Does place still matter in the age of the internet? Do digital startups care about their physical surroundings?

It is tempting to think that, for digital businesses and online services, the virtual world is all that matters. However, one of the propositions of the European Digital City Index (EDCi) – Nesta’s ranking of EU cities, for startups and scale-ups – is that environmental conditions within cities have a strong impact on business innovation.

 The index, which is funded by the European Commission, was launched in 2015 before being updated this year as part of Global Entrepreneurship Week. The revised index, which expands the number of cities from 35 to 60, reinforces our previous findings. It illustrates striking differences across Europe in the “fertility” or receptiveness of cities towards digital entrepreneurs.

One reason why place still matters, at least for entrepreneurship, is that local cultural attitudes vary a great deal with geography and thus influence the number of people who are willing to take the risk to set up a new business. With echoes of Weber’s Protestant Ethic and the Spirit of Capitalism, there still seems to be a significant North-South divide here. In particular, Northern/Western European respondents state that they are less risk averse and have more trust than their Southern/Eastern counterparts.

Another reason why location can matter for digital startups is skill and talent acquisition. As the House of Lords reported earlier this year, the UK faces a digital skills crisis. In contrast, several eastern European cities such as Bucharest and Zagreb are producing technical talent that is not only well-trained but also affordable.

Some organisations are clearly taking advantage of this cheap, overseas talent through outsourcing, virtual companies or distributed teams. One example is Buffer, a startup which changed base several times before becoming fully distributed internationally. However, if place really were irrelevant, why would all UK firms not be doing the same, instead of worrying about the need for highly-skilled immigration?

The answer, of course, if that for many roles, proximity and collocation are still hugely important. Notwithstanding the increase in remote working over the past two decades, most organisations find that some direct personal connections are still necessary for establishing trust, rapport and common understanding. This is true not only among co-workers, but for other business relationships, such as mentoring.

Similar concerns affect access to capital. This is the life-blood of young and growing businesses and, despite the global nature of capital flows, physical connections between people are significant in forging business relationships. Many business angels and venture capitalists prefer to invest in specific regions, and research shows that reducing the travel time between VC firms and their portfolio companies does indeed lead to more attention and better performance. Access to capital is one of the primary reasons why London tops our 2016 Index, as it did in 2015. 

Place also matters to those digital firms that rely upon local network effects, even if only at the initial stages. For instance, many “sharing economy” businesses and other firms based on peer-to-peer interaction only work if there is a sufficient concentration of local users; this is why Uber aims to grow city-by-city, in geographically-bound markets, rather than going global all at once.

Local markets can also matter where physical installations and pilot projects are required – after all, digital does not necessarily mean software only. Some city authorities have gone out of their way to make their town’s infrastructure available to startups, as with the Smart London Infrastructure Network, Datacity Paris, Barcelona Open Challenge, and Bristol is Open. Each is a different example of a city council working with startups and larger companies to fast-track installation of technologies such as smart sensors, hopefully for the benefit of all concerned.

In addition to the above, the performance of local digital infrastructure is obviously of concern to digital firms, and an area where the UK lags much of Europe, as is the cost of renting or purchasing office space. This is a particularly difficult conundrum for cities like London, Stockholm and those in the Netherlands, where real estate prices have rocketed in recent years.

As the nature of work continues to change, and as communication technology inexorably improves, perhaps fully distributed organisations may become the norm – at which point, it may not even make sense to talk of firms being located in a specific town.

Until that time, however, local predispositions and attitudes towards entrepreneurship, a readily-available pool of skilled talent, region-specific investments, robust digital infrastructure and affordable office space will all still continue to matter deeply to digital companies. Only cities which address these physical factors will find that they also harness the power of the virtual world.

Siddharth Bannerjee is a researcher, and Chris Haley head of start ups, at Nesta, the innovation foundation.

The European Digital City Index is a project managed by Nesta, as part of the European Digital Forum with funding from the European Commission.