Vertical integration—the strategy of acquiring businesses that tangentially support your operations—is becoming the modern day choice for tech-sector businesses seeking to streamline processes, increase profits, gain market edge, and avoid finding themselves at the mercy of forces outside their control.
In the last few years, several major companies have made moves to more deeply own their supply chain. Samsung Electronics’ recent purchase of an artificial intelligence platform is aimed at bringing more in-house functionality to its digital devices, while Amazon’s move to own logistics is designed to remove friction from its e-commerce operations. Tesla and Apple are veterans of this business approach, using it when developing their electric cars and iPhones, respectively.
But is vertical integration right for your business?
By the winter of 2016, Tesla was already approximately 80% vertically integrated—an impressive feat for a car manufacturer. In addition to its massive 5.5 million square foot plant in Fremont, California, the electric green vehicle maker owns manufacturing and tooling facilities. Its vertical integration strategy is also focused on the hardware that goes into its vehicles. For example, Tesla is hardly alone in developing and testing autonomous vehicles, but it is the only automaker creating its own semiconductor to power these self-driving vehicles.
For Samsung Electronics, using vertical integration is a way to gain a competitive edge. Voice-activated digital assistants are all the rage thanks to Amazon’s Alexa, Apple’s Siri and Google Assistant. Samsung’s foray into the market, Bixby, has failed to take off in a similar fashion. Enter Viv Labs, the San Jose virtual assistant startup AI platform and the team behind Siri. Samsung paid $215 million for Viv and the once-separate company’s technology is expected to debut in the next iterations of Samsung smartphones and digital devices.
Another major example: A few years ago Amazon had to apologize to irate Prime customers when holiday packages didn’t fully live up to the e-commerce giant’s two-day delivery promise. Today Amazon is using vertical integration to reduce its reliance on third parties—particularly when it comes to delivery. The company recently launched a program in which it will help independent delivery drivers create their own businesses handling packages for Amazon. Entrepreneurs who take advantage of the program get access to Amazon's delivery technology, training, and discounted vehicle leasing and insurance. The drivers earn more money and Amazon can better ensure delivery quality.
Apple has long been a big believer in vertical integration. When it launched the first iPhone in late June of 2007 the device ran on its own operating system with components made internally. Even with the unveiling of the iPhone X more recently, Apple opted to go with an AI chip made in-house.
A Stabilizing Force
Vertical integration is of obvious interest to any enterprise relying on a bevy of third parties. It can present an opportunity to eliminate some or all of these middlemen, potentially improving product/service quality, increasing productivity, and reducing expenses.
The business would control more of the supply chain, creating stability and predictability. A staff freed from working with vendors and contractors can focus on innovating and growing the business, which can help an enterprise improve business planning, identify sales trends, zero in on peak and trough periods, and differentiate itself in the marketplace.
Remember, companies that rely on outside partners are only as good as those outside partner’s operations. If the vendor suffers a calamity—from a plant fire to data breaches—it can impact everyone’s ability to conduct business.
The more ownership a company takes, the fewer interruptions it faces.
How Vertical Integration Can Be Applied to Your Business
Businesses can apply vertical integration in three ways:
- Backward integration: A company acquires an existing supplier, bringing a portion of the production in-house.
- Forward integration sees the organization expand into another aspect of its business, eliminating the middleman.
- Acombination of the forward and backward integration, often called balanced integration.
Not every company is well-suited for vertical integration. For the enterprises that operate in certain traditionally risky business environments, however, it can be helpful in mitigating some of those risks.
It's also useful in businesses where vendors or service providers have more market power than the organization. Companies that operate in declining markets where opportunities to enter adjacent areas on the cheap are present may also benefit from vertical integration as could startups at the forefront of developing a new industry.
Vertical Integration & You
Vertical integration is a significant investment. It requires considerable upfront outlays to bring the processes in-house before any costs savings are realized—and then, moving forward, those processes also must be maintained and kept operational. If a company is incapable of managing the new activities, vertical integration could potentially become more of an expense than if operations had remained outsourced.
Further, if a company is struggling to manage all the production aspects, it could create a lack of focus. A company may be great at manufacturing products, for example, but selling those wares through a retail store could prove more difficult and distracting than imagined.
In order to win at vertical integration, companies have to ensure the benefits outweigh the costs and avoid integrations that result in more bureaucracy and less flexibility.
Like any other strategy or model, vertical integration isn’t right for every business. And it comes with its own set of challenges and hurdles.
The good news? Leveraging financial sponsors, banking partners and industry experts can significantly increase your chances of success with this trending business approach. Tailor it to your own set of unique needs, resources, and goals and you may be surprised by the degree to which vertical integration can broaden your business horizons.