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 Samsung Electronics Co. Ltd. (Korea: SEC) and LG Electronics Inc. (London: LGLD; Korea: 6657.KS) 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 Corning Inc. (NYSE: GLW) 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, Apple Inc. (Nasdaq: AAPL) 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 Ericsson AB (Nasdaq: ERIC) 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.

By Ken Bradley – Lytica Inc. Founder/Chairman/CTO

Ken Bradley
Ken Bradley

Ken Bradley is the Chairman/CTO & founder of Lytica Inc., the world’s only provider of electronic component spend analytics and risk intelligence using real customer data.

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