Proximity to peers is vital for ICT companies’ success which, in turn, strengthens the entire sector in that region. Ashleigh Lezard reports.

“Economic geography in an era of global competition poses a paradox. In theory, location should no longer be a source of competitive advantage. Open global markets, rapid transportation and high-speed communications should allow any company to source anything from any place at any time. But, in practice, location remains central to competition,” says Professor Michael E Porter at Harvard Business School.

Location, therefore, still seems to be a key factor in the global economy. This particularly rings true for the information and communications technology (ICT) industry. In a sector that relies on constant innovation, both a formal and informal infrastructure is extremely important. The need for technology companies and associated universities and institutions to be located near each other is necessary for the development of the sector in terms of creating and sharing knowledge. This locating of a “geographically proximate group of interconnected companies and associated institutions in a particular field linked by commonalties and complementaries”, as Prof Porter puts it, is more commonly known as the forming of clusters.

The different elements of an ICT cluster have to work in synergy to make it successful, according to Julian Jenkins, a partner at accountancy and consultancy firm Ernst & Young. Several key elements work together to create this synergy: intellectual capital and skills, a research and development (R&D) infrastructure, a funding and business development infrastructure and market access. Most importantly, says Mr Jenkins, “there has to be something to sell”.

Credible location

Walter Herriot, managing director of St John’s Innovation Centre, a high tech incubator in the UK city of Cambridge, agrees. “You cannot set up a knowledge-based centre in the middle of the desert. To set up a cluster from scratch, providing a credible location is important but there has to be a technology ethos and there has to be something to sell.”

The commercialisation of this

technology ethos is the element that sustains the cluster and creates critical mass, which in turn creates and brings in more business. “The university is the spark that generates ideas and innovation. This has to be sustained through investment and new business to produce a magnetism that attracts more business. This eventually results in enough gravity to create a critical mass,” says Mr Jenkins.

Getting the different elements to work together successfully appears to be the aim of most ICT clusters around the world. As this model is largely based on the development of Silicon Valley as the centre of innovation in the world, Mr Jenkins suggests how it all comes together in this location. “Silicon Valley has the university, the flexible intellectual property, venture capital and the market access; it also has 30% of the world technology market on its doorstep,” he says.

In a recent interview, Intel chief executive Craig Barrett points to how countries around the world are trying to emulate the business model created in Silicon Valley. “The world has discovered entrepreneurship in the form of start-up companies, and stock options and all the things that made Silicon Valley the hub of innovation.”

Role model

This is hardly surprising when companies like Intel, Apple and Hewlett Packard were spawned from the Silicon Valley model. A report commissioned by ICT Ireland, the representative body for the country’s high tech sector, and published earlier this year, identifies and compares seven world-class clusters that have developed the right conditions to attract investment and encourage business development.

The report, Creating a World Class Environment for ICT Entrepreneurs, regards Silicon Valley, Boston, Cambridge, Finland, Munich, Sophia Antipolis and Israel as the benchmarks for Ireland’s development based on certain criteria: government policy, market access, funding, R&D and skills.

Government influence

The findings emphasise that the role of the government has a “profound influence both directly and indirectly on the companies within the cluster and on the environment in which they operate”. Government involvement stems from a clear strategy to initiate top down cluster development – for example in Sophia Antipolis in the south of France, to use public funds to create incubators and encourage the transfer of technology. Another example is Bavaria’s software initiative, which is one module of the Bavarian government’s high tech initiative that was launched in 1998. It invests proceeds from the privatisation of public shareholdings (amounting to about E1bn) into R&D, training and other areas.

Other measures identified include government support of indigenous ICT companies, for example, the US government must purchase 23% of it prime contracts from small and medium-sized enterprises, under the Small Business Act.

The right skills and intellectual capital are also important both in terms of providing skilled people to work in technology companies and in generating new ideas. The presence of a university attracts investment from multinationals and collaboration between them provides the multinationals with a flow of innovative ideas, while the presence of multinationals helps the transfer of business skills and know-how.

Stephen Bold, managing director at Sharp Telecommunications and Sharp Laboratories, based in Abingdon, near the UK city of Oxford, highlights some ways in which the Japanese multinational uses connections with universities. “We work with universities in many ways. We have pre-university students come to us under the excellent Year in Industry scheme of the Royal Academy of Engineering. We maintain a connection with some of them during their courses and they often come here to work during the vacations. We sponsor PhD students to do projects with us; while primarily based at university they often spend time with us. We take on students during the summer to carry out short feasibility studies for us.

“We collaborate with universities on large EU-funded research programmes. We sometimes sponsor an academic directly to do a specific targeted piece of research, where there is a need for it,” he says.

Although universities draw clear benefits from these collaborations, the system has been criticised for putting too much emphasis on the growth of spin-outs (projects that have emerged from other companies rather than universities). A recent study by the UK government, Lambert Review of Business-University Collaboration, revealed that there is too much emphasis in the UK on spinning out new companies instead of licensing to existing companies and transferring knowledge.

In Cambridge, which is well known for its prominent university, only a small proportion of new business has emerged from the institution. “ A vast majority (of new companies) are spin-outs from other companies or consultancies,” affirms Mr Herriot. According to the Lambert Review, this is largely due to confusion over intellectual property and patenting – each university in the UK has its own intellectual property laws and the quality of implementation is varied. Cambridge University has flexible intellectual property rules and, although this encourages academic freedom, Mr Herriot admits that it probably could have benefited more over the years.

Dealing with issues such as patenting and intellectual property can be confusing for a small company that is only experienced in technical ideas. As a cluster grows and becomes self sustaining, as Mr Jenkins puts it, the need for a business support network is vital. Management consultancies, lawyers, banks and accountants that understand and specialise in the high-tech sector are needed to ensure that the technology transfer is driven by business ideas. The same applies to the eventual sales and marketing of the products created in the clusters.

The ICT Ireland report reveals that although prominent clusters can attract people to study scientific-related disciplines, most are much weaker when it comes to the amount of people with the right sales and marketing skills, and simple practical management skills, such as people and time management (see table 1).

A spokesperson for Invest in Bavaria emphasises that the incubator facilities, like the ones provided by the high tech initiative, aim “to create a link between industry and science by mediating entrepreneurial thinking and action to students and scientists at an early stage through the science, industry and financial network”.

The business network is highly important to the development of a cluster. Mr Jenkins says Cambridge is a good example of a cluster that developed as a result of business input. “The university may have provided the intellectual capital but without the business skills to develop this – provided by, for example, PA Consulting – the transfer of knowledge into commercial ventures would never have happened,” he says. This provided a role model for other people to develop businesses and set up an informal network in which peer pressure in the cluster encouraged people to develop commercial ventures rather than stopping at the R&D stage.

Management factor

Good quality management is vital for attracting the most important element in cluster development: funding. And, according to Mr Herriot, it is in this area that the US ICT clusters are way ahead. “In 1992, there was a company that came from St John’s [Innovation Centre]. It split into two projects – same company, same people, same laboratories – but one lot went to Silicon Valley, one lot stayed in Cambridge. The US project got $5m in funding while the Cambridge company had to bootstrap to get money. The US venture is now worth $100m, while the UK venture is worth Ł2m [$3.3m]. The funding made things move quickly,” he says.

The ability to gain funding is vital because it brings in not only money but also the benefits of accumulated knowledge and a well-developed network of value-adding contacts that understand the development cycle of the ICT sector, the need to continuously invest in R&D and understand the risks involved. This all contributes to the development of critical mass: “Clusters have to get to a certain size to deal with downturns,” says Mr Jenkins.

This especially rings true of eras like the high-tech boom of the 1990s. According to figures from Venture One/Ernst & Young (see table 4), at the height of the boom, equity financing for US venture-backed companies in the IT sector was about $58m. However, by the first half of this year it has fallen to about $4m. In Europe, the figures have fallen from E12,487m at the height of the boom to E358m in the first half of 2003.

Invest in Bavaria agrees that there has been an effect on funding in the Munich cluster. “Some of the start-ups [in the software incubator] were in the period of the second funding stage, and then it was difficult for them. The banks almost withdrew from funding and the venture capitalists normally asked for a much higher share of participation [to reduce risk],” it says.

Funding tumbles

According to Chris Davidson, head of research at Alt Assets, a London-based private equity research company, the fall in money raised in the past few years will have “pretty profound” implications on the sector. “Venture capital funds are now investing at a later stage to reduce risk with a short-term view. This is dangerous for the cycle and investors in venture capital funds get annoyed that the investment strategy has been changed,” he says. This could lead to large institutional backers halting investment in venture-backed companies and therefore there would be even less money in the cycle threatening to slow down innovation in the sector, he says.

Mr Herriot says that as the technology opens out and opportunities become more niche and appeal to smaller markets, not only will venture capitalists be more unlikely to take risks at earlier stages of development but business angels are reluctant to get involved in projects that they do not understand. He emphasises the importance of government seed capital schemes to provide funding to early stage companies to keep the cycle going. The UK government is giving out Smart Awards worth up Ł75,000 to innovative new companies, for example.

There are other ways, says Mr Herriot. He is lobbying the UK government to provide mezzanine funding, which involves loaning money at different stages at high interest, and therefore justifying the risk. He sees this as a way of closing the massive shortfall in funding, which Cambridge is suffering. “Venture capitalists will deal with four to five investments in a region but really there are 100, therefore shortfall is approximately Ł25m per annum. In the Cambridge region alone, there is the need is for 100 companies seeking Ł25,000 each,” he says.

Discerning investors

Mr Davidson believes that there is a gradual recovery in the venture capital sector, particularly in the US where it is mirroring the macroeconomic recovery. The mistakes made during the high-tech boom are likely to affect the way funding works in ICT clusters for good but, he says: “It has been a difficult few years but there is still capital around. In Silicon Valley, the venture capitalists are starting to invest again, this time in really smart young companies. There is no more following the herd.”

There is a “gentle trend”, according to Mr Davidson, “which has seen venture capital funds basing themselves near to where technology is developed, whether it be in Silicon Valley, Medicon Valley, Grenoble, London or Munich”. This trend once again emphasises the need for “interconnected companies and associated institutions in a particular field” to develop in the same location, as Prof Porter has predicted.