeconomic policy, it is very hard to get investment. People would always be cautious of investments if taxes are high or inflation is going to spike. So, we need a good stable macroeconomic policy.  This is an issue for India but there is room for improvement. 

The other area is human development and clinical institutions. If we don’t have the foundation of human development i.e. basic education & health, we can’t be productive. So, we must invest in human development to improve the competitiveness. If we are going to be competitive the political institutions should work efficiently. If government is inefficient, they waste money, things are slow, institutions are corrupt, and it is very hard to create a productive economy. Endowments are sort of foundation but they depend on the environment you are in. Macroeconomic competitiveness creates a platform that can be more and more conducive to prosperity but prosperity is created at the top of this chart i.e. with consideration to microeconomic circumstances of the country.

For a productive economy, we must have productive companies and productive workers. If the companies can’t operate efficiently, be world-class, use the latest technology and the latest concepts for management, then it is going to be very hard to have a productive economy. Secondly, we need an efficient business environment. For example, we can have a sophisticated company on logistics and supply chain but if the roads are bad, if there is no transportation system, it’s very hard for the best company in the world to be productive in the wrong business environment. In the middle, we need clusters. Clusters are where groups of companies in a particular field come together, are co-located in a region or in a city or an area of a society. Fundamentally, if we want to raise prosperity and productivity we need to have decent endowments and understand what they are, we need to put these endowments in the right framework at the macroeconomic level with the right microeconomic capabilities and efficiency and assets.

The fundamental way of looking at the business environment is the framework called the diamond model, which looks at a lot of dimensions. It has to do with the inputs. The companies can get access to the skills of the people, to capital and how costly that capital is, the physical infrastructure, the scientific base to do with the technological sophistication, the administrative infrastructure, the rules, the permits, and all the mechanics that every society has in terms of doing business. If we don’t have good business environments, it is very hard to be productive and then hard to be prosperous.

The competition policy also matters. We cannot have a firm distorting the market or controlling the market. There should be open competition and this is the reason for success of the US for so many years.  We should have good corporate governance, have transparency, accountability through boards of directors etc. Companies cannot be just doing anything they want and not being responsible to anybody. We also need good protection of the intellectual property to make progress. Companies should get a fair return for their innovation and ideas and, therefore, develop more ideas and get better. 

Next are the demand conditions, i.e. the nature of local needs and the local consumer and whether companies and governments in the society are sophisticated buyers. We want a customer that has demanding needs. Countries where customer demand is sophisticated and where customers put a lot of pressure on companies are the countries that do well.

We see clusters all over the world in every economy whether poor or rich. If we look at the tourism cluster in Australia in the region around Cairns, the cluster looks at all the companies and businesses that come together in tourism. We have hotels, restaurants, transportation companies, beach or the museums or the sports teams or the historical sites, travel agents that get people in and out, tour operators, food suppliers, property services, souvenirs providers and the local transportation and taxies. We have government agencies that worry about tourism and industry groups and all these entities depend on each other. Any one business is dependent on these other businesses that are around. So, the cluster determines our success. We are finding that developing a strong effective cluster allows the entire group to get better and more productive and produce a higher prosperity and higher wages for the people that work in that field.  If there is a cluster, we can get the skills, technology and all the other things required for setting up a company. If we are on our own with no one around in our field then it is hard to start a new company. So we find a new business formation is overwhelmingly within clusters. It also starts to drive strategic innovation on the part of the companies. It also fosters a kind of a competition among the companies that is very healthy and very dynamic. The wine cluster in Australia is one of the biggest success stories of the last 25 or 30 years. Australia went from basically 0 wine exports to billions of dollars of wine exports over about a 15 to 20-year period as they built a cluster. 

National policies, tax laws, trade agreements can be quite important but most of the real drivers of competitiveness are much more local.  They are in the states or regions or cities and so increasingly as we think about economic development, we need a national plan, but we clearly need plans at the state and regional level. Our states in the US have a lot of influence, lot of ability, lot of incentive to compete, and they do so by focusing more effort on the state. A monolithic federal top down effort does not work. We must have each region and cluster taking responsibility to drive things forward. 

India is one country but there are enormous differences in prosperity across the country and enormous differences in the rate of progress.  We have some areas that are not progressing, other areas that are. This is because of the difference in competitiveness. Every region must find its own unique situation, its own strengths, its own clusters and how to move its circumstances forward in a way that gives it an ability to have a competitive advantage over some other region.  Every region in US is different, has a different mix of industry, different mix of clusters, different circumstances, different strengths and that is the reason for success.   A key idea in competitiveness is to be dynamic. Similarly, with the Indian states, some states are making rapid progress than others because they’re more dynamic and focused but we have to spread this across every state.  In many ways, the governor is more important than the Prime Minister in competitiveness and every state and every regional economy is going to have its own development path. 

If you can create competitiveness, then you’ll build jobs.  But if you try to artificially build jobs and subsidize and protect, then you would fail because it won’t be sustainable. Cluster-based development is the right and powerful tool to develop an economy. Most of public and government activity towards economic development needs to be organized around the cluster concept. We need to understand what clusters we have and then we need to promote those exports because that’s where we’ll have the most success when we are doing job creation and skill development. We want to understand where the jobs are, where the emerging parts of our economy are that are going to need skill, what do they need, and how do we link our skill development to the needs of those companies.

India has not had a powerful tradition of cluster development and cluster thinking. Most of the work in India on clusters has been around SMEs in traditional sectors and that was a natural place to start, but clusters are even more important in the new high-tech sectors.  When we talk about clusters, we are also talking about connecting business to educational institutions, to research institutions and to universities. Everyone must be in sync if we are going to build highly successful, highly productive, highly innovative companies in computer science or software or automotive or any other field.

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