Vertical Integration Works for Apple — But It Won’t for Everyone

11 Apr 2012 Sandeep Mehta

An interesting article from Knowledge@Wharton has good info for R&D managers Vertical Integration Works for Apple — But It Won’t for Everyone. Apple’s success with iPhone has increased the emphasis on vertical integration – controlling most parts of the value chain to the consumer:

“Vertical integration dictates that one company controls the end product as well as its component parts. In technology, Apple for 35 years has championed a vertical model, which features an integrated hardware and software approach. For instance, the iPhone and iPad have hardware and software designed by Apple, which also designed its own processors for the devices. This integration has allowed Apple to set the pace for mobile computing. “Despite the benefits of specialization, it can make sense to have everything under one roof,” says Wharton management professor David Hsu.”

As the article points out, Google’s purchase of Motorola, Oracle’s acquisition of Sun etc all point towards more vertical integration. Clearly, more pieces of the value chain a company controls, the better it will be at differentiating itself from competitors. Vertical integration will allow organizations to develop better products faster because of fewer IP constraints and better collaboration.

what Apple’s competitors really envy is the company’s control of its ecosystem. 

However, control of the ecosystem requires more than controlling the product.  Google and Oracle are attempting to control hardware and software aspects of their products.  
It is not easy to align hardware and software development paths.  As we have seen in the past, Steve Jobs actually disconnected the two during  iPhone development. 

Hrebiniak notes that hardware and software require different competencies and skill-sets in areas such as manufacturing, procurement and supply chains. In that respect, the challenges these firms face will be similar to what many diversified multinationals deal with when managing disparate business units.

However, to achieve Apple like results, they will need to control many other parts of the value chain as well.

“It is important to distinguish between a motivation to manage the interface between hardware and software and a desire to manage one’s ecosystem.

One key point that people forget is that Apple has had a 30 year history of vertical integration. Their corporate culture is built around that concept.

.”Apple does well, but has had top-down integration of hardware and software for more than 30 years,” Hrebiniak states. That integration, which requires centralization foreign to Google and many other companies, is hard to deliver.

There are many  negatives to vertical integration.  Larger R&D organizations become virtually connected regardless of the physical location and suffer the same disadvantages of a multi-organization team. Add to it the fact that large teams pay a performance penalty.  Vertical integration will also expose companies to significant other risks ranging from culture clash to development efficiency:

For instance, Hsu suggests that the advancement and growth of Google’s Android technology may slow if the company is juggling hardware and software efforts. Even though Android is technically open source, Google drives development. “Google integration with Motorola Mobility could make products better, but the risk is that Android may not evolve at the same pace it would under a specialization model.”

Companies planning vertical integration should consider approaches to build focused R&D communities. Companies will also need to enhance their management processes for virtual teams. They will also need to master distributed product development.  Finally, they will need to learn from Apple and improve their R&D project portfolio management.  Alternatively, companies can use Codesign  to work around vertical integration. More importantly, it is essential to remember that all business models can lead to success and that different business models lead to a more vibrant and vital competitive landscape.

but you need multiple models in the technology industry,” she says. “If every tech company followed Apple, there would be a degree of novelty and innovation lost.”

More importantly, no one knows how much of Apple’s success was tied to Steve Jobs:

After all, Apple’s success may be largely a function of a command and control structure instituted under former CEO Steve Jobs.

learly, there is an increasing trend towards vertical integration in the technology industry.  However, this is not a new phenomenon.  Companies such as GE have ventured down the path many decades ago and are now actually scaling back to achieve focus.

“Haven’t we seen this movie before?” asks Whitehouse, pointing to the rise of multinational conglomerates in the mid-20th century. For example, Vivendi transformed itself from a water company to one focused on media, while GE started as an electric company but later expanded into such disparate businesses as microwave ovens and the NBC television network (which it recently sold to Comcast.) “Conglomerates are now refocusing after spreading themselves too thin,” says Whitehouse. “Can expanding tech companies learn the lessons of an earlier wave of conglomerates?”

Companies move away from vertical integration when their market becomes commoditized.  In commodity markets, it is important to focus on efficiency which can only be achieved through focus.  When that will happen in the tech industry in unknown.

 Typically, companies back away from vertical integration as products become more commoditized. It is unclear when that will happen in the smartphone or tablet markets, but the advent of that period would likely mean trouble for vertically integrated firms.

Apple has been able to successfully avoid  commoditizing by moving into new market segments.  Any company considering vertical integration should also keep that in mind.  When Apple tried to compete in the commodity market with vertical integration, it failed!

“What Apple has done well is stay ahead of commoditization,” Hsu notes. “Apple is more of a trailblazer and that opens up possibilities.” The catch is that a vertical approach does not provide a significant advantage if a firm is unable to stay ahead of the competition. Indeed, Apple’s integrated approach in the PC market did not work to the firm’s benefit when it was battling Microsoft in the 1980s and 1990s.

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