As organizations scrutinize their office footprints, company leaders may want to ask themselves: Are your neighbours successful enough? It turns out, physical proximity to a highly successful firm can have tangible benefits for a firm’s own productivity, new research suggests.

While the study was conducted using data that predates the COVID-19 pandemic — and the evolution of remote work that came with it — one of its co-authors says the results offer considerable food for thought for businesses weighing decisions about office locations and hybrid work structures today.

“The big takeaway is that firms benefit more from being near other firms that are more productive, that are able to produce more output using the same amount of workers and real estate,” says co-author Nathaniel Baum-Snow, a professor of economic analysis and policy at the Rotman School of Management. “The implication is if you can find a way to locate [your firm] next to another firm that has twice as much revenue, then our estimates say your own revenue will be about 2.5 percent higher.”

The study suggests “knowledge spillovers” that come from firms being beside each other are primarily driving the increase in productivity and revenue.

“This could be things like overhearing conversations about using Excel in a new way, using a pivot table or something like that, that people didn’t know about, and bringing it into their own firm and adopting these practices,” says Baum-Snow. “This could be recognizing that your neighbor, say in the next building over, is working on a similar problem and being able to go over there and talk to them about how they solve this problem.”

Proximity, however, is key: The study indicates benefits are found for firms within 75 metres of more productive firms — a distance about four times as long as a bowling lane — but those perks decline rapidly farther out. (For reference, an average city block in the study area is about 75 meters long.)

The study also found no evidence of aggregate benefits to having less productive firms cluster together. Effectively, if you have a choice of locating your firm next to one very productive organization, that’ll pay out more in the long run than neighbouring with two that are half as productive, Baum-Snow explains.  

The study — published in American Economic Review — looked at high-skilled, single-location service firms, which can include law offices, consulting firms and financial service firms. (Businesses such as restaurants and retail were not included because the research sought to understand potential spillovers in productivity, not so-called customer spillovers, Baum-Snow says.)

For the study, the researchers analyzed Canadian administrative tax data, looking at information that included sales, prices and postal codes for more than 55,000 firms between 2001 and 2012. Specifically, they focused on the densest areas in Toronto, Montreal and Vancouver.

While the data used is not reflective of today’s workplace evolutions, the paper’s results are still useful for business leaders, Baum-Snow says.

“It's very clear that the only way that these knowledge spillovers can happen is if people are near each other,” he says. “Zoom is good for some things, but it's only good if you know what you're looking for. It's very unlikely to give you certain kinds of kind of random bits of information that you might find useful to improve business practices.”

If the study was run using present-day data, Baum-Snow says, it’s possible that the productivity spillovers observed would be even lower, given that workers are often physically in the office less than before.

“The opportunity for being exposed to other ideas has gone down,” he says.

That reality has knock-on effects that organizations today need to consider, says Baum-Snow.

“Now the benefits of being at King and Yonge have gone down because spillovers have gone down,” he says, referencing a key intersection in the heart of Toronto’s financial district. “The willingness to pay to be right there has gone down. A lot of these small firms are asking whether it make sense to have an office at all.”

While the implications for the office real estate market can be significant, high-skilled service firms should conduct a careful cost-benefit analysis when assessing their physical footprints.

“We're in a brave new world when it comes to the office market and the location decisions. Even if you lose a little bit in productivity by having work from home, you can save a lot in rental costs,” says Baum-Snow. “There's definitely a balancing act.”