Definition of cluster theory

A cluster consists of groups of associated and interconnected proximate firms that are linked vertically and/or horizontally through their commonalities and complementariness in products, services, inputs, technologies or outputs activities.

The presence of leading financial centres on the world map suggests that much of competitive advantage lies outside a given company or even outside its industry, residing instead in the location of its business units.

Cluster theory argues that co-location with other firms does not imply clustering when associated benefits like prolific innovation, increase in productivity, and/or the presence of externalities cannot be demonstrated.

Research reveals that strong clusters generally tend to attract more firms, and clusters with strong innovative records have an advantage in achieving more innovation and higher productivity; these are self-fulfilling and path-dependent.

While cluster theory includes strands on the types of externalities, linkages, heightened demand, productivity and innovation, one key tenet is path dependency. Positive feedback is seen to be playing a central role in clusters. Firstly, research has shown that the growth of incumbents and new entrants increase the intensity of clustering and can support further growth and attract even more entrants. Secondly, this path dependency will not remain positive indefinitely once the cluster reaches a critical mass. Beyond some saturation point, congestion and competition might slowdown the cluster, and eventually possibly contribute to the decline of the cluster.

The theory suggests that externalities that initially draw firms together into clusters could eventually erode due to congestion and competition. A life cycle in clusters is now evident, where cluster formation, growth and decline are set against the background of an industry life cycle. This is put forth by Kuah and Ward (2011) in the UK financial services.*

The findings suggest that established and older institutions in a cluster (for example in the City of London) may not benefit from congestion signified by localisation externalities or more competitors. Newer and smaller institutions in a cluster, however, have a greater reliance on such spill-over effects and supporting inputs from other financial institutions around. This is a more complex appreciation of clustering. It provide evidence that clusters do have a lifecycle and is more helpful than the simple assumption that bigger clusters are always positive for incumbents.[1]

*Kuah, A.T.H. (2002) 'Cluster theory and practice: Advantages for the small business locating in a vibrant cluster'. Journal of Research in Marketing and Entrepreneurship. 4 (3): 206-228.

*Kuah, A.T.H. and Ward, D.R. (2011). ‘An Investigation of Age-Dependent Agglomeration Effects in Financial Services’. Singapore Management Review, 33 (1): 17 – 35.

FT Articles & Analysis

No articles are associated with this term