Clusters may not be a familiar business model to many US companies, but when considering establishing European operations, it might be the most important factor when determining where to set up shop.
US companies considering expanding into Europe for the first time must weigh the costs, risks and benefits of where to put down roots. Though Brexit’s impact has yet to be fully understood, the UK has historically been viewed as the most sensible location on account of its relatively similar regulations and accounting practices, and lack of a language barrier. However, companies would be remiss to rule out the rest of Europe, as other countries could be a better fit for their business model. A key factor that US companies may not be considering—but should—is clusters.
Clusters are groups of companies in related industries that operate in a concentrated area—based on demand, supply chain and resources—and they form naturally as a result of spillover. Well-established across Europe, clusters can be beneficial at both the company and regional levels, and they often become areas of concentrated employment.
Clusters don’t garner significant attention in the US, despite well-known examples such as Silicon Valley, Hollywood and Detroit, but they’re prevalent in Europe and play a vital role in its economy, which is largely a combination of interdependent clustered regions. The European Cluster Observatory—an initiative run by a unit of the European Commission—dedicates itself to studying clusters across the region. In November 2016, the Observatory published its second "European Cluster Panorama," which found that Europe consists of 327 clustered regions, each possessing a unique profile and differing performance capabilities. The report also identified 51 clustered industry categories across Europe, all of which depend on one another in some capacity.
Because of their prevalence, clusters can have a significant impact both on the European and global economies, so understanding the advantages and challenges they present is important for companies considering expansion.
Speaking to the European Parliament ahead of the vote that elected him European Commission president on July 15, 2014, Jean-Claude Juncker outlined his policy agenda, detailed in “A New Start for Europe: My Agenda for Jobs, Growth, Fairness and Democratic Change.” With the EU’s economy still recovering from the global financial crisis, economic stimulus was highly emphasized in Juncker’s plan. Consequently, the commission launched a wide range of initiatives aimed at revitalizing the economy.
Clusters were, and still are, essential to the European Commission’s initiatives because of the important role they play in job creation and improving growth and investment opportunities. The Panorama identified the top 20 percent of regions by location quotient, which measures a region’s industry specialization by calculating its shares of employment for both the region and Europe as a whole. As a result, “strong” clusters were defined as “situations in which a region is specialized in a set of related industries relative to peers.”
In addition to recognizing strong clusters, data from the Panorama can help to more clearly detect areas of economic concern, such as potential regressing clusters and unemployment hotspots. While a clearer understanding of these areas is important in helping inform policymakers’ initiatives, it’s also crucial information for companies to consider when evaluating expansion in Europe.
Clusters are most effective when they’ve reached critical mass, which indicates significant market demand for a particular good or service. The European Commission’s “Smart Guide to Cluster Policy” explains that this, in turn, allows companies to narrow their focus and specialize in a particular area. As companies become more specialized, employees develop more advanced skills, ultimately resulting in higher levels of overall productivity and innovation. As competition increases, companies must continue innovating and developing new products and services to maintain a competitive advantage and remain afloat. And the companies that thrive often become more competitive not just regionally, but also globally.
Clusters typically serve markets beyond their immediate area, connecting to other industries with complementary strengths in regional and global supply chains. The Smart Guide notes that as specialization increases among companies in a specific cluster, they have to rely on business partners to supply the products and services outside their scope of work. As a result, cross-industry supply chains are created and grow, spreading benefits such as increased employment across industries and regions.
The Panorama found that clustered industries account for 47 percent of all European employment covered in the data. At the time of its publication, the average annual full-time salary for clustered industries was 34,800 euros ($39,023) in Purchasing Power Parity (PPP), which accounts for differences in local price levels. This represents a salary 17 percent higher than non-traded industries, whose production is only consumed locally, as opposed to traded industries, whose production is consumed beyond the immediate region. This wage gap has been growing slowly over time, and likely comes as the result of some of the benefits of clusters: higher levels of productivity, more capital and enhanced skills. The Panorama determined that the oil and gas industry leads Europe’s cluster categories with an average annual full-time salary of more than 63,000 euros ($70,648) in PPP—about five times higher than the apparel industry, which pays the average annual salary of clusters.
A key strength seen in clusters is their ability to not only survive, but to thrive by adapting to changing conditions over time. As mentioned above, the most successful clusters innovate constantly, rather than staying rigid in their operations and processes. This pays off, as the Panorama found that strong clusters account for 46 percent of all traded industries’ employment, and they have about twice as much economic activity in a specific cluster category than the European average.
The Panorama assigned “performance stars” to identify regions that most successfully leveraged a cluster’s presence. Stars were awarded to locations that ranked in the top 20 percent of European regions in any of the following three categories:
The map shows the top 10 regional cluster hotspots by number of stars:
For all of the benefits clusters bring, they’re not perfect. The Panorama noted that economic forces naturally encourage dispersion, so as clusters grow, the disadvantage of “congestion costs” emerges as a result of clusters’ agglomeration. This can be most prevalent when companies bid higher prices for scarce resources, such as salaries for employees with desirable skills.
As discussed throughout, successful clusters thrive by continually innovating, but disruption still remains a potential drawback, especially as clusters grow in size. The Panorama referred to this as the “lock-in” effect, which occurs when all the companies in a cluster use a certain technology that is then disrupted by innovation in other locations. The Panorama noted that the interplay between the “forces of agglomeration and dispersion shapes the evolution of clusters over time.”
As companies consider expanding into Europe, an understanding of local clusters can help them make an informed decision about the right location in which to establish operations. And despite any short-term startup challenges, companies should remember that clusters have proven staying power and can help position them for long-term growth in the European market.
We welcome you to get in touch with us today to learn how we can help your company best position itself for overseas expansion.
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