Why Vertical Integration is my default choice of Strategy in Business
Vertical integration is a concept in microeconomics and business management where it is an arrangement in which the supply chain of a company is owned by that company. The best example of a vertically integrated company is Apple. Apple’s vertical integration is precisely the reason why it is difficult to compete with them despite the company is now going through ongoing turbulent currents.
Why am I a fan of vertical integration? There are weaknesses associated with this model. I will name the most common three reasons. First, you are your own supplier whether in components and services, and if part of your supply chain is not competitive against the other available vendors out there, you may be forced to switch and you incur high transition monetary costs for both potential organizational and structural changes. Second, it requires a specific investment to compete against the players already out there and of course, time is of the essence if you want to get a product out in the shortest time to go to market. For example, if you are buying components from a company that innovates and specializes on that core competency, unless you have a good reason that you can do it cheaper, faster and better, trying to vertically integrate by building a competitor is not cost efficient and can achieve a totally different outcome which you want your company to benefit from the economies of scale that it enjoys against your other competitors. Third, it leads to the monopolization of markets, but it’s in the eye of the beholder. If you are Amazon and you are leading, why do you care if you have a high market against your other competitors? Peter Thiel will tell you that most powerful and high growth companies will eventually strive to monopolies.
Let me explain why I am in favor of vertical integration as a strategy in business. First of all, I like the fact that I can build the different parts of businesses in a modular manner like how I fit lego bricks to build a few things and eventually lead to a strong, sustainable and robust structure. Second, as an executive who has worked in both start-ups and multi-national corporations, I have worked on many strategic partnerships with other companies and at times, it might be better if we have just built a competitor from scratch and instead of wasting our time partnering with them. The problem with partners is that you will have to make a tremendous amount of effort to integrate with them. At times, they may not be reliable and they have their business agenda which may or may not align with your businesses. In simple words, sometimes it’s best to trust and use our own hands to do the work than rely on others.
I often like to make the following comment in a seemingly joking manner to professional friends in my network by saying the following, “Don’t be surprised if you will find me starting an ice cream shop or restaurant someday. It’s not going to be an ordinary restaurant, because I will vertically integrate every part of the user experience from how the food is made to the stage where it’s served to the customer aligning both the customer and the operations team on the ground. I will leverage on the special technology stack I have from AI, IoT (and pick your buzzwords) to blockchain where you do not know that they are the technology layers that empowers the business operations of this restaurant or ice cream shop and make it better than everyone else.”
The reason why I made the above comment is that vertical integration is the best model that I feel most comfortable to execute as compared to the other strategies I have leveraged in my corporate career. Till date, it has happened to me once and that experience was great. I was first the head of digital services where I spent most of my time trying to align the digital assets to solve other business units’ needs. One major challenges (which I will elaborate in future articles someday) in digital transformation is that the heads of the traditional business units may not agree with your digital integration to add digital business revenues on top that may or may not disrupt the supply chain. Finally, when I held the portfolio of being both the head of digital and post office network together, I was able to drive the vertical integration from digital to the offline retail at a much faster pace than both the predecessors before me, because I was uninhibited by being a digital native who can enhance and augment the traditional business quickly. That can never be done if it has been the opposite of requiring two heads to align on business strategy. In fact, upon takeover, all digital integrations were done within half a year, as compared to them taking two years and the project was in constant delay. I was convinced after the results that the best way to do digital transformation is to have profit and loss control for the digital leader to have control of both digital and traditional business at the same time.
Let me offer an example of how having the vertical integration mindset can drive better business outcomes. You may have heard many examples from Apple to Amazon in different aspects of their businesses from retail to logistics, but the best one is Uber Eats. When Uber first started Uber Eats, they started their own “restaurants” to serve the customer. The reason is that they want to capture the user experience not just from the customer who order the food, but also the chefs and the restaurant staff who are waiting for the order to come in, prepare the food and then hand over the food to the Uber food delivery men and women. Through a fully integrated model, they were able to understand the problems clearly in each stage of the supply chain. They realized that they need to integrate with the point of sale (POS) systems, and how to ensure the user experience are completely aligned from the restaurant to the customer across their platform. Being vertically integrated, they discovered that most consumers do not care about lunches that much as compared to their dinners. So, in addition to the restaurants, they also have their own “restaurants” where they use a central kitchen in the city to prepare and deliver the food. What they have benefitted, is that they are able to drive more revenues and disrupt the supply chain.
Finally, I am not against the idea of partnering with other businesses if that is not the core competency of my business. However, as Jeff Bezos put it elegantly, “Your margin is my opportunity.” If my partner proved to not as good as what I want them to be, then I will definitely get my team to explore and exploit that opportunity.
Acknowledgements: I want to dedicate this article to both Justin Gong and Fang Yi, who I have met during the Zhuhai airshow 2018 and have that spirited discussion on this topic during our evening drinks in the bar. They have inspired me to pen this.
Picture Credits: A photo of a city built in Lego which I have taken during the Lego World Exhibition in Fort Canning, Singapore 2017.
