Clustering approach in SME development

In this era of liberalisation and globalisation, creation of demands depends on the ability of SMEs to improve their efficiency and productivity and to adapt to and be flexible as regards market, product, technology, management, and organization. As the era generates larger market opportunities, individual SMEs are often unable to capture these opportunities that require the following:
Clustering creates external economies through joint actions and increases scope for efficiency. In effect, individual enterprises in a cluster can gain collective efficiency. Proximity facilitates establishment of enterprises in the locality of industrial links without substantial transaction costs or difficulties. However, these economic advantages can only be achieved if the cluster has well-developed internal and external networks.
Internal networks can be defined as business co-operation or links among enterprises inside the cluster, which can be in various forms like marketing, distribution, production, procurement of materials, and training of workers.
External networks help establish business and other forms of relationships among enterprises inside the cluster and actors outside the cluster such as local entrepreneurs (LEs), suppliers of inputs, providers of business services, and so on.
Further, internal networks or inter-firm co-operation can be divided into horizontal and vertical co-operation. The first type is co-operation among SMEs occupying the same position in the value chain. Through such co-operation, enterprises can collectively achieve scale economies beyond the reach of individual enterprises and can obtain bulk purchased inputs, achieve optimal scale in the use of machinery, and pool together their production capacities to satisfy large-scale orders.
It also gives rise to a collective learning process where ideas are exchanged and developed and knowledge shared among individual enterprises in a collective attempt to improve product quality, upgrade technology, and move to more profitable market segments. The second type is co-operation among SMEs along the value chain. With this, an enterprise can specialise in its core business and offer other related works to enterprises in the cluster.
However, in many cases, it has been found that many individual enterprises have vertical co-operation with LEs outside the cluster through subcontracting arrangements. Thus, in many cases, the vertical co-operation consists of both internal and external networks.
From a public policy perspective, SME development policies with a clustering approach is important because it is more effective and easier for the government to provide technical and management supports, training, and general facilities, such as large machinery for raw material drying and processing into half- finished goods, to a group of firms located in one place than to individual firms in dispersed locations.
It is also easier for local universities/research and development institutions to provide technical or training supports, local banks to provide loans, and LEs to conduct subcontracting networks with firms located in one cluster. The participation of these institutions in promoting SMEs is certainly very helpful for the government in implementing its SME cluster development policies. The government can encourage their participation by giving them fiscal or other forms of incentive.
Development of a cluster depends on four main factors: (1) context for firm strategy and rivalry inside the cluster; (2) demand conditions; (3) related and supporting industries; and (4) factor conditions. So, SME development policies with a clustering approach consist of direct policies toward cluster (for example, provision of technical development and management training, and general facilities such as large machinery for raw material drying and processing into half-finished goods), and indirect policies through supporting these four factors.
With respect to the first factor, the government should eliminate barriers to local competition, attract investment (both foreign and domestic) in and around the supported cluster, promote export of the cluster's products, and organise relevant local government bodies around the cluster.
With respect to the second factor, the government should create streamlined pro-innovation regulatory standards affecting the cluster to (1) reduce regulatory uncertainty; (2) stimulate early adoption; and (3) encourage innovation in product as well as production process.
In addition to improving demand conditions for the cluster's products, the government should also sponsor independent testing, product certification, and rating services. Also, the government should act as a sophisticated buyer of the cluster's products. In supporting SME clusters through developing related and supporting industries, the government should sponsor forums to bring together cluster participants, create a business- friendly environment to attract suppliers and service-providers from other locations, and establish cluster-oriented free-trade zones, industrial parks, or supplier parks.
Finally, SME cluster development policies through improving factor condition should include efforts to create specialised education and training programmes; establish local university research efforts in the cluster-related technologies to support cluster-specific information gathering and compilation; and improve specialised transportation, communications, and other infrastructure required by the cluster. So, it is obvious that this approach is also very important from a regional economic development policy perspective.
Development of clusters in a region supported by policies with a clustering approach also promotes development of related and supporting industries, industrial or suppliers parks, business development services, training facilities, local research and development activities, financial institutions, infrastructure, and free trade zones in that region.
It will also attract investment in that region from abroad or from other regions within the country. The development of clusters can also be an effective way of promoting rural economic development because well- performing SME clusters will generate 'trickle-down effects' on other local economic activities through their direct as well as indirect production and income linkages.
SOME SUCCESS STORIES: In view of the complexity of cluster development processes and the wide range of instruments applied, it is hardly possible to determine policy contribution to successful cluster development of Indonesia. Nevertheless, public intervention is likely to have contributed to a number of success stories such as development of the wooden furniture cluster in Jepara (Central Java), which is among the largest clusters in the country.
A comprehensive development package including, for example, technical upgrading through provision of a common service facility, export training, and investment into improvement of the regional infrastructure (container facilities, roads, telephone), helped the cluster to gradually develop export markets. Similar effects were brought forward by creating a small industrial estate combined with a common service facility for wood processing, a joint showroom, and trade fair participation support in Sukoharjo, near Surabaya (East Java).
The area is now a leading exporter of wooden, rattan, and metal furniture. There are, however, other factors that have significantly contributed to the aforementioned success stories: (1) strong local sector associations; (2) long exposure to foreign tastes brought forward by international tourism; (3) a considerable medium-scale direct investment by western immigrants married to Indonesians; and (4) a strong role of trading houses in brokering and organizing exports. In particular, exports seem to benefit from some trading houses' traditional connections to China, which is one of the world's largest markets for furniture.
Overall, relevance of public intervention has to be seen in the light of the fact that two large and successful clusters for leather goods and traditional handicrafts in the Yogyakarta area (Central Java) have developed virtually without public intervention. The clusters' initial driving force was demand from international tourists visiting Yogyakarta. In the early 1990s, trading houses started to purchase part of the clusters' production for sale to large retail chains in Jakarta and for exports, mainly to Southeast and East Asia.
The writer is Secretary and CEO, India-Bangladesh Chamber of Commerce and Industry. The article is based on a paper he presented at the South Asia Economic Conclave held in Delhi on September 28-30, 2015 and organised by the Confederation of Indian Industry, CII.
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