Vertical Integration Champions

Now that the Consumer Electronics Show (CES) 2012 is over and the flurry of activity resulting from it is under control, I have had time to reflect on the various participants at the exhibition and the issue of vertical integration.

I must confess to being most impressed by the Koreans and would give them the top Vertical Integration Award if I had one. Both {complink 4751|Samsung Electronics Co. Ltd.} and {complink 3074|LG Electronics Inc.} stole the show with their OLED TVs. While other companies had interesting technology and displays, the achievement of these companies, enabled by vertical integration, won out.

Western companies impressed me as technology providers and providers of materials based on technology. DTS Audio is a good example of the first, and {complink 1356|Corning Inc.} of the second with its Gorilla glass. DTS Inc. is having great success using its IP to improve the user sound experience with small-format mobile devices. If you have a blu-ray player or small mobile audio device that sounds good, it probably has DTS technology in it, regardless of its country of origin. Our western companies, at least for now, appear to be in good shape on intellectual property creation, although the intelligence to create it seems to be sourced globally.

Being differentiated and embedded in someone else's end product is a good thing. But it's not quite the same thing as owning the product and being in complete control of it. When you are embedded, you need the end product guys to create your product's demand, and you are vulnerable to being swapped out during the next design cycle. As an end product guy, you gain time-to-market by using these third-party technology platforms and save on development costs. These benefits, however, are usually offset by higher product costs, which may or may not be a concern. These higher product costs arise from margin stacking and often suboptimal design resulting from the lost knowledge of vertical integration.

Can the knowledge and coordination that comes about in a vertically integrated company be attained to prevent suboptimal design as non-integrated companies work together? I think the answer is yes but it requires a lot of effort and management. As EBN editor in chief Bolaji Ojo has pointed out, {complink 379|Apple Inc.} seems to be doing it. Apple's investment in display technology, and its ability to bring differentiated products to market enabled by display technology, is evidence. (See: 4 Things Apple Can Do With $98 Billion.)

I have also been told of a case where {complink 1879|Ericsson AB} worked with its supplier to develop a completely new display that resulted in very successful products for both. In this story, there was very high-level executive involvement and commitment from both companies; each company's employees worked as one with shared risk and reward. Ericsson got a successful telecom product, and the supplier got a successful high-volume display line and business.

Unfortunately, I think what Ericsson did in this example and what Apple appears to be doing is rare in Western companies. It is rare because of the degree of engagement needed to match that enabled in vertically integrated companies. This needs true supplier relationship management, with strategic supplier management at its core. It is not the standard procurement babble that a supplier is “strategic” because it supplies a lot. It is a core competency both of the OEM and the supplier(s). It is an investment in time and money and it is nurtured. This kind of relationship is as hard to disengage from as if the employees and factory were directly owned.

Although companies with vertically integrated operations are not always successful, it seems that those with it have an edge. For those Western companies that have given up their capability as a vertically integrated operation, it makes little sense to recreate it around existing technology.

I believe a more successful way of regaining lost market share from vertically integrated competitors is to use technology discontinuities and controlled market access to establish a foothold as a next generation vertically integrated company. This requires investing in core next-generation technologies and their manufacturing. Quantum dot technology may represent an entry for some back into North American manufacturing of displays or TVs.

There are numerous other nanotechnologies and energy conversion technologies that could also enable a rebirth. In the US, Homeland Security and the Military represent markets favoring high-end technologies and US manufactured products. What a wonderful (and protected) place to start.

7 comments on “Vertical Integration Champions

  1. Eldredge
    February 28, 2012

    When you are embedded, you need the end product guys to create your product's demand, and you are vulnerable to being swapped out during the next design cycle.

    Yes, and you are also dependent on the marketing and competitive acumen of your customer to maintain your demand (unless you are also embedded in the competitors technology as well).

  2. Barbara Jorgensen
    February 28, 2012

    I think another problem with outsourcing is both partners have to “win” in the relationship. I think this makes companies risk-averse. A vertically integrated compnay may be more willing to spend money on something that will pay off in the long run, rather than attaching a value to it at the outset.

  3. stochastic excursion
    February 28, 2012

    Generally that's true, but inasmuch as a component adds value to a product, the component manufacturer can negotiate a better deal for itself.  Look at the tablet designs driven by Intel's processor architecture.

  4. prabhakar_deosthali
    February 29, 2012

    In my opinion , to be a successful vertically integrated product company , you need to have a long time vision, commitment, deep pockets and some say in the government to keep the  policies and taxation in your favour. So a company's aim should be to become a national icon or an object of pride – the way AT&T ( Ma Bell) or GM or Ford were once upon a time.

  5. Barbara Jorgensen
    February 29, 2012

    As Ken points out, Samsung is an example of cautious vertical integration. Right now Samsung is struggling, but the model has worked pretty well. Samsung's LCD business was its biggest asset until LCDs became just another commodity product. The spinoff should help offset that and retain Samsung Display as a supplier. And, if competitors start clamoring for OLEDs, Samsung is in the drivers'seat–it can either supply OLED to itself or charge top dollar to its competitors.

    You have to have a superior, in-demand technology for vertical integration to work, but there are a number of examples to show that it does.

  6. Taimoor Zubar
    February 29, 2012

    I think an important decision that vertically integrated companies have to take is whether to sell a raw component as it is or us it to make it's own finished products. For instance, if there's a limited number of OLED screens that Samsung can manufacture, would be more profitable to sell them as it is to other manufacturers, or would a better option be to use them in Samsung's own smartphones and tablets. Many a times it may be a very difficult decision to make.


  7. Taimoor Zubar
    February 29, 2012

    I think another problem with outsourcing is both partners have to “win” in the relationship”

    I agree. Vertical integration has it's own merits where there are lesser formalities involved compared to a relationship between two companies. This can make it faster to roll out new products in the market.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.