The standard economic textbook treatment of competition gives the impression that production and consumption take place on the head of a pin, as if space did not matter. In reality, of course, space does matter, in ways that constrain the boundaries of competitive domains and the intensity of competition in those domains. The resources for which firms compete are not evenly distributed in space, but are geographically clustered, often independent of political administrative boundaries. Agglomerations such as the wine industry in Southern California, the financial district of the City of London, the Indian film cluster in Mumbai, the surgical instruments cluster in southern Germany, or the boat building cluster in northern New Zealand all conjure images of highly localized business activities, supported by locally specific institutions and social structures.
Local competition may be understood from two perspectives, with different predictions for the nature of business transactions. Standard economic theory suggests that within a given locale barriers to entry are lower than elsewhere to the extent that labor skills, material and financial assets, information, and other inputs are more readily available locally. The presence of a large number of firms in the region is predicted to increase business entry rates into the region because potential business founders will view a large local business population as an indicator of market and investment opportunities. By contrast, the ecological approach to competition highlights the crowding effects of business populations. A large population of firms, which all draw on the same or similar resources, is predicted to depress firm entry rates. The more firms’ market domains overlap, the more strongly they compete. The addition of a firm to an existing population has stronger competitive effects on firms in the same domain than on firms in more distant domains, reducing founding rates and increasing failure rates.
One way to reconcile these theoretical predictions is to consider the definition of competition that they assume. Economic theory views rivalry more as a form of competition among a narrowly defined population of firms, focusing on the social and cognitive aspects of competition. Local competitors, from this perspective, tend to orient their activities toward those firms they perceive as rivals. The ecological perspective, by contrast, subscribes to a less-social definition of competition. It highlights the more diffuse and indirect interdependence between firms that may or may not be directly aware of each other. Of course, economic rivalry and ecological competition may operate jointly in a given setting. For example, firms may compete globally in product markets, but locally in factor-input markets.
Our understanding of local competition draws on substantial academic research that typically falls in one of three categories. One line of research focuses on the geographic distribution of resources. A second body of literature studies the flow of information across space. And a third body of research focuses on the level at which economic aggregates can develop competitive advantage. While each of these literatures has a distinct focus, they share the argument that the optimal location of a firm depends on the locations chosen by the firms with which it interacts. Local competitive processes reflect the resource interdependence of firms.
Research on the geographic distribution of resources suggests that the local availability of resources influences the location decision of firms, evident, for example, in the spatial concentration of new business foundings. Many of the resources that firms require to compete effectively are considered, from the perspective of the individual firm, more or less fixed in space. They include human capital, special-purpose equipment, and a range of specialized infrastructure services that are very difficult to transfer across large distances. The market is thus said to require local coordination and control of economic activities and a division of labor between independent but interlinked producers. Localized production systems are evident particularly in those industries that face significant uncertainty, such as software, design, fashion, and high-technology manufacturing. The negotiations involved in production and exchange in such industries are less easily carried out at a distance. Many firms, therefore, remain local, and they depend strongly on their immediate competitive and institutional environments for economic resources, public support, and customer demand. The intensity of competition among firms is a function of the similarity in resource requirements.
Interestingly, the location of a firm relative to its competitors can increase both the intensity of competition and the likelihood of cooperative behavior. The possibility of and need for collaboration with local competitors is the focus of analysis of a second body of research, which investigates flows of information across firms and related organizations. Geographic colocation of competitors makes it easier to observe and monitor competitors. Managers are generally more sensitive to the strategies and actions of local competitors because of their limited capacity to collect information on nonlocal competitors and the ambiguity of interpreting information from a distance. This suggests that managers focus on the actions and capabilities of competitors located in close vicinity.
Research shows that business networks tend to be localized because reliable information is usually best conveyed through direct, personal contacts. For this reason, information and knowledge tend to diffuse slowly through space away from the point of origin. This process can affect the spread of new strategies and products, the adoption of innovations, and the diffusion of organizational models. When combined with dependence on a common resource base and recruitment from a common labor pool, frequent business interactions tend to increase the level of information exchange among local managers, thus improving the awareness of the capabilities of local competitors.
A third line of research is concerned with the extent and form of local competition (and cooperation) as a source of competitive advantage, not for individual firms but for the business population in which they are located. Competitors outside the local production system do not have equal access to the cost advantages of local populations, and they struggle to maintain competitive parity with the clustered competitors. The central argument is that the sustained competitive advantage of local populations of firms is based on knowledge that limits the spread of such knowledge to other populations and regions. Such knowledge is often referred to as architectural knowledge, because it relates to the complex and intangible understanding of how the entire production system works. Such knowledge tends to develop as an inseparable part of the local production complex and is, therefore, not easily transferable to other locales.
In sum, research on local competition suggests that geographic distance continues to play an important role in economic life. While technological advances in communication have reduced the costs of economic transactions and cross-border trade agreements have led to the gradual softening of trade barriers, the transfer of outputs, labor, and information has not become instantaneous or frictionless. Local transactions are increasing in many regions around the world even more rapidly than global transactions. The increased sophistication and differentiation of goods and services in many industries requires an increasing number of transactions and creates local interdependencies that are nontradable. This explains why there will continue to be regional disparities in economic development.
- Arindam Bhattacharya and David C. Michael, “How Local Companies Keep Multinationals at Bay,” Harvard Business Review (v.86/3, 2008);
- Michael T. Hannan and John Freeman, Organizational Ecology (Harvard University Press, 1989);
- Gard Hopsdal, “The Far Side of International Business: Local Initiatives in the Global Workshop,” Journal of Economic Geography (v.8/1, 2008);
- Paul R. Krugman, Geography and Trade (MIT Press, 1991);
- Michael E. Porter, The Competitive Advantage of Nations (Free Press, 1990);
- Baruch Shimoni, “Separation, Emulation and Competition—Hybridization Styles of Management Cultures in Thailand, Mexico and Israel,” Journal of Organizational Change Management (v.21/1, 2008).
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