Clusters of Innovation: Regional Foundations of U.S. Competitiveness

EXECUTIVE SUMMARY OF THE CLUSTERS OF INNOVATION NATIONAL REPORT(2001)

Professor Michael E. Porter, Harvard University

Monitor Group on the FRONTIER
Council on Competitiveness

• This national report draws heavily upon the five regional studies and synthesizes the implications for any region that seeks to improve its economic performance. The report examines the composition and performance of regional economies, how industry clusters develop and innovation arises, how clusters affect a region's economic future, and how a region can establish a strategy and action program to drive its economy and clusters forward.

Introduction

During the 1990s, Americans found a way to do what seemed no longer possible - grow the economy, create jobs, and increase the standard of living, without driving up inflation. Much of the credit goes to the nation’'s ability to develop and commercialize new technology. The result: one of the most robust periods of economic expansion and prosperity of the past century.

Today, the nation is experiencing an economic downturn. While fiscal and monetary policies pump dollars into the economy to boost the level of activity, innovation infuses the economy with growth-incubating new ideas, new products, services, and technologies. National policies and national investment choices have much to do with the growth and capacity of the American economy. For innovation, however, the real locus of innovation is at the regional level. The vitality of the U.S. economy then depends on creating innovation and competitiveness at the regional level.

In healthy regions, competitiveness and innovation are concentrated in clusters, or interrelated industries, in which the region specializes. The nation’'s ability to produce high-value products and services that support high wage jobs depends on the creation and strengthening of these regional hubs of competitiveness and innovation.

The Clusters of Innovation Initiative was launched to help meet this challenge. The Initiative examined five regions around the country: Atlanta, Pittsburgh, the Research Triangle, San Diego and Wichita. These regions were selected to provide a diversity of size, geography, economic maturity, and perceived economic success. The regions were similar enough to allow interesting comparisons, yet diverse enough to encompass a wide variety of challenges and opportunities in regional economic development.

Data for the study were drawn from a number of sources, but the principal sources of data were the Cluster Mapping Project of the Institute for Strategy and Competitiveness, the Clusters of Innovation Initiative Regional Surveys™™, and in-depth interviews of business and government leaders in each region.

A summary of the findings and implications is provided below:

Regional Competitiveness and Innovative Capacity

• The economic goal for regions should be a high and rising standard of living.
• This depends upon creating a high-quality business environment that fosters innovation and rising productivity.
• Strong and competitive clusters are a critical component of a good business environment and are the driving force behind regional innovation and rising productivity.
• The prosperity of a region depends on the productivity of all its industries.
• Productivity does not depend on what industries a region competes in, but on how it competes.

Innovation and the Standard of Living

• The most important sources of prosperity are created not inherited.
• Any regional economic development effort has to start with an assessment of regional economic performance.
• Economic performance is best measured on multiple levels to capture prosperity, productivity and innovative capacity.
• Regional economies are composed of three types of industries: traded, resource-driven and local industries. While local industries account for the majority of employment in regional economies, traded industries are the dynamic core of a regional economy.
• The evolution of regional economies is a lengthy process. While inherited factors, geography, climate, and population are important, other factors such as entrepreneurship, the presence of research and training institutions, the composition of the regional economy, and public and private sector actions are important influences.
• All levels of government can influence the business environment and the productivity of clusters.
• While government can help foster a favorable business environment, companies and industries must ultimately achieve and sustain competitive advantage.
• Formal and informal institutions for collaboration such as regional economic development organizations and alumni of large influential companies are important contributors to cooperation in advanced economies.

Findings and Implications

Economic Performance of Regions

• Regions vary greatly in terms of economic performance: Some regions have high average wages, while others have low average wages; some regions are growing rapidly, while others are shrinking.

• A region’'s average wages must be assessed in the context of that region’'s cost of living: Regions that exhibit high growth do not necessarily prosper due to cost of living increases that negate or diminish gains in average wages.

• Higher levels of innovation output lead to higher levels of prosperity: Above-average economic performance measures are not enough to ensure regional prosperity.
Maintaining, much less increasing, a region’s standard of living requires the steady growth of productivity, which in turn requires innovation.

• Innovation output varies greatly across regions: Just as regional economies have different levels of average wages and job creation, so too do they have very different levels of innovation output.

Economic Performance Indicators

• The relative effectiveness of commercialization greatly affects the economic impact of research: Commercialization of basic research is a difficult but important ingredient for generating entrepreneurship. Some regions have high levels of R&D investments and numerous specialized research centers, but still lag in terms of innovation output because knowledge is not effectively or rapidly transferred to companies.

Implications:

- The need for a distinctive strategy: No single policy or strategy will work for all regions. Each region must craft a distinctive approach based on its unique assets and relative strengths.

- Growth vs. prosperity: Growth is not the same as prosperity. Growth is only desirable if the standard of living of citizens rises. High growth per se often leads to a rising cost of living that erodes prosperity and degrades natural resources and physical infrastructure that support quality of life.

- From efficiency to innovation: Current economic performance does not assure future performance. Maintaining, much less increasing, a region’'s standard of living requires the steady growth of productivity. Innovation output leads to higher productivity levels, and is critically
important if a region is to reach the upper quartile of high-performing regions.

- Measuring multiple dimensions of performance: Measuring only a few indicators of performance will not give an accurate view of a region’'s strengths and weaknesses. A number of performance measures need to be assessed, including economic performance, innovation output, and effectiveness of commercialization.

Economic Composition of Regions

• The composition of regional economies differs greatly: The Cluster Mapping Project has identified 41 types of clusters in the U.S. economy. While any given region will have some employment in the vast majority of these clusters, regional economies are typically very strong in only a handful.

• A wider geographic focus often identifies more available assets in a region: Regions tend to focus on narrow geographic areas when devising economic development strategies. A broader geographic area is sometimes more appropriate.

• Some regional economies are highly dependent on a few clusters or even companies: Although all regional economies specialize in a few areas, some have especially narrow breadth. These economies have a disproportionate share of employment in one cluster, and even in a handful of companies, which makes them unnecessarily vulnerable.

• “High-Tech” clusters account for a small percentage of jobs and wages in most regional economies: Several types of clusters are especially innovative: communications equipment, analytical instruments, biotechnology/pharmaceuticals, and information technology. These clusters are very productive, and pay high wages, and regions with strength in these clusters certainly benefit from their presence. However, the overall impact of these clusters on a regional economy is usually relatively small.

• Higher wages in traded clusters tend to pull up wages in local clusters: The way to increase prosperity of an entire region is to increase average wages in traded industries.

Implications

- Defining the right region: The composition of regional economies can shift significantly depending upon the geographic area considered. Regions have a tendency to follow political jurisdictions and omit important surrounding areas and assets. A broader, geographic definition widens opportunities and brings constituencies together.

- Building a strategy: Successful regions build strategies on their unique assets and strong clusters, where they have the greatest advantages. Strength then spreads to additional clusters over time.

- Clusters of clusters: Focus on a few clusters exposes a regional economy to booms and busts. Regional strategies should encompass a wide range of clusters, and be attentive to clusters that overlap. Overlapping clusters offer potential synergies in skill, technology, and partnership.

- Widen innovative capacity to many clusters: The majority of traded jobs in any region are in clusters that are not generally perceived to be “high-tech” (e.g., business services, financial services, education and knowledge creation, transportation and logistics, and hospitality and tourism). In order to meaningfully increase overall regional prosperity, innovative capacity must be built in many clusters.

Specialization of Economic Areas, Narrow Cluster Definition

Source: Cluster Mapping Project, Institute for Strategy and Competitiveness

Evolution of Regional Economies

• Successful regions leverage their unique mix of assets to build specialized clusters: Successful regions do not pick winners, but build on their inherited assets (e.g., geography, climate, population, research centers, companies, governmental organizations), to create specialized economies that both differ from other regions and offer comparative advantages to local companies.

• Building strong regional economies takes decades: There are many steps in building a regional economy—-developing inherited assets, creating new assets, linking companies to these assets, attracting outside companies—-and this process takes time.

• Institutions for collaboration play an important role in building regional economies: Institutions for collaboration help build regional economies by facilitating the flow of information, ideas, and resources among firms and supporting institutions.

Implications

- Long time horizon: Meaningful changes in regional development require investments that generally take decades before significant dividends are reaped. Long time horizons create challenges for leaders seeking reelection, and make it more difficult to mobilize community support behind an economic development strategy. These realities highlight the need for an institutional structure for regional development that goes beyond government, as well as the need for private sector involvement.

- Building on traditional industries: Inherited assets matter to a region’'s economic development. Established and already emerging clusters offer the greatest prospects for near term growth. Strengthening established clusters should be one of the early priorities in regional economic development.

- Investing in unique and specialized assets: Many inputs in regional prosperity often require substantial investments in specialized assets such as university campuses, research programs, logistical infrastructure, and the like.

Regional Business Environment

• A strong physical and information infrastructure is a baseline requirement to establish and sustain a prosperous regional economy: Good quality roads, highways, airports, railroads, water, and power support the efficient movement of people, goods, and services as well as the quality of life of citizens.

• A strong K-12 educational system is important for developing local talent and attracting outside talent: The quality of K-12 education is growing ever more critical because it establishes the baseline of talent for entry-level jobs and the pool of specialized talent critical to cluster development. It also helps in the recruitment of individuals and companies.

• Universities and specialized research centers are the driving force behind innovation in nearly every region: Although companies and individuals do create a large number of innovations, universities and research centers institutionalize entrepreneurship and ensure a steady flow of new ideas.

• Specialized talent and training are more important than abundant labor: It is not abundant low wage labor that attracts innovative companies, but rather highly talented, specialized, and often expensive labor.

• Government can have a significant influence on the business environment, both positively and negatively: Government at all levels influences the business environment through policies and services that influence factor inputs, context for firm rivalry, demand conditions, and related and supporting industries.

• Poor coordination among local jurisdictions impedes efforts to improve the business environment: Regional economies encompass many political jurisdictions. Efficient coordination among them is important for maintaining and improving physical infrastructure (e.g., road, airports, water ports, communications systems), creating strong K-12 education, offering a business-responsive political environment, and promoting cross-cluster collaboration.

Implications:

- Challenges of success: Successful regional economies tend to experience rapid growth, which stresses the physical infrastructure. Foresight and a conscious strategy are needed to maintain and improve infrastructure in advance of the strains caused by growth.

- Recognize the need for strategic transitions: Over time, regional development strategies run their course. Success at one strategy creates the challenges that need to be addressed by the next strategy.

- Institutionalizing innovation: Successful regions do not rely on chance, but rather seek to institutionalize the innovative process by building strong universities and research centers, and by attracting research divisions of major companies, to create continuous innovation and entrepreneurship.

- Moving to commercialization: Commercialization is a vital step in the innovation process. Some regions have high levels of R&D investments and numerous specialized research centers, but still lag in terms of innovation output because knowledge is not effectively transferred to companies. Having many different types of research institutions (e.g., public universities, private universities, for-profit research centers, non-profit research centers, etc.) appears to foster commercialization.

Determinants of Regional Productivity

Clusters

• Proximity fosters productivity and innovation: When members of a cluster are located in close proximity, they can capture synergies that increase productivity, innovative capacity, and new business formation.

• Clusters often share common industries: Some industries are in more than one cluster. Overlaps provide opportunities to use strength in one cluster and build new clusters.

• Clusters with depth and breadth enjoy advantages over narrower clusters: Clusters with strength across a broad range of sub-clusters have advantages over more narrow clusters due to the extensive market, technical, and other specialized information which accumulates within a regional cluster.

• Cluster strength is often disproportionately concentrated in a few sub-clusters: Clusters are composed of many sub-clusters. Even relatively weak clusters can often have strength in a few sub-clusters.

• Cluster-specific institutions for collaboration facilitate the flow of information and resources throughout the cluster: Diverse groups (e.g., rival firms, related and supporting industries, universities and research centers, training institutions, government, and so forth) contribute to cluster strength, but their contribution is not automatic. An organization dedicated to mobilizing these groups does much to strengthen a cluster.

Implications:

- Sub-cluster interactions: Even if full clusters are relatively weak in a region, there may be a constellation of related sub-clusters that constitute a differentiating advantage.

- Proximity: Firms can be encouraged to locate near each other through zoning, and the provision of easily accessible infrastructure.

The California Wine Cluster

Source: California Wine Institute, Internet Search, California State Legislature. Based on research by MBA 1997 students R. Alexander, R. Arney, N. Black, E. Frost, and A. Shivananda

The Development of Clusters

• Clusters can be strengthened by increasing awareness of the cluster among local firms and organizations: Not only must firms be aware of the presence of a local cluster, they must also get together and coordinate activities to improve the cluster’'s business environment. Acceptance of new companies is important if the cluster is to grow quickly and reach a critical mass.

• New firm and cluster opportunities arise at the intersection of existing clusters: Economic development strategies can leverage these opportunities to diversify a regional economy.

• Anchor companies play a disproportionate role in seeding cluster development: Anchor companies support cluster development by acting as magnets for other major companies; organizing other companies in the cluster for collective action; supporting projects that improve the local quality of life; and producing numerous spin-out companies, which strengthen key elements of the cluster.

• Institutions for collaboration can significantly increase the success rate of start-up companies: Cluster development depends in large part on generating new companies from within a region. Successful regions almost always have a hospitable environment for start-ups.

Implications

- An explicit cluster development program: Although chance events play a role in the formation and development of clusters, conscious efforts to raise cluster competitiveness and innovative capacity can meaningfully influence the trajectory of cluster development.

- Recruiting for clusters: Recruitment strategies at the regional level should target clusters in which the region has strength, or clusters which overlap with other clusters. This allows the region to market its unique assets rather than compete on subsidies. In recruiting efforts, regions should also identify gaps within clusters, and seek to attract companies to fill them.

- Opportunities at the intersection of clusters: Opportunities for growth often arise at the intersection of clusters where a region has strength.

Creating and Implementing a Regional Strategy

• Regions often encounter a common set of pitfalls: Because no single nationwide policy will be entirely appropriate for every region, policy setting at the regional level is especially important.

• Regions need to overcome transition points in the development of their economies: Regional leaders encounter transitional challenges as they develop their economies. Addressing these challenges should be targets of regional economic development strategies.

• Broad-based collaboration is needed for development strategies to succeed: Successful regional economies benefit from the contributions of a wide array of organizations. Organizing for action entails arriving at consensus and creating the capacity for regions to implement development strategies.

• A shared economic vision helps elicit broad support and coordinate activities: To achieve good coordination among many diverse groups, a shared vision of common objectives and methods is vital.

• Strong leadership is a necessary part of any successful economic development strategy: Strong leadership committed to regional economic development is needed to ensure that companies, knowledge centers, governments, and collaborative institutions contribute to their full potential.

• An overarching organization for economic development helps coordinate and routinize the process: A formal organizational structure and process for working on economic issues helps maintain a consensus behind an economic strategy through periods of economic and political change.

Creating the Capacity to Act

Action Agendas for the Public and Private Sectors

FEDERAL GOVERNMENT

• Invest in the foundations of science and technology.
- Increase federal funding of research at universities and other research centers.
- Establish federal overhead recovery rules, and other policies, to encourage investment in universities’' science and technology infrastructure.
- Provide federal support for specialized training programs in science and engineering.

• Improve the innovation policy context.
- Fortify intellectual property protection.
- Strengthen and enforce anti-trust laws with a greater weight on innovation.
- Reinforce federal tax incentives that encourage business investment in R&D and industry-university collaboration.

• Allocate federal resources to reinforce cluster development.
- Distribute federal research funding through a system of peer-reviewed competitive grants in a way that fosters cluster development
- Encourage locally-based federal agencies to communicate and coordinate with local business, institutions for collaboration, and educational and research centers based around clusters.

• Provide better data for measuring regional economic composition and performance.
- Collect more up-to-date data down to the county level.
- Collect measures of both economic performance and innovation.

• Encourage the development of regional economic development strategies that stress innovation.

• Provide federal matching funds for innovation-focused state and regional economic development strategies.

STATE GOVERNMENT

• Invest in the foundations of science and technology.
- Recognize the state government’'s important role in supporting R&D funding at state universities.
- Establish and maintain high levels of state support for community colleges and specialized training centers.
- Create a strong university or college presence in all major regions of the state.

• Sponsor state programs that encourage cluster development.
- Build cluster thinking into research parks and incubators.
- Organize state systems of higher education around local clusters.

• Focus business recruitment around strong clusters.
- Coordinate activities with firms, universities, and training centers to recruit anchor companies to their region.

• Create regional dimension to state economic development strategy.
- Encourage and assist regions to develop economic strategies.
- Cultivate attitudes toward collaboration and sharing of information among firms, universities, training centers, labor, institutions for collaboration, and government.

• Improve information systems to regularly collect data and measure progress.

REGIONAL AND LOCAL GOVERNMENT

• Strongly support K-12 education, and create strong standards and accountability.

• Upgrade core business infrastructure.
- Transportation infrastructure.
- Communications infrastructure.
- Ensure specialized training programs are a high priority in any economic development strategy.

• Develop a regional strategy that involves all stakeholders.
- Support regional benchmarking initiatives.
- Encourage a common vision and collaboration among firms, universities, and training centers.
- Work with firms, universities, institutions for collaboration, and state government to create an organizational structure to help implement a regional strategy.

• Encourage cluster development.
- Establish research and industrial parks that encourage innovation-based competition.
- Implement cluster-focused and innovation focused recruitment efforts.

UNIVERSITIES AND RESEARCH INSTITUTES

• Recognize the important role of universities in regional economic development.
- Take the lead on, and participate in, regional and cluster development efforts.

• Create and support technology transfer offices.
- Work with firms and venture capital to streamline the technology transfer process.
- Benchmark the commercialization of university-created intellectual property using measures that promote efficient dissemination of knowledge.

• Actively participate in cluster development efforts.

• Align university curricula and research to meet the needs of local clusters.
- Create cluster-specific institutions to support collaboration between academia and industry clusters.
- Work with local industry to create areas of excellence within universities that differentiate the university and complement local industry strengths.
- Integrate research and training efforts with the needs of local industry.
- Participate in the recruitment of companies.

• Support company start-up efforts by professors and students through mentorship, entrepreneurial education, and financing.

CLUSTER-SPECIFIC INSTITUTIONS FOR COLLABORATION

• Promote cluster awareness.

• Engage in ongoing diagnosis of cluster’'s competitive position.
- Compare position relative to other regional clusters.
- Identify constraints, obstacles, and advantages.

• Develop training and management programs.
- Provide programs through institutions for collaboration.
- Coordinate with local institutions to provide programs.

• Actively participate with government in recruitment efforts.
- Communicate with firms in clusters to identify gaps in the cluster and recruit accordingly.

• Widen institutional membership to include all cluster constituents.

FIRMS

• Recognize the importance of location to competitive advantage.

• Take an active role in improving competitive environment.
- Consistently communicate your needs and desires (e.g., for talent, ideas, patents) to local universities, research institutes, and training centers.

• See their cluster as a competitive asset.

• Contribute actively to cluster development activities.
- Actively participate in cluster activities to identify issues of common concern and opportunities for mutual gain (e.g., regulatory matters, new buyer needs, innovative supplier capabilities).
- Support recruitment activities of local chambers and other regional economic development officials to bring in companies that will fill missing niches in the cluster (e.g., suppliers, services providers, competitors).
- Contribute to programs that support new ventures (e.g., improving access to risk capital, mentoring programs, and specialized services) in order to build-out cluster.