Why You Need to Understand Agglomeration Economics

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Normally the very first questions asked by a broker of a tenant looking for new office space tend to be around location, size (space needs) and cost.

As far as location is concerned however, there are a number of issues that business owners and managers will need to consider, particularly when choosing new office space with the intention of improving business performance. Specifically, they will need to answer the following question and this should be the very 1st question a tenant rep asks: Is there a particular reason that your business should be located where it is?

If the answer to the question is yes, then there is nothing further to explore regarding geographic location. If the answer is no, then that opens up a wide range of possibilities that might include the Central Business District (CBD) of a major capital city, a location in a nearby commercial centre, a main street precinct or office park, somewhere adjacent an industrial or educational node, or even a regional township. Generally speaking, the farther you are from the CBD, the cheaper the rent will be, but it might also mean you are farther away from your clients, customers, staff, supply chains and operational requirements from a logistics perspective. These geographic possibilities should therefore be explored by the tenant rep asking the next two questions:

  1. Can the location of your business affect turnover or sales?
  2. Can the location of your business affect your staffing and logistical needs?

When addressing each of these questions, a business owner must reflect upon the most critical needs of the business and the market that it services. The tenant rep should then ask their clients to consider the next 5 questions:

  1. Where are your customers or clients best served in relation to your location?
  2. Where are your closest collaborators or partners located? This will be relevant to your location if it makes your business more efficient or productive when it comes to these relationships.
  3. Is it to your advantage to be located near your competitors or away from them?
  4. Are there any suitably trained staff near your proposed office location? If not, will that be a significant impediment to your business?
  5. Are your operational needs compromised by your office location?

Some of the above questions or issues may be resolved either by the way your client’s business operates or by its reliance on certain types of infrastructure. For example, staffing needs may not be a problem if their office location is well serviced by transportation infrastructure and other amenities that will likely attract staff. Likewise, most services-based businesses do not have particularly complicated supply chains or logistical needs. These are the businesses that make up the majority of our CBD’s.

Regardless, an investigation into the location of partners, collaborators and competitors is a valuable undertaking and raises the question of what opportunities might arise for a business through the economics of agglomeration.

The concept of clustering businesses together that share common goals or synergies has been shown to be beneficial to their performance*. Economic agglomeration is the term used to describe the benefits which flow to firms from locating in areas which have a higher density of economic activity. Often measured by employment, this higher level of commerce allows firms to achieve economies of scale through a larger customer base, access to skilled staff, more efficient supply chain logistics and access to shared services. We often see this type of clustering in major capital cities where finance and insurance services or government services may be found a relatively short distance from one another.

In particular, this ‘co-location’ exploits the prospect for creativity and innovation by providing the opportunity to capture valuable knowledge sharing and interactions with like-minded individuals and corporations. This is particularly true of creative businesses, as exemplified by Hollywood, Silicon Valley and Digital Media City in Seoul, where the creative tension that exists between partners, collaborators and competitors works to produce innovative products or services and exploit the economies of scale mentioned above.

It is therefore incumbent upon tenant reps to prompt their clients (business managers and owners) to explore the relationships that exist for them within the markets they serve, to investigate whether there might be an opportunity to take advantage of the growth and profitability benefits that agglomeration may bring to their business. In these instances, the question of location becomes far more strategic, both in the asking and in the investigation of the opportunities uncovered.

* Andersson, Roland, Quigley, John M. and Wilhelmsson, Mats, “Agglomeration and the spatial distribution of creativity. Papers in Regional Science, Volume 84, Issue 3, pages 445–464, August 2005

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