Co-located teams are more effective communicators and can sometimes experience increased productivity by up to 60% if situated together in the same room. More simply stated, the greater the dispersion factor, the greater the challenge of collaboration. Note that time zones are often considered the largest dispersion factor and can have a greater impact than geography.
Although it is strongly recommended that teams be co-located, it is not mandatory to success. In fact, certain Agile practices have factors, tools and techniques inherent to them to help bridge some of the shortcomings of increased dispersion, such as a higher reliance on frequent collaboration and communication. But to be clear, they do not replace the value of face-to-face conversation, they are merely a crutch to not having it. (Senior Agile Coach Jerry Doucett)