Carla I. Koen. Comparative International Management

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NETWORKS AND CLUSTERS OF ECONOMIC ACTIVITY 511

watch). In terms of price these new devices aimed to rival the watches made in Japan.

In particular this last strategy turned out to be a fruitful approach. Swatch as a ‘new

combination’ of traditional Swiss quality and trendy marketing was soon a popular

concept that contributed to the revival of the local watch industry. Nowadays, the

Swiss watch-making ﬁrms can still proﬁt from being part of a close network of formal

and informal institutions in the Jura d’Arc. In short, they are part of an innovative

milieu.

11.6 Conclusions

In this chapter we have identiﬁed globalization, technological developments and changes

in market demand as trends in the world economy that have not only intensiﬁed compe-

tition, but have also changed its character. The competitiveness of ﬁrms has become

increasingly dependent on their ability to innovate and cooperate with other parties in

innovative clusters. As a result, ﬁrms have to ﬁnd a balance between competition, on the

one hand, and cooperation on the other. The notion of networking and clustering has

been studied by several authors over time.

Transaction cost considers networks as alternatives to markets and hierarchies.

Additionally, network theory conceptualizes networks as separate forms of economic co-

ordination in which social and institutional factors play an important role. The spatial

dimension of cooperation is emphasized in literature on industrial districts, as well as

Porter’s work on clustering.

The approaches of networking and clustering essentially try to combine several

dimensions of clusters. In fact, the ideas discussed in this literature only differ to the

extent that they stress one or more dimensions of (spatial) cooperation in particular.

By combining the several views, a multidimensional cluster approach arises that can

take into account the pluriformity of networks and clusters in business life. Moreover,

by combining the insights of authors working in transaction cost economics, the

network theory, the industrial district tradition, the ideas of Porter and the inno-

vative milieux literature, the following dimensions for defining clusters can be

derived.

1. A horizontal dimension: linkages between ﬁrms that perform similar activities and that

are direct competitors outside the cluster on the product market.

2. A vertical dimension: (innovative) cooperation between synergetic interdependent

ﬁrms (suppliers, main producers and users) in a value chain.

3. A geographical dimension: a concentration of economic activities in a region with the

presence of a skilled labour pool and ﬁrms providing specialized inputs to other ﬁrms.

4. An institutional dimension: a cluster as a cooperative in which, apart from ﬁrms,

several institutions (e.g. knowledge institutes) are involved.

These cluster dimensions can be illustrated with many examples of existing clusters.

To conclude, three Dutch examples will be discussed (see Boxes 11.4–11.6): the Océ-cluster,

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512 COMPARATIVE INTERNATIONAL MANAGEMENT

the TIMP-cluster and the Mass Individualization Network (Klein Woolthuis et al., 1996;

Ministry of Economic Affairs (EZ), 1997).

Box 11.4: The Océ-cluster

Situated in the southern part of the Netherlands, this is an example of a geographically

concentrated cluster in which networks of small supplying ﬁrms cooperate with a large

company (Océ) in the development of innovations. Océ makes use of up-to-date digital

technologies to develop new colour printers and colour copiers. In order to remain

competitive in the industry this company cooperates with about 45 supplier networks

in the south-east of the Netherlands. Each network of suppliers has the task of devel-

oping a module for a new product, such as the control panel of a copier. Thus, Océ

wants its suppliers to combine both the R&D and the production of the module. This

type of cooperation has enabled Océ to shorten product development times and, ulti-

mately, to produce better printers and copiers (Klein Woolthuis et al., 1996).

Box 11.5: The Twente Initiative for the Development of Medical

Products (TIMP)

TIMP is another interesting example. The network illustrates all the dimensions men-

tioned above. The cluster is situated in the Dutch region of Twente and is composed of

parties maintaining both horizontal and vertical technological relationships. In the

cluster, two main producers, six small suppliers, two regional economic development

agencies and the University of Twente contribute to the development of new medical

technologies for homecare and rehabilitation. The cluster appears to be successful

because the cooperation reduces the lead times and the costs of new technologies.

Klein Woolthuis et al. (1996) argue that this success can be explained by both econ-

omic and regional factors. The economic factors include the joint interest of the parties

in exploiting market opportunities, and the availability of subsidies for cooperation. In

addition, the regional aspect is important for the cluster’s success. Because the parties

involved have the same cultural, educational and professional background, they feel

strongly connected with each other and behave cooperatively within the cluster.

Box 11.6: The Mass Individualization Network

This is a national cluster in which the Dutch Ministry of Economic Affairs and about

50 large and small competitors (e.g. retailers) participate (Ministry of Economic

Affairs (EZ), 1997). The cluster is based on the observation that the preferences of con-

sumers are becoming more and more individualized and unstable. This trend of

‘customization’ clearly creates economic opportunities for the market parties. How-

ever, responding to different customer needs requires a more ﬂexible organization of

ﬁrms and a good network for the provision of information. Therefore, with the assist-

ance of the Ministry, the ﬁrms cooperate in projects to ﬁnd solutions to handle the

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These examples make it clear that networks and clusters are composed of several

parties (e.g. large ﬁrms, small ﬁrms, public institutions) and can be understood as a com-

bination of different dimensions. It is important to realize that each of these cluster

dimensions requires ‘tailor-made’ ﬁrm strategies related to clustering (Jacobs and de Man,

1996). In consequence, a multidimensional approach is needed to understand the variety

of networks and clusters in practice.

Study Questions

1. Explain why networks and clusters are important for business life.

2. Discuss how geographical clustering can enhance a firm’s competitive position.

3. Explain how Burt’s structural hole theory can help us understand the increased

competitiveness of firms located in networks.

4. Assess the explanatory power of the concept of ‘cultural embeddedness’.

5. Discuss how industrial districts exhibit a mix of cooperation and competition.

6. In recent years, firms that are part of the Japanese keiretsu and the Korean

Chaebol are argued to experience deteriorating performance precisely because

they are part of a network. Use network theory to explain these negative side-

effects.

7. Silicon Valley is a successful example of an innovative cluster of firms. Use the

knowledge introduced in this chapter to explain why and under what conditions,

or why not, governments should try to emulate the Sillicon Valley story.

Further Reading

Ebers, M. (1997) The Formation of Inter-Organizational Networks. Oxford: Oxford

University Press.

This book includes excellent papers that all focus on the recent trend among organ-

izations to form networks with competing organizations. Most of the theory

presented also applies to networks among non-competing organizations.

Faust, K. and Wasserman, S. ( 1999) Social Network Analysis: Methods and Applications.

Cambridge: Cambridge University Press.

NETWORKS AND CLUSTERS OF ECONOMIC ACTIVITY 513

trend of customization. The example of the Mass Individualization Network illustrates

two important points regarding clustering. First, though clusters are often regionally

embedded, this is not always the case. Second, the innovations resulting from clusters

are not restricted to new technologies or products; the clustering can also be directed

to the development of innovative services that are important in ﬁelds like retailing.

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514 COMPARATIVE INTERNATIONAL MANAGEMENT

For the diehards among you; this book is highly recommended for those wishing to

carry out quantitative analysis on networks.

Murphy, J.T. (2002) Networks, trust, and innovation in Tanzania’s manufacturing

sector. World Development 30(4), 591–619.

Excellent article, which explores the societal dimension of innovation for a group of

manufacturers in Mwanza and Tanzania.

Parrilli, M.D. (2001) The social roots of successful economic policies: the cases of the

third Italy and Nicaragua. L’institute Discussion Paper 18, Institute for Industrial

Development Policy: Ferrara, Italy, www.linstitute.org/papers/.

On the basis of an analysis of the districts of the third Italy and of Nicaragua’s clus-

ters, this paper shows that the difficulty that policy-makers have in replicating

successful stories in developing contexts stems from a neglect of the ‘real society

that exists behind the market’ that surrounds the local production system.

Case: Networks in China or Guanxi

Case written by Carla Koen on the basis of Davies et al. (1995); Xin and Pearce

(1996); Tsang (1998); Park and Luo (2001).

he People’s Republic of China (PRC) is becoming a major economic power, with

a population making up approximately one-fifth of the world’s consumer

market. For a number of reasons,the situation in the PRC changed significantly

in the course of 1992 and 1993. First, leader Deng Xiaoping made a highly publicized

tourof rapidly growingareasinSouth China, giving his explicit support to the pace and

direction of change in those areas, and encouraging other parts of the country to

emulate their success. Second, the FourteenthParty Congress, held in October 1992,

confirmed that the commitment to market-based reform would be maintained,

thereby increasing confidence that rapid growth rates could be continued. Third, it

became clearthat the reportedfigures for national income, and, hence,the size of the

Chinese market,are almost certainly quite substantial underestimates.Finally,there

have been strong signs of the existence of a large consumer market. McKinsey esti-

mated that the number of relatively affluent Chinese consumers is around 200

million; the Beijing branchof McDonald’sis reported to be one of the largestandmost

profitablein the world;andAvon has 15,000 salesladiesin Guangdong Provincealone.

At the same time, the Chinese government has made further moves to

reduce controls over the economy and to open the vast domestic market to foreign

competition. Price controls have been relaxed for many kinds of raw materials

and commodities, customs duties have been reduced for over 200 types of con-

sumer and industrial goods, and the attempt to accommodate the GAT

requirements for membership have led to liberalization of imports and the

removal of further structural constraints.

Despite the opportunities now presented by the Chinese market, however,

the evidence suggests that doing business in China can be cumbersome and

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NETWORKS AND CLUSTERS OF ECONOMIC ACTIVITY 515

strenuous. Generally, the daunting outcomes experienced by western business-

people arise from the need for investment in network building, after which the

transacting process may be quite efficient. The establishment of personalized

trust through networks is particularly crucial to the conduct of business in China.

Networks, translated as guanxi, have been the dominant form of transactional

governance in China long before the concept was taken up by western scholars.

The concept refers to the drawing on a web of connections to secure favours in

personal and organizational relations. It has been pervasive for centuries in every

aspect of Chinese social and organizational activities; and modern Chinese

society still operates within the realm of these countless social and business

guanxi networks.

A good illustration of the latter is provided by an experienced US general

manager of a joint venture packaging company in Nanjing who observes that, ‘The

most common contrast between western and Chinese management practices lies

in the emphasis placed on written contracts and procedures in the former, com-

pared with personal relationships in the latter.’

Guanxi, or Chinese networks, are characterized by continuous relationships,

which require that activities undertaken by the parties in a relationship cannot be

completed without the active and reciprocal involvement of both parties (or con-

tinuing reciprocal obligation). A person is viewed as untrustworthy when he or she

fails to return a favour, and he or she does not follow the rules of reciprocity. The

rules of reciprocity establish a structural constraint that curtails self-seeking

opportunism. Therefore, in China, transactions often follow successful guanxi,

while in the West a relationship follows successful transactions.

As suggested, trust and credibility are two other important ingredients of

guanxi. In fact, trust and credibility sometimes play a more salient role than legal

contracts.

An illustration of the importance of these two concepts is provided in the following

example.

A Chinese deputy general manager of a Sino-foreign joint venture urgently

needed certain components in her factory. The components were in short

supply, but through her guanxi, she managed to obtain them from a friend in a

factory in another city. Based on mutual trust, a cash-on-delivery price was

agreed verbally and the components were sent to her factory. However, her

factory was experiencing a cash-flow problem when the components arrived.

In order to uphold trustworthiness, she paid the bill out of her own savings –

an amount roughly equal to her annual salary. She says that if she had not done

so, the guanxi with her friend would have been blemished (Tsang, 1998: 66).

Clearly, the long-term viability of guanxi depends on the members’ commit-

ment to guanxi and to one another. Guanxi does not specify the range or frequency

of exchanging favours. Guanxi members are tied together through an invisible and

unwritten code of reciprocity and equity. Failure to respect the commitment

damages one’s reputation, leading to a humiliating loss of prestige, or face.

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516 COMPARATIVE INTERNATIONAL MANAGEMENT

Face is a key element in the development and maintenance of guanxi. As

suggested, face is an individual’s public image, gained by performing one or more

specific social roles that are recognized by others. Though highly abstract, the

concept of face is treated by the Chinese as something that can be quantified and

measured. How much face an individual has depends partly on his or her guanxi

or network. The larger one’s guanxi – and the more powerful the people con-

nected with it – the more face one has. In addition, one needs to have a certain

amount of face in order to cultivate a viable guanxi.

Guanxi is utilitarian rather than emotional. It is based entirely on the

exchange of favours, not on emotional attachment. Accordingly, guanxi does not

necessarily involve friendship, although friendship is preferred.

The practice of guanxi stems from Confucianism, which fostered the broad

cultural aspects of collectivism manifested in the importance of networks of

interpersonal relations. It is deeply embedded in China’s culture with a history of

over 5000 years. Chinese society has been functioning as a clan-like network

since Confucius codified societal rules, values and hierarchical structures of

authority during the sixth century

BC. Guanxi operates in concentric circles, with

close family members at the core and with distant relatives, classmates, friends

and acquaintances arranged on the periphery, according to the ‘distance’ of the

relationship and the degree of trust involved. When a situation arises that is

beyond an individual’s capacity, the guanxi network is mobilized to accomplish the

desired results.

In the present-day Chinese environment, guanxi has become even more

entrenched, with strong and direct implications for social attitudes and business

practices. China’s recent economic transition has produced a high degree of insti-

tutional uncertainty. Despite ongoing attempts to facilitate market transactions,

China’s economic reform remains incomplete, with a mix of both plan and market

systems operating in the economy. China’s transitional economy is characterized

by weak capital structures, poorly specified property rights, and institutional

instability, of which a lack of coherent business law is an example. These charac-

teristics make market exchanges uncertain and costly. Hence, transaction costs

remain high for firms to secure necessary inputs and legitimize their existence.

As institutional uncertainty increases, firms more eagerly turn to guanxi to lower

external dependence for key resources. Thus guanxi helps firms to overcome the

lack of resources to accommodate growth while alleviating substantial bureau-

cratic costs that would result from internalizing operations. As a loosely

structured network, guanxi is an efficient mechanism to facilitate economic

exchanges and to overcome administrative interventions by the Chinese govern-

ment.

Moreover, the ambiguity regarding property rights, and the fact that production

factor markets are inoperative, explains why the survival of firms also depends

largely on their networking with local governments. Private firms have grown

quickly, while the control of financing and key scarce resources remains largely with

the state. In a country with uncertain property rights, the potential for threatening

interference and expropriation from party and governmental officials is great. Given

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NETWORKS AND CLUSTERS OF ECONOMIC ACTIVITY 517

such institutional uncertainty, private firms nurture a long-term reciprocal relation-

ship with local government through various formal and informal ties (i.e. guanxi).

Facing ineffective factor markets and ambiguous property rights, guanxi substitutes

for government-instituted, formal channels of resource allocation and dispersal.

Moreover, as market information is greatly distorted in a transition economy,

guanxi becomes a reliable source of necessary information for the making of stra-

tegic decisions. Guanxi is thus a valuable entrepreneurial tool for bridging gaps in

information and resource flows between unlinked firms, and between firms and

important outside stakeholders.

Additionally, given the uncertainty and confusion in China’s transition

economy, firms develop guanxi to broker structural holes and alter the existing

network structure. Firms use guanxi to mobilize complementary benefits by arbi-

traging different networks and even potentially negotiating between competing

networks. There are substantial rewards, such as commissions, bonuses and pro-

motions, for managers’ personal guanxi utilized for organizational purposes to

source key inputs and marketing products.

Furthermore, small or newer organizations can overcome legitimacy barriers

through involvement in guanxi, thus gaining wider opportunities to influence the

local, political and/or regulatory environments. The following testimony from the

general manager of a small private computer company is illustrative.

My company had bad luck. We were audited for income tax fraud. The Auditing

Bureau has red eye disease [jealousy]. Whenever they see a private company

doing well, they come and find problems.

The tax auditor just showed up one day and wanted to see company books.

There are no standardized rules on how to keep books in China, especially for

small private companies like ours. If they want to find errors in your income

tax, they will always find something wrong. If we had been found guilty of tax

fraud we could have faced thousands of yuan in fines and the possible suspen-

sion of our business licence.

Our accountant was very worried. I called my administrative assistant, X, into

my office and told him the situation. He smiled and said: ‘Give me a 2500 yuan

allowance [equivalent to a middle managers’ six-month salary] and I will take

care of everything.’ I had no choice. So I said, ‘I will give you 2500 yuan but you

will lose your job if you cannot handle this crisis.’

By noon, my phone rang. X asked me to go to lunch with the auditors, at the

best restaurant in the city. We hired a Mercedes Benz and went to lunch. The

auditors kept saying that they only needed a working lunch. After expensive

drinks and Peking duck, the head auditor started to praise our accounting

system, saying how good and efficient it looked. After lunch the head auditor

left me a notice requesting a 2500 yuan income tax supplement. The reason he

had to force us to pay the supplement was that he had to report to his boss on

what he had accomplished that day. Later on I found out that X’s father is a

good friend of the head auditor. (Xin and Pearce, 1996: 1652–3).

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518 COMPARATIVE INTERNATIONAL MANAGEMENT

Indeed, organizations in China receive different treatment and resource allo-

cations from the government depending on their institutional and organizational

orientations – such as ownership, size, experience and skills. Therefore, there is

a great deal of variation across Chinese firms in terms of their institutional advan-

tages and disadvantages and, hence, in terms of the use of guanxi.

Questions

1. Assess and discuss whether transaction cost theory can help you explain the

current use of guanxi fully, or whether other explanations are needed and, if

so, which ones.

2. In accordance with Hofstede’s national cultural dimensions, China is a collec-

tivist country. Discuss what type of inter-organizational relationships one

should expect in collectivist countries, and explain whether the case confirms

this picture.

3. Explain, on the basis of this case, the influence of the institutional environ-

ment on the type of network that has developed in China.

4. Would you assume that, if the institutional setting became more stable and

reliable, the current type of network:

(a) would change (and, if so, in what direction?)

(b) become disfunctional, or

Explain your answer.

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