Knowledge From Vertical Integration

Exactly what knowledge do market-leading companies gain from vertical integration? My thought process here considers a very high-level product design process. Though I will portray that process as linear and sequential, the reality is messier, iterative, and probably chaotic.

For my purpose, the process starts with a market spec, which defines the customer experience (a display that can be seen from anywhere in a room), and then moves to a design spec, which defines the technical attributes of the product (a viewing angle of 110 degrees). From there, it moves to architecture, where the decisions are made about which technologies will be used and what tradeoffs will be made in creating the product.

Architecture defines what is done in hardware, what is done in software, whether to use serial or parallel processing… things like that. Decisions also need to be made as to whether the design should use traditional technologies or more leading-edge ones.

Over time, significant shifts in technology have delivered considerable advantages to their adopters. As examples from the silicon world, I have capacitors that enabled enhanced analog performance, the use of multiple layers of metallization to simplify integrated circuit interconnection and reduce die size, and copper interconnect to overcome aluminum’s resistivity and increase circuit speed.

All these examples are very old, but they illustrate the point quite well. Each technology offered an enormous advantage at the product level, but the first adopter was taking a huge risk on whether it would work in the timeframe required (or at all). As a general guideline, consider that a circuit running at a certain speed would need half the circuitry if it could run twice as fast to do the same job. Think of the cost advantage if your product ran twice as fast as those of your competitors and needed half the number of similarly priced components, all because of your technology and architecture.

Vertically integrated companies can bring their architects and process technology experts together to work out the benefit-risk equation. Process experts can propose technology alternatives and assign success probabilities. Architects can weigh the product impact and even influence the market spec to improve features or capability definition. Vertical integration provides a coordinated mechanism for making better architectural decisions.

The majority of what passes for electronic design today (yes, I am being a bit harsh, but not by much) is laying out reference designs from different component suppliers to fit a new product shape. (This leads to an unnecessary proliferation of resistor and capacitor values and MPNs within a product's approved vendor list or manufacturer part number. Each reference design specifies slightly different values for pull-ups and terminations.)

Further reference designs almost always contain components that are unnecessary to the application but get left in the product, adding unnecessary costs forever. This “building block” design has tremendous time-to-market advantages, but it does not yield a competitive advantage over a product with a superior architecture enabled by vertical integration. When pitted against a vertical integration enabled product, the building block design means a fast time to second or third place marketshare or worse.

I do not believe vertical integration by itself is enough to create the competitive advantage. {complink 2125|Foxconn Electronics Inc.} and {complink 2085|Flextronics Corp.} are both vertically integrated, but theirs is more of a manufacturing integration, rather than a product-enabling one. These companies get significant benefits from their factory assets, but those benefits relate more to margin-stacking than enabling products or technology.

Most contract manufacturers' ODM products tend to focus toward the lower end of a product line. Having said that, these manufacturers are in a great position to evolve and grow if they choose to compete with their customers.

My point is evident when looking at the array of new products and technology here at the 2012 Consumer Electronics Show. I am at the Lytica booth (beside ESPN and Ericsson) promoting and the new Component Cost Estimation Tool — a must-see tool for electronic designers and buyers. The tradeshow is the perfect place to see what all of the leading companies are doing in consumer electronics. It is clear that vertically integrated companies lead the way in product wow factor.

This amazing show highlights some really cool new products. A large portion of the show is devoted to next-generation TVs, smartphones, and tablets. Asian companies (all vertically integrated) appear to have the largest booths and the most advanced technology: glass-panel thin OLED TVs, glasses-less 3D, etc.

I will provide more CES insights in the days ahead.

6 comments on “Knowledge From Vertical Integration

  1. bolaji ojo
    January 11, 2012

    Ken, Did Western OEMs give up too early on vertical integration? I know in hindsight — and based on your presentation in this blog — the advantages of vertical integration are many. So why did we give it up and is it still possible to move the process back inhouse to regan the benefits?

  2. Ken Bradley
    January 11, 2012

    Bolaji, In hindsight it's easy to be critical of western managers who abandoned vertical integration but it may really be that they moved too fast and our Asian friends moved too slow. Western managers are under tremendous pressure for financial performance, much more so that their Asian counterparts and the impact of turning factories and inventory into cash was very compelling. Acceleration after the crash of 2001 was definitely a factor increasing this financial pressure. In many cases, it was also most likely the right thing to do. Balancing an intangible second order effect like technology coordination against cash is a hard thing for an MBA to do.

    If I use Nortel as an example getting rid of their surface mount lines was not a mistake, getting rid of their semiconductor group was. At CES I am seeing many examples at the consumer product level where vertically integrated companies are advancing to an untouchable position against western counterparts. I am also seeing examples of western companies working at a technology level in silicon or intellectual property algorithms (Intel, Qualcomm, DTS…) where their world leadership is evident

    My next blog will address how western companies may be able to fill in this coordination void caused by vertical disintegration.

  3. _hm
    January 11, 2012

    There may be many more equally important factors to be consider in vertical integration. Does the success of this integration depends on many differernt aspriration?



  4. Barbara Jorgensen
    January 12, 2012

    I wonder, though, whether Wall Street supports the vertical integation model. In terms of Apple, I guess it does, but that's more about products than manufacturing. Wall Street is driven by ratios that reward low costs and high profits, and vertical integration generally requires significant investment in technologies and facilities. I'm sure there is a hybrid model that works–originally, outsourcing was done where it made sense to do so–that retains an OEM's core competencies and leverages the skills of others.

  5. Eldredge
    January 12, 2012

    Ultimately I think i t comes down to how verticle integration is implemented and leveraged. It can't be done blindly, but with an eye to gaining some value in the structure.

  6. SunitaT
    January 17, 2012

    The majority of what passes for electronic design today is laying out reference designs from different component suppliers to fit a new product shape.

    @Ken, I totally agree with you that majority of them use reference designs from different component suppliers because most of them are concerned about time to market. Even if they use different component suppliers it becomes crucial to choose the component whose specs are closely match the requirement so that optimal performance can be extracted.

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