Location Quotient 101: How site selectors identify clusters

We talked about the importance of the local business ecosystem too. If you own a tech company it makes sense to locate near other tech companies – they’re a source of partnership, expertise and talent. If you are a manufacturer, it makes sense to be close to other manufacturers for many of the same reasons. It’s pretty intuitive.

Communities aren’t all created equal when it comes to business ecosystem. In tech, for example, you’re likely to find communities with barely any tech companies, other communities that are pretty average and communities with substantial tech clusters. Again, this is obvious, but how do you quantify it?

In economic development and site selection we use something called location quotient.

What is location quotient?

Location quotient (LQ) quantifies the clustering effect, helping decision-makers identify communities that are truly unique or specialized in a particular industry. To do this, we compare an industry’s share of employment in a specific location with the national average. Is it higher than average? There’s a clustering effect happening. Is it way higher than average? You might be looking at a premier location for that industry. Is it lower than average? You might want to look elsewhere.

Why is location quotient important?

LQ can help us understand which communities are flourishing in a particular industry quickly and easily.

This is important in making an expansion decision because a community with a high location quotient has a strong business cluster. The cluster effect is a big deal – studies have shown that it can help increase productivity of companies in the area, helps drive innovation and stimulates the formation of new businesses within a cluster. According to the Harvard Business Review, a cluster allows each member business to benefit as if it had a greater scale or had joined with others formally while retaining the flexibility that comes with being an independent business.

How is location quotient measured?

It’s pretty simple, actually. You compare the percentage of employment in a specific industry at the local and national levels. Waterloo EDC uses North American employment as the denominator in order to make cross-border comparisons possible. For example, if technology accounts for 7% of a community’s jobs and 5% of all national jobs, the LQ is calculated like this:

(0.07 / 0.05) = 1.4

If a community’s LQ is 1, it’s equal to the national average. If the LQ is greater than 1, the local industry is more clustered than the national average, and, if the LQ is less than 1, it’s the opposite. If a community’s LQ is, say, 4 in technology, then the local technology cluster is four times as concentrated as the national average. If you know how to read LQs (greater than 1 = good; less than 1 = bad) then it simplifies and quantifies cluster concentration.

However, there is one caveat – it isn’t always great to have a high LQ if it comes at the expense of economic diversity in a region. Not only is diversity often an important characteristic in community resilience and risk management, but the collision between industries also has a role to play in innovation. For example, Waterloo is home to Canada’s largest robotics and automation cluster – this is at least partly due to interaction between our large manufacturing and technology clusters.

How can my company use location quotient?

If you’re looking to relocate or expand your company, then LQ should be a major part of your decision-making process. It provides a simple, objective and quantifiable way to evaluate a community’s business ecosystem, which is tough to do otherwise. Identifying talent sources and real estate are still important, of course – LQ is just another tool in your toolbox when considering expansion into a new community.