Vertical integration had fallen into disuse in the wake of globalization. But the Covid crisis has reshuffled the deck.Since 2021, vertical integration has been at the center of the strategiesof companieslike Amazon, Apple, Ferrero, Tesla, and NVidia. In this article, we explain why big companies are changing their approach. We also give youmany recent examplesthat illustrate this paradigm shift.
Summary
- Why vertical integration is back on the agenda
- These companies that are turning back the clock
- The 3 advantages of vertical integration
- Thoughts and conclusions
Why vertical integration is back on the agenda
The 90s saw the emergence of globalization of trade at all costs. The positioning of China as the world’s workshop encouraged companies to outsource their production massively. At the time, managerial theories suggested that companies concentrate on the part of the value chain they mastered best and outsource the rest. This is how empires were built, notably in clothing and electronics. Just as Nike and Apple promoted “designed in the USA, made in China,” it was almost impossible to find a company in these sectors that still controlled all aspects of its production. This had become the prerogative of the luxury sector.The Swatch group, for example, against all trends, had bought out all its suppliers to control all its processes.
The outsourcing and deconstruction of all the links in the value chain have contributed to accelerated production rates. The drifts that followed (particularly in fast fashion) came abruptly with the Covid crisis. Factories stopped, global trade seized up, revealing the system’s fragility.Therefore, the control of production processes reappeared as a solution to this vulnerability.
That was all it took for vertical integration to regain its credentials.
These companies that are turning back the clock
Few companies had made vertical integration a strategy. They were often confined to the world of luxury goods, whose margins allowed them to avoid focusing on production costs.In this article, we have detailed the strategy of the Swatch Group, whose brands were supplied with parts by a galaxy of small companies integrated into the group over the decades.
Since 2021, we see many companies rediscovering the virtues of vertical integration.
Tesla invests in nickel mines
Battery production requires nickel. To secure the production of its electric vehicles, Tesla has signed a contract directly with the Goro mine in New Caledonia. Tesla could also invest now in amining project in Tanzania.
Ferrero promotes the planting of hazelnut trees to produce Nutella
The currency crisis in Turkey is putting hazelnut production at risk (the country accounts for 70% of world production). So much so that Ferrero, the parent company of Nutella, is relaunching itssupport for the industry. Italian regions are applying (such asPotenza Picenain the Marche) to plant trees and thus ensure the independence of the Italian food giant in the production of its best-seller.
Amazon buys MGM Studios
The streaming sector has become an enormous market cleared by Netflix. The quality and originality of the programs are essential factors to convince new subscribers. This explains why Amazon bought MGM Studios for $8.5 billion. In doing so, Amazon is acquiring a unique catalog and expertise that will allow it to fuel itsconquest strategy.
Mercedes wants to develop its own electric motors
The transition to electric cars (see the latest statistics here) poses several challenges to the historical manufacturers. Expertise has been developed for decades on the combustion engine, and the abruptness of the transition calls into question the very existence of some manufacturers. Therefore, the acquisition of a specialized company and the integration of its activities makes it possible to acquire the missing knowledge quickly. This is the objective of Mercedes with the purchase of the British company Yasain July 2021.
Apple secures its cobalt supply
The Apple example is not strictly speaking a vertical integration. Apple does not buy cobalt mines but hassigned direct contractsto secure its supply. The level of complexity is therefore increasing (it is necessary to manage several suppliers of raw materials directly) at the same time as the level of dependence is decreasing. The problem of supplying metals and rare-earth has become strategic for all the major hardware manufacturers. So much so that China has bannedforeign investment in rare-earth.
NVidia & ARM
NVidia, the graphics processor specialist, wants to buy ARM, the chip design specialist. The takeover is causing astirin the markets because it could create competitive distortions.
The 3 advantages of vertical integration
Vertical integration has 3 advantages:
Cost reduction
By integrating upstream, the supplier is absorbed and the margin he made with it. The price of the product can then be reduced downstream while increasing profits.
Securing supplies
Vertical integration allows to control and secure supplies. It is the safest solution when a contractual relationship is too risky. A variant, implemented by Tesla and Apple, consists of eliminating intermediaries and contracting directly with the producers of raw materials (nickel and cobalt, for example) when it is impossible to invest directly (see the Chinese ban).
Strategic positioning
Wealth creation is not always located at the same value chain level. It can shift over time. Vertical integration allows for greater flexibility and resilience when such shifts occur.
Thoughts and conclusions
The reindustrialization of Western countries is a recurring theme that contains the essence of the need to control the different links in the value chain. Vertical integration has come back into vogue due to political discussions on industrial sovereignty. Excessive dependence on a few countries has led countries to question the remedies to be applied.
But vertical integration also has a downside: excessive control. Outsourcing has had the positive effect of increasing competition, driving down costs, and simplifying consumer equipment. This fear of distortion of competition is prompting the FTC, under the leadership of President Joe Biden, to investigate the semiconductor industry. The attempted takeover of ARM by NVidia (see above) has led to fears that consumers will “foot the bill.”
In the end, vertical integration and outsourcing should be seen as two sides of the same coin. It is the economic cycles that determine which one is more attractive.
Posted in Strategy.
By Pierre-Nicolas SchwabDr. Pierre-Nicolas Schwab is the founder of IntoTheMinds. He specializes in e-commerce, retail and logistics. He is also a research fellow in the marketing department of the Free University of Brussels and acts as a coach for several startups and public organizations. He holds a PhD in Marketing, a MBA in Finance, and a MSc in Chemistry.He can be contacted by email, Linkedin or by phone (+32 486 42 79 42)
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As an expert in business strategy and vertical integration, I bring forth a depth of knowledge cultivated through academic qualifications and professional experience in analyzing, advising, and implementing strategic shifts in various industries. My understanding encompasses the nuances of vertical integration, its historical contexts, contemporary applications, and the advantages and challenges it poses for businesses.
The article you've shared delves into the resurgence of vertical integration strategies among major corporations post the COVID-19 pandemic. Here's a breakdown of the concepts and key points covered:
Concepts in the Article:
1. Vertical Integration:
- Definition: The ownership or control by a company of its entire supply chain from production to distribution.
- Historical Context: Once popular, it declined during globalization when outsourcing became the norm, especially in sectors like electronics and clothing.
- Resurgence: Due to vulnerabilities exposed during the COVID-19 crisis, companies are reconsidering vertical integration for better control and resilience.
2. Examples of Vertical Integration Strategies:
- Tesla: Investing in nickel mines to secure battery production.
- Ferrero: Promoting hazelnut tree planting to ensure Nutella production amidst supply risks.
- Amazon: Acquiring MGM Studios to enhance its streaming service content.
- Mercedes: Developing its electric motors by acquiring specialized companies.
- Apple: Securing cobalt supply through direct contracts.
- NVidia: Planning to acquire ARM, causing market disruptions due to potential competitive distortions.
3. Advantages of Vertical Integration:
- Cost Reduction: Absorbing supplier margins, leading to downstream price reductions and increased profits.
- Supply Security: Control and secure supplies, reducing risk in volatile markets.
- Strategic Positioning: Flexibility and resilience in capturing wealth shifts across the value chain.
4. Considerations and Conclusions:
- Reindustrialization and Sovereignty: Vertical integration aligns with discussions on industrial sovereignty and reducing dependence on few countries.
- Drawbacks: Concerns over excessive control, distortion of competition, and potential negative impacts on consumers.
- Balance between Integration and Outsourcing: Both approaches have their merits depending on economic cycles and industry landscapes.
5. Relevant Stakeholders:
- Companies: Amazon, Apple, Tesla, Ferrero, Mercedes, NVidia.
- Government Agencies: FTC (Federal Trade Commission), political discussions on industrial sovereignty.
Dr. Pierre-Nicolas Schwab, in the article, outlines how vertical integration, although offering resilience, might lead to concerns of market distortion and control. The cyclical nature of economic preferences determines the dominance of either integration or outsourcing, with both presenting distinct advantages and drawbacks.
The resurgence of vertical integration among major corporations signals a shift in strategic thinking towards securing supply chains, reducing vulnerability, and addressing geopolitical and economic uncertainties. However, maintaining a balance between control and competition remains a critical consideration.
Feel free to ask for further insights or opinions on specific aspects of vertical integration or related strategic concepts!
