The Return of Vertical Integration

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The Return of Vertical Integration

A century ago, the titans of industry—Ford Motor Company, U.S. Steel, Standard Oil, and others—strove to secure competitive advantage by controlling both the means of production and the path to market.

This strategy made perfect sense. At a time of rapid growth in demand for their products, a company like Ford couldn’t take the risk that its primary supplier of rubber would double its prices overnight. It couldn’t take the chance that the supply of metal it needed for automobile bodies would be available if key suppliers slowed production or went bankrupt. Neither could it expose itself to the possibility that a competitor would outbid Ford for access to railcars hauling raw materials to Detroit and finished automobiles to the rest of the country.

So like the other giants of the Mass Production Era, Ford secured the resources it needed by controlling everything it needed to build a vehicle. The company owned rubber plantations, iron ore mines, and railways—of course, it already owned the sprawling factories where its cars rolled off the assembly lines.

But as Ken Favaro of the consulting firm Strategy& noted recently in Strategy+Business, “[V]ertical integration largely fell out of favor when conglomerations became fashionable during the late 1960s and early ’70s. In fact, many industries underwent vertical disintegration. Today, for example, almost three-quarters of the parts going into American cars are sourced from outside the United States.”1

In the early years of the Digital Revolution, new technologies and the rise of globalization enabled the splintering of the value chain. Companies could collaborate with partners around the world. Low-cost manufacturing, particularly in China, made it foolish for U.S. companies to pay union factory workers high multiples of the cost of outsourcing production overseas.

Moreover, the most influential management advice, such as C.K. Prahalad and Gary Hamel’s 1990 Harvard Business Review article, “The Core Competence of the Corporation,” advocated that businesses “stick to their knitting” by focusing on what they do best and outsourcing all the rest.2 The most famous example of a company that followed this approach is Nike, which focused on designing athletic shoes and apparel and marketing its brand, while outsourcing the actual production of its products to outside vendors.

Similarly, in industries like software and energy, companies now focus on specific stages in the value chain rather than trying to own all of it. For example, in the oil business, some companies concentrate on finding oil, others on extracting it, others on refining it, and still others on selling it to consumers at the gas station...

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