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The Virtues of Vertical Integration

I am in the business of price benchmarking and cost reduction, but even so, I am amazed at what supply chain professionals have achieved.

With specials and deals of all kinds during the holiday season, it is astounding the value that is being passed on to customers at very low prices in electronic products. Thirty-two-inch LCD TVs under $200 and microwave ovens at $50 are ridiculously cheap. I know these are loss leaders, but even the prices of the regular stock show that the management and execution of the planning, sourcing, manufacturing, and logistics functions of the chain are incredibly well tuned.

Note that these products are mostly Asian — predominantly Japanese and Korean (increasingly Korean, but let's not forget Taiwan and China). Almost all are from companies with high levels of vertical integration; that is, they own the technology from design through end product, and if they don't own or control all of the technology, they control the most important bits.

It is interesting that these companies don't force their product groups to use their own component brands. This direction keeps their sourcing competitive while at the same time forcing the inhouse component groups to be aggressive on price and quality. It is a win-win strategy if you happen to be them! These companies dominate these product segments to the point that I find myself skipping over domestic brands with a perhaps unfair sense of their inferiority.

There are segments where domestic companies continue to do well or have not yet conceded defeat to foreign competitors. Autos (Ford, GM, Chrysler), cellphones and tablets (Apple and RIM), and games (Microsoft's X-Box) are examples, but cracks are showing and those with the largest cracks seem to be the least integrated. What is it about vertical integration that makes such a difference? Or, is vertical integration a factor at all?

I believe competitiveness derived from knowledge is likely at the root of the vertical integration advantage. Can you get this knowledge without technology and manufacturing ownership? Fabless semiconductor company success might suggest one doesn't need manufacturing ownership, but this by itself is not convincing. Technology knowledge seems vital as I can't think of a successful product company without technology control. What I am convinced of is that companies with more knowledge will outperform rivals if they are capable of acting on that knowledge.

Domestic (Western) companies tend not to be vertically integrated, although there are exceptions. While the offshoring trend seems to be reversing along with some manufacturing repatriation, most companies remain a long way from being truly vertically integrated.

This year my New Year's resolution is to create jobs through my company and within my customers' companies by making them more competitive. While these jobs will be created globally, I hope that the majority are created domestically because a stronger economy at home is good for all. I plan to do this with a series of new product releases aimed at creating knowledge and transparency around pricing and supply chain risk. I will be showing the first of these new products, a component cost estimation tool, at the Consumer Electronics Show in Las Vegas next week.

This show will be a telling event for competitiveness, as many hot new electronics products will be unveiled. While many attendees will be looking at how cool the new products are, I will be considering their supply chains and how they derive competitive advantage from them. I will be at the Lytica booth and would love to talk with any of you planning to attend this event.

8 comments on “The Virtues of Vertical Integration

  1. Barbara Jorgensen
    January 3, 2012

    @Ken–I was also pleasantly surprised at how inexpensive electroncis items were this season. LCD TVs have been around awhile, but even so, the discounts were much higher this year. Foxconn has maintained a limited vertical integration for some time now, and perhaps other EMS compnaies are following suit. Worth watching in 2012

  2. bolaji ojo
    January 3, 2012

    Ken, Happy New Year. If vertical integration is making a quiet comeback, what does this mean for the wave of changes that broke down the electronics industry's vertical manufacturing structure over the last two decades? Does this mean the companies that sold off operating divisions (semi, manufacturing) to focus on “core competencies” might have made a major mistake? Or would it be correct to assume that the “vertical integration” you mentioned in the blog is somehow different in its structure and implementation than the old system?

  3. Ariella
    January 3, 2012

    @Ken I applaud your New Year's resolution and hope you will be able to achieve it.

  4. Ken Bradley
    January 3, 2012

    RePost

    Bolaji,     The wave of changes that broke down the electronics industry's vertical manufacturing structure over the last two decades happened mostly with western companies and, as such, vertical integration didn't breakdown in the electronics industry, just in the western managed part of it.  I believe these companies have thrown out the baby with the bathwater. Here, the baby is the key strategic bit that gives competitive advantage and the bathwater is the rest of the factory. I don't see any competitive advantage in assembling, for example, surface mount boards but I do see it in high end silicon, displays and other unique technologies. Manufacturing of these more differentiating technologies may not be important in itself unless the manufacturing enables underlying technology development in process or product.

    To list a few things that I think are critical in product success, I would choose technology choices, vendor selection, test and product verification. I admit this list is biased towards technology companies and technology products and I would have a different list for markets like cosmetics (marketing) or publishing. What's important about my list is that the elements are based on knowledge, not ownership unless ownership somehow creates knowledge and often it does.

    I will use my Nortel Networks (a technology company) expedience to illustrate the point. Every successful product that Nortel ever made had at its core a differentiating semiconductor technology.   Whether it is the early adoption of customer silicon and software in its PBX (1970s), the filter-codecs enabling digital switching (1980s) or jitter free lasers allowing high speed optical networks (1990s), all of these products had market leading positions. Their wireless (2000s) products did not have such differentiation. This I feel is one often overlooked reason why the company is no longer with us.

    I think it would it be correct to assume that the “vertical integration” in the blog is somehow different in its structure and implementation than the old system. It is knowledge vertical integration. What we need to figure out is how we get it with or without the factory.

  5. bolaji ojo
    January 3, 2012

    Ken, I like the idea of “knowledge vertical integration.” And you were right, Western companies gave up on vertical integration but many other companies in the electronics industry didn't. The big Japanese OEMs have been reorganizing and restructuring operations for years but many of them still have a vertical structure in place. I am not sure if this has helped them or not but it would be a shock if Korea's Samsung were to give up manufacturing chips, for instance.

    I see an example of “knowledge vertical integration” at play at Apple, which has been involved in designing chips for its products and recently reportedly acquired Anobit, a flash memory vendor in Israel. Anobit was already a supplier of flash memory to Apple. The report has not been confirmed by Apple but it is indicative of what you were pointing out.

  6. Daniel
    January 4, 2012

    The basic ideas behind low cost devices are capturing the market at the earliest. If it’s from reputed brands then the process becomes much easier also.

  7. Ken Bradley
    January 4, 2012

    Jacob, I have a different view on low cost supply chains.  While fast time to market correlates with market share, it does not address cost.  This “Time to Market” relationship was shown many years ago by Synopsys in their diagram of three different sized, isosceles triangles, each enclosed within the larger ones and right side and bottom aligned where the bottom axis represents time and the apex represents the relative market share for each company represented by the triangles.  You don't want high market share with high cost or you are dead.  Every company must try to be the low cost producer in the market space where they play.  Low cost comes from good supply chain design and good supply chain design supports fast time to market and cost effectiveness over a products lifecycle.  Barbara's comments about LCD TV being old technology and low priced illustrates the point.  These companies captured market share early and deliver low cost throughout their lifecycle. 

    Bolaji, you get it.  Love your comments and examples.  I don't think we want to copy the Asians; we must design a better way. 

  8. stochastic excursion
    January 5, 2012

    Bolaji, the idea of “knowledge integration” is definitely key to sustaining a product and product road map of successive roll-outs.  I believe vertical integration does not necessarily foster this though. 

    When a supply chain is made up of separate entities in many cases, companies are forced to maintain visibility for their products up the chain using applications engineers and sales engineers.  Often these professionals work closely with designers to bring about product improvement.  A top-down organization may not be as conducive to collaboration between internal suppliers and assembly designers.

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