Industrial Clusters and Business Development

In recent years, “cluster strategies” have become a popular economic development approach among state and local policymakers and economic development practitioners. An industry cluster is a group of firms, and related economic actors and institutions, that are located near one another and that draw productive advantage from their mutual proximity and connections. Cluster analysis can help diagnose a region’s economic strengths and challenges and identify realistic ways to shape the region’s economic future. Overall, the review’s most important findings for policymakers and practitioners are:

  1. Clusters are the key organizational unit for understanding and improving the performance of regional economies. The foundation of a regional economy is a group of clusters, not a collection of unrelated firms. Firms cluster together within a region because each firm benefits from being located near other similar or related firms. The firms in a cluster have common competitive strengths and needs.
  2. Cluster thinking matters because it orients economic development policy and practice toward groups of firms and away from individual firms. It is more important and fruitful to work with groups of firms on common problems (such as training or industrial modernization) than to work with individual firms. The cluster approach leads to little if any reliance on economic development subsidies and recruitment efforts aimed at individual firms; if these individual, firm-based policies are used at all, they should be focused on firms that fit within existing clusters.
  3. Cluster thinking offers important lessons for economic development policy and practice. Cluster thinking teaches policymakers and practitioners to:
  • Build on the unique strengths of their regions rather than try to be like other regions. Different regions have different sets of economic development opportunities. Not every place can or should become another Silicon Valley.
  • Go beyond analysis and engage in dialogue with cluster members. Many policymakers and practitioners treat research on and analysis of clusters as the only elements of a cluster strategy. In fact, they are only a starting point for a cluster strategy. Identifying a cluster’s competitive strengths and needs requires an ongoing dialogue with the firms and other economic actors in the cluster. Although the public sector cannot be the exclusive driver of cluster policy, it can play a central role in convening cluster members and working with private-sector cluster organizations.
  • Develop different strategies for different clusters. Clusters vary from industry to industry and from place to place and operate in many different dimensions. Different clusters have different needs. There is no one set of policies that will make all clusters successful. For example, a technology cluster may require help with research or capital, while a metals industry cluster may require assistance with job training or technology deployment.
  • Foster an environment that helps new clusters emerge rather than creating a specific cluster from scratch. It is difficult for public policy to create new clusters deliberately. Instead, policymakers and practitioners should promote and maintain the economic conditions that enable new clusters to emerge. Such an environment might, for example, support knowledge creation, entrepreneurship, new firm formation, and the availability of capital. Cluster policy is not about “picking winners” or excluding industries.

Examples of Clusters


The UK has a leading position in the technology-driven motorsport industry. It has a large number of motorsport companies. Their precision engineering and advanced technology skills are increasingly exploited by the mainstream automotive industry. Most UK motorsport firms are based in an area known as ‘Motorsport Valley’. They supply the technology used in Formula One and dominate the production of cars and components to ‘Champ Cars’ and other top US racing formulae. Motorsport Valley is an area based largely in southern and central England. Here most specialist motorsport firms have their research, design, engineering and production facilities. It acts as a global centre for the production of cars and parts. About 4,000 companies are involved in the UK motorsport manufacturing industry and its wide-ranging support activities. The engineering sector of the industry has an annual turnover of £2.9 billion, more than half of which is exported. Motorsport Development UK is the partnership responsible for implementing a five-year investment in British motorsport. Funding for the programme comes directly from BERR and four regional development agencies:

  • Advantage West Midlands (AWM)
  • East of England Development Agency (EEDA)
  • East Midlands Development Agency (EMDA)
  • South East England Development Agency (SEEDA).

The investment agenda is focused on five areas seen as key to a successful motorsport cluster in the UK. They are:

  • business development and technology transfer
  • a Motorsport Academy to improve skills and coordinate learning
  • a Motorsport Learning Grid of educational activities
  • development of energy efficient motorsport (EEMS) in the UK.

Food and drink

The food and drink sector in the northeast comprises more than 1,500 companies. Collectively these firms generate an annual turnover of £3.5 billion and employ 45,000 people. Food and drink processing is a leading employer in the region’s manufacturing sector, employing about 20,000 people. It has attracted some of today’s leading producers, including Nestle, United Biscuits, PepsiCo and Kerry Foods and contributes approximately £2 billion a year to the regional economy.

One NorthEast and regional partners are investing in this sector to develop growth and competitive advantage. Key actions include:

  • developing and funding a food group for the region
  • building supply chain capacity
  • providing start-up grants for new firms in the sector
  • addressing shortages of premises
  • supporting export initiatives
  • promoting and providing access to training and development.

For more than two decades, policymakers and economic development professionals have stressed the importance of encouraging and supporting industry clusters to promote job creation and economic growth.

A cluster-based approach starts with the industries and assets that are already present in the region and regional stakeholders pursue initiatives to make those industries better. An approach for creating entirely new clusters in a region is a strategy to improve overall business environment conditions, by upgrading skills, access to finance and infrastructure, by streamlining government rules and regulations, by supporting local demand, and by being open to foreign investment and competition.

While clusters of industries that are present in a region do not necessarily need public sector strategies in order to exist—the industries cluster regardless—the right policies and strategies can help the businesses within a cluster become more successful and competitive. A cluster-based strategy is not, in other words, necessarily organized around attracting large entities from elsewhere.

Simply put, industry clusters are regional concentrations of related industries. Clusters consist of companies, suppliers and service providers, as well as government agencies and other institutions that provide education, information, research and technical support to a regional economy. One might say that clusters are a network of economic relationships that create a competitive advantage for the related firms in a particular region. This advantage then becomes an enticement for similar industries and suppliers to those industries to develop or relocate to a region.

Think of it this way: if you wanted to relocate your smartphone application development company from your basement in Loogootee, would you move it to Vermont or to the Bay Area? On the other hand, if you made artisanal cheeses in your barn out back and wanted to expand, would you move to the Bay Area or Vermont? Whether you know it or not, your decision on relocation is informed by the presence of strong industry clusters.

Developing industry clusters has become a key goal for regional economic development as clusters have been shown to strengthen competitiveness by increasing productivity, stimulating innovative new partnerships, even among competitors, and presenting opportunities for entrepreneurial activity. Michael Porter and others have identified which industries tend to cluster together. This serves as the analytical foundation for cluster-based economic development strategies that may target certain types of industries to locate in a region to strengthen a cluster, or they may target regional resources to help bolster a developing cluster. A cluster-based development strategy may not be easy or quick to implement, but the supporting argument is that it beats a piecemeal or scattershot approach to generating jobs. Instead of looking at specific industries or types of companies, cluster analysis detects the potential spillovers of technology, skills and information that cut across industries, workers and resources.

The Economic Impact of Clusters

Cluster-based strategies have an economic rationale and, for the sake of argument, let’s operate under the assumption that the approach will endure. The question then becomes, what else does an economic development practitioner need to know? We posit that applying the cluster framework to economic impact studies can provide a more comprehensive picture of the potential benefits of a cluster-based strategy.

Economic impact studies typically ask the question: if Production Plant Z with 100 workers is located in Rajasthan, how many more jobs will be created in the region? The size of the regional impact depends on the industry for Production Plant Z. If it is a food processing plant, the workers may not be as well compensated compared to a gas turbine assembly plant. In other words, just as all employment multipliers are not the same industry to industry, employment multipliers vary based on a type of cluster.

One of the benefits of clusters is that they are easier to get one’s hands around. It is a more manageable set than detailed industries. There are some 450 industries in a detailed input-output table, which is the table of industry inter-relationships used to estimate the economic impact of an economic event (like establishing a new production plant). Meanwhile, there are 27 industry clusters. While there are more clusters than can easily fit on a page, the greatly reduced set makes analysis and results easier to absorb for the average analyst, policymaker or practitioner.

The 27 clusters are grouped into two large categories: “traded” (21 clusters) and “local.” Local relates to those industries that generally serve the regional population, including health care, food services, residential construction or personal services. While these local clusters may be very interrelated, may share workers and are important for the well-being of the local population, they don’t inject money into the local economy. Traded industries, on the other hand, do inject money into the local economy. Traded industries, generally speaking, make for and sell to those outside the local economy. Economic impact studies are generally focused on traded industries.

IBRC researchers assigned the full set of 450 “economic impact” industries into the 67 clusters to determine which industry clusters would have the greatest effect on the economic development of a region. Put another way, an attempt to draft a regional economic development strategy by assessing the potential economic impact of some 450 individual industries would be overwhelming. The attempt to convey the potential impact of a new project—say a new production plant—on 450 industries runs the risk of overloading economic development practitioners with too much information. Furthermore, this level of disaggregation may overlook the linkages and profitable connections between industries within the same cluster.

Using the Porter cluster aggregation scheme, IBRC researchers estimated output, employment and total value added multipliers for a five-county region in south central Indiana4 together with the state of Indiana and the entire nation. If the five counties comprised a region that was in the process of coordinating their economic development strategy and efforts—these five counties are more of a hypothetical than a real region with a common development strategy—then the magnitude of the multipliers could be one of many criteria for defining the focus of their partnership.

The larger the multiplier, the larger the ripple effects for a particular industry cluster. For example, an employment multiplier of 1.9 in the medical devices cluster suggests that for every 10 employees hired in that cluster, another 9 jobs would be created in the region in this and other clusters (both traded and local).

The Role of Regional Purchase Coefficients

It is important to note that due to variations in how much of the regional consumption of inputs (for example, a raw material like wood for making furniture) can be supplied by regional production—a measure called the regional purchase coefficient—multipliers for one particular industry or cluster can vary greatly between regions. The regional purchase coefficient (RPC) is the proportion of the total demand for an input by all users in the study area that can be supplied by producers located within the study area.

For example, if the RPC for hardwood is 0.4, then 40 percent of the local demand for hardwood can be met by local loggers and millworks, while 60 percent of the demand for hardwood must be satisfied from outside the region. Multipliers increase as the region expands in scope because as the geographic area expands, it becomes increasingly likely that a region can supply its own inputs.

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