The Role of Business Clustering to Enhance Competitiveness of Indonesian Small and Medium Enterprises (SMEs) Facing The ASEAN-China Free Trade Area (ACFTA)

December 14, 2011 in Conference and Research Paper

By : Mukhammad K. Mawardi
Small and medium enterprise has long been acknowledged as significant actor in Indonesian economy by providing job opportunities and contributing to value of non oil and gas export. However, the significant role played by SMEs tends to be eroded by free trade agreements in the form of ACFTA rather than be stimulated to compete globally. Therefore, this article proposes conceptual model in enhancing the competitiveness of Indonesian SMEs throughout cluster approach. The model relies upon critical literature review undertaken by author. Finally, the model would academically contribute to the development of cluster theory and provide benchmark for policy maker in designing the local development. .
Keywords: cluster, competitiveness, SME

Since ASEAN leaders signed the agreement with China leader on 4 November 2002 in Phnom Penh, Cambodia and followed by the implementation of ASEAN–China Free Trade Area (ACFTA) on 1 January 2010 (Cheng, 2004), the globalization of economy was intensively discussed in Indonesia. The debate of ACFTA emphasizes on the crucial questions whether Indonesian industry is or not ready facing the global competition. Several Indonesian experts and official governments are sceptic about the readiness of Indonesian industry to participate in free trade agreement. However some of them are optimist about this global challenge by putting ACFTA in positive perspective. They belief that the emerging of global business is about the time, and is not relating to the readiness of the Indonesian manufacture (Chandra, 2004). It is interesting to consider the survey undertaken by Lingkaran Survey Indonesia from 1-10 May 2010 which involves 1,000 respondents. The survey revealed that more than 60% respondent did not know about the existence of AFCTA, but 57.3% respondent believed that this free trade agreement would disadvantage Indonesia and 55% of them were worried that domestic market would be flooded by China’s commodities. (The Jakarta Post,31 July 2010). This survey justifies that the dissemination of information of ACFTA is more important rather than anxiety of the negative impact of this free trade agreement, because most of Indonesian do not know and do not realize that they are facing global competition.
Consequently, the Indonesian industry, including SME sector have to begin preparing for global competition. This intention could be realized by involving all stakeholders in strategic project to enhance the competitiveness of Indonesian firm, particularly SME. Small business sector become important, since it plays significant role in Indonesian economy. Tambunan (2008a) asserted that Indonesian SME plays significant role in providing job opportunity and contributing for non oil and gas export. Therefore, enhancing the competitiveness of Indonesian SME raises importance for national economy.
The contribution of SMEs in creating job opportunities is figured out by data from The Indonesian Ministry of Cooperation and SMEs in table.1. It shows that the number of employment within Indonesian micro, small and medium scale firms was gradually increasing between 2005 and 2008. In 2005, SMEs could employ 83,586,616 workforces and this number was gradually inclining to 90,896,270 persons in 2008. Furthermore, the data also indicate that SMEs employed workers more intensive than large firms in that period, almost 97% of Indonesian labours were working in micro, small and medium sectors and only 3% of them are absorbed by larger enterprises in formal sectors. The evidence visibly justifies that small scale industry plays significant role in reducing unemployment problem in Indonesia.
The next function of SMEs in the Indonesian economy is as a contributor of non oil and gas export. Table 2 demonstrates that micro, small, and medium enterprises increasingly exported commodities during 2005-2008. Their value of export rose from Rp. 110,338 billion to Rp. 183, 759 billion during that time. By contrast, the value of export contributed by large firms was fluctuating because it decreased in 2006 and was increasing for the next two years. Furthermore, the data reveals that micro, small, and medium firms share in total non oil and gas export in Indonesia at lower level compared to large firms, but the tendency data points out that export value contributed by SMEs remained increasing. Therefore, it could be indicated that small scale industries are potential to consistently support the Indonesian export.

Table 1
The number of Indonesian employments by industrial scale
Scale employments (person)
2005 2006 2007 2008
Micro, Small and Medium 83,586,616 86,834,807 88,739,744 90,896,270
Micro 69,966,508 79,993,756 81,732,430 83,647,711
Small 9,204,786 3,758,199 3,864,995 3,992,371
Medium 4,415,322 3,082,852 3,142,319 3,256,188
Large 2,719,209 2,697,593 2,788,518 2,776,214
TOTAL 86,305,825 89,532,400 91,528,262 93,672,484
Source: The Indonesian Ministry of Cooperation and SMEs (2009)
Table 2
The Indonesian non oil and gas export by industrial scale
Scale Value ( Million rupiah)
2005 2006 2007 2008
Micro, Small and Medium 110,338,065 121,950,799 143,012,332 183,759,076
Micro 13,477,193 15,024,845 20,247,208
Small 28,048,167 29,365,374 34,661,828 44,148,312
Medium 82,289,898 79,108,232 93,325,659 119,363,556
Large 604,394,520 485,135,439 572,228,650 727,168,860
TOTAL 714,732,585 607,086,238 715,240,982 910,927,936
Source: The Indonesian Ministry of Cooperation and SMEs (2009)

Since Indonesian SMEs tended to locate in dense location, cluster might be one of the solutions for the problem in SMEs. The cluster which was initially developed by Marshal (Belussi and Caldari, 2009) as a concentration of industry in certain localities, likely appropriates in removing the barriers and enhancing the productivity of SMEs(Weijland, 1999; Tambunan, 2005). This solution also underscored by several studies(Fromhold-Eisebith and Eisebith, 2005; Tambunan, 2005; Karaev et al., 2006; Parrilli, 2007; Mesquita and Lazzarini, 2008) in different countries, they have discussed the issue in line with the importance of cluster or industrial district as an alternative approach in promoting SMEs. According to Eisebith and Eisebith (2005)and Karaev et al (2006), cluster may generate ‘agglomeration effect’ or geographical proximity advantages in form of higher specialization, innovation and knowledge transfer, which is capable of reducing the transactional cost. The decreasing transactional cost allows clustered SMEs to increase their competitiveness and innovativeness (Tambunan, 2005) and to electively grow (Parrilli, 2007). Finally, the competitive and innovative clustered firms would be able to access global market(Mesquita and Lazzarini, 2008).
In regards with the importance of cluster approach to enhance the competitiveness of the firm, this study aimed to propose conceptual model of cluster strategy in stimulating the development of Indonesian SMEs in facing ACFTA. In order to support the feasibility of the proposed conceptual model, sufficient theoretical underpinnings and previous relevant studies are critically reviewed in this study. Furthermore, to obtain the objective of the study, this study discuses the cluster and SME competitiveness and the driving factors of cluster development, and proposes the conceptual model of cluster strategy. Finally, the study is ended by provide several recommendations.
The cluster and SME competitiveness
The two stances of literature refer to the initial definition of geographical agglomeration of firms are cluster and industrial district theories. Fundamentally, these theories root on similar theory, moreover they also recognize significant role played by cluster to enhance the competitiveness of the firm. However, cluster and industrial district theories have different perspective in describing the dynamics of cluster actors and in identifying influential factors of cluster performance (Porter and Ketels, 2009).
According to the cluster theory, cluster is defined as a geographical agglomeration of companies, suppliers, service providers, and associated institutions in a particular field that compete but also cooperate (Porter, 2000). Moreover, Humphrey and Schmitz(1995), and Sonobe and Otsuka (2006) asserted that the cluster is a geographical concentration or localization of firms producing similar product or closely related product in certain area. Those definitions recognized that cluster includes not only the firms which compete and cooperate with others firm in the similar value chain but also institutional supports which sustain the dynamics of cluster. Yet, the definitions solely emphasized to the identification of the cluster members rather than explicitly recognize the level of significance of roles played by every cluster actors.
In contras, Parrilli (2009), Becattini (2004), and Bianchi (1994) cited in Cainelli (2008) highlighted that the industrial district is a socio-geographical entity of small and medium enterprises (SMEs) producing a specific commodity in industrial atmosphere. The socio-geographical entity is characterized by the existence of interpersonal relationship among actors, and the common social and cultural background owned by SMEs. Furthermore, the definition of industrial district also explicitly recognized the dominant role played by SME as a central actor in the industrial district. SMEs often gain more benefits being member of cluster, due to the existence of industrial atmosphere. Industrial atmosphere facilitates the emergence of agglomeration effect, such as knowledge and innovation spillovers, external economies and joint actions. In other word, the industrial district is typically dominated by SMEs with their social and cultural embeddedness. Furthermore due to the similar characteristics between industrial district explained before and the SME cluster in Indonesia, industrial district might be appropriate to capture the phenomena of SME cluster in developing countries, more specific in Indonesia. Therefore, the concept of industrial district would be employed in this section to represent the agglomeration of SMEs in certain regions. Yet, cluster and industrial district terms would be remain used in this study because the interchangeable usage of industrial district and cluster seems to be common and acceptable (Schimtz, 1999; Parrilli, 2007; Landabaso and Rosenfeld, 2009).
Considering to the roles of the cluster in enhancing the competitiveness of the firm, there are several functions might be performed by cluster, such as increasing the productivity, boosting the innovation and facilitating the global access. The first role functioned by cluster is increasing the productivity of clustered firms. The increasing of productivity of cluster members is contributed by the raising number of output(Sandee and Rietveld, 2001) and the decreasing of production cost (Caniëls and Romijn, 2003; Karaev et al., 2006). Sharing order and sub-contracting might stimulate the increasing demand of commodity among firm locating in industrial district (Sato, 2000; Molina-Morales and Martinez-Fernández, 2010; Nam et al., 2010), while transferring of new knowledge and adapting new technology stimulate the efficiency and capacity of production (Sandee and Rietveld, 2001; Chaminade and Vang, 2008). In turn, the increasing number of demand and the high capacity of production positively affect the output quantity of the enterprises locating in cluster. Meanwhile, the availability of abundant workers and low price of material contribute to the reduction of production cost (Nadvi, 1999a; Caniëls and Romijn, 2003). It could be concluded that the large number of output and the efficient cost of production would increase the productivity of the clustered firms.
The next function of cluster is nurturing innovation of the firm. Study carried out by Bell (2005) in Canadian mutual fund companies has revealed that clustered firms might perform more innovatively rather than non-clustered firms. Parallel with Bell’s study, Molina-Morales and Martinez-Fernández (2010) underscored that SMEs located in cluster members have higher innovative capacity, in term of product and production innovation compared to non district members. If Bell (2005) Molina-Morales and Martinez-Fernández (2010) did not consider the age of the firm, Gilbert et al. (2008) confirmed, moreover, that industry cluster improves the innovation performance of new ventures confronted with high uncertainty. Furthermore, the increasing innovation capacity within cluster members is stimulated by formal and informal transfer knowledge (Muscio, 2006) that may in the form of informal communication among cluster members (Caniëls, 2003). In sum, it could be highlighted that SMEs inside in cluster could enhance the innovative capacity by establishing network relying on diverse type of ties and links.
The last function of cluster is facilitating its member to be global firm. This function drives clustered firms, in particularly SMEs to compete globally by linking with foreign buyer or participating in a global value chain. The collective efficiency generated by cluster, in the form of horizontal and vertical linkages might facilitate clustered firm to access global market and link with foreign buyer (Nadvi, 1999a; Mesquita and Lazzarini, 2008). Based on his study, Nadvi (1999a) argued that in cluster, the collective efficiency could be passively acquired from external economies and actively generated through joint action by firm. Moreover, the advantages of joint action within cluster member also indicated by Mesquita and Lazzarrini (2008), they asserted that horizontal and vertical linkages among SMEs associate with collective efficiency which in turn help SMEs to access global market. Participating in global value chain also enforces cluster members to market their product overseas (Andadari, 2008). Specifically, Giuliani et al (2005) justified that there is relationship between upgrading, collective efficiencies, and global value chain. In other word, cluster contributes for enhancing the competitiveness of the firm by stimulate their members to link with foreign buyer and compete globally.
The driving factors of cluster development
According to Parrilli (2009), three fundamental and influential determinants of cluster development are collective efficiency, policy inducement and social capital. Collective efficiency represents economic motive attracting SMEs to locate and maintain inter-linkages action within cluster participant, whereas policy inducement refers to regulation or mechanism designed by government or inter-nations organization to facilitate and stimulate the dynamics of cluster. Furthermore, social capital embodies the local value strengthening ties within clustered SMEs.
The first driving factor of the cluster development is collective efficiency. Schimtz(1999) defined collective efficiencies as competitive advantages which derived from local external economies and joint actions provided by SME industrial district. As a local external economies or agglomeration economies are automatically gained by cluster participants due to their geographical location in industrial district, the joint action should be deliberatively acquired by cluster actors to raise more potential benefits (Nadvi, 1999a; Schimtz, 1999; Caniëls and Romijn, 2003; Parrilli, 2009)
The external economies could be classified onto the real and pecuniary external economies. Stewart and Ghani (1991) asserted that the real externalities are the effects of firm’s production function toward others firm’s production function, while the pecuniary externalities affect the price (including input price and output price) faced by others. Moreover, Caniëls and Romijn (2003) categorized real external economies as a spillover effects, while pecuniary external economies as a cost reduction effects. Those two general types of external economies have already recognized by Marshal (1920) cited in Schimtz (1999), and have echoed by several studies (Nadvi, 1999a; Giuliani et al., 2005; Parrilli, 2009), as a forms of agglomeration effect
Even though, external economies raise the efficiency, accelerate the learning and upgrading, and enable SME to face external challenges, there is more opportunity to reach greater advantages through collective action with other actors in cluster(Nadvi, 1999a; Schimtz, 1999; Giuliani et al., 2005). Joint action could be in the form of horizontal and vertical ties, if the horizontal linkages might connect the firm with the competitor individually or collectively, the vertical ties could link backwardly with supplier and forwardly connect with buyers (Giuliani et al., 2005).
Considering to the forms of these inter-actors cooperation, Schimtz (1999) identified some forms of horizontal bilateral (horizontal ties within individual firms), such as joint purchasing of input, joint production, joint marketing, order sharing, sharing equipment, exchanging information of market and know how. Despite horizontal relations, joint action could be in the form of vertical linkage that connect firm with the suppliers or buyer in the same value chain. The sub-contract linkages between SME and the large enterprises are common forms of vertical network used by SME to distribute the product or absorb new information about market (Nadvi, 1999a; Sato, 2000; Berry et al., 2002; Giuliani et al., 2005; Andadari, 2008; Nam et al., 2010). Moreover, the vertical linkage between SMEs and the supplier able to reduces input cost and minimizes uncertainty risks.
The second influential factor of cluster development is policy inducement. Since cluster has long been developed throughout deliberative policy, the government intervention toward industrial district becomes demanding issue arise in cluster study. Chamindale and Van (2008) pointed out that government facilitate the development of several industrial districts by providing favourable facilities, stimulating involvement of private sector, and initiating social network program. Another type of institutional participation in cluster development could be in the form of public-private partnership (Aylward, 2004). In addition, the broader initiative to enhance the competitiveness of SME cluster across the countries was conducted by the Organization of Economy Cooperation Development (OECD) (Möhring, 2005; Ceglie and Stancher, 2009). OECD was successfully developed the capacity building of SME cluster in South America countries (Mexico, Nicaragua, and Honduras) (Ceglie and Stancher, 2009) and in the Eastern Europe countries (Möhring, 2005).
Cluster policy is defined as a set of policy or measurement aiming to induces and supports inter-linkage between cluster participants and to increases value added of their activities. (Boekholt and Thuriaux, 1997; Fromhold-Eisebith and Eisebith, 2005). Cluster policy also designed, moreover, to overcomes market failures, provides public good and service and boosts the competitiveness of industrial cluster(McDonald et al., 2007). The policy inducement in cluster development is underscored by Porter (1998b), he argued that the basic macro economy and general micro economy policy may not be sufficient to enhance the competitiveness of cluster. Moreover, Porter (1998b) stated that it solely creates precondition and shapes the conductive environment for the initial development of SME cluster rather than induces the dynamics and the growth of cluster. Therefore, the specific solutions and cluster-target policy, such as the provision of credit, the training of worker and entrepreneur, the provision of real service, and wage negotiation, are needed to overcome the specific constrain faced by cluster (Altenburg and Stamber, 1999; Ceglie and Stancher, 2009; Tambunan, 2009).
In conclusion, policy inducement has been considered as a factor determinant in cluster development because government or inter-governmental organization may deliberatively stimulate and manage cluster, in the micro, meso and macro level and also induce the emerging of social capital within cluster. Consequently, it could be hypothesized that
The last factor affecting the industrial district development is social capital. Social capital refers to the common norm or value influencing the interaction between individual-social network (Putnam, 2000; Bowles and Gintis, 2002). In practically, Molina-Morales and Martinez-Fernández, (2010) conceptualized dimensions of social capital onto social interaction, trust, and shared vision. Social interaction is any contact or relations that an actor from one firm keeps with other actors from other firms in the community. Social interaction can affect their access to and use of knowledge resources of the firm. In respect with this issue, Nadvi (1999b) indicated that social network often relies upon kinship, family and localness. If kinship is primarily shaped on tribal lineage while family refers to lineage both immediate and extended family, localness is formed more socially, it can obtained by being located within the local community and neighbourhood.
Moreover, trust refers to the degree to which an actor or a firm is considered to be fair and honest in the interchange of whatever resources (Morales and Martinez-Fernández,2010). The significance of the trust in inter-firms connection also recognized by Parrilli (2004; 2009), he asserted that trust contribute to the cluster growth, instead of self realisation. Parrilli (2004; 2009) argued, furthermore, that when trust and social cohesion are not open the participations of external actor are not going to be smoothly absorbed by the local community, which may lead to higher transaction costs (contracts, employment). Higher transaction cost may limit the increasing number of firm in cluster (Parrilli, 2009).
Finally, shared vision refers to an attribute that people and firms may have that can facilitate and offer them certain benefits (Morales and Martinez-Fernández,2010). The second dimension of social capital identified by Parrili (2009), self-realisation, likely can be put in this category. Because self realisation is defined as the spirit to encourage entrepreneurship, innovation, firm creation and spin off and it can be shared within clustered SME. And in turn, cluster may stimulate the emerging of new business (Porter, 1998). In other word, if the industrial district lacks of self-realisation value (as a one type of social capital), it may decrease the entrepreneurial orientation among cluster members and in turn it often discourages the emerging of new firms.
The proposed conceptual model of cluster strategy
Considering to the significant role and the driving factor of cluster discussed below, this section explains the proposed conceptual model of cluster strategy to enhance the competitiveness of Indonesian SME. The model originally developed by Parrilli (2009)
to explains the developmental process, the constraint and the growth prospect of SME industrial district in Forly Italia. Due to the similar characteristics among Forly cluster Italy and Indonesian cluster, in terms of how collective efficiency, policy inducement and social capital affect on the cluster development, the model is assumed will appropriate to be adapted in Indonesia.
As this model emphasizes on three driving factors of cluster growth, collective efficiency, policy inducement and social embeddedness or social capital, the strategy to enhance the competitiveness of Indonesian SME within cluster could be analysed from these factors. Firstly, the growth of SME cluster could be stimulated by generating the collective efficiency. The fundamental forms of collective efficiency are external economy and joint action (Nadvi, 1999a; Schimtz, 1999; Caniëls and Romijn, 2003; Parrilli, 2009). Furthermore, Study undertaken by Sandee and Rietveld (2001) and Sato (2000) revealed the emerging of external economy within several Indonesian SME clusters. If Sandee and Rietveld (2001) indicated that clustered SMEs have more opportunity to absorb new knowledge and upgrade new technology, Sato (2000) recognized that inter-linkage formation within cluster encourages SME to obtain abundant order and get more information about market. In spite of external economy, joint action was facilitated in Indonesian SME cluster. Several SMEs located in cluster often participate in global vale chain (Andadari, 2008)and engage in sub-contract partnership with large firms (Berry et al., 2002). These studies justify that Indonesian SME cluster has potency to generate collective efficiency, therefore strengthening capacity of cluster to generate more benefits for SMEs and managing the dynamic of cluster may enhance the competitiveness of clustered firms.
Secondly, since a cluster strategy has long been adapted by government and inter-nation organizations across the globe to develop the competitiveness of both region and firm, it provides lessons could be learned by Indonesian government. Cluster strategy should be put as a national strategy in obtaining national and regional competitiveness (Porter, 1998; Tambunan, 2005). The recommendation toward the application of cluster approach have been echoed by Porter (2009) in his presentation to Presiden Susilo Bambang Yudhoyono on 28 Septmeber 2009. However, the implementation of cluster strategy to enhance the competitiveness of SMEs remains uncertain. The limited attention paid by government in developing SMEs, has been indicated by Hall (2001). He asserted moreover, that Indonesian government have never enunciated a coherent, clearly defined and prioritized SME policy and strategy. Hence some regulations tend to erode the competitiveness of business sector, in particularly SMEs rather than stimulate to compete globally (Tambunan, 2007). Therefore, collective awareness is required for enhancing the competitiveness of Indonesian SME facing global competition. The collective awareness may be realized by implementing cluster approach to promote the competitiveness of SME. Tambunan (2005) argued that cluster approach is appropriate to promote the Indonesian SMEs., due to comprehensive framework and advantages provided by cluster.
Lastly, the model also acknowledges the importance of social capital as a “glue” to bonds firms within cluster. The main dimensions of social capital are social cohesiveness and relation (Parrilli, 2009). If social cohesiveness relates to the value tie firms within cluster, social relation refers to the forms of social network among clustered firm. The Indonesian SMEs often located in specific region with common culture value (Perry, 2005a). Hence, they have strong social cohesiveness in doing business within cluster. The social cohesiveness or social tie commonly relies on religion or culture value. Religion and culture generate common value in conducting daily activity, including doing business. The common value may in the form of honesty, collectiveness (gotong royong), or familiarity (kekeluargaan). Moreover, Sandee and Roetveld (2001) indicated that these values commonly influence the social network among actors in cluster. Their study revealed that the transfer of knowledge circulates within actors with family tie in initial stage. However some values likely have been degraded during the developmental of cluster (Nadvi, 1999b). The recent phenomenon shows that more developed SMEs be more individualistic; they tend to monopolize or take advantages from their business network rather than voluntarily share their link. Therefore, the management of cluster should be designed by maintaining local value and also adjusting the potential development.

Conclusion and recommendation
The study shows that AFCTA as a type of global economy forces is viewed in contradict perspectives. In initially stages, this trade agreement is negatively viewed due to the its impact on domestic market and more optimistic perspective view AFCTA as an opportunity for Indonesian product to enter foreign market. However, the latter perspective requires the commitment to prepare the Indonesian industry, including SME sector facing this challenge. Therefore, this study proposes the conceptual model to enhance the competitiveness of Indonesian SMEs throughout cluster approach.
Cluster may enhance the competitiveness of Indonesian SMEs by increasing the productivity, boosting the innovation and facilitating the global access. The first role functioned by cluster is increasing the productivity of clustered firms. However, to support the development of cluster, there are three fundamental factors should be taken into account, collective efficiency, policy inducement and social capital. Therefore, the interpretative comprehensive model which was developed by Parrili, is proposed to increase the competitiveness of Indonesian SME.
Beside proposes the conceptual model in enhancing the competitiveness of Indonesia SMEs, the study also provides theoretical challenge and raises methodological issue in conducting study in cluster, particularly in Indonesia context. Moreover, the study also echoes the importance of cluster strategy for national and regional government in developing their regions.

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