Clustering in the Software Industry

In the last decades we have witnessed a shift towards globalization across all industries. However, the engagement of industries is not equally divided and it is unclear exactly to what degree the different industries have engaged in the globalized context. It is fascinating to see what determines whether or not an industry is suited for operating in a globalized world. Even if the world is becoming a horizontal, flattened playing field, as Friedman (2005) argued in his book “The World is Flat”, it is not an equal playing field for all, as the industries are fundamentally different and therefore have different barriers for becoming globalized. In this situation globalization is referred to as attaining a foothold on the global market, not necessarily being truly global with globally integrated processes and economic activities.

The software industry is largely recognized as one of the industries that are highly suited for operating in globalized context. This is partly due to the low entry barriers in the form of low immediate investment in assets and ease of distribution through web 2.0. Some literature even states that given the software products interdependency of geographical location, software products, by definition, are “born globals” (Madsen & Servais, 1997). This is because they can easily be developed, distributed and serviced across national borders limiting the need for physical presence and thereby lowering transaction costs. Taking the interdependency of geographical location into consideration, it is interesting to see where software companies are most likely to emerge and where the most profitable companies are located.

By quickly investigating the current localization of well performing software companies, it is especially Silicon Valley in the southern part of the San Francisco Bay Area that has lately been conceived as the technological mecca of the world. Based on the preceding, we suspect that this is not coincidental. Earlier studies of this phenomenon have defined it as “industrial clustering” (Porter, 2000) or “Specialized clusters” (Dicken, 2011), but have primarily been concerned with the competitive advantages of clustering. They fail to investigate the effects of diversity in industries and very little study has been conducted on how the software industry is affected by industrial clustering.

In order to determine the existence of specialized clusters within the software industry, we have gathered a list ranking the 100 largest software companies in 2012 based on revenue by PwC. What is important to mention about this list of rankings is that it only concerns itself with companies that do sale of software. This means that companies that would otherwise be considered as “software companies”, that operate their own platform, (such as eBay or Facebook) will not figure on the list, since they have little to none direct sales of software in their organization. Subsequently some extra sorting were done to this list (which I will not go into detail with here) leaving us with a final number of 62 companies.

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By plotting the headquarters of 62 (Some sorting companies into Google Maps with different color pins, a map displaying the geographical distance between each headquarter.

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It is easy to see a pattern within the software industry's “big players”. A large part of them are settled within clusters in central Europe, Western America and Eastern America. San Francisco alone host 11 of the 62 largest software companies’ headquarters, which confirms our hypothesis about specialized clusters in the software industry.

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In order to determine why this phenomenon is relevant in the software industry, we must first establish a general understanding of the drivers for clustering, as well as an understanding of the competitive advantages companies can achieve from positioning themselves in an industrial cluster.

Why do companies settle into clusters?

Settling into clusters can help companies in a wide variety of ways both on a local scale and global scale. In this section of the article we will touch on some the advantages and opportunities that being in a cluster yields. The cluster’s industry will of course also have an impact, since different industries will benefit from different advantages. To get a general understanding of clusters, we will try to give a broad description of commonalities among different industrial clusters.

One of the clear benefits of being positioned in a cluster is the human resource aspect that is one of the major pull forces for settling in a cluster (Porter, 2000). This means that all the skilled workers will be located in one place and thereby providing a solid foundation for companies to attract a highly competent workforce. A large cluster will not only attract a talented workforce but also suppliers for companies within that cluster. Porter uses an example of a wine cluster in California. The wine cluster holds both wineries, grape farmers and suppliers of equipment needed for the process. Since these companies are dependent on each other it is smart to settle in the same location. This collaboration of different industries is called a “cross industry cluster” (Porter, 2000). This easy access to suppliers can help create transparency while also reducing transaction costs. Most of the big clusters do not rely on a single industry, but often feature different industries.

Gathering into clusters will not only give the companies the opportunity to work closely with their suppliers but also to work closely with their competitors (Porter, 2000). The companies will be able to share knowledge and work together to get an edge on the competition on the market outside the cluster. This knowledge can be strategic plans, new technologies and much more. The companies inside a cluster will also have a strong incentive to work together through DPD (Amaral, 2011), where every part of the product is produced by the most suitable developer. This can be done on a global scale as well, but doing it in a cluster will grant advantages such as transparency and low transaction costs. An example could be a car manufacturing cluster. It is very common for car manufacturers to use motors and other parts from other car manufacturers. If these manufactures are all located in the same place it will be very easy for them to collaborate on R&D aspects of the car manufacturing. Looking at lead times and transaction costs, this will also serve as a great benefactor. Working together like this can enable companies to move into new markets with new products based on the knowledge of all the companies involved. Another way the companies can benefit from being located at the same place, is if they have a mutual opportunity for improvement (Porter, 2000). This could be a common demand among the companies that will increase the chances of a supplier moving to that location. Another option could be joint marketing between different companies where companies can work together on promoting collaborative products.

When all of these companies settle into the same area there are bound to be an increase in competition, which will pressure the companies into continuous improvement by lowering costs, increase productivity or an increased focus on innovation. This helps the companies to pursue a better position on the market, but also helps the industry advance as a whole. With the intensive competition inside the cluster many of the companies will gain an edge on the competition outside the cluster that may not be forced to be as innovative as the ones on the inside.

Creating a competitive advantage in the form of higher entry barriers due to increased competition. This may lead new firms to start new businesses that support the existing business, instead of trying to compete with the already established businesses within the cluster.

As mentioned earlier the actual advantages of being part of a cluster is highly reliant on the specific industry. In the following section we will use the software industry as a perspective to explain the advantages that software companies can get from being part of a cluster.

How does the software industry benefit from this? Looking specifically towards the software industry we can easily conclude that clusters of software companies are concentrating at certain locations in the world. As demonstrated with a little help from Google Maps, we saw a clear tendency that many of the software companies with the largest revenue are based near the west- and east coast of USA. In Europe, a significant portion of the larger companies are located in London while we see a smaller portion spread across Germany.

Expounding the advantages of clustering in the previous section, it is no surprise that this phenomenon is also present for the software industry. We tried to outline some of the general benefactors of being located in a cluster, recognizing that software clusters share a lot of trades with traditional clusters.

One of the things that differentiates software companies from companies in general is that they are highly knowledge intensive, meaning that the vast majority of people working there have received education at a higher level. This means that companies that operate in this field must put in a lot of effort to attract the right talent. Being located in a cluster serves as a big advantage for dealing with this issue since the greater the concentration of job opportunities in an area, the greater the pull effect will be towards potential employees. Not only do the clusters have a massive attraction from a human resource perspective, but we also found them to be epicenters of venture capital. To show how the concentration of venture capital in the tech industry is spread around the world, Richard Florida have collected data about venture capital firms in the tech industry and plotted their relatively size on a world map.

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Richard Florida states in his article that “The largest dots, indicating the largest levels of venture capital investment, are located in the East and West Coasts of the United States, Western Europe, and around the metropolitan areas of China and India” (Florida, 2016). Comparing this to our observations regarding the clusters in the software industry, it is clear that software companies and venture capital firms have an equivalent attraction on each other and to a great extent are located in the same clusters around the world. If we turn to Forbes’ projections of the most profitable industries for 2016 this makes great sense, ranking technology business among the most profitable for the years to come (Forbes, 2015).

Another thing that is highly relevant for software companies situated in clusters is the option for sharing information locally. In places such as Silicon Valley that homes a large concentration of giant software companies, we see a growing tendency to share information across companies creating synergies in the industry as a whole. This is a strong shift in trends, where software companies earlier have been very protective about their infrastructure and internal projects, they are now showing an increased willingness to share their ideas and frameworks with other companies. Naturally this creates a great effect of synergy among the different corporations that takes part in these associations.

A great example from the software industry of how different companies connect in a shared knowledge network is the Open Compute Project. The Open Compute Project is a union of many of the largest technological companies around the world that allows them to share information about their data centers and computing infrastructure. The movement was started by Facebook but was recently joined by Google, giving the movement a solid seal of approval.

But these are by all means only a small fragment of the competitive advantages that can be achieved if a company locates inside a cluster. Naturally many of the benefits can be partly achieved with the help of the internet but there is no denying that the clustering of software companies involves a lot of potential competitive edges.

By identifying the locations of headquarters of the world’s largest software companies in Google Maps, we established that clusters are present within the software industry. To mention one example of the US, we found that a large cluster is based in San Francisco, in the technology cluster often referred to as Silicon Valley. It was somewhat surprising to discover that clusters are that noticeable in the software industry because, as earlier stated, software products are often perceived as having a “born globals” nature due to the interconnection that has been established with the widespread use of the internet.

Looking at the advantages that can be achieved engaging in clusters, it is clear that software clusters share much of the same traits as general clusters. Both software and traditional companies can achieve many benefits from clustering and creating synergies around different parameters.

What distinguishes software companies from companies in general is that much of their competitive advantage comes from being able to ideate, design and produce products of an innovative nature. In order to be able to do this, the companies are highly dependent on attracting the right people. Much like gravitation, the greater the concentration of companies in an area, the greater the “gravitational” pull it will have on suitable candidates. Going through the advantages of being part of a specialized cluster, it is clearly not coincidental where the leading companies has positioned themselves geographically.

Taking our findings into consideration along with the predictions made by Forbes (2015), further investigation into what impacts this can have on the global economy would be an interesting future work direction and potential extension of this article.