Choosing where to locate a global company is a vital strategic decision. A study co-authored by NEOMA’s Helen-Shanqing Du suggests that multinationals have to make a trade-off: the benefits of collocating with other business activities versus proximity to local industry clusters. The research shows how the international connectivity of major cities influences their strategies.

In our globalised landscape, the geographic location of international firms is a genuine strategic decision that may have an impact on their competitive advantage. It dictates production costs, and is a factor in attracting talent and determining natural and socio-political risks. Multinationals have traditionally always elected to disperse their activities so they can exploit various local benefits… but it’s a strategy that drives up coordination costs. It means companies have to find a balance between consolidating their activities so they can leverage internal advantages and locating in industry clusters to capitalise on external benefits.

The study by the NEOMA researcher and her co-authors focused on trying to understand the location decisions across different value-chain activities. How do these multinationals juggle between the internal and external advantages of their geographical location? How does the international connectivity of the city where they are situated influence their strategy?

Internal versus external agglomeration

The researchers investigated two strategies: internal and external agglomeration. With the former, the multinational consolidates several of its activities in the same location. But this approach may amplify the firm’s vulnerability if, for example, its supply chain is interrupted. At the same time, it’s a strategy that facilitates communication and knowledge-sharing between a company’s different units. What’s more, bringing the various activities of the same firm under the same umbrella and sharing costs makes it easier to attract, retain or reassign workers. Likewise, the transportation costs of inputs are also reduced.

The aim of external agglomeration, on the other hand, is to locate certain activities in industry clusters, which facilitates access to specialised suppliers and a skilled workforce. In addition, this closer proximity creates relationships with companies in the same industry that are faced with similar problems. Nonetheless, this strategy may heighten the risk of losing talent in an increasingly competitive environment.

The study ultimately shows that these two strategies are diametrically opposed. In other words, there is no advantage in locating a company’s entire portfolio close to an industry cluster: there is a higher risk that the transfer of internal knowledge will “spill over” to rival firms.

Reshuffling the cards in global cities

International connectivity is also one of the reasons why multinationals are attracted to certain locations. The study focused exclusively on corporate investment in global cities, which are fully-fledged economic powerhouses, such as Paris, New York and Singapore.

The researchers showed that the fact that these cities are embedded in an international network shrinks the importance of the physical proximity that is a driver in the two strategies outlined above. In fact, global connectivity facilitates the flow of people, knowledge and services across the world. Major cities nowadays are similar to industry clusters that are geographically very disperse. This means there is no real need for multinationals to be located close to other firms or to consolidate their portfolio of activities so they can trade on the advantages of large cities.

Sector of activity: an important factor

The researchers point out that the impact of the connectivity of global cities varies according to the nature of a multinational’s business. For headquarters and service-related activities such as sales and marketing, where interactions are largely immaterial, connectivity plays a pivotal role. It reduces the costs of remote coordination and streamlines interactions with external parties and internal units at a distance. In particular, firms can opt for temporary interactions, such as business visits, rather than being dependent on a more costly internal agglomeration.

Connectivity plays a less prominent role, however, in production-related activities such as R&D and manufacturing. As well as being expensive, transferring knowledge and raw materials over long distances calls for more extensive, intensive interactions. It follows that in these cases physical proximity is the preferred option.

The study opens up new avenues for companies to explore the optimal ways of minimising their costs while maximising their profits and competitiveness by working on the geographical spread of their activities.

Find out more

Belderbos, R., Castellani, D., Du, H.S. et al. Internal versus external agglomeration advantages in investment location choice: The role of global cities’ international connectivity. J Int Bus Stud (2024). https://doi.org/10.1057/s41267-024-00686-7