The Indonesian Small and Medium Enterprises (SMEs) Cluster

December 14, 2011 in Articles

Due to significant contributions of SMEs in mitigating unemployment and alleviating poverty, The Indonesian government are expected to pay more attention to SMEs. The data from the Indonesian Ministry of Cooperative and SME shows that SMEs absorbed 90,491,930 workers in 2007, and it gradually increased at 96,211,332 in 2009. It means that the domestic economies of majority of Indonesian workers(about 97%)are depending on this sector. Therefore, the strategy to enhance the sustainable development of SME remains important.     

In spite of their contributions on Indonesian economy, the interest to the SMEs development could be relied on their geographical agglomeration characteristics, such as locating in dense are, performing inter-firms cooperation, and producing similar products. Since the majority of Indonesian SMEs are located in a dense geographical area, investigating this characteristic is relevant for explaining the Indonesian SME. This phenomenon had been the concerned of Alfred Marshal in the last nineteenth century. Marshal (1920) argued that firms tend to be located in a dense geographical location in order to obtain skilled labour easily and market and technical information intensively. These goals thus could also be achieved by SMEs if they are located in an industrial district. Furthermore, the Marshalian industrial district has inspired the emerging of cluster theory. Two fundamental theories of cluster commonly referred to by scholars recently are cluster and industrial district theories. The former was developed by Porter (1998a) while the latter was proposed by Bianci (1994, in Cainelli, 2008). Fundamentally, these theories are similar (Porter and Ketels, 2009), but the industrial district provides more attention on the SMEs as a majority members of cluster and explicitly recognizes the importance of social capital in cluster development (Becattini, 2004; Cainelli, 2008; Parrilli, 2009). Therefore, the industrial district theory will be used to investigate the development path of Indonesian SME cluster.            


The industrial district theory defined cluster as a socio-geographical entity of small and medium enterprises(SMEs)producing a specific commodity in industrial atmosphere (Becattini, 2004; Cainelli, 2008; Parrilli, 2009). The socio-geographical entity is characterized by the existence of interpersonal relationship among actors, and the common social and cultural background owned by SMEs . This definition of cluster highlights the social and geographical bonds among cluster members. Thus inter-connections among cluster firms rely upon the common social and culture values and the geographical boundary differing cluster and non cluster members. Moreover, the industrial district also recognizes the inter-related business activities in generating commodity within cluster. In conjunction with the definition of cluster, the Indonesian Ministry of cooperative and SME identified cluster as a centre of business operations of SMEs in certain region where inter-related activities in using resources and producing commodity are performed (The Indonesian Ministry of Cooperative and Small and Medium Enterprises, 2002). Weijland (1999) further added that cluster commonly consists of twenty SMEs or less for cluster with export orientation. Finally, it can be highlighted that cluster is a group of SMEs in a similar values chain of product which is bounded by common social and value ties and geographical border.  

 Based on those definitions of cluster, Perry (2005b) asserted that Indonesia provides interesting cases of cluster, in particularly case of SME cluster. The  cases of Indonesian SME cluster are significant since study under taken by ter Wengel(2002)recognized about 25,000 SME clusters located across the regions in Indonesia with varied types and developmental stages (Perry, 2005a). However, only limited SME clusters have been investigated, such as a furniture cluster in Jepara, East Java (Alexander and Alexander, 2000; Andadari, 2008), a furniture cluster in Bukir-Pasuruan and leather cluster in Tanggulangin, Sidoarjo (Marijan, 2005a), a metal casting cluster in Ceper, Central Java (Sato, 2000), and a roof tile cluster in Karanggeneng, Central Java (Sandee and Rietveld, 2001). Therefore, some fundamental questions related to the existence of SME cluster in Indonesia arise: Do the Indonesian SME clusters represent the cluster defined in Industrial district theory?: What are the specific features of Indonesian SME cluster?.

 To answer these questions, the comprehensive model proposed by Parrilli (2009) is used in this study. The similar characteristics owned by the Indonesian SME cluster and the furniture cluster in Forly, Italy (a cluster under studied by Parrili(2009)), such as the domination role of SME, the existence of inducement policy, and the local value tie within cluster, justifies the use of Parrilli’s model in explaining whether Indonesian SME clusters do or do not correspond to the cluster concept in the industrial district theory. Additionally, the model is also employed to describe the common characteristics of Indonesian SME cluster.

 The driver factors of cluster development

Parrilli (2004; 2007; 2009) comprehensively described the developmental stages and the challenges faced by Forly, Italy cluster. He recognized three driver factors influencing the development of Forly, Italy cluster: collective efficiency, policy inducement, and social capital. In order to explain the  concept of collective efficiency, Parrilli adopted the frame-work proposed by Schmitz (1995)[1]. The framework acknowledges two types of collective efficiency advantages driving the SMEs to be located in a dense geographical location, they are local externality and joint action. If the local externality can be obtained by SMEs passively within cluster, the benefits of joint action can be achieved by cluster through deliberative actions, in the forms of vertical, horizontal, bilateral or multilateral partnership.

 The second factor affecting the development of cluster is inducement policy. Parrilli (2007) argued that policy inducement and collective efficiency should be viewed together in developing cluster because collective efficiency represents the endogenous factor which is influenced by the specifics feature of cluster and while policy inducement represents macro framework which foster the development of cluster. Moreover, the government policy may contribute to the development of cluster in two ways; stimulating the emerging of SME cluster and managing the internal dynamics of cluster. In the initial stage, government and private sector may induce collectively the emerging of cluster in a certain region. Next, the government can takes a part in managing the internal dynamic of cluster (Parrilli and Sacchetti, 2008). Facilitating infrastructure and stimulating SME to participate in value chain process of large firms are common forms of cluster inducement program designed by government. Boosting transfer technology from leading firms to SMEs within cluster and regulating fair competition among cluster firms is general government regulation managing the dynamic of cluster. Furthermore, Tambunan (2005) classified cluster policies into direct and indirect cluster policies. The former refers to the government initiative that places SME cluster as a policy target, such as providing financial support, performing training and technical supervision, providing machinery and conducting trade fair. On the other hand, the latter represents the macro policy of government influencing the development of cluster. This type of cluster policy could be explained by a cluster model proposed by Porter (1998b). In his model, Porter (1998b) argued that development of cluster could be shaped by supporting firm strategy, structure, and rivalry, demand and conditions factors, and supporting industry.  

 the third factor driving the development of cluster is social capital. The social capital is common value and norms influencing social interaction among individual (Putnam, 2000; Bowles and Gintis, 2002). Molina-Morales and Martinez-Fernández (2010) asserted that social capital encompasses social interaction, trust and shared vision dimensions. In conjunction with these dimensions of social capital, Parrilli (2009) identified trust as a form of social cohesiveness within cluster while entrepreneurship spirit as self realization. However, most of these dimensions of social capital are intangible, and thus the existence of social capital within cluster is hard to identify. Study conducted by Miguel et al (2003; 2005) are likely helpful for indentifying the existence of social capital within Indonesian community due to the real parameter used, such as the existence of community group, informal social capital, and family impact which are easily measured. Thus, the development of cluster is also influenced by the existence of social capital that bounds the cluster member in the common social and culture values. 


Traditional agglomeration of Indonesian SME cluster

It was explained in previous paragraphs that collective efficiency can be obtained in the forms of economy externality and joint action. These two types of collective efficiency will be used to investigate whether the Indonesian SME clusters do or do not provide the collective efficiency for their member. 

 Since most of the Indonesian SME clusters root to the local economy and culture, they tend to spontaneously growth without government intervention (Weijland, 1999; Marijan, 2005b). This condition eventually impacts on the motives of SME manager in operating business within cluster. Most of them operate business due to continuing family business or following the success other entrepreneurs. In other words the entry barriers for locating in cluster are not constraints for their business. Hence this condition imposes the importance of further explanation why SME tends to locate in a dense geographical location.    

  SMEs may gain the external economy by locating in cluster. Due to sufficient infrastructures, such as road, and communication network, SME cluster will be able to provide external economy for their members by reducing transportation cost and attracting potential buyer. While the most of Indonesian SME clusters are located in remote area, some are located in an urban area with sufficient supporting infrastructure (Weijland, 1999). Studies undertaken by Sandee and Rietveld (2001) and Andadari (2008) revealed the impact of the availability of  public facilities provided by government on the performance of SME cluster. It was found that SME cluster gained external economy in the form of increasing market access due to public facilities within the cluster. Furthermore, The Indonesian government also promoted the development of cluster by conducting trade fair and boosting the upgrading technology among SMEs (Sandee and Rietveld, 2001).    

 Another type of collective efficiency is joint action. This type of collective efficiency should be obtained by clustered firms through deliberative action, such as vertical, horizontal, bilateral or multilateral partnership. Joint action may encompass producers, suppliers, distributors, and supporting institutions. Essentially, joint action within cluster will lead cluster become a complex production system which perform a value chain process to generate a certain commodity. Regarding the existence of joint action within Indonesian SME cluster, Marijan (2005b) asserted that the majority of Indonesian SME cluster merely consume the passive advantages of collective efficiency (external economy)and less perform deliberative action to obtain more benefits from cluster. Sandee et al (2002) and Tambunan (2005) echoed this argument by categorizing most of SME clusters into dormant  or artisanal cluster. This type of cluster refers to the cluster with low level of joint action and productivity and merely serves local market. However, Sandee et al (2002) and Andadari(2008) argued that there are several dynamic Indonesian SME clusters which both successfully export their product and actively participate in global value chain. Therefore, it could be concluded that the Indonesian SME cluster could not be generalized due to varied characteristics and developmental stages.

 Regarding joint actions within Indonesian SME clusters, Kuncoro (2000) indentified the common types of joint action involving cluster members, they are  Perkebunan Inti Rakyat (PIR)  or nucleolus agricultural enterprise, trade partnership, vendor linkages, and sub-contracting. PIR is commonly applied in agriculture sectors to support transfer knowledge from large agricultural enterprises to small farmers, while the trade partnership leads a large enterprise to play as a distributor agent of cluster SME in distributing commodity to the market outside the cluster. The third type of cluster is vendor linkage. Private or state owned enterprises often design vendor linkage as a form of their corporate social responsibility. In this program clustered SMEs gain marketing or technology assistance by large enterprises with different core business, which aims to strengthen the performance cluster SMEs. Next, sub-contracting puts SME in cluster as a sub-contractor that provides certain component of the final product generated by large enterprise. Likely, this type  of joint action is the most appropriates form to stimulate cluster providing more benefits for SME and to exploit local value for export commodity   (Berry and Levy (1999) cited in Berry et al., 2002) asserted that sub-contracting may exploit local value for export commodity.  Finally, this type of joint action is commonly founded in major Indonesian SME cluster, such as furniture, rattan, garment (Berry et al., 2002) and metal casting cluster(Sato, 2000; Hayasi, 2002)

 Inducement policy of cluster development

The cluster development in Indonesia has been discussed in the national level during the last decade. The deputy of SME resources development in The Ministry of Cooperative and SME, I Wayan Dipta asserted that an SME may operate efficiently and access financial resources from bank and non bank organization easily by locating it self within cluster. The efficiency operations and strong financial support lead to the competitiveness of SME( Monday 8 November 2010). In conjunction with the previous statement, The vice leader of The East Java chamber of commerce, Muhammad Rizal, acknowledged the strategic value of cluster to leverage the market capacity of SME, he further argued that financial support from Corporate Social Responsibility program of state owned enterprises may enforce the production capacity of SME (Citra, 2010). The economics observer, Irawan (2010 )added that cluster is able to create multiple effects in the long term by stimulating the emerging of new business formations. However, both of them regret the absence of clear implementation of cluster policy.

Regarding this issue, Sutrisno (2009) asserted that the initiatives of Indonesian to develop SME cluster originated from the establishment of SMECDA (Small Medium Enterprises and Cooperative Development)[2]. This forum has three fundamental functions in developing SME cluster, to develop business operation, provide financial support and stimulate investment, and provide consultation. SMECDA also significantly contribute to the institutional and policy transition from The Directorate General of Small Scale Industry under Department of Industrial to The Directorate General of SME Development under The Ministry of Cooperative and SME.

 This transition process thus leads to the emerging of programs for SME cluster development in Indonesia. Sutrisno (2009)identified the two most success programs: Business Development Service (BDS)and Modal Awal Pendanaan (MAP) or the initial capital programs within SME cluster. While BDS facilitates managerial and technical supervision, MAP provides financial support mainly from micro financial institutions.  The Indonesian Statistics survey revealed the significant contribution of these programs to the increasing sales among 25% cluster SMEs participating in the program, and the stimulation of  SMEs survival during the economy crisis (Sutrisno, 2009). These finding echoed by Rosyadi’s (2005) study on the association between services provided by BDS and the performance of cluster SMEs in East Java region.

 Social capital

The next factor influencing the development of SME cluster is the existence of social capital. Studies undertaken by Miguel et al (2003; 2005) are likely relevant for describing the social capital within Indonesian community. Both of these studies offered three dimensions of social capital, they are community group, informal social capital, and the family impact[3]. Moreover, Miguel et al (2005) asserted that social capital does not affect the industrialization in Indonesia. They argued that due to great effects provided by cost, local economy and institution, and political factors to the industrialization, the social capital effect apparently does not emerge significantly. Reversely, in their previous study investigating the effect of industrialization on social capital, it was found that the increasing of industrialization accords with the increasing of social capital (Miguel et al., 2003). Even though Miguel et al’s (2003; 2005) studies clearly described the existence of social capital within Indonesian society, their dimensions of social capital seemly did not represent the social capital within SME cluster. 

 The community group and informal social capital dimensions are relevant for investigating the role of social capital in the development of cluster. If community group could be explained by the existence of koperasi or cooperative, informal organization, or arisan (Miguel et al., 2003), represent the informal social capital which could be referred into social network that proposed by Molina-Morales and Martinez-Fernández (2010). While community group, particularly the cooperative usually plays a significant role in collective purchasing material and providing credit for cluster SME, informal social capital (informal network) contributes in transactional cost reduction among cluster members (Weijland, 1999). Furthermore, Weijland (1999) explained that cluster actors often use informal network for absorbing workers and stimulating new business establishments within cluster. Sandee and Rietveld  (2001) added that informal networking among cluster members also contribute to the technological upgrading process in SME cluster. Finally, Alexander and Alexander (2000) indicated that informal social ties remain to be used by cluster SME in the production process. It could be highlighted that the social capital in the forms of community group or social network contribute individual for the firm and contribute collectively for inter-firm cooperation.      

 In spite of the community group and informal social capital, the existence of social capital could be identified by from the emerging of shared vision among cluster members (Molina-Morales and Martinez-Fernández, 2010). Moreover, Marijan (2005b) asserted that the Indonesian cultural values, such as gotong royong or social joint action is  potential as foundation for building shared vision within cluster. However, shared vision is often eroded by opportunistic behaviour performed by cluster SME. Sato (2000) indicated, in some cases, the tendency of successful SMEs enhance their competitiveness individually rather than share potential market information or perform joint action with neighbouring firms because the manager/owner of successful SME assumed that producing various types of product would generate more profit. Kuncoro (2000) and Widyaningrum (2003) asserted, furthermore, that opportunistic behaviours common occur in sub-contracting relations between large firms and cluster SMEs. The large firms that ideally function as a source of knowledge and innovation merely exploit the cluster SME by purchasing output of cluster in low price. Consequently, in terms of the shared vision, specialization of production is hardly founded in Indonesian and the exploitation of production capacity of SME cluster often occurs in sub contracting relations.

 Two cases from SME cluster of East Java.

In order to provide depth analysis and specific findings, the study focuses on two cases from SME clusters of Eas Java-Indonesia: furniture cluster of Bukir- Pasuruan and footwear cluster of Wedoro-Sidoarjo. 

Furniture cluster at Bukir Pasuruan

Bukir is a village located in Pasuruan, East Java that is recognized as the biggest furniture cluster in East Java because of the common profession among the villagers as a carpenter or craftsman. Initially, they learned how to make and craft furniture from craftsmen in Jepara (the Indonesian largest furniture cluster). Afterward, the crafting skill was spread across the villagers. In addition to the increasing number of craftsmen and the inclining of furniture demand entails the development of the cluster. Hence, in 1973 the local district government of Pasuruan relocated the business centre of Bukir-Pasuruan to a more representative location (Anonymous, 2007). Table 1 exhibits the potency of wooden furniture industry in Pasuruan and shows that all the indicators of the wooden furniture industry tend to increase. The number of establishment of wooden furniture production grew from 2,295 to 2,314 units during 2006-2007. Consequently, the number of employment involved in this industry also increased from 20,516 to 20,644 workforces. The increasing trend also occurred in the value of investment and of production of wooden furniture industry. 


Table 1

The potency of wooden furniture industry in Pasuruan





Number of establishment






Value of investment (IDR.000)



Value of production (IDR. 000)



(Badan Penanaman Modal dan Pelayanan Terpadu Pasuruan, 2008)


Table 2      The export contribution of wooden furniture industry in Pasuruan 2006-2007




Volume of export

3.594.402 kg

4.549.652 kg

Value of export

5.290.048 US $

6.287.040 US $

(Badan Penanaman Modal dan Pelayanan Terpadu Pasuruan, 2008)

 Furthermore, the majority of Bukir furniture cluster members are small and medium enterprises (SMEs) which are commonly in the form of family business and employs workers under family or neighbouring ties.  However, some export-oriented firms are also located in the cluster. Export-oriented firms usually originate from SMEs which have successfully expanded their market from domestic to foreign. Beside marketing their product overseas, due to high demand of the furniture commodity within Bukir cluster, some export-oriented enterprises implement dual operations in producing the furniture: direct production and product outsourcing. The former refers to the mechanism in which firms produce the furniture in theirs own workshop, whereas the latter applies to the mechanism in which firms order unfinished (unpolished) furniture to the SMEs and improve it into the finished product.  In outsourcing product, moreover, the firms remain controlling the quality for ensuring that product will be accepted by foreign buyers. The combination of these systems likely contributes to the production capacity of large firms to serve both domestic and foreign markets. Even though SMEs and export-oriented enterprises have different capacity, both of them use the middle technology which combines traditional techniques and modern machinery in producing furniture. Hence, the categorization of Bukir cluster members into SMEs and large enterprises does not rely on the technology adoption but merely on their market orientation and financial capital.

In regards with market orientation, the members of Bukir cluster perform different strategies to obtain potential buyers. Due to the popularity of Bukir furniture cluster across the cities in East Java, the cluster members are less motivated to seek potential domestic buyers because the domestic buyers will usually visit and buy furniture directly in the cluster. However, some (particularly large enterprises) are quite proactive in looking for potential foreign buyers, for instance by participating in international furniture fairs or designing a website.  The export contribution of the wooden furniture is shown in table 2. The data depicts that the volume and value exports were inclining during 2006-2007. If the volume of exported furniture increased from 3.594.402 to 4.549.652 Kgs, the export value of this commodity rose from  5.290.048 to 6.287.040 US$.

Regardless of those potencies, the Bukir furniture cluster is facing several constraints for development. The scarcity of raw materials, insufficient infrastructure, limited financial capital, and inadequate production facilities are common obstacles among the Bukir cluster members (Badan Penanaman Modal dan Pelayanan Terpadu Pasuruan, 2008). Since furniture producers hardly find teak wood, they use lower quality of wood, for instance mahogany for the raw material of the furniture, which results in the reduction of the product value. The next constrain is poor public facilities, particularly the access to the cluster location. Even though the central business of Bukir cluster is located close to the main road of East Java, other parts of Bukir cluster located in a remote area remain isolated from market access. And the rest of the obstacles posed by Bukir cluster members are likely inter-related. Due to the limited financial capability, cluster firms are unable to employ production facilities with advanced technology.

 The foot wear cluster of Wedoro, Sidoarjo.

Since footwear industry has been acknowledged by Indonesian chamber of commerce as an industry that support the Indonesian export value, this industrial sector has more attention from the Indonesian government. There are several policies were implemented by Indonesian government to support this industry, such as The Instruction of President (Instruksi Presiden) in encouraging to use Indonesian product, The regulation from Indonesian Ministry of Trade No. 45/2008 about import mechanism of certain commodities, including footwear commodity, The regulation from Indonesian Ministry of Industry No 94/M-IND/PER11/2008 about machinery restructuration  program for SME in textile and footwear industries, and tax incentive and financial credit. The Indonesian minister of Industrial, M.S Hidayat, furthermore, asserted that cluster strategy may enhance the competitiveness of footwear cluster, particularly in East Java by pushing the supply and pulling the demand of this industrial sector (Noveiy, 2010). Cluster strategy can provide the efficient supply chain of the footwear industry by stimulating the industries which are supplying the raw material the footwear industry, such as a sole producer and a leather manufacturer, to locate closely to the footwear industry. Moreover, cluster strategy can increase the demand of this industry by fostering the sub contract mechanism between large manufacturer and SME that are operating in footwear industry. It could be seen that the Indonesian government pay more attention to the footwear industry due to the significant contribution of this industry in Indonesian export value.

Wedoro is the one of the Indonesian footwear cluster that is located in Waru district, Sidoarjo, East Java Province. In fact, 9 of 17 villages that are located in Waru district of Sidoarjo are industrial districts of footwear, but the largest of footwear cluster in this area is Wedoro (Surabaya Tourism website). Furthermore, the development trajectories of this cluster could be classified onto four phases:

  1. Phase 1950’s: The emerging of Wedoro footwear cluster was initiated by ten entrepreneurs who generated shoe and sandal in this area.  These products are solely provided for local market. 
  2. Phase 1960’s: Due to better condition of local economy which is featured by the emerging of several new shopping centres around the cluster, SMEs that operated within Wedoro footwear cluster started to expand their market to the broader area, such as Surabaya (the capital city East Java province).
  3. Phase 1990’s: There was extensive growth in this stage, because several SMEs successfully exported their product to the foreign market, such as India, Africa, and Saudi Arabia. Moreover, the number of SMEs that are operating in this cluster was dramatically increased into about 800 SMEs.
  4. Phase 2000’s: this stage is the decline stage of this SME cluster, as the number of entrepreneur decreased onto 250 SMEs. Even tough, the cooperative organization was set up by several entrepreneurs for supporting supply of raw material and enhancing sales of the product, it is likely enable to stimulate the re-emerging of this cluster (Anonymous, 2010).

The development phases of Wedo cluster shows that likely this cluster is in the decline stages.

 There are several development constraints faced by entrepreneurs in Wedoro cluster, the two main obstacles that may erode the performance of this cluster are low access to raw material and the invasion of China’s product (Anonymous, 2010). Since small scale manufactures of footwear unable to independently generate sole (a component of shoes), they source this component from large supplier. Due to absence of strong supplier-small producer within this cluster, the large manufactures of footwear often dominate supply chain of the material. This condition leads the scarcity of material particularly at the peak season when the demand of shoes is increasing. Consequently, SMEs are unable to provide shoe although the demand of this product increases. Moreover, the implementation of China-ASEAN Free Trade Area (CAFTA) which allows China’s shoes enter Indonesian domestic market, likely lead SMEs in Wedoro footwear cluster in the worse condition. Due to efficient production system, the price of china’s shoes is relative cheap compare to the Indonesian made. As a consequently, China’s shoes dominate the Indonesian domestic market which are commonly sensitive in price.  Finally, several pragmatic entrepreneurs prefer to change their profession from shoe makers to shoe (including China’s shoes) traders.         



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[1] The collective efficiency framework was employed in several studies to investigate the development of cluster in developing countries. The most influential study using this framework is the project was funded by World Bank. The results of this project were published in several journals ( Schimtz, 1999, Schimtz  and Musyck, 1999, and Nadvi , 1999a, 1999b)

 [2] SMECDA intensively coordinate the development of SME cluster through online communication at

[3] The measurement of these dimensions employed the indicators from Indonesian Statistics (Miguel et al, 2003; 2005)

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