Economic Complexity from Within: How Organizational Adaptability Drives Regional Diversification
- Jonathan H. Westover, PhD
- Sep 28
- 12 min read
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Abstract: This article examines the critical relationship between organizational adaptability and regional economic diversification. While economic complexity research has predominantly focused on macro-level patterns, this analysis explores the organizational mechanisms that enable regions to develop new capabilities and expand into related industries. Drawing on evidence from economic geography, organizational science, and innovation studies, the article identifies how firms' internal capabilities—particularly knowledge absorption, network formation, and strategic flexibility—contribute to broader regional diversification. The analysis demonstrates that regional diversification trajectories are significantly shaped by organizations' capacity to recombine existing knowledge into novel applications. The paper presents evidence-based organizational strategies and governance mechanisms that foster adaptability, highlighting practical approaches for policymakers, business leaders, and regional development agencies seeking to enhance economic complexity and resilience against sectoral shocks.
When Nokia's mobile phone business collapsed, Finland faced a potential economic crisis. Yet within a few years, the country had pivoted—transforming Nokia's engineering talent into a flourishing ecosystem of technology startups, gaming companies, and specialized service firms. This transformation exemplifies what economic complexity scholars call "related diversification"—the process by which regions leverage existing capabilities to develop new economic activities (Hidalgo et al., 2018).
Economic complexity theory has revolutionized our understanding of development trajectories by demonstrating how nations and regions evolve their productive capabilities. However, a critical gap exists in understanding the micro-foundations of this process—specifically, how organizations themselves adapt, recombine capabilities, and ultimately enable regional economies to diversify. As economic shocks accelerate due to technological disruption, climate change, and geopolitical instability, understanding these mechanisms becomes increasingly urgent.
This article bridges economic complexity research with organizational science to examine how firm-level adaptability drives regional diversification. It explores the organizational capabilities, structures, and practices that enable regions to develop new economic activities and increase complexity. By examining these dynamics, we provide practical insights for policymakers, economic development agencies, and business leaders seeking to build more resilient and diversified economies.
The Economic Complexity Landscape
Defining Economic Complexity in Regional Development
Economic complexity refers to the diversity and sophistication of knowledge embedded in a region's productive capabilities (Hidalgo & Hausmann, 2009). Rather than simply counting industries, complexity measures the interconnectedness of knowledge and its application across different economic activities. Regions with high economic complexity host organizations that collectively possess diverse, specialized, and rare knowledge that can be recombined to produce sophisticated goods and services.
The concept rests on two key principles. First, the "principle of relatedness" suggests that regions diversify into industries that share knowledge bases with their existing activities (Boschma, 2017). Second, the "capability theory" posits that economic development involves acquiring increasingly complex capabilities that enable the production of more sophisticated goods (Hidalgo & Hausmann, 2009).
While these concepts effectively describe macro-level patterns, they provide limited insight into the organizational mechanisms that enable or constrain diversification. Organizational adaptability—the capacity of firms to reconfigure resources and routines in response to changing conditions—represents the critical missing link in understanding how regional economies evolve.
Prevalence, Drivers, and Distribution of Complexity Patterns
Empirical research shows remarkable consistency in how regions diversify. A study of 50 countries over 50 years found that 65-80% of new export products developed in a country are related to existing capabilities (Hidalgo et al., 2018). Similarly, research across European regions demonstrates that new industries are highly likely to emerge adjacent to existing regional specializations (Balland et al., 2019).
However, the distribution of economic complexity remains highly uneven. Advanced economies like Germany, Japan, and Switzerland consistently rank highest on complexity indices, while resource-dependent and less-developed economies rank lower. Even within countries, stark regional differences exist—for instance, Massachusetts and California demonstrate substantially higher complexity than resource-dependent states like Wyoming or Louisiana (Mealy et al., 2019).
This pattern persists because of several interrelated factors:
Path dependency: Historical specializations shape future possibilities
Knowledge spillovers: Geographic proximity enables tacit knowledge flows
Institutional complementarities: Formal and informal institutions reinforce certain development paths
Organizational ecosystems: The presence of adaptable firms and supportive organizations enables capability development
The uneven distribution of complexity across regions suggests that structural factors alone cannot explain diversification patterns. Rather, organizational agency—the strategic choices, capabilities, and adaptability of firms—plays a crucial role in determining whether regions can break path dependencies and develop new economic activities.
Organizational and Individual Consequences of Economic Complexity
Organizational Performance Impacts
Economic complexity significantly impacts organizational performance through multiple mechanisms. Firms operating in more complex regional economies benefit from knowledge spillovers, specialized supplier networks, and deeper talent pools. A study of 42,000 European firms found that those located in regions with higher economic complexity demonstrated 18% higher productivity and 12% higher innovation rates, controlling for firm-specific factors (Balland & Rigby, 2017).
These benefits accrue unevenly, however, based on organizations' absorptive capacity—their ability to recognize, assimilate, and apply external knowledge. Research examining manufacturing firms across regions found that the performance gap between high and low absorptive capacity organizations was twice as large in complex regions compared to less complex ones (Boschma & Capone, 2015). This suggests that regional complexity creates both opportunities and challenges for organizations, depending on their internal capabilities.
Organizations that successfully leverage regional complexity demonstrate several distinct characteristics:
Strategic flexibility to recombine internal and external knowledge
Boundary-spanning networks that connect to diverse knowledge sources
Organizational structures that facilitate knowledge transfer and recombination
Investment in human capital development and learning
Critically, these organizational capabilities not only determine firm performance but collectively shape regional diversification trajectories. As Saxenian (1994) demonstrated in her comparison of Silicon Valley and Route 128, organizational culture and inter-firm relationships significantly influence regional adaptability and diversification potential.
Individual Wellbeing and Stakeholder Impacts
For individuals, economic complexity creates both opportunities and challenges. Workers in more complex economies typically enjoy higher wages—research across US metropolitan areas indicates that a one standard deviation increase in economic complexity is associated with 5-8% higher average wages, controlling for education and other factors (Balland et al., 2020).
However, these benefits are distributed unevenly. Workers with higher educational attainment and transferable skills can more easily transition between related industries during diversification processes. A longitudinal study of worker transitions in Sweden found that workers with post-secondary education were three times more likely to successfully transition to emerging industries compared to those with only secondary education (Neffke et al., 2018).
For local communities, economic complexity creates resilience against sectoral shocks. Regions with more diverse and complex economies typically recover faster from economic downturns. Following the 2008 financial crisis, regions with above-average economic complexity experienced unemployment increases 30% smaller than less complex regions (Boschma, 2015).
This resilience has significant implications for social welfare and community stability. Regions dependent on single industries or sectors face heightened vulnerability to economic disruption, resulting in prolonged unemployment, population decline, and associated social challenges. Diversification strategies that build on existing capabilities while developing new ones can mitigate these risks and create more sustainable development paths.
Evidence-Based Organizational Responses
Building Absorptive Capacity Through Talent Development
Organizations that effectively contribute to regional diversification demonstrate strong absorptive capacity—the ability to identify, assimilate, and apply valuable external knowledge. Research shows that absorptive capacity directly influences an organization's ability to pivot into related activities during economic transitions (Cohen & Levinthal, 1990; Zahra & George, 2002).
Effective approaches to building absorptive capacity include:
Diverse knowledge acquisition strategies:
Strategic hiring from adjacent industries
Cross-functional team formation
Formal education and training programs in complementary domains
Rotating employees across departments and functions
Knowledge integration mechanisms:
Regular cross-functional knowledge-sharing forums
Documentation and codification of tacit knowledge
Internal platforms for sharing insights across business units
Incentives for knowledge contribution and reuse
Procter & Gamble transformed its innovation capability through its "Connect + Develop" program, which aimed to source 50% of innovations from outside the company. By developing systematic methods to identify, evaluate, and integrate external knowledge, P&G created over 100 new products combining internal capabilities with external technologies. This approach enabled P&G to diversify into adjacent product categories while maintaining core competencies—illustrating how structured approaches to absorptive capacity enable organizational adaptation (Huston & Sakkab, 2006).
Strategic Network Formation
Organizations that successfully drive regional diversification typically build strategic networks that span industry boundaries. These networks facilitate knowledge flows that can trigger new capability development and identify novel recombination opportunities (Powell et al., 1996).
Effective network development approaches include:
Ecosystem engagement strategies:
Active participation in industry associations spanning multiple sectors
Engagement with regional innovation hubs and incubators
Strategic partnerships with universities and research institutions
Participation in pre-competitive research consortia
Knowledge brokerage mechanisms:
Dedicated boundary-spanning roles within the organization
Regular scanning of adjacent industries for transferable knowledge
Systematic documentation of external partnerships and learnings
Cross-industry innovation challenges and hackathons
ARM Holdings exemplifies effective network formation for regional diversification. Originally spun out from Acorn Computers in Cambridge, UK, ARM developed a partnership-based business model that positioned it at the center of a diverse ecosystem. Rather than manufacturing chips, ARM licensed its processor designs to partners across multiple industries. This approach enabled the company to diversify from desktop computing into mobile, IoT, automotive, and AI applications. ARM's strategy helped transform Cambridge into a globally significant technology hub spanning multiple sectors—demonstrating how a single organization's network strategy can catalyze regional diversification (Garnsey & Heffernan, 2005).
Organizational Ambidexterity
Organizational ambidexterity—the ability to simultaneously exploit existing capabilities while exploring new opportunities—emerges as a critical enabler of regional diversification. Ambidextrous organizations can maintain current operations while developing new capabilities that contribute to regional complexity (O'Reilly & Tushman, 2013).
Effective approaches to developing ambidexterity include:
Structural mechanisms:
Dedicated innovation labs with protected resources
Corporate venture capital units to engage with emerging sectors
Skunkworks projects outside standard reporting structures
Acquisition and incubation of startups in adjacent domains
Process innovations:
Stage-gate systems adapted for different types of innovation
Exploration budgets protected from short-term performance pressures
Regular portfolio reviews balancing core and emerging activities
Metrics and incentives aligned with both exploitation and exploration
Fujifilm successfully navigated the decline of traditional photography by developing organizational ambidexterity. While the company maintained its core film business, it systematically explored new applications for its chemical, material science, and precision manufacturing capabilities. This approach led to successful diversification into medical imaging, cosmetics, pharmaceuticals, and advanced materials. By 2020, these new businesses represented over 80% of Fujifilm's revenue—demonstrating how organizational ambidexterity enabled the company to pivot its capabilities into new domains. This transformation contributed significantly to Japan's regional diversification in advanced materials and healthcare sectors (Komori, 2015).
Institutional Entrepreneurship
Organizations can actively shape the institutional environment to support regional diversification through institutional entrepreneurship—actions that create or modify institutional arrangements to support new economic activities (Battilana et al., 2009).
Effective institutional entrepreneurship approaches include:
Ecosystem development initiatives:
Creating industry consortia around emerging technologies
Establishing standards and platforms that enable new markets
Developing shared training programs and skill certification systems
Supporting specialized infrastructure for emerging sectors
Policy advocacy and implementation:
Engaging with policymakers to shape supportive regulatory frameworks
Participating in public-private partnerships for capability development
Contributing to regional economic development initiatives
Aligning corporate and regional development strategies
CEMEX, the global cement manufacturer, demonstrates how institutional entrepreneurship can drive diversification. Facing commoditization in its core business, CEMEX developed "Patrimonio Hoy," a program providing financing, materials, and technical assistance to low-income homebuilders in Mexico. This initiative not only created a new market segment but established new institutional arrangements connecting financial services, construction materials, and technical assistance. The program has since expanded across Latin America, transforming CEMEX from a pure cement producer into a provider of integrated housing solutions. This transformation contributed to regional diversification in construction technologies and financial services for underserved markets (Prahalad, 2006).
Building Long-Term Diversification Capability
Developing Dynamic Capabilities for Continuous Adaptation
To sustain diversification over time, organizations must develop dynamic capabilities—higher-order capabilities that enable systematic adaptation to changing conditions (Teece et al., 1997). These capabilities allow organizations to continuously sense opportunities, seize them through resource reconfiguration, and transform their operations accordingly.
Three critical elements constitute effective dynamic capabilities for regional diversification:
First, systematic environmental scanning processes must extend beyond current industry boundaries to identify related diversification opportunities. This requires dedicated resources for horizon scanning, competitive intelligence that encompasses adjacent sectors, and regular assessment of capability applicability in new domains.
Second, organizations need resource fluidity—the ability to rapidly reallocate resources toward new opportunities. This requires governance structures that balance stability with flexibility, modular organizational designs that enable recombination, and financial systems that can redirect resources toward emerging opportunities.
Third, successful diversifiers develop learning systems that accelerate adaptation cycles. This involves structured after-action reviews following both successes and failures, knowledge management systems that make learnings accessible across the organization, and metrics that capture learning velocity alongside performance outcomes.
The integration of these elements creates a self-reinforcing system that enables continuous adaptation and diversification into related domains.
Fostering Collective Learning Ecosystems
Regional diversification depends not only on individual organizations but on collective learning ecosystems that facilitate knowledge exchange and capability development across organizational boundaries (Lundvall, 2016). Organizations can strategically contribute to these ecosystems while benefiting from shared learning.
Effective approaches include developing communities of practice that span organizational boundaries, creating shared research infrastructure accessible to multiple organizations, establishing talent development programs that build regional capability pools, and designing open innovation platforms that facilitate structured collaboration.
Critically, these initiatives must balance cooperation with competition—what scholars call "coopetition." This balance enables knowledge sharing in pre-competitive domains while maintaining incentives for commercial application. Formal governance mechanisms, such as intellectual property frameworks and data-sharing agreements, can help maintain this balance.
Organizations that successfully foster collective learning ecosystems position themselves at critical nodes in knowledge networks, enabling them to detect and shape emerging diversification opportunities before they become obvious to others.
Embedding Diversification in Corporate Governance
Sustainable diversification requires governance mechanisms that balance short-term performance with long-term capability development. Research shows that organizations with governance structures explicitly supporting capability development are more likely to successfully diversify into related domains (Aoki, 2001).
Critical governance elements include board composition that brings diverse industry perspectives, executive incentive systems that reward capability development alongside financial performance, capital allocation processes that explicitly consider capability-building value, and reporting frameworks that track capability development metrics.
Particularly important is aligning governance timeframes with capability development cycles. While financial performance operates on quarterly and annual cycles, capability development for diversification typically requires 3-7 year horizons. Governance mechanisms must accommodate these different timescales to enable effective diversification.
Organizations that successfully embed diversification in governance typically develop explicit capability mapping processes that connect current capabilities to future opportunities, providing a framework for strategic discussions at the board level and creating continuity in diversification strategies despite leadership transitions.
Conclusion
Organizational adaptability serves as the critical link between existing regional capabilities and economic diversification pathways. While economic complexity research has established the importance of relatedness in regional diversification, this article demonstrates that organizational capabilities—particularly absorptive capacity, strategic networking, ambidexterity, and institutional entrepreneurship—determine whether regions can successfully leverage existing knowledge to develop new economic activities.
The evidence indicates that regional diversification emerges from the interaction between organizational strategies and broader ecosystem dynamics. Organizations that systematically develop internal capabilities for adaptation while simultaneously shaping their institutional environment can substantially influence regional diversification trajectories. Conversely, regions dominated by organizations lacking these capabilities face significant constraints in their diversification potential, regardless of their theoretical relatedness to new activities.
For policymakers and regional development agencies, this suggests the need for more nuanced approaches that address organizational capabilities alongside broader structural factors. Rather than focusing exclusively on attracting new industries or building general-purpose infrastructure, policies should target the specific organizational capabilities that enable effective knowledge recombination and diversification.
For business leaders, recognizing the bidirectional relationship between organizational adaptation and regional diversification opens strategic opportunities. Organizations that align their capability development with regional strengths can leverage external knowledge more effectively, while those that actively shape regional institutions can create more supportive environments for their diversification efforts.
As economic shocks accelerate due to technological disruption, climate imperatives, and geopolitical realignment, the ability to diversify into new activities becomes increasingly critical for both organizational and regional resilience. By understanding and developing the organizational foundations of economic complexity, leaders can build more adaptive organizations and regions capable of continuous reinvention.
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Jonathan H. Westover, PhD is Chief Academic & Learning Officer (HCI Academy); Associate Dean and Director of HR Programs (WGU); Professor, Organizational Leadership (UVU); OD/HR/Leadership Consultant (Human Capital Innovations). Read Jonathan Westover's executive profile here.
Suggested Citation: Westover, J. H. (2025). Economic Complexity from Within: How Organizational Adaptability Drives Regional Diversification. Human Capital Leadership Review, 26(1). doi.org/10.70175/hclreview.2020.26.1.2
