A Complex Vertical Jump: Pushing for Vertical Integration

Check out this article: http://knowledge.wharton.upenn.edu/article.cfm?articleid=2959

Many companies across various industries use vertical industries. For example, one of the best features of Zara’s business model is its vertical integration strategy. Vertical integration is when a single company owns several parts of its value chain. For Zara, this means it manufactures its clothing in its own factories rather than obtaining it from other companies. They produce sixty-percent of their merchandise in-house, whereas many clothing retailers outsource their production to cut labor costs. With localized manufacturing, Zara is able to more easily utilize just-in-time manufacturing. This allows them to maintain low inventories and produce only the amount of items demanded by customers in an efficient manner. A unique thing about Zara is that half of its fabric arrives in the factory un-dyed so that they can immediately adjust colors of clothing in-season as trends change. Vertical integration works very well for Zara because they have impeccable coordination of their business activities and produce efficiently. They have driven great demand for their products through limited runs of specific types of clothing because the exclusivity encourages customers to buy as soon as new clothing is released at full price.

Vertical integration is a strategy used in other industries and companies as well. The article explains that the tech industry is moving towards greater use of vertical integration. Apple has successfully utilized this strategy for thirty-five years by integrating its hardware and software production. As companies such as Google and Sony start vertically integrating their business models, there is concern that these tech companies will lose coordination. They feel pressure to keep expanding into new areas of technology, but in doing so they may have weaker parts in their supply chain. For many companies, focusing on one part of the supply chain is better because they learn to do their part efficiently and minimize confusion. The focus of the company can be lost when it turns into a conglomerate because there are multiple product lines that do not all receive enough attention to perfect them. The article says “there is a reason that large conglomerates tend to trade at a discount on Wall Street—they are harder to manage.” In addition, consumers may suffer by having products with less overall quality.

Apple has done well managing the hardware and software of its various products, but most PC companies rely on many companies to supply specific parts. This allows for more specialization because each companies focuses specifically on one part of the entire supply chain and perfects it. Typically, the specialization strategy is effective with commoditized products because less differentiation is necessary. Vertical integration is becoming more favorable to tech companies because they are able to differentiate their product offerings, as well as have more control of individual parts that lead to the final product. For example, Google expanded its focus from just serving as a search engine to creating the Android mobile operating system and then acquired Motorola Mobility to make its own smartphones and television set-top boxes. Similarly, Samsung makes many products ranging from smartphones to televisions. On the other hand, Sony has struggled to effectively manage its TVs and game systems with a vertical integration strategy. Research in Motion has also had difficulty with integrating the operating system of an acquired company with their own hardware.

There are concerns with vertical integration in both the retail and tech industries. Zara has set up the infrastructure for high efficiency; similarly, Apple has built its company up so that it has strong leverage with its contractors. To achieve these business models takes time and careful planning, but many companies are trying to convert too quickly or on too great of a scale. Some tech companies may start working on too many products in the industry and lose the high performance of specific parts that they had previously focused on. How will companies balance this transition and is it even worth it?

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6 thoughts on “A Complex Vertical Jump: Pushing for Vertical Integration

  1. Very informative post! I like how you were able to link what we learned in class, vertical supply chain with Zara, to the technological industry. Although we learned a lot about Zara in class I am still quite curious about how they were even able to start a supply chain, I am assuming that their CEO was quite rich before he created Zara which allowed him to own multiple factories and create it’s own fabrics.This allows them to use just-in time manufacturing which cuts down there inventory and as we have learned inventory equals death.

    The decision to integrate vertically is very tough and I think expanding in certain sectors of the industry it may not be worth it. I think that technological companies are more pressured to transition into vertical supply chains because tech products become outdated very fast, they are not inimitable, and there are many threats of substitutes.Today we saw how Dell, which primarily focused on desktops, is now not performing as well as in the past, and that through expanding into the market of cloud computing experts have said they are shifting in the right direction, so in this case vertical integration had a positive effect. However when Dell tried to make other products such as laptops they were not quite as profitable.

    Google was definitely able to catch the smartphone frenzy, by making the android platform, but I think that ship has sailed and few companies will be able to copy Google’s success. Google was able to create the Android platform as a competitive alternative for those who did not want an iPhone or a Blackberry and is now the platform used by many cellphone brands. Even the Window’s platform for Nokia cannot really compete with it. Likewise I do not think that expanding into the software industry is worth the investment because Windows and Mac IOS as well as Linux are already big established brands that people have become accustom to.

    There are many factors that weigh into the decision of transitioning to a vertical supply chain. Products frequently become outdated and companies fear that they will diminish through creative destruction, however entering into another industry is a huge challenge that maybe end up being a profit loss. I do hope though that if a company decides to transition to a vertical supply chain that they do not sacrifice quality for quantity.

  2. Thanks for the insightful comments! After reading this article http://www.reuters.com/article/2011/07/19/inditex-chairman-idUSLDE76G05K20110719 I found that the founder of Zara actually had a fairly humble upbringing. Ortega and his wife began by making clothes in their own home! He went from working in his home to making a fortune of $31 billion which I find to be very impressive.

    Personally, I think that for the majority of companies it is better to stick to their own niche, rather than trying to own all parts of the supply chain. This way, they are able to focus all of their efforts on specific parts and make the best product possible for the consumer. However, in the case of Zara who started out by building the infrastructure to support vertical integration, I think they should continue their business model because they have created a system of impeccable efficiency. Google, on the other hand, is trying to get into so many different markets right now that I don’t know how they are going to fare in the long-term. They seem to have too much to focus on that they will be unable to perfect one segment. I look forward to see what happens with Google Glass!

  3. This is a great article that shows the traditional benefits of vertical integration and the new trials it faces. There are always trade-offs when doing business this way. On one hand a company has complete control over its production. On the other, there may be a company out there that can do one step better. Apple dominates in design, but there are somethings it does not do best. It does not make its own processors, and it cannot assemble with the efficiency of FoxConn in China. A company must check its ego and know when someone can do a step better.

  4. Vertical integration seems to be the way to go in business now days. In comparison to horizontal integration, which is highly prohibited and often is blocked by government agencies. e.g. the attempted purchase of T Mobile USA by AT&T, vertical integration is less monitored by the government. I wonder when will government and will they step in anytime because it might not be fair competition?

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