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The review should ONE single-spaced pages long, with a font type of Times New Roman, a font size of 12, and 1 inch page margins. The review needs to cover the following two components: - A brief summary of the article. (3 quarters of the page) - What are the major insights that you get from reading the article? (1 quarter of the page) Regional Networks and Industrial Adaptation Cityscape 41Cityscape: A Journal of Policy Development and Research • Volume 2, Number 2 • May 1996U.S. Department of Housing and Urban Development • Office of Policy Development and Research Inside-Out: Regional Networks and Industrial Adaptation in Silicon Valley and Route 128 AnnaLee Saxenian University of California, Berkeley Abstract The competitive advantages of regional clusters are the focus of much scholarly and policy attention. The literature relies heavily on the concept of external economies to explain the advantages derived from the spatial clustering of economic activity. This article compares two of America’s leading technology regions—California’s Silicon Valley and Massachusetts’ Route 128, to suggest the limits of the notion of external economies and to propose an alternative network approach to analyzing regional economies. By rejecting the sharp distinction between what occurs inside and outside the firm, the network approach illuminates the complex and historically evolved relations between firms and the social structures and institutions of a par- ticular locality. Through a set of comparisons of companies in Silicon Valley and Route 128, the article explains the divergent performance of these two apparently comparable regional clusters, and in so doing provides insights into the local sources of competitive advantage. The competitive advantages of regional clusters have become a focal point of scholarly and policy attention. The work of Paul Krugman (1991) and Michael Porter (1990) has spurred widespread interest in regions and regional development, once the sole province of economic geographers and regional scientists. These newcomers have ignored an al- ready extensive and sophisticated literature on the dynamics of industrial localization (see, for example, Storper, 1989; Scott, 1988a, 1988b; Vernon, 1960). Yet, like their predecessors, they share a reliance on external economies to explain the advantages of clustering of economic activity. This article compares California’s Silicon Valley with the Route 128 beltway around Boston, Massachusetts, to suggest the limits of the concept of external economies and to propose an alternative network approach to analyzing regional economies. The common notion of external economies is based on an assumption that the firm is an atomistic unit Saxenian 42 Cityscape of production with clearly defined boundaries. But by drawing a sharp distinction between what occurs inside and what occurs outside the firm, scholars overlook the complex and historically evolved relations among the internal organization of firms and their connec- tions to one another and to the social structures and institutions of a particular locality. The network perspective helps explain the divergent performance of apparently compa- rable regional clusters, such as Silicon Valley and Route 128, and provides important insights into the local sources of competitive advantage. The Limits of External Economies Alfred Marshall (1920) developed the notion of “external economies of scale” to refer to the sources of increased productivity that lie outside individual firms. In the classic view, producers derive external benefits by sharing the fixed costs of common resources, such as infrastructure and services, skilled labor pools and specialized suppliers, and a common knowledge base. In addition, some theorists distinguish external economies that depend on the size of the market—including such factors as a labor pool and specialized supplier base (pecuniary external economies)—from those that involve spillovers of knowledge between firms (technological external economies). When these factors of production are geographically concentrated, firms gain the additional benefits of spatial proximity, or “agglomeration economies.” Once established in a locality, such an advantage becomes self-reinforcing through a dynamic process of increasing returns (Arthur, 1990; Krugman, 1991; Scott, 1988b; Storper, 1989). Students of regional development typically treat Silicon Valley and Route 128 as classic examples of the external economies that are derived from industrial localization. They are seen as cumulatively self-reinforcing agglomerations of technical skill, venture capital, specialized input suppliers and services, infrastructure, and spillovers of knowledge asso- ciated with proximity to universities and informal information flows (see, for example, Castells, 1989; Hall and Markusen, 1985; Krugman, 1991; Porter, 1990; Scott, 1988b). Some researchers have compared them with the 19th century industrial districts described by Alfred Marshall (Piore and Sabel, 1984). Yet this approach cannot account for the divergent performance of the two regional economies. In spite of their common origins in postwar military spending and university- based research, Silicon Valley and Route 128 have responded differently to intensified international competition. Although both regions faced downturns in the 1980s, Silicon Valley recovered quickly from the crisis of its leading semiconductor producers. Route 128, however, shows few signs of reversing a decline that began in the early 1980s. The rapid growth of a new wave of start-up businesses and the renewed dynamism of estab- lished companies such as Intel and Hewlett-Packard (HP) were evidence that Silicon Valley had regained its former vitality. By contrast, start-ups along Route 128 failed to compensate for continued layoffs at the Digital Equipment Corporation (DEC) and other minicomputer companies. By the end of the 1980s, Route 128 producers had ceded their longstanding dominance in computer production to Silicon Valley. Regional data underscore this divergence. Between 1975 and 1990, Silicon Valley firms generated some 150,000 new technology jobs—triple the number created along Route 128—even though the two areas enjoyed roughly the same employment level in 1975. Regional Networks and Industrial Adaptation Cityscape 43 Source: County Business Patterns In 1990 Silicon Valley-based producers exported more than $11 billion in electronics products—almost one-third of the Nation’s total—compared with Route 128’s $4.6 billion (Electronic Business, 1992). Finally, Silicon Valley was the home of 39 of the Nation’s 100 fastest-growing electronics companies, whereas Route 128 claimed only 4. By 1990 both southern California and Texas had surpassed Route 128 as locations of fast-growing electronics firms. These rankings are based on the growth rates of 5-year sales, but the list is not limited to small firms. Multibillion dollar companies, such as Sun Microsystems, Apple Computers, Intel Semiconductor, and HP, ranked among the fastest-growing enterprises in 1990. Figure 1 Total High Technology Employment, Silicon Valley and Route 128, 1959 to 1990 1959 199019851980197519701965 0 300 250 200 150 100 50 E m p lo y m e n t (T h o u s a n d s ) Silicon Valley Route 128 Saxenian 44 Cityscape Source: Electonic Business, “The Top 100 Exporters” The concepts of agglomeration and external economies alone cannot explain why clusters of specialized technical skills, suppliers, and information produced a self-reinforcing dynamic of increasing industrial advances in Silicon Valley while producing relative decline along Route 128. The concepts account for regional stagnation or decline through imprecise references to “diseconomies” of agglomeration or the accumulation of negative externalities. Yet if such diseconomies are related to the overall size of a regional cluster, the degree of congestion, or the costs of production, growth should have slowed in the more densely populated Silicon Valley long before Route 128. The simple fact of spatial proximity evidently reveals little about the ability of firms to respond to the fast-changing markets and technologies that now characterize international competition. Figure 2 Fastest Growing Electronics Firms, Silicon Valley and Route 128, 1985 to 1990 1985 19901986 1987 1988 1989 Silicon Valley Route 128 0 20 15 10 5 40 35 30 25 C o m p a n ie s 22 4 39 7 33 10 26 14 25 15 25 14 Regional Networks and Industrial Adaptation Cityscape 45 The distinction between internal and external economies is based on the assumption that the firm is an atomistic unit of production with clearly defined boundaries. Treating re- gions as collections of autonomous firms has even led some observers to conclude that Silicon Valley suffers from excessive, even pathological, fragmentation (Florida and Kenney, 1990). Proponents of this argument overlook the complex of institutional and social relationships that connect the producers in a fragmented industrial structure. Re- searchers who adopt the broadest interpretations of technological external economies recognize that firms learn from one another through the flow of information, ideas, and know-how (Storper, 1989), but they do so only by denying the theoretical distinction between internal and external economies, between what is inside and outside the firm. A Network Approach to Regions Far from being isolated from what lies outside them, firms are embedded in networks of social and institutional relationships that shape and are shaped by their strategies and structures (Granovetter, 1985). The network perspective helps illuminate the historically evolved relationships among the internal organization of firms and their connections to one another and to the social structures and institutions of their particular localities (Nohria and Eccles, 1992b; Powell, 1987). A network approach can be used to argue that, despite similar origins and technologies, Sili- con Valley and Route 128 evolved distinct industrial systems in the postwar period. The differences in productive organization have been overlooked by economic analysts or treated simply as superficial differences between “laid-back” California and the more “buttoned- down” east coast. Far from superficial, these variations demonstrate the importance of local social and institutional determinants of industrial adaptation. In particular, they help explain why these two regions have responded so differently to the same external forces, from the lowering of global trade barriers and the intensification of international competition to cuts in the domestic military budget. Silicon Valley has a regional, network-based industrial system that promotes learning and mutual adjustment among specialist producers of a complex of related technologies. The region’s dense social networks and open labor markets encourage entrepreneurship and experimentation. Companies compete intensely while at the same time learning from one another about changing markets and technologies through informal communication and collaborative practices. Loosely linked team structures encourage horizontal communica- tion among firm’s divisions and with outside suppliers and customers. The functional boundaries within firms are porous in the network-based system, as are the boundaries among firms and between firms and local institutions, such as trade associations and universities. In contrast, the Route 128 region is dominated by autarkic corporations that internalize a wide range of productive activities. Practices of secrecy and corporate loyalty govern rela- tions between these firms and their customers, suppliers, and competitors, reinforcing a re- gional culture that encourages stability and self-reliance. Corporate hierarchies ensure that authority remains centralized, and information tends to flow vertically. Social and technical networks are largely internal to the firm, and the boundaries among firms and between firms and local institutions remain far more distinct in this independent, firm-based system. Saxenian 46 Cityscape Regional Networks and Industrial Adaptation Understanding regional economies as networks of relationships rather than as clusters of atomistic producers and thinking of the regions as examples of two models of industrial systems—the regional, network-based system and the independent, firm-based system— helps illuminate the divergent trajectories of the Silicon Valley and Route 128 economies during the 1980s. For example, Silicon Valley’s superior performance cannot be attrib- uted to differentials in real estate costs, wages, or tax levels. Land and office space were significantly more costly in most of Silicon Valley than in the Route 128 region during the 1980s; the wages and salaries of production workers, engineers, and managers were higher (Sherwood-Call, 1992); and there was no significant difference in tax rates between California and Massachusetts (Tannenwald, 1987). Nor can the differences in regional performance be traced to patterns of defense spending. Route 128 has historically relied more heavily on military spending than has Silicon Val- ley and thus is more vulnerable to defense cutbacks. However, the downturn in the Mas- sachusetts electronics industry began in 1984, when the value of prime contracts to the region was still increasing. Although defense spending cannot account for the timing of the downturn in the region’s technology industry, military spending cutbacks that began in the late 1980s exacerbated the difficulties of an already troubled regional economy. Finally, while it may be tempting to attribute Silicon Valley’s prosperity to the ability of local firms to shift low-wage jobs elsewhere, that alone cannot account for the differential performance of the two regions. Technology firms from both Silicon Valley and Route 128 have, since the 1960s, moved their routine manufacturing operations to lower wage regions of the United States and the Third World (Scott, 1988b; Saxenian, 1985). Route 128’s difficulties lie in the rigidities of the local industrial system. The indepen- dent, firm-based system flourished in an environment of market stability and slowly changing technologies, because extensive integration offered the advantages of scale economies and market control (Chandler, 1977). Route 128 has been overwhelmed, how- ever, by changing competitive conditions. Corporations that invest in dedicated equip- ment and specialized worker skills find themselves locked into obsolete technologies and markets, and their self-sufficient structures limit their ability to adapt in a timely fashion. The surrounding regional economy, in turn, is deprived of resources for self-regeneration, because large firms tend to internalize most local supplies of skill and technology. In contrast, regional, network-based industrial systems such as Silicon Valley’s are well suited to conditions of technical and market uncertainty. Producers in these systems deepen their capabilities by specializing while engaging in close—but not exclusive— relations with other specialists. Network relations promote a process of reciprocal innova- tion that reduces the distinctions between large and small firms and between industries and sectors (DeBresson and Walker, 1991). Evidence from the industrial districts of Europe suggests that the localization of know-how and information encourages the pursuit of diverse technical and market opportunities through spontaneous regroupings of skill, technology, and capital. The region, if not all of the firms in the region, is organized to innovate continuously (Best, 1990; Sabel, 1988). The competitive advantages of network organizational forms are reflected in the experi- ence of Japanese industry as well. Japanese producers of electronics and automobiles, for example, rely on extensive networks of small- and medium-sized suppliers, to which they are linked through ties of trust and partial ownership. Although Japan’s large firms may Regional Networks and Industrial Adaptation Cityscape 47 have exploited subcontractors in the past, many of these firms are increasingly collaborating with suppliers, encouraging them to expand their technological capabilities and organiza- tional autonomy (Nishiguchi, 1989). Like their Silicon Valley counterparts, these firms tend to be geographically clustered and to depend heavily on informal information exchange as well as more formal forms of cooperation (Friedman, 1988; Imai, 1989). As the case of Japan suggests, there are large- as well as small-firm variants of network- based systems (Fruin, 1992; Herrigel, 1993). Large corporations can integrate into re- gional networks through a process of internal decentralization. As competition forces independent business units to achieve the technical and productive standards of outsiders, these units often rely on external institutions that facilitate knowledge sharing and collaboration with suppliers and customers. Of course all economic activity does not cluster within a single regional economy. Firms in network systems serve global markets and collaborate extensively with distant custom- ers, suppliers, and competitors. Producers of new electronics and computing technologies, in particular, are highly international. However, the most strategic relationships are often local, because timeliness and face-to-face communications are very important in complex, uncertain, and fast-changing industries (Nohria and Eccles, 1992a). Regional Network Versus Firm-Based Systems In the remainder of the article, I use a set of paired comparisons to illustrate the differing organizational and adaptive capacities of Silicon Valley’s regional network and Route 128’s independent, firm-based industrial systems. The comparison of Apollo Computers and Sun Microsystems—both 1980s’ generation start-up companies competing in the emerging workstation market—demonstrates how small firms benefit from the open flow of information, technology, and know-how in a network system. The comparison of DEC and HP—the leading computer systems producers in the two regions—in turn shows how regional networks can facilitate the reorganization of large firms. Clearly, these cases alone cannot encompass the total experience of two complex regional economies, nor can the focus on individual firms fully portray the myriad decentralized rela- tionships in a regional, network-based system. Indeed, the resilience of Silicon Valley’s net- work system lies precisely in the fact that it does not depend on the success of any individual firm. However, these comparisons illustrate the social and institutional dimensions of produc- tive organization that are overlooked in the concept of external economies and the competi- tive advantages of regional networks under current economic conditions. For an extended treatment of the origins and evolution of the two regional economies, see Saxenian (1994). Start-Up Companies: Apollo Computer and Sun Microsystems The largest wave of start-ups in Silicon Valley’s history began in the late 1970s and accel- erated during the 1980s. The region was home to scores of new ventures that specialized in everything from workstations and semi-custom semiconductors to disk drives, network- ing hardware and software, and computer-aided engineering and design. These start-ups contributed to the diversification of the regional economy from its original concentration in semiconductors to a complex of computer-related specialties. In contrast to the upsurge of entrepreneurial activity in Silicon Valley, the pace of start- ups along Route 128 slowed during the 1980s. Massachusetts experienced lower rates of new high-technology firm formation between 1976 and 1986 than either the rest of New Saxenian 48 Cityscape 1981 1989198819871986198419831982 0 400 800 1,200 1,600 2,000 $ M il li o n s 1985 Northern California Massachusetts England or the United States as a whole (Kirchoff and McAuliffe, 1988). Also, the perfor- mance of companies founded during the 1980s was disappointing. Nothing in the Route 128 experience matched the spectacular successes of the 1980s’ generation of Silicon Valley start-ups, such as Sun Microsystems, Conner Peripherals, and Silicon Graphics. By the end of the decade, public companies started in Silicon Valley during the 1980s collec- tively accounted for more than $22 billion in sales, whereas their Route 128 counterparts had generated only $2 billion (Standard & Poor’s, 1992). Investment decisions contributed to this divergence. Annual venture capital investments in northern California during the 1980s were double or triple those in Massachusetts. Moreover, there was a significant regional reallocation of capital away from Massachu- setts and into northern California. Over the course of the decade, Massachusetts-based companies received about $3 billion in venture capital, or 75 percent of the total raised within the region, whereas firms in northern California received $9 billion, or 130 percent Figure 3 Venture Capital Investment, Northern California and Massachusetts Source: Venture Capital Journal Regional Networks and Industrial Adaptation Cityscape 49 of the total capital raised locally. As a result, Silicon Valley companies were consistently awarded at least one-third of the Nation’s total venture capital pool during the 1980s and early 1990s (Venture Capital Journal, 1980–92). By 1992, 113 technology enterprises located in Silicon Valley reported revenues exceed- ing $100 million, compared with 74 companies along Route 128. Moreover, the great majority of Silicon Valley’s $100 million enterprises were started during the 1970s and 1980s, whereas the overwhelming number along Route 128 had been started prior to 1970 (CorpTech, 1993). The comparison of Apollo Computer and Sun Microsystems demonstrates how the autarkic structures and practices of Route 128’s independent, firm-based system created disadvantages for start-ups in a technologically fast-paced industry. Apollo pioneered the engineering workstation in 1980 and was enormously successful initially. By most accounts the firm had a product that was superior to that of its Silicon Valley counterpart, Sun Microsystems (which was started 2 years after Apollo, in 1982). The two firms competed neck and neck during the mid-1980s, but in 1987 Apollo fell behind the faster moving, more responsive Sun and never regained its lead. By the time Apollo was pur- chased by HP in 1989, it had fallen to fourth place in the industry, whereas Sun led the industry with more than $3 billion in sales (Bell and Corliss, 1989). Apollo’s founder, 46-year-old William Poduska, was one of Route 128’s few repeat entrepreneurs, having worked for Honeywell and helped to found Prime Computer before starting Apollo. Not only was Poduska himself well steeped in the culture and organiza- tional practices of the region’s established minicomputer firms, but the entire Apollo management team moved with him from Prime. This history contrasts with that of the typical Silicon Valley start-up, in which talent typically was drawn from a variety of firms and industries representing a mix of corporate and technical experience. Not surprisingly, Apollo’s initial strategy and structure reflected the model of corporate self-sufficiency of the region’s large minicomputer companies. In spite of its pioneering workstation design, for example, the firm adopted proprietary standards and chose to design and fabricate its own central processor and specialized integrated circuits. Al- though it contracted for components, such as disk drives, monitors, and power supplies, Apollo began with a proprietary operating system and architecture that made its products incompatible with other machines. Sun, in contrast, pioneered open systems. The firm’s founders, all in their twenties, adopted the UNIX operating system, because they felt that the market would not accept a workstation custom-designed by graduate students. By making the specifications for its systems widely available to suppliers and competitors, Sun challenged the proprietary and highly profitable approach of industry leaders, such as IBM, DEC, and HP, which restricted customers to a single vendor of hardware and software. Sun’s strategy allowed it to specialize—to focus on designing the hardware and software for its workstations and to limit manufacturing to prototypes, final assembly, and testing. Unlike the traditional, vertically integrated computer manufacturers, Sun purchased virtually all of its components from external vendors and subcontracted the manufacture and assembly of its printed circuit boards. (In the late 1980s, Sun began assembling some of its most advanced printed circuit boards internally.) The firm even relied on outside partners for the design and manufacture of the reduced instruction set computing (RISC)-based microprocessor at the heart of its workstations and encouraged its vendors to market the chip to its competitors. Saxenian 50 Cityscape Although specialization is often an economic necessity for start-ups, Sun did not abandon this strategy even as the firm grew into a multibillion-dollar company. Why, asked Sun’s Vice President of Manufacturing Jim Bean in the late 1980s, should Sun vertically inte- grate when hundreds of Silicon Valley companies invest heavily in maintaining a lead in the design and manufacture of integrated circuits, disk drives, and most other computer components and subsystems? Relying on outside suppliers greatly reduced Sun’s over- head and ensured that the firm’s workstations contained state-of-the-art hardware. This focus on purchasing equipment also allowed Sun to introduce complex new pro- ducts rapidly and to alter its product mix continuously. According to Bean, “If we were making a stable set of products, I could make a solid case for vertical integration.” (Whit- ing, 1987.) Relying on external suppliers allowed Sun to introduce an unprecedented four generations of major new products during its first 5 years in operation and to double the price/performance ratio each successive year. Sun eluded clone-makers through the sheer pace of its new product introduction. By the time a competitor could reverse-engi- neer a Sun workstation and develop the manufacturing capability to imitate it, Sun had introduced a successive generation of the product. As a result the Sun workstations, although vulnerable to imitation by competitors, were significantly cheaper to produce and sold for half the price of the proprietary Apollo systems (Bulkeley, 1987). Sun Chief Executive Officer (CEO) Scott McNealy described the advantage for customers: “We were totally open with them and said, ‘We won’t lock you into anything. You can build it yourself if we fail,’ whereas our competition was too locked up in this very east coast minicomputer world, which has always been propri- etary, so that encouraging cloning or giving someone access to your source code was considered like letting the corporate jewels out or something. But customers want it.” (Sheff, 1989.) It quickly became apparent that customers preferred the cheaper, nonproprietary Sun workstations. However Apollo, like the Route 128 minicomputer producers, was slow to abandon its proprietary operating system and hardware. As late as 1985, the firm’s man- agement refused to acknowledge the growing demand for open standards and even turned down the offer of a state-of-the-art RISC microprocessor from Silicon Valley-based MIPS Computers. Apollo finally committed 30 percent of its research and development budget to RISC development in 1986, but the effort became an economic burden, and the chip it ultimately developed internally was no faster than the chip it could have purchased 2 years earlier from MIPS. Sun’s innovative computing strategy was inseparable from the firm’s location in the sophisticated and diversified technical infrastructure of Silicon Valley. Apollo, in con- trast, responded sluggishly to industry changes, in part because of a more limited regional infrastructure. According to Jeffrey Kalb (1991), an engineer who worked for DEC along Route 128 for many years before moving to Silicon Valley to start the MasPar Computer Corporation: It’s hard for a small company to start in Route 128 because you can’t get stuff like IC’s and disk drives fast. Route 128 is dominated by large, vertically integrated firms that do everything themselves. In Silicon Valley, you can get anything you want on the market. You can get all those things in Route 128 sooner or later, but the decisions are much faster if you’re in Silicon Valley. From the east coast, interacting with the west coast is only possible for 3–4 hours a day because of the time difference, and you spend Regional Networks and Industrial Adaptation Cityscape 51 lots of time on the phone. It’s no one thing, but if you get a 20–30 percent time to market advantage by being in Silicon Valley, that’s really significant. Apollo’s other major misstep was its 1984 choice of a president and CEO to replace Poduska. Following the tradition of the large Route 128 companies, Apollo hired a long- time east coast corporate executive who had worked his way up through the ranks at General Electric to become the president of GTE Corporation. The 53-year-old Thomas Vanderslice was asked to bring “big-company organizational …