Despite technology making it easier than ever before to source materials, inputs, employees from across the
world, the most innovative, iconic, and productive groups flock to central hubs. Examples of clusters are
Hollywood, Silicon Valley, Wall Street. But other, more niche clusters exist too, and very much influence the
trajectory of industries and progress: Boston for biotech, Shenzhen for hardware & electronics, South Germany for
automobiles, Southern California for wine, and more. And this is nothing new, historical clusters include
20th century Göttingen and Berlin for theoretical physics, Renaissance Florence for fine art, ancient
Athens for philosophy, industrial London for engineering, and more.
This piece is based on an HBR article about the economics of clusters, and I'll draw on some of its content while highlighting the factors I think contribute most to giving clusters a disproportionate edge. I'm slightly biased towards clusters because I moved to SF thinking that the internet makes it as easy to start a successful company in London or Abu Dhabi as in the Valley, only to see firsthand how wrong I was, and how many decades ahead the rest of the world the Valley was.
Historically, competitive advantages came from sourcing better inputs for a lower cost than your competitors. Because the differences in input costs could be such a stark advantage, improvements in knowledge, management and technique weren't as valued, and being close to a port or railway line was an immense advantage, and so companies would cluster around them. As freight and shipping make procuring quality goods from across the world cheap, reliable and quick, the advantages in knowledge, management and technique have become decisive. Clusters having a huge advantage on this front, too, as a consequence of in-person meetings being significantly more effective at inciting progress and action than virtual ones--a fact I conjecture, but one that seems to be empirically true. At a high level, I think the advantages clusters hold in a modern knowledge economy include: lower barriers to entry, process knowledge, peer pressure, agglomeration economies, sophisticated markets, and public investment.
- Barriers To Entry: Vertical integration; that is, doing everything yourself--like Apple did from software to hardware--is hard, and usually only enormous companies have the resources to pull it off. In other words, if you're starting a trading business based on your innovative algorithm, you don't want to spend time doing perfunctory paperwork--you pay a lawyer to do that. Clusters have abstractions available for common use cases that you can't easily get access to outside them, and this means people starting new ventures in those clusters get them off the ground significantly faster. In the context of a technology startup: when you're living in South Park in San Francisco, your friends tell you about another tech startup that was created to automate accounting for companies. It hasn't grown outside the Bay Area yet, but because you're headquartered next door, you grab a bite with the founder--you're his third ever customer--and arrange an informal deal to have them automate your accounting for significantly less expense and time than if you were to go through the motions and paperwork yourself. These abstractions exist far beyond legal and accounting: there are obscure but powerful Python packages you might only hear about from someone in the Bay Area who made them, or a novel technique for rendering more realistic shadows in paintings invented by your neighbour when you're living in 15th century Florence that painters in Rome or Milan competing with you simply do not know exists.
- Process Knowledge I actually think this is the most important reason clusters succeed. Process knowledge is the knowledge taken for granted by experts, and the type of knowledge that can't be written down. If you had a master chef write out a recipe in painstaking detail, giving ample detail on exactly how to do everything, would an amateur chef's output using that recipe be just as good as that of a Michelin-starred virtuoso? No, and that's because of process knowledge. Dan Wang wrote an excellent piece on it here.
- Peer Pressure This isn't very complicated. To be great at something, you must live, eat, breathe and shit it. When you see the guy next door's lights on at 2am and you know he's working on the script for his movie while you just got back from doing coke at a party, you can't help but feel bad and become more disciplined as a result.
- Agglomeration and Economies of Scale: By being in a cluster, small startups and creatives can reap some benefits as if they were huge companies without sacrificing the agility that makes them able to be so innovative in the first place. They can have their cake, and eat it too. Startups need to do less training and in-house education of their own when the big companies next door do it for them; the startups just need to poach employees, which they often have no trouble doing. Another example is easier access to talent because smart people reduce risk by choosing to work in a cluster: if they lose their job, it'll be easy enough to find another one. Such is not the case if you're a biochemistry PhD laid off from your pharma research job in Anchorage, Alaska. Startups also have access to cheaper inputs more easily obtainable because suppliers are competing for market share in a huge market. If they want to try something new, materials and expertise can be on their doorstep the next day, significantly reducing the barrier to experimentation.
- Sophisticated Customers Markets for products in clusters are often both more demanding and tolerant than markets for the same thing elsewhere. As with the example of an accounting automation startup finding its first customer in another fledgling startup located next door in San Francisco, is the case with Los Angeles movie-goers being more willing to experiment and explore unconventional and potentially disruptive new media formats, and with New Yorkers being more educated about personal finance than the average American, and being more willing to put their money into new and innovative instruments. The customers in a cluster have preferences that are often 5-10 years ahead of the world at large, such that often listening to the pulse of consumer demand in a cluster can tell you the future direction of your industry: a remarkable advantage, and certainly one that cannot be "digitalized" in any meaningful way.
- Public Investment Clusters have large masses of people, and are therefore powerful political forces. And since clusters need a functioning ecosystem to survive (a tourism cluster can't survive without functioning public transport), governments are happy to support them in any way possible, since clusters often contribute a disproportionate amount to national economies. Startups also benefit from workers educated on state money in the case of public universities, like Berkeley in Silicon Valley or UCLA in Los Angeles. It is also telling that many developing economies don't have clusters because they lack government support or have governments that actively work against them.
This access to abstractions, coupled with the availability of talent & capital, high risk tolerance of experts in the area, and general atmosphere of "it's okay to fail" that is pervasive as much in Hollywood as in Shenzhen make it very easy for talented employees at big companies or ambitious graduates of top universities--both of which are present in copious amounts in hubs--to leave and recruit some friends to start the next big thing, whether that's making Rocky, writing A Midsummer Night's Dream, or founding Tencent.
In another context: in Silicon Valley cafés, in casual conversation, you never have to explain was "SaaS" or "B2B" means, it's as much part of the vernacular as "lmao" is to teenagers on their phones. Before I moved to the Valley, people told me the Valley was ahead because it's easier to source capital and talent there than it is anywhere else. This may be true, but I don't think that's the main reason it's a better place to start a high-tech company than anywhere else. I think the real reason is that starting new ventures-- whether it's a company, artistic movement, religion, hedge fund, or film idea--is difficult. In the case of SV, if you're starting a payments company, and Max Levchin lives down the road and is willing to grab coffee to talk about the problems you're having, you'll have your questions about, say, early user acquisition in payments, answered by perhaps one of the only 10 people in the world equipped to answer them. A pow-wow over coffee or drinks with movers and shakers that have struggled through that which you're struggling reveals insights and paths that just are not possible to get when you're teleconferencing from the comfort of your Colorado home.
This sense of informality, the ability to move fast and break things, is something you can never get through "formal partnerships" of the kind mediated through email and contracts and video call. This is related to my earlier point about low barriers to entry, as well as to my later point about agglomeration economies.
To conclude, I think clusters are one of humanity's most powerful engines for progress. As globalization further increases,
I think their importance will only grow--social media led to more college parties, not less, and teleconferencing compounded the
importance of in-person meetings instead of obviating them. Information technology makes the world more dynamic and
knowledge/service based, which in turns gives outsized advantages to those that can easily identify and adapt to new trends and
access 'insider' knowledge. It's a positive feedback loop. I'd welcome suggestion on how
both legislation and technology can make large cities in developing and developed countries alike potential breeding grounds for