Vertical vs. Horizontal Integration: Which is a Better Operations Strategy?
Apple is moving in one direction. What is better for your company?
The debate between vertical or horizontal integration appears to be reinvigorated. Vertical or horizontal integration is at the heart of a company's operations strategy. We’ll talk more about why there is new momentum around vertical integration, but first we ask which model provides the greatest operating leverage and opportunity for success? This decision is a fundamental business strategy decision and the answer depends on your company, your unique value proposition and your capabilities/resources to deliver small portions or the majority of that value proposition.
Vertically or Horizontally Integrated?
Starting with the Model T and coming off the heels of WW I, a centralized, command and control business and operations strategy began to take hold. Vertically integrated businesses, leveraging mass-production principles of efficiency, dominated the corporate world until the later part of the 20th century.
In the late 1900s, thinking around horizontal integration began to emerge as a popular trend. Why own “all” the assets of manufacturing and production, why not partner for some of the components and processes needed to create, produce, distribute, sell and support our product? Also, why not take advantage of extremely low costs of manual labor in other parts of the world and just ship our final product to points of demand? This federated (horizontal) approach began to take hold, but with some interesting implications.
Vertical Integration-- The model T helped start it; PCs helped end it; and now Samsung and Apple are reintroducing it. What is right for your company?
I started my career just as the PC revolution was just taking hold. Vertically integrated, mainframe-computer manufacturing gave way to Intel, Microsoft and the client server approach to computing. Intel and Microsoft are excellent examples of companies who introduced disintermediation into the computing paradigm and decided to carve out their niche (very strategically it proved) in the computing value chain. These companies began to help their value chains compete (and win) against the mainframe and other computing value chains of the day.
Eventually, the client-server model evolved and companies like Apple and Google have adopted a more vertically integrated approach to their strategy (owning both operating systems and platforms). But from a product development, procurement, manufacturing, supply chain perspective, these companies appear to take a value chain orchestration approach.
Or do they? Have you seen Apple’s capital investment expenses lately? Not only are they spending their money on data centers (like Google), but also they are spending around $5B a year on manufacturing equipment to produce the proprietary components of their products. Apple has produced their own chips for many years and some say they will make an acquisition in this area in an effort to extend their design, development and in-house production capabilities. They certainly have the cash available to buy a legitimate asset (enough cash to buy Intel at the moment). Processors aside, they are also creating their own manufacturing equipment and producing some of the most sensitive components of their products in their own factories. So they are starting to own everything in house from design, development, manufacturing (still obviously using Foxconn and others for the bulk build and assembly), marketing, sales (their own retail stores), support and service (Genius) and content (Apps and iTunes).
So, this is what we are seeing as we near the end of 2012. We see companies embracing both models. Samsung as a fully, vertically integrated company (yes - they have received plenty of government subsidies over the years); and Intel, very much a horizontally integrated company who leverages OEMs and their distribution channels to take their products to market. These two opposing models have a completely different mindset from one another and completely different consequences.
The table below outlines some of the operating implications of each model.
The decision between vertical or horizontal integration will determine your operating strategy. There is certainly room for debate on this topic and arguments that support both models. It eventually boils down to what is right for your unique situation and value proposition. It’s always helpful to think about supply chain segmentation and aligning to your unique customer value proposition. By doing so, you can honestly understand what model yields the best product, experience, availability, price, service and support for your customers.
Proprietary or Open-Standards
I’d bring one other point into the conversation for High Tech industries: Open Standards. Many times you can equate vertical integration to proprietary standards and horizontal integration to open standards. When you have to work with many value chain partners, it’s obvious that open standards must be embraced in order for the partners to interoperate and products to come together. In my experience, open standards always prevail. Proprietary operating systems, platforms and products many times lead the way into new areas and functionality, but eventually open standards prevail. We see this happening already with Apple and Google. Android is dominating the sales of mobile devices over Apples IOS. The last report I saw showed Android phones garnering 75% of the market while iPhones accounting for only 15% of the market. Apple still enjoys superior profitability and they will see a bump when the iPhone 5 numbers are released. But, over-time, open standards usually win.
So are you an Apple or an Intel?
Either one isn’t so bad. Intel is taking a bit of a beating of late along with PCs, but think about what is right for your company. Horizontal integration is the right play for the majority of companies. Even if you are Google, operations teams must orchestrate a very complex cadre of value chain participants. This value chain orchestration requires high collaboration, trust, transparency, visibility, very frequent communication and working together to win against other competing value chains.
Let me know what you think and which model you see as winning or if you see other models emerging.
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