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Friday, August 18, 2006

A Trend Toward Vertical Integration?

Daniel Gross writing in Slate sees a new trend towards vertical integration, reversing the de-integration movement of the 1990s when firms began to focus on "core competencies":

Dis-Integration? Why Michael Dell needs to act more like John D. Rockefeller, by Daniel Gross, Slate: On Monday, in a front-page article by Timothy Aeppel, the Wall Street Journal heralded the return of one of the great industrial developments of the late 19th century: vertical integration.

Responding to the recent rise in prices for crucial commodities like copper, rubber, nickel, and oil, manufacturers of all types have taken steps to ensure they have adequate supplies of raw materials and parts. The article cited several examples of companies that bought outright or took stakes in their suppliers...

There's something larger going on. Vertical integration, pioneered by titans of industry like Andrew Carnegie, John D. Rockefeller, and Henry Ford, was the logical endpoint of the Industrial Revolution. As companies gained size and scope, they could realize huge efficiencies by controlling everything from the raw materials they used in the production process to the distribution of their finished products. So, Rockefeller, who started as an oil refiner, branched out into production (oil wells), distribution (pipelines and rail cars), and retail (gas stations).

Over time, this bureaucratic structure fell out of favor in the executive suite. It's difficult for companies to excel at and maintain competitive advantages in a range of disciplines. And a new set of mega-trends emerged that pushed companies away from vertical integration. [This]... led firms to focus on performing only those functions they could carry out profitably and to outsource everything else...

The ability to outsource was abetted by another huge trend: the massive expansion of global trade and the emergence of armies of suppliers and workers in places like China, India, Eastern Europe, and Latin America. As a result, in the 1990s, the world was a huge discount shopping bazaar for purchasing managers. Whatever you needed—labor, finished textiles, oil, copper, electronic components—was suddenly available at low prices in markets that had, until recently, been closed. ... It made sense to deintegrate as much as humanly possible. Indeed, the company whose stock performed the best in the 1990s was a poster child for this trend: Dell outsourced virtually everything—the production of components, assembly, installation, and help—much of it to Asia.

But in recent years, companies have increasingly come to realize the limits of deintegration. And today we're witnessing the flip side of the 1990s dynamic. Back then, the integration of China and India into the global economy was a huge factor in keeping inflation under control. Now, it's a huge factor in pushing inflation up. The prices of key raw materials ... have all risen dramatically in recent years, driven in large part by growing demand from emerging economies. ... [F]or the last few years, all the world's major economies have been growing... The rapid growth has raised concerns about the adequacy of supplies of key commodities, which has pushed prices up further. Put it all together, and in a relatively short time, some big purchasers have gone from being the masters of the global supply chain to helpless victims caught between world markets and their customers, who have grown accustomed to cheap goods. ...

Besides the need to ensure a reliable supply, which is likely a driving force behind these movements, information technology allowing improved management and coordination of production from a distance may also be a factor in the recent movement toward vertical integration.

    Posted by on Friday, August 18, 2006 at 12:06 AM in Economics | Permalink  TrackBack (0)  Comments (9)


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